Intl stock markets vs US markets

Of late, international stocks have been falling more rapidly than US stocks. There are a couple of reasons for this.
- Redemptions from hedge funds, US mutual funds investing in intl stocks. Note that the dollar has appreciated very significantly in the near past. This is of course both the cause and the effect for investors pulling cash out of other currencies, markets and commodities.
- US equities stared off with lower P/E's at the high so have less to fall
- Since the rest of the world especially China was a big manufacturer of goods destined to the US, there is significant overinvestment in capital expenditures. Also, commodity producing countries like Brazil, Australia and Russia have been hammered.
- In India, the monetary policy is still quite restrictive thus encouraging saving. Inflation has also not subsided enough but it should in the near future. I think Indian stocks represent quite an opportunity at 8000 sensex levels.

Q&A

Folks..I strongly encourage you to send in questions even if they are very basic. After all, my goal here is to communicate my understanding of things to people who are not expected to be aware of financial terminology and the latest happenings in the market.I sent in a question to Trader Mark and he replied immediately and I liked his straightforward reply. I will attempt to do the same.

Q from me:

Hey Mark,

    Firstly, I've been impressed with your commentary - it's honest
and entertaining (and of course insightful). I'd like to know with
all the carnage going on, what are the markets pricing? In spite
of hedge fund blowups etc. and all the uncertainty, what earnings
for SnP are we anticipating? I mean...i don't think we expect
earnings to fall below $60 next year, do we? But still, if companies
have enough cash to weather this and corporate yields for
non-financial companies are still so high, I guess they are a safer
bet than stocks right now considering a lower probability of
defaults. But I can't state any of this in numbers, wondering if
you can.
Stimit

A from Mark:

I don't know what earnings will be next year - a lot of it will be based on availability of credit which we should know within 90 days. If we are stuck at this level it could be horrific simply because we have lending not near anywhere where it should be. We have to see what the new fed programs they are rolling out over next two weeks do to the market and if it opens the spigots

Trough PE ratio is generally 7 so thats why people are throwing around $60 x 7 = 420 which takes you back to mid 90s.

Generational imbalance

I've been studying for the CFA and was planning to post insights I picked up from the various chapters. For multiple reasons, one of which is that I have not read all that much material :) I've been lax in this regard. However, this just struck me as something I must write about since this dwarfs all our present problems!

The fiscal imbalance, which is the present value of the government's commitments to pay benefits minus the present value of its tax revenues stands at a staggering 54 trillion dollars. This is almost 4 years of the entire nations present GDP. Guess what..the only way to meet this gap is
- Raise income taxes
- Raise social security taxes
- Cut social security benefits
- Cut federal govt. discretionary spending

And to think that we are going to be running deficits for sure in the next few years to tackle the "financial crisis" leaves me wondering what the hell can be done. The dollar will get smashes over the span of the next 20 years. The US will have to increase exports like crazy to the rest of the world, exports of tangibles (including software :) and inflation will run rampant. As always though, there will first be a hint of deflation before inflation. Are we back into the 70's inflationary spiral?

A question on gold

I recently submitted a question to Marcus Grubb who is the Managing Director of Investment Research and Marketing at the World Gold Council and will answer readers’ questions on the outlook for the bullion market on Monday, October 27 in the Financial Times. Let's see if he considers my question worth answering

Gold is generally considered a hedge against inflation. However, my confusion is related to the different rates of inflation in Asian countries as opposed to developed economies. If the Indian Re were to appreciate back to 40/$, gold would be considered extremely cheap in India and demand would grow, more so with a 10% inflation. Am I correct in my thinking?

Brilliant..how to work the TARP

From the nytimes:

The Swiss National Bank said it had created a fund that would enable UBS to transfer $60 billion worth of toxic assets from its balance sheet. UBS said the fund would be capitalized with $6 billion of equity capital provided by UBS and $54 billion from the Swiss National Bank.

UBS said in a statement: “With this transaction, UBS caps future potential losses from these assets, secures their long-term funding, reduces its risk-weighted assets and materially de-risks and reduces its balance sheet.”

This drew a big aha from me. Now I have an idea of how to work the TARP (Troubled Asset Relief Program) with the remaining $500B. Set up a fund that will be capitalized with 10% from the bank (from the earlier govt. infusion of cash :o) that holds the asset and 90% from the govt. Move the toxic asset into the fund at the most recent mark to market value. That's it..the bank is done and they limit their losses and so get some certainty (which helps them calculate value-at-risk, etc.). And now the biggie...any losses < 10% will effectively be borne by the bank earlier held those assets. Sounds like something workable.

It will get better before it gets worse

Remember this...right now this is a financial crisis and not an economic collapse..yet. Hence there will be a rebound based on the unprecedented response from the governments of the world to rescue the system. Ben Bernanke in fact has an opinion piece today in the WSJ titled "We're laying the groundwork for recovery".

However, the problem is much much bigger. It's of the debt burden carried by individual Americans and the country itself. It's of unsustainable consumption in the US and the difficult in controlling commodity costs when welcoming billions of Indians and Chinese into the middle class. It's of the ridiculous leverage built up in the system which will not end until it is smoked out!

In short, my forecast is of a recovery to 1200 this year. This will be fueled by the fed cutting rates further, Obama being elected president and hope that the bottom in housing is in. In fact, we may even see a rise up to 1300 early next year. From there I strongly believe it will start getting worse, slowly at first and then faster as the effects ripple through the real economy. I think a real bottom for housing will not be until 2010 or 2011 followed by flat to modest increases thereafter. Right now, I think the best time to buy is end '09 to early '10. As always, watch this space for updates to all the forecasts :)

Way smarter

Haha..i'm sure you think I'm talking about myself but I'm not. And in fact, this is not even a post related to the markets or finance. It's my reaction to an interview with Peter Galbraith I just heard on NPR. Earlier, a few weeks ago, I'd heard a roundtable interview with 5 former secrataries of state..imagine the star power in that room. These people are really brilliant when it comes to foreign policy and whenever they speak, even if they don't intend to, they end up showcasing how fu#@$@ terrible the current administration has been. I wonder if there will be a witch hunt when W. packs his bags and leaves the white house. That is already been seen in the case of the firing of the 9 attorneys by Alberto Gonzales. I am waiting for Obama to be elected and take office and I strongly believe he will change the perception of the US on the global scene.

Causes of the downside acceleration in stocks

I'll just make a list. All I can say is if we fall below 800 on S&P, the market will crater to 600 very soon! Ouch. However I think the more likely scenario is crazy volatility but above today's levels.

- Letting Lehman fail: This triggered a wave of panic from anyone who held Lehman debt (stockholders would have been wiped out anyways) and more so from the insurers of that debt (through Credit Default Swaps). Just today that debt was auctioned at 9 cents on the dollar meaning the insurers had to come up with the rest which in all is said to have totaled 270 Billion dollars. Additionally, this created confusion as to who would be allowed to fail and who would be rescued.
- Margin calls at large hedge funds: Even the big brokers like Goldman and Morgan Stanley increased margin requirements for hedgies. Since stocks were some of their most liquid assets, they blindly dumped these to raise cash.
- LIBOR widening and no one willing to lend to no one: This is more from a loss of faith in the counterparty. Since most rates in all sorts of contracts (even US mortgages) are tied to the London Inter Bank Offer Rate, this increased financing costs for everyone. In fact, ICICI is paying more than 20% interest for some short term loans to shore up liquidity
- Govt plan to buy equity stakes in banks: Interestingly, although in the intermediate term this will be positive for banks, investors bailed when they realized that their holdings would be diluted even further!
- Short selling ban in financials being lifted: This brought back rumor mongering strategies back into action. Also the etf's that engage in short strategies had short (or effectively short) a bunch of these shares.
- And finally, the back and forth on the bailout plan: If one thing markets do not like, it's uncertainty. The rejection of the plan in the congress was a shocker. Even if they had approved say a smaller bill I think it would have been fine. But first rejecting and then approving just created confusion followed by panic.

Shorts for slaughter

The ban on short selling of financial stocks was lifted today and immediately, banking stocks fell. Morgan Stanley (now a bank) collapsed over 15% on rumors that an equity injection from Mitsubishi bank will not go through. Paulson said they were willing to take equity stakes in banks. Tie it all up and to me, it seems like the treasury will announce an equity injection into banks that have the most short interest! What a brilliant idea to skewer those evil rumor mongers.

The fact that the market has been unable to rally inspite of being way way oversold is very scary. I saw a panel discussion on Cspan yesterday which was fascinating. There are very smart people out there with suggestions of what to do next. Some of the things possible are

- Another stimulus package
- Another 50bps Fed rate cut
- Nationalization of banks
- Buying up subprime mortgages using reverse auctions (the Moody's economist said this and I'm not too sure how it works)

But for sure, something significant will have to be done to shore up the confidence of international investors. A sure sign of this will be the Middle East weatlh funds putting capital into the system.

A picture worth...

10 yrs of words! Will we see a reaction low to 1050 followed by a sharp reversal to 1200, test for support and then vroom to 1300?

A weekend rate cut?

Is it possible that the markets are rallying today in anticipation of a fed rate cut over the weekend? The yield curve is certainly telling us one is due and today's job report makes it more likely. So why is a fed rate cut such a good thing? The simple answer is that it reduces borrowing cost. Another interesting thing is that it forcibly steepens the yield curve i.e. 10 yr interest rate > 2 year interest rate > 3 month interest rate. Banks and other lenders really like this since they can now borrow over the short term and lend over the long term thereby locking in the yield differential as profit. An interesting tidbit...the auction rate securities market that failed spectacularly earlier this year intended to allow everyone to borrow over the short term. These securities were then "auctioned" every so often to the lowest bidder. Unfortunately, the liquidity crunch meant no one was willing to buy these and so the interest rates skyrocketed!

This looks like rockbottom

From 200 day moving average of # of SnP500 stocks below 200DMA (surprised such an indicator exists!), it looks like we should have reached pretty close to a bottom for the year. Investor pessimism is at extremes, Buffett is investing in solid companies like GE and Goldman Sachs. For the risk averse, do consider a good corporate bond fund like LSBRX. It's sporting never before seen yields!

When fear feeds on itself

An interesting thing is happening in the markets recently which is almost a mirror opposite of how things were just a few years ago. Since most people understand things going up better, it's somewhat easier to imagine how the dot com boom transpired, or how the investment banks/hedge funds could leverage to 30x capital, etc. Unfortunately, the flip side i.e. the compression side of things happens much much faster and is way more painful to watch. A number of hedge funds have received redemption requests from their clients. In fact, the Lehman failure and the AIG near death experience have strained markets to an unimaginable extent, leading to severe margin calls and further forced liquidation!

The VIX ("fear" index) is very high which usually means that a lot of uncertainty is already built into valuations. However, this is the exact time for things to get from bad to worse. Do not be surprised to see another of those whopper down days in the near future. Although I think 3 months down we will be better than now, be very cautious of short term directional bets. Caveat emptor.