We also have UBS & Goldman providing upbeat reports with sizeable market rally expected by the second half of 2009, albeit according to them the markets may see some downside before doing that. According to Goldman the investors are likely to price-in a short deflation before the market moves up by second half. A downside of 20 to 30% is also seen as possibility as investors price it in.
This to me appears to be a conspiracy of optimism. Have the markets really discounted all possible bad news? Does the market have enough information today to discount even a possible deflation – short-lived or otherwise? And that all such bad news will be discounted in the next six months to see a low by then and then see the up move coming?
Given that US markets are setting the tone for all other markets lets take a closer look.
While I do not have the resources and tools to make this kind of judgment (which some of these institutions probably have) I explored available public information to check if this may be a possibility. This list of by no means is exhaustive. The judgment, if the implication of these have been discounted or is likely to be discounted in the next six months – I leave it to you.
1. The NYT notes the bad employment numbers do not include people who are under-employed or who have simply stopped looking for work. Counting those folks would nearly double the November unemployment tally, putting it at 12.5 percent instead of 6.7 percent. President-elect Barack Obama called for public spending to solve the crisis, but the Times says Obama's vague plan to create 2.5 million jobs would "barely recover the jobs that have disappeared over the last year," given the accelerating losses.
2. The big (little!) three may ultimately require $75 to $125bn. If the government does not help they would file for Chapter 11, a restructuring, but it would likely turn into a Chapter 7, a liquidation. Their factories and other operations would be shut down and their assets sold to pay creditors – Mark Zandi of Economy.Com in his testimony to senate banking committee.
3. A record one in 10 American homeowners with a mortgage were either at least a month behind on their payments or in foreclosure at the end of September as the source of housing market pressure shifted from risky loans to the crumbling U.S. economy. The jump has been steep – from 7.3 percent to 9.2 – year on year for the quarter ended June 08 as per reports. Is there a redemption to this problem in the near term is the question.
4. According to a news letter that I receive – an analyst from Oppenheimer and Co. stated that...
“We expect available consumer liquidity in the form of credit-card lines to decline by 45 percent. The credit card market will be 18 months behind the mortgage market and will begin to shrink by mid-2010”. This translates into $2 trillion cut from consumer credit card accounts alone. More on credit cards here.
This newsletter further makes a good point: “We had the dot-com bust. There was a recession, but consumers didn’t really stop spending. They didn’t need to. The value of their homes started moving higher. And that’s when they figured out that they could use a line of credit on their home, and spend more. In the end, the boom we had after the 2001 recession was due to an expansion of credit, not to an increase in wages. The proof is in the pudding, adjusted for inflation, wages are down since the year 2000.”
That is future spending power for you –more job losses, falling wages & no or very less credit. Would interest rate matter unless you are saver? Actually deflation will help.
5. For those who are more analysis oriented - John Mauldin provides support to point 2 above with some excellent graphs in his analysis ‘The Velocity Factor’ which if correct says a lot. While details are available in his report I have taken the liberty of showing some of them.
“Notice that the velocity of money fell during the Great Depression. And from 1953 to 1980 the velocity of money was almost exactly the average for the last 100 years. Also, Lacy pointed out, in a conversation which helped me immensely in writing this letter, that the velocity of money is mean reverting over long periods of time. That means one would expect the velocity of money to fall over time back to the mean or average. Some would make the argument that we should use the mean from more modern times since World War II, but even then mean reversion would mean a slowing of the velocity of money (V), and mean reversion implies that V would go below (overcorrect) the mean. However you look at it, the clear implication is that V is going to drop. In a few paragraphs, we will see why that is the case from a practical standpoint.”
Explaining the concept of velocity of money he says:
“Basically, this is the average frequency with which a unit of money is spent. Let's assume a very small economy of just you and me, which has a money supply of $100. I have the $100 and spend it to buy $100 worth of flowers from you. You in turn spend the $100 to buy books from me. We have created $200 of our "gross domestic product" from a money supply of just $100. If we do that transaction every month, in a year we would have $2400 of "GDP" from our $100 monetary base.”
Explaining why the velocity will fall he says:
“…that the Fed will soon move rates close to zero. For all intents and purposes, the markets have already moved there. But is it having an effect on the willingness of banks to lend? Not hardly. Standards for lending are tightening every week. Look at the graphs below. The willingness of banks to make consumer loans is dropping to a 28-year low. And they are tightening standards on all sorts of business loans.”
From an implication point of view it would be impossible for any on make a judgment as to how far this mean reversion could go and how long will it take. The background to this is that banks have already taken a $1trn. hit and more is likely to come. Also, that many of the global big players are now to be run by government and/or their representatives. Proof is here.
6. The scramble for treasury securities is high given the recessionary fear factor and the safe haven it is supposed to provide. The US government has committed itself to more that $7trn. in the form of various packages.
But there is a catch…a dangerous one. Staying on with treasuries will make sense only if you feel that the rescue package/s will not work. If they do than then appetite for risk may come back and may see treasury prices sliding. With yields new zero for 3 month papers and low for longer papers this is at best a capital protection plan if the package/s do not work or are prolonged. But will it protect capital in which case? If the rescue plans do not work the loss of confidence in the government may lead to panic selling. A treasury bubble seems to be in the offing!!
7. And what is the consequence of lower interest rates? Says Macro Man:
“While lower long-term rates may be seen as a boon to spending, they also substantially increase the net present value of pension fund liabilities. Coming at a time when declining asset performance has left a hole in pension funds' balance sheets, lower long term rates make the asset-liability mismatch even worse. Among those funds most adversely affected include, quelle surprise, the defined-benefit plans of the Big 3, who themselves are lobbying for fresh government bailouts.”
Now these are the collateral damages I have mentioned in my previous posts. Market needs to know and understand all such possible future consequences.
8. The geo-political risks worldwide have increased since the Mumbai attacks. According to NYT report - “… by the time the crisis finally ends, foreign policy experts say, the fallout may have expanded to include the United States, NATO, Afghanistan and Iran.”
This a point I have made in my previous posts already and the dimension of this seems to expanding.
9. One writer has the following to say when telling folks that it is time to buy:
“But before you rush to write checks, please remember that you shouldn't put money into stocks or houses or other investments unless you can do it while adhering to the three eternal verities of financial survival. They are: Live within your means or below them; shun credit card debt like the plague it is and don't borrow except for an education, a home or a car; and use your house as a place to live, not as a cash machine or a get-rich-quick scheme.
In addition, don't start investing until you've accumulated an adequate reserve fund. To me, that means enough to cover your bills for at least three months if you (and any other employed people in your household) lose your job (or jobs).
You need to have staying power. Don't borrow to buy stocks. Don't use your eating money or next year's college tuition money to buy stocks. Don't bet on having a much better year financially than you're having now unless there are special circumstances, such as being a medical resident about to become a practicing physician. Invest only money that you can afford to tie up for years, if not decades, and that you can afford to lose.”
After what you have gone through in the last 12 - 18 months how many will have the surplus after providing for all of the above, without stretching yourself and have the psyche for tying up money for years?
The next true up move will happen when the proportion of those who can do so increases substantially. When? Your guess is as good as mine.
Disclosure: No stocks discussed – No Positions
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