Wednesday, September 17, 2008

some observations from wednesday, 9/17/08...

at 11:42 am central time, it was noted that U.S. three-month treasury bill yields fell to 0.02%, according to traders - AMAZING

while this is very clearly a unique and historic financial market environment, the one aspect of investing that NEVER changes is human nature, which is driven by fear and greed. a panic indicator i've come across, which incorporates the TED spread, High Yield Debt spreads, a ratio of Volatility to 3-month Treasury Bill yields and High Yield CDS spreads, is a broad indicator designed to sense fear/greed in various different financial assets and the indicator hit a truly historic extreme yesterday by moving up to 5.0.

Since 1950, this level has only been seen 6 prior times – 05/28/1962, 05/27/70, 08/17/82, 10/19/87, 08/20/07 and 03/19/08. As you can see by those dates, some were historic lows and some were temporary lows – but they were lows and were typically retested. In fact, when these instances have occurred, the S&P 500 was up 5.5% on average over the next two days. The only instance where there was no retest or break of the lows was 1982. The most recent two led to tradable rallies, but obviously were not major market lows.In my view this is a great indicator from a trading basis and certainly suggests now is NOT the time to sell, but I am still not willing to suggest investors begin to become more aggressive in buying for a sustainable rally. A few days ago, I said that at least one of the 3 questions must be answered affirmatively for us to change my firm's view to at least a "tactical" buy:

Are the major market indices such as the S&P 500 (SPX) in extreme oversold condition using my trusty 14-week stochastic indicator?
* Are any actions by the Treasury or Fed improving credit or going to make banks more willing to lend rather than trying to sell assets?
* Is the outlook for global growth getting better?

So far, the answer to all of these remains not yet. From a tactical basis, if the markets do see a sharp bounce over the next couple days and retest the low, the 14-week stochastic should get to a level on the retest that suggesting something more than a bounce for a few days. From a fundamental basis, I continue to believe the liquidity given by the global central banks is a positive, but does not address the underlying problem of delevering and global economic deceleration. Not allowing catastrophic failure by backstopping AIG (AIG) is definitely a positive, but is still not a growth strategy.

What would change my view to very fundamentally positive on a dime? We have suggested for the past six months that either the creation of an RTC (Resolution Trust Corporation) like entity that can buy the distressed/bad assets and/or a massive coordinated global rate cut is necessary to resolve the current financial crisis that is now rapidly leading to a global economic crisis. Unfortunately, neither of these moves appears likely at the moment so we are stuck with a "tactical" market environment. In today's Wall Street Journal, Nicholas Brady, Eugene Ludwig and Paul Volcker highlight what an RTC like entity has/could look like based on historic precedent. The appearance of their view in the opinion pages may mean we are getting a bit closer to addressing the real problem – toxic assets and paper where price discovery is next to impossible.

The longer we delay setting up such an entity, the longer the crisis will go on and the deeper the global economic consequences. We need buyers of financial assets and to date, there has been nothing done to make that happen. Equity mutual funds are seeing net withdrawals every day, investment partnerships (I wish the term "hedge funds" would be characterized properly) are moving to cash for fear of withdrawals and major financial institutions are liquidating or trying to move assets off their balance sheets in order to protect their businesses. All the greatest fundamental or technical analysis in the world doesn't change the fact that if you don't have a sustainable buyer, prices can't move sustainably higher.

I continue to suggest staying on the sidelines (in cash for aggressive funds) and neutral to benchmarks as much as possible (for long-only funds) until there is some more clarity on the above points. Again, there could be a "trade" higher, but the odds highly favor at least a retest of the recent/coming low if a bounce comes over the next couple days.....

it's certainly interesting that a very well-capitalized bank can be shorted out of existence as the structure is built on leverage and trust in the system. If you cause enough pressure on a bank, then you can create a fear induced spiral. CDS spreads spike, stock rips lower, ratings agencies downgrade, borrowing costs spike and in a short matter of days a very well-capitalized bank can be threatened. Note the action in Morgan Stanley (MS) or Goldman Sachs (GS) just today. Firstfed Financial (FED) was almost shorted out of existence with more shares short than the existing float.

I would not endorse an end to all shorting but in this environment not allowing the shorting of banks and brokers may actually prove to become necessary -- especially since we are in a world experiencing its first major market dislocation without spread, specialists, uptick rules and this absolutely insane FAS 157 rule.

Marking to market very long-lived illiquid assets makes as much sense as a bank granting a loan on a house based on what it would fetch in a 15 minute auction.

marking to market very long-lived illiquid assets makes as much sense as a bank granting a loan on a house based on what it would fetch in a 15 minute auction.....

tomorrow is the last day of trading for S&P 500 (SPX) September options and if things get hairy tomorrow, after being so today, there is no more painful way for shorts to wake up Friday morning to a surprise pre-open rate cut....

Difficult times indeed.

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