Coming Full Circle

Is it just me or does anyone else find it somewhat ironic, that one of the most often sighted reasons for the current predicament we now inhabit, namely that interest rates were held too low for too long by the Greenspan Federal Reserve, is apparently one of the cures.

The cheap money policies of the Federal Reserve that led directly to the biggest housing bubble in history and an acceleration of an even bigger debt bubble, is now the one the answers for how to fix it. Inquiring minds may wish to ask why the US government's brightest think this is the right path to take.

Quite simply the answer is that they don't know anything else, the Federal Reserve is the proverbial one trick pony. They encourage speculative bubbles on the way up and then rather than let them deflate of their own accord, try to reflate them on the way down.

This asymetric approach to monetary policy is a key reason why the US stockmarket is now lower than it was 10 years ago. Instead having a proper recession in 2001 and letting asset prices correct to realistic levels the Fed propped it up with cheap money.

That may seem to be a strange statement in light of the fact that the S&P500 declining -49%, but that was after the ridicuous prices of the dotcom bubble. That meant that the ensuing bullmarket that kicked off in 2003 started at the highest market P/E ratio in history.

The corporate profits that drove stock prices were underpinned by an unsustainable low cost of capital causing unsustainably high profit margins. What you are seeing now is a steady reversion to the mean. However, once again the one trick ponies at the Federal Reserve are doing their best to prevent that from happening.

Will it work? David Callaway of marketwatch.com suggests it won't and I think he may be on to something.

Arguably, it was a dramatic easing of interest rates after the tech bubble collapsed that plunked us into the systemic soup in the first place, allowing people to take out mortgages at ridiculous rates and Wall Street to make a killing by packaging the mortgages and playing various rates off each other. But it won't work this time around. Nobody's lending, and nobody is borrowing.

Since the current consensus is that financial armageddon and the great depression markII has been avoided, attention has turned to how bad the current recession will be and how bad are corporate profits are going to feel the pinch. There mainstream is that the 4Q08 will be the trough of the recession and that the US economy will be on the road to recovery in the second half of 2009.

Since the consensus never saw the current crisis coming, never saw a stockmarket decline or a corporate profits recession, I feel comfortable in betting that the consensus will be proved wrong again.

US Home Prices Down 20%+ Cash Shiller

Both the 10 city and 20 city Case Shiller Home Prices Indices are now down more than 20% from peak to trough. I'm actually surprised that the year over year declines continue to increase, albeit at a slower pace. Remember that the Case Shiller numbers are for August and that recent data on new and existing home sales point to further declines in US home prices.

That shouldn't be surprising, on a 20 city basis, US home sales have reverted to price levels last seen in May 2004. So if you bought a home prior to 2004 there is a good chance you are still in front. However whatever gain you are sitting on will continue to erode or disappear altogether over the next 12 - 18 months

Did Someone Say More Capital?

Last week I noted in "Bank Injections just the Beginning" that US banks would need much more than the $50 billion that has been injected by the TARP program to date. The story below is about UK banks, but it is a pre-cursor to what is coming down the pike for US banks. From the TIMESONLINE:

Banks may need further support from taxpayers as recession bites
Britain's banks may need to raise capital above and beyond the £50 billion of taxpayer-underwritten money already earmarked for them.

The Bank of England's report into financial stability today suggests that a recession as severe as that of the early 1990s would lead to credit losses of £130 billion for Britain's six biggest financial institutions and possibly wipe out the entire government-backed funding package.

Not only will US banks be getting more capital but I think one or more of the large players, GS, C, MS for example will be forced to merge with another entity just to survive.

Sign of the Times in Retail

Oh well, Friday in the US turned out to be somewhat of a fizzer, the market falling just -3.5%. A year ago a move of that magnitude would have seen major headlines, today however, such moves seem relatively tame.

Markets in asia today continued to slide, the Nikkei opened up and is now down more than -5% as I write. But enough of the market commentary. This post is about somethign much more trivial. Today I had a read of Specialty Fashion Group's annual CEO's report. This is what it had to say on the outlook for 2009.

We anticipate a tough financial year ahead. As mentioned previously, July trading was good and we saw positive growth compared to last year. However, since then we have experienced a decrease in foot traffic through our stores and like for like sales have been negative for the past three months.

We certainly support the Federal Government’s pre Christmas spending package and anticipate the extra cash for pensioners and families will provide some boost for us through the significant Christmas trading period.

The environment is very volatile at present and with the Christmas trading period still ahead of us, our first half results remain unpredictable.

There is nothing special in this, it is just a continuation of a growing trend within the retail industry. If you didn't see it last week, here is what Harvey Norman had to say on their October sales:

Like for like writen sales for the 28 days ended 19th October 2008 from the franchised "Havey Norman" stores in Australia decreased by 5.8% when compared to the same period last year. Retail margins continue to be under pressure.

I'm aware that retailers like JB Hifi seem to be continuing to do well, but for how long can that be sustained? Unemployment in Australia has yet to rise significantly and with households carrying the biggest debt burden in history the stimulus lobbed at Australian consumers by the government will be barely noticed.

Whilst the stock prices of retailers have taken a battering along with the rest of the market, given the headwinds faced by consumers, I believe the extent of the economic slowdown in Australia is yet to be priced in for most of the major retailers. My favourite pick in this sector is TRS, but even they need to get cheaper for me to dip my toe in.

Are You Exhausted Yet?

As I sit down to type this on Friday night, the German and French stockmarket's are down more than -8%, the UK is down more than -7%, S&P500 futures are down -6.5% which is limit down. Limit down is the circuit breaker that prevents further selling until the market has had time to cool off.

The speed at which events are unfolding is mindnumbing. There are so many things to write about but it is just impossible to include them all. Things like the Baltic dry index, down more than 90%, the UK economy has just contracted -0.5% in 3Q08. The unintended consequences of backing Australian bank depostis leading to a halt on redemptions by the likes of Perpetual, AXA and Babcock & Brown. OPEC cutting 1.5 million barrels of production. Falls in International air passenger traffic not seen since the SARS scare of 2003. and on it goes.

It's against this backdrop that panic is starting to take hold. Just 2 weeks ago stockmarkets experienced their worst week since the great depression. However the panic seems more extreme at this moment, I heard on bloomberg tonight one trader say "God help us!" That is the kind of talk I've been wating to hear. The capitulation low that everyone has talked about might be here.

That said, I wouldn't be surprised to see the market finish up in the US today, although it looks highly unlikely at the current time, that's the kind of volatility we are dealing with. The VIX has exceeded all previous records - which leads to another point worth noting.

We keep hearing comparisons to previous times, the bear market of 1974, the recession of the early 1980's, the depression of the 1930's. However, this market continues to defy all expectations. We are in unchartered territory and all the old metrics can't be relied upon.

We have unprecedented leverage in the form of hedge funds and exotic financial instruments such as credit default swaps. Sure there have been times of excessive leverage in the past but nothing even comparable to the present day.

All that said, if you are a long term investor that tries to purchase shares in good businesses at fair prices then there is reason to be optimistic. The current prices of many businesses have not seen such attractive levels for a couple of decades. It takes of bit of courage to wade into the markets with such uncertainty, but if you can stick to a disciplined approach you will be well rewarded in a few years time.

ANZ Profit Down -23%, Waffle on Outlook

ANZ today unveiled a -23% drop in cash earnings which had largely been flagged to the market well in advance. Basically ANZ suffered from a few large exposures to weapons of finacial mass destruction as NAB did. As can be seen below those exposures led to a huge spike in credit loss provisions.

On the all important outlook for 2009, ANZ bascially admitted that they don't have a clue.:

Commenting on the 2009 outlook for ANZ, Mr Smith said: “Market conditions globally remain difficult and unpredictable. The restructure of our business announced in September is designed to accelerate progress with our Super Regional Bank strategy, lift customer focus and drive performance improvement.

“Managing a large commercial bank means managing through a range of conditions. While we expect choppy conditions to continue in 2009, ANZ is well positioned to manage this cycle, to continue to invest and maximise the opportunities which arise.

“We have the foundation, a clear direction and the capacity to deliver performance and value to our shareholders over the longer term,” Mr Smith said.

That is corporate speak for we don't have a clue. Again, as with NAB if you think these these banks are relatively stable and can maintain earnings and therefore dividend levels then they may not be such a bad place to be as interest rates continue to be cut. However, given the outlook for credit can how much certainty can you put in that scenario playing out?

Bank Injections just the Beginning

I've noted over the past week the improvement in certain credit metrics such as the TED spread and LIBOR rates, however it is one thing to provide liquidity and guarantees to the system but quite another to get banks freely lending to corporates and houselholds.

The conventional wisdom of the treasury directly injecting capital into the "chosen ones" is that it will help shore up their capital bases and that would give them confidence to start lending to each other again and kickstart lending in the broader economy.

However, as Chris Whalen of Instituional Risk Analytics points out in the following interview, the losses coming down the pike will mean that the capital injections will be used just to absorb those losses and thus more funds will be needed to prop up these institutions in the coming months.

Who the hell is Chris Whalen and why should we believe him? Whalen is one of the few that went against the chorus of bullish cheerleaders and predicted the current crisis and the implosion of Freddie and Fannie. Much more credible than the pundits that never saw the current crisis coming and are now saying that the worst is over.