2008 is here again

Aug 12, 2011
2008 is here again
By Scott B MacDonald

NEW YORK – No one can blame investors for feeling like 2008 is back. After all, there has been a return to acute market volatility, financial and industrial stocks have been beaten up, and the VIX, a popular index of volatility, was up 7.93 points today, reaching 42.99. The Dow is down a little over 7% for the year. With the exceptions of gold and silver, commodities have also undergone a brutal re-pricing. Additionally, the panic mode has sent gold to all time highs, bolstered the Swiss franc and made the US investment grade corporate bond market a relative safe harbor especially in the plain vanilla industrial names. What do we take from this market upheaval?

1. Credit, equity and commodity markets are pricing in a recession. US economic data has been signaling that the “soft patch” may be something more significant – a stall that could well turn into a recession. This explains the re-pricing in those sectors associated with economic growth – mining, materials, oil & gas, retail (clothing), and infrastructure. Financials, the villain at the heart of the drama in 2008, are also under pressure in both spreads and stock prices. (This was also pushed by a degree of contagion from French banks and concern over their exposure to peripheral European economies.) The Bank of America 5-year credit-default swap ended the day at 300/310 basis points and its stock was at $6.77 (down from a high in the year of $14.89 on February 14).

2. While the Standard & Poor’s downgrade of the United States sovereign debt to AA+ was the spark that appears to have lit the market explosion, it is not the core reason. The core reason is that the US and other advanced economies are in the middle of a multi-year process of deleveraging. This is impacting the public sector and households. The S&P downgrade only underscored that the US political establishment did a very poor job in dealing with a problem that was well-identified and had considerable time before the August 2 deadline.

3. Although the market re-pricing is brutal, it comes at a time when US corporate strength is solid. Earnings over the last quarter were good, with far more positive surprises than negative. Moreover, earnings forecasts for the rest of the year depicted a degree of caution, not Armageddon. It is often forgotten, but market upturns and downturns tend to overshoot.

4. The US banking sector is in better shape now than it was in 2008. Although banks and other financial companies have been pummeled in the market downturn, there has been a considerable effort to reduce toxic assets, rebuild balance sheets and stockpile reserves. Creditsights (August 10, 2011) observed: “The takeaway message is that the large banks and brokers should have sufficient liquidity resources to manage through these market dislocations caused by S&P’s sovereign downgrade.”

Significantly, Bank of America, one of the bank’s most beaten up in the downturn, reported in in the second quarter of 2011 that it has global excess liquidity sources totaling $402 billion, up $66 billion (20%) from year-end 2010. The bank had reserve repo assets of $235 billion, versus repo liabilities of $240 billion, for net liabilities of $4 billion. This means that net liabilities were a manageable 1%.

5. There is a path out of the downturn. What will make a difference in this market panic is traction on the economic policymaking front. If nothing else the S&P downgrade and ensuing global market sell-off penetrated the seemingly thick cranial zones of Washington’s political elite, providing a very good reason to take fiscal consolidation more seriously.

http://www.atimes.com/atimes/Global_Economy/MH12Dj01.html