This is a weekly update on what I've been reading and watching. To encapsulate, you had asset class predictions from GMO and BCA's perspectives on Brazil. Three strategists recommended selling this rally. Peter Bernstein reflected on the similarities to the Great Depression, and Bill Gross talked about a fat-tail possibility. The Indian finance minister's comments qualified him for the "bizarre quote of the week".
I haven't had a chance to read the transcript of the annual Berkshire conference. I did manage to catch this quote from a Marketwatch article, which discussed Berkshire's acquisition of a portfolio of subprime mortgages with frozen interest rate resets.
We're not in the business of resetting mortgages higher.
That's quintessential Buffett for you. Candid, honest and fair. Long term profitable ventures are sustainable in nature, and you cannot sustain predatory lending which dupes gullible borrowers beyond a point. Berkshire's enterprises have a very human face to them (Sudan and PetroChina controversy notwithstanding), something that corporations would do well to keep in mind. With this fitting prelude, let's dig in.
Jeremy Grantham came out with GMO's seven year forecast on various asset class returns. I thought this chart was good food for thought:
BCA Research is clearly positive on Brazil's prospects:
P Chidambaram (Indian Finance minister) (Bizarre quote of the week):
If rightly or wrongly people perceive that commodities- futures trading is contributing to a speculation-driven rise in prices, then in a democracy you will have to heed that voice.
Comment: I seriously worry that we could have a black swan event in food and commodity prices, further exacerbated by political expediency. There are elections in India next year, and the political posturing has begun. Deficit is high, inflation is out of control, futures trading on food staples has been banned, fuel subsidies are distorting fuel usage, exporters are demanding tax incentives, sops or government intervention in keeping the rupee pegged to the dollar. The list goes on.
The news from China isn't getting any better. Increasing emerging markets trade protectionism could undo the WTO trade benefits, further throwing a spanner in the Doha round of negotiations.
Check out this Don Coxe interview for his take on the current situation.
The central bank's rescue of Bear Stearns (NYSE:BSC) was the worst policy decision in a generation. The panicked decision jumped over other possibilities and may prove as damaging as Fed policy errors that caused the "great contraction'' of the 1930s and the "great inflation'' of the 1970s. The Fed's actions eliminated forever the possibility that the Federal Reserve could serve as an `honest broker'. The central bank also "tilted the political playing field toward direct mortgage relief."
Further interest rate cuts and a second stimulus package are required. Unorthodox measures are needed to stabilize the housing market.
- Household wealth reduced by $2 trillion till date.
- Real prices 20% above equilibrium.
- Excess inventory of 1 million.
- Case-Shiller Indices predicting further declines.
- Sub-prime lending dried up.
- Record foreclosures.
- Commercial property burst.
- Goldman Sachs (NYSE:GS) estimates 1.2 trillion in losses.
- Interest rate spreads have widened, neutralizing Fed's interest rate cuts.
- Fiscal stimulus neutralized by high oil prices.
- CDS market a hidden non-bond sector danger.
I'm a child of the Depression, and I am thinking about what the early years were like after World War II. It took a very long time to get the memory of the Depression out of business decisions, and certainly banking decisions. I think this is going to be the same.
The people who think we will have turned in 2009 are wrong. There has to be a respite along the way. Nothing goes in one direction forever. But it will take longer than people think.
Money markets are reflecting a level of caution which is not reflected in credit or equity markets. The difference between the two is that … a money market trader has a much better idea of solvency of their trading counter parties than does an asset fund manager. Given money market traders’ proximity to balance sheets, they get clear information from buying and selling of money between each other. The view of the equity and credit market is far too sanguine.
The real economic effect of this credit crunch is only beginning to be felt. We are going to see a much more substantial impact than is reflected in equity and credit markets.
Morgan Stanley analyst Betsy Graseck: Sell bank shares
“We think it is a mistake to chase this rally,” she writes. “The risk is much greater that credit deterioration will accelerate and banks will raise more dilutive equity and cut dividends than expected.” Consumer net worth is likely to decline 11% over the next two years due to the housing decline, and loan losses will continue to rise. This will drive weakness in commercial asset classes, “as corporates who sell to consumers suffer from slower top-line growth... We think we are only in the 3rd inning of the credit cycle and expect this credit cycle will be worse than 1990-91.”
We turned bullish at the January 2007 “lows,” cautious at the subsequent February “highs,” and aggressively bullish on the March downside re-test of those January “lows” believing the re-test would be successful; and, that the ensuing rally would carry the averages above the February highs, eventually scooting into the 1400s basis the S&P 500. From there, if the envisioned pattern continues to play, we should see a decline. To reiterate, that decline should be measured by “if” the U.S. economy spills into a recession; and that then, the extent of the decline should be measured by if the recession is short-and-shallow or long-and-deep.
To take advantage of the aforementioned potential stock market pattern, we have recommended numerous trading and investment positions. Speaking to the trading positions, we have continued to move stop-loss points “higher” as the rally has progressed; and would look to sell many of these positions into any “blue heat” upside type of hour toward SPX 1440.
Lower Fed Funds? They would, in PIMCO’s opinion, likely do more damage than good from this point forward.
Mohamed El-Erian has been counseling to at least consider a fat-tail possibility that could stop us in our tracks on the list of our strategic battle plan. (Note: I pondered on the possible consequences of this possibility in this post.)
Mohamed suggests the possibility, not the probability, that recent euphoric moves in equity prices and credit market spreads might be premature. The market’s justification may rest on the two-barreled conclusion that,
- the delevering of the financial system is reaching a natural culmination as prices stop going down and banks and investment banks recapitalize their balance sheets, and
- that numerous and previously unthinkable policy responses have restored enough liquidity to relubricate our finance-based economy.
Recession, and its vicious-cycle effect on employment and consumer spending, remains a threat and this recession, although currently mild and as of yet not even officially validated, may not be your garden-variety, father’s Oldsmobile-type of downturn.
Because the U.S. and selected other economies are now substantially asset-based and dependent on stable and upward tilting prices, a deflation of an economy’s primary financial asset can be ruinous. Its deflationary thrust must be countered, wrote Minsky, or else the battle might be lost. If so, the real economy as Mohamed El-Erian suggests, might become so shell-shocked that financial markets once again turn down instead of up.
Full Disclosure: No positions in any securities mentioned.