World Recession and the Perfect Short Squeeze

Yesterday’s MASSIVE rally will reveal itself to have been nothing but a cruel April Fools joke. I say it here and now. Let me explain:

It was the first day of the new quarter and therefore, NEW money was deployed. While this wasn’t the primary driver, keep this in mind.

Both UBS (UBS) and Lehman (LEH) announced new capital infusions. Now this is where it gets interesting. In both cases the capital is being raised in a very specific way.

But first some background: When large speculators, such as hedge funds, find an ailing company that has the very real possibility of becoming financially impaired they naturally start to short the COMMON shares. As the COMMON shares get HAMMERED DOWN and time passes, more and more information about the company’s financial situation gradually becomes public knowledge. This means that even the companies bonds start to loss value. Those same large specs might even start BUYING them for CENTS on the DOLLAR.

Now what? The large spec has a big fat UNREALIZED profit. Buying the shares back would be counter productive as the shares would LIFT on the sudden demand and reduction of supply. Since the company is really in financial distress, the large spec now approaches the company and financial intermediaries and expresses their interest in ‘supporting’ the company. The bankers get giddy with excitement and arrange for a secondary offering of COMMON shares which the large spec subscribes too. The large spec buys the shares, thereby covering their shorts. The firm gets fresh capital and increases its odds of survival. Existing shareholders get DILUTED. The large spec also makes money on the bonds as the risk of default suddenly drops.

See. SHORT SELLERS aren’t actually pure EVIL. They serve a legitimate purpose. This actually works and works well because existing longs may not be interested in adding to their long exposure and FRESH, NEW longs may be hard to come by.

In the case of UBS and Lehman, the money was raised from those NOT SHORT common. There went the ‘OUT’ for the shorts and BANG, there is your short squeeze.

Lehman reps actually came out and explained it on CNBC yesterday. Cramer did the same for UBS. He even giggled about it.

To make things worse, the financial community appears to have gotten together and made both UBS and Lehman ‘hard to borrow’. Suddenly those who were short were told they MUST cover.

If you’re long, you can decide if you want your shares to be available to be borrowed or not. Some well placed phone calls to some hedgies and friends that were long common, and suddenly the shares available to be borrowed DISAPPEARED.

There you go. Toss in some FRESH money on the first of the quarter and you’ve got your low volume super-spike. This is how you engineer the perfect short squeeze.

IMF Cuts Global Forecast on Worst Crisis Since 1930s (Update2): “The International Monetary Fund cut its forecast for global growth this year and said there's a 25 percent chance of a world recession, citing the worst financial crisis in the U.S. since the Great Depression.

The world economy will expand 3.7 percent in 2008, the slowest pace since 2002. In January the fund projected growth of 4.1 percent.”

The IMF is SLOW and LATE. They cut growth LAST and LEAST. For them to say there is a 25% change of a WORLD RECESSION, is something to take VERY seriously. This is a very careful and conservative organization.

“The reduction is the third by the Washington-based lender since last July, when it predicted the world economy would cope with the U.S. credit squeeze and grow 5.2 percent this year.

The IMF gave a 25 percent chance that global growth will drop to 3 percent or less in 2008 and 2009, a pace the fund described as equivalent to a world recession. The last time that happened was in 2001.”

I would put the odds of a WORLD RECESSION at greater than 50%. EASILY. You can’t have a GLOBAL CREDIT BUBBLE ,a GLOBAL ECONOMY and GLOBAL PROSPERITY without the flip side: GLOBAL RECESSION.

“The fund lowered its forecast for U.S. economic growth to 0.5 percent this year, according to the document, below a 1.5 percent prediction made in January. The world's biggest economy will expand 0.6 percent in 2009, it said.

The euro region will expand 1.3 percent in 2008, the document said, down from the fund's 1.6 percent projection in January.”

It’s amazing how easily people forget this. Sure, everybody is happy pumping money into EMERGING ECONOMIES and COMMODITIES on the GLOBAL GROWTH story. But they conveniently ignore the implications of slowing growth in the U.S., the EU and Japan. When the single largest economic bloc of CONSUMERS simultaneously slows, all the export economies around the globe have to stall out.

“Japan's economy, the world's second largest, will grow 1.4 percent in 2008, less than the 1.5 percent the IMF predicted in January, according to the statement. China will grow 9.3 percent this year, slower than the 10 percent projection made in January, the statement said.

The Asian Development Bank today lowered its forecasts for Asia, and said central banks in the region would pursue policies to quell inflation rather than spur economic growth. The World Bank earlier this week also warned of the threat of rising energy and food prices.

Asia excluding Japan is predicted to expand 7.6 percent this year, less than a September estimate of 8.2 percent, the Manila- based ADB said in a report today.”

ADB Cuts Asia's Growth Forecasts, Warns of Inflation (Update1): “The Asian Development Bank lowered its economic growth forecasts for the region as a global slowdown weighs on exports and expansions in China and India cool.

Asia excluding Japan is predicted to expand 7.6 percent this year, less than a September estimate of 8.2 percent, the Manila-based institution said in a report today. The economies grew 8.7 percent in 2007, the fastest clip in almost two decades.”

The global ‘decoupling’ argument is a dead. I’ve argued this before:

The Global ‘Decoupling Theory’ is Garbage
Global Decoupling Theory, Correlation Contagion

Consumers that make $3k to $9k a year and have a HIGH savings rate, are not going to behave the same as consumers that make $21k to $37k a year and spend as if they make $50k - $100k a year. You can’t just SWAP one out for the other and say, “Ta da! Carry on! This party is just getting started!”

“Although developing Asia is now exporting more to other emerging economies, this is unlikely to compensate fully for losses in the much larger, more established markets. Market penetration of Asian suppliers in China's final goods markets is limited, and strong growth in China will provide only a limited cushion against the downturn.”

Related Headlines:
UBS, Lehman Raisings May Signal Rout Is Nearing End (Update4)