Tuesday, October 23, 2007

Subprime collateral damage.

Wow. The whole article by Stephen Roach is very thought-provoking. The only caveat is that consumer slowdown in the US has been predicted unsuccessfully for the past few years. Never bet against the American consumer. But the consumer only has to slow down once to disprove this notion. The absence of a black swan does not preclude it's existence.

Will it happen? I think so. $100 crude might just do the trick.

From John Mauldin:

As always, the cycle of risk and greed went to excess. Just as dot-com was the canary in the coalmine seven years ago, subprime was the warning shot this time. Denial in both cases has eerie similarities - as do the spillovers that inevitably occur when major asset bubbles pop. When the dot-com bubble burst in early 2000, the optimists said not to worry - after all, Internet stocks accounted for only about 6% of total US equity market capitalization at the end of 1999. Unfortunately, the broad S&P 500 index tumbled some 49% over the ensuing two and a half years and an over-extended Corporate America led the US and global economy into recession. Similarly, today's optimists are preaching the same gospel: Why worry, they say, if subprime is only about 14% of total US securitized mortgage debt? Yet the unwinding of the far broader credit cycle, to say nothing of the extraordinary freezing up of key short-term financing markets, gives good reason to worry - especially for over-extended American consumers and a still US-centric global economy.

How all this plays out in the global economy in the years immediately ahead is anyone's guess. I have long framed the tensions shaping the outlook in the context of "global rebalancing" - the need of a lopsided world economy to wean itself from a US-centric growth dynamic. A partial rebalancing now appears to be at hand - likely to be led by the coming consolidation of the American consumer. That is painful but good news for those of us who have long worried about the destabilizing risks of a massive US current account deficit. But a more complete global rebalancing is a shared responsibility - one that must also be accompanied by an increase in domestic demand from surplus-saving economies elsewhere in the world. To the extent that doesn't happen - and, as underscored above, that remains my view - then a asymmetrical rebalancing dominated by slowdown in US consumer demand should take a meaningful toll on global growth.

It is high time for monetary authorities to adopt new procedures - namely, taking the state of asset markets into explicit consideration when framing policy options. Like it or not, we now live in an asset-dependent world. As the increasing prevalence of bubbles indicates, a failure to recognize the interplay between the state of asset markets and the real economy is an egregious policy error.

I never thought about collateral damage from subprime. Subprime related losses are estimated to be upwards of $240 billion, excluding any collateral.

Inflation targetting by the Fed, is probably worth another post.

Valuations in emerging markets have reached an interesting crossroads. Economist came out with an article which suggested that 2008 for emerging markets might be like 1999 for tech stocks. You can make a fortune off a bubble. I would like to believe that markets like Taiwan, Singapore and India will one day resemble a bubble valuation (with PEs in excess of 50s). At a PE of around 25 with operating earnings growth of 30%, we have some ways to get there.

Enjoy the party while the music is loud.

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Friday, October 5, 2007

Richard Russell

From investmentpostcards :
Richard Russell: “There are times when all you have in this business is your instinct. I’m going to use my instinct now. I think it’s time to be rather cautious toward this market. We’re in a very tricky area. I’ve said repeatedly that this is not an institutional market. It’s more of a trader’s market. And traders can reverse their opinion and actions at the drop of a hat.

“I’m getting a bit nervous about this market. It’s not one thing that I can put my finger on, but I’m watching those Lowry’s figures. I’m watching the rising number of new lows, and I keep waiting for volume to expand on the days when the market is higher. So let me put it gingerly. My instinct tells me that this is not a great time to be loaded with a broad spectrum of stocks. I think the best thing that could happen now would be the majority of stocks fluctuating within a trading range, while the Dow and maybe the ‘big’ stock averages tend to head higher. This has become a true two-tier market.”

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Monday, October 1, 2007

Bankruptcy bonanza: defaults to soar 10 times.

This was scary

...Bankruptcy experts believe that what lies ahead for their industry is the greatest market since the epic failures of Enron and WorldCom led a parade of corporate defaults that ultimately totaled $290 billion. With the credit markets in turmoil and the financial wreckage from the subprime mortgage meltdown spreading, the number of companies in financial distress rose the fastest in four years last month. Standard & Poor’s says defaults could soar nearly tenfold next year.

Over the next three years, $470 billion in loans to financially shaky companies will mature, according to Jefferies, as will an additional $120 billion in junk bonds. Many of those companies will find new loans hard to get, or at the very least far more expensive in a market now wary of risk.

“The opportunity [for firms like ours] has the potential to be larger than the last [down leg of the] cycle,” said Thane Carlston, co-head of Jefferies’ financial services advisory group.

Restructuring experts believe that the bumper crop of bankruptcies will include some of the richest pickings ever. They note that bankruptcy work in recent years has become more complex—and lucrative—because of a host of financial innovations. High up on that list is the explosion of derivatives that enable investors to bet on defaults.

These instruments, in their infancy when Enron and WorldCom collapsed, represent a $35 trillion market today. With investor exposure to default so vast and diffuse, it would take time to figure out who exactly is on the hook for precisely what in a big bankruptcy case.

“These are uncharted waters for everybody,” said Mr. Carlston.

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