After the brutal sell-off of the last two days, markets are now enjoying some much-needed respite. Last night, the S&P 500 gained +0.7%, while the NASDAQ added +0.9%. This positive momentum continued this morning, as the Topix is up +1.4%, the Hang Seng has added +0.8% and the Kospi is up +1.3%. Meanwhile, the Yen has weakened by -0.7% to ¥117.3/US$, as investors piled back into the carry-trade.

And interestingly, yesterday, we saw a number of stories in the financial press about how exaggerated the subprime mortgage story has been (for an example, see this article in Forbes). In addition, Lehman Brothers, the second biggest US underwriter of mortgage-backed bonds, came out and stated that the risks posed by rising home-loan delinquencies are "well-contained", and that they will have little effect on the firm's earnings.

What about additional risk to the housing market? As we see it, the most likely development is that vulture funds will eventually buy up mortgages on the cheap. Then they will probably sit on their collateral until they can sell it at a profit. They are unlikely to accelerate foreclosures for properties for two reasons. First, there is absolutely no bid for such properties at almost any price. Second, subprime loans are almost all second mortgages, which cannot foreclose without agreement of the first mortgage. It is hard to see why first mortgages would allow this to happen, since they would also lose money and face write-offs in forced sales. In any case, second mortgages are usually just 20% of the property value and almost every foreclosure would wipe this out immediately. Thus, subprime lenders who foreclose today would face immediate 100% write-offs. They (or their liquidators) would be better off selling the mortgages for 10 or 15 cents on the dollar to vulture funds which can afford to hold onto the paper for a few years, while house prices stabilise and recover.

And aside from the stress on the relatively small subprime lending sector, economic fundamentals are still looking very decent. US overall mortgage applications rose by +2.8% to the highest level since early December (see chart); UK February unemployment fell by -3,800 to the lowest level in a year;

China's retail sales rose by +14.7% YoY in the first two months of the year; Chinese industrial production accelerated to +18.5% YoY (expected +15.0%); and South Korean February unemployment fell to 3.2%, the lowest level in four years. On the market side, we note that the BDI has jumped +17% in 17 straight sessions of gains, hardly a sign of an impending global slowdown.

Overall, we remain very optimistic on equities, especially since the last sell-off failed to break through the lows of the previous deluge. As we see it, this is a sign of strength by the markets and could very well prove to be an attractive buying opportunity.


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