Milton Ezrati: Market Pricing Assets to Fear, Not Value

Milton Ezrati opened the Information Management Network's “Distressed Investment Summit: Credit Crunch Investment Strategies for Institutional Investors” conference on Monday. From his viewpoint, the market is running on emotion, which is covering up current market fundamentals. And the market ran on emotion over the last couple of years, which previously covered up really bad fundamentals. But the markets have overreacted and are pricing assets to fear instead of to value. And the markets are slowly recovering from the emotion-based marking.

Ezrati illustrated his point of view with a few examples:

• The TED Spread: Has historically bubbled around 25-30 basis points. It rose to 460 basis points in November 2008 and has since dropped down to 100 basis points - still not back to normal, but recovering.

• Credit Spreads: Junk bonds, which normally trade around 500-600 basis points, reached 2100 basis points but have fallen to 1500-1700 basis points.

• Merrill Lynch: In their sale to Bank of America, mortgage assets were priced at $0.22/$1, indicating that 78% of assets are worthless; yet 60% of sub-prime borrowers are current (and this doesn’t even count the intrinsic value of the properties themselves…)

In discussing today’s market as compared to the Great Depression, Ezrati offered some salient points:

• There was no bank deposit insurance then.

• There was no unemployment insurance then.

• Unemployment rose to 30% during the Depression, versus 8.1% now

• 9000 banks went bust during the Depression, versus 40 banks now.

Other key points from his address:

• Worker Productivity rose in Q4-2008, even with the massive layoffs in the economy. (Those numbers have since been revised to show a -0.4% downturn in productivity, but given the sharp increase in unemployment in Q4, this value seems to indicate that productivity is still ahead of employment declines.)

• Personal Savings have risen to nearly $600 billion since 2007. (You can verify this at the Bureau of Economic Analysis.)

• While the current government’s actions may create an inflationary environment, he is not forecasting any inflation at this time.

• When asked about China’s role in financing our debt, Ezrati likened the situation to a manufacturing company subsidizing a customer at a loss, only to gain when selling the end product. As long as China continues to run an export-oriented economy, then they have little choice but to finance US debt because of their reliance on the US for its economic base.

• When asked about drawing an analogy between Japan plight in the 1990s to the current U.S. situation, Ezrati cited that Japan’s government failed to acknowledge bad debt at the start (versus the mark-to-market requirements in the U.S.), that Japan’s sub-prime debt was non-paying (versus a 60% repayment rate in the U.S.), and there was not much of a corporate debt market in Japan (borrowers had to go to a bank for a loan). So overall, Ezrati indicated that the current situation in the U.S. does not compare to that of Japan’s a decade ago.

Overall, Ezrati saw reasons for abatement in the market’s negative direction, but as you might expect, hedged that with a little caution that future economic events such as inflation could hamper recovery in the intermediate.

Comments

[MarvinMBA:]

The ponzi scheme that Uncle Sam is now trying will be non productive and will accomplish nothing except inflation that will put a greater stress on the now seriously stressed out economic DEPRESSION that we are in. MarvinMBA PS this latest endeaver will just extend the problem time.

Mar 19 05:14 PM

[Fred Voetsch:]

There were negative earnings in the DJIA during the depression and there are negative earnings in the S&P 500 now.

The S&P 500 currently has a P/E ratio of 50.
www2.standardandpoors....

Earnings are falling.

Housing has yet to bottom.

Consumers are deeply in debt with little savings.

Unemployment is rising rapidly.

Leading Economic Indicators are falling.

Industrial Production is falling.

Trade has dropped off a cliff.

Protectionism is starting to appear.

Demographics for the next two decades suggest a slow but stead drain (at best) for the stock market.

Taxpayers (including business) are on the hook for trillions of dollars of debt and will almost certainly see taxes raised dramatically in the coming decade.

All of it is fundamental. None of the above has anything to do with emotions except that when you combine it all with a stock market that was double its fair value (at 14,000) fear was a wise thing to feel in 2007. Unfortunately, because of pollyannish people like yourself millions of people have lost trillions of dollars as they were advised to hold on to investments that were tremendously overpriced, and still are, given that we are in the middle of a great unwind.

Mar 20 01:25 AM

[Mr. Ed, Jr.:]

"...Merrill Lynch: In their sale to Bank of America, mortgage assets were priced at $0.22/$1, indicating that 78% of assets are worthless; yet 60% of sub-prime borrowers are current "

Or, another way of putting it would be...40% of sub-prime borrowers are NOT current. It should also be noted that with ARMs resetting in a couple months and unemployment rising fast, that unimpressive 60% number is only "for the moment"

Even if the assets are being priced to fear, there is probably a lot more fear coming.

Mar 20 03:42 AM

[Scott Sambucci:]

Hi Fred - Thanks for the reviewing the post and your comments. Absolutely agreed on many of your points.

"Unfortunately, because of pollyannish people like yourself..."

Remember - don't shoot the messenger... This is a synopsis of Milton Ezrati's presentation and not my personal opinions...


On Mar 20 01:25 AM Fred Voetsch wrote:

> There were negative earnings in the DJIA during the depression and
> there are negative earnings in the S&P 500 now.
>
> The S&P 500 currently has a P/E ratio of 50.
> www2.standardandpoors....;br/>
>
> Earnings are falling.
>
> Housing has yet to bottom.
>
> Consumers are deeply in debt with little savings.
>
> Unemployment is rising rapidly.
>
> Leading Economic Indicators are falling.
>
> Industrial Production is falling.
>
> Trade has dropped off a cliff.
>
> Protectionism is starting to appear.
>
> Demographics for the next two decades suggest a slow but stead drain
> (at best) for the stock market.
>
> Taxpayers (including business) are on the hook for trillions of dollars
> of debt and will almost certainly see taxes raised dramatically in
> the coming decade.
>
> All of it is fundamental. None of the above has anything to do with
> emotions except that when you combine it all with a stock market
> that was double its fair value (at 14,000) fear was a wise thing
> to feel in 2007. Unfortunately, because of pollyannish people like
> yourself millions of people have lost trillions of dollars as they
> were advised to hold on to investments that were tremendously overpriced,
> and still are, given that we are in the middle of a great unwind.

Mar 20 09:31 AM