We all have certain level of comfort and trust with some authors – even if we don’t know them or meet them in person. What they say makes sense to our own logic, however illogical it might sound to others. Whenever I come across an article by Bennet Sedacca, President of Atlantic Advisers (who specialize in mortgage paper) I will read it and read it again to digest the infinite wisdom he ingests into his articles.

Back in August when the market was perking-up with bubbling “worst is over, new highs by the end of the year” optimism, I was questioning my bearish outlook. Then I read Sedacca’s “A Tale of Two Markets” (a 3-part article at Minyanville). I questioned my outlook no more. At that time everything he said that made sense to me, not just because he agreed with me. It was just a level of trust and comfort in his expertise and exposure, which I lack. In that August article what he essentially said was equity markets are emotional and at times can be illogical. But the bond guys are usually sane and it is tough to pull a short-squeeze in bond market.

This is what I call “Zero Hour,”  concept I have been featuring for years that was originally brought to us by Barry Bannister.

I wish that wide spreads were contained to FNMA, GNMA or FHLMC, but sadly they’re not. In fact, spreads in the credit markets are at historically wide levels and show no signs of tightening. It is my belief that the credit market is a rational place where balance sheets, cash flow, and write-downs/write-offs are burying many companies into a hole that they will not be able to emerge from for quite some time.

Equity markets, on the other hand, are much more emotional and susceptible to trades like “Get Shorty.” “Get Shorty” would be a very tough trade to pull off in the credit markets, so Fed, SEC and Treasury officials concentrate on equities, even though if credit spreads don’t tighten and credit isn’t made more available to individuals and institution, the system will continue starving for much needed stimulus.

For another example, consider the case of American International Group, the once great insurance behemoth. It’s now, in my opinion, been reduced to a company that is spinning out of control, unable to determine how bad its credit portfolio is and how bad its investment portfolio is. Mind you, this is a company with $1 trillion in assets, but bonds that are going down in price quickly and probably not coming back anytime soon. I have been contemplating ever since Stage 2 of the Credit Crisis began what company would be first to not be able to finance themselves.

I thought it could be Lehman Brothers (LEH) (it still could), Merill Lynch (MER) (they sold their Bloomberg stake and other assets and diluted common shareholders at 10-year lows just to stay alive), but I hadn’t considered AIG and the insurance companies. But I am now.

Take a look at how AIG bonds are trading after its disastrous announcement. It’s absolutely un-economical, in my opinion, to raise more capital as it already buried equity and preferred buyers on its last asset-raising go-round, so I don’t know how it stays alive.

Its comments in the press clearly demonstrate the lack of risk-controls. The problem here, of course, is that AIG isn’t alone. It’s just one of scores of companies that cannot finance themselves. The credit market is speaking, loud and clear.

As you can see, his conclusion was that equities (notice the names he mentioned) will eventually follow the bonds. They sure did. Now that I have convinced you about Sedacca’s expertise, whether you are bullish or bearish in your market outlook, YOU SHOULD READ this latest 7-page article by Sedacca: Setting the Bull Trap. You can make-up your own mind about what he has to say and how to take the information he provided and profit from it. Still, I would like shed some light on some excerpts from this article.

Here is the magical question: “why is there is so much bad news, and is it fully discounted in prices?” If so, “why are the Fed, FDIC and Treasury Department so desperate to drive down interest rates to zero, buy troubled assets, ruin what used to be an efficient debt market in Mortgage Backed Securities, Corporate Bonds and Preferred Stock?”

There seems to be two distinct markets that have developed for debt—one that the U.S. Government stands behind with all of OUR money and the one that exists in the “free market”.

….

…you will note that 7% Freddie Mac (FGLMC) pools trade at the same price as Freddie Mac 6% pools and lower in price than 6 ½% pools. This is yet another example of how the markets have become so disorderly and difficult to trade. But for the icing on the cake, feast your eyes on what the Prudent man would invest in during times of rebuilding one’s balance sheets, Treasury Bills.

Yes folks, cash is now officially trash. If you buy 1 month Treasury Bills, you are rewarded with a yield of a gigantic 0.02% per year. That’s right, 2 basis points per year. I suppose people with more than enough money can keep it invested for an entire year and make nothing or they can succumb to the pressure of, “I can’t make zero forever if I want to retire.”

….

I believe very strongly that investors who believe that they must be invested in risky assets at the expense of prudence will rue the day that they did so. As it relates to stocks, when I consider the risk/reward ratio with equities at 22 times earnings (using 931 S&P 500 and $42 in earnings in 2009), I cringe when I hear people say that stocks are cheap. (Schweizer, are you paying attention?)

What about municipal bonds? Pundits are declaring municipals cheap relative to Treasury bonds. Treasuries are not a good barometer as they are being manipulated lower in yield. With the insurers like MBIA and AMBAC gone, and little if any research available on the nearly 50,000 issuers out there, and downgrades coming like Noah’s Flood, I cringe to think that they are attractive as well.

When I consider junk bonds, with new issuance at zero (a whopping one new issue was completed in the 4th quarter of 2008), they may seem cheap relative to Treasuries, but with the window for new money issuance closed, and money scarce, who will the buyers be? Expect a record high default rate in junk bonds in 2009-2010.

….

In sum, I think many investors are being forced into taking risk so as to avoid a zero return when they actually would rather play it safe. Again, we remain conservatively invested with a trading attitude towards the best of breed companies and sectors, those that do not need Federal assistance to stay in existence.

Charts are great timing tools. Insights gleaned from articles like this tell you which way the charts are supposed to be headed in general. Reading is essential for the health of your portfolio. My final comment: you don’t need to subscribe to expensive news letters to lose you money. Just read this whole article – which is free, will you?