Gene Inger's Daily Briefing. . . . for Friday, November 9, 2007:
Good evening,
Multidimensional challenges . . . to the economic structure, are so pervasive now, that they finally get more realistic attention even from former delusionary permabulls; which both redefines the risk a bit (as we'll address in tonight's extensive audio-video commentary), and allows periodic (as noted yesterday) mini-washouts that trigger the sort of snapback as we saw in Thursday's late going. Is this a significant reversal that can stand the test of time? That too we'll explore in tonight's audio-video remarks.
Profligate Gilded Age leverage gamblers (smaller fry mostly in real estate and big boy types in debt and structured investments) and their excessive large-cap holdings, for sure were not been easily parted from their pollyannaish perspective. I think that's in part because most such players were institutional geniuses, who are indeed nobody's fool, and we thought have likely been spending the better part of the last 3 months or so 'off-loading' risk as best able, while promoting the idea of buying stocks to others.
That wasn't sufficient to eliminate risk, but provided a bit of cushion to the worst-case exposure risks; and quite possibly meant the difference between survival or failure at a couple places 'perceived' to be too-big-to-fail (or at least a reduction to mediocrity).
There is something else; the Fed is injecting liquidity like there's no tomorrow. Ideally there is a tomorrow; so even we wonder what that's all about. Commercial Paper risk was our speculation yesterday; though we can't pin anything down on that score yet. Via courtesy of a member firm and rating service; we have another sort of tabulation of total derivatives exposure; again the firms' hierarchy is about the same as months ago in that regard. However, this is 'total', not merely CMO's or CDO's, represented.
In our thinking, many firms probably don't know themselves how to assess or value derivative holdings they have; and nothing that could likely occur now changes what's an ongoing reticence to extend massive credit, even as the Fed does exactly what I'd projected they would from before the first Discount Rate cut: back systemic liquidity in an effort to protect against total structural financial failure, not bail-out the greediest.
Daily action . . . persistently noted the magnitude of risk has been brewing all year; as in the generals were way ahead of the troops (narrow poor big-cap leadership) as it headed into the tunnel, with the troops not charging behind. The permabulls tended to believe there was light at the end of the tunnel; and historically we lean bullish too; but in this case we thought (as we did in 1969; 1973; 1987 and early 2000) that there was no real argument for anything sustainable on the upside; so that light was just an old oncoming freight. (Hence our July call for 'zero' prospect of upside extensions, at the same time we expected a 'Chinese water torture' decline due to excess optimism.
However, this kind of cleansing will contribute to reform; to the realization that banks, for the most part, should be in the banking business; not the speculation business, or engaged in complex arbitrage and structured-to-fail deceptively-labeled plays that are paraded as investment grade, when in reality they are merely new era 'junk debt'. Do you hear it called that much? Not yet; but history may realize the Enron-ization as did exist; because any normal accounting standards or risk-management would normally have concurred with what we've warned of all year. That makes me ponder whether it is something on the level of a major bust at a financial institution, even beyond what's implied by the curious Fed injections now, that's approaching (maybe within days, as it is not customary for the Fed to take such measures very far in advance historically).
Last night we provided several charts as were self-evident, proving our various points as relate to experience in early stages of bear markets associated with 'rate curves', and some other aspects of liquidation. The behavior in 'recessions' is also depicted. Besides tonight's; I call new ingerletter.com members attention to these as archived.
Hence the 'greatest story never told' is about the abuses and predatory practices, not a vicious overreaction to minor stuff in a global boom as was typically portrayed. Also it is about extreme deviation if not violation of the spirit and intent of all FDIC and Fed regulations conceived over the years, particularly as regards financial 'bundling' or as it's called 'integration' of banking, M&A, brokerage and debt structure and percentage holding guidelines (for the firms themselves), as we have warned for six months now.
Besides all that, the disingenuous focus on free trading as if we were all fools, sans a realization that the pendulum will swing away from un-American lopsided rediculosity. (Better that average Americans spend 50 cents more on a T-shirt, and make wages a bit closer to 18-20 bucks an hour, than 8 bucks an hour as a retail store's greeter. For all the savings in retail; for years we've argued this was diminishing citizen spirits too, as even the supposedly-sacred crown jewels of technology were compromised as the parts increasingly, and then the whole products, were assembled overseas for greed. Nothing wrong with free and fair international trade; but not stupidity which destroys a good bit of America's financial sovereignty and even compromises policy hegemony; I have argued this for 20 years even while bullish most of the time on stock markets, while realizing and contending that the projected 'reflation' was a gamble all along.)
Subsequently, the Fed has had to issue numerous waivers of certain regulations that are intended to prevent the banking side loaning too much to another side of internal operations, something we argued decades ago could ultimately be problematic. I am sorry that we were right in opposing particular aspect of Wall Street 'modernizing' of integrated financial services (so-called financial 'supermarkets'); as now its debatable how much the outflow impacts all Americans; as the palpable tone to the Chairman's testimony today, sort of had me thinking (I tried to look in his eyes while he spoke).
This is extremely important, as 'blame' is generally not involved at all, with respect to the Fed here (really I think Bernanke is doing a flawless job; undoing the preceding errors of 1999-2000 as set-up the backdrop of what became a bull market in big-caps and partial rebounds in the majority of also-ran stocks); as we've noted here for many months now…which is why it seems they pushed tech or so on, so as to try to get the troops to kick-into-gear with the generals, probably knowing that if that didn't happen the market had little chance to remain stabilized beyond narrow leadership that gave an illusion of strength in retrospect for longer than historically made sense; but that's in-part due to a structure of ownership / management, that we've also often explored.
I really didn't wish to approach this subject again; but some in media are focused on saying this is caused by Cuomo, or Bernanke, or other stuff, and I think that's puffery and buffoonery. They're responding and trying to address messes, that were caused by abhorent inappropriate oversight of regulators, risk-management staff, absence of compliance with existing regulations, FHA/Fannie Mae guidelines too, or even actual mortgage fraud; for which some collusion likely existed, as we've contended before it hit the fan, basically all year, in warning that 'structured to fail' deals were just that, so it was not just real estate, though it was (relatively) low-hanging fruit of the era. I add that while warning for two years about real estate; I also warn no upcoming lows yet.
I looked at the 'pooling' of such 'junk debt' paper into CMO's and CDO's overall, and realized (that was part of the call this past Summer) it would be virtually impossible to audit that from the top down, in order to ascertain what 'actual' paper was worth. That in fact (for the majority resold in the secondary mortgage market) was a reason why it seemed illogical (even when the President proposed it, and we wish it were so simple as outlined) to expect lenders to be able to go back and 'fix' what they no longer held.
Also; importantly and dangerously, the impact on the equity (nest egg perceptions) of at least tens of millions of Americans (not everyone, because oil producing areas are doing great) who were prudent and responsible (often more so than their brokerages, bankers, or politicians, until after the horses were long gone from the barns) was, I'd opined, not likely to emerge unscathed in this. I wished otherwise; but tended toward realism. Again; the permabulls or marketers minimized the impact of subprime; tried to convince everyone it mattered that most people paid their mortgages; embraced a few homebuilders or even financials; and to this day do not acknowledge not only the handwriting was documented as being on the wall, but failed to see any risk of a fall. Now they are finally starting to crack their façade of impenetrable virtue; after a drop.
So now we're falling; with intervening bounces. Sorry to say 'great' but; history shows most 'serious' money is made by buying crumbs from disasters, rather than chasing upside momentum at the point of no return (or small returns) … and I mean disasters in big companies that otherwise would be successful; not those whose prospects are evaporating because of reasons other than being swept-out with the tide.
By the way, even with the accompany table, I do not mean to suggest any particular firm engaged in intentional subterfuge, or that managements even really knew what their risk-management people knew or did not know. I'm sure some were even aware of modern portfolio theory, or conventional banking guidelines and lending standards either; nor common sense (if it can't be understood; don't do the deal). Plus I do not mean to convey any particular knowledge of anything specific until or unless evident. Just call me Sgt. Schultz; I know nothing. I know nothing. But did call this market :-}.
Summary: Are we short this market? Index-wise yes; you bet. Constantly, from S&P 1585.
We don't mean to scare anyone; nor paint overly negative pictures; now well into a forecast decline. I do mean to be realistic. I don't believe that consumers can deal with what's developing constantly with periods of hope that do not come to real fruition or resolution. I believe that our warning (which on real estate goes back two years or so) rather for the most part have been helpful, and gave a modicum of sufficient time to take action if one was inclined (I don't give advice on anything; just our perspective). And our equity call in June for 'unsustainable' rallies into July with 'zero' chance of extension; nailed it.
Bottom line: signs as we interpret them, included the (slightly updated only) following bullet points:
· Iran has enough centrifuges to build a nuclear bomb within one year or so; contingencies?;
· China has indicated commencement of 'redirecting' of reserves into 'strong' currencies;
· More risk for mortgage, pension and misc. insurer's; also based on derivative exposure;
· There is 'zero' interest by actual smart investors in buying until funds go ex-dividend; caution;
· There may even be some nailing down of gains ahead of sales to pay such distributions;
· China 'ordered' cooling of speculation within the next few weeks; whatever that may portend;
· Is it coincidental that lots of analysts last week suggested 'C' as a 'bargain stock' to buy?;
· Is Merrill Lynch situation (pensions) similar to what we noted Arthur Levitt warned about;
· Mr. Levitt's comments to the NYT emulated our overall concern about pensions and insurers;
· Add my concern about Commercial Paper holdings or even money funds not in Gov'ments;
· Dollar dangerously down; likely bottoming very soon (or starting); at least temporarily;
· If not, or after failing coordinated intervention; real problems and serious stagflation risk;
· China ordered increased bank reserves; still not generally reported; market(s) flings risky;
· Asian markets in-general extended; and cash flow to here limited based on protectionist fear;
· Net capital inflows likely continue constricted as forecast; as U.S. cut interest rates too much;
· 'Crack Spread' issues meant rising U.S. gasoline would press consumers anew (ongoing);
· Moral hazard of SIV fund situation smacks of Enron; must be monitored (not working well yet);
· Debt issues are not resolved; massaging of every aspect being attempted as 'they' best can;
· Subprime bubble forecast to burse was a microcosm of bigger issues clearly not resolved;
· Institutional debt issue; housing; commercial property bubble bursting; are all 'acts in motion';
· Collapse of consumer addiction cycle debated; we suspect ending like all excessive habits;
· The question is not whether we have 'recession' (likely underway); but something worse;
· Murky financial structures have less liquidity than 'advertised'; there is only limited cushion;
· Many major banks have far larger and riskier derivative holdings than generally realized;
· Fed action or actions stop systemic freezing; but won't instantly solve overall credit crunch;
· Oh yes; we are not withdrawing our suspicion about foreign markets breaking hard too;
· In the long-run this forced 'weaning away' from international financing will be quite bullish;
· In the short-run (1-3 years or as determined), downside will ameliorate only if implodes;
· If house prices dip into '09-'10 (per Fed's own bell-curve chart); more than just recession risk;
· Keep in mind my own forecast; for prior 'hot' areas, near all preceding bubble gains give-back;
· To wit equity risks being entirely wiped-out for leveraged homeowners in such regional areas;
· There is no way the property-bubble-based spending spree continues in that environment;
· As stated; U.S. situations are not 'in-isolation'; global markets are dependent on us; so get hit;
· Rebound should be false & abortive; rallies limited with markets at risk of pop-and-new-flop.
We continue to believe the erudite 'economy is better than you think' is a modern-day equivalent of Yale's Irving Fisher in 1929 saying a 'permanent higher era arrived'. In this case we are seeing the continuity of 'panicky peddling pummeling prices', but is it actual panic given the levels of this market? That phase may lie ahead, aside interim interventions or efforts by the Fed to modulate, not abort, the overall declining trend.
Key credit or derivative issues are not ameliorated, as projected Fed actions were, though 'structuring' does move toward improvement, essentially 'pushing on a string'. That's a different issue then just stemming a tide. The Fed is treading maturely, and doing the right thing. We are hardly yet out of the woods with respect to housing; or debt or war issues. Important: a Fed 'staying ahead of a situation', isn't preventing it.
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.
PURE Bioscience (PURE) announced expanded EPA efficacy claims approved for its SDC additive (for use in private labels, and intended for CIBA clientele worldwide, both in terms of fighting common germs or viruses, as well as Norovirus and MRSA / Staph). The shares (as noted in recent comments) had a nice little pullback and then rallied, in the face of sharp market declines; may actually be likely press highs soon. As outlined by Pure's president last week, if they conclude a first series of deals this year, we anticipate an initially higher move, with targets as outlined here last week.)
Also; we noted two days ago that we'd sell Cisco (CSCO), not buy it for the earnings, as the pattern generally has been to fade good reports (sign of exiting) in many large stocks for weeks, and take out and 'shoot' anybody that even slightly misses. This of course was a classic sign of distribution along with narrow leadership. We have had no idea why so many folks were optimistic in a classic unconfirmed distributional rise (and we emphasized that nightly here in these missives). Classic bear market start; of course unless one realizes 'the market' never made new highs this year; only the capitalized big-cap Index like the Dow did; the NDX and SOX only retraced part of a very big spike in the late '90's, which may be argued as a bear market snapback. No way was the highly commoditized technology sector going to be a salvation this year. Now for the future, we have some thoughts; which is why the decline can be bullish. But not immediately, any more than any other such sequence of events historically.
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.) Are we maintaining high alerts?
Are we about to hear more about redemptions; reduced capital flows or Fed 'waivers' of regulations intended to separate banking, brokerage or investment banking rules? And are we going to hear that there are lots of other (heavy shoes; almost boots) that are going to drop over a period of time. Including from brokerage firms squeamish as to the revelations to a degree we would consider open forthcoming transparency.
Slow growth has likely descended into recession; of course that fear prompted what the Fed did, inline with expectations (and a tad more), albeit with a bigger reaction to it. Our 2007 view has been that we're in an ill-defined recession; likely recognized if at all, only later. As to whether it descends into something like post-railroad debacles of the 1880's; well in-part it's what the Fed worries about. Regression to the mean and traditional affordability 'rules' will be hallmarks of lending guidelines for a while.
McClellan Oscillator finds NYSE 'Mac' folding after the intervening bull-bear shuffles on the NYSE and NASDAQ. Reflex rallies allowed 'risk off-loading' tactics; many of the 'Street' debt holdings aren't investment grade. Multi-month efforts are evolving. In this regard, we suspect that strategy is ramping-down with the markets; not trying to revive attractiveness of structured-to-fail creative financial paper. So many of the analysts are 'volunteering' what bargains financial firms now are; makes it dubious.
Fears are rising in the credit markets that the turbulence could last for months as big US & European banks come under pressure due to losses in US mortgage securities, and as the America media generally avoids talking about German or Chinese banks, and what's happening with the Hang Seng (and why). The 'cover' of strong economic activity is masking the greatest credit bubble ripple effect risk since the 1907 Panic, if not the 1930's. The similarity is (if anything) somewhat like I recall in the 1880's when the 'railroad' bond debt fiasco took the Nation into a situation taking years to recover from. Frankly, though there will be trading opportunities; folks will pay for real growth; it will often be in smaller domestic stocks, not yet big-cap multinationals or financials.
There's reason we emphasized housing, CMO's etc; not the Fed's appropriate action. Some said another 10-15% come off price levels for housing; so, that could decimate equity for millions of prudent Americans; and that's indeed a serious problem. There is no way the U.S. economy holds up with that kind of condition, because the ripple effects spread too widely irrespective of short-term actions by the Fed. As Bernanke agrees (comes close to saying so); bulls moan; but it would be folly to cut rates anew.
Long-term of course rates will be lower (but not now because all it would do is cause rates to rise significantly); but after a descent into recession becomes visible to rose-colored-glass crowds as it is to citizens. Best forecast: interim rebounds false and abortive; then (if left alone as actually might be best), we get an historic plug-pulling. Meanwhile, the PPT (Plunge Protection Team) was activated we ruminated last week so that's why (reserved for ingerletter.com members). We wish them luck, but for the most part doubt they can do more than cushion a long march into deeper recession.
Enjoy the evening,
Gene
Gene Inger,
Publisher
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