Bond Outlook November 7th

The oil price is at an all-time high and rising, the USD is dropping by the day, food is more and more expensive, foreclosures are climbing, house prices are dropping, and yet the US stock markets stage a recovery. Do we explain this as wishful thinking on the part of equity investors, or are there genuine reasons why the stock market should apparently deny the risks facing the US economy? We lean toward the former, but must admit that a lower dollar and the prospect of lower interest rates can explain optimism about company earnings.

Several pessimistic analyses have been published in the last few days about banks, starting perhaps with the Merrill Lynch analysis of UBS having more losses to declare, but now going beyond one bank criticizing another. Some of the issues have already been addressed on this page, but are worth repeating anyway:

1. off-balance sheet investment vehicles cannot simply be lopped off like a dead branch – they are returning to banks' assets and liabilities
   
   
   
   
2. asset-backed commercial paper is being renewed as on-balance-sheet commercial loans
   
   
   
   
3. level 3 assets – the ones that (apparently) cannot be sold or priced but which are valued by unproven models – are in excess of major banks' own equity (exception ML), suggesting, but not proving, that the banks' equity bases are threatened
4. sub-prime losses (which are proving to be more than sub-prime assets themselves) are reckoned to be anywhere between USD 100 and 300 billions, but only USD 20 billion have been declared.