2011Aug22 Someone Pulled the Plug

"The Fed can print dollars, but it can't print confidence"

~ David Bianco, chief equity strategist at 

Bank of America Merrill Lynch

Markets:

 Dynamic Asset Evaluation

 

The Standard & Poor's 500 Index has fallen for four straight weeks, losing 16 percent from July 22 through Aug. 19. Global stock markets erased $1.8 trillion of wealth as Morgan Stanley said the U.S. and Europe were "dangerously close" to recession. After S&P cut the U.S. credit rating on Aug. 5, the Dow Jones Industrial Average had the biggest one-day loss since 2008, igniting memories of the housing-induced financial crisis that triggered a global recession and wiped out more than 8 million U.S. jobs.

 

It is important to remember that this is not 2008 all over again. Much of the investment community is now bracing for a repeat of that crash, when the S&P 500 plunged by a gut punching 52%. For proof, look no further than last week's dramatic selling, when traders could not unload equities fast enough. As we have said before "panic is not a strategy". Here are some of the data points that make 2011 a little different:

  • In 2008, banks were essentially insolvent. Since then, they have raised over $50 billion in primary capital.   
  • Nonfinancial companies are sitting on the highest cash mountains since 1955, some $2 trillion, or 11% of total assets.   
  • In the last three years, the consumer savings rate has leapt from 1% to 5.4%.      
  • Business inventories have gone from bloated to fighting lean.   
  • Debt/GDP has fallen from 100% to 90%.   
  • The cheap dollar is fueling surging exports.   
  • Short term interest rates have fallen from 3% to 0%, and will remain there for two years.   
  • Junk bond yields have plunged from 25% to 8%, opening up financing avenues for many subprime corporate borrowers.   
  • Companies have announced buyback programs of $550 billion, and some $450 billion of this may be executed.

So while all is not well, there are some parts of the economy showing some strength.

 

Real Estate:

 

From Bloomberg:

 

"Sanjay Jain called his real estate broker four days ago to cancel a deal to buy a three-bedroom home in Folsom, California, unnerved by another plunge in the most volatile equities market on record.

 

"Seeing what's happening on the stock market made me think that it's not a good time to be buying a home," Jain said. "I'm going to wait and see."

 

"As the U.S. economy shows signs of sputtering, instability on Wall Street is sapping the confidence of would-be property buyers, said Karl Case, co-founder of the S&P/Case-Shiller home- price index. That means housing, which aided every recovery except one before the most recent recession, may deepen its five-year drag on growth.

 

"There's a dramatic effect on an economy when a major sector is flat out," said Case, professor emeritus of economics at Wellesley College in Massachusetts. "If housing takes another leg down, it's an accelerator. It's going to make a recession happen faster and deeper."

 

"A lot of people have seen their down payments for a home disappear in the stock market," said Keith Gumbinger, vice president of HSH Associates, a loan-data firm in Pompton Plains, New Jersey. "It served as a reinforcement to the hunker-down mentality that a lot of homebuyers already had."

 

"Before the start of the economic recovery in mid-2009, the U.S. had not exited a recession without being aided by housing, its largest asset class, except for 1981, according to data from the Bureau of Economic Analysis. That year, the recovery was followed by a second, and deeper, recession in 1982.

 

"Since the 2006 real estate bust, a measure of homebuilding and brokers' commissions known as residential investment has drained gross domestic product by almost three-quarters of a percentage point annually, on average.

 

"The share of mortgages with late payments in the second quarter rose to 8.44 percent from 8.32 percent the previous three months, the Mortgage Bankers Association reported today.

 

"The degenerating housing market has confounded attempts by Federal Reserve Chairman Ben S. Bernanke to revive demand by lowering interest rates. The Fed purchased more than $2 trillion of mortgage-back securities and Treasury bonds in the last two years to hold down long-term borrowing costs.

 

"Bernanke got the cheaper home-loan financing costs he wanted -- last week, rates for 30-year fixed mortgages fell to 4.15 percent, the lowest in more than half a century, according to Freddie Mac. Still, rates that have been below 5 percent in all but two weeks of this year have failed to spur sales enough to support economic growth."

 

Europe:

 

Here is most of what you need to know about Europe in one neat graph from Morgan Stanley:

 

 

The bottom line is that as of August there is no long-term debt market for the EU financials. This is the kind of liquidity crunch that has the potential to get ugly very fast. Germany has stated that they are no longer interested in supporting the economically weaker countries without much more control over fiscal decisions on an ongoing basis. This may turn out to be a very different looking Europe.