If I had really good answers for
these questions I would be filthy, stinking rich a year from now. So
much is uncertain that I'll just have to make some educated guesses.
1) Value for S&P. I think that
the SPX is highly valued now and that earnings are going to decline at
least 10% so 1,200 is probably in the ballpark. If we have a recession,
and I believe we will, declines often run 30-40% from peak value so
that yields 1050-900. The sovereign wealth funds are going to be a new
factor so I think that may provide better support. On balance, around
1,200.
2) The world economy is now built
upon exponential leverage of debt. Not just mortgages, but credit card,
autos, home equity, CDO's, CLO's, SIV's, ABS, you name it. Something
which has not even surfaced is the leveraged counter-party risk when
counter-parties start defaulting ... the modern day equivalent of the
1980's "portfolio insurance" which was thoroughly discredited in the
1987 crash. I think that the global financial system will get it worked
out but it is going to require time, lots of time, to find where the
crap and the weak hands are and clean it up. I don't think there can or
should be an instant "fix".
3) Problem with the credit system
is shrinking liquidity. Credit holdings can not be valued due to the
way credit has been sliced and diced (horizontally and vertically) and
then securitized. Not knowing what is functional and what is not,
everyone is hoarding cash. That is taking liquidity out of the
financial system much faster than the Fed can add it. A low FF rate
will do no good if no one wants to borrow.
I am about 65% cash now. I expect
that the 1Q earnings reporting season is going to see a lot of downward
revisions and a lot of crap being written off the books to clear the
decks and get the problems behind. I hope there will be some real fear
and loathing in the market at that point. I expect that write downs in
some of the better financials may (eventually) be proven to be
excessive leading to future gains. 1Q won't be the end by any means but
I suspect it may be shopping time. If not 1Q, then 2Q.
Earl
At 07:37 PM 12/9/2007, you wrote:
The problem is not a few sub-prime
borrowers being unable to refi homes which they should not have
purchased, the problem is that the credit markets are dysfunctional.
So what is the correct level for the S&P in your opinion?
Obviously, it isn't zero and equally obviously it isn't where we are
now so what is, (in your opinion), the correct index level for the
current conditions?
Second question: What do you believe needs to be done to cure the
problem? We are beginning to see the depth of the sub-prime problem so
that is coming into focus but what else needs to happen so the credit
markets can become functional again?
Last question: What do you see as the functionality problem with the
credit markets? Is it business capital availability or consumer credit
or both? Consumers have been living on credit cards for at least 2
decades so there is nothing new there but they have less access to
additional mortgages due to falling property values. One of my credit
card companies just raised the credit limit on my account to 34,000 and
I have no balance and have never asked for an increase so it seems they
aren't limiting anything to credit worthy customers.
Thanks for your time and insight Earl,
Bob