Serenity Now...Thoughts out Loud
A: Insanity Later? Boy oh boy oh boy. Folks, we have reached the panic stage of this massive credit deflation cycle. Back in February I devoted an entire discussion noting that stocks are lagging the credit markets, and still, there are people out there that are only now waking up to this reality and wondering why their portfolios are getting whacked. When it comes to stocks, you got to be IN IT to WIN IT. With risk comes reward, so NEVER forget the risk part of the equation! I'm reading headlines like, "Retirement Accounts Lose $2 Trillion", and "Stocks Battered Again", making the fear grow amongst the masses. This is a time for transparency, for trust, and for confidence, and right now there isn't much of any. Until this changes, the story continues.
Stocks are lagging the credit markets, and have been for the past 14 months! The stock market is a discounting mechanism which lead many to believe it is a forward looking indicator! The flaw is that the stock market is both not rational and not always right. Certainty and Confidence are the bloodstream! Since the stock markets have such a far reaching and psychological effect, the cycle feeds on itself. Right now, credit deflation and the acceptance of peak credit is hitting consumers, small and medium sized businesses, most sectors of the debt markets, global markets, commodity markets, and stocks are adjusting at a lag! As the adjustment occurs, people get more and more aware of what has going on around them.
I noticed something today. My office was ripe with circles of agents talking about how bad this stock market is. We are passed denial and maybe entering the anger phase. People are pissed. You know when this is all over, we'll have our dose of lawsuits and criminal charges leading to jail sentences. Then comes the regulation so that this NEVER happens again! Oh, and the fact that we will have to deal with the after-effects of massive treasury issuance to fund all these rescue tactics/deals.
Here is an interesting thought. The fed is pulling out every facility and maneuver they can think of to target their shot at a specific sector, and yet, stocks continue their freefall. It's because stocks lag the credit markets and know that a broken credit market means a prolonged/deeper slowdown for the economy!
The two most important fed moves this week were:
a) fed to pay interest on bank reserves - The fed giving money to guys for the reserves sets up an interest stream flowing the other way...back to the banks from the fed...making the banks net borrowing cost over a period of time lower.
This has the effect of lowering fed funds effective rate for the banks without encouraging them to provide cheap money - thus avoiding the knock on effect in the economy. An unforeseen consequence of this is that you encourage banks to hold excess reserves and therefore reduce the incentive to lend...making the credit supply situation worse.
b) injection into the commercial paper market - setting up a separate entity (SPV - special purpose vehicle) to buy three month unsecured and asset backed commercial paper directly from issuers. The hope is to free up lending to the small, medium and large businesses that rely on loans to operate; that means paying their employees and their suppliers/advertisers/logistics, etc..! The chain is long!
Now, the commercial paper news had an immediate impact on short term T-bill yields as it seemed there was less interest here; a good sign as the targeted action worked a but! A deeper look doesn't paint as bright a picture, as Across The Curve discusses little buying in the corporate bond market:
"The corporate bond market is mired in a melancholy malaise. Sentiment is glum and no amount of good news can shift sentiment. The Federal Reserve announcement this morning of the CP rescue package should have sparked some buying. One veteran corporate bond salesman noted that he saw not even a nibble."But stocks still sold off. Lets face reality. Credit markets are STILL dysfunctional as evidence by distressed LIBOR, CDS, TED spreads levels. There is no trust amongst banks, no certainty, and very little transparency. The suspension of mark-to-market accounting rules will only prolong restoration of these three key market elements.
It's as if the credit markets are in the process of a transformation to something else. The old credit market is gone, and a new one is coming. For now, we have to live in a world of financial fear and risk aversion. The ultimate impact this standstill has on economic data down the road is yet to be seen; but we don't need Einstein to solve this equation. Weak GDP readings and rising unemployment is in the cards.
We're in a recession that cannot be compared to others because the combination of forces we face today are truly unprecedented for our time (credit bubble bust, MEW bubble bust, tons of debt, securitization model extinct, dead secondary mortgage market, insolvent banks, no more investment banking, staggering debt-to-GDP levels, commodity bubble bust, housing bubble bust, strapped consumer, stock market bust, and on and on). So act accordingly and look for signs of transparency, trust, and confidence to return to the credit markets, because only then, will stocks be close to a bottom. Until then, purge on!
Comments (9)
There are a couple of other dynamics at play here that we need to acknowledge. I've been in touch with a number of brokers/financial advisors as well as hedge fund managers, and massive selling pressure is coming from:
(1) Hedge funds liquidating based on actual/anticipated redemption notices. Remember, the first (failed) bailout vote came just a day before the redemption deadline for 90 day funds. You can rest assured that the vote had a net effect of higher redemption requests from individual and fund-of-fund LPs;
(2) A generational liquidation. Baby boomers and elderly who are or will be retired soon are PANICKING. Freaking out. Selling it all. This is their nest egg. They have been saving/investing for decades, and the thought of losing more is absolutely sickening and unpalatable. One broker friend of mine just got a call today from a client in her 60s who said "I want out of everything."
There is of course plenty of overlap between (1) and (2).
Point being, this quarter should be the climax, or capitulation, in my mind. Everyone I speak to who is net long is sick over the market. Many of them who "were patient" are no longer.
Me? I'm sick over my few long positions, but nibbling here and there. I'm nibbling precisely because I feel sick about my long positions.
Posted by yournamehere | October 7, 2008 6:43 PM
yournamehere - agreed! Gr8 comment.
Jeff discussed high water marks and hedge funds on SEPT 22nd specifically, and he has discussed the deleveraging and hedge fund mess that was upcoming a few times in the past. For me, we have a lot longer of unwinding ahead of us and that includes the hedgies!
As far as the generational comment, great point! And I agree that people are angered, pissed, and scared now. We have reached that point. But I think we have more pain ahead, hopefully with some relief rallies in between to lessen the pain.
My biggest position is gold, and Im trading in and out a bit after covering my shorts unfortunately around DOW 11,200 or so.
DOH! But I never really got long. Im nibbling now too for a trade!
Posted by Noah | October 7, 2008 6:59 PM
If you are going to trade gold, make sure you buy physical gold only, in this market environment. The 'paper' gold market is 4x the size of the physical market. That is because the gold ETFs have no obligation to be 100% backed by physical gold reserves. If you doubt what I am saying, I encourage you to actually READ the prospectuses of your gold ETFs. At the moment, the price discrepancy between physical and 'paper' gold securities is $120/ounce. I expect this spread to widen, as investors wise up to the actual content of their paper gold ETFs.
And of course, keep on shorting REITS. This has been one of my best performing investment themes of the last 9 months.
Posted by chris | October 7, 2008 7:22 PM
yea, I covered my short VNO trade and never put more puts/shorts on unfortunately...good trade, but Im pissed at myself for not playing it right.
Chris, I own GLD & DGP as my gold positions, no physical gold. I was told that GLD owns physical gold and doesnt rely on complex derivatives to track gold leaving it open to counterparty risk. You are right though, and Im not sure about DGP.
Anyway, Im hearing more and more of what you are saying. Buy physical gold, that you can bite down on. Prices are nuts though, so on a deleveraging round selloff, if it comes, Ill try to dabble in some physical gold
Posted by Noah | October 7, 2008 7:36 PM
I put everything in money markets (because of my husband's job we are only able to invest in mutual funds, so I didn't have the flexibility to do any real targeted investing) when I was down about 8% from October's peak. At the time most were saying there were still plenty of opportunities, rallies to be had, etc. My money market funds MIGHT tank, but at that point we're all pretty much screwed. Sure am glad I didn't listen to Cramer, et al. I can't imagine what it must feel like to be 50+ right now, and still long in this market.
Posted by brenda | October 8, 2008 7:54 AM
I agree Brenda. The problem is that most people are not active investors. Rather, they trust fund managers and money managers who tell them buy and hold, which is wrong for obvious reasons. The way to make money is to wait for assets to have appreciated to a point that they are attractive to you, provided that you have a long enough time frame for the assets to appreciate, and you cash position is such that you can be flexible in that time frame if you need an additional year or two to achieve your objective. In addition, once you start building positions in stocks, you need to sell some as theses stocks when they have an irrational run up in value, and then use some of that cash to buy more later in the stock goes down and you still feel good about the valuation and exogenous factors that will impact the underlying company.
I have no idea how to day trade, but I know enough to know that it is pure gambling, same as betting on the Jets. Investing means seeing opportunities that others do not, being positioned to purchase those assets at a cheap price, and having the ability and patience to wait to achieve your objectives. I truly feel bad for the elderly who were advised to ride this market down, only to sell at a near bottom.
Right now is an incredible opportunity to start building positions in companies that you like, assuming that s that you do not think we are heading into a prolonged global depression, or you need the cash. Never ever put money into the stock market that you may need over the next five years, and that is just as true in bull markets as it is in bear markets. The problem is that most people are greedy and impatient, and that is why the get hurt.
In this crisis, we have a global effort and commitment to prop up and then strengthen the financial markets. They will do whatever it takes to achieve this objective. If you believe, as I do, that in five or ten years the moves today will translate into higher prices for stocks, certain parcels of land, certain commercial properties and certain collectibles, then now is a great time to buy. The hedge funds that are selling now are no different then the guys who are starting to dump real estate at a steep discount because they NEED to get out. Ask yourself, can that NEED be used by and investor to extract a price that is more than attractive. Ask GE and GS if they like the deal with Buffet and then ask Buffet the same question. One party was desperate to sell and another was able to craft an amazingly profitable deal. That is investing.
Posted by mh23 | October 8, 2008 8:14 AM
I think we are 85% through this crisis period...yes the fallout will last for 6- 10 years (of good underwriting ...thank god) and the recession may last for another year or more. But I disagree that this is the beginning of armageddon. Its a zero sum world and the imbalances that were making markets crazy: overheated growth in emerging markets, fed by leverage growth in the US and other developed markets, are going to be re-balanced. The deflationary force of a major slowdown in the emerging markets is and will continue to correct the commodity bubble (not to say the 10 year view for commodities is poor, we just have to consolidate the 8 year bull). Everyone is cutting rates because everyone...not just the US was irresponsible and unbalanced. The US will be one of the best at getting re-balanced because we have the most flexible and transparent economy. I agree wholeheartedly that hedge funds are being liquidated...this bubble is over. The model dosn't work with no leverage, severely limited shorting ability and costs of borrowing stock 9% or more. I agree that from what I see around me many individuals are liquidating stock market positions (after a lost decade in terms of returns). But don't forget mutual fund year-end and major tax loss selling too. Long time smart investors I know of are buying here. They are buying $10 stocks down 40% + with $8 of cash and positive free cash flow. These companies are not going out of business even in a depression....people still do have to eat etc. I see a bad economy ahead and years of slow growth, but I think it is fairly discounted in the stock market at this point. I'm going to start buying some stocks. I'll admit the money I put in around the Bear Stearns debacle has taken a big haircut so far....but you gotta buy when their is blood in the streets. I knew it was the bottom in 2003, when bond guys were petrified to do anything due to World Com going under and Ford becoming paper becoming junk. The credit market can be irrational too and it is being so now....the credit market is driving the economic decline, not the other way around...a sentiment shift will change a lot.
Posted by jeff | October 8, 2008 8:59 AM
great point Jeff...Although this latest fed cuts effect on equities ran out literally in 45 minutes!
the credit market IS driving the decline, but most people dont understand the credit markets and simply look to stocks as their guide. So they blame wall street greed and politics. This credit boom is over, securitization as we knew it is over, and a new engine of growth, a heavily regulated one, will be replacing it. For not, like you said, we transition/liquidate/delver or whatever you want to call it
Posted by Noah | October 8, 2008 9:08 AM
How is it that we can be nearing the end of this crisis and the closest to rebalancing. The rate of change in the money supply driven by all of these bailouts and liquidity-funding efforts should be such that no coordinated dollar-boosting effort can hide it. Couple that with consumer confidence in the value of the dollar dropping (as basic goods are still more expensive) - I'd say that we're in for more trouble yet.
Posted by Anonymous | October 9, 2008 2:09 PM