WRFest 23Mar08(Markets): From Margin Call to Great Unraveling
This has been an interesting, even bizzarre, market as those who feel that the kitchen sinks are accounted for and discounted in prices "debate" those who feel it hasn't been. As you might have gathered we're definitely in the latter camp. Along with such minor and inexperienced observers with names like Feldstein, Summers, Greenspan, Krugman and Volcker. In the long-run what we're seeing here is the beginnings of a "great unraveling" where the excesses in financial markets and the industry as whole are undone and then repaired. And when the unsustainable levels of Consumption that have been financed with debt-based funny money are also. In fact we're in the early stages of a reversal of over two decades and beginning to enter an entirely new and different regime for which noone is prepared, at least broadly speaking.
In the short-run we may get a bounce as optimism triumphs over both experience and the data.
In fact from the chart at right you can get a sense of how this argument has been playing out. It
shows the SP500 for the last six months. After a bit of contemplation and reflection we noticed something interesting which is captured in the added trendlines. As the financial breakdown has played out we got a stair-step market that's moved thru 2+ phases. In each of the phases you can see a flag or pennant forming with lower highs and higher lows which is often taken to be a sign of a breakout to a new upturn. Yet in each of the prior two cusp points there was another breakout to the downside where the downtrend became steeper. The Fed's drastic actions last week may have cleared the clogged arteries but that'll just enable the machinery to conduct an orderly unwinding IOHO. In the short-term, and since we're using a chart thru the end of last week without capturing the first part of this, we might see the uptick continuing. The technical test will be if the market manages to climb back above the 50-day MA, which so far it hasn't done. Historically btw March has always been one of the best months for markets so if a new bounce isn't established it could get to be an ugly summer. My favorite financial columnist (Jim Jubak) has about 50% of his portfolio in Cash for example ! Unless you're a trader that's probably a very good strategic position right now. Even if we break thru the 50Da MA that will still not reflect the underlying realities of growth prospects, earnings and necessary PE revisions. Again of course in our 'humble opines !
Now to be fair several key players have actually been bothanticipating and positioning themselves for this mess and done so presciently and brilliantly. The hedge fund managers who profited in the $Bs come to mind as does Wilbur Ross who began re-positioning his companies early least year. But the man who takes the cake is Bill Gross, the Bond King, who's been pretty forthright on his views (his monthly PIMCO columns are always a worthwhile reading investment and can be compared to Buffet's shareholders letters - Buffet of course has also proven prescient and well-positioned). If you click to read nothing else read the NYT story on how he's been running PIMCO in this crisis.
Just for fun, and infotainment,lets hat-tip Mr.Ritholz at BigPicture with his take...
Last week, I questioned the conventional wisdom which claimed that there was Not Enough Bullish Sentiment? It seemed that there were plenty of Bulls who looked at the 15% pullback in the S&P500 as an ordinary dip-buying opportunity.In a moderate recession, an 85 day, 15% drop would likely be insufficient to reflect the changes in both growth and earnings -- much less a deeper, more protracted recession.The counter-argument is that the Fed has flooded so much cash onto the system, the recession no longer would matters.Looking from a sentiment perspective, its hard to say that the we've seen the sort of fear that typically accompanies a lasting market bottom. There's still plenty of speculative juice around. Consider these headlines from over weekend:The closest thing to an admonition of caution was Barron's Technical columnist, Michael Kahn, who called this The Market Bottom That Wasn't. That doesn't mean we can't see a decent bounce here -- there's lots of liquidity, and as we saw last week, the market stopped going down on bad news. That's usually good for a 5-10-15% counter trend rally. We saw that begin last week.But Dow 20,000 this year? I highly doubt it . . .
UPDATE: Yahoo Finance had an interesting online opinion poll that pretty well captures the diversity in the debate on the outlook. Notice that the answers are pretty evenly distributed.
| With the stock market showing renewed strength is it safe to buy ? |
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Markets & Investing
What Created This Monster? LIKE Noah building his ark as thunderheads gathered, Bill Gross has spent the last two years anticipating the flood that swamped Bear Stearns about 10 days ago. As manager of the world’s biggest bond fund and custodian of nearly a trillion dollars in assets, Mr. Gross amassed a cash hoard of $50 billion in case trading partners suddenly demanded payment from his firm, Pimco. And every day for the last three weeks he has convened meetings in a war room in Pimco’s headquarters in Newport Beach, Calif., “to make sure the ark doesn’t have any leaks,” Mr. Gross said. “We come in every day at 3:30 a.m. and leave at 6 p.m. I’m not used to setting my alarm for 2:45 a.m., but these are extraordinary times.”Even though Mr. Gross, 63, is a market veteran who has lived through the collapse of other banks and brokerage firms, the 1987 stock market crash, and the near meltdown of the Long-Term Capital Management hedge fund a decade ago, he says the current crisis feels different — in both size and significance.The Federal Reserve not only taken has action unprecedented since the Great Depression — by lending money directly to major investment banks — but also has put taxpayers on the hook for billions of dollars in questionable trades these same bankers made when the good times were rolling.“Bear Stearns has made it obvious that things have gone too far,” says Mr. Gross, who plans to use some of his cash to bargain-shop. “The investment community has morphed into something beyond banks and something beyond regulation. We call it the shadow banking system.”It is the private trading of complex instruments that lurk in the financial shadows that worries regulators and Wall Street and that have created stresses in the broader economy. Economic downturns and panics have occurred before, of course. Few, however, have posed such a serious threat to the entire financial system that regulators have responded as if they were confronting a potential epidemic.
News Analysis: A Wall Street Domino Theory The Federal Reserve’s unusual decision to provide emergency assistance to Bear Stearns underscores a long-building concern that one failure could spread across the financial system. Wall Street firms like Bear Stearns conduct business with many individuals, corporations, financial companies, pension funds and hedge funds. They also do billions of dollars of business with each other every day, borrowing and lending securities at a dizzying pace and fueling the wheels of capitalism. The sudden collapse of a major player could not only shake client confidence in the entire system, but also make it difficult for sound institutions to conduct business as usual. Hedge funds that rely on Bear to finance their trading and hold their securities would be stranded; investors who wrote financial contracts with Bear would be at risk; markets that depended on Bear to buy and sell securities would screech to a halt, if they were not already halted.
· WSJ Graphical Timeline of Crisis
· Bove on BSC Deal - Taking Too Much Risk ( Bloomberg vidclip)
Making sense of this bizarre market To answer those questions, think of what the stock market has been through in the past 10 days as something like a giant margin call. In today's market, because no one is sure who owes what to whom (yes, derivatives are that complicated) and because no one is sure what the very thinly traded assets in the typical Wall Street portfolio are worth, Wall Street behaves at the slightest sign of trouble as if it were going to receive a massive margin call. It sells everything, especially its winners, in a panicked rush to pile up the cash it would need just in case the next time the phone rings it is a real margin call. The effect is to turn modest downturns into panic selling that takes down all sectors, the relatively strong and the relatively weak alike. In recent weeks, this panic selling has pushed the stock market to a series of ever-so-slightly lower lows. Ultimately, though, it isn't the market technicals that will decide where stocks are going. They're just a reflection, albeit a very useful one, of investor psychology. Finally, it will be the economy that counts. Frankly, I remain skeptical that a Wall Street so near to panic on one day can be completely healed the next. I doubt that the problems in the financial system that were so serious that the Fed had to arrange a forced sale for one of the biggest U.S. broker-dealers can be fixed in a day. And I find it hard to believe that an economy so sick that it requires three interest rate cuts totaling 2 full percentage points in two and a half months can be so easily fixed. So, I'll wait with half a portfolio in the market and half in cash until I can decide whether we've really moved beyond a margin-call market.
Buy Signals Abound in U.S. Stocks, Shadowed by Bear Markets of '70s, '30s U.S. stocks are on the brink of the broadest bear market in four decades as investors ignore the strongest buy signals in almost 20 years. The retreat by all 10 industries in the Standard & Poor's 500 Index pushed the measure down 19 percent since its Oct. 9 record and 13 percent since the start of the decade. The plunge resembles declines in the 1970s and 1930s, the two worst periods for U.S. equities in the past 80 years. The last six times the index has fallen by 20 percent, only once -- on Black Monday in 1987 -- has the sell-off been so encompassing. ``I tend to agree with the fellow who says, `Hey, this is the greatest financial crisis since World War II,''' said Jean- Marie Eveillard, 68, who runs the $21.3 billion First Eagle Global Fund in New York. The declines have left companies in the S&P 500 trading at the cheapest levels in more than 18 years to forecast profits, while valuations versus 10-year Treasuries are the lowest in at least two decades. Investors aren't acting on the traditional buy signals in the midst of the worst housing slump since the Great Depression, $200 billion in bank losses tied to mortgages and the bailout of Bear Stearns Cos. last week by the Federal Reserve and JPMorgan Chase & Co.
· Granville Says Market Is `in a Crash;' Stovall Says `Contagion' May Spread Joseph Granville and Robert Stovall, octogenarians who've seen every financial market downturn since the 1950s, say the current one may be the worst and is far from over.
Why the Fed can't put out the fire. Even many of those who believe Fed must make another big rate cut Tuesday concede it can't do much to calm troubled markets. With Wall Street hit by a crisis of confidence, many are hoping the nation's central bank can save the day. The Federal Reserve's main weapon: Cutting interest rates, and most economists expect a big slash of three-quarters of a percentage point on Tuesday. But even those economists in favor of such a move concede it will do little to calm investor fears. But Lyle Gramley, a Fed governor from 1980 to 1985 and now a senior economic advisor for the Stanford Washington Research Group, said that such a failure would have far broader implications for the economy and the financial markets and the Fed has to do what it can to avoid that. "If the Fed had sat aside and let Bear go down the tubes, the cascading effects would have been ghastly," he said. Gramley and some other experts believe the solution to the current credit crisis will have to come from Congress, not the Fed, and that the federal government will have to take steps to bail out both Wall Street firms holding mortgage-backed securities as well as homeowners who have mortgages with balances greater than the value of their homes. And no matter what the Fed does, market fears probably won't go away any time soon. After all, some investors will probably take more Fed cuts as a sign that the central bank sees more trouble ahead.
U.S. Mulls Next Steps in Crisis The U.S. is likely to respond to the unfolding financial crisis with a heavier hand, in the form of corporate bailouts, fiscal incentives and regulation. The swiftness and virulence of the financial problems have been stunning. The problems are rooted in a bipartisan goal to figure out ways for lower-income Americans to buy homes, so that they could build financial wealth and plant deep stakes in their neighborhoods. But the instruments that mortgage companies devised included provisions -- interest resets after five years, no down payments -- that buyers didn't fully appreciate could backfire. When those subprime mortgages were bundled into packages of debt and sold to a daisy chain of interlocked financial institutions, the risks of those provisions eluded investors considered far more sophisticated than first-time home buyers. Essentially, the risks were hidden from view -- "a lack of transparency," financial types call it. The irony is that the U.S. and the International Monetary Fund have been lecturing developing countries since at least the 1980s of that very danger. If economic risks aren't transparent to investors, they're likely to blow up, and can drag down an economy. Barry Eichengreen, an economic historian at the University of California at Berkeley, says that institutions bailed out by the government can expect stricter government oversight. That includes investment-banking firms, now that they are able to borrow from the Fed, and could include hedge funds and private-equity firms if they get government bailouts. "If we're going to use public money to prevent the finance system from collapsing," he says, "the quid pro quo is more oversight during normal times." "This regimen of total deregulation has essentially allowed the economy to be held hostage to some financially irresponsible actions," says Rep. Frank. "There is no choice but to pay some ransom."
- As financial officials ponder measures to stem the credit crisis in the U.S., Japan's bad-loan malaise of the 1990s may shed light on the effectiveness of injecting public money into banks as a way to limit damage.
· Fed Lends Securities Firms $28.8 Billion, Expands New Auction Collateral The Federal Reserve, in its first extension of credit to non-banks since the Great Depression, lent $28.8 billion as of yesterday to the biggest securities firms to try to stabilize capital markets. In a separate announcement, the Fed expanded collateral eligible for its first auction of Treasuries March 27 to include bundled mortgage debt and securities linked to commercial real- estate loans. The value of the sale was set at $75 billion, part of a $200 billion facility unveiled last week. The auctions and Wall Street's new loan facility are Fed Chairman Ben S. Bernanke's answer to a credit squeeze that's eroded U.S. economic growth and forced Bear Stearns Cos. to sell for $2 a share to JPMorgan Chase & Co. The recipients of the Fed's credit are getting cash and Treasury notes in exchange for securities tied to mortgages and other distressed debt. Bernanke Vindicated as Fed Lending Spurs Commodities Drop, Rally in Stocks
SEC's Failure to Grasp Plight of Bear Stearns Exposes Cracks in Vigilance U.S. Securities and Exchange Commission Chairman Christopher Cox was asked on March 11 if he was concerned about the financial condition of Bear Stearns Cos. ``We have a good deal of comfort about the capital cushions at these firms at the moment,'' Cox told reporters in Washington. Bear Stearns's forced sale days after the SEC chief's reassurances is raising questions about the vigilance of the top U.S. securities regulator, which is charged with making sure Wall Street firms have enough cash to survive a crisis. The SEC, as part of its supervision of Bear Stearns, the fifth-largest U.S. securities firm, and its rivals, tries to ensure the industry has adequate funds to meet expected obligations for at least one year during periods of ``stress,'' according to the agency's Web site.