Monday Outlook: Ascendant Fear

The moment of good feeling in the money markets which I referenced on Friday has evaporated. My money market source says that the headline news from Europe has overwhelmed the markets and fear is once again ascendant. In addition to the widely disseminated headlines, there are other stories percolating below the surface which have also contributed to the dire glum mood.

S&P has down graded Swedbank, a Swedish mortgage bank.

Fitch has downgraded Baltic banks.

There was some small relief in Libor this morning. Overnights set higher at 2.37 versus about 2.00 percent Friday. However, the key 3 month rate declined 5 basis points to 4.29 percent from 4.34 percent.

Prices of Treasury coupon securities are surging in overnight trading as the massive maelstrom known as the credit crisis intensifies. The situation in Europe deteriorated markedly over the weekend as authorities scrambled to keep the system afloat and to avoid some financial Armageddon which appears increasingly nigh. Over the weekend central bankers and regulators who should have been passing quality time with family and friends worked to stave off several financial disasters when markets opened on Monday.  At the moment fear still rules as bond markets render a harsh judgment and still throb with palpable fear.

In Germany the government struggled to cobble together a deal to bail out Hypo Real Estate Holding. An earlier deal worth about $50 billion collapsed as banks backed away from providing funds to the troubled lender.

Belgium and Luxembourg stitched together a plan whereby BNP would take a controlling stake in Fortis.

In Italy, Unicredito issued an earnings warning and sought to raise 3 billion Euros of new equity capital.

Iceland’s banks are at risk as confidence wanes regarding their ability to remain adequately funded. The Wall Street Journal reports that the country might sell pension fund assets and use the proceeds to bolster the capital of the banks.

Germany and Sweden joined Ireland in issuing a blanket guarantee of bank deposits.

Equity markets around the globe have taken a battering in overnight trading. On Balance, equity markets have dropped from 3 percent to 6 percent. Equity futures trading portends a drop of close to 3 percent for US stocks.

Against that background yields on benchmark Treasury issues have moved sharply lower. (Coincidentally, each benchmark is flirting with a round number.) The yield on the 2 year note has dropped 7 basis points to 1.51 percent. The yield on the % year note has tumbled 11 basis points to 2.53 percent. The yield on the 10 year note dropped 9 basis points to 3.51 percent and the yield on the Long Bond dropped 8 basis points to 4.01 percent.

The 2year/10 year spread narrowed 2 basis points to 201 basis points.

Without a doubt today will be another volatile session and will tax the energies of traders, portfolio managers, and regulators.

The conventional wisdom held that the successful passage of the rescue legislation would introduce some stability into the markets. The ink was not dry on the legislation when stocks began to head south again, and in a serious manner. It is beginning to look as though the authorities will need divine intervention to save the day.

My suggestion is that members of the staff at the New York Fed should take some time and trek two blocks south to Our Lady of Victory Church at Pine and William. They should get down on their knees and pray, and then light a candle.

That looks like the only viable solution for now.

Comments

[whidbey:]

The moment of truth has arrived for the Western world and I think it will come for Russia and China and So America as well as the links between their economies are seen to be dependent on Western consumption.

We should fear deflation since fiat currencies and notes are just puts on the future productivity of an economy. Right now the Big Freeze is here and will stay for a while until a balanced policy aimed at both the consumer and the financial sector is adopted and executed. In the end we can not be sure that deflation for a substantial period is not our destiny.

2008 Oct 06 09:10 AM

[David White:]

If everyone is really scared at the moment (i.e. sure there is more downside), then a contrarian would say that it is time to buy. Historically, when the market emotion runs too heavily in one direction, you should do the ooposite to profit. Add to this the fact that GS had predicted a couple of weeks ago that the downside bottom to be about $107 on the SPY. You get the feeling that the near tem bottom at least may be near. Of course, GS probably hadn't predicted this crisis, nor Congress's reluctance to address it. That could always add a little something to the downside risk. Still when you see stocks like PBR selling for around $30, it is probably time to buy.

2008 Oct 06 09:30 AM

[Shiv Kapoor:]

Never any harm and saying a prayer.

But I believe Bernanke & Paulson will turn this ship around over the next six months. Personally, I expect the next six months to be the healing period and I expect the healing to start about now with a final cycle bottom somewhere between 9,800 and 10,500 and the start of early expansion during q2 09. Risks remain elevated maintain defense overweight (health-care/staples). Keep in mind that the next economic cycle might be somewhat anemic for the broader market; this is a cycle when I expect to see a global trend for capacity creation to facilitate the next stage of expansion (this is why I remain long term bullish on materials & energy). The following cycle, is when you can expect to see utilization of created capacity come into use to generate earnings growth which can drive the broad market. Finally, cost of basic materials and energy need to fall in order to facilitate the next phase of industrial expansion - they have fallen a long way, but they have further to fall. I would gradually accumalate into the bottom instead of trying to time the bottom.

2008 Oct 06 09:39 AM

[David White:]

You should probably also consider that the VIX exceeded 50 this morning. Historically that has often marked near term bottoms.

2008 Oct 06 09:52 AM

[John Pseudonym:]

GOTO CASH PEOPLE!

As the dollar gains strength in short run, use that strength to buy hard assets.

The end is coming for the dollar too, but for now use it's strength to your advantage.

2008 Oct 06 09:54 AM

[buyitcheap:]

The proper positioning imo seems to be cash, gold and index short.


Also, once this fear subsides, the treasury prices will crash to near par instead of 22% over.

2008 Oct 06 10:04 AM

[Saw It Coming:]

I am sure there are a lot of reasons for the current meltdown but certainly the die was cast when George W. Bush was chosen by a Republican Supreme Court over Al Gore in 2000. The wrong man was put in the White House and through his inaction to sound intelligence that terrorists were planning an attack, and by overreacted to 9-11 (primarily to enrich defense contractors and oil companies), a bogus war was launched that will cost over 1 trillion dollars. Foreign borrowing and debt has never been higher and the world has largely become disenchanted with the U.S. as the world's financial tent pole. Bad leadership put in place through electoral fraud and a level of corruption once unimaginable in America have all conspired to drag the country down with a massive economic collapse that may yet put the global financial system in jeopardy. Quite frankly, the more the U.S. can morph into a blend of capitalism balanced with socialism, as seen in the UK and western Europe, the better off the taxpayers and nation will be.

2008 Oct 06 10:15 AM

[freefall51:]

The credit crisis has arrived at the insurance industry. Time to check if the default swaps really work. I am betting that the cardhouse is crashing in a couple of days. The only way to avert this is to have the countries all over the world riding for rescue. But they are not conditioned for that, as Germany has demonstrated over the weekend. This is not a normal bear. I am out but that was brutal.

2008 Oct 06 10:33 AM

[gabe borens...:]

The 700 billion dollars"aid" will provide the necessary economic/market stability.Unfortunatel... we need incremental amount of time for the "stability"plan to be implemented .The real threat to our economy has been averted even if mass psychosis grips the market .The FED should ease immiediately 50bps -100bps pending the iimplementation of the" liquidity injection".
Europe ,Asia and Emerging market economies are anothers story .
They are on the verge of their own Armageddon which they refuse to acknowledge.
Given the lack of response from the relevant Central Banks and the governments,Europe ,Asia and the Emerging Market economies are set up for a major tailspin.
U.S on the other hand has addressed the issues with a vey potent antidode and is short period away from stability and rebound ,psychology notwithstandig.
The investors need to dissassociate American economic outlook from the events outside.
The massive flight to dollar(assets),will accelerate geometrically(flight to quality).
Major equity rally is on the way and foundations for a major economic rebound are in place.
Psychology and the facts/fundamentals are divergent but bullish fundamentals will prevail.
I have warned investment universe against current turmoil as early as June of 2005 and as late as September 18 /2007.
Now,I am quite convinced that the neccessary remedy has been applied but we need bit more time to feel major economic/market rersponse.

2008 Oct 06 10:35 AM

[piedra.j:]

The Fed need to act as a credit clearing house at least in the short term. In addition, lowering rates and buying corporate cash bonds would send a strong message.

The problems seem to be going over their head here.

2008 Oct 06 10:47 AM

[John Pseudonym:]

This train cannot be stopped; get out of the way.

A bubble is forming is short term treasuries in the flight to safety.

That bubble will burst last sending interest rates souring just as everyone realizes they are broke; except those of us sitting on cash and hard assets as we will be the wealthy class of the future.

2008 Oct 06 11:47 AM

[John Pseudonym:]

PS> Don't sell today! 10,000 is a very big psychological number. Just as we sliced through 11,000 a while back we shot about it in short order.

The same will happen here; a big drop below 10,000 followed by a huge short profit taking rally. That rally is your last chance to get out before DOW 8000/9000.

2008 Oct 06 11:49 AM

[John Pseudonym:]

PS> Don't sell today! 10,000 is a very big psychological number. Just as we sliced through 11,000 a while back we shot back above it in short order.

The same will happen here; a big drop below 10,000 followed by a huge short profit taking rally. That rally is your last chance to get out before DOW 8000/9000.

2008 Oct 06 11:50 AM

[Jason Rines...:]

I agree more with John on this. A couple of other notes: June 2007 economic study I conducted showed upwards of 20% overcapacity in the US economy.

As the US is going from Efficient Market back to Save and Invest, this overcapacity is coming off, 10% this year and 10% next year or two.

In any event, I watch Washington these days alongside potential market movement. The two have been intertwined for quite awhile which was stated in my comments here for over a year.

That said, I will wait to invest into anything until I see what the economic policies will be in March when the new Administration are in place. Until then, it's all falling knives to dodge.

I do like Consumer Healthcare as a hedge and my position is in this space and has been for the last two years as a business owner. There should be golden opportunities in big pharma next year but again, let's see if Washington and big pharma cooperate as it looks like they are just starting to do or if big pharma gets it's own version of a 'windfall profit' tax in various indirect or direct forms.

2008 Oct 06 12:07 PM

[JasonC:]

There is no such thing as "destiny", and of course it can be stopped. All the Fed needs to do it turn on the FOMC and buy double digit yield debt of financial companies in the secondary market, hand over fist, for new dollars. They will make a $1 trillion profit in a matter of months.

Never starve a panic. All the populist luddite nonsense has to stop yesterday. Just intervene.

2008 Oct 06 02:02 PM

[JasonC:]

As for the specific issue behind today's action, look at Royal Bank of Scotland. The stock is off 25% today, 85% since last year. S&P just downgraded them to single A plus from double A minus. This is a bank with 1.9 trillion pounds in liabilities - that is $3.2 trillion at today's collapsing pound exchange rate.

2008 Oct 06 02:14 PM

[Owen:]

JasonC,

You seem to be under the impression that the American public wants to solve this problem. I don't see that being the case. I believe Americans are more interested in revenge and punishing the guilty than in seeing the problem fixed profitably. After all, if everyone wins, it means the evil-doers also win. Cutting off your nose to spite your face is much more satisfying.

2008 Oct 06 04:11 PM