Fifteen Notes on the Markets
Saturday, November 1st, 20081) Where are we? Is the equity market cheap or dear? Personally, I think it is cheap, and though it might rally in the short run, it could get cheaper. When the financials are compromised, all bets are off. Here are some article indicating that things are cheap:
- Steve Leuthold (what a guy!)
- Wall Street Journal
And, not cheap, consider the arguments of this humble student of the markets. He considers survivorship bias and war as factors that investors should consider. I agree, and I would urge all to consider that wars often occur as a result of economic crises.
2) The trouble is, quantitative finance is tough. We don’t have enough data. Our models are poor, and until recently, often reflected two major bull cycles, and only one bear cycle. My view is that the equity premium is more like 3% over the long run, and not the 6% bandied about by careless consultants.
3) During the “great moderation,” I argued over at RealMoney that volatility and credit spreads were too low, and would eventually snap back. Okay, we are there now. Volatility is high, and so are credit spreads. The brain-dead VAR models used by Wall Street have been falsified again. Quantitative investors have gotten savaged again; it only works when implied volatility is flat/declining — it is an implicit credit bet.
4) This is a global crisis. Where is it appearing?
- The Gulf States (notable since they have had huge trade surpluses)
- Emerging markets, especially Ukraine
- Japan (and again)
- More emerging markets
5) As I have mentioned before , the IMF, previously seeming irrelevant, has a new lease on life. But how much firepower do they have, and will countries in crisis send them money to aid foreigners?
Consider their new plans for a short term lending facility, and the exogenous shocks facility. They will have a lot to fund in this environment.
6) Might government programs to guarantee bank deposits have caused a shift from stocks to bank deposits? Possible, though for every seller, there is a buyer.
7) How do we pay back what we borrow? Who will borrow more from us? Those are the great unanswered questions as we attempt to bail out many troubled entities. I’m a pessimist here, and think that we will have higher long rates as a result, and that “Bernanke” will become a cuss word. (Among the cognoscenti, only “Greenspan” will do as a proper insult.) On the despondent side, will the US default in 2009? Doom-and-gloomers are always early, and ignore the flexibility in the financial system prior to failure. I see default as more of a 2017-2020 issue.
8 ) Uh, let Lawrence Meyer pontificate. There is nothing good about a zero Fed funds rate. Let him wax grandiloquent about Japan over the past two decades. Consider how low interest rates destroy money markets funds. Consider as well how much low rates destroy saving, sometyhing that we have had too little of.
9) In an environment like this, every M&A deal is open to question. M&A is credit sensitive, and higher volatility impairs the flow of credit.
10) I don’t think that GAAP mark-to-market accounting has had a material impact on this crisis. True, many accounting firms have interpreted mark-to-market as mark-to-last-trade, but that is not what SFAS 157 specifies, and firms can ignore their auditors (with some risk). The truth is that the firms that have failed choked on bad balance sheets and inadequate cash flow. It doesn’t matter what the accounting rules are when a company is running out of cash. Cash is impervious to accounting rules.
11) Want a closer view of the Fed and politics. Read this piece at The Institutional Risk Analyst. While at RealMoney I espoused a view that the Fed was more political than economic. This article confirms it.
12) How do I view Greenspan’s apology?
13) At a prior employer, we often commented that credit risk in credit cards appears late in the credit cycle. Well, we are there now. It is seemingly the last form of credit to default on. In this environment, one can lose their home, but losing financial flexibility can be bigger.
14) The FDIC can modify many mortgages, at a cost to taxpayers. It could cost a lot, and many people who made dumb decsions could be bailed out by the prudent.
15) If John Henry were alive, he would be smiling. Let humans make markets, and not machines.
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