Jump off the deranged bull now
Tags: housing market, Interest rates, credit crunch, Global markets, Currencies, Ben Bernanke
Startto take profits right now. Trim any American, British, and Europeanequity that is highly geared to the credit cycle. Layer out ofhigh-risk plays over the next ten days or so, until you reach adefensive level of exposure.
This is no time for bullish behaviour
Donot ride this deranged speculative bull into late October. The balanceof risk and reward are just too far out of kilter. Do not under anycircumstances join the mad scramble for emerging market stocks. Cutpositions in Latin America, Eastern Europe, Asia, and China.
AsAlan Greenspan said this week about the Shanghai market, “If you everwanted to get a definition of a bubble in the works, that’s it.” Healso said that US house prices were going to fall “a lot further thanpeople think”. Bet against him if you dare. The relief rally since theFederal Reserve slashed rates half a point to 4.75pc is a moral hazardbet, based entirely on assumptions that Ben Bernanke will debauch themonetary system to boost asset prices.
This is a fatal misreadingof the intentions of the Fed, and of Ben Bernanke’s austere moralcharacter and economic ideology. It ignores the nature of the crisisthat has ripped through the credit system over the last two months.
Thebelief in perpetual rate cuts assumes that Bernanke – and the monetaryhawks in Dallas, Richmond, and St Louis – can possibly countenance themoral hazard of further stimulus when the Dow is rocketing to alltime-highs. This rally is inherently self-defeating. It mustshort-circuit.
“The equity markets are pricing in a 'BernankePut’,” said Rob McAdie, head of credit at Barclays Capital and a manwith a front row seat at the credit crunch.
“They are bettingthat the Fed will cut again and again, but they are not factoring inthe effect that this credit squeeze is having on the financial system.Cheap money is now history. There are not going to be any more of thebig leveraged buy-out deals for a long time because the CLO market thatfinanced them is effectively closed,” he said.
“Banks are notwilling to lend to each other beyond a week. The current situation ismore systemic than the crisis in 1998. It effects far more institutionsand will have a much greater impact on the global economy.”
Yetthe markets are indeed betting on a 1998 replay, a reliquified surgeinto the stratosphere for two more years. Beware. There was no USproperty collapse then, and the world was still in a benign cycle offalling inflation.
Today feels more like January 2001, when theS&P 500 rallied for two weeks on the Fed’s emergency cut, only totank by 19pc over the next two months as it became clear why the Fedhad taken drastic action – and what this meant for profits. Wall Streetfell a lot further thereafter, taking two years to stabilize. TheS&P 500 halved in the end.
Or if you like parallels, tryOctober 1987, when the US dollar was falling in the same disorderlyfashion we have seen since August this year.
It is fundamentallyworse this time: the global dollar index has hit record lows; and theUS is no longer a net creditor. It now has external liabilitiesreaching 35pc of GDP, putting it within a few percentage points of acompound debt crisis.
We will find out from the TICs data inNovember whether China’s central bank was responsible for the $48bnfall in official foreign holdings of US Treasuries in July. But ifChina wasn't, somebody was. Who? Why?
The pattern leaves the USreliant on short-term funding to cover its trade deficit. This is awell-trodden path to crisis, as Latin America can attest.
TheFed is boxed in by the dollar, and by lingering inflation. Oil hasjumped back up to $82. Copper is over $8,000 a tonne again. Wheat hasrisen 70pc in a year. Gold has kissed $750, the ultimate reproach.
Inthe first eight months of 2007, the US consumer price index rose at anannual rate of 3.7pc. It may nudge higher in November and December asbase effects kick in. A headline rate of 4pc is not impossible. DoesBernanke want that on his resume? He believes in inflation targeting,after all.
The 10-year “break even inflation rate” as reflectedby the US bond markets jumped from 2.27pc to 2.37pc after the rate cut.The yield on 10-year Treasuries has risen from 4.48pc to 4.56pc. Watchthose bond vigilantes.
The `China effect’ of falling manufacturedprices has gone into reverse. China’s inflation is now 5.6pc, thanks totheir dollar-peg policy.
My own view is that inflation willsubside as the global economy tips over, but with a lag. It will setoff a few alarms first, enough to seriously crimp the Fed.
By theway, while I did not expect the Fed to cut a half point in September, Idon’t not share the view that this was a reckless bail-out. It wasentirely necessary, given the heart attack in the commercial papermarkets – which have contracted $368bn in seven weeks, and are stillcontracting; and above all, given the speed with which the US housingmarket is collapsing.
Robert Schiller is now warning that pricescall fall 50pc in some areas. It is already well under way.(Interestingly, auctions of foreclosed buy-to-let properties in the UKare selling at 40pc discounts already – buy-to-let is Britain’ssubprime)
Yes, the Fed made a grievous error of keeping rates at1pc until June 2004 – unforgivable in hindsight. It then fell asleep,claiming the subprime crunch was “contained” when it had in realitybecome systemic. But given the mess we now face, the September rate cutwas fully justified.
So batten down the hatches until the stormpasses. By all means keep very long-term investments or isolated`rifle-shot’ plays that buck the market.
Will it take a 25pccorrection in New York, Frankfurt, and London to flush out theexcesses? Or more? Japan’s Nikkei fell 81pc over fourteen years from apeak of 39,000 in December 1989 to a nadir of 7,600 in May 2003. Landprices in Tokyo fell by four fifths. House prices fell by over half.
True,Tokyo delayed recovery with a bad mix of policies in the 1990s. But arethe bubbles in America, Britain, Australia, Canada, Ireland, Spain,Greece, Latvia, Romania, Kazakhstan, the Gulf, Argentina, and above allChina, really that different from Japan’s errors in the late 1980s?