Oct

23

I always find Mr. Caravaggio's writings very thoughtful and insightful. However, I don't agree that it was a bubble. Prices were and will be completely justified. What was wrong was that the financial companies were leveraged to debt of 30 times their net worth. When the value of their assets which to a first approximation equaled their debt declined by 3%, their net worth was wiped out. The problem was that they made their money by making 1% more than their debt for a long time, and when the negative news had its day on home prices, it was enough to temporarily mark their assets down by 10 to 20 percent or so, without regard to subsequent return. What a former colleague insightfully would call "selling premium." Ouch. Okay, the banks erred. That doesn't mean that they will err again or that cycles will repeat or that the economy will not be resilient. Regions come back much stronger after natural disasters. Things have been worse. The banks were given say 100 billion of money from the rest of us to recoup their bad debt. They're happy. The process of recovery will occur. Proper money management and adherence to economic principles is called for now. The difference between the returns on equities and debt and the required rate of return a priori which is equal to the actual realized return on average, and the average non-understatement of earnings estimates is paramount. Let the bygones be bygones.

Vince Fulco adds:

Institutional investors now have a decade of no return. With some detailed credit work they can get 15-20%+ annualized from more senior securities and meet long term liabilities. Why subject oneself to the vol of equities when all your peers are moving to liability management policies and many are way behind the curve? The word on the street is hedgefund managers (those still in existence) are blowing out their equity teams under the banner, "debt is the place to be for the next decade." Granted equities are undervalued by many historical measure but can stay so for a lengthy amount of time and the recent moves can be lethal if not careful.

Riz Din replies:

Lack of returns is a problem for this generation but when I hear of the 'death of equities' I can't help but to think of past messages such as 'death of inflation' and 'death of cheap oil' and how they turned out.

Rocky Humbert remarks:

I'm watching for an inflection point on the number of Google hits for "Nouriel Roubini" as an important signal for a persistent rally in all risk assets.


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6 Comments so far

  1. Prudence Gently on October 23, 2008 1:47 pm

    I keep hearing talk about the “end of conventional wisdom” –- yet I don’t see how this is so. For instance, many have said they couldn’t see the housing bubble building, yet no less obvious a source than the Economist magazine had been calling this a housing bubble for a number of years, based on traditional wage to rent ratios. The Economist also warned about how housing bursts are historically much more damaging to the economy and longer lasting than stock market crashes.

    If this magazine doesn’t represent the “conventional wisdom” –- what does?

  2. Nigel Davies on October 23, 2008 2:27 pm

    There can be something to conventional wisdom, for example here's an IMF study on house price busts (2003)

  3. George Parkanyi on October 23, 2008 11:29 pm

    The decade is not "lost" yet. Yeah, maybe for a few months, but when the market rallies, that will change. Dividends kicked in some return, and even a mindless, broad asset-allocation strategy would have produced some return.

    A decade of bonds now? Sure, if the environment stays deflationary. But countries like China, Brazil, and India (well, maybe not India) don't have the option of standing still. Those economic hamsters need to keep the tread-mills moving - or the powers that be aren't going to be powers that be for long. And judging by recent events, it's not like we're not ready to print money at the drop of a hat to forestall deflation. What if we have accelerating inflation or stagflation instead? Imagine trying to manage a debt portfolio - maturities, quality etc… in a volatile inflation and interest rate environment? Is that any easier than equities?

    If corporations can survive having their countries bombed to rubble (e.g. Germany and Japan), then they can also manage inflation - some companies anyway. In equities, there will always be some game that works now - so you figure out which and you can make money. Or you can hedge your bets and allocate across different sectors and economic scenarios and play the volatility or price divergences to advantage.

    Equities are the fundamental basis of the capitalist system. The system for pooling capital, spreading risk, and providing participation in, and the possibility - if not always the actualization - of, unlimited wealth creation and capital appreciation.

    Equities I say! Debt be d**ned! :)

  4. Sam Kumar on October 24, 2008 3:42 pm

    Victor writes

    The banks were given say 100 billion of money from the rest of us to recoup their bad debt.

    end quote.

    What would Ayn Rand say about that?

    Why the endless invocation of Ayn Rand (during the times when the thieves and rogues on Wall Street were giving the impression that all was hunky-dory with predatory capitalism) to bitch and moan about pennies given to some indigent wretch from the public exchequer and now this glib forgiveness of tax payer assistance on such a colossal scale to those who failed so spectacularly, threatening the whole world’s welfare in the process?

  5. Matt Johnson on October 24, 2008 7:44 pm

    I really want to read this post but I can’t get past the periwinkle sport coat…gutsy.

    I agree with your friend, selling options is like picking up nickels in front of a steamroller.

  6. glenn shaw on October 26, 2008 1:08 am

    Vic; that sounded very well at the end regards your what was the one house coat hit?..cary grant /s.loren in HouseBoat…I luv that movie…regards glenn

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