My Dairy 448 ----Globalization, Panic, Reflexivity, J.M.
(Note: Global stocks rallied strongly today in response to the widespread government efforts over the weekend to shore up the world's battered financial system. But I believe this is a typical bear market rally after the sharp decline over the past week. And the big concern ahead of us is that global regulators are behind the curve to mop up the mess as all the key money market indicators remained at elevated level --- LIBOR =475bps, TED spread = 457bp and Libor-OIS spread =362bp)
October 12, 2008
Globalization in the wrong way vs. Panic in the same way --- I am not criticizing the progress of globalization which has helped substantially liberalize and improve our lives as human being. But over the past weeks, I saw a wrong way towards the globalization, ranging from the wipeout of Wall Street to the free fall of Iceland Korna and from the doubled European bank bailouts to the blow out of bank CDS in India. Indeed, one must think very hard to figure out how can
This scenario typically happens when things get out of control. Here are something I have learned this week --- 1) the financial system is breaking down, panic and lack of confidence in any counterparty is rising sharply and investors have totally lost faith in the ability of policy authorities to control the meltdown; 2) the process of simultaneously deleveraging does not happen at a constant gradual pace but rather it's a sequence of events that more resembles a nuclear chain reaction; 3) the world is now in a secular credit contraction that is going to involve debt pay-down, asset liquidation and rising personal savings rates, and this deflationary process is very likely to last well into 2009 and quite possibly beyond.
A naturally follow-up question is what can we do to stop the panic from spreading out? In the past two weeks alone, global central banks executed emergency interest-rate cuts and pumped more cash into markets, the Fed said it would buy US CPs, European governments bailed out banks and the
On the back of these observations, we take a peak of market performance. Globally, stocks declined 4.98% on last Friday, collapsing 23% mtd and 42.7% ytd. Regionally, equities were down 38.8% in US, 43.8% in EU and 45.5% in AP region, year-to-date. UST curve steepened with 1M @ 0.06%, 2yr @ 1.63%, 10yr @ 3.87% and 2-10 spread widened to 226bp this week. Since last Friday, USD is 5% lower vs. YEN (100.67) and 1% lower vs. EUR (1.3409), but up 4% against broader EM currencies. 1MWTI oil decreased ~$9 to $77.7/bbl, down $24 this month and is currently at its lowest price of the year.
Looking ahead, as indicated by “The Theory of Reflexivity” we are entering a different dimension that will be ruled by new, and unknown, principles of finance to be discovered by experimentation as we go. As George Soros wrote in his book in1994, “...In certain circumstances, financial markets can affect the so-called fundamentals which they are supposed to reflect. When that happens, markets enter into a state of dynamic disequilibrium and behave quite differently from what would be considered normal by the theory of efficient markets. Such boom/bust sequences do not arise very often, but when they do, they can be very disruptive, exactly because they affect the fundamentals of the economy”…Yes, someday this will end, but when does it end? I only know it won't end because stocks have had 8 days down in a row, or because valuations are cheap, or because this is the worst week ever (40bp less than July 21, 1933, -18.6% wow then). The simultaneous bursting of this super bubble is not about just stocks, it's about deleveraging the system of all excess assets --- housing, equity, bond, credit, commodity, hedge-fund and private-equities and even better- performing economies such as BRIC are at risk of “a hard landing.'' So all the pain will end when enough asset have been purged to get leverage down to tolerable and sustainable levels.
J.M. Keynes and J.K. Galbraith
Having presented the above observations, I think the worst is probably ahead as this credit crisis broadens out into the real economy, although we have seen enough “the worst” things. Over the past few days, US stocks fell for 8 straight days, with the Dow capping its worst week since 1914, Nikkei had its worst weekly drop in history, and MSCI World Index was set for its biggest weekly decline since records began in 1970.
Just after many investors were inspired by Warren Buffet’s deals with Goldman Sachs & General Electric, there were +$4trn been erased from global equities this week, amid the stock market's worst yearly slump since 1937. Even the world’s richest person has seen his instant paper profits on GS ($437mn) and GE ($566mn) wipe out…Right, to a super, long-term investor like Warren Buffet, this is the time to buy more than other times, and this is one of those times where it buys more. But for most of the traders and, they may not have his leisure of time and performance measurement pressure. I think for now, all traders need do is watch the LIBOR (+7bp to 4.82% on Friday) and the TED spread (423bp) to gauge the extent of likely deleveraging. Equity markets will not turn until we start to see some relief in the money markets…Keep in mind that normal indicators of stock market bottoms are broken in this environment.
Earning wise, street analysts now expect a 7.5% drop in 3Q08profit at S&P 50, according to BBG, with earnings at financial companies to slump avg 74% in the same period. However, according to David Rosenberg, during the previous bear markets, a typical peak-to-trough decline in profits is around 25%, and during the actual economic contraction phase, earnings go down 15% on average...Thus we has 50% more to go at least and that is not even the case for non-financials as consensus earnings expectations for the non-financials component of the S&P 500 are still centred on prospects of around 20% earnings growth through 2007-'08. As US economic growth falters, there is high possibility for earnings risks of non-financials turning to the downside, underscoring another downleg for global equity markets yet to be seen (Reminder, we have seen bad number from BOA, Alcoa and MetLife, and the cut of profit forecast from Macy’s Inc and CBS), Historically, what we have seen is that since 1855, a normal recession lasts 18 months and from the start of the recession to the low, the S&P 500 is typically down another 15%.
Thus, we now ask ourselves two important questions: 1) do equities still look cheap? No, until the negative feedback loop is interrupted; 2) when will it end? I still don't know, but it will have at least 6 months to go…Oh, I got it from John Maynard Keynes --- “The market can stay irrational longer than you can stay solvent”, and from J.K. Galbraith (The trouble with Prosperity) --- "The singular feature of the great crash of 1929 was that the worst continued to worsen. What looked one day like the end proved on the next day to have been only the beginning. Nothing could have been more ingeniously designed to maximise the suffering." (Note: MXCN is trading at 7.5XPE09 and 13.5% EPSG, CSI300 at 9.8XPE09 and 18.3% EPSG, MXHK at 9.7XPE09 and 5.4% EPSG, compared with MSCI AxJ at 8.6XPE09 and 5.1% EPSG
Two Signals of US Consumer Recession
Over the week, global central banks finally eased in a coordinated fashion with even the PBOC joining the party. While few expect the rate cuts will have immediate benefit in terms of stimulating credit growth (except in China), the good news is that the bond market viewed the rate cuts as inflationary, reflected by that 10 year UST yield rose 16bps on the back of the rate cut, which is unusual. The bad news is that the co-ordinated rate cuts and the UK bank assistance package (3.5% of GDP) did nothing to stem the upward move in LIBOR, implying there is no quick fix. What has dragged down the risk asset prices is the threat of a global financial meltdown which could result in a decade- long ''L-shaped'' recession -- like
Having said so, I did a quick check of the two engines of global demand, US consumers and
Asia,
Globally, there are two global business cycle indicators pointing to further downside risks. One is the plunge in Japanese capital goods orders. In the recent quarter, US,
The second one is the collapse of September
Talking about Asia, we can not ignore
Put all these analysis together, it makes more sense to understand why IMF, in its recent World Economic Outlook, said that US will expand just 0.1% in 2009 after 1.6% growth this year. And, the global economy is now forecast to expand 3% next year; that's down from the initial forecast of 3.7%.
Good night, my dear friends!