For the second half of 2009, Wall Street had a message for Main Street: “Who you gonna believe, me or your own eyes?” And Main Street’s reply? “We’ll believe our own eyes, thanks.”

The results from a recent USA Today/Gallup poll tell the story.

As Gallup reports, “Americans are thinking in terms of years, not months, when pondering how much longer it will be before the U.S. economy starts to recover. The vast majority (67%) believe it will be at least two years before a recovery starts, and nearly half (46%) think it will be at least three years.”

The stock market has long been touted as a leading indicator of economic conditions. This was a dubious idea in the best of times – market history is riddled with false dawns and surprise downturns. Against a backdrop of massive government intervention, the notion becomes pure fantasy. As the Gallup poll shows, Americans have not been fooled. In spite of paper stimulus, they know it will be a hard road.

The chart above – a snapshot from Friday’s trading – shows how the Dow has breached its 50-day exponential moving average for the first time in six months. The stimulus buoyancy effect is wearing thin. Long-only money managers hoping to squeeze out a final 5 or 10% are now nervously eyeballing the exits, wondering if they shouldn’t make the dash to cash a step or two ahead of their peers. (Of course, when a bunch of money managers have the exact same thought at the exact same time, things can get interesting very quickly.)

Earnings season has more or less been a success by the numbers – but success was also more or less “priced in” beforehand. The hurdle of high expectation was too great; the actual results brought little cheer. Worse still, a rising tide of uncertainty is washing away investor confidence. Here is a short list of worries and woes:

• Rising fear that the ECB (European Central Bank) is on the cusp of losing credibility.

• Rising fear that one or more eurozone countries are headed for sovereign default.

• Rising concern that China will have to slam on the fiscal policy brakes.

• Rising fear of a “double dip” recession (and further uptick in U.S. unemployment).

• Fresh concern that President Obama’s proprietary trading ban will hammer the banks.

Volcker Gets His Man?

Most of the above concerns have seen ample coverage in Taipan Daily. (Only a week or so ago we urged caution, noting the lessons of 1932.)

Let’s talk about that last bullet though, as the potential for crackdown on the banksters... real crackdown this time... is something new.

Your editor has made clear his opinion of Tim Geithner and Larry Summers, two key members of the White House financial team. Over the past year or so, these spineless, feckless shills of Wall Street have bent over backwards to give their puppet masters comfort (and cash) at every turn.

Meanwhile the one forthright and honest financial point man in Washington, Paul Volcker, was exiled to the policy-making equivalent of Siberia (likely via maneuvering by Summers). Through rapid execution of a “bait and switch” job, the financial idealists were out within days of Obama’s election – and the back-room sycophants were in.

But now, finally, it appears President Obama has woken up and smelled the outrage. As we have said previously in these pages, Goldman Sachs is as big a problem to the current White House occupant as Halliburton was to the last one. Wall Street as a culture had overwhelmed (and captured) Washington. For a maddeningly long time, Mr. Obama seemed blind to the blatant rip-offs taking place under his nose. But then the Democrats lost Ted Kennedy’s Senate seat, and the depth of public anger finally struck a chord.

In an effort to shift public opinion, a new, angry President Obama came out with fighting words for the banks – real fighting words for the first time in a while. Paul Volcker stood symbolically by his side, a quiet rebuke to Tweedle Dum and Tweedle Dee (Geithner and Summers).

“Never again will the American taxpayer be held hostage by a bank that is too big to fail,” President Obama said. “Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds or proprietary trading operations for their own profit, unrelated to serving their customers... these firms should not be allowed to run these hedge funds and private-equities funds while running a bank backed by the American people.”

To the president, your humble editor says: Thank you, sir. It may be too little and too late... but better late than never, sir.

More Turmoil Ahead
           
If America is to have any hope of getting back on its feet, reining in the banks will be a key task (as Simon Johnson spelled out so memorably last year in “The Quiet Coup”). That makes the crackdown a bit of good news. And yet, the financial sector has been thrown into turmoil – and potentially the rest of Wall Street with it – because no one can be sure what the new “Volcker Rule” (as these changes have been dubbed) will really and truly mean.

That is to say, the new bank crackdown and proprietary trading ban could result in one of two polar extremes.

On the one hand, the changes could be a genuinely crippling blow to the old bankster business model. If things play out in this direction, it will no longer be possible to combine risky high-leverage trading and plain-vanilla banking under one too-big-to-fail roof.

On the other hand, the banks may well be able to exploit a “customer-related business” loophole that is so big and wide they will hardly be affected at all. (The banks can argue that the vast majority of their trading is related to customer transactions and thus necessary for business.)

So, will the new rules be ruthless... or toothless? It is honestly too early to tell. Then, too, there is the question of what will happen to the proposed rules as they wend their way through Congress. That is a whole new gauntlet of uncertainty and risk, with the forces of populist anger and the forces of lobbyist influence clashing to great affect.

There will be more market turmoil ahead because, on top of all the other jitters on investors’ minds, the outcome for the big bank trading desks remains unknown. This creates fresh uncertainty relative to the large trading positions held by prop desks and bank-owned hedge funds. Will those positions have to be unwound or otherwise unceremoniously dumped on the market? Will the bank crackdown lead to fresh forced waves of selling? Could all of this result in a new crescendo of panic, or otherwise feed a panic that is already getting going?

No one really knows. One certainty, though, is that market risk at this juncture is high.

Warm Regards,

JL