Confidence In Credit? It's A Fragile Thing!
A: Most of the indicators on the credit markets have eased nicely since the chaos hit it's peak in mid-March, and the fed saved the financial system. But things are starting to seem a bit murky again in creditville; a not so nice place to call home. While things like the TED spread seem fine, the AAA ABX index is once again falling and when I look at the stock prices of investment bank Lehman Brothers and bank Washington Mutual, I wonder if another disaster is setting up? One thing I do know, is that if we do have another shock to the system, expect confidence in the credit markets to once again be rattled!
Take a look at what the ABX AAA Index has done over the past few weeks (via Markit):
Notice the deterioration in the past two weeks, quickly approaching the lows hit in mid-March when fear level from the credit crisis hit it's peak. The vix hit 32 during that time. Currently, the volatility index is around 19.50, up from a low of around 16.30 a few weeks ago, but still well below the fear level peak when Bear Stearns decided to hibernate forever.
Not all of the credit indicators are deteriorating though. Credit spreads seem ok for the most part, TED spread is below 1, and LIBOR seemed to come in a bit when compared to the fed funds rate of 2% (although it has come to light that banks have been misstating LIBOR rates for fear that it will show distress for those banks quoting higher rates). Yet all these indicators can change very quickly should another shock to the system occur; and when I look at where LEH, WM, and C are trading right now, it seems traders are pricing in some uncertainty for these guys.
In short:
LEHMAN BROTHERS (NYSE:LEH) - down 28% in 1 Month
CITIGROUP (NYSE: C) - down 18% in 1 Month
WASHINGTON MUTUAL (NYSE: WM) - down 26% in 1 Month
Imagine what would happen should Washington Mutual come out and say they are insolvent? Or, if Citigroup announces it must cut their dividend and write down another couple of billion? Or if Lehman comes out and says everything is fine, they dont need any capital, but they will dilute shareholders anyway and raise another $4 Billion? Oh wait, that just happened!
According to Clusterstock.com's article, "Lehman's Laughable Damage Control; Don't Need To Raise Capital, Just Might Want To":
Lehman Brothers (LEH) was hammered yesterday on fears that the company will have to sell more equity in another emergency capital raise. The WSJ put the amount at a highly dilutive $4 billion of common equity on an $18 billion market cap--this after the firm has raised $6 billion in the past two months.Why would a company dilute shareholders if they didn't need to? The answer: because they have to! I don't need to explain to this audience the critical nature of confidence, and how a crisis of confidence can destroy a firm. It seems Lehman is trying to retain confidence, and as the article states, "...understanding that preventing a run on the bank is all about perception."
In typical fashion, however, Lehman comes out fighting, saying in a statement (per CNBC) that it doesn't need to raise the money that it is only considering raising it because it might want to.
Please. Companies don't dilute shareholders by 20%+ when their stocks are already down more than 60% from their peaks unless they absolutely have to.
The point of this post is to explain that with the stock prices of LEH, C, & WM down at these levels, confidence is a very fragile thing right now. Sentiment, especially in the credit markets can change very quickly and do some damage. While the credit markets seem to be in a much better state than it was in mid March, there are still concerns! The last thing we need is an insolvent Lehman or a bankrupt Washington Mutual. Something like that will shatter confidence and erase all the progress that the credit markets made since the fed saved the financial system!
Posted by jeff
Wed Jun 4th, 2008 08:57 AM
I have been expecting a second round of angst....which we are now getting....and there will probably be a third round when another bought of heavy write-offs hits at year-end. However, my guess is that we don't re-test the lows and in the process we set up for the "less worse bull market". I am getting ready to start buying stocks again as I did just before the Bear Stearns debacle and here's why. A year ago when I wrote about the 1987 crash 20 years later, bond yields were rising and the dollar was weak, while stocks were on fire and every Monday was a buyout orgy...it was just too good to be true....recall that the housing market had "bottomed" according to pundits. Today the dollar is bottoming, bond yields have run up but are set up to come down on the slow U.S. economy, slowing world economy, continued credit losses and better dollar atmosphere. The housing market will never bottom according to pundits. The oil bubble is likely ready for a rest....it will still take years to adjust to peak oil with substitute hydrocarbons and more efficient cars, but last week's Business Week cover "Oil & The Economy", probably marked the top of the recent run up. I hear lots of pessimism, but see lots of ways things could get better from here....the opposite of this time last year.
Posted by AA
Wed Jun 4th, 2008 09:18 AM
Hey Noah and Jeff, wanted to get your macro opinion on a different subject. In my opinion, the Fed must keep rates low due to housing/consumer, etc. Outside of the US, emerging market countries are experiencing sharp increases in food costs which has a severe impact on their population, much more than oil costs has on ours. So my question is, holding US short term rates stable, what happens to NY real estate if rates globally begin rising a lot?
Posted by Noah
Wed Jun 4th, 2008 09:46 AM
Jeff - nice to get a sense of optimism out of you! I just worry about the consumer, and that this downturn will be deeper and longer than expected as the platform for growth going forward will be without the availability of credit as we got used to in years past. Add in a weak jobs market, tapped out consumer, contracting home equity lines, rising commodity inflation and its lagging effects, and I see a longer period of slower growth.
I think the system has another few shocks left in it, unfortunately.
Posted by Noah
Wed Jun 4th, 2008 09:49 AM
AA - hmmm. great question. Well, it will cause a decline in confidence in NEW foreign demand, and any slowdown overseas may cause a lagging '2nd home/investment property syndrome' to occur from all the action that foreigners made here in NYC over the past few years on the currency trade. Should things get tight due to higher costs/slowdown/inflation, its the 2nd home or investment property that will get sold first.
I certainly expect inventory to have another leg up as 2008 goes on.
Posted by Query1
Wed Jun 4th, 2008 01:27 PM
As to Jeff's perspective, I would be interested to know how the profit trend in 1987 compared to what is happening now. It seems to me from the last few GDP reports and productivity reports that top line profits and profit margins are falling. Usually that means lower employment which is another hit to final demand from the consumer sector to be added to flat wages and the need to delever the household balance sheet. This makes me think we just are on the beginning edge of earnings for the non-financial sectors to take their turn to be hit. If that is true, then lower prices for these stocks should still show up. I know the equity markets are forward looking, but what is projected now as to future earnings may be coming off an unrealisticly high base if the above is correct. That's my two cents.
Posted by jeff
Wed Jun 4th, 2008 08:09 PM
AA and Query 1,
Ok let's take a look at both your questions. First, I expect world economies to slow. Inflationary pressures associated with continued economic growth, the weak dollar/currency pegs and with real shortages of commodities are forcing interest rates higher in many emerging markets (and possibly the EU - despite their floating currency). Eventually the global tightening cycle (both interest rate and underwriting driven) will slow these economies. While higher global rates will put pressure on US rates...I think the market has already anticipated this and has already adjusted the $ accordingly. As for profit trends in 1987 etc. The profits recession didn't happen until 1990. The stock market has a huge rebound after 1987, because the weak $/rising interest rate regime ended when the fed cut rates and the impact of the real estate debacle didn't catch up for a while. The issue of lags between market moves and economic changes is instructive. These lags are precisely why I see a better stock market for the next six months followed by the double dip issue of gathering bak write-offs/tight credit, savings rate increases by consumers and slowing global economies. My bet is H2 2009 and 2010 is when things get ugly again in the banking system and economy. I think the huge capital raises and unnatural acts by the fed, and momentum in emerging markets give us a bounce back until then.
Posted by Query1
Thu Jun 5th, 2008 11:24 AM
Jeff...Maybe as to market moves things are at the point where one of two types of economic recoveries is what the market is going to anticipate. One would be the "w" shaped recovery and the other would be the "u" shaped recovery. I interpret your comments to align with the market anticipating a "w" shaped recovery with the middle peak coming from anticipated positive effets from the avoiding collapse of the financial sector, the fed. re-flating the nominal economy and EM momentum producing real earnings for about 50% of the S&P companies. Added to this would be the fiscal stimulus giving the consumer relief.
The "u" shaped scenario is the market anticipating a low, slow contribution from the financial sector as they rebuild their balance sheets, tighter credit,inflation, and EM tightening keeping business growth low and slow, and the household sector slowly restoring its balance sheet by saving.
The "u" shaped version makes more sense to me, but...a bounce is a lot more interesting and given the amount of $ out there ready to pile in, I can see how you may be right in sync with what is about to happen.