“A Whiff of Panic...”

The Fed slashes rates 75 bps – and another 75 bps are implied for next week's meeting. There is a none-too-faint whiff of panic about today's actions.

What does this mean for investors? Quite a number of things – none of which are particularly good over the long term:

1) Why Cut Today? What was the motivation for today’s cut? Is it that the equity markets are not working properly? Likely not. Are rates too high? I doubt that's the reason for any of our economic woes. Then what is it – are lowered equity prices a problem?

Globally, equity markets have been in the process of “Repricing Risk” – why is the Fed disrupting that? Further, there is now a recognition that S&P500 earnings were priced way too high – especially in the event of a European and Asian slow down. That lowered “E” in the P/E adjustment is also under way.

2) TANSTAAFL: The free lunch crowd (a/k/a Long & Wrong) has been chanting for Fed cuts. However, these are not without consequences, as Inflation remains a pernicious threat.

Here’s a question: What goes to $5 a gallon first – Milk or Gasoline? How about $6?

3) How Independent is the Fed? The Fed is supposed to be an independent entity, whose mission is a) price stability (inflation) and b) maximizing employment (growth).

However, today’s action reveals an apparent third obligatory goal – protecting investors and market prices. I had no idea that back-stopping speculators and hedge funds was part of their mandate...

4) Capitulation? The Market gapped 400 points, and is now climbing higher (off 300 as I type this). My second biggest concern is that the Fed merely delayed the inevitable. This market saving cut prevented a thorough, 5% wash out. In other words, all the Fed did was prevent a healthy capitulation.

5) Pushing on a String? My biggest fear is that we close down 500 points anyway. That would be the worst of all worlds: A compromised, political Fed, working on behalf of speculators, to the detriment of ordinary taxpayers, is proven to be a paper tiger. That scenario would but the “F” in Fugly.

6) Decoupling US Equities from Global Slowdown? Other markets were down much more than the US. But that makes sense, seeing as they have been a whole lot more than the US over the past 5 years . . .

This was a shot of penicillin to a cancer patient.

Comments

[Reinko]

And nr 7:

M3 money growth was around 17% Y on Y and with this weird far to low to fight inflation rate it will likely climb above 20%.

We only wonder: Why did the FED stop publishing M3 money growth back in 2005?

[David White]

We now get back to the FDR saying in the depression, "We have nothing to fear, but fear itself." The Asian markets, etc. all believed that the U.S. was going to fall apart. Therefore they have just tanked substantially. Of course, some bad news from the Bank of China and a major French bank probably had something to do with it. These problems seemed to be triggered by the U.S. subprime problems. No doubt the Fed action was partially due to a desire to prevent a further spread of the problem.
Now should the U.S. then tank in response to the other markets tanking? The reason would of course be that the multi-national corp.'s would do worse than expected. I'm sure you can think of other reasons too. The bottom line is though, stocks are only mispriced if the global economy is going to seriously underperform the current estimates. Apparently those other markets only believe that will happen if the U.S. tanks (and the subprime situation worsens considerably). If the Fed and the President/Congress can manage to right the ship for the U.S., the other economies will likely follow suit for the most part. Europe is already talking of following the Fed. If we stop spending, no one in the U.S. will have a job because no one will be buying anything. Don't let the panic become a self-fulfilling prophecy.
The last news item I saw agreed with you that the Fed would lower interest rates again next week, adding to the already deep cut. It, and I, disagree that it will be a 0.75 basis point cut though. I think the idea may have been to stabilize the markets first. Then the second cut would reaffirm that the Fed was very serious about helping the U.S. markets (and by doing so the world markets). I and the news blurb both think this second cut will be a lesser cut (perhaps 0.5 basis points) because the markets should no longer be in free fall. There is also the stimulus package to come. Don't be so negative! This cut, and further cuts, should do a lot to help the home owner, the banks, etc. The cuts should buoy house prices by making them effectively cheaper (as most people buy them with loans). It may take a while for all of this to take hold, but this all sounds good to me. There seem to be a lot of U.S. industries that have been doing reasonably well. If the Fed, etc. can right the ship for housing, banking, and retail, the other industries should thrive. I think today's action was a great step toward alleviating the short term problems.

[David White]

I should have added that a better energy policy is clearly a big part of a longer term solution. The U.S. has to find some way to stem the outflow of money from the economy (the trade deficit). A greater adoption of solar would help. Spurring U.S. development of oil resources would help. We would at least be paying ourselves, and the greater total amount of oil would tend to keep the prices down. The oil shale in Utah, Colarado, etc. certainly seems like a possible area in which Congress could spur development. There is supposed to be more oil there than in all of Saudi Arabia.

[Dan Weiss]

Overall, you have made an interesting analysis. However, what the Fed is giving consumers is a sense that they will do what is needed to improve confidence. The subprime and CDO issues are serious issues but the reasons that consumers have cut back significantly in recent weeks is primarily due to a lack of confidence in future economic activity along with growing concerns about job safety. The Fed cut will likely act to improve overall confidence that the Federal Reserve will do what is needed to lower the odds of a long recession and will lower the cost of borrowing not only for consumers (I looked today and a 30 year mortgage can be had for 5 3/8% with no points for credit-worthy borrowers) but for businesses as well. The danger of the Fed is very active is that the Fed cuts too much and we either have inflationary pressures or we have a repeat of 03-06 and have a bunch of liquidity floating around and we once again have inflated asset prices in certain parts of the market (i.e. housing, emerging markets, commodities). To me I think the Fed made the correct move at this point of the cycle I would rather risk a small amount of inflation for an increased likelihood of having a much milder slowdown.

[billspaced]

Where does the author get his "facts?" Point #3, about the Fed charter. Where the heck does it say that they have those missions (price stability and employment maximization)?

I think the author needs to do some research before he publishes.

I mean, the Fed may state that it has those two purposes, but its mission was spelled out in its charter. Price stability and employment had nothing to do with it.

[Chuck]

Promised Land, Unpromised Land,

Oil Shale, Oil Sands...
I see pollution and extreme energy to get a barrel of oil from those locations. To be profitable I suspect that oil will have to sell for at least $200 a barrel. And the cleanup from the process will cost at least $100 a barrel.

Oil Sand and Oil Shale just ain't gonna happen in my (limited) view.

[bobotheclown]

It's taught in pretty much all economic classes, what else would the job of the fed be? To ensure that the stock market goes up?

[mmmparsley]

It's pretty interesting to see how people are reacting to the news today. It seems like it all depends on whether they were waiting on the sidelines (for those it was bad news for independent investors - because it's going to take a couple days to move funds into trading accounts from savings accounts) or attempting to catch the falling knife (for those it was very good news - more cash in the system means savers lose and investors win over the long term). Barry apparently was playing it cautious - and I don't blame him, but in the end, technicals don't matter and fundamentals do.

Growth would have to go deep into the red for a considerable period of time before investments fairly valued at these prices. Companies with 30% growth are priced at 10-12 PE's right now. I'm looking at a few companies that traded for under cash value today - one includes OPTT which may in the next decade post First Solar-like earnings growth. OPTT was free this morning - with a rebate! If I can buy a house for $100,000 in a nice neighborhood, get a green pasture with horses for free, and find $100,000 neatly stacked in "Benjamins" in the front hallway - I'd be a fool not to buy that. That is, effectively, what happened this morning when a few companies - such as OPTT - went into panic mode.

The recoiling we saw this morning was strong, and it appears almost certain that many stocks have hit a bottom. I'm only bearish on strowth growth companies with PE's over 25-40 (EG Goog, Appl) that merit strong earning's growth in the future to validify current prices. Still, those companies are a lot cheaper now than they were a few months ago when irrational speculators were taken ill-advised risks in high-growth companies.

I may be wrong - but I think this is a long-term bottom. All the fed did was inject more liquidity into the system. That has to be a good thing for financial markets - unless you are afriad all that cash is going to end up in the piggy-banks of the struggling American middle-class! HA!

I've been wrong before. Don't quote me!

[Lexxy]

Solar panel production capability is in line with market forces and it currently limited by a shortage of high grade silicon. Nothing is going to change that near term. If we want to significantly reduce our consumption of oil, what we need is a massive investment in nuclear power and a technology called concentrated solar which is far more economical that photovoltaics. Lastly, I take great offense at any suggestions from non-Coloradans/Utahns with regard to resurrecting oil shale production. There has been some enthusiasm directed at a nascent refrigeration barrier/in situ processing technology. Believe me when I say this will generate 2-3x more greenhouse gases per barrel of convention oil and still has the potential to greatly contaminate our water supply. Don't give Big Oil the chance!

[Reinko]

Dear folks, isn't it weird that this is done on this day? Why carpet bomb with 75 basis points?

I thought about that one and I guessed that otherwise we would have a tidal wave of bankruptcies into the US financial sector.

Well the next one I have from Russ Winter:

There is only 200 million of real reserves left in the US banking system.

Don't believe me? Look for yourself, here is the link:

www.federalreserve.gov.../

In practice this means that if the stock markets close this day on a negative footing; the last 200 million will be gone too...

[mmmparsley]

Reinko,

Do you think this portends to more aggressive rate cuts? If so, I think gold/international equity markets are safe havens from the US government printing press.

Also, do you think these numbers may be the reason we're seeing heavy selling on international markets. I see from the published spreads that individual Thai and Indian investors (among others) have been accumulating in the SET and SENSEX, while international holders (likely large banks) of foreign stocks are bailing - perhaps only for liquidity purposes.

Don't you think this is a reason for buying at these levels? The depressed prices have nothing to do with valuation reasoning.

[Reinko]

To: mmmparsley1

I am expecting more rate cuts but on how large they will be I have little clue. For myself I always used the FED flow of funds sheet to try and get a grip on the behavior of the FED and ECB. Until now this has worked fine.

Here is a link:
www.federalreserve.gov...

Here in Holland most banks and government folks do not understand how dire the situation is; for example I had to email our own central bank a few times before they got it.
The pattern is always the same: I email some central bank, for example our Dutch or the ECB and you always get an answer.
Then I keep on pushing with things like 'do you understand what will happen?' and then there is no answer anymore...

So all in all I think most (central) banks still have no clue but smart foreign investers might be better in understanding relity. And you are right; this might be a reason for buying at these levels.

[Reinko]

Before I forget this; honor goes to the guy that deserves it:

It was Russ Winter from the Winter blog and the entry where he placed his finding that there is only 200 million US$ of real reserves left in the entire banking system is here:

wallstreetexaminer.com...

In the beginning Russ is a bit difficult to read because he has all kinds of standard things that are a bit difficult to understand in the beginning. For example when he writes FC he means fictious capital and that is the difference between the value in the books and the real value when you would try to sell it.

His rantings are always a beauty to read and very important: when you here some strange rumor over there (like for example: there is only one dollar in reserve for every 500 dollar lended out) later it is often comfirmed with rigid and solid evidence.

[mmmparsley]

Reinko,

Pardon my ignorance. I have one last question.

Don't you think investments banks, for the sake of the broader economy, should start going back to their roots and doing more banking and less investing?

It's been mentioned that if the Fed Rate is considerably higher than the market rate for bonds, that banks would rather park their money in government bonds instead of take unnecessary lending risk at a lower return.

I am a believer that the international market panic we noticed early this week was a result of western institutions bailing to provide immediate liquidity to stay solvent. After all, there is no more liquid asset, other than cash, than equities.

How I'd approach the market:

If I had any free cash after buying some OPTT and TCM, I'd be an aggressive buyer of Asian ETFS or Precious Metal Miners. GFI, perhaps?

What about you?

Dave

[User 86999]

" ... free lunch crowd (a/k/a Long & Wrong) ..."

There is a reason why shorts are called derivatives. Think about it! What a moron.

[A.S.D.]

mmmparsley1, you forgot the third group, those who went to bed on Monday wishing they had cashed out at Friday's prices. They got their chance today. Barry, history will tell if Fed was correct to act, but who (other than shorts) really wanted to see Dow 700 down followed by another 5-10 percent drop overseas tonight and what if that wasn't the end of it. David, if you own Royal Dutch/Shell I hope it's not because of their US oil Shale project which is in research phase and even they don't expect anything to come of it for several years. Myself, I'm sticking with my Canadian junior gold (can not be shorted, can be acquired), a couple of beaten down Chinese stocks and TRAMX (Africa/Middle East fund) which just took a big hit; and plenty of cash for now.

[Reinko]

To Dave:

I have thought a bit more around why the spreads are getting wider on a trading day like yesterday. Very likely it is just irrational behavior from paniced traders/investers.

As for your last question, quote:

Don't you think investments banks, for the sake of the broader economy, should start going back to their roots and doing more banking and less investing?

If it was your baker and say 'he should bake more bread and stop his investing games' every body would agree. And it's not just investment banks, it is all banks and this is the work of Alan Greenspan. Alan was very glad that banks took off debt from their balances (and thus started trading with that) because that brought finally more economical activities.

Well today a decade later we have an entire shadow banking system sitting on it's ass having billions and billions of debt because stuff was not regulated from the beginning. The whole 'off balance trades' are now a mill stone around the neck of the formal banking system.

If I were a central banker I would never have gone down that road, you cannot have hidden exposures to banks because for example investers cannot judge if a bank is worth it's stock price.

The allowance of an entire shadown bank system is contrary to transparency so I would never have gone down such a weird road.

But this is the problem of Alan Greenspan: A genius in detailed economical knowledge but horrible when it comes to understanding macro economics.

To foreigner: Nice to know that there is stuff that cannot be shorted... Lately I was talking with the head of an elementery school and I explained a bit how markets work these days. And he was bewildered: "How can you sell stuff you don't own?"
But in todays financial markets anything goes, leverages are climbing thus risk of total system failure too... Nobody acts.

[A.S.D.]

Reinko, thanks for the lesson. I guess I should've said extremely hard to short due to float position...better?