Wednesday, March 11, 2009

Clumsy and Random Thoughts on "The Bottom"

Yesterday had to set a record for pronouncements of a Bottom (tm) on CNBC. I've said many times that I really hate the sport of bottom calling. First, I think most investors who try to time bottoms wind up losing money. Second, I think even thinking in terms of a bottom winds up distorting one's thinking, focusing you on the immediate term movements rather than fundamental value. Bottoms (tm) are mostly about fear anyway, so anyone who thinks they know where the bottom is is making a statement about market psychology.

As an aside, I absolutely don't get the people who are now doing 90-year SMA charts or measuring resistance points from the 1997 lows. I'm not condemning charts as an investment tool, at all. But looking back 90 years and pretending any of that is relevant is dumb.

All that being said, I sure wouldn't bet that we've seen the bottom. Its possible but not my view.

In order for the economy to start turning around, we must deal with bad bank assets. Ideally, we'd get a decent government-led bad bank plan. I am working on a new idea along these lines right now. As much as I believe a so-called Aggregator Bank could work, I'm not optimistic that the government will successfully put one together. More likely is that the government announces a plan to cleanse bank balance sheets that looks good initially, but the details wind up somehow circumventing the program's purpose.

Second, I think that many investors are overly focused on housing right now. As a result, when housing starts to improve, they will start to buy. I actually think housing will start improving a good deal ahead of general economic improvement.

Why? Because a combination of government programs and time are starting to make progress in getting home inventories down, or at least to where inventories aren't rapidly rising. Home are relatively affordable vs. renting again, and good borrowers are finding it easy to get a loan. I think that in less than a year, home prices stop dropping.

But remember that recessions are the result of necessary adjustments in how companies finance their activity. Where once liquidity, availability of debt financing, counter-party solvency, etc. was all considered a given, now it isn't. It will take years for companies to restructure themselves to this new reality.

Pile on top of that the massive loss of wealth at the consumer level. This will force much higher savings rates and higher labor force participation (people getting second jobs or putting off retirement.) While this is probably a long-term positive for our economy, it will require a near-term adjustment. It will mean we've got too much retail capacity in this country, for one. Again, this adjustment will take years to play out.

And that doesn't mean that the economy contracts for years and years, but that housing alone won't fix the economy. Maybe pre-Lehman/AIG/GSEs/WaMu/Wachovia housing alone could have pulled us out of recession, but not now.

Anyway, back to the stock market. Stocks are forward looking, so the Bottom (tm) will almost certainly come before the economy starts recovering in full. So sure, its possible that I'm overly pessimistic and we've already seen the bottom, especially if the Aggregator Bank actually winds up working.

But I'm betting we still go lower.


vm said...

I didnt think that the memo from City CEO would automatically to create a bottom to the stock market. But it was good to see a rally in a rather depressed market. We really need to see something concrete from Geithner to move this market upwards in a meaningful way.

In Debt We Trust said...

I have some honest questions. As a futures and options trader I have to practice sound money management. This includes posting adequate margin and monitoring stops.

Do ABS traders follow the same rules? What sort of margin requirements do you guys follow (if any)? What about following technical analysis? How often are trades marked to market? Do you segregate client funds from firm funds in separate escrow accounts (like you do in futures)?

I find the concept of trading in an OTC market highly disingenuous for those of us operating in an exchange driven environment. There is a lot of mythology flying around about the CDS and ABS market. I would appreciate some clarification on these issues.

Accrued Interest said...


ABS and CDS have the same answers. The margin requirements are set by whomever is extending the margin. So if I am getting my funding from JPM they might have one haircut. UBS might have something different for the same asset.

They will require you to increase your equity if the market value of the position falls. They can also change the haircuts with little notice. I know a lot of people lost their funding entirely in September.

Everyone follows technicals in the bond market, although if you trade distressed stuff its not very important.

Anyway, I'm not an expert on this since we don't lever our accounts. Maybe someone else can give a more complete picture?

In Debt We Trust said...

Thank you for responding.