A new and experimental feature, spawned out of the sudden, early-morning realization that I think Daniel Mark Harrison's optimism is the daft raving of naivete, and he thinks my pessimism the product of that burnt out, hollow shell of an organ I call a heart. Who prevails? We collide, you decide.
As Ms. Private lost the coin toss, she begins....
Equity Private:The Abyss Yet Approaches:
I find it extremely hard to even empathize with, much less support the bull case in this environment. Owning to the lag between the onset and the reportage of disaster, we simply haven't yet seen the impact of the credit crunch on earnings yet. Add to this the fact that, I hope short of outright accounting fraud, firms have been doing everything they possibly can to avoid bleeding out. I was amused to watch several banks push out the definition of some of their loan "defaults" to 120 days or beyond on to buy another 30 days (and therefore another quarterly report) on the write downs. This isn't all. Anyone who believes LIBOR is anything but a convenient fiction to ignore how desperate European banks (who ironically tended to be even more levered in some cases than their American cousins) have become is permitting hope to prevail over reason. Pouring money in may prevent total meltdown, but not a painful downturn.
I haven't even begin to talk about the consumer shock that must eventually follow, again lagged, from this major lending contraction. Even a small spike in unemployment will push foreclosures (and therefore write-offs) up. Even if we offer foreclosure assistance, delay it for years if you like, someone eventually has to pay the mortgage for that capital to end up on the income statements of financial institutions. Then there is commercial real-estate, commercial real-estate loans, and LBO debt which hasn't burst its rivets quite yet.
Finally, I don't think many people have appreciated the importance (and wonderful timing) of a sudden drop in oil prices. Crude futures are less than half what they were just three months ago. Certainly, that's more than the Fed could ever do to buoy things, but it is also dangerously out of the immediate influence of the likes of OPEC. They are at the budget breaking $70 (far below the $90 line for Russia) right now. As drastic measures are sure to follow, I wouldn't want to rely much on this cushion being around much longer.
Daniel Mark Harrison:The End Of The Abyss:
I'm going to be the first to call it: we're at the bottom. The Dow is unlikely to fall below the 8,500 mark, and will most probably not close below 8,852.22 points again this year. Oil prices are in a natural free-fall, and no amount of equity gains is likely to propel the price anywhere near $100, above which it had a destabilizing inflationary impact.
Much of the dramatic sell-off we have seen in the past few weeks has been because central banks have been ill-prepared to fight illiquidity: in short, U.S. policymakers dithered. Now that the economy has become a political issue, transcending partisan debate, action will swiftly correct valuations in the event of further freezing of credit. We're already seeing signs of this in action, with LIBOR spreads lowering even as additional Asian and European bailouts are being granted. The Dow rose 4% Monday, even with additional abysmal news in the mortgage market.
China's spiraling GDP and inflationary numbers will ultimately end up putting it back in the position of exporting deflation rather than inflation, as it did before 2003. Emerging markets are the great casualty in this crisis, while the U.S., with its ample arsenal of funds, markets, and insatiable consumption demand, will stay afloat while stocks surge at year-end.
Collisions, after the jump.
EP: Well, we can at least agree that the drop in energy has lifted things. So I take it that since we agree on the devastating effect oil can have, you must, by extension, be predicting a sustained depression in energy prices, particularly oil. What exactly is your price target for crude, and how long can it be sustained?
DMH: I have predicted since June that oil would reach a "fair value" of $45 a barrel, and slowly rebound to $60 a barrel. Given the current valuations of stocks and oil, either equity prices have to increase or oil prices have to decrease to constitute fair value in both markets. Most likely both will do so at once- before rebounding to fair value.
EP: Ok, Goldman boy. But you agree that another rise would be disastrous?
DMH: In the current market climate, a rise above $100 a barrel for oil would be economic HIV, pure and simple. Then again, that's about as likely to happen as me sleeping with Kate Moss.
EP: Ok, Mr. Doherty. So the Ketamine has obviously kicked in, I'm going to guess that's a "yes?"
DMH: Yes. And I have to say I still don't understand the pessimism when it comes to the financial institutions. Hasn't mark to market accounting already served its purpose in socking the punch to balance sheets? You're from private equity or something, right? How is it you don't know this?
EP: I don't think the purpose was, as you so tactfully put, to sock the punch to balance sheets. In the first place, mark to market accounting shouldn't hit balance sheets that hard if the balance sheets aren't filled with illiquid assets and lots of leverage. This is something that seems to escape even the cleverer on the Street and I still don't understand why. An asset that no one will buy or lend against is worth... nothing. You can play all sorts of games and talk about prices "not reflecting long-term value," but that requires a very subjective take on "long-term value." That's just another way to say "mark-to-myth." Or maybe, mark-to-hope. Blaming mark-to-market accounting for some kind of market "punch," presupposes that it's inaccurate to say that something that cannot be sold is worth nothing.
DMH: But hasn't the damage to liquidity already been done, given the never ending round of stimulus packages and the final decline in lending rates?
EP: "Final decline in lending rates," now your a fixed income expert too?
DMH: I work for Dealbreaker. There is no such thing as fixed income in my world.
EP: Ok, so to summarize, at some point last night, you slipped into a K-hole and came out with a deep understanding of the energy markets, you are now certain that oil is going to stay cheap indefinitely, and that next week Tears for Fears is going announce that they are getting back together again to tour. Just like old times. '80s revival. Does that about cover it? That's your economic acumen?
DMH:You're a decade out. I think Simple Minds is going to announce their reunion tour. Yes. Just like the old times. The '90s revival. Guns 'n Roses too. Why not?