Tuesday, March 04, 2008

Is It Really This Bad?

Top Line: Tuesday saw a large reversal in the final hour of trading, that would be in the up direction. We argue that any rally should be sold. The next big move will be down.

In the late day trading, Ambac was rumored to have yet another bail out program in place driving the price of it and the general market up from the depths of dispair. The Dow had been down over 200 points just before the rumor hit and ended the day down a mere 45 points. We can't disregard the reversal but we don't think it is meaningful in the larger sense.

Let's get to the post for this evening...

We received an email from one of our readers, thanks CM, asking if we thought things were as bad as an article that he referenced. This article describes 12 events, or 12 acts in a tragedy, and we would like to recount them here along with our opinion.

1. Home prices will fall 20% to 30% from the peak
Since this blog has this as a tenet, yes, we would agree with this one.

2. Prime and near-prime mortgages losses
Again, we believe the mortgage problem will extend to the prime sector.

3. Consumer debt defaults will increase sharply
We think the consumer has and will continue to retrench and spend less. The reason is due to problems with servicing their debt.

4. The credit insurers rescue package is insufficient
We agree--it is insufficient due to the nature of the problem. There isn't enough "insurance" to cover these losses.

5. Commercial real estate loan market will deteriorate
Yes, commercial real estate has already deteriorated somewhat and with the state of the consumer, the commercial world has fewer and fewer reasons to set up shop.

6. Some large banks with heavy mortgage exposure will fail
Ok, here is where the Fed is trying its hardest to avert trouble. Large banks are their domain and they will fight to keep them solvent. But, again, the problem is that there have been too many poorly underwriten loans causing the problem. We foresee bank failures, we don't know how large the banks will be. We would say smaller banks have the initial problems and then we will see how far up the size band the troubles go.

7. Banks' losses grow as asset values drop further
Yes, we think the banks assets (their loans to consumers and corporations) will go down in value, more than they have already.

8. Once the recession gains speed, expect corporate defaults
This is where the real surprise is happening. Most investors, and we're talking about professionals, thought that corporations had tightened up their balance sheets over the past five years so they would be able to withstand a consumer retrenchment. But, the consumer represents two thirds of the economy and with their own problems, consumers have pulled back and will continue to do so.

9. Unregulated 'shadow banking system' facing huge problems
We have described the problems in the SIVs but not much about the hedge funds that rely on the banks for financing. In these entities there are many potential land mines which we have started to hear about recently.

10. As recession spirals out-of-control, stock markets drop again
Since this has not happened to date, we think this item is not worthy of mention. It is more like a conclusion to the argument. We would still agree with the basic idea.

11. Credit crunch will dry up liquidity in many financial markets
This has already begun to happen and will continue.

12. Massive global recession spreading, spiraling down
This resembles number 10 and is a conclusion.

Our take on this list is that the creator has not seen the future so much as is recounting what has already happened. If you have been reading our blog for a while, we have been talking about these things for a while now. Still, there is no big "problem" or accident going on in the stock market.

So, while we agree that at least 10 of these items have already begun, the last act, so to speak, has not been written. The trouble is that we don't really know what is going to happen but we do know this, it is not a good path to be on. We speak in the general sense of living in this world, not being bearish on the stock market specifically.

We are pretty confident that the financial world does not appreciate the full impact of the troubles that we are facing in the real economy. But, this recognition is about to be felt and that will drive the price of stocks down.

With all of these known problems described in this article, the stock market still has not dropped enough to account for them. Our thought is that the stock market has a long ways to go down.

FSI: 71.77 ( another new low based on GOOG's 12 point drop on the day)

Trish, we did get out at a good price, didn't we :-) And, just for you, here is another pic:

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