INSTITUTIONAL ADVISORS
FEBRUARY 14, 2008
BOB HOYE
PUBLISHED BY INSTITUTIONAL ADVISORS
The following is part of Pivotal Events that was
published for our subscribers February 14, 2008.
SIGNS OF THE TIMES:
Last Year:
"Global investors are increasingly snapping up corporate bonds backed by Brazilian beef, Mongolian bank loans and Mexican mortgages"
"The surge in such bonds is part of a sea change in the capital markets of developing countries."
– Wall Street Journal, February 13, 2007
Regretably, that sea change lasted until May when the reversal in the yield curve and credit spreads announced that the tide was going out. This always reveals just how ugly the bottom of the harbour is.
"Hedge Funds Beckon Small Investors"
– Wall Street Journal, February 14, 2007
Last year, that was likely taken as another "Happy Valentine" opportunity.
* * * * *
This Year:
The following has an interesting way of arranging data on a horror story.
"Foreclosures: 100 Worst-Hit Zip codes"
" The Las Vegas Valley is home to seven of the top ten zip codes and fifteen of the top hardest hit by the housing/foreclosure meltdown"
– February 10, 2008
Today’s Valentine is:
“Auction-rate securities failing to draw bidders”
“It was a quest for yield. As soon as you get all of these synthetic products based upon other products, it’s a cancer that refuses to stop spreading.”
– Wall Street Journal, February 14, 2008
Stock Markets: Last week's review of the futility of the theories and practices of interventionist economists left out that their favourite subject – GDP – does not have a board lot. So if there is no high, low or last trade why even talk about it?
To be serious, there is something very dysfunctional about using economic projections to forecast the course of the stock market. The course of the stock market always leads the economy--in this instance, to the bottom of the harbour.
Our main theme has been that the change in the credit markets in May was cyclical. With this, stock markets and industrial commodities would follow, with eventually all commodities declining with the general contraction. More specifically by July, credit spreads and curve deterioration was sufficient to make the conclusion that the greatest train wreck in the history of credit was underway. It is not over.
More recently, the last decline was likely to complete in January, and the panic registered a rare "Downside Exhaustion" on the Nasdaq. A rebound amounting to a 40% to 50% of the loss was possible into March. As it turned out, short-covering was brutal and in many cases the rebound was accomplished in quick time.
Last week, we reviewed this and noted that the stock market had likely enjoyed the best of the possible gain, but on the time factor could churn up and down for a few weeks.
The panic in August was a "heads up" on the degree of untempered speculation, and its vulnerability to shock as money-market spreads sharply widened.
The plunge into January was forced liquidation of equities and lower grade bonds accompanied by unsettling economic reports and desperate banking conditions.
A few weeks ago we mentioned that the "Unemployment" model had indicated a possible low in January. The way this works is that when the rate of change on unemployment claims rises above zero, which was on September 21, the stock market turns down to a fairly severe hit some four months later, and the low was on January 23. Usually, the rebound occurs and the low is tested within 10 to 15 days, which has been the case.
The rebound has been technical, and as we noted at the bottom, the rally would make the rescue packages look like they are actually working. A little more up and there will be a round of self-congratulations.
However, the credit contraction and its repercussions are not over.
Often a big squeeze in commodities can set up a crisis that when it lets go can dislocate other markets. Wheat is in this excruciating condition now, and typically, when the game reverses it is usually violent.
While the next dislocation could be from the grain crisis, there is this week’s discovery of another disaster in synthetic securities. This one is in some things called “auction-rate” securities and “tender-option” bonds, which have suddenly gone “no-bid” and “no-tender”.
Like us, if you have never heard of them you are fortunate.
The possibility of a rebound into March has been due to technical forces. As noted, the action would be vulnerable to more bad news from the banks. This is new “bad news” and it could be enough to curb any further advance.
Technical failure is possible before March. This would be indicated by the Dow taking out the last low at 12,069, and for the S&P its 1,317, and for the Naz its 2,253.
Sector Comment: Dr. Copper had been expected to set a low late in the year, and then rally out until March, and this is working out. Base metal mining stocks (SPTMN) took the hit down to 598 in January, and retraced 50% of the loss on the rebound to 771. Generally, this is likely the best that could be expected, and this needs to be tested, which would provide another selling opportunity.
Base metal prices are in a cyclical bear, and now so is this stock sector.
As represented by the BKX, banks and financials also accomplished a very spirited 50% retracement to 96 early in the month. At 121 a year ago, this sector was the big bastion of complacency. Now it has made its best on the rebound and is vulnerable to disastrous reports that will continue.
It is ironical, that every financial party occurs with a dramatic decline in the real cost of money, and the contraction occurs as Mother Nature severely begins to ration credit. This shows up in the typical post-bubble increase in real long interest rates, which has been huge and is reviewed below.
INTEREST RATES
The Long Bond: Usually at important lows, we like to emphasize that for the potential rally "real men trade long bonds". None of the wussey ten-year stuff for us, indeed. In looking at the remarkable damage, we should have added that "real men don't buy bond insurance". What a crock.
Our website (www.institutionaladvisors.com) has a section on the credit markets. This has been expanded with a review of all of the key calls made during one of the most remarkable changes in the credit markets. Also from a few years ago we have included an early edition of our "Real Men Trade the Long Bond".
Our January 24 edition noted the degree of overbought and advised that traders should play the short side. The high was 122.81 in January 23, which was just as the general panic was ending, and the decline has been to today’s 116.22. The action appears to be a spike that has been followed by a damaging stair-step down.
Inevitably, as most traditional corporate bonds become toxic the revulsion will spread to long treasuries. It is also worth thinking about all the high-grade bonds still held by banks and that these could be liquidated as reserves disappear.
Link to February 15th ‘Bob and Phil Show’ on Howestreet.com:
http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/778
HOYE, INSTITUTIONAL ADVISORS
