The U.S. Recession Goes Global
09/30/08
Stock hedge funds fell an average of 8.6 percent in September, the biggest one-month loss since Hedge Fund Research Inc. began collecting data in 1990. While that was better than the 12 percent decline by the MSCI World Index, a benchmark for global stocks, industry analysts expect investors to increase their requests to pull money from funds. Funds in all investment categories fell 6.9 percent in September, according to Hedge Fund Research's Global Hedge Fund Index. That's the worst month for the $1.9 trillion industry since August 1998, when the Russian debt default triggered the collapse of Long-Term Capital Management LP. U.S. equity markets meanwhile are becoming ever more volatile. The Volatility Index has reached a ten year high and may reach an all time high any day now. Take a look.
Equity markets, however, are merely a symptom of the global de-levering process. The real damage is occurring in the credit markets. The commercial paper market for instance, all but seized up. The amount of outstanding CP declined by almost 100 Billion in one week. Lack of trust has people withdrawing cash from Money Market Funds, which are the primary buyers of commercial paper. Liquidation of Money Market Funds leads to declining demand for commercial paper. As a result corporations, who routinely relied on issuance of commercial paper for their funding needs, can no longer access that market and are strapped for cash. As trust all over the system is evaporating, suppliers ask for cash payment upfront. Trust and credit (Latin: credere "to trust, entrust, believe.") become scarce and yields for everything but government paper are exploding to the upside. Treasury Secretary Henry Paulson's plan to revive the U.S. financial system by pumping as much as $700 billion into the markets was finally approved on Friday last week. The Troubled Asset Relief Program (TARP) effectively uses the U.S. Treasury's balance sheet to take on impaired mortgage assets from banks and other financial institutions that can't find buyers for such instruments. In theory, the TARP would purchase those assets at prices above fire-sale levels, but not so far above that the government -- that is, taxpayers -- couldn't profit down the road. It is doubtful, however, that the key ill crippling the capital markets and the U.S. economy will be cured quickly. Borrowers are unable to obtain credit from lenders unwilling to extend it. The whole thing is reminiscent of Japan's post-bubble crash in 1990. When that country's real estate bubble burst, leaving a trail of bad real estate loans, officials flooded the economy with cash only to see banks hoard the money instead of lending it out. The result has been a series of recessions and persistent deflation for more than a decade. To avert a similar fate further action needs to be taken, not only by the U.S. Government, but also by the European Community. Barron's thinks that "The quickest and easiest first step would be an internationally coordinated cut in interest rates carried out by the Big Three central banks -- the Federal Reserve, the European Central Bank, the Bank of Japan -- with the Bank of England, the Swiss National Bank, the Bank of Canada and the Reserve Bank of Australia all joining in."
I agree, but I admit to having to suppress a chuckle. Trichet was only this week getting off the idea that interest rates should be hiked to combat inflation, if you can believe it. The man has been consistently out of touch with reality so I do not even want to entertain the hope that a European Central Banker may get with the program in a timely fashion. Had he paid attention by looking at the following charts, he would have understood.
The first chart shows the above mentioned commercial paper market. The second chart shows the Yield difference between Moody's "Baa Seasoned Corporate Bond Yields and T-Bond Yields". The yield difference has risen to levels last seen in 1935, at the tail end of the depression. Risk aversion is apparent wherever one looks. Mr. Trichet, of course, does not have access to data like this. He must care not for the U.S. but for Europe alone, whose leaders met today (October 4, 2008) to convene on the global crisis, but who were unable to agree on a quick solution. So far they agreed on only one thing: Europe likely won't emulate the response of the U.S. This is very disappointing since the crisis engulfed Europe with a vengeance this week. Fortis, the giant Dutch-Belgian bank, was partially nationalized last week; Hypo Real Estate in Germany received a 35-billion-euro ($49 billion) bailout, and U.K. lender Bradford & Bingley was taken over by the British government. Meanwhile, the Fed has been furiously pumping liquidity into the global banking system, extending massive amounts of credit to U.S. institutions and sharply increasing the swap lines with foreign central banks to $630 billion. The Federal Reserve is also pumping liquidity into every district. The chart below shows the effect.
The Federal Reserve is the only lender of any consequence at the moment. The de-levering of the financial system continues and our calls for a stock market bottom have been premature. Perhaps this week will the markets show the capitulation that everybody has been expecting for weeks. I, for my part, am preparing my list of candidates to buy. When the time comes, everybody, who wanted out through the same door like everybody else, wants to come back in through the same door like everybody else. You will see an explosion of demand for stocks people chasing price for weeks. This will be the time, when stocks anticipate the end of the credit crunch. The Volatility Index tells us that we are very, very close in time, if not in price.
Hermann Vohs
"Democracy is the theory that the common people know what they want and deserve to get it - good and hard. "
H.L. Mencken
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
