Sunday, January 20, 2008

The Four Horsemen Ride

Well it looks like the government realizes that old school fiscal stimulus is better than openly socialist policies; no rate saving package will be offered to the US consumer but a $150B give away is around the corner. This news plus the expected minimum 50bp rate cut have done nothing to reassure the investor. Tens of billions of investments from SWF's and venerable institutions like the Capital Group have made little impact either.

It appears we get to add to the subprime/CDO exposure at banks around the world: monoline downgrades, SIV liquidation, CDS write offs and consumer recession based write offs. And that's just this year. Next year comes the pay-option ARM resets and the Alt-A speculation walk away scenario.

So the markets are reacting to this continued meltdown of the credit markets, plus the Yen based carry trade unwind, the lack of liquidity in the credit markets to refund maturing short term debt commitments, a slow down in China... the markets start to look positively ugly. This is the credit contraction in full force. All those financially engineered companies (Aussie property trusts come to mind) haven't really added much value in the past few years, just leverage.

If the US goes into recession and China slows from 11% to, say 9%, oil is going down in the near term. Cambridge is out there saying peak oil is hogwash, OPEC usually implodes after a period, and now the oil stocks are beginning to break down - COP, SLB, APA, APC. I would imagine metals follows the same path. China is the price setter in all of these commodities.

If oil does drop enough, then it triggers a meltdown in much of the support for the recent Dow rally above the Jan 2000 high of 11,900. Oil co's plus the services co's plus ag, solar, engineering and construction and coal represent a ton of market cap and are all based on high oil prices. I believe the Saudis have been holding to a tight production schedule for a good reason - the current prices are not sustainable, particularly in a global slowdown. Even the Saudi and UAE stocks are beginning to reflect this.

The Dow is sitting on a huge head and shoulder, neck line broken and R2 says the Dow Theory bear market is in force as of July of '07. Whether it is a secular or cyclical bear is the next question. I guess that depends on oil, because the financials are not coming back any time soon and the US markets depend on at least a flat financials for a positive market move.

It is quite possible, as the scary Christopher Woods at CLSA suggests, that the structured finance model is over. I bank earnings get cut dramatically and permanently, and productivity in the capital markets gets a major setback. The volumes of credit card receivables, residential and commercial mortgages, and other debt previously sold off might spend a lot more time on bank balance sheets. Looking at the H&S charts and the violation of 200 day MA's of every major name except GS, I'd say the market has figured it out. I have sold out of SKF, early and stupidly, but both MS and LEH look like they could take some more pounding.

In the meantime, back on main street, after a 20 year boom in consumer debt, the US might be over retailed from a square footage and brand name perspective. While many of the retail names have fully registered the coming crunch, some are still ripe for the picking. I covered SKS because I keep reading about private equity interest from the Middle East (they don't need debt), but I am looking at ANF. I figure if the parents aren't spending at TIF, why would they buy their kids $100 jeans?

I sold gold as well; if oil is headed down and inflation expectations are tempered by a global slowdown, gold's due for a breather. It's primary correlation seems to be with the US$ and that looks to holding steady against the Euro, and up against the Pound. Our rate declines are pretty well telegraphed, as are the UK's and I think the Euro is gonna come around to the same view. I don't think investors view gold as a safe haven like fiat cash and T's unless the anarchists really win.

Housing is still in a state; I guess we need to see some bankruptcies and consolidation and maybe even some bulldozing of newly created ghost towns. This housing boom appears to have been the penultimate housing cycle move: the boomers start shifting into a housing light position in the next decade and that will last for a generation. This may be a dead asset class for decades and more regional than ever. They are leaving us quite a legacy, but that's for another time.

There is little the fed can provide. Lower rates may help put in a bottom in housing, but it will provide little impact on disposible income for the US consumer. In a worldwide slowdown, corporates will likely spend less anyway. The only real beneficiary are the banks who will love the resulting steep curve. Even fiscal stimulus will only have a limited, time constrained benefit.

I'm still in IBKR, DXD, ACM, DBA and nibbling on some MU (bad habits die hard). I am watching the Baltic Dry Index for clues on the next move. I believe ore represents 25% of the volume shipments and the negotiations between the ore co's and China is in progress. When the deal gets done (and it could take months), we'll have a better picture of China's expectations and the shippers will look good.


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