Monday, August 20, 2007

Kass: 'Don't Fight the Fed.' How Quaint

'Don't Fight the Fed.' This phrase will from now on put on the table almost every day from CNBC, Cramer, Wall Street etc. And with the macro news getting worse days by day it it probably their only argument for a long time to come. Remember that this new "Mantra" will be coming from the same guys that didn´t see the housing bubble, then said housing is contained, talked about a "Private Equity Put", said the market is cheap, there is cash on the sidelines, will come up with the Fed Model...

So it is good that Doug Kass is providing some "anti spin". The only thing that might dampen the slump a little bit is that the world economy is much stronger than during the past. But this won´t save the US from going into a recession.

'Don't Fight the Fed.' Diese Redewendung wird uns die nächsten Monate unweigerlich jeden Tag von Seiten CNBC, Cramer, Wall Street usw. begegnen. Und da sich die Marcodaten Tag für Tag verschlechtern bleiben aus Bullensicht natürlich auch nicht mehr allzu viele Argumente übrig. Man sollte dabei jedoch bedenken das dieses neue "Mantra" von denselben Leuten kommt die erst keine Immobilienblase erkannt haben, dann das Immobilienproblems als isoliert bewertet haben, die einen "Private Equity Put" gesehen haben, die steif und fest behaupten der Markt wäre günstig (trotz 30-40 % Finanzgewichtung), die Tonnen von Cash an der Seitenlinie vermutet haben, die das sog.Fed Model bemühen.........

Da tut es gut wenn Doug Kass wie üblich zum "Anti Spin" ausholt. Das Einzige was evtl. den Verfall etwas abmildern könnte ist die noch immer rund laufende Weltwirtschaft die sich so stark wie noch nie präsentiert. All das wird aber die USA nicht vor einer happigen Rezession schützen.

On Friday night, I appeared on CNBC's "Fast Money" and was asked a critical question: Why fight the Fed in maintaining a cautious market view? After all, the markets soared after the Fed eased in response to the Long Term Capital Management (LTCM) bailout in 1998.



I'll answer that question now.

Back in 1990-1992 and 2001-2003, the Fed lowered interest rates 100 basis points, secure in the belief that it had thwarted a recession. Both times, the Fed was wrong: A recession commenced, and a bear market in equities followed. For example, the DJIA soared nearly 3% with the surprise January 2001 interest rate cut. Three months later, the markets made new lows and ultimately fell 20% from the highs.

Seven years ago, the economy was soaring with real gains of about 4%, productivity was unprecedented, technology was in the midst of a renaissance, and the consumer was in fine shape. The LTCM issue was fairly contained; it was an isolated liquidity crisis in a hedge fund that was forced by the misuse of leverage and the insolvency of a relatively small economy, Russia.

The result was a 75-basis-point reduction in the fed funds rates, which restored calm in the financial markets in a matter of weeks.

Things are far different today.

Today, we face an economy that has far less promise with participants (consumers, hedge funds and borrowers of all kinds and shapes) all hocked up. Unlike 1998, today's housing market is in a sustained downturn, which will not likely recover until 2010. The consumer is at a tipping point, hedge funds don't hedge, and the world's economy faces a broad credit crunch. What was a liquidity issue seven years ago is both a liquidity and solvency issue today.

I have argued that, in the current credit cycle, nontraditional lenders have proliferated by circumventing Regulation T and banking reserve requirements, serving to soften or even dull the Fed's role in monetary policy. In turn, this systemic change has led to unusual borrowing in the form of interest-only and teaser adjustable-rate mortgage loans and levered quant hedge funds.

Furthermore, growth in the derivative market ran amok, serving to underwrite the sale of a broad-based group of products (such as motorcycles, automobiles, furniture, etc.) and also serving to brighten the markets for private equity.

This added liquidity from nontraditional lenders also buoyed the credit market, allowing companies that should have failed to tap large sums of equity and bonds. This created the feeling that all was well with the business world as stock markets rallied around the globe and corporate default rates hit all-time lows in 2006.

> Here are more charts that shows how deep the US consumer is in trouble

> Here mehr Charts die eindrucksvoll zeigen wie tief der US Konsument inzwsichen im Schuldensumpf steckt

But this was an illusion.

With credit being extended to everyone, the consumer -- already having ponied up to the Credit Bar Saloon -- went further into hock by loading up on ARMs and "no-money-down" durable (and nondurable) purchases. The hedge funds, in this period of mispricing of risk, got into the act by levering up in order to capture unsustainable returns. (According to Merrill Lynch hedge fund assets now approach $10 trillion, which is supported by less than $1.5 trillion of equity.)

The "hot money" provided by nontraditional lenders eventually led to what we have today and what I have described as a tightly wound financial system vulnerable to any interruption or negative event. The subprime mess was the event that triggered a chain reaction and a reassessment and repricing of risk; it was a ticking credit time bomb that most ignored -- until recently.

Pushing on a String
Pushing on a string means that the positive impact of lower interest rates is overwhelmed by the reduction in credit availability and the desire to borrow, as lenders try to improve the quality of their loan book and repair their balance sheets.
> I think the chart for corporate loans in 2006-2007 is looking similar

> Ich denke das der Chart für gewerbliche Kunden in 2006-2007 wohl ähnlich aussehen dürfte

The 50-basis-point reduction in the discount rate will likely be followed by further easing by the Fed, but it will do little good

The combination of stressed and stretched individual mortgage holders, a consumer levered far greater than in 1998, crippled nontraditional lenders, grossly extended hedge funds and debt-heavy subprime companies will exacerbate the downturn in the domestic economy in a far more severe manner than during the LTCM crisis. The two periods, quite frankly, are not even comparable in terms of how secure or shaky the economic foundation is.

Regardless of the Fed's actions, the odds favoring a 2008 recession have been increasing daily and until recently have been almost entirely ignored.

Political Consequences
After the LTCM mess in 1998, the Republican Congress was firmly in control and so was the security of lower taxes for both individuals and corporations. This is not the case in 2007, as the rising odds of a recession and the possible perception that the Fed is working as an agent for corporate America to bail out the hedge funds and troubled lenders already follows the Democratic midterm election victories of 2006.

Also, the growing schism between the haves and the have-nots in 2007 over 1998 will likely serve to give the Democrats the 2008 presidential election on a silver platter -- and with it, the headwinds of rising trade protectionism and higher taxes.

"Don't fight the Fed," a phrase promulgated by Marty Zweig, is one of those nonrigorous "truisms" that may no longer be useful. The markets in August 2007 have had the expected and Pavlovian reaction by immediately soaring; this is just what occurred on Jan. 3, 2001, after another surprise rate cut.

Back then, the Fed and the markets briefly thought that the threat of recession had been eliminated. It had not; we entered a recession soon thereafter. Today, the financial system is far more levered (and stressed) than in 2001, and a reduction in interest rates would simply ease a small portion of the pain of the debt excesses since 2000.

Our investment eyes need to be washed by tears once in a while so that we can see the markets and economy with a clearer view again. From my perch, we are in one such period. Everybody is going to hurt.

Fight the Fed.

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10 Comments:

Blogger jmf said...

As always also great fun to read


Five Things You Need to Know: Permabears!; Why Traditional Bank Runs Do Not Occur; Why Traditional Bank Runs Do Occur; Money Market Infections; Department of Weirdly Accurate, Yet Strangely Unrelated, Headlines

10:56 PM  
Blogger jmf said...


China's Inflation Will Stymie Subprime Response: Andy Mukherjee



``China's liquidity problems stem from its undervalued currency,'' Diana Choyleva, an economist at Lombard Street Research in London, wrote in an Aug. 13 research note.

And the inflationary consequences may have already become inevitable, not only for China, but also for the world.

``Whether the yuan appreciates fast, Chinese producers continue to pass on increased input costs to the global consumer or there is a protectionist backlash, China is set to export inflation,'' Choyleva said.

got Gold ? :-)

12:46 AM  
Blogger Edgar said...

Moin jmf!

Your English is very good. I am assuming that it is not your first language, otherwise I might not make this observation on your use of American colloquialism. You wrote:

With credit being extended to everyone, the consumer -- already having ponied up to the Credit Bar Saloon...

I think you may mean "bellied up". "Ponied up" means he paid, and we both know the American borrower is in no position to pay his bar tab. Not to be picky, I thought you might appreciate. Edgar out.

6:04 AM  
Blogger jmf said...

Moin Edgar,

i would rate my english as sub par...

"With credit being extended to everyone, the consumer -- already having ponied up to the Credit Bar Saloon..."

... is from Doug Kass.

You are correct that i am appreciate any hint if my english is too far of the mark

7:11 AM  
Blogger Edgar said...

Sorry jmf, I thought that was you. I should read more carefully. Still the premise holds, U.S. debtors are in no position to "pony up" anything of value. They have already hocked our manufacturing base to the Asians, we have nothing left but scummy RE scams and paper games. I am shocked at how the ROW (rest of world) keeps propping up the stupidest and most criminal administration in history. Is it a misguided attempt to help the average American? Believe me, if you are helping the Bushies you are not helping middle America, and there will be no thank you from the masses.

7:28 AM  
Blogger jmf said...

Moin Edgar,

no problem.

I think Germany and Europe were shocked to see Bush got reelected.

And I think after the subprime mess is now "contained" in Germany more and more people will understand how weak the economic foundation of the US is ....

They will realize ( I holpe) that the "strength" of the US economy was build on asset price inflation and cheap credit & financial innovation to keep the game going another extra inning.....

7:35 AM  
Blogger Edgar said...

Good point jmf, I hope you are right. Tying off to the Titanic while it is going down is not a good situation. Better to pick up survivors after it goes down. We have been sold out by the political classes for thirty pieces of silver. The American people need to learn a hard lesson about complacency. If the world will not allow it then we will drag everyone down with us.

7:44 AM  
Blogger jmf said...

More from the Private Equity Put......

Private equity dealmaking slumps in August

Private equity's record-setting run in the mergers and acquisitions world may have finally come to an end. Financial sponsor-led deals have fallen to just $9.3 billion during the month of August, putting the industry on pace for its lowest monthly total since January 2004, according to Dealogic. In addition, there has only been one deal valued at more than $5 billion since July 3

8:10 AM  
Blogger Edgar said...

I think Germany and Europe were shocked to see Bush got reelected...

Bush didn't win either election, he stole them. Besides, what choice did we have, Herman Munster? In case no-one in Europe has noticed, we have fallen under a fascist regime. I hope we can all laugh about this someday.

1:34 PM  
Anonymous long-term investment said...

I studied the history of Fed rate cuts of 200bp and more and the subsequent stock market responses. My study show there is a truism to "Don't fight the Fed." Read the "Fed rate cuts and stocks" study here.

1:23 PM  

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