Wednesday, March 19, 2008

Today's Market

I wanted to talk a little more about todays action. As i discussed earlier today I thought the market would reverse today. I didn't see a 300 pointer however!! the lack of follow through on yesterdays gains was a very bearish sign. It seems to me that the market just wants to sell into any strength because no one has any convictions to hold stocks and they are extremely fearful.

I am fearful! I saw a lot of bad things today. Gold dropped $60 an ounce as it was time for the hedge funds to pay the piper. Margin Call City!!! What is happening in the markets right now is a massive deleveraging of debt.

Banks need cash so they call their hedge fund customers that leveraged up 10-1 or 20-1 in AAA debt and are telling them they need to get the leverage down to 5-1 and hitting them with margin calls. In order to raise cash to pay the margin calls the hedge funds must sell good assets like gold or other stocks/commodities. The majority of the drop in gold was margin calls. The strength of the dollar also brought it down a little as well.

I think you will start to see some hedge funds go under over the next few weeks. Many do not have the cash to deleverage down. What you saw today in the stock market was a liquidation of assets forced by margin calls. This can stop a market dead in its tracks.

The scariest part of the deleveraging is no one really knows how bad this will be because there is so much leveraged and bad debt thats been placed into derivatives and other investment vehicles that are a result of our financial "innovation". I have yet to find anyone who understands or can predict how this $500 trillion dollar derivatives market will unwind.

This is causing a lot of the fear out there. Because of the fear our financial institution's risk management teams are forcing margin calls and reigning in lending which tightens the money supply. Going forward cash will be king and being swamped in debt will be a nightmare. Its been the other way around for the last 20 years. When you paid 200k for your house and then you could sell it for 350k 3 years later then debt was great. You could borrow off it, turn it into cash, buy a Hummer. Well now when you buy a house for 400k and its now worth 350k its not so cool to have debt anymore. We will all become savers again as a result of this crisis.

This is the conundrum that we find ourselves in. The Fed has injected massive liquidity into the markets which means there should be tons of money out there to borrow. The problem is the banks are not making the money available because they are not confident in the market conditions. This is why the Fed cuts really don't have an effect other then the euphoria the day of the cut.

So could this deleveraging send the market down the tubes? Its looking more and more like the answer is yes because I don't see any confidence in the markets and it looks more and more like deflation similiar to Japan. The money supply is shrinking due to the banks tightning on lending and we are already in a recession IMO.

Some advice:

If you have debt pay it off as soon as possible. Banks are going to keep raising rates on balances in order to increase their capital. Have a little cash in the house. The banks are very shaky right now. If Bear Stearns can have a bank run so can your local bank so stash a little cash in the closet or a safe if you have one. Be very careful with your investments. Be very conservative and have a large position in fixed income. Right now nothing is working in equities. The commodities were working up until today but now it seems they might pull back. There is NOWHERE TO HIDE right now in equities.

Dennis Gartman who is one of the smartest guys on Wall St. said tonight that he is almost all in cash. He followed up by saying that he has NEVER seen as volatile a market in his 30 years on Wall St. If a guy like this can't trade right now none of us should be trying. Its a time to hunker down and ride out the storm. We have a ways to go before this hurricane is over.


Avl said...

Great post, Jeff. Thanks for the advice. Yes, we readers/consumers need to grasp the big picture of de-leveraging of multiple markets, rather than stories about recession, foreclosures, moral hazard, and fed policy moves.

We’re also prognosticating on ‘market bottoms’ and thus the ‘end point; the time when markets can re-price real estate, paper, and obligations, and reach an ‘equilibrium’.

A simple 5-syllable word, ‘equilibrium’, doesn’t have the gravitas to capture the monumental task and timeline that may be involved an unwinding inter-twined highly leveraged markets totaling 10s or 100s of $ trillions.

Here’s a good visual: re-pricing and equilibrium may be a quixotic task of interminable duration, like waiting for something the size of earth’s interlinked oceans to achieve ‘equilibrium’ after absorbing a vast yet slow-moving disruption. The tsunamis just keep rolling and rolling and rolling. And they’re looking awfully slow moving when viewed from a great distance. But they’re devastating and frightening when it’s your own harbor/beach/coast facing one.

But wait, there’s more: are we assuming we know what this new world will look like? IF excess leveraging is bad, then everything obtained via over-leveraging should not have occurred. It’s not just that 100,000s of houses would not have been built, and the land never cleared. Start-up firms would not have started; recent ownership changes in many Fortune 1000 firms would not have occurred. Massive numbers of vehicles would not have built, auto factory hours never would have occurred, auto payrolls would not have been as big. Eye-boggling facilities for the 2008 Beijing Olympics might not have happened; the waging of two simultaneous Middle East wars may not have unfolded as they did if over-leveraging made government deficit financing more feasible.

If our post-deleveraging future comprises much less debt and leveraging, would it closely resemble, say, an American economy circa 1972 (before the disruptive oil shocks and inflation) that’s far less innovative and consumer-driven?

Jeff said...


Great comment. I think we areheading back to a more "simple" life circa 70's style. Smaller cars, smaller houses. I am curious to see how history will paint this period of time.

What you bring up is the big question with this deleveraging. How long will it takeyo get to equililbrium? No one seems to know know and we very well could see tsusami like waves of selling until we get there. The one thing I am sure of is it will be very painful.

I can remember people calling bottoms every 500 points down or so during the tech bubble from 5000 down to under 2000. they were calling bottoms all the way down.

I think we will have our answer pretty soon. It looks like the crisis has is ready to hit the markets full force. I think today might have started a wave of selling. Time will tell. Great post.