Wall Street CEOs and long-only mutual fund managers may have to "tap dance through mine fields" as part of their job description - but that doesn't mean you do.

Chuck Prince, the deposed CEO of Citigroup, has a quote that will haunt him for the rest of his life.

In the summer of 2007, the subprime mortgage crisis had not yet blown up. The warning signs were there, and plenty of observers were alarmed… but Wall Street was still fat, happy, and oh so complacent.

In July of that year, for an interview with the Financial Times conducted in Japan, Prince uttered the words he will forever regret.

“When the music stops, in terms of liquidity, things will be complicated,” the onetime Citigroup CEO said. “But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

The chart above shows you how well the whole “still dancing” thing worked out.

When the subprime crisis hit with full force, Citigroup – one of the largest, most powerful financial service firms in the world – saw its balance sheet blown to smithereens. Citigroup’s share price went into terminal meltdown in result, plummeting from the lofty heights of $50 to a lowly buck fifty per share.

Thanks to Prince (and other Wall Street CEOs like him), $100K worth of Citi stock purchased pre-meltdown would barely buy a used car today.

Chuck Prince got canned, but his golden parachute ensured a cushy landing. After blowing up their respective franchises, he and Stan O’ Neal (the CEO of Merrill Lynch) walked away with tens to hundreds of millions. Citi, meanwhile, only survived courtesy of taxpayer-funded injections, to the tune of hundreds of billions.

The moral of the story? Tap dancing through mine fields is a pretty stupid thing to do. (Unless, of course, you know there will always be some other sucker, er, generous soul to bail you out and pay the tab.)

Puttin’ on Their Dancin’ Shoes

As the stock market goes into full-on euphoria mode, your bemused editor can’t help but shake his head and chuckle. Investors hear that sweet, sweet music, and they are tap dancing once again.

The “land mines” in this particular environment are many and varied. What’s more, they seem to be popping up with ever greater regularity. For instance, the following examples were all taken from just one 24-hour news cycle:

• Brazil Retaliation Threatens a New Trade War.“Brazil moved to raise tariffs on a wide range of American goods on Monday,” the Financial Times reports, “potentially igniting a trade war with the US over cotton subsidies after eight years of litigation at the World Trade Organization.”

• China Sounds the Alarm Over Local Government Debt. “China plans to nullify all guarantees local governments have provided for loans,” Bloomberg reports, “…as concerns about credit risks on such debt increases. The Ministry of Finance will also ban all future guarantees…”

It seems that China’s local provinces are going crazy with what they perceive to be “risk-free” infrastructure projects, building empty shopping malls and bridges to nowhere like it’s going out of style. Sooner or later, maybe sooner, China’s banks are going to be hit by an NPL comet – NPL stands for “non-performing loans – and when that happens the great China real estate bubble will burst.

• Carnegie Economist Predicts “Virtually Inevitable” Greek Default. Noted economist Uri Dadush, currently with the Carnegie Endowment and previously with the World Bank, believes it all but guaranteed that Greece will “either default or need a bailout of some sort.” European political responses to the Greek crisis thus far have been the height of idiocy. At some point it will become clear to the world that the eurozone is financially ungovernable, with hot air promises floated one day and nixed by waffling the next.

• State Tax Revenues Take an $87 Billion Hit. As we will cover in more detail in a future Taipan Daily, the “state of the states” is one of absolute peril. Local tax revenues have just registered their biggest year over year decline in history. Record tax hikes will be the response. As the majority of U.S. states have balanced budget amendments, there is no allowance for deficit spending. This means services will be slashed, property and business taxes will rise, and consumer and small businesses will take the blow hardest.

• The Fed Is Set to Embark on “A Tightening Cycle Like No Other in Its History.” That exact phrase, “a tightening cycle like no other in its history,” was recently used in a speech by Brian P. Sack. And just who is Brian P. Sack, you ask? He is the “executive Vice President of the Markets Group at the Federal Reserve Bank of New York.” In other words, an insider’s insider. Sack is rumored to be the guy who runs the “Plunge Protection Team,” for those of you who do not doubt the PPT’s existence. This connected insider is warning us that the mother of all tightenings is coming.

Once again, the above “land mines” were not cherry picked from weeks’ worth of news. They were taken from a single 24 hour news cycle. And there are plenty more where that came from.

Won’t Matter ‘Til It Matters

“Who cares about all that stuff,” investors seem to be saying now. “It won’t matter til it matters.”

And you know what – that’s absolutely true. But the important thing to understand is, this is the exact same mentality Chuck Prince and his buddies had, circa summer 2007, when they justified their intent to “keep on dancing.”

As mentioned in recent weeks, we continue to see a slugfest between the forces of “top down” and “bottom up.”

On the “bottom up” side, we are coming off a period of mass-stimulus injection unprecedented in all of financial history. These injections, coupled with a resilient corporate sector that has responded to the crisis by getting “lean and mean,” have created the powerful appearance of gradually spreading recovery.

But now a curious calculus is coming into play. Just as investors’ expectations of full recovery are getting fully priced into the market, the stimulus injections are about to be withdrawn… and the tightening cycles are preparing to begin.

“Normal Cycle” or Supercycle’s End?

In a bigger-picture sense, there are two views of what is happening now.

The first, more or less unspoken view is that the global financial crisis, while hairy and scary, was not much different in scope or impact than any other “cyclical” downturn. By way of this view, the world will be headed back to “normal” soon – and the problems of the past few years will simply melt away, like the foggy fragments of a soon to be forgotten bad dream.

The other view, which your humble editor holds to, is that the market ain’t in Kansas anymore. Much as the willfully naïve optimists might wish, we can’t simply click our heels three times and whisper “there’s no place like home.” Instead, we must face up to the following facts:

• The West is at the tail end of a 25-year leverage and debt “supercycle.”
• The great task before us – the need to “deleverage” – has hardly begun.
• All we have done, thus far, is transfer private leverage into public hands (via government stimulus and taxpayer funded bailouts).
• The ability of sovereign governments to carry more debt is near the limit.
• Stimulus will end – and a new hiking cycle begin – just as unrealistic market expectations hit their peaks.

How many times have we seen this cycle play out now?

Mr. Market gets severely bummed out and panics. Then things improve – often with the help of aggressive stimulants – and as the picture gets better, Mr. Market swings from depressed to euphoric. Manic downside becomes manic upside. Then reality hits Mr. Market in the face with a frying pan, and we get another brutal downswing again. Due to our inability to learn the first time around, the second dose of harsh medicine tastes even more bitter than the first.

It’s the same movie, over and over and over again. It’s right there, in all the market history books (including recent history). On an individual level, the human capacity for learning is most impressive. On the level of masses and crowds – the level at which the market operates – we NEVER seem to learn.

Don’t Be Like Chuck

Mutual fund managers have a dirty little secret. Like poor old Chuck Prince, they have to keep tap dancing through the land mines, no matter what. That is because every mutual fund manager has a nasty little demon sitting on his or her shoulder that goes by the name of “career risk.”

This demon whispers all day into the mutual fund manager’s ear, saying things like “You’d better stay fully invested, because if your performance isn’t as good as your peers then you’re dead!” It’s like a knock-down, drag-out race to “keep up with the Joneses,” where those who fail to keep up get fired from their cushy jobs. The only problem is, it’s not THEIR money being risked in this race. It’s yours!

Of course, you don’t have to clear out all your investments and get the heck out of dodge. Instead, you can protect yourself – and hedge against the inherent risks of being long in such an overextended, precarious market – by considering the different ways and means of going short.

We’ll talk more about that on Friday.

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Other Related Topics: Justice Litle , Macro Trader , Stock Market Analysis , Wall Street

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