Several weeks ago, I suggested that we are in a period where events are driven by systemic risk. The old definition was, in the simplest of terms, a wrong solution to one problem causing a higher degree of risk in the next succeeding problem.
Now this definition has been broadened by the interaction of all sectors of the global credit market. “Problems” are not necessarily isolated to one type of instrument. And the more arcane the instrument the worse the sentiment seems to get. As you and others have observed, the problems are occurring in unexpected places.
Result: loss of confidence and inertia – two conditions missing and needed for “better markets”. The interactions of traders and asset managers ultimately determine price. Until there is restoration of confidence by these professionals, perception of the underlying value of credit instruments is simply not going to improve.
And, if the rating services and financial insurers are not doing their jobs, fire them. You’d do it if your employees were creating similar dislocations and risk. Look kindly upon those in your organizations who perform analytical, quantitative and qualitative investment research. This may be the resource that ultimately will preclude asset managers from purchasing toxic waste while breaking down a link in the systemic risk chain. At least a start and, perhaps, one long-term solution to what is hoped to be a series of short-term problems.
As TB has alluded previously, all of the above is a direct result of misplaced capitalist thinking. Looking at the short run instead of long term…aided and abetted by institutional shareholders whose time horizon is 72 hours…and an SEC and CFTC who have become complacent thanks to Sarbanes-Oxley and who has allowed trading to be merely a matter of muscle…naked shorts, low margin requirements, elimination of the uptick rule for shorting. Someday this will be a better world but not until we act responsibly!
A quick look at Bloomberg top stories overnight is not encouraging:
*Lehman Puts, Default Swaps Show Investors Bet on Further Decline in Share…sorry to report this.
*Interest-Rate Derivatives Signal That Banks’ Credit Woes Likely to Worsen…not behind us, no sir.
*U.S. Mortgage Applications Decline 15.3% to the Lowest Level in Six Years…re-fi -25.7%! Ouch!
*Service Industries in U.S. Probably Grew at a Slower Pace as Spending Cooled…U.K.’s did and Consumer Confidence there shrunk.
As if that isn’t bad enough California salmon, like Abalone may wind up a nostalgic memory, the latter replaced by calimari and scalone…ain’t no substitute for the real thing, and the salmon is coming from Norway and becoming more expensive. If you are a oenophile like TB you might be interested that profits for Chilean winemankers are shrinking as the Peso rallies with copper and other commodities. After visiting two of TB’s favorite boutique winemakers, Rafanelli and Montemaggiore in the Dry Creek Valley he reported on the surging cost of organic chemicals…some by tenfold. There is no pricing power in wine these days and one is doing well to hold them…other than a few cult wines and first growth Bordeaux.
This is oddly funny: ECB President Jean-Claude Trichet, the inflation hawk, who like Don Quixote has been jousting with windmills is now starting to look more dovish while Bernanke is sounding more hawkish (don’t bet on the latter). Anyway, prices for consumer goods in the EU fell…except LIPSTICK!
Does this mean you can put lipstick on a pig but it’s still a pig…sorry, it just tied in.
Oh yeah, just in Clinton is out Obama is in…this after what seems to be an entire year of blather from the media…and we still have FIVE more months of concentrated election news…and what have we learned?
OK, what’s a financial column without a discussion of markets, right? The above tells us what is wrong with them but what is happening to them? The stock jocks all feel like they have it worse than anybody, but that is as the comments above on analysts imply, self-inflicted. Reread those top stories and tell TB and yourself the worst is behind us. The best could be that we bottom and skid along for months…or more, while the worst could be sharp declines followed by relief rallies that trap new money.
Bondo’s have no clue…how does one explain the lack of interaction between bonds, stocks, and the dollar over the past week or so?…or the daily volatility that once again exhibited itself yesterday? But it is the commodities mavens that have problems as their market first expanded from traditional commercials and speculators to be overrun by hedge fund speculators and as they pulled back to avoid scrutiny (it would be disastrous for them if there was transparency in their futures trading), replaced by pension funds…yes, pension funds directly and in the form of commodities index funds and even ETF’s!
But the grief for everyone could increase on Friday when we get the payrolls report(s). Not only are jobs expected to decline by 50k or more…TB thinks more…and the unemployment rate expected to rise to 5.1%…Steve Wood of Insight Economics has it at 5.2%…but the number is meaningless as the participation rate due to household employment merely masks the number and can cause ridiculous swings…if economics is an art, this is a roulette table, or worse. Challenger, Gray & Christmas (they should lose the last name as they are never merry), reported this morning that layoff announcements rose by 45% in May! This dovetails into the fact that Wall Street layoffs running at a lower pace than 2002, and this is the worst (in magnitude at least) credit crisis in history…of course it is not really a crisis, right?
We have had everything from the Sir Lawrence of Kudlow myth that subprime is too small to have any impact showing just how divorced from reality the man is, to “the world will carry the U.S. economy even if the consumer slows down,” to “the worst is behind us”…all have been just that: myths!
Look below at the overnight stock markets and you will note that only two bourses are positive (Japan and Korea), while the rest are foundering. First, the U.S. markets declined…then the Asian markets followed suit due to varying degrees of pegs to the U.S. dollar…then the European markets…leaving just Russia, Brazil and Mexico…but now commodities inflation is hitting the latter two leaving just Russia and it is beginning to look toppy…don’t forget those huge resets on corporate debt looming after the low rates on bonds from just before they collapsed in 1998 that are now sharply higher. So of the four BRIC’s, we are reduced to one…and it might be slipping. Japan has been a laggard and Korea looks like it too may not have much more left…auto news doesn’t bode well for them but they have a lot of electronics products…but in a global slowdown…
In equities, both domestic and European, TB has favored solid regional banks with solid, but not high dividends which could be cut if those yields are due to stock weakness (5% is the sweet spot to him), with a solid record of increases and a growth rate of 5% or more, and preferred’s…but not the new trust preferred’s like Citi is issuing; preferred stocks with dividend yields of around 7%. That strategy, along with select fixed income ETF’s, etc. has served him well…until the delinking of the bond/equity/dollar markets that began last week. Oddly, it is the fixed income side that has not done its job of stabilizing the portfolio…but probably will over time. That is why he believes that an ‘income’ approach, not a ‘fixed income’ portfolio may perform best over the coming year(s), since at these low yields bonds offer no inflation protection…unless you assume credit risk and that can be daunting. Even TIPS which have performed so well over the past five years (3.60% 3mos; 5.15% 1 yr; 6.58% 3 yrs; 6.75% 5 yrs), are starting to show weakness…most likely temporary, especially if a global slowdown emerges.
Now add to the above concerns a lack of responsibility, transparency, and regulatory supervision and you have the makings of weak markets and economies for years to come. If this sounds depressing, you can feel better that the money you lost was over a long period of time…contrast that to those “smart” sovereign wealth funds who lost it at a much faster rate…right, Norway?
Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC June 4, 2008
