Sunday, 21 September 2008

Watching a Train Wreck in Slow Motion.

It was difficult not to get caught up in the events of the last week. Stockmarkets around the world were yanked violently in both directions as The United Soviet States of America took another step toward socialism by banning short selling on financial companies. Not only that, the latest news is that the Federal Government is going to take hundreds of billions (Probably trillions) in mortgage related assets onto their balance sheet.

We should not underestimate the gravity of the situation. The financial world is in turmoil and understandably so, as the biggest credit bubble in history, 25 years in the making, continues to implode. However this is no ordinary implosion, this is not a stockmarket correction or an economic slowdown. This is a once in a lifetime event, a train wreck in slow motion.

The train has been off the rails for a while but all the passengers had the illusion of safety. More recently a couple of the dare devil passengers fell out the window, or were they thrown? However, the train driver (the US government and the Federal Reserve) is soothing the rest of the passengers nerves with reassuring bromides like "the US financial system is fundmentally sound". Of course they would say that wouldn't they?

But the financial system is not fundamentally sound, in fact it is fundamentally unsound. How sound is a financial system where one small broker dealer called Bear Stearns could threaten to bring down the entire system and lead the Federal Reserve to step in and guarnatee $30 billion in liabilites?

Some of the passengers have woken up to this fact and have begun short selling financial companies. They realise that the broker dealer model built on ridiculous leverage and worthless mortgage paper is dead and that certain banks will be writing off foreclosed homes for years. However, before they could really get going the train driver gave them all an anesthetic and threw them under the wheels.

However the train keeps moving on, gaining speed, so the train driver looks around for something else. US taxpayers! That'll do the trick and out the window they go, but the train ploughs on. They could pull on the brake but noone wants to do that, there is no political will, anyone with the power to pull on the brake has too much at stake. And so the maintenance of the gravy train must go on.

Do I have an unhealthy obsession with trains? No, I just got carried away with the analogies. I apologise for that. Hopefully you didn't get lost. The point is, the US government has now reached desperation stages and is now pulling out all the stops. How and when will it all end? I won't even pretend to know the answer. All I know is, it will get worse before it gets better, much worse.

The actions to prevent short sellers repricing financial stocks closer to fair value doesn't mean a floor has been put under stock prices. It just means the revaluing of asset prices will take longer and be more drawn out.

In the space of 4 trading days, MQG shares fell more than -40% and then bounced back almost 38% the very next day. What the true value of MQG shares is a question I don't purport to answer, but the point is that the market clearly doesn't either.

So don't get caught up in the day to day noise, except when stocks with good economic fundamentals, get absolutely punished to the point where they represent good buying opportunites.