Wednesday, October 15, 2008

beware the trend

one of the most important forces in financial markets -- or human behavior in general -- is the TREND.

after decades of strength, the US credit market may be entering a long-term SECULAR BEAR MARKET TREND.

however, one step in the FDIC plan guaranteeing bank debt, might save the day.

trends occur when people move towards a new belief or idea. some principle -- whether it's prohibition of alcohol, or a bullish feeling in a stock -- offers an intellectual appeal. they can be "proven" and articulated. people's minds can take ownership over them and feel they're true.

the idea wins early converts. they see people getting drunk and beating their wives and neglecting their children, so they condemn liquor. they see computers spreading like wildfile through companies and households. they see microsoft beat estimates and some people start buying the shares. (money is how you express yourself in markets.)

in something like prohibition, the idea builds in a small circle over time. it then grows increasingly mainstream after the civil war, when millions of new adherents banned alcohol in about 124 countries, according to wikipedia. (jack daniels is distilled in a dry county.) during WWI, different groups such as employers, women's groups, religious and the military embrace prohibition at the same time. once it's broadly accepted, the constitution is amended and the era of the bootlegger began.

microsoft muscles its way into the computer market with an operating system that creates a single platform where software developers and computer makers competed to create more and better products. MSFT doesn't care if IBM sells more PCs than DELL, or anything else. they profit from everyone using windows-powered computers. MSFT shares become a vehicle to ride that broad societal trend and rise from 10 cents to over 70.

financial market trends can work in the opposite direction... an asset has appreciated for years, and everyone owns it. some people start selling it to raise cash... others start to notice it's not going up anymore. they also become sellers. it then moves lower over time as people come to assume that now it's going lower.

for many years, the credit of businesses, households, municipalities has been in steady demand. investments by pension funds, mutual funds, hedge funds, insurers, foreigners have crammed debt into every corner of our economy where it can go. it climbed every year since the 1950s at about twice the pace of GDP growth. it built modern america.

credit is widely owned and has been in a bull market for decades. now the prices start to weaken and people are increasingly assuming the worst and giving up hope. if we go into a real bear market, the bedrock of capital under our lived environment starts to crumble. houses, shopping centers, etc, all become worth less than their debt. stripped of equity, owners start to walk away. that's when the real collapse occurs. this started with home prices falling. that destroyed the mortgage market. now people can't get loans, and it's becoming a self-perpetuating cycle.

we've already seen a gradual slowdown in borrowing....

if this is a trend, it will accelerate and the lines on this chart will cross into negative territory.

it seems overall lending really started contracted after lehman failed in early september. so consumers and financials have now apparently turned negative. it will be interesting to check the next z.1 for data on how much companies and municipal issuers turned to bank lines and reduced term debt issuance.

a bona fide collapse in lending in the US could prove a major shift in the continuum of money, time and space.

we now face the real decline I have been fearing. all financial assets - stocks, bonds and commodity futures - are plunging in value as liquidity dries up.

some observations on the sp-500 stock index:

it took 23 months in 2000-2 to fall 45% from 1530 to 850.
this time, it has fallen about the same amount in just 12 months.

it posted a similar drop oct 73-74 and bounced back. but there was much less debt and people were forming families. today, people are downsizing homes and paying off debt.

reading some research: it seems that people are now assuming the worst instead of buying credit on dips. after the collapse of bear in march, demand returned for financials and other corporate issues. when in doubt, investors assumed the best and bought.

lehman destroyed that confidence. years of excessive trust became complacency. when the bliss ends, it's replaced by fear and paranoia. just as it was irrational to lend money to many people who got mortgages, the pendulum might swing back just as hard in the opposite direction and deny credit to worthy businesses. it seems to be starting now.

the assumption is increasingly that bad news is coming next. it's like a meteor striking in the middle of the ocean, with people knowing a tsunami is hours away. we know the economy will suffer, and now everything is becoming a self-fulfilling prophecy. now even with some evidence of improvement in commercial paper, the market is shooting first and asking questions later.

getting back to the sp-500: in 1974, it fell to a support level set 12 years earlier. if we span the same amount of time today, it puts the sp-500 around 677.

assuming we continue to fall, the next real support is about 813, an old high reached back in feb 1997.

one major thing that could undermine my fears about a collapse in credit is the government's apparent promise to insure financial bonds. it would target the same goals as my own proposed plan, and might accomplish the same goals of taking the pressure off the short-term debt markets. the more I read the research, the more bullish it makes me want to get...

apparently, it will provide a 3yr guarantee to new issues of senior unsecured bonds issued through june 30, 2009. if it works, this could take armeggedon off the table for a little while longer and result in a buying opportunity. still, there is so much negativity in the stocks now, and that trend might continue even as the funding picture starts to improve. and, how much else will be lost in the meantime... this is why they should just start buying corporates right now.

finally, let me just observe that the market for financial issuance seems to have shut down as early as May. was it actually the collapse in the PRIMARY MARKET that killed lehman?


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