What The Market Knows

By: Greg Silberman | Mon, Dec 10, 2007
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As market practitioners we are more concerned with the markets reaction to news than the news itself. Yesterday's announcement that Variable Mortgage resets could be frozen for 5-years is telling in that regard.

During the 1980s the international community got fed up with South Africa's Apartheid policies. Their response was to punish South Africa economically through broad sweeping trade sanctions (which ultimately brought the country to its knees). One far reaching measure was to shut the South African Government and its Corporations out of the international Debt markets. No new debt could be issued internationally.

South Africa's response to the rest of the world - bugger you - and refused to pay anything on their outstanding loans (principal and interest).

In other words, the credit market shut out both lender and borrower.

This situation is not unlike the one we see unfolding today.

By announcing a potential 5 year freeze on variable interest rate mortgage resets, the Government has effectively put a moratorium on mortgage debt. No issuer in there like mind would continue extending loans on the condition they may not fully reap the rewards. Likewise borrowers have no incentive to pay off loans if the Government shows a propensity to bail them out at every step.

The Fed is the grease monkey in the wheel since it's their job to ensure smooth operation of markets. So far their efforts to lower rates have not helped an ailing credit market and have hurt the Dollar. With further rate cuts in the wings and the announcement of a de facto debt freeze you would have expected the Dollar to swoon on the prospect of even larger liquidity injections going forward.

Not so!

Figure 1 - US$ rallying on news of 5yr freeze on mortgage resets

On yesterday's news Stocks rallied hard as earnings uncertainty reduced AND an oversold Dollar rallied strongly. When markets move contrary to expectations it is time to sit up and notice.

The market is indicating a freeze on mortgage resets is likely to repair the credit markets, reduce the need for rate cuts and bolster earnings growth. A tall order indeed! This may also encourage lenders to disclose more fully the extent of their exposure. As a result, we may see a nervous market in December but first quarter '08 may see the beginning of a multi-month rally in Stocks.

International, commodities and growth themes may have a way to go yet...

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Author: Greg Silberman

Greg Silberman CA(SA), CFA

Greg Silberman

Profession: Research Analyst and Newsletter Editor
Company: Ritterband Investment Management LLC

Career Brief: Greg qualified as the youngest Chartered Accountant and Chartered Financial Analyst (CFA) in South Africa in 1998 at 25 years old. After completing his traineeship with Grant Thornton he moved to London where he worked for JP Morgan Chase in their Fixed Income Swaps Division. Sick of the grey skies and cold weather Greg relocated to Atlanta, Georgia where he spent the next 4 years freelancing as a management consultant. His targeted clients were fast growing mid size US based companies and he worked across many industries including credit cards, health insurance and energy trading. Greg has recently returned from Sydney Australia where he spent the last 2½ years working in Equity Derivative Structuring for Perpetual investments a major Australian Asset Management Company.

Greg has a passion for the markets and has been writing Greg's market newsletter for 2-years. A newsletter focused on metal and energy stocks and recently non-resource small caps listed in the US and Internationally.

This article is intended solely for information purposes. The opinions are those of the author only. Please conduct further research and consult your financial advisor before making any investment/trading decision. No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

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