October Finale: Trick or Treat?

 |  Includes: BCS, HIG
by: The Mole

This past week, the market just couldn't make its mind up whether to go to the Halloween Ball as Nouriel Roubini or Hank and Ben.

But this past week was really about the correlation between the foreign exchange and equity markets. The best barometers of this are the yen and the Aussie dollar as they reflect the ebb and flow (panic) of de-leveraging and worries about the stability of the global financial system.

In a nutshell, equities take fright when the yen ralles as this is a sure sign of global risk aversion on the uptick, while the AUD is the ultimate carry trade currency. Its appreciation (rise) is usually a good indicator that the market is looking to embrace a more positive outlook for stocks.

Breaking News Stories and Market Movers Yesterday

  • So Japan arrives late to the global co-ordination rate cutting ball with a meager 0.20% cut (bringing rates back down to just 0.3%). But it was a drama queen 5 to 4 split decision by the Bank of Japan board with the governor casting the deciding vote. One smells more than a whiff of outside political pressure i.e. that this had been agreed at G7 / G8 level. The markets' disappointment with the result is clear. The Nikkei lurched 5% in 15 minutes and the Hang Seng went off 4%. Risk aversion should hold sway ahead of a long weekend.
  • The ECB’s resident uber-hawk Axel Weber has gone all weak at the knees and warmed us up for the expected ½% cut next Thursday by saying that “if the economy cools, then rates have to come down rapidly so one doesn’t risk falling behind the curve”.
  • It seems Barclays (NYSE:BCS) is in line for a very expensive GBP 7.3bn capital injection from the Middle East, according to the FT. They would have found it cheaper to take the strings attached Queens schilling!

Graph showing Hartford Financial Spread BetIt looks as if the insurance industry is the next in line to go cap in hand  to Capitol Hill looking for bailout judging by the performance of stocks in the sector of late. Check out the performance of Hartford Financial (NYSE:HIG) and other US insurers. The penny has finally dropped for investors that banks / hedge funds and pension funds weren’t the only ones with dodgy, over valued assets on their balance sheets. Due to the more opaque nature of insurance company accounts though, these firms had slipped under the market's raider until recently.

  • San Francisco Fed board President Yellen said that the FoMC could “go a little bit lower” than 1% as it is “concerned about weakness in the economy”
  • UK GfKconsumer confidence survey is in the basement again. It has fallen 4 points to it’s lowest level since 1974, while John Lewis department stores' sales fell a worrisome 9.8% y/y in the week to Oct. 25% and British Petroleum (NYSE:BT) put out a profits warning.
  • The much respected and widely followed Martin Wolf in the FT is pleading for the BoE [MPC] to slash rates to 2.5% ASAP. The leader in the same paper suggests doing it in one bold leap of faith.

The big picture remains one of de-leveraging. Note Thursday’s “better than expected” abacus accounting results from German giant Deutsche Bank (NYSE:DB) couldn’t disguise the fact that they are still 30 times leveraged.

Markets will remain vulnerable and volatile until this process is completed. I’d guess we are maybe 60-75% of the way through this torturous process.

The second phase of this cleansing process is now upon us with a global recession. This sadly has only just begun. Decoupling was a myth.

The phase will be marked by aggressive rate cuts, further bailout programs financed by bond issuance and possible currency intervention to prevent the yen appreciating. Only in late 2009 , early 2010, will the air clear as economic data will have reached their lows and financial dislocations will have abated.