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We are almost beginning to believe that there might be something in the “Tuesday effect” we half-jokingly hypothesised last week. It is not just that Tuesdays are proving to be positive for the DJIA, but that the market rebounds are happening despite a series of bad news. This week there has been no shortage of negative announcements. Whereas a couple of weeks ago the talk was of USD 20 billion announced losses from sub-prime out of a likely total loss of USD 100 – 200 billion, now it is USD 50 billion out of a likely total of USD 400 billion. The latter figure concerns only sub-prime. Already in the mortgage market, contagion to “Alt A” and prime mortgages is showing up, not least in the losses announced by the two government-sponsored mortgage agencies. More is likely to be revealed about the practices of the two agencies. Have they been fulfilling their duty to assist the general public in acquiring housing or have they been stepping outside their remit? |
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There are at least six other asset types, often “level 3” (meaning basically unsaleable). with uncertain values and probably subject to write-downs: |
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- Insurers, including “monolines”
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- Asset-backed commercial paper
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So, do we believe the stock market provides a guide as to whether the credit squeeze is over? Decidely not! Do we believe the USD has now stabilised? No, not when we learn that USD dollar inflows are now falling well short of covering the current account deficit. Even the Chinese are now net sellers of US T-Bonds. The Economist opines, “the dollar’s decline already amounts to the biggest default in history, having wiped far more value of foreigners’ assets than any emerging market has ever done”. |
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Do we believe the USA will avoid a recession? There we cannot answer so firmly. A significant slowdown in growth, certainly, but two quarters of GDP decline may well be avoided by a Fed rescue. We are convinced that the pressures on the Fed to support the economy by further cheapening of money will overcome their reticence to tolerate inflation imported by a lower USD, rising Chinese prices and ever higher oil and food costs. The effect on longer-term yields depends on that unanswerable question about recession. Recession would pull down long-term rates, inflation would increase them. For the moment, then, the two risks seem to be in equilibrium and longer-term rates should move but little while the yield curve steepens as short-term yields are brought down by the Fed. |
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Our own subjective assessment of the credit squeeze and of the liquidity of markets for corporate bonds is that, after an improvement following the summer crisis, the situation is again worsening. It is now usual for the screen-posted price to bear no relationship with the price actually obtained, and in other cases there is simply no bid price at all. Fortunately, our clients, initially suspicious of the prices we were achieving for them, now understand the problem and, paradoxically, have developed an ever closer and more transparent relationship with us. |
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Not surprisingly our basic recommendation on fixed income markets is to stay with quality. |
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Focus |
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(–) US housing: “worse than could be imagined”, dixit Tony James, President of Blackstone (private equity) |
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(!) Government sponsored agencies: the share prices of Freddie Mac and Fannie Mae have fallen by nearly a third |
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(!) Switzerland: Swiss Re CHF 1.2 billion write-down but accepts this as a “30-year event” like any natural catastrophe |
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(–) UK: the BoE advance of GBP 25 billion to Northern Rock may be indefinite |
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(?) USA: Nobel prize-winner Joseph Stiglitz has openly accused Greenspan of having pushed the USA into its present predicament (it is nice to know we have respectable company!) |
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(+) Europe: the ECB still sees countering inflation as its priority, even though the Bund’s yield has fallen by 70 bps to match the 10 year USD T-bond yield at a fraction over 4%. Euro zone GDP growth is running at 2.7% |
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(–) Food price inflation: in China food prices are growing at 17.6% and Italy has a 20% increase in pasta prices. |
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(+) positive for bonds (–) negative for bonds (!) watch out (?) begs a question |
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