Seven Notes on the Current Market Mess

1)  Avoid short-cycle data.  When writing at RealMoney, I encouraged people to ignore short-term media, and trust those that gave long-term advice.  After all, it is better to learn how to invest rather than get a few hot stock picks.

In general, I read writers in proportion to their long-term perspective.  I don’t have a TV.  I rarely listen to radio, but when I do listen to financial radio, I usually feel sick.

I do read a lot, and learn from longer-cycle commentary.  There is less of that around in this short-term environment.

When I hear of carping from the mainstream media regarding blogging, I shake my head.  Why?

  • Most bloggers are not anonymous, like me.
  • Many of us are experts in our  specialty areas.
  • Having been practical investors, we know far more about the markets than almost all journalists, who generally don’t invest, or, are passive investors.

Don’t get me wrong, I see a partnership between bloggers and journalists, producing a better product together.  They are better writers, and we need to get technical messages out in non-technical terms.

We need more long-term thinking in the markets.  The print media is better at that than television or radio — bloggers can go either way.  For example, I write pieces that have permanent validity, and others that just react to the crisis “du jour.” Investors, if you are focusing on the current news flow, I will tell you that you are losing, becuase you are behind the news flow.  It is better to consider longer-term trends, and use those to shape decisions.  There are too many trying to arb the short run.  The short run is crowded, very crowded.

So look to value investing, and lengthen your holding period.  Don’t trade so much, and let Ben Graham’s weighing machine work for you, ignoring the votes that go on day-to-day.

2)  Mark-to-Market accounting could not be suppressed for long in an are where asset and liability values are more volatile.  Give FASB some credit — they are bringing the issue back.  My view is when financial statement entities are as volatile as equities, they should be valued as equities in the accounting.

3)  Very, very, weird.  I cannot think of a man that I am more likely to disagree with than Barney Frank.  But I agree with the direction of his proposal on CDS.  My view is this: hedging is legitimate, and speculation is valid to the degree that it facilitates hedging.  Thus, hedgers can initiate transactions, wtih speculators able to bid to cover the hedge.  What is not legitimate is speculators trading with speculators — we have a word for that — gambling, and that should be prohibited in the US.  Every legitimate derivative trade has a hedger leading the transaction.

4)  I should have put this higher in my piece, but this post by Brad Setser illustrates a point that I have made before.  It is not only the level of debt that matters, but how quickly the debt reprices.  Financing with short-term dbet is almost always more risky than financing with short-term debt.

Over the last six years, I have called attention to the way that the US government has been shortening the maturity structure of its debt.  The shorter the maturity structure, the more likely a currency panic.

5)  Look, I can’t name names here for business reasons, but it is foolish to take more risk in defined benefit pension plans now in order to try to make up  the shortfall of liabilities over assets.  This is a time for playing it safe, and looking for options that will do well as asset values deflate.

6)  Junk bonds have rallied to a high degree; at this point I say, underweight them — the default losses are coming, and the yields on the indexes don’t reflect that.

7) Peak Finance — cute term, one reflecting a bubble in lending/investing.  Simon Johnson distinguishes between three types of bubbles — I’m less certain there.  Also, I would call his third type of bubble a “cultural bubble,” rather than a “political bubble,” because the really big bubbles involve all aspects of society, not just the political process.  It can work both ways — the broader culture can draw the political process into the bubble, or vice-versa.

The political process can set up the contours for the bubble.  The many ways that the US Government force-fed residential housing into the US economy — The GSEs, the mortgage interest deduction, loose regulation of banks, loose monetary policy, etc., created conditions for the wider bubble — subprime, Alt-A, pay-option ARMs, investor activity, flipping, overbuilding, etc.  In the process, the the federal government becomes co-dependent on the tax revenues provided.

I still stand by the idea that bubbles are predominantly phenomena of financing.  Without debt, it is hard to get a big bubble going.  Without cheap short-term financing, it is difficult to get a stupendous boom/bust, such as we are having.  That’s just the worry behind my point 4 above.  The US as a nation may be “Too Big To Fail,” to the rest of the world, but if the composition of external financing for the US is becoming more-and-more short-term, that may be a sign that the endgame is coming.

And, on that bright note, enjoy this busy week in the markets.   Last week was a tough one for me personally; let’s see if this week goes better.

6 Comments

  • JoshK says:

    David, I always enjoy your articles and often agree with them. What I don’t get is why you would impose such strict limits on CDS? Much of finance is gambling, that doesn’t justify singling out CDS. We often value deep OTM puts similarly to CDS. I’m not sure I see the difference.

  • Dan says:

    David,

    Underweighting junk seems reasonable enough, but what if cash or govts are not available options? If your only other choices were equity-like, would you still want to pare high-yield? I’m trying to gauge the relative effects of rising defaults. Thx

  • Mikey says:

    couple typos in one sentence: “Financing with short-term dbet (debt) is almost always more risky than financing with short-term (long-term) debt”

  • IF says:

    4) Replace second ‘short’ with ‘long': “Financing with short-term dbet is almost always more risky than financing with short-term debt.”

    5) I will call Calpers: http://www.calculatedriskblog.com/2009/07/double-up-to-catch-up.html

  • Dave: “I still stand by the idea that bubbles are predominantly phenomena of financing. Without debt, it is hard to get a big bubble going. ”

    I agree with you that debt elevates a bubble to a much larger one; but we can certainly have big bubbles without debt. Consider the dot-com (aka TMT) bubble in the late 90’s. I would argue that had little to do with debt yet it was a massive bubble (not as big as the current credit bubble & bust but still very large)…

  • q says:

    @Sivaram — he said “predominantly”, and he also said “financing”.

    the dot com bubble was aided by easy equity financing, not debt financing.

    debt bubbles are ‘worse’ in several respects, stemming from the fact that creditors have a strong claim to being paid back whereas equity holders simply see their equity disappear.

    one of the reasons it passed quickly was that the assets involved were all marked to market and the financiers didn’t have any claim to being paid back.