Getting Directions on the Road from Bad to Worse

I’m not going to comment on Lehman (LEH), Merrill (MER) or AIG (AIG). The Internet is rife with insights on these situations. My take today is the same as it was nine months ago:

DON’T BUY FINANCIALS.

However, one thing needs to be noted… as bad as stocks behaved yesterday, the credit markets behaved even worse. The cost of default protection hit record highs yesterday on fears that Lehman’s $2 trillion in open credit default swaps might detonate, causing the entire $62 trillion credit default swap market to implode.

Things are indeed worsening. The financial crisis that claimed three investment banks—Bear Stearns, Lehman, and indirectly Merrill Lynch—is now threatening to topple its first insurance victim, AIG, and maybe even a major bank, Wachovia IWB). In light of this, investors are selling EVERYTHING and piling into Treasuries. Yields on the 2-year note hit a five month low yesterday as traders pushed two-year notes up by the largest single day jump since the 9/11 attacks.

Few commentators realize just how worrisome this development is. The credit markets and Treasuries have led stocks since the financial crisis began in earnest back in July 2007. If Treasuries are rallying this much it means today’s action may be just as bad, if not worse than yesterday’s. I’ll explain…

Institutional investors are currently on the sidelines as far as equity markets go — a record $3.5 trillion is sitting in money market accounts right now. Treasuries, however, are largely institutions’ domain. So to see Treasuries rallying means institutional investors — typically far better informed than their retail counterparts — are moving in… which means real trouble is afoot and yesterday’s action in equities won’t be a one-time deal.

Yesterday, I wrote a note to subscribers recommending they shift a substantial portion of their assets into cash. I strongly suggest you do the same. We are indeed in dangerous times. The last time investors navigated markets during these sorts of conditions was in the late ‘20s. I’m fairly certain everyone knows how that turned out.

The regulatory bodies — the Fed, Treasury, and SEC — have pulled out all the stops trying to shore up financial markets. They’ve failed. And given the frantic nature of the deals we’re seeing announced — Merrill’s shotgun wedding to Bank of America — it’s clear they have realized this crisis is spinning out of their control.

I hate to say it, but the likelihood of a crash has increased dramatically. So while a 3% return in a CD or money market account might not strike you as sexy, it sure beats losing 18% with stocks: currently the S&P 500’s return for the year.

Now is the time for extreme caution. Act accordingly.

Comments

[Chris B:]

The institutions would have been smart to make that move this time last year. Besides, wouldn't a contrarian call this a sign of capitulation?

2008 Sep 16 03:09 PM

[fxtrader07:]

sorry, safe as treasuries might see, short term, they are absolutely expensive right now. and a lot of that money in the money market funds is from corporations which drew their bank credit lines and parked the money. because otherwise those credit lines would have been shut.
And boy, are there a heck of true bargains now in the equities markets - world wide.

2008 Sep 17 06:08 AM

[peterthepai...:]

capitulation day is coming..but not before an election!

...HANK, though is winning the game hands down as he buys them up or gets a black hole bank to swallow them.

ANTI-MONEY has been canceling out all the PONZI-MONEY ever since the DOLLAR COLLIDER caused a DELEVERAGING BLACK HOLE that has sucked liquidity out of the ecomomy and caused an alleged RECESSION....

...the hope is that this will prop up the markets and sweep the alleged recession under the
GREY HOUSE carpet until after the election.

2008 Sep 17 06:39 AM

[Takayama:]

Investigation should be set up to study the events leading to the excessive risks undertaken by these financial giants. The assets of those CEOs who gained from these high risk, high greed undertakings must be confisticated, and the guilty ones severely punished, jailed and disgraced.

The Chinese have this ancient wisdom, "Kill one, to warn a hundred".

2008 Sep 18 01:58 AM