The beginning of the bottoming process

The headlines are becoming so depressing and it’s ‘given up’ tenor is making me believe that the bottoming process has started. By no means am I trying to predict the bottom or for that matter say that the worst for the markets is over. I’ am starting to sense now that the second half recovery theme is history. The tone of the optimists is tending to sort of say – ‘we probably underestimated the depth of the problem.’ And now the depth of the problem and the issues, to me, is getting a slow but definite over extension to the other side. The sense of gloom being predicted smells of converts and the conversion rate is accelerating. Sample this:

1. Financial Crisis sparks unrest in Europe
Read about a series of unrest in this region. I'am sure other regions too are reporting such instances.

2. Gold – Haring away

One is reading/hearing ‘Gold’ every where. Sure signs of panic are emerging.

“People have long viewed gold, rightly or wrongly, as a hedge against high inflation and a weak dollar. So when the gold price briefly broke through the $1,000 mark in March last year, it was easily explained by fears that rising commodity prices (and, in America, a weak dollar) would feed inflation. An earlier run-up in gold prices, between 2002 and 2005, coincided with a sustained fall in the dollar. But now gold is strong even as the dollar thrives and economies face deflation.

“Gold is something you buy if you have something to lose,” ... What links today’s gold fever with the 1970s rush is negative real deposit rates. Many savers now prefer a claim on gold in a vault to one on cash in the bank. There is less risk that a counterparty blows up, and the “carrying cost” of gold in terms of lost interest is, in any case, vanishing.

How high might the gold price go? Gold bugs talk excitedly about it reaching $2,300, which would match the January 1980 peak in real terms…”

3. Next Stop for Gold $2,000 Per Ounce!

“How high can gold ultimately go? Mark my words... gold will hit $2,000 per ounce or even higher.

Recently gold has been on an absolute tear as investors are piling into the yellow metal as a safety hedge. People are still quite concerned about the current economic crisis and are unsure what will happen in the future. The financial downturn we’re experiencing has crushed conventional investments like stocks and real estate and gold has shined throughout this downturn.

Gold is certainly in full bull market mode right now. Recently it headed higher on worries of both inflation and deflation. Surprisingly, central bankers are in favor of higher gold prices because it suggests their attempts to head off deflation are starting to work.

Now, the average person is not worried about inflation or currency debasement. They are worried about the money in their bank account. That’s just one reason that gold prices are rising. People are turning to safe havens because they think their banking system is on the brink of failure and they see the stock market is in the toilet.”

4. Stress Test Mess

The idea of ‘Tangible Common Equity (TCE)’ is bizarre. These sudden discoveries are just an exhibition of the fear factor. Tier I capital was what all bankers/regulators for long have looked at - through most good and bad times.

“Judged by tier-one capital, a common measure of adequacy, America’s ten biggest banks by assets appear in reasonable shape. Typically, their ratios of tier-one capital to risk-weighted assets exceed 10%). However, the quality of their tier-one capital has crumbled. Only about half now consists of tangible common equity, the purest and most flexible form of capital which bears the “first loss” when an asset goes sour. The rest is largely preference stock, much of it government-owned, which is not truly loss-bearing. For example, the dividends on Citigroup’s government preference shares can be deferred but not cancelled, unlike those on common stock. The original Basel rules on capital adequacy sought to limit such “hybrid” capital that sits between equity and debt. But most governments like preference stock because it does not carry votes, and thus avoids nationalisation, and because the more secure dividends protect taxpayers, providing the bank does not go bust.”

Just by transferring the money from one pocket to another you cannot create more cushion for loss provisions except for the dividend flow that you may save through such conversion to common stock.

While a bank is definitely obligated to pay interest on its borrowings – it makes money/profit or not – as regards preferred to the best of my understanding the bank is obligated to pay only if it can i.e. it has sufficient reserves and/or profits to do so. If it cannot, then it can cumulate based on the terms. And if at maturity it still cannot pay – period it cannot pay.

First there is a clamor that TCE is not sufficient and then when it is provided through some level of nationalization then the allegation is that you have moved away from the ‘Right’. So this ‘damned if you and damned if you don’t’ attitude shows the paranoia in the market where all logic seems to have been lost.

5. Even the best like Mr. Buffet who has sown the seeds of success on others fears and reaped the benefits from others greed has stated in his annual letter to shareholders that:

“During 2008 I did some dumb things in investments. I made at least one major mistake of commission and several lesser ones that also hurt. … Furthermore, I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action.

We're certain, for example, that the economy will be in shambles throughout 2009… and, for that matter, probably well beyond … but that conclusion does not tell us whether the stock market will rise or fall.

Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown. Had that occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat.”

Such desperateness and pessimism shows that even at such levels of knowledge, experience and expertise doom and gloom conversion is happening. A definite positive sign.

Read this conversation too.

6. The protectionists mess up is starting.

“President Barack Obama’s proposed removal of tax incentives for American companies outsourcing jobs could mean that large outsourcing customers such as GE and Citibank might have to pay certain taxes on their income from international markets, making it less attractive for customers to send IT projects to cheaper offshore locations…

However, experts argue that such protectionist measures are short-sighted because many US companies derive significant revenues from outside the country, and any protectionist stance could lead to a backlash in other markets. For instance, Citigroup in 2007 generated 52% of its revenues outside the United States, and over 60% of its workforce operated from abroad, as its banking business spanned 100 countries. Citigroup’s international revenue streams kept pace through 2008, despite the financial crisis, and amounted to a whopping 74% of the total revenues.”

These signs are by no means are exhaustive but do provide some vital pointers. As I see it we are some where close to beginning of the lower part of U and the bottom formation may run for a reasonably long period and may take a more flattish shape. How long, depends upon how the politicians across the globe play their cards.

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