Confusion Reigns

Confusion reigns. How bad is it really right now? How bad will things get? Was this a correction and is it over now? Will there be a Recession? The Bulls and Bears are at war.

BIS, S&P Disagree Over Severity of Credit Market Rout (Update1): “The market fallout from the subprime mortgage slump is less severe than in 1998 after Russia's default and the collapse of Long-Term Capital Management LP, the Bank for International Settlements said.

The assessment from the BIS, which monitors financial markets for central banks and regulates lenders, contrasts with analysis from Standard & Poor's, which last week said the outlook for securities firms is worse than in 1998.”

I believe that the guys at S&P have a better grasp of the situation and that their analysis of the consequences is more accurate than that of BIS:

“S&P, based in New York, last week said revenue from investment banking and trading may fall 47 percent in the final six months of this year, compared with a 31 percent decline nine years ago. Moody's Investors Service on Aug. 16 said a hedge fund collapse on the same scale as LTCM was possible.

Investment banks face larger losses than in 1998 as they write down high-risk, high-yield loans and asset-backed securities they can't sell amid the slump in global credit markets, according to Nick Hill, an analyst at Standard & Poor's in London.”

Fed, Blamed for Asset-Price Inaction, Is Told `Tide Is Turning': “Federal Reserve officials, wrestling with a housing recession that jeopardizes U.S. growth, got an earful from critics at a weekend retreat arguing they should use regulation and interest rates to prevent asset-price bubbles.”

Bernanke is stuck with the mess that Greenspan made. Cleaning it up won’t be easy. After all, Greenspan too was stuck with somebody else’s mess…

“Controversy on how to handle asset prices has been stoked by two crashes in the past decade. Some economists blame former Fed Chairman Alan Greenspan for not raising rates enough to curb the Internet-stock boom in the late 1990s. That soured in 2000, contributing to a U.S. recession the next year.

By cutting rates to a four-decade low in 2003, the Fed inflated property values, Ed Leamer, head of an economic forecasting group at the University of California at Los Angeles, said at the conference. The ensuing housing slump, the worst since 1991, and the credit-market turmoil that followed, threaten to undo the six-year economic expansion.”

I have noticed a peculiar trend: When dotdumb stocks were flying high, speculators were telling anybody who would listen how super smart they were and how they were really really skilled traders. When housing prices were jumping 10% a month, speculators were telling everybody how they were real estate ninjas climbing the property ladder to great wealth. BUT, when the bubbles finally burst, and these novice speculators get pwn’d it was NEVER their FAULT.

Cheapest Stocks in 12 Years Greet Investors After Summer Swoon: “U.S. investors are returning from summer vacation to the cheapest stock market in almost 12 years, and some of the biggest fund managers say they're ready to load up on shares of technology, energy and industrial companies.”

Sounds very interesting. A no brainer basically. Or is it?

“Estimated profits at companies in the S&P 500 represent a yield of 6.46 percent of share prices, or 1.93 percentage points more than the yield on 10-year Treasuries, Bloomberg data show.”

Aaah. Stocks are cheap based on FORWARD earnings ESTIMATES. Considering analysts DOWNGRADED most home builders, mortgage originators and other financial firms long AFTER they had been destroyed by the market, could it be that these estimates are a little optimistic? Have these estimates been adjusted already to account for the effects of this recent liquidity crunch? Can the effects even be measured and estimated with any confidence?

“Catching falling knives is a dangerous art and not one I have perfected,” said Edwards, the firm's managing director. “They're only cheap if the earnings hold up, and there's not a lot of confidence with the E portion of their P/E ratios.”

Yen Gains as Carry Trades Pared, Qatar Plans to Invest in Asia: “The yen rose against the 16 most- active currencies as a decline in stocks prompted investors to pare purchases of riskier assets, and after Qatar said it will reduce dollar holdings and invest in Asia.”

The appetite for risk has been curbed severely and does not yet show any sign of returning. This is ultimately both dollar bearish and equity bearish.

Treasury Market Volatility Rises to Most in 3 Years (Update1): “The global flight to the safety of government debt is causing the widest price swings in Treasuries in three years, driving away traders who rely on computer models to guide their strategies and raising costs for investors.”

As long as the flight to quality is in force, equities can’t make sustained runs.

Recession Risk Rises as Consumers Feel Pain of Tighter Credit: “The pain from higher borrowing costs may be spreading as consumers and businesses follow investors in shying away from risk, increasing the odds of a recession.”

Now, two areas of the economy that have held up well so far, jobs and consumer spending, no longer appear immune as cheap credit dries up all over the globe…