Saturday, October 11, 2008
market outlook as of 10/11/2008
The Global stock market caped the worst week: US S&P index dropped 21% without a break; Russian and some Asian countries halted their trading on Friday; the Nikkei 225-share index fell by 24% on the week, twice the weekly fall of the 1987 crash; Not just stock market, conservative market was busted too, where IG lost-11% and HY lost -17% in the past five weeks based on ML. Admittedly, margin calls, funds redemptions, and panic grip the market. But global economic fundamentals have been playing its role too. Full scale bailout Some US banks, like MS, are in a shakey position. They have to act swiftly. History taught us a lesson that big bank crises were ultimately resolved using large amount of public money and a early and desive action, wether recapitalisation or take on torulbed asstes, would minimize the damage to economy. Over the weekend, some new measure will be rolled out. Treasury might roll out a balanket gurantee of all deposits and direct capital injection into hammered banks. Credit Market Remains Tight A series of global governments high profile moves, 50 bp cut of global interest rate , the capital injection and debt garantee of European banks was unable to unfreeze interbank lending market. Ted spread reached 462 bp, a historic high since Bloomberg begin compiling data in 1984. Treasury's direct intervention to buy CP from issuers thaw the CP at some degree. But the whole market was down by nearly $200 bil from 1.75 tril. Corporte bond markets become all but extinct. Only a few other credits, like IBM, raised corpordate bonds in the past weeks. As I have commented last week, the short term credit market condition would and had to tend to normal within a month, since the complication of its strain could potentially cripple the whole economy. European Banks look precarious America commerical banks' leverage levels much more conservative, hovering around 20 or lower. If you are feel uneasy at its investment banks' leverage level, around 30-40, you will be shocked in face of European banks higher leverage, 40-50. The develerage process has started and taken a toll on some victims. Iceland country is over. With ~300k population, banking business lent aggresively abroad and banking assets is 10 times the GDP. The credit crisis stormed its banking industry, culminating in the nationalization of the largest bank and receivership of the next top two banks. It is a national bankruptcy. Will this be the end? No. Who will be the next? Switzerland is at the center stage. UBS, Switzerland's largest bank, has writen down ~45 Swiss Franc assets. Should it capsize, the consequences will be grim since its balance sheet size is 4 times of the size GDP. That said, I would expect more turmoil in European market. Foundamental issues still not rooted out yet This crisis rooted in housing and credit bubble, complicated by the global dimension. Housing market has witnessed the 20% drop. It would probably drop another 10%. Inventory of existing hoomes is still around 10 months. 30 year Mortgage rate rose from 5.7% to 5.9%. Given the large hangover, still tightness in mortgage credit, and looming recession, Treasury bailout of housing market will not bear fruit until at least 3 months later. Credit losses is also mounting from non-mortgage related assets. Consumer defaults in auto loans and credit cards are increasing. Unemmployment is still around 6.1% in Sep. But recent seizure of money market and bust of capital markets will further erode economy, cauing more layoffs down the road. I would not be surprised to see the unemployment soar above 6.5% or even 7% by the late of the year or early next year. In its recent calculation, IME reckons that worldwife losses in debt originated in Ameica would reach 1.4 tril, up by almost half from the prevoius estimate of $945 bil in April. Until now, only $760 bil of loss have been reported by banks, insurance companies, hedge funds, etc. This crisis has not touched the bottom yet. Silver linings Fortunately, commodity prices have dropped. This would give Fed reseve more proof to slash interest rates. I would the rate ultimately be cut to 1% or even lower. Trading Opportunities Credit Market ML AAA index trading at really attractive level, around 350 bp over the Treasury. I would not expect the index to trade belove 300 within 3 months. Equtity Market Financial market have been hammer a lot in the past weeks. I expect the comming measures would salvage banks. So it might be a good time to index based on US large banks.