Tuesday, January 22, 2008

The Death of Equities

It sure is not easy to be part of capital markets these days. Weather you are an economist in the forecasting business, or an analyst or investor you have to make decisions that have the potential to be hurtful, particularly for the investor with actually money on the line. All this, of course, on the back of manic-depressive markets, that can prove you wrong faster than you can gobble up an excuse. Market movements according to market research are always unpredictable, but this time around the outlook for capital markets is even more on the balance than in some time in the past. There are those who say the economy is in good health, jobs are plentiful and corporate earnings will continue to grow, and then there are those who predict economic Armageddon and the death of equity prices. The first group, with such knowledgeable economists like Brian Wesbury, point to economic indicators which have not shown the deterioration that is expected by so many, at least not yet. The second group led by Nouriel Roubini is less optimistic in their forecasts. While I hope that the first group is right I can't help but lean toward the second group. Although not clearly seen in my blog I have always maintained a rather cautious if not outright bearish outlook. When the first Bear Stern HFs defaulted on structured credit products back in August I was shocked like anybody else, but I always knew that the authorities would come to the rescue and organize a bail out. Once the FED's powder would be dry I was sure the markets would continue the correction that started in the summer of 2007. I would maintain my bearish outlook when the authorities would show signs of capitulation. While I do think we are not there yet, we have come a long way and the first cracks are opening up. I expect a more dramatic bail out of the bond insures where the government has to take over all the liabilities of the two largest in the country, and more cuts from the Federal Reserve to accommodate short term funding markets. Nevertheless the signs are mounting that the end is neigh.
The FOMC cut rates aggressively today. It remains to be seen if this can turn around the tide. Nevertheless we have already seen how many are potentially swimming naked, and the picture is not pretty. In this volatile times cash is king!

The three pillars of the death of equities:
Federal Reserve cuts rates only by 25bp in its October meeting indicating that inflation is a concern. It shows that the FED is between a "rock and a hard place". They clearly do not want to cut rates in this inflationary environment but they feel obliged to Wall Street.

Fears of a consumer led recession start mounting. Anecdotal evidence from earnings reports and weak holiday sales point towards a weakening consumer, which is one of the reasons for the stock market plunge since the beginning of this year.

Fears of counter party risks emerging. The downgrades of ACA, MBIA and Ambak are cause for serious concern and the other reason for the obliteration of equity prices since the beginning of 2008.

No comments: