The G7 Put vs. the Greenspan Put

936 points on the Dow. 11.1%. Oh. My. Goodness. Almost unbelievable. I'll leave to others to put it in context in terms of 'biggest first day after apocalypse rebounds on prime numbered weekdays in October', but I'll just say this:The G7 put sure beats the crap out of the Greenspan put. (Click chart to enlarge.)

Somewhat more seriously, has it changed anything for me? Not really. Governments around the world have said that they will prop up financial markets, not letting major institutions fail. And that's mostly good, if not entirely unexpected, and if replete with unintended consequences galore.

But let's get big picture for a second. Recall, there had been been two broad fears taking markets lower. First, a fear that financial systems themselves were collapsing worldwide. That fear seemed overdone (if understandable in the context), given the actions governments were willing to take. And now markets feel justified in bouncing the other way with the G7 essentially supplying a "put" option here -- it is saying that the credit system itself will not be allowed to fail.

The second fear has not gone away, however. And that is a global recession caused by an immense contraction caused, in large part, by a credit bubble collapse. Having saved the credit system, we are not going to return to the days of yore, with too many banks, too much leverage, and too much consumer debt. The system will not do that again -- if not never, then likely not again in our lives. As a result, consumers will become savers, to the extent they can, and the upshot is that credit market weakness, having hit the broader economy, will circle back and hit credit markets, and that will circle back to consumers again. Earnings estimates for 2008 and 2009 are too high (I will come back to that in another post), and while markets aren't as expensive as they were, they are far from cheap. We may not have 20% more downside, but churning away in place seems the most plausible present bullish scenario.

Comments

[Diane Ritter:]

"we are not going to return to the days of yore, with too many banks, too much leverage, and too much consumer debt. "

I truly hope you are right. But could you expand on why you don't think so?

2008 Oct 13 07:38 PM

[Freedoms Truth:]

The second fear has not gone away, however. And that is a global recession caused by an immense contraction caused, in large part, by a credit bubble collapse. Having saved the credit system, we are not going to return to the days of yore, with too many banks, too much leverage, and too much consumer debt. The system will not do that again -- if not never, then likely not again in our lives."

Oh, but I think we will. We will inflate our way to a not-so-bad recession, save the 'system', and in the process with all this liquidity set ourselves up for the next bubble ...

The merry go around keeps going:
AsianFlu-Y2K->liqui... bubble->punchbowl-removal->tech collapse->9/11->... ramp ->commodity and housing bubble->collapse-&g... crisis-> global panic ->global credit response...

Why would it stop now? Why wouldn' t the seeds of inflation down the road not be sown by the coordinated actions now?

Now if I can just figure out what that next bubble is, I'd like to get in early.

2008 Oct 13 10:13 PM

[SugarDaddy:]

This has to be "The" biggest Fed circle jerk of all times. Manipulation extravaganza that will end up being a gigantic inflation bubble of epic proportions followed by stagflation, resulting in a severe depression.
Grab a chair I say, because the Fed's have figured out a short term way to keep the music playing while Wall Street gets their ducks in a row...

2008 Oct 14 12:55 AM

[Old Rick:]

Like freedoms truth, I'm worried that the current "cures" will "sow the seeds of inflation down the road". However, I take comfort in the fact that the the 10-yr Treasuries are at 4.02% this moment. This is nominal inflation plus about 1.5% which is (I believe) slightly below the historic long term average cost of money. This seems to indicate (to me anyway) that the "market" is pricing in inflation rates similar to what we are currently experiencing. I would also note that the 10-yr yield has moved up a bit recently. Of course these prices could also reflect a "flight to quality" phenomenon vice an inflation indicator. Thoughts??

2008 Oct 14 12:52 PM

[D. McHattie:]

The reason there was a liquidity crisis was because, if you valued all their toxic assets correctly, many of these firms were insolvent. This is a solvency crisis and no amount of liquidity can change that.

Let's not forget exactly what 'liquidity' is in this context: a credit limit. All we do when we increase liquidity is increase the credit limit, allowing insolvent firms to borrow even more. This will buy the insolvent some more time but they are no less insolvent.

The money supply is being increased with no commensurate increase in actual 'value'. Direct result: inflation.

2008 Oct 14 10:13 PM