 SIGNS OF THE TIMES - Aug 24, 2007
Conditions remain hazardous
Bob Hoye
Institutional Advisors
Aug 27, 2007
"This is a liquidity driven market.
"Getting rid of M3 makes expansion invisible.
"Bernanke is closely attuned to the market and
as to how much liquidity needs to be in the system for the market
to be supported."
-Marty Chenard,
StockTiming.com, July 20
That was not an isolated voice
of confidence, as one usually-critical and widely-followed observer
on August 18 wrote, "Rather than the End of the World,
credit markets will get back to normal, as there is a lot of
money that needs to find a home."
Then on August 21 someone at
the Wall Street Journal less conditioned by wishful thinking
reported, "Debt isn't merely more expensive, it
is scarcely available at any price or on any terms."
The latter is reality and it
will likely be as severe as when Thomas Gresham was agent and
advisor to the British government in Antwerp when it was the
financial capital of the world. Elizabeth's royal demands for
funds were considered undeniable, but during the crisis of 1561
Gresham was obliged to report that there was no credit available,
"even at double collateral."
Being a trader he could accept
fate in the market place. There have been many booms and panics
since accompanied by generations of academics who all seem to
have to do something about the crisis and over the centuries
all come up with the same solutions to a credit contraction.
Add more credit without understanding that the problem is directly
due to the over-use of credit, and cut administered rates without
understanding the short-dated market rates of interest plunge
during the early stages of a contraction.
As the saying goes, "Nonsense
so blatant that only an intellectual would fall for it".
Stock Markets continue to be suspended by convictions
about earnings, valuations, the miracles of policymaking and
the soundness of the economy. This is the story that has worked
since 2003 when the economy began to support the bull market
that started in October 2002.
The point to be made is that
the stock market leads major turns in the economy so there is
little reason to use economic trends or, shudder, projections.
The next point is that changes
in credit markets lead turns in the stock market, and central
banks typically follow changes in the yield curve.
For some months now we've been
trying to place orthodoxy in perspective and recently market
forces are adding a practical instruction. A salient event was
that the decline in bill yields, in Canada and the US, was not
by any means anticipating a "managed" decline in administrative
rates. The decline in bill rates is a classic "cash in a
crash" rush, which is the next indelible step towards a
cyclical credit contraction.
And as these pages repeat,
credit is money of the mind and that mind has changed, from using
any asset for the application of leverage to a revulsion for
credit.
The truly sophisticated series
in the play is once again the yield curve. Inversion shows a
strong demand by speculators for short-term funds and the transition
to steepening indicates a decline in speculative demand and all
that that entails.
Of course, with the boom NYSE
margin debt soared, exceeding the peak reached in 1Q 2000 by
some 35%.
On the big picture, this is
nothing. In May the guys at Dominion Bond Rating Service (DBRS)
provided a world-wide calculation on different positions and
they go as follows:
1% Cash
10% Securities such as stocks,
bonds and money market
11% Structured asset-backed
product
78% Derivatives
This attempts to put some numbers
on the most egregious house of cards in history. At the culmination
of great manias, typically the reckless exposure is in fringe
banks that are going to show traditional banks the "new"
way to do business. In the 1772 bubble it was the Ayr Bank, which
example was used by Adam Smith in The Wealth of Nations,
published in 1776.
As noted in The Unholy Trinity
of July 21 (www.institutionaladvisors.com) the corruption
of fiduciary responsibility starts at the top with the Fed, which
has been run far too long as an instrument of experimental economics.
The next two corruptions have been math modeling of pricing and
credit rating.
This has enabled the penetration
of fringe, or as described in the US during the calamities of
1837 and 1857 as "wildcat", banking
further into the realm of traditional banking than at any time
in history.
In some religions repentance
takes only a moment. In political-economy it takes a lot longer,
with salvation much longer than that.
It seems like changes in credit
markets will continue to influence the stock market. In looking
to the near term, there has been little change in traditional
credit spreads over the past week and the BBB subprime bond price
has improved from 41.42 last Thursday to 43.21.
This has likely been the foundation
of the rally since last Thursday.
The change in the credit markets
has hit credit spreads from long to money market desks, and has
done a huge number to the curve. The loss of liquidity has yet
to hit long treasuries - it will, and it could be the last boot
to fall.
Conditions remain hazardous.
[Wall Street is] "a
colossal suction pump steadily draining the world of capital."
-Jesse Livermore,
June 11, 1929
"If recession should threaten (as is not indicated
at present) there is little doubt that the Reserve System would
take steps to check [it]."
-Harvard Economic
Society, October, 1929
-Bob Hoye
Institutional Advisors
email: bobhoye@institutionaladvisors.com
website: www.institutionaladvisors.com
SIGNS OF THE TIMES - AUG 24,
2007
Hoye Archives
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