John Kenneth Galbraith (1908 - 2006)
This week has the G-20 meeting in Washington as the big highlight - even President George W. Bush will leave his ranch in Texas to attend!
We had our Weekly Investment Meeting this morning and unlike last few meetings we had some "clarity" in our assessment;
- Financial Solvency is yet again an issue - AIG, Fannie Mae et al all were "maybe" solvent for about two month but with stock markets down 25% plus in September and as credit spreads continues to be elevated they now need further capital.
- Private consumer solvency is now main issue - yes, interest rates have come down, taking off pressure momentarily, but now the private sector is starting to pay the price: net net we are now worse of than when it was merely a financial sector insolvency. Basically we now got both major parts of the financial sector and the private consumer being insolvent at the same time
- ==> We are entering final leg of the deleveraging proces
The political reaction to the above will be what we call the "50/50" solution:
50% of the insolvency will be solved through additional capital injection
50% through easier accounting rules, solvency calculations, tax deferences et al.
Problem with this being it as per usual does nothing to the real issue: the solvency - the model used right now is one based on "hope".
Hope the markets will correct and then improve market valuations through better asset prices - good thing religion is so popular these days!
The G-20 meeting does seem to have some "real soluations" on the table - the latest one which Wall Street Journal picked up yesterday does make some sense to me: Spain's Bank Capital Cushion Offer a Model to Policy Makers: http://tinyurl.com/6x6lms
The argument being that the accounting rule change in 2004, which made the companies only take loss' when incurred made sure the leverage increased dramatically, without making provisions for future loss' - should be unwinded.
The Spanish model will give some "cushions" against loss - the issue with this being it INCREASES THE LACK OF TRANSPERENCY - actually almost everthing policy makers does from TARP to accounting changes works the same way: Adding layers of non-transperency!
Back to our Investment meeting:
The investment meeting had following conclusion:
The three driving premises for our research remains:
- Cost of funding drives market and valuations
- Price of liquidity new unknown (tax on money)
- No prior analogy historically will work (because this is different, very different)
The market has re-entered negative bias - we still look for minimum 765.00 in S&P.
We remain at 75% cash but now we use the 25% for downside plays in markets
We favor being short stock markets, long US dollar (US Dollar balance sheet issue is back with year-end), short commodities and long fixed income.
Our asset allocation model (100% mechanical expects 1 month return of:)
MSCI World: -0.77%,MSCI EMG: -0.84%, Commodities: -1.22%, and Bonds: +0.87%
The model allocates as follows: Short 10% MSCI, Short 34% MSCI EMG, short 7% commodities and long 47% bonds - this is our WORST Scenario: OUTRGIHT bearish. The model is based on our leading Global Indicator Model - and regression analysis of expected return. It is not an exact science, but its a mechanical way of getting expected returns from one consistent source. The expected return from this allocation is: +1.75%
Economics
Incoming data continues to accelerate negatively - our model and forecast does not see any improvement in the next month.
The political landscape is getting more complicated. Treasury only got 40 bln. US Dollar left on the initial 150 bln. USD - and Paulson will soon be back in Congress asking for more, and the Democrats wants him to "fix" the auto-industry - making the bill bigger and bigger.
The fastest deaccelerating economies remains Sweden & Australia (hence best government bond buys).
Fixed Income
Credit remain scarce - credit spreads are not really moving - market starting to look at year-end balance sheet, and we expect serious deteriation of credit facilities and more and more corporate blow-ups like Circuit City yesterday.
We like Bunds over Treasuries. We like TIPS still.
Equity
Earnings forecast still too high - market looking for +15% 2008/2009 earnings. Per share it is at least 35-40% too high - I remain extremely sceptical on all earning forcasts with a positive sign on them - the insolvent private consumer is going to hurt EVERYONE in the business cycle, seems the analyst' have not been in out shopping recently.
I have to warn you - this is only the beginning - the next few month will be the worst part of this cycle - as several forces works against the markets:
- Bankrupt consumers
- Insolvent banks
- No credit creation
- Policy solutions based on hope
- The "everything is "really"cheap "relatively" clowns
- High expectations to G-20 meeting & incoming President Obama
We are short Stoxx50 & S&P. No longs at all.
Commodities:
Crude should hit 50.00$ - Gold below 680.00 - There is no value in commodities in this part of the cycle.
Conclusion
The meeting had higher conviction rate - we are now yet again outright short the markets - break of 895.00 on the close will confirm intermediate top in place - in STOXX50 this translates to 2540.00. Watch VIX above 63.00/64.00 will confirm next bearish leg has started.
We are: Short Stoxx50, long EURHUF, short EURCHF, short EURUSD, long Bunds - looking to sell crude, to buy some Private Equity & TIPS.
This is extremely important week.
Finally,
I am just back from Dubai - I had the pleasure of spending the Sunday in the Desert - you must try it - makes you realise how insignificant ones life is in the grand scheme of things - but what a place, the quietness and light... amazing.
Safe trading,
Steen
