Equity Markets Tank 5%-6%+ / Gold Surges

Posted by urbandigs

Mon Aug 8th, 2011 05:22 PM

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A: We have now seen a roughly 16%+ selloff in stock indexes over the last 3 weeks. This is the kind of market activity that causes people to slow down and take a breath or two. In the face of a US credit rating downgrade, US treasuries are still rallying hard sending yields much much lower. This is a sure sign that investors continue to perceive US govt debt as a safe play relative to other options out there; even in the wake of the recent downgrade. It is also a sign of declining confidence. Many thought, myself included, that a credit downgrade would bring with it at least a slight reversal in the recent treasury rally. It didnt; the opposite occurred. The fact that gold and bonds are surging while equities around the world sink, tells me that investors are pricing in the likelihood of a notable global economic slowdown with the potential for more stimulus/bailouts or other central bank types of market interventions. Lets discuss.

First I want to get this out of the way. The US will not default on its debt obligations when we can print more money to pay interest to creditors. Rather, this debt downgrade is more a function of a) the unsustainable direction of our nations debt, call it debt trajectory if you want + b) governments unwillingness to compromise on a solution to reverse that trajectory. There are other countries out there rated AAA with a debt to GDP worse than ours, so it goes beyond the math here. That is what worries me and I think is what is driving the recent selloff. If the US is not AAA, how can France or Luxembourg or the UK be? Make no mistake about it, issues in the Eurozone are playing a big role in global markets right now. Take a look at the snapshot of US markets to the right as they ended today; one for the books.

Back to the US downgrade. Part of our debt trajectory is due to the ginormous bailouts and transfer of wealth that our government and our fed did to stave off a depression. So lets not point fingers at the teaparty, or the republicans, or the democrats. We knew this was coming. We brought this onto ourselves with our repealing of Glass-Steagall in the late 90s that separated investment firms and traditional FDIC insured banks, with the de-regulation of derivative markets in 2000, with our easing of leverage rules in 2004 that allowed investment firms to lever up 30:1, 40:1 or more, with super loose monetary policy from 2000-2003 fueling a housing/credit bubble, the push for subprime lending to stimulate homeownership, the push for easier/automated underwriting policies to get the loans through so they can be packaged and resold, and with the piss poor ratings of highly complex CDOs and other mortgage derivative products by S&P, Moodys and Fitch (read Barry Ritholtz's summation of each here). This is a whole chapter of mistakes that will definitely make it in the history books. These structural problems are at least a decade or more in the works and those toxic assets that everybody forgot about as the fed engineered carry trade attempted to calmly mark them down to market, are haunting us behind the scenes.

After a 2yr engineered reflation fueled on a weak foundation of government and central bank guarantees and liquidity injections, markets are now signaling global economic weakness in a big way. This time around, central banks are as close to helpless against market crises as they have ever been. Seriously though, what can our fed do that they havent already done? They can implement QE3 and buy treasuries or other mispriced assets and further degrade their balance sheet. But what else can be done that markets wont interpret as reactions in the face of pure fear? Greece just banned shortselling on their exchanges for the next 2 months. The ECB is now intervening and buying Italian & Spanish bonds to so called 'support markets'. I dont know, to me this is more reason to be concerned. Id rather a marketplace that does not require massive central bank intervention to operate, dont you?

Whats the takeaway here? Im not sure about you, but Im losing confidence. It started weeks ago when Treasury markets started to rally in the face of rising debt issues. There is less certainty in the world today than there was only 4 weeks ago and that is what the markets are all about. Volume on this most recent selloff is huge, telling me there is a 'sell sell sell' mentality out there; and the VIX rose 50% to 48 today confirming heightening levels of fear as investors pay more for downside protection. Ugly.

To the point of becoming sickeningly annoying discussing it, I have talked about the potential for "future unintended consequences of policy actions" taken to stem deflationary forces (google shows 136 entries with that phrase). This may be it playing out across the world as investors realize that there are no free lunches out there. You can kick the can down the road and cover up mispriced assets and huge loads of debt only so long. I wonder, what artificial engineering will force money into risk assets this time around like it did back in 2009 to 'prop' up markets? Im just not sure but Im confident we will see stabs at it in the near future.

Get ready for a bumpy ride and surprising attempts of stabilization by co-ordinated central bank actions and 11th hour emergency meetings. For Manhattan real estate, this is the kind of environment that brings pause to buyers - which means, if you have a time pressure to sell your best way to get a bid fast is to aggressively lower your ask. I wonder what % of Manhattan sellers are in this boat right now, willing to take a hit to liquidate in the face of recent market events.