The Fed can’t be who they were then; perhaps they never were
While the Financial Times runs such idiotic editorials as this one, asking us to imagine USD50-per-barrel oil (why don’t I imagine that we all learn to run our cars on our own telekinesis, while I’m at it?), and while Greenspan moves from being someone I dislike (for letting Bush have his deficits and tax cuts, while allowing the storm of sub-prime to gather) to someone I think I hate (for writing a book and making news blaming all of that on other people, the superstar).
Via the blog the Big Picture, a very cool article about how little the Federal Reserve can actually do to help you. This is not uncommon – as key to prosperity as Central Bank Independence is, we/our governments routinely (try to) lean on them to solve our problems. Particularly lately.
- Housing collapse: The housing depression will continue despite Friday’s announcement by the government of a call to reduce delinquencies and foreclosures. The record level of unsold homes, the pace of mortgage resets and the likely deterioration in coming jobs reports coupled with still-stretched affordability issues suggest that the inherent supply/demand imbalances will continue for some time despite government intervention. Every recession since 1960 has started with a decline in home construction — the recession of 2008-10 will be no different.
- Retail woes: The recent weakness in retail comps could extend into the current back-to-school period, which in turn has historically demonstrated a high correlation directly with the Christmas season’s prospective retail sales.
- It’s the end of the expansionary credit cycle: No longer is the world of CDOs, CLOs, MBSs and other misguided credit packages being celebrated. The 2000s version of credit will turn out to be more destabilizing than the past financial creations by those wonderful folk on Wall Street. The instability and limitation of credit supply, a slowing consumer and continued weakness in housing will likely impede business spending and retard sales growth (negatively affected by slowing securitizations). The credit winddown will take months, not weeks, and maybe more than a year.
- In the process, there will be many more “accidents” uncovered. (Some of my thoughts on the credit cycle and the relationship between equities and the leveraged loan market were included in John Mauldin’s Sept. 3 “Outside the Box” issue, which includes an essay, “Vectors of Credit” by Harch Capital’s Michael Lewitt. (Though Lewitt misstated my conclusion on the causality between the leverage loan market and the U.S stock market!)
- The Fed ain’t my friend: If my economic concerns are realized (as housing’s negative multiplier gains effect), there remains a chance that the Federal Reserve will be perceived as “falling behind the curve.” Should the Federal Reserve lower fed funds by only 25 basis points or not at all (as Bernanke emphasizes his independence early in his Federal Reserve gig) at its September meeting, investors will be disappointed and markets will be pressured.
- Fund-of-funds and hedge-fund imbalances and disintermediation: Despite the 1.5% rise in the S&P 500 index for the month of August, the fund-of-funds community (the financing wheel of many a hedge fund) had one of its worst months in history as a number of quant-based strategies proved to be more market- and long-biased than their “models” indicated or than investors realized. (Even Entourage’s Nicki Rubenstein got “smoked by a hedge fund that went bad” in the season’s last episode.)
- This weekend I learned from several funds of funds that there have been notifications of large withdrawals, and in many cases (by year-end) previously invested monies are being diverted further away from typical long/short strategies into non-correlated strategies.
- Politics as unusual: The skeptic in me suggests that Friday’s “bailout” of housing will have only a modest and delayed impact (I was quoted by Barry Ritholtz and Alan Abelson in this week’s Barron’s on the same subject). Moreover, Virgina Republican Senator John Warner’s resignation (in 2008) and Idaho Republican Senator Larry Craig’s resignation (now!) could further weaken the Republican base and give the Democratic party even a greater majority. And with it will come the politics of trade protectionism and higher corporate and individual taxes.
- Disequilibrium is the constant in private equity: With over $300 billion of delayed financing (bridge loans and high-yield bonds), the likelihood of deals between now and year-end seems increasingly less likely. As well, aggressive hedge-fund activism will be stilted by limited funding availability – in turn, this could lower the pace of corporate stock buybacks (which, to some degree, have been launched to fend off those activists).
- Sentiment reads too optimistic: Over here, Barron’s reports that most investment strategists – far more influential than market writers in other surveys – remain relatively constructive despite less-than-optimistic economic views. The notion of a “negativity bubble” proved bunk, as did the view that the shift into market-neutral funds was evidence of a too conservative trend (stat arb, market-neutral, etc., got schmeissed over the last two months, clearly proving their long biases). Mutual fund cash remains low – by historic standards.
- Over there (in emerging markets), the behavior of some markets such as China is eerily reminiscent of the U.S. market in the late 1990s — spectacular IPO gains and generally uninterrupted price appreciation.
- Corporate profit margin and earnings expectations also read optimistically: Especially vulnerable are a wide swath of industries that face a mean regression and normalization in credit losses. Financial profits represent nearly 30% of the S&P index’s total earnings – even more if one includes the role of financial subsidiaries at major industrial companies such as Caterpillar, General Electric, General Motors, etc.
None of this ought to be new for readers of most of the financial end of the blogging world, but this is a nice piece.
This of course won’t stop Bernanke trying to play everyone against a big recession – that’s his job, and Lord knows everybody sincerely hopes he can pull it off (without building new problems for 10 years from now, like his predecessor). Nor will it stop the Bush administration trying to treat us as idiots the way they do the rest of the electorate; hopefully insulting our intelligence is the extent of the damage that does.
Teaching macroeconomics later this semester sure is going to be interesting…
UPDATE! I forgot, there’s also a piece about Greenspan and forthcoming political pressure on the Federal Reserve, which is worth reading – mostly because it is true, but won’t get many column-inches unless people like Greenspan talk about it.