Signs of the Times

By: Bob Hoye | Fri, Jan 18, 2008
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"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works."

- John Stuart Mill, 1867


From Last Year:

"Derivatives, particularly in the oddly named credit default swap market, which essentially insures the holders of debt losses, also play a big role in reducing the risk in lending money. Now the biggest banks don't hold much debt, having sold it to others."

- Wall Street Journal, January 2, 2007

"Dow Hits Year's First Record as Oil Prices Drop"

- Wall Street Journal January 12, 2007

From This Year:

Well, we haven't seen it but if one wanted to write a headline: "Dow Hits New Lows as Oil drops"

"Law Firm To Lay Off 35 Attorneys"

That was out of 750, or 5% due to the decline in finance and capital- markets side of the business.

- Wall Street Journal January 11, 2008

It wasn't until March of last year when Wall Street strategists advised that the turmoil in sub-prime bonds could be contained.

Now even lawyers are being laid off.

"I'll go further and suggest that a severe tightening of Financial Conditions has abruptly made many business borrowing plans unviable; many a balance sheet and debt load untenable; and vast numbers of business strategies - crafted in altogether different financial and economic times - much less viable. Some companies will make the necessary adjustments and many will not. The unfolding backdrop definitely makes a lot of stock buyback plans imprudent and growth strategies highly risky. The aggressive risk-taking business manager - having previously capitalized on the protracted boom - will now be at a similar handicap to that which afflicted the zealous home buyer and lender banker."

- Doug Noland,, January 11, 2008

Stock Markets: Last spring we described that the bear started as an outbreak of "Rational Exuberance" exhausted itself and failed. Initially it was technical deterioration and that ran until a couple of weeks ago when economic fundamentals were reported as weakening. This placed the stock market and business fundamentals in harmony. Although the harmony may be awkward, it is the way a cyclical contraction works and is likely to run for many quarters.

If the past continues to guide, the bottom of the bear will likely occur some 10 months or so before the fundamentals begin to turn up. The initial opportunities usually become available accompanied by continuing gloomy economic reports, but hey - it will be the right kind of disharmony. Also, with considerable irony the opportunities will be accompanied as short-dated market rates of interest reverse to a solid uptrend.

As to the official determination of the recession; it seems appropriate to recall that with the 1973 - 1974 contraction the NBER spent a year saying that there was no recession, and when finally announcing it actually started in November, 1973 - a year earlier!

When it comes to making money in the stock markets - either up or down - research on credit markets and technical analysis has been reliable.

On the near term, the big step was down started two weeks ago as a number of indexes took out their August lows leading to the same failure for the senior indexes last week.

However, short rates have been declining and the Fed will be forced to follow. Although the next scheduled cut is possible with the January 30 FMOC meeting, this week's slide is increasing the clamor for a futile gesture. Perhaps something "impromptu' will be done before then, which could prompt a brief rally. At Bernanke's testimony today, some politician recommended issuing more food stamps as a stimulus.

To be clear, this is now a methodical bear market and each significant step down can be followed by a rebound that retraces some 40% to 50% of the loss.

Sector Comment: It has been likely that once the fundamentals failed, the decline would encompass most sectors.

One of the most important has been banks and financials. In bear markets Citigroup (C) records a reliable pattern, with remarkably similar declines. Following 2000 the loss was 51%, and in the 1998 LTCM collapse it was 61%, and to the 1990 low it was 55% and in the 1987 crash it gave up 56%.

By this reckoning, the decline for Citigroup is unlikely to exceed 61%. So far, the decline amounts to 51%. But not all of its, or for that matter the whole sector's liquidity problems, have been resolved. However, it is beginning to register a downside capitulation on the weekly numbers. The condition could last for a few weeks before the rebound is released.

Obviously, there has been considerable drama in the sector, and it is tempting to consider that most of this phase of the contraction is in. In which case, last summer we outlined that the traditional conclusion of a financial bubble saw the speculative momentum high in May or June. In all cases the summer was spent with hope accompanying the setbacks and the full liquidity crisis was usually complete by mid November. One example - the 1825 Bubble - was slow in rolling over and the panic ran into January of 1826.

The question now is "Has enough of the bad paper has been jettisoned to keep the global banking system afloat?"

Not likely. In most religions redemption can be achieved in an instant, but a couple of generations of reckless commercial and central banking can't be absolved so readily. No matter when the initial forced liquidation ended all of the great financial manias were followed by a multi-year contraction.

What has been missing on this failure has been pressures equivalent to last August's which included a panic in traditional spread markets from the long end to the money market desks. Maybe "they" are deferring this part to another day. This is a quip and prudence still suggests caution for investors, and we will advise on trading opportunities.

We had one of these opportunities in base metal mining stocks out of the low in November. Last week we were looking for the SPTMN to test August's low close and this is happening. Also, our base metals index needs a good test of the 605 low set in mid December, and it seems worthwhile to wait a bit before trying a long trade.

Energy Prices: Last spring the rallying cry of the oil crowd was "100 before it gets to 60". We know of no other item whereby participants work on such an unusual forecasting model. We will have to ask one of them if it now has to go to 60.

Seriously, there was an effective high of 100 in November and the test actually reached 100 at the first of the year. This was with considerable momentum divergence and a lot of enthusiasm. The price has stair-stepped down to 89.10 today, and there is support at 87.5 and at the interim low of 85.62. Taking those out would set the downtrend, and this could be assisted by a firming dollar.

On the big picture, the credit markets are in the worst train wreck in history, which we have been expecting to force a cyclical bear market for most commodities, and related items. Base metal prices are in a bear, as are the Baltic Freight Rate, and stock markets. Grains have been the last to run and the action has become impetuous. This week's crash in agricultural stocks has been impressive. The Baltic is down 37% from the high of 11.039.

Another point we have been making is that a number of governments as well as the United Nations have got on the energy band wagon and the last time that happened was at the secular high in 1980.

And to borrow the style of the oil patch - "Crude will have a cyclical decline before it has a secular one."

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Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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