Fundamental-less Fundamentals And The Supposed Panic Of 2007
The general consensus amongst many is that investors have been acting unnaturally and irrationally with the recent decline of stock markets around the globe. And that somehow Bernanke could easily "fix" the global asset markets with a waiving of the wand. Ah, the omnipotence of the U.S. Federal Reserve. And how might he do that? Like central bankers did in 2000? Or by walking on water? (That might actually work.) As we've talked about before, central bankers do not control the economy. How again does more liquidity fix a problem caused in part by too much liquidity? What would financial institutions do with more liquidity? Resume their foolhardy behavior requiring even more money to clean up? The Fed is highly unlikely to panic but rather deal with events as they unfold. Attempt to let the markets work and work in "cleanup" mode if something breaks. That is about the only prudent course of action they can take. Now, might world governments enact legislation to help mitigate some of the outcomes? Possibly. But, in the end that is likely to help individuals at the expense of financial stocks. So, how is that good for the stock market?
I also want to respond to those in the media ridiculing the Fed as incompetents. I'm a supporter of the concept of a lender of last resort. That being the Fed. History is littered with tens of thousands of bank failures caused by greed and mismanagement. Now, does that mean I believe governments should be able to spend money at will? No, but those are two separate issues. So, why is the Fed focused on inflation in their public statements? What does the Fed mean when they say inflation pressures remain elevated? Are they stating that the economy is overheated? That they are concerned about wage growth, the lowest since before 1929, putting pressure on inflation? The Fed knows the economy is weak. They've given countless public speeches on weakness in wage growth, income disparity, housing concerns, debt concerns, etc. No, the Fed is fighting the ability of financial institutions and foreign entities to manufacture liquidity, the associated inflationary pressures and all of the other problems they are creating. And, how do I know the Fed is fighting these growing imbalances? Two reasons. One, the Fed is not printing money as every uninformed blogger and conspiracy theorist from here to the moon seems to believe. And, two because I actually listen to what the Fed says versus what the media reports. Example; is it a coincidence that the Fed, the European Central Bank and the Bank of Japan have been vociferous about lax risk management practices and soon thereafter the global markets blow up? Of course not. Ample warning was given in advance. Wall Street, bankers, mortgage companies, hedge funds, etc. didn't listen. They were too busy basking in the financial bubble they were creating. Just like China and emerging markets are too busy basking in their bubble mania as I write this.
Remember, it wasn't the Fed that repealed Glass-Steagall and approved the financial industry's liberalization and deregulation. Many Fed members have argued against it for decades. The Fed does not legislate in the U.S. or elsewhere. Their mission is to keep the system running as best they can no matter what legislators do. (Remember those posts ardently criticizing financial deregulation from last year? At the time they seemed so meaningless. And now?) As an aside, isn't it also ironic that at a time when the markets are starved for liquidity, world governments are consuming large lots of it by running huge deficits? Now what do deficits do? They take money out of the markets and reduce economic vitality and investment. Who needs that money now? Governments or markets?
The Panic of 2007 is being discussed in nearly every form of media. So, is the recent market action based on panic? Was it a panic in 2000 when the same use of terminology was so prevalent? Is this correction purely technical as leveraged funds unwind? Or is it also based on a rational response to fundamentals? How about a simple "panic" quiz. Do you want to invest in a hedge fund right now? Or buy stock in the nation's largest mortgage company, Countrywide? Is one acting irrationally if the answer is no? Are you logical or panicked by saying no? How about taking a different perspective than I've read anywhere else? Have you ever thought that the market was acting irrationally for much of the past five years with nearly no measurable regard for risk management and now the market is simply starting to act rationally to fundamentals? The media keeps telling us the markets aren't acting rationally to the great global fundamentals. Did all of that money and leverage used to abnormally ram global asset markets like never before really reflect fundamentals? The undisputed facts are some significant number of hedge funds and trading desks at major financial institutions have no clue what they are doing as we are finding out. Because someone can borrow money at an attractive rate and use it to artificially push equities higher with manufactured money does not mean it is either justified or based on fundamentals. Is this really any different than speculation in the real estate markets using borrowed capital? Is Wall Street's patronizing behavior any different that that of the individual real estate speculator? They'd like us to believe they are too sophisticated for such action. Do we need another history lesson as a reminder? And what of emerging markets? Do emerging markets, which typically have little transparency, crude financial infrastructures, weak regulatory controls and immature capitalist and democratic structures really deserve to be fundamentally valued at a premium, comparative or absolute, to U.S., Japanese and European equities, real estate, bonds, debt, currencies and other assets? (Remember those posts as well?)
Is this really about subprime debt instruments? Or is that simply the exogenous shock which wakes the world to very heightened risks across a multitude of areas? Are the global fundamentals really supportive of what is the most expensive market in history by many measurements? And, is a ten percent correction enough to bring valuations back in line so that we can start another bull market? For those of you who have been with me since I started this blog, you know the answer. If fundamentals and quantitative analysis are any indication, and in my world they are the only things that matter, the answer is clearly and emphatically no.
I also want to respond to those in the media ridiculing the Fed as incompetents. I'm a supporter of the concept of a lender of last resort. That being the Fed. History is littered with tens of thousands of bank failures caused by greed and mismanagement. Now, does that mean I believe governments should be able to spend money at will? No, but those are two separate issues. So, why is the Fed focused on inflation in their public statements? What does the Fed mean when they say inflation pressures remain elevated? Are they stating that the economy is overheated? That they are concerned about wage growth, the lowest since before 1929, putting pressure on inflation? The Fed knows the economy is weak. They've given countless public speeches on weakness in wage growth, income disparity, housing concerns, debt concerns, etc. No, the Fed is fighting the ability of financial institutions and foreign entities to manufacture liquidity, the associated inflationary pressures and all of the other problems they are creating. And, how do I know the Fed is fighting these growing imbalances? Two reasons. One, the Fed is not printing money as every uninformed blogger and conspiracy theorist from here to the moon seems to believe. And, two because I actually listen to what the Fed says versus what the media reports. Example; is it a coincidence that the Fed, the European Central Bank and the Bank of Japan have been vociferous about lax risk management practices and soon thereafter the global markets blow up? Of course not. Ample warning was given in advance. Wall Street, bankers, mortgage companies, hedge funds, etc. didn't listen. They were too busy basking in the financial bubble they were creating. Just like China and emerging markets are too busy basking in their bubble mania as I write this.
Remember, it wasn't the Fed that repealed Glass-Steagall and approved the financial industry's liberalization and deregulation. Many Fed members have argued against it for decades. The Fed does not legislate in the U.S. or elsewhere. Their mission is to keep the system running as best they can no matter what legislators do. (Remember those posts ardently criticizing financial deregulation from last year? At the time they seemed so meaningless. And now?) As an aside, isn't it also ironic that at a time when the markets are starved for liquidity, world governments are consuming large lots of it by running huge deficits? Now what do deficits do? They take money out of the markets and reduce economic vitality and investment. Who needs that money now? Governments or markets?
The Panic of 2007 is being discussed in nearly every form of media. So, is the recent market action based on panic? Was it a panic in 2000 when the same use of terminology was so prevalent? Is this correction purely technical as leveraged funds unwind? Or is it also based on a rational response to fundamentals? How about a simple "panic" quiz. Do you want to invest in a hedge fund right now? Or buy stock in the nation's largest mortgage company, Countrywide? Is one acting irrationally if the answer is no? Are you logical or panicked by saying no? How about taking a different perspective than I've read anywhere else? Have you ever thought that the market was acting irrationally for much of the past five years with nearly no measurable regard for risk management and now the market is simply starting to act rationally to fundamentals? The media keeps telling us the markets aren't acting rationally to the great global fundamentals. Did all of that money and leverage used to abnormally ram global asset markets like never before really reflect fundamentals? The undisputed facts are some significant number of hedge funds and trading desks at major financial institutions have no clue what they are doing as we are finding out. Because someone can borrow money at an attractive rate and use it to artificially push equities higher with manufactured money does not mean it is either justified or based on fundamentals. Is this really any different than speculation in the real estate markets using borrowed capital? Is Wall Street's patronizing behavior any different that that of the individual real estate speculator? They'd like us to believe they are too sophisticated for such action. Do we need another history lesson as a reminder? And what of emerging markets? Do emerging markets, which typically have little transparency, crude financial infrastructures, weak regulatory controls and immature capitalist and democratic structures really deserve to be fundamentally valued at a premium, comparative or absolute, to U.S., Japanese and European equities, real estate, bonds, debt, currencies and other assets? (Remember those posts as well?)
Is this really about subprime debt instruments? Or is that simply the exogenous shock which wakes the world to very heightened risks across a multitude of areas? Are the global fundamentals really supportive of what is the most expensive market in history by many measurements? And, is a ten percent correction enough to bring valuations back in line so that we can start another bull market? For those of you who have been with me since I started this blog, you know the answer. If fundamentals and quantitative analysis are any indication, and in my world they are the only things that matter, the answer is clearly and emphatically no.
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