Sunday, April 27, 2008

Quotable quotes: The World this week.

This is a weekly update on what I've been reading and watching. Here's what the market gurus are saying and how they are positioning themselves in the near future.

Robert Shiller:

Yale University economist Robert Shiller, pioneer of Standard & Poor’s/Case-Shiller home-price index, said there’s a good chance housing prices will fall further than the 30% drop in the historic depression of the 1930s. Home prices nationwide already have dropped 15% since their peak in 2006, he said.
“I think there is a scenario that they could be down substantially more,” Mr. Shiller said during a speech at the New Haven Lawn Club.

Joseph Stiglitz: US facing long recession:

The U.S. economy is already in recession -- and may echo the 1930s, Nobel Laureate Joseph Stiglitz said Friday.

"This is going to be one of the worst economic downturns since the Great Depression," said Stiglitz.

Other downturns were primarily caused by excesses in inventories or inflation; but this slowdown is due to the condition of "badly impaired" banks and financial entities, which are unwilling and/or unable to lend capital -- stymieing the very borrowers who usually drive the country back to vitality, Stiglitz said. And the Federal Reserve may have used up its ammunition -- and the faith investors and planners have put in it.

"The savings rate as we go into the recession is zero. Which means [savings] will go up, " he said -- decreasing consumer spending and weakening retail further.

"If you really wanted to stimulate the economy, increase unemployment insurance," he suggested.

Economy has been impaired by Bush tax cuts. These, plus the Iraq war, are to blame for the majority of the mess we are in.

Jeremy Grantham rips Greenspan: (Must read)

It’s not that the former Fed boss Greenspan was incompetent that is remarkable. Incompetence is common enough after all, even in important jobs. What’s remarkable is that so many people don’t seem, even now, to get it. Do people just believe high-quality self-justifying blarney?
Greenspan came onto my radar screen in the late sixties as a seller of economic and financial advice to the investment industry. To be brutally honest, he was considered run of the mill by anyone I knew then or have met later who knew his service then. His high point in most memories, certainly mine, was a famous call in January 1973 that, “it is rare that you can be as unqualifiedly bullish as you now can,” a few days before a market decline of over 60% This was one of the first of a long line of terrible prognostications for which he has remarkably not been remembered.

Greenspan’s book and, even more disgraceful, articles in the Financial Times (and that’s a very high hurdle!), sidestep all blame and admit few errors. His article described housing “as an accident waiting to happen.” Actually it’s brilliant when you think about it: take a distant, almost academic tone and perhaps people will ignore the facts that: first, you allowed the situation to develop; second, did not apparently see it forming (despite 2½ to 3 standard deviation data for housing that suggested a 1 in 80-year event); and third, obliquely or directly blame others. It really is shameful!

Looking back at the evidence (strong circumstantial evidence is all you can often get in economics), we can see that the two great economic setbacks of the 20th Century – the 1929-34 Depression and the rolling depression in Japan since 1989 – were both preceded by major asset bubbles and speculation. Milton Friedman and his troops can maintain that this suggested relationship between bubbles and troubles is nonsense and that all that was needed was good monetary policy. My response is that this view represents a touching faith in economic and financial theory of which tricky humans make a mockery.

Equities, though, are the Mr. Hyde to fixed income’s Dr. Jekyll. Where poor Dr. Jekyll sees drawn out problems, Mr. Hyde sees opportunities and quick recoveries. The animal spirits of the stock market have been nurtured by strong fundamentals and generous credit globally and fertilized by increasing quantities of moral hazard since 1982. Stocks refuse to worry that this is indeed the end of an era, as we believe, and apparently as much of the fixed income market believes. This has been a classic case where secondary, low-quality companies that have fundamentally thrived in this extended boom ended up with both peak margins and a premium P/E. Because of this past favorable set of circumstances, the low-quality companies are exposed to a triple threat: their absolute and relative margins decline; their P/Es fall relative to the market, multiplying their pain; and they are far more exposed than average to a severe credit crisis. still believe that the U.S. market will not bottom for some time – 2010 still looks good – we must be prepared for plenty of rallies to fill in the time. High animal spirits, fortified for so long by good times and moral hazard, will not give ground easily.

David Kotak (Cumberland) :

The minimum bid in the most recent auction (April 21) was 2.05%. In the previous auction (April 7) the minimum bid was 2.11%. In the most recent auction the stop out rate which was awarded to all bidders was 2.87%. In the previous auction the awarded rate was 2.82%. So the minimum bid went down while the award rate went up. The spread widened by 11 basis points. That is not suggestive of a market returning to normalcy.

Remember that this auction occurs when the Discount Window rate is 2.5% and when the targeted Fed Funds overnight rate is 2.25%. And it is important to understand that the minimum bid specified is a market based price of the expected Fed Funds rate over the 28 day term. We should also note that the TAF auction rate was very close to LIBOR. And LIBOR has been the subject of much negative press recently as followers of money markets know.

Our conclusion is that credit markets are still dysfunctional and the process of normalcy restoration has a long way to go. And there seem to be reasons why banks are reluctant to borrow and extend credit to others in the banking fraternity. Some suggest that there is distrust of banks by other banks. They call this counter party risk. Others suggest that banks are hoarding cash and quoting higher interbank lending rates in order to discourage borrowing.

We offer this final note. Various measure of spread based risk premiums have been at extraordinary levels since last June when the turmoil started. These widened spreads are taking an economic toll. We expect that the Fed will persist until it gets them to narrow.
If the Fed fails, we will have a difficult and protracted deflationary recession. If the Fed succeeds, the slowdown will be shorter and shallower. The Fed’s success will be easily measured in the narrowing of spreads. In the case of the TAF one will see the stop out rate fall to a level closer to the Discount Window rate.

John Mauldin: (Money Velocity mean reverting)

Now, why is the velocity of money slowing down? Notice the real rise in V from 1990 through about 1997. Growth in M2 (see the above chart) was falling during most of that period, yet the economy was growing. That means that velocity had to rise faster than normal. Why? Primarily because of the financial innovations introduced in the early 90's like securitizations, CDOs, etc. It is financial innovation that spurs above trend growth in velocity.

And now we are watching the Great Unwind of financial innovations, as they went to excess and caused a credit crisis. In principle, a CDO or subprime asset backed security should be a good thing. And in the beginning they were. But then standards got loose, greed kicked in and Wall Street began to game the system. End of game.

What drove velocity to new highs is no longer part of the equation. Its absence is slowing things down. If the money supply did not rise significantly to offset that slowdown in velocity the economy would already be in a much deeper recession.

Bill Miller :

I think the credit panic ended with the collapse of Bear Stearns, and credit spreads are already much improved since then. If spreads continue to come in, the write-offs at the big financials will end, and we may even have some write-ups in the second half instead of write-downs. Valuations are attractive, and valuation spreads are now about one standard deviation above normal, a point at which valuation- based strategies usually begin to work again, and momentum begins to fade. I think likewise we have seen the bottom in financials and consumer stocks, but not necessarily the bottom in headlines about the woes in those sectors. Although the economy is likely to struggle as it did in the early 1990s, the market can move higher, as it did back then.

The wild card is commodities. If commodities break, or even just stop their relentless rise, equity markets should do well. If they continue to move steadily higher, they have the potential to destabilize the global economy. I agree with George Soros that commodities are in a bubble,
but it also appears he is right when he describes it as one that is still inflating, and we still have the summer driving and hurricane season with which to contend.

The Fed, in my opinion, needs to focus on the value of collateral and not on the price of credit.

Michael Kahn (Barron's getting technical):

Helping the bullish argument: The S&P 500 index has been able to hold its ground over the past few days. Mild pullbacks are often due to profit-taking rather than an urgent desire to get out of the market or sell it short. Contrast recent action with the January, February and early April peaks when the market sold off sharply within only one or two days. Strong markets tend to pause at resistance levels as they prepare to break out to the upside.

Market bears point out that volume over the entire March-April rally declined. I am always harping on how a rally without volume is like a car on an empty fuel tank. It can coast, but powering higher is unlikely.

But the index made a slightly lower low in March than it did in January, while technical indicators such as momentum made a higher low. This divergence between price and indicators is somewhat bullish and that makes resistance at 1395 for the S&P 500 important from a long-term point of view as well as from the short term.

A move above that level would also resolve a long-term pattern to the upside at the same time as breaking out from a shorter-term pattern. It is decision time for the market. There is technical evidence favoring both bulls and bears so we have to let the market decide who is right. Drawing a conclusion while the S&P 500 and many other indexes are in four-day pauses below key resistance levels is a bit hasty.

John Thain:

On the capital side, we've increased our stated capital from $36.7 billion at the end of the fourth quarter to $41 billion. We are well capitalized under the risk weighted asset tests. And, for those of you who like to blog, we do not have any plans to raise any additional common equity, and Nelson actually agrees with that.

Deutsche Bank:

Germany's biggest bank today banned staff from visiting brothels on expenses and putting hotel TV porn channels on their company credit card.

The crackdown came in new rules issued to executives as Deutsche Bank cuts costs after losing at least £2billion so far in the global credit crunch.

"Deutsche Bank does not approve of any adult entertainments and such expenditures will not be reimbursed", according to the memo leaked to news magazine Spiegel. According to Spiegel, the new edict was aimed at senior staff in the bank's communications and social responsibility department.