Gene Inger's Daily Briefing. . . . for Monday, September 17, 2007:
Sellers retreated; buyers defeated . . . pretty much describes the rangebound chop of the week just past, which included the fairly typical rebound of midweek prior to the Quarterly Expiration week. Volatility and sobriety should increase in the new week for a series of reasons ingerletter.com members are aware of; plus increasing likelihood that an aware general public will start to comprehend the depth-and-breadth of debt issues we forecast to dominate the last few months distribution including a finale rally transpired and completed in the targeted mid-July timeframe. Ready for next phases?
While most optimists generally now portray what is an historic distortion of derivatives assets on the books of many entities; including larger money-center banks, in varying degrees of magnitude, by simplifying matters to such phrases as the market's 'bark is worse than its bite', the reality is something considerably more dangerous ahead. That may be so even 'if' markets respond favorably to daily-basis Fed action unless it also develops that something is done to reverse the 'structured to fail' mindset. Also it was notable that our interpretation of Chairman Bernanke's Berlin remarks were very clear, and revealed the likely predilection of Fed monetary policy leanings, contrary to all perceiving it arcane. That clarity is reemphasized by former Chairman Greenspan.
When you envision the long-term Dow or S&P charts accompanying these remarks, you can visualize what we have talked about with respect to a 'solo-walk' of the Dow Industrials, versus a long-term double-top of the S&P, during the much-ballyhooed advance of the stock market earlier this year, and as we forewarned that rallying was dangerously in a narrow-universe of stocks. It is particularly interesting to look at the long-term, versus arguments from pundits that we 'already' had sort of big corrections which haven't occurred this year from a significant historical perspective. Sure, that's no assurance it's out there, though I tend to suspect (as noted to members), for any number of reasons. Well advertised now? Yes, that's partially why or how the market rebounded, with historic short-interest present. But a long-term perspective doesn't negate reality of fully priced stocks even when based on earnings, particularly (more).
That is no assurance that the powerful monetary authorities here and abroad won't in a sense dampen the impact of such threats (they have been doing a spectacular job, in our view, so far), but what isn't generally appreciated is they cannot reverse trends to 'sudden sobriety' that has gripped everyone from consumers, to investment banker types, to equity speculators, and certainly homeowners who increasingly recognize it is not an issue isolated to real estate, or relegated only to speculative areas as were, during the initial stages of the erosion which commenced well over a year ago, more or less limited to the then-high inventory states. Actually chatted with a sage investor in the northern mountains (he's not hiding as it's beautiful country) who notes builders presumed immune in such areas from the coastal (and desert spec) issues no longer are so insulated, as speculative investment and even 'coastal flight' has evaporated, at least for the time being. We think the attractiveness of such areas will revitalize all such (seemingly) trouble-removed areas eventually; but that may be some (time) out. Why? Because typically speculators using leverage for non primary residences can't, as those seeking to 'move' won't, until or unless they're able to sell homes elsewhere.
Once again; this brings the specter (as much as we disdain the term but forecast it as a prospect months ago) of stagflation; where energy and food pricing remains high or even rising (typically for unrelated reasons), while perceptions of property wealth tend to erode. Taxing authority pressures don't let up even while politicians distance reality from desire, by failing to recognize that assessed valuations will have to be reduced a lot in the year or two ahead, as millage can't easily be raised without taxpayer revolt. At the same time the rating agencies, beholden somewhat to their lending customers, aren't making it easier for less-astute governance to come to task, efficiently enough.
In the short-run, the 'shock value' of the debacle was minimized by projected actions by the Fed, commencing with our desired Discount Rate cut before they actually did it following the detected round of coordinated interventions. Again the Discount window may be revisited, because it's the best way to facilitate systemic liquidity while not, of course, either underwriting risk nor particularly contributing to a weaker Dollar, which could be unfavorably impacted by cutting Funds rate excessively, essentially as akin to pushing on a string, while nevertheless still risking negative currency impacts. That concern in-and-of-itself tends to retard an overly-aggressive Fed stimulus effort now, so if anything supports return to 'measured pace' changes in overnight lending rates.
Daily action . . . much discussion about what the Fed does this coming week may be either 'discounted' in the marketplace, and hence likely to pale in actual impact from a move, or the talk expects yet-another 'silver bullet' coming from the Fed, as may have a temporarily salutatory perceived benefit.
If the Fed goes 'that far', it might imply some sort of further train-wreak ahead they're trying to steer away from, or suggest caving-in to those interests trying to resuscitate, what for all practical purposes, is a period of speculative profligate lending or also of borrowing, that is past the putrefaction state of drowning (we're addressing of course not only the property situation, but leveraged buying binges, as heavily contributed to debt obligation re-pricing mess as yet not fully recognized by a majority of investors). Not to be forgotten, the near-term evaporation of the CP (Commercial Paper) market, which in a sense contributed to monies flowing into equities, seeking hiding places. In the aggregate, members know our view about constant searching for 'what works'.
While we would not argue that 'core' retail activity has been reasonably satisfactory in light of everything going on, the majority of the impact on individuals still lies ahead of course. While an aggressive Fed intervention remains welcomed, there is unlikely the kind of environment that will be remedied solely by aggressively flooding more money into the system. The printing presses are humming so fast that India's ink essentially is backordered; but that blunt instrument of Fed action isn't going to restore lunacy to the extent that was prevalent for the first time in this generation, as related to lending, or related to the public sector, and not just the investment crowd, as were prior cases (including the 1999-2000 scenario). That's why this situation is so dangerous; given a perception on Wall Street that somehow an aggressive transparent Fed rescues all.
In this regard the common perception is that asset classes advance across the board including property, by virtue of some draconian cut. Ideally that won't happen; while it is reasonable to project a nominal cut in the Funds rate or possibly Discount Rate as well. Again, the latter is more important than the former ahead of 'risk revelations' that we suspect are forthcoming in the weeks just ahead, to protect systemic liquidity, not to bailout all those seeking a resurrection of what (sorry) can't yet be easily retrieved. Yes, if the Fed acts responsibly that crowd will blame them for what follows, and once again it won't be the Fed's fault, for they will merely be buttressing the system, while I suspect at the same time not encouraging a sort of renewed 'Fed rule' circumvention.
Summary of our overall view may be gleaned by reviewing the recent Daily Briefings.
One of the main points was to note who might be holding so-called 'investment grade' products, which turn-out to be comparative modern-day equivalents of junk bonds, or collateralized debt obligations. Whether real-estate origin or related to LBO's, or to other investments, these were dependent on artificial low rates, which only gradually return absent an horrific event (financial or otherwise as mentioned to our members).
It is to an extent the failure of such holders to do proper due diligence, or of the rating agencies to accurately label such instruments, that is at the root of the retention (or at least as relates to certain brokerages and so on, holding such as basic net capital). In this regard the least-covered aspect has been the off-loading of such risk by big firms fairly persistently since the projected July / August cratering, as that's where the Fed came-in as forecast they would in August as others were still demanding intervention.
Pundits tend to argue 100% efficient market theory, the ability to absorb or adjust and minimize, concerns about spillover effects of arcane structure (to the average person) impacts on everyday life for the mass of consumers, not just investors. While I concur that the 'shock effect' (we've said that repeatedly over the past month) ameliorates, a bit at least, to allow reflex rebounds as forecast into the Labor Day / Rosh Hashanah vicinity (it persisted a bit longer day-to-day; likely because nobody's too excited about getting-out in-front of the FOMC meeting or possibly a crucial Expiration they 'hope' is upward-tilted). The actuality is a bit more involved, especially if optimists are failed by a responsible Fed, and as they realize that no contraction will be isolated to the USA.
This is not (though we don't mean to trivialize corporate governance or other issues) a mere options backdating issue, or earnings certification oversight, or other scandal; nor a single hedge fund in trouble (though there are elements of all of those present).
In this case trillions of Dollars sitting in derivatives, is not really in the same or similar camp as option and earnings considerations. An inability of 'marking-to-market' these trillions, combined with full-blown aftereffects from previously blown bubble mania in housing, or dare we say (because most on Wall Street minimize unrelated borrowing and leverage as they're more directly aggressively involved with) CDO's, Commercial Paper Debt Obligations, CMO's of course or the winding-down of an overheated LBO craze to more normalized M&A levels of traditional merit, fairly evidently is upon us.
The first of a series of 'magic (Fed Funds) rate cuts' are unlikely to erase this 'worry'. I am emphasizing the difference between a 'fear' and a fate accompli essentially. Sure, we ourselves felt the shock value had diminished; again that was the basis of the call for rebounds from the August mid-month washout lows; but it is not a presumption of being out of the woods for (redacted for ingerletter.com members). It may be argued 'they', not those careful, are 'fighting the Fed' as they try to restore systemic balance.
The latest arguments by permabulls is that inflation-adjusted oil prices are not high at this point; that the 70% contribution of consumers to America's economy will be offset by end-run financing structures (which by definition invite transference of debt, versus a reduction of debt exposure, which might be in most families general interest) as has begun to appear; and that we are increasingly seeing the edges of 'capital flight' risk beginning, which is part of why (redacted in fairness to members). Then there's trade imbalance, but if anything that's slightly assisted by weaker currency, and reflected in such stocks. Ideally, the Fed will not respond to all seeking hyperinflation, thus (etc.).
Finally . . . this boils down to whether this kind of situation, with housing decline from an overall perspective (and the ripple effects) ultimately is uncharted territory. Yes, in a sense it is with respect to (post-Depression era) modern times. Falling prices, rising delinquencies, and bank failures due to derivatives are indeed scary, but avoidable at least with respect to 'too big to fail' money-center banks, and likely not avoidable with respect to consumer-related implications of this. Nor Wall Street's slowing, in relation to layoff's, leveraged activity, or hope for 'creative' short-run borrowing methods.
Traders are very nervous; those shorting or embracing bearish strategies ahead of a very vaunted Fed-cut expectation, are engaged in controversial debate about what's in our future, depending what the Fed does or says. If they cut (as universally viewed now, we'd say because the Treasury markets are ahead of them in this regard), but it is done with continued reference to 'inflationary worries' such as from oil prices (that's not the real reason, as this isn't a demand-pull situation), 'stagflation' fears reappear. Consider implications of a remark the other day: lowering rates result in higher rates.
How much will continuing financial market disturbances infect the overall economy? The key to that question is thought to be what banks will do, and how much impact it will have. The reality is they will likely help certain areas (as I delved into last night).
Actually, we do believe a contraction is particularly likely across a broad front; but we also know that 'hope springs eternal', whether among Wall Streeter's or homeowners for that matter. We don't exhort that 'the sky is falling', but do believe you sometimes have to fly from Seattle to Boston with a southern detour fueling stop; say in Houston.
So we seriously doubt this Fed intends essentially legislating the 'business cycle' out of existence. To do so is the debate over a 'risk Put' underlying more than a systemic concern, which is a legitimate effort for the Fed (as they are doing) to insure against.
Put differently; sometimes you have to go south for a while to refuel for a flight north.
This sufficiently challenging situation can't easily be swept under Wall Street 'wings'. If the Fed is very mild with the Funds rate, but more aggressive with Discount Rates, that is an implication that the Fed remains committed to their primary mandate: their directive to provide systemic liquidity, not fund an underwriting of excessive risk. As a result this likely stokes confidence in (asset classes explored via last night's remark).
To those who missed our speculation on 'why' Oil rose; and military possibilities, we'd suggest reading Thursday's comment posted yesterday, for a speculative discussion of what actually took place recently in the Middle East, and why that is being missed.
Consumer spending is contracting in fits-and-starts, and varies somewhat regionally. Mortgage defaults, the broader economy, and some of the hiding places are not likely to be made 'whole' just because stocks lifted somewhat out of the hole, temporarily at least, over the weeks just past (generally as expected). Reasons for calling for reflex, or intervening rebounds have been thoroughly explored over the course of last week.
'Creative destruction' is not exactly what this is about; even the Fed Chairman has an opinion about inevitability if we don't embrace traditional speculative limits. The risk of 'loosing control' is enhanced if the Fed succumbs to political pressures from those on Wall Street, who aren't readily willing to surrender the extended Gilded Age for shots at the 'brass ring' once the merry-go-round of investing does another circle. We're the ones who forecast the 'reflation', calling it just that in 2002; and for it to end in 2007.
MarketCast (intraday analysis & embedded Daily Briefing audio-video). . . remarks in the last month projected a washout and 'relief rebound' called in the midst of Fed injections and Discount Rate cuts, both projected before the Fed commenced doing that; as is important because many act as if the Fed's blindsided, which they are not.
Great companies have excellent balance sheets. But that has little to do with equity valuations, business activities, or even earnings; now. What it does is enable basic survivability of underlying businesses of such companies. And in time of war that's so important as we have to be fairly resilient. In this regard it enhances a comeback that inevitably follows. But, companies are unlikely inclined to increase long-term Capital Expenditures, until stabilization returns. A dysfunctional 'commercial paper' market is a partial tip-off to 'actual' rather than 'perceived' attitudes of big firms. More coming.
Key credit or derivative issues are not ameliorated; though of course a 'structuring' does move toward improvement, which is a different issue then just stemming a tide. The Fed is treading carefully, and doing the right thing, at least so far. All Americans should encourage continued responsible behavior, vs. acquiescing to 'blame games'.
The '60 Minutes' Greenspan interview will address the essential stimulus from 2001 inline with our own calls for reflation. He was not too fast (no choice really), and now Mr. Bernanke is not too slow. It was 'those that took advantage' worthy of blame, and in Mr. G's case, his error was the one we long-ago noticed in calling for the 2000 hit; that was growing of the money supply along with higher rates; a contributing factor at the time to unsustainable 'spikes', and contrary to his own 'irrational exuberance' call.
Now the latest Daily Briefing audio-video MarketCast final 'chart' comments: Daily Briefing audio/video
(members see full-screen video; nightly & intraday samples available at ingerletter.com)
Bits & Bytes . . . provide investors ideas in a few stocks, often special-situations, but also covers an assortment of technology issues (needed for assessment of general factors in tech overall, or as compelling developments call for) that are key movers in the NDX, SOX or S&P, plus ideas ingerletter.com thinks might merit further reflection. Rarely we will comment about stocks in text. Typically remarks are via audio-video.
In summary . . events continue reminding us of risks Allied fighting forces face, given continued attacks on free peoples, by elements including organized terrorist forces in various countries. A world addressing terror threats continues, as domestic issues absorb us less as we focus on the Middle East crisis and World War III avoidance. (In this case World War III is Islamic terrorist and Iranian interference, targeting 'global village' communication or necessity supply-chains.) Did we move to higher alerts?
Slow growth will descend into recession, of course only after the fact. Our 2007 view has been that we are (or were) in an ill-defined recession to be recognized only later. As to whether it descends into something like the post-railroad debacle in the 1880's; well guess what, it [redacted]. Regression to the mean and traditional affordability.
McClellan Oscillator finds NYSE 'Mac' eroding from overbought on-cue, with those intervening bull-bear shuffles reversing per forecasts (noted) on the NYSE; (noted) NASDAQ. As LBO / hedge funds increasingly implode (post-forecast reprieves), of course allowing rebounds until or unless an 'event' occurs (as noted) we'll respond as needed. Rebound rallies projected seemingly minimize significance of systemic risk evolving; but financial media omitted noting 'risk off-loading' implementation tactics. These are ongoing; holdings aren't all investment grade. Multi-month efforts evolve.
Issues continue including oil, terror; China, Pakistan (possibly the key to survival for a number of aspects of the 'war on Terror'); certainly all the Middle East, Korea, and economics. As assessed for a couple weeks, watch the Dollar and Oil in all of this. It is also pertinent not to forget that when there's one cockroach, there are likely others.
Issues continue including oil, terror; China, Pakistan (possibly the key to survival for a number of aspects of the 'war on Terror'); certainly all the Middle East, Korea, and a hangover of funny money NY economics. Members here at ingerletter.com know all our views about what likely happens after the FOMC next week, and may or may not be accelerated after Quarterly Expiration. Don't miss those other shoes as may drop.
Enjoy the trading week!
Gene
Gene Inger,
Publisher
~Gene Inger’s Daily Briefing™ (The Inger Letter daily analysis on www.ingerletter.com)
~Gene Inger’s MarketCast™ (Intraday audio updates emphasizing S&P futures and market action)
