Oct

12

BucketThings have been moving at lightening speed recently and only now at the weekend do market folks get the much needed reprieve, the few days of quiet time to rebuild depleted mental strength, collect thoughts and ponder future moves and plays. I've collected a bunch of research from the Street that I thought may be worth a skim read to some on the list.

James Montier - Mind Matters: The Strangest Feeling Goldman Sachs - Europe: Portfolio Strategy - Recession – now priced as the central scenario Rosenberg - Global economics weekly UBS - The broken lighthouse
UBS - Global Bear
UBS - A Bear Market & Then a Crash Macqaurie Research - Japan strategy weekly - Bear market bottom indicators Morgan Stanley - FX Pulse

Just to cover myself, I'll provide the caveat that I generally look at bank research to broaden my outlook, learn new things etc, but I find it almost meaningless for specific forecasts.

Best wishes to all in the week ahead. It's tough navigating out there. Personally, I'm bullishly optimistic that the UK bank rescue plan will be adopted in various guises internationally and that this will provide the basis for a sharp recovery in the markets. Whether it's a good thing for the world in the long term is another issue, but what it almost does seem to succeed in achieving is eliminating the tail risk of risk of a sustained evaporation of credit leading that would lead to the hell in handbasket scenario. I may be missing something big here, and whether we fall further or not at this particular juncture is unknown, but over the weekend I went to the gym to strengthen body and mind have since been building a confident belief that the way things are developing the situation is increasingly turning in to an asymmetric bet with the world government confirming that they will do whatever it takes to stop the system from seizing up.

Here are a few quotes and notes from the pieces:

David Rosenberg from Merrill Lynch gives an nice overview of the policy response (a spot of optimism from Rosenberg of all people!):

"Policy crescendo: We have now had in very short order some extraordinary moves by policy makers. In no particular order, a UK bailout (the best, most comprehensive one we have had by any country so far, in our view), Fed buying commercial paper, a Spanish TARP, coordinated rate cuts, deposit guarantees in Europe, a banking sector support plan in Russia, Brazil intervening, etc. Unless we are assuming that global policymakers are incompetent, they will sooner or later get it right.

Critical policy measures: guaranteeing term funding and EM CB reserves The UK likely achieved the former the best way, with a 250bn sterling scheme to provide government guarantees of new short- and medium-term debt issuance to assist in refinancing maturing funding. The Fed's move on commercial paper has been nothing short of extraordinary.

CBs and sovereign wealth funds globally control US$9tn in assets. These have been built up for a rainy day. Well, the rainy day has arrived. Watch as EM CBs start utilizing these reserves creatively. Brazil intervened for the first time, joining India, Korea, Russia and others. Russia has been the most creative, using reserves to support its banking system, domestic equity market and currency."

James Montier says, 'Only 2 stocks manage to pass our deep value screen in the US. However, 35 names in Europe pass and 125 in Japan. This emerging value presents me with the strangest feeling, I think it is called incipient bullishness! Obviously not on the overall market, but with respect to a basket of deep value stocks.'

The two US stocks are Ashland (ASH) and Nucor (NUE). Montier provides a full screening list in the note.

'In the short term we must rely upon the margin of safety concept, which argues that buying stocks that are already heavily beaten up provides us with some protection against the downside. Having cash is a suitable hedge and provides the opportunity to deploy capital at a later stage if we are too early. So a barbell strategy of cash and deep value looks to be the best idea to me.'

The Macquarie Japan report hunts down indicators for a bottom in the Japan bear and provides some insightful charts:

'Japan's P/BV, at 1.05x, is at 20-year lows, having fallen beneath the 1.25x level of September 2002. The latter was a time of intense financial system stress in Japan. Japan's dividend yield is blowing away its 20-year history, reflecting increased payouts on increasingly respectable corporate profitability.'

'With bank deposit rates near zero, the history relative to the yield on 10-year government bonds is shown below. The equity dividend yield is now materially above the bond yield.'

UBS Broken Lighthouse report starts off with:

'we all assess market opportunity and risk in a way that gives us signals about when and how to act. But what happens when those signals lead us astray? We liken the current situation to a ship and a lighthouse. A ship's captain counts on the light from the lighthouse to keep the boat safely away from land. But if the ship runs aground, then what? The next time the captain sees the lighthouse, can it be trusted again? Similar to the ship's captain, there has been a loss of confidence in recent weeks of investors in global equity markets. Stocks everywhere have been under massive pressure, with all-time high readings on volatility and risk aversion. Despite some signs on (desired) policy response the sell-off has been relentless. Indeed, those signals that may have guided optimism in recent weeks, have been false signals.'

I find table 3 in this report quite insightful. It looks at historic bear markets and recoveries, albeit only going back to the 1970s. Simply judging by the duration of previous declines we are much closer to the end than the beginning.

From 'UBS - A Bear Market Then A Crash':

'Fundamentals are irrelevant today, but today won't last forever. To be clear, we expect a recession and every additional day credit markets remain frozen the more challenging it is likely to be.'

'Excluding (these) financial write-downs the S&P is trading at 9.8x trailing EPS. On an interest rate adjusted basis, we believe this could be the least demanding trailing S&P 500 PE ever.'

Phil McDonnell replies:

P McDThanks to Riz Din for this font of current wisdom.

However it is far from clear that the various government geniuses have it right yet. They have no plan to revive real estate values. That is the fundamental underlying factor in this situation. Not only do they not have a plan, they aren't even talking about the need for such a plan. If we don't solve the right problem then any solution, no matter how brilliant, will come to nought.

Even a zero down, zero per cent interest, 30 year mortgage will not convince anyone to buy a home in a declining real estate market.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008


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3 Comments so far

  1. rob d on October 13, 2008 9:00 am

    Exactly, Phil…I sold my house Aug 2006, and have been patiently waiting for some kind of conclusion to this debacle. I have taken alot of abuse, until this month. It’s hard to talk finance and economics with people when you are a science teacher. They automatically assume you have little working knowledge of things outside of your chosen field, or that your opinions have little validity - especially when they are against the “experts”. Somehow, though, Ben Stein still has a column…anyway…

    I will NOT buy until I know what kind of policy blunders are going to be made…too many variables and rule changes. Talk now is of “cramdowns”, rates don’t follow any logic, home sellers naively think the “rescue bill” will support prices, and so they will not lower or negotiate price…it’s a good thing I am patient (the wife, not so much :) )

    this will all end in tears, and until it does, I will survive in my apartment…I told friends and relatives that I will not have a mortgage in a few years, and I am determined to see that through.

  2. Greg Vinately on October 13, 2008 9:54 am

    “However it is far from clear that the various government geniuses have it right yet.”

    Also it is far from clear that any of the geniuses liquidating stocks at firesale prices are correct in their assessment of the future outcome of events. In the same manner that all the geniuses were buying near the market top after a humongous market rise without a 10% to 15% correction for more than 4 years!

    Just consider the fact that the cascade of stock selling has been on the heels of forced liquidation and on the premise that NONE of the implemented monetary and fiscal measures (from government geniuses) will work. The market is giving no consideration to lag of policy implementation or to depressed valuation of individual companies likely to strive in the upcoming economic cycle.

  3. John White on October 14, 2008 4:07 pm

    We don't need a plan to revive real estate values. Real estate was overvalued, and is coming down as it should. It won't stop going down until it is undervalued to the point where investors and first time buyers can't resist.

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