03
Jun
2008
| Financials on the Brink, Housing in the Drink |
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| Written by Justice Litle, Taipan Publishing Group |
03 Jun 2008 |
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Another day, another round of bad news from the brokers and the banks. The financials got whacked again yesterday -- taking the market down along with it -- on news of further debt downgrades from Standard & Poor's. On the i-bank side, Lehman, Merrill and Morgan all saw their credit ratings take a hit. On the commercial bank side, Wachovia and Washington Mutual said sayonara to their current leaders. This implies more bad news in the pipeline.
About a month ago, your humble editor compared Western banks to an old radio filled with cockroaches. (See Banks a Lot archived on the TPG Web site.) Four weeks later, the roaches are still pouring out. At various times in the past few months, Taipan Daily has pounded the table for shorts on the broader financials. Those shorts are working well now, with XLF (the financial SPDR) trending lower in stair-step fashion and the Philly Bank Index ($BKX) testing its lows. But in terms of keeping a finger on the pulse, the new bellwether for financial stocks just might be Lehman Brothers (LEH:NYSE).  Lehman is the smallest bulge-bracket investment house on the Street now that Bear Stearns is no more. Many thought it would follow in Bear's footsteps during the heat of the crisis. (That's where that big downward spike came from in early Feb.) So far, Lehman has defied its critics -- thanks in part to the smart moves of CFO Erin Callan and CEO Dick Fuld. But the sharks are still circling, and some very smart people think Lehman is still teetering on the brink. The sharks smelled blood in the water this morning, as news arose that Lehman may be forced to raise billions in fresh capital to shore up its balance sheet. The big question is how much exposure the investment bank still has to toxic mortgage trades and so-called "level 3 assets" -- opaque stuff holdings that are extremely hard to value. Watch LEH and the $BKX. If one or the other cracks, there could be another big downward whoosh for the financials. ("Whoosh," of course, being a highly technical trading term.) Buy One, Get One Free  Meanwhile, the housing bust is still in full swing. The above chart was featured in a recent Chart of the Day, but is worth reposting for those of you who didn't catch it. The Economist has reported that the current house price drop is even nastier than what was seen in the Great Depression. (Now that's nasty.)  The nuttiness of the housing bubble -- and its still unfolding aftermath -- has perhaps expressed itself best in California. (And really, could it have been any other state?)The LA Times captures the new zeitgeist with news of an Escondido developer's "two-for-one" offering. Buy One, Get One Free. Seriously. Maybe this is just a publicity stunt... It doesn't feel like it, though. Why would a builder want to embarrass himself like that for the sake of a laugh. Where could this trend lead to, one wonders. Perhaps we'll start to see real estate advertised on those little food signs above the gas pump. Along with your 32-ounce drink and your jumbo hot dog, get an additional 10% off your next faux-Colonial McMansion with every 10 gallons of gas. Or maybe we'll see the builders adopt the "Crazy Eddie" electronics-and-mattresses personas of vintage '80s television. "Everything must go!" The Starbucks Test When the boom was ramping up a full head of steam, you could walk into a Starbucks and hear would-be players talking about real estate deals and happy couples going over renovation plans. Now the inverse of that -- which we aren't quite seeing yet -- is just around the corner. It's only a matter of time before the corner Starbucks is filled with fuming ex-wheeler dealers. "Just get me out! I don't care what the price is -- just get me the $@#$@# out!" In the stock market this is a process known as "capitulation." We haven't yet seen true capitulation in the housing market. Or at least not here in Nevada, home to one of the highest rates of foreclosures in the country. Sales signs are popping up everywhere, yet average prices have merely notched down from extremely insane to moderately insane. Prices are still far from cheap, even in relative terms. When sellers throw in the towel, that could change. A Ways to Go Because the pain of the housing bust isn't done, nor is the Fed. Thoughts that the Fed is done stimulating the economy -- and that interest rates will soon be going up -- are seriously premature. The Fed won't be done until the massive debt levels worked up in the housing bubble are worked off. The need to stimulate won't go away until U.S. consumers have gotten back to some form of reasonable financial health. That's a long, long ways off. Consumer pressures are increasing, not easing. In light of this, thoughts that the dollar is going to get buoyed this year are far too optimistic. Pundits who expect a quick shift just don't understand the logic of the bind we're in. The logic of the "Austrian endgame" (i.e., the cycle of unwind predicted long ago by Ludwig Von Mises) is this: We've loaded up on way too much debt, mainly as a result of the government's efforts to massage the credit cycle and keep the party going. Piling on that debt was a Faustian bargain. The good times it created laid the groundwork for the bad. Now the Fed will have to "destroy the economy or destroy the currency," as Von Mises laid out the choice. It's the overhang of debt that forces that choice... an overhang that is far from being worked off as of yet. Talk is Cheap  The reality just described explains why things will have to get worse before they get better. The piper hasn't been paid in full just yet, and the payments don't come easy. As consumers wrestle with $4 a gallon gasoline, mounting debts and shrinking discretionary income, the Fed will have no choice other than to keep running the printing press. On television and in the newspapers, it's a game of bait and switch. Bernanke and his governors can talk tough about inflation all they want -- but behind the scenes, they have no real options. It's easy to talk tough because talk is cheap. The hidden imperative is "inflate or die." And once again, the bind we find ourselves in is not new, and not all that surprising. It was predicted long ago by those who understand the nature of debt, the nature of human nature, and the nature of how reality works. Opportunity Knocks There's opportunity in at least two places here. In respect to the financials, there's still good money to be made selectively shorting them. (Although we're getting to the point where it's better to be adding to existing positions that were established from higher levels, rather than opening up new ones.) There's also still opportunity in anti-dollar asset classes like precious metals, in that people don't realize how far the Fed is from being done. The hopeful mood of the pundits, and the desire to see an end to the journey with every bend in the road, provides false hope to many and great opportunity to a clear-eyed few. |