Where Are the Bodies Buried?

Whatever your views on yesterday’s Fed action might be, a disturbing question is emerging that few seem to be paying much attention to – How long does it take for the financial system to identify who owes what to whom?

CDOs of CDOs of CDOs of CDOs cannot stand unaccounted for indefinitely. Knowing where the bodies are buried is a vital component to putting an end to the uncertainty risk premium that has elevated the fear factor among many investors, which, in the process, has sucked the Fed into reverting to the Greenspan playbook of more liquidity. But will more liquidity alone do the trick?

The Bank Credit Analyst’s thesis, “The Debt Supercycle”, says liquidity will work its magic, provided inflation remains relatively tame. Massive amounts of money can be pumped into the system to help reflate assets and preemptively avoid a severe economic downturn. All well and good, but a reflating system that contains untold amounts of hidden toxic paper may end up producing unintended and unforeseen consequences. A true manifestation of the expression, “You don’t know what you don’t know”.

Therefore, as we approach the six-month anniversary of the great awakening, the moment when complacent investors woke up from their Goldilocks stupor and came to recognize that all was not kosher, the question of who owes what to whom still remains unresolved.

The longer it takes bankers to identify the toxic paper on and off the books, the more damage to the global economy they will incur as trust erodes both within and without the core of the financial system thereby exacerbating an already tenuous credit situation.

With bankers still unable (unwilling?) to identify where the bodies lie and horde their precious capital, the far less than transparent New Power Brokers (Petrodollars, Asian Central Banks and their Sovereign Wealth Funds, Hedge Funds, and Private Equity) have stepped into the breach to save the day. However, their rescue efforts come with a price – opacity. And opacity is precisely what is not needed at a time when so much remains unknown and trust hangs in the balance.

Investment Strategy Implications

Equities are undervalued and yesterday’s Fed action certainly helps improve everyone’s valuation model. Equities are undervalued in a scenario that overstates the downside risks to global growth and corporate profitability (see “Here Comes the Global Depression”). Equities are not undervalued, however, in a world of endless undisclosed toxic paper and new capital opacity.

It’s high time we all learned where the bodies are buried.

Liz Ann Sonders

Topics discussed in today's inaugural interview with Liz Ann Sonders, Chief Investment Strategist, Charles Schwab & Co. include economic sectors and investment styles, the fixed income market, and the credit crisis.

The length of the interview is 10 minutes 45 seconds.

Financial Contagion and the Negative Feedback Loop

Alternative media sources contain some of the best information for investors. Such is the case with the podcast service, “Bloomberg on the Economy” with Tom Keane. In a recent podcast, which is available via iTunes, Mr. Keane’s guest was economist Nouriel Roubini.

The program format allows for the deeper exploration of a topic, which in the very capable hands of Mr. Keane enables a listener to learn about a guest’s views that go beyond the sound bite.

In the interview, Mr. Roubini describes the chain reaction that is at the heart of much of fears of the financial contagion swirling about the investment markets. Coupled with the potential negative feedback loop to the real economy, the dangers of the credit crisis are better understood.

The case made by Mr. Roubini flows as follows.

Mr. Roubini describes the current financial system as a subprime financial system, lacking transparency and one in which a contagion could readily spread from the subprime mortgage market to other areas of the credit market.

The flow looks something like this:

From

• Subprime to
• Near Prime to
• Prime to
• Consumer Credit to
• Auto Loans to
• Credit Cards to
• Student Loans to
• Commercial Real Estate to
• Leveraged Loans to
• LBOs to
• Corporate Bonds

Note: The last item listed (corporate bonds) dovetails tightly with the credit default swaps (CDS) of corporate bonds and the concern expressed by PIMCO’s Bill Gross, as noted last week on this blog (“Here Comes the Global Depression”, Jan. 22, 2008). Additionally, Mr. Roubini notes that the CDS market is a $45 trillion financial Frankenstein, which did not exist a mere ten years ago.

Investment Strategy Implications

Current valuation levels support higher stock prices. This is true if one believes, as I do, that earnings for 2008 will not collapse by 20% plus. However, the situation is still very fluid and risks of contagion and the negative feedback loop exist and are very real.

The positive equity market assumptions made on this blog and in my reports are twofold:

• Earnings for 2008 will be better than the bear case expects thanks to the global growth story and stimulative actions (fiscal and monetary) taken by government bodies
• Financial contagion outlined by Mr. Roubini will not unfold to greatly significant degrees thereby mitigating the negative feedback loop between the real and financial economies

The risks to these points rests in their interrelated nature, one that is mutual reinforcing. Moreover, it must be noted that even if my two points do hold, the danger point has not completely passed for equities as the special aspects of 2008 (electoral campaigns in the US and the China Olympics) give way to 2009, a year without such positive factors at work.

At that point, a second wave of earnings declines could stretch a 10% decline in earnings for this year (a much more realistic expectation) into another 10% decline, or more, in 2009. This, however, is not the consensus view and, therefore, should be noted but not stressed at this time.

Bottom line: good valuation levels, a more resilient global economy, an oversold stock market, and high degrees of investor pessimism should be strong enough underpinnings for an equity market that is almost priced for a financial contagion disaster.

The Negative Feedback Loop

excerpts from this week’s report:

“In a week packed with reports, speeches, and events about the only thing that is nearly 100% to occur is the beginning of the end of Rudy Giuliani’s quest to become President of the United States. As America’s Mayor competes with Fred Thompson for the most boneheaded political strategy award, investors will focus on the plethora of data to be issued over the next five days.

For example, this week includes:

• Earnings reports (120 of the S&P 500)
• Economic reports (Dec. Durable Goods, 4Q advance GDP, Dec. Personal income and spending, Consumer sentiment, Jan. ISM Mfg., and Jan. Employment data)
• Speeches (Bush State of the Union)
• Events (FOMC rate decision, US Senate on stimulus package, IMF economic forecast, Florida primary)

The crosscurrents that will result from the above…”

Investment Strategy Implications

“With valuation levels forecasting a deep recession (see Expected Return Valuation Model on page 4 of report)*, any development that changes this newly entrenched thinking stands a reasonable chance of breaking the negative feedback loop. The great risk, of course, is should the vicious downward spiral…”

also in this week's report:

* Expected Return Valuation Model
* Moving Averages Scorecard
* Model Growth Portfolio
* Sectors and Styles Market Monitor
* Key US Economic Indicators

*To gain access to this week's report (and all reports), click on the subscription information link to your left.

Picture This: Société Générale's Head of Risk Management

When you lose €5 billion, there can be only one answer as to who's in charge of risk management.




Have a good weekend.

Technical Thursdays: When to Sell the Dead Cat Bounce

On the assumption that yesterday’s rally did not produce a selling climax and that more work needs to be done to complete the bull market correction we are in, the next investment strategy decision point will be when to sell/rebalance your existing portfolio. For this, a very useful tool is the same one used for the Lunch Money trades that occur from time to time – momentum and MACD.

The chart to your left* shows the current state of momentum and MACD (second and third lines below the price chart) for the S&P 500. Two points to consider:



1 - MACD is so depressed and, therefore, provides evidence that the market decline is not over as it is nowhere near a crossover point (blue above maroon line), which would signal a key reversal of the near term downward trend**. As a result, the current rally is most likely little more than an oversold market rally resulting in your standard dead cat bounce.

2 - If so, momentum becomes the primary guide to timing the portfolio adjustments one might wish to make. The rule of thumb is when momentum approximates the zero level the portfolio selling/adjustments should begin.

Investment Strategy Implications

For short-term timing purposes, momentum and MACD applied correctly are very useful indicators. The current condition of the equity market suggests that the dead cat bounce will exhaust itself when the oversold condition of the market reaches equilibrium, which is zero in momentum.

Note: There are other alternative outcomes, such as a resumption of the market decline before momentum reaches zero, which will be discussed in future blog postings should they occur.

*click image to enlarge. chart source BIgCharts.com
**Key reversals require both momentum and MACD to non confirm a new high or low in an index. For examples, please see prior Technical Thursday postings.

Priced For Recession - and Then Some

In this week's report, my proprietary Expected Return Valuation Model (ERVM) produced a result that a good friend of mine noticed matched quite tightly with the historical data of earnings declines in recessions.

The EVRM has the market trading at fair value on the assumption that, in a worse case scenario, earnings decline 22% this year. History shows that the last two recessions (2001 and 1990) produced earnings declines of 31% and 24%, respectively. Clearly, this is the thinking that pervades most investors. At least, as of today.





What this suggests is twofold:

• The market has already reached a zone of a realistic worse case scenario valuation with an overshoot to the downside likely.
• Any changes to this view will have an immediate impact on present value levels.

Two positive factors to consider:

• Should decoupling show itself to be more resilient than the bears think, upside adjustments to the current worse case scenario thinking will take hold rather quickly.
• If the fear of more credit derivative shoes to drop diminishes, upside adjustments will also take hold rather quickly.

Investment Strategy Implications

I would argue that both positive factors will occur in some form before this quarter is over as the global growth story is more well entrenched than the bears give it credit and that the worst of the credit derivative write-offs are behind us. Moreover, an election year has a way of producing a sense of urgency that should inspire elected officials to act more swiftly.

Many have equated the current economic climate to that of 1990. If so, the short but violent 20% decline in equities that took place then has already been achieved now. All that's left is a capitulation of the bulls.

* click on image to enlarge and sing along!

Here Comes the Global Depression

excerpts from this week's report:

"Forget recession, try depression. At least that’s what the momentum driven panic in the equity markets is signaling.



Valuation levels are now so low that fair value readings are aligned with an earnings plunge in S&P 500 operating earnings for 2008 of nearly 22%!* To achieve such a collapse the world economy and not just the U.S. must slump into a massive recession this year. And for this to occur, policy actions taken by central banks and governments..."

"Adding fuel to this fire are the words of key market influencers like Bill Gross of PIMCO. His missive this month speaks of yet another credit derivative shoe dropping in the form of credit default swaps. According to the Bank for International Settlements (BIS), there are approximately $45 trillion of credit default swaps. Mr. Gross points out that..."

"As if this weren’t enough, an increasing number of market technicians have now signaled that the bear has arrived. Be it the crossover of the 50 day moving average..."

Investment Strategy Implications

"Investor fear is so thick you can cut it with a knife. Yes, the market should be lower due to the credit crisis (it’s reached that status) and an economic slowdown/recession in the U.S. However, to take prices down to 20% plus undervalued levels is more than..."

*see table on page 3 of this week's report

also in this week's report:

* Expected Return Valuation Model
* Moving Averages Scorecard
* Model Growth Portfolio
* Sectors and Styles Market Monitor
* Key US Economic Indicators

To gain access to this week's report (and all reports), click on the subscription info link to your left.

Quotable Quotes: Adversity

"Adversity begets opportunity."
Catalano proverb

Therefore, a few words on adversity.


“Things that were hard to bear are sweet to remember”
Seneca’’

“When everything seems to be going against you, remember that the airplane takes off against the wind, not with it.”
Henry Ford

“There is no education like adversity”
Benjamin Disreali

“Sweet are the uses of adversity.”
William Shakespeare

“I know God will not give me anything I can't handle. I just wish that He didn't trust me so much.”
Mother Teresa

“If I had a formula for bypassing trouble, I would not pass it round. Trouble creates a capacity to handle it. I don't embrace trouble; that's as bad as treating it as an enemy. But I do say meet it as a friend, for you'll see a lot of it and had better be on speaking terms with it.”
Oliver Wendell Holmes

“I ask not for a lighter burden, but for broader shoulders.”
Jewish Proverb

Hiding in the Healthcare and Consumer Staples Bushes

Last night's Market Forecast dinner here in Boca Raton produced the first full blown bear. So, when panelist Jeff deGraaf (formerly with Lehman Bros. now with Ed Hyman's firm, ISI Group) described his market view as being totally bearish, it was a breadth of fresh independent thinking.

Combining both fundamental and technical analysis (he holds both a CFA and CMT designation), Jeff's overall market conclusions differ from mine but that's okay, even good. I have a great deal of respect for Jeff and look forward to exploring his view this evening at my next Market Forecast dinner in Naples.

While Jeff and I may disagree on the macro picture, we are in complete alignment on two economic sectors - Healthcare and Consumer Staples. As the above chart shows, these traditionally defensively viewed sectors have far outperformed the broad market since the summer of 07.

Investment Strategy Implications

Be you bull or bear, Healthcare and Consumer Staples (including Global Consumer Staples - KXI) appear to be sectors well suited for the investment times. For bears like Jeff, they are solid defensive plays. For correction bulls like me they are appropriate for the corrective times I believe we are in.

Practical Tactical

Regardless of your view re the current market decline - bear or correction, there is a very reliable investment rule of thumb that should not be ignored: Don't sell into an oversold market.

The accompanying chart* of the S&P 500 provides evidence - in the form of momentum and MACD - that the current decline is well into oversold territory. Moreover, it is highly likely that more than a few market traders and commentators will note that the current decline has brought the market down to support levels (previous decline lows).

Investment Strategy Implications

The market appears ripe for a bounce. What also makes a bounce likely is the fact that the epicenter of the decline, the Financials, have begun to exhibit relative strength, despite having everything including the kitchen sink being thrown at the sector.

Perhaps Warren Buffet's words from last Friday should be revisited, particularly the one about profiting from the market's follies.

(Then again Mr. Buffet's advice re market forecasters may apply!)

*click on image to enlarge

Decoupling is Real

In the few moments we have before investors become consumed with news re Citigroup, inflation reports, etc., here’s a little data point that you might find interesting.

In a report published yesterday by Credit Suisse, evidence of decoupling can be seen in two charts.

The above first chart* shows quite clearly that the US economy means far less to China than it had in the past. As for the second chart*, Chinese domestic growth is not just strong but is actually accelerating.

Investment Strategy Implications

As the charts above show, there is ample evidence that decoupling is real. Therefore, while the US economy may suffer a recession, the global growth story appears to be intact. Maybe the end of the world is not just around the credit derivatives corner.

* click image to enlarge

Judgment Day

excerpts from this week's report:
"A worse case scenario is unfolding in the equity markets as valuation levels have entered extreme undervalued territory. According to the Expected Returns Valuation Model, rates have now gone so low that many 12% return zones are literally off the charts (see report). Moreover, one can find the 12% zones in the highly depressed levels of S&P 500 operating earnings (i.e. dropping below $82!). Since virtually no one is calling for such a decline in S&P 500 operating earnings over the next twelve months, there are two conclusions an investor can reach. Either:

• The US economy (and therefore the world economy as well as corporate earnings) will turn out to be far worse than expected or
• Stocks are currently severely undervalued

In the mix is also the issue of the credit squeeze and its real economy effects.

Presently, there are many that view the black hole of credit derivatives as being..."

"...The technicals for the market are, in a word, lousy. Mega trends readings (based on the Moving Averages Principle) have undergone a serious deterioration over the past several weeks to the point where every major style index tracked is flashing..."

"...With the disciplines outlined, there is one last piece to this investment strategy puzzle that bears noting.

The consensus thinking of many investment strategists is nearly unanimous and shows signs of groupthink. For example, the current issue of Barrons mirrors what panelists on the first of my Market Forecast events for this year stated..."

Investment Strategy Implications

"Having been in the investment game for over three decades, it is just such times as now when..."

also in this week's report:

* Expected Return Valuation Model
* Moving Averages Scorecard
* Model Growth Portfolio
* Sectors and Styles Market Monitor
* Key US Economic Indicators

To gain access to this week's report (and all reports), click on the subscription info link to your left.

Quotable Quotes: Warren Buffet

In our highly uncertain times, a little sage advice is always welcome.





“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”

“You only find out who is swimming naked when the tide goes out."

“Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful."

“We've long felt that the only value of stock forecasters is to make fortune tellers look good.”

“If past history was all there was to the game, the richest people would be librarians.”

Warren Buffet

Have a good weekend.

Technical Thursdays: What a Decline to 1360 Means – Revisited

Bernanke pledges to cut rates. And from a technical analysis perspective not a moment to soon.

The recent market corrections – four since the summer of 07 – are taking their toll on the technical conditions of the market, most notably in the area of the highly reliable mega trend tracking tool - Moving Averages Principle.





As the above chart* shows, the current price of the S&P 500 is below both its 50 and 200 day moving average. This is not unusual as the crossover of price below both moving averages has occurred several times during this bull market. Rather, the key risk factor, one that has not occurred once since the bull market began nearly 5 years ago, has to do with the 50 day in relation to the 200 day AND the slope of each.

Should the stock market fail to stage some sort of a meaningful rally, along the lines of reversal of the decline experienced thus far, the 50 day will cross decisively below the 200 day and, importantly the slope of both averages will point downward.

This risk was noted several blog entries ago (“What a Decline to 1360 Means”) and one that would necessitate a reduction in equity market exposure despite its obvious whipsaw potential (also noted previously). What makes this potentially negative event particularly scary is the fact that the S&P 500 is not alone.

According to the Moving Averages Scorecard that covers 20 different segments of the global equity market and US economic sectors (weekly report, subscription required), an increasing number of sectors and segments are now borderline negative, much like the S&P 500 is.

Investment Strategy Implications

The technicals are the big fly in the bullish ointment, assuming one buys my decoupling/valuation scenario. Time will tell if the Fed will ride in and rescue this technical damsel in distress.

* click image to enlarge

2008 Themes: A Less Correlated World Part II – Sector Divergences

In 2008, decoupling will likely apply not only to the global economy picture (as noted in yesterday’s blog posting) but also to the recent high correlations between and among asset classes. Until recently, some of the most notable examples of high correlations have been in the economic sectors (see blog postings for previous correlations, particularly the July 11, 2007 posting).

This year, however, there’s a very good chance that correlations will diminish.




As the above chart from investment strategist extraordinaire, Tom McManus, shows the variance between sectors has begun to rise.

Investment Strategy Implications

Since starting this blog back in March of last year, I have noted correlations 10 times. Each time, the references have been toward the trend that was in place – higher correlations. With the advent of the credit crisis last summer, the trend toward lower correlations has become apparent. Gold, for example, was once highly correlated to the equity markets, even though logic dictates it shouldn’t be. Clearly, something has changed and that change is producing a divergence that has already manifested itself in not only Gold but also in weak trending economic sectors such as Financials and Consumer Discretionary.

Hedge funds and 130/30 managers will likely contribute to the trend toward lower correlations. Alpha seeking among a more seasoned and aggressive growth of credit fiasco survivors coupled with momentum investing should be key factors in bringing about a greater divergence between and among asset classes and sectors.

As a result, momentum investing, a key component of many investment professionals preferences, will likely, in 2008, become more concentrated as hedge fund managers as well as more aggressive 130/30 mutual fund managers seek to segment the sectors and styles, the regions and countries that the global growth story provides.

So, here’s a little investment rhyme that should play out this year:

The strong get stronger,
The weak will fade.
All gets overdone,
There’s money to be made.

2008 Themes: A Less Correlated World Part I – Decoupling

The political scene today is littered with the word Change, as Barack Obama captures the high ground on this issue. So, too, have the markets embraced the C word. Unfortunately, it is in the form of an economic change for the worse.

Yet, there may be another way to view the changing economic and investment environment, one that investors can more profitably exploit if my following thesis turns out to be correct. The change I am speaking of is a change in the degree to which economies and markets are correlated.

Over the past decade, markets, sectors, and even styles have become more highly correlated. I have noted this issue in previous blog postings. However, high correlations are not just the domain of the investment markets. As economies have become more interconnected they have, as a result, become more highly correlated.

All this may change this year.

Correlations may diminish this year driven by two forces – one economic, the other financial. In the case of our globally interconnected world, a change from high correlation may occur in the form of decoupling: most notably a lessened economic effect emanating from the US.

Granted, decoupling may not result in a significantly lower correlation as economies are influenced by each other to a large degree. However, decoupling may prove to be more prevalent than many think as policy actions undertaken by various other global actors, such as China, will likely produce stronger domestic demand thereby delivering the sorely needed non-US consumer demand to sustain global growth.

If so, then a US recession (or, more likely, a growth recession – growth below potential) will not have the same effect on global growth as it has had in the past. In my opinion, decoupling is not just possible but probable for two primary reasons.

To begin, the financial health of most economies is quite strong. For example, the current account balances of nearly every emerging market economy is positive. In the past, such economies have been a source of economic global turmoil. That is not the case today. Moreover, Eurozone economies are, for the most part, also in good economic shape.

As a result, containment of the pain in the US will likely be limited to domestically oriented businesses while the more globally oriented will reap the fruits of globalization and the global growth story. In this regard, what may be lost to some is the fact that businesses that serve a true global audience via the Internet may also experience positive economic results which will help minimize the damage of a credit derivative inspired economic contraction.

A second factor that will likely play out this year is the Olympic games to be held in China this summer. It is hard to imagine that the leaders and policy makers will not pull out all the financial stops to ensure a rosy picture.

As for the US, the damage emanating out of the credit derivative fiasco will almost certainly run its course over the first half of this year. Yet, given the political realities of a major election year, it is hard to see our government exercising an electoral death wish and not act to assist the US economy work its way out of what amounts to a financial, not economic, crisis. To the naysayers I say, the policy tool kit contains many more instruments than you are giving it credit for.

Investment Strategy Implications

There is a considerable amount of skepticism regarding decoupling. And that skepticism is deserved. After all, the world has function a certain manner for just over a century. Yet, as is the case with the US political scene, meaningful change may be occurring below the radar of many investors. Globalization, the Internet, and financial innovation are just a few examples of a changing world.

Many are uncomfortable with change. For change means a disruption of the status quo. Ways of life are constructed around the status quo, as processes and systems enable the early adopters to gain competitive advantage and the spoils thereof.

Yet, change, for good or ill, is the one constant in life. Recognizing it can produce alpha.

Note: Tomorrow, in Part II, I will explore the issue of lower correlations between and among markets and sectors.

Off The Deep End

excerpts from this week's report:

"Many investors and nearly all in the media have become Roubinized: seeing the glass half empty, filled with dirt and mud, and leaking out the bottom.


The herd on the street mentality starting 2008 contain the same characteristics as it did at the start of 2007 – only in reverse. One year ago all the talk was about a never-ending Goldilocks scenario. Kudlow was in his glory and largely ignored were..."

"To be clear, there is a huge difference between those who expressed concern over the lack of transparency in the credit derivative mess and the off-the-deep-end club..."

"In 2007, I was early in my concerns re the credit fiasco. Maybe I am early again in my skepticism re the consensus thinking for 2008. For example, at last Thursday’s NYSSA Market Forecast luncheon, all three equity strategists expressed the view that..."

Investment Strategy Implications

"The fear factor today is beyond palpable as early 2008 appears to be the flip side of early 2007 - too much complacency, only this time to the downside.

Perhaps I will once again be early. Perhaps 2008 will follow the consensus course for a while. However, in a market that is quite undervalued (see Expected Return Valuation Model in report) and one that has not triggered the full complement of negative technical signals that a bear market produces (see Moving Averages Scorecard in report), the off-the-deep-end club is likely to be just as wrong this year as the Goldilocks club was last.

Advisable course of action: Take a breath, take a pill (if need be), drink some chamomile tea, meditate, enjoy a sunset, smell the roses, diversify away from weak US sectors (tied to the US consumer), wait for a major buying point in Financials (yep, you read it correctly), and always be on the lookout for Lunch Money trades,.."

also in this week's report:

* Expected Return Valuation Model
* Moving Averages Scorecard
* Model Growth Portfolio
* Sectors and Styles Market Monitor
* Key US Economic Indicators

To gain access to this week's report (and all reports), click on the subscription info link to your left.

Quotable Quotes: Wisdom

With each passing data point, it is increasingly clear that the Bernanke Fed is faced with hard choices re the US economy – rising global inflationary pressures AND a potential domestic recession. Did somebody say stagflation?

Perhaps a few words on wisdom would help.


“Wise men speak because they have something to say; Fools because they have to say something.”
Plato

“The well bred contradict other people. The wise contradict themselves.”
Oscar Wilde

“The invariable mark of wisdom is to see the miraculous in the common.”
Ralph Waldo Emerson

“Too bad that all the people who really know how to run the country are busy driving taxi cabs and cutting hair.”
George Burns

Have a good weekend.

What's On Your Mind?

Today's Market Forecast kickoff events in New York and Stamford, CT afford me an opportunity to ask questions of my expert panelists. I wish to extend that ability to you.

Therefore, please e mail any questions you may have for the following panelists and I will get as many in as possible.

The panelists are Mary Ann Bartels (Merrill Lynch), Tom McManus (Bank America Securities), Phil Orlando (Federated Investors), Glenn Reynolds (CreditSights), David Wyss (S&P) , Dan Clifton (Strategas), Sarah Mulholland (CQIG), Beth Ann Bovino (S&P), and Chrisitian Stracke (CreditSights).

My e mail address is vinny@bluemarbleresearch.com.

My blackberry will be on for the entire program.

Note: A link to my opening Powerpoint comments is provided to subscribers. Subscription required.

Bye, Bye Sanguilla. Hello, Elmer FUD.

The flip side of investor psychology entering 2007 is now in play entering 2008. What was once confidence and complacency is now doubt and nervousness. As wrong as the sanguine crowd was entering 2007, ignoring the warning signs eminating from the black hole of credit derivatives, so, too, will time show that the angst so abundant in today’s equity market be as misplaced.

To illustrate, let’s look at one of the issues that is generating so much FUD (fear, uncertainty, and doubt) – mortgage resets.


The above chart comes from today’s FT Alphavile (a must read service). The data shows a seemingly mountain of resets headed the US consumer’s way. What should be noted is the fact that this is an election year, not just for a new US President but for the entire House of Representatives and many in the Senate. Therefore, unless our elected officials have an electoral death wish, it does seem reasonable to assume that money will be made available to help alleviate the real economy dangers eminating from this manifestation of the credit derivative black hole. Moreover, after the first wave of resets is dealt with in 2008, a reduction takes place making the management of the problem more, well, manageable - at least for the subsequent 12 months.

Investment Strategy Implications

The start of 2007 was happy time for many investment strategists. I was not one of them. And for a time (until mid year), I was on the wrong side of the trade. But all that changed as reality bit in mid summer (see relative performance chart of the Model Growth Portfolio from mid 2007 to year end).

The start of 2008 is a fear-laden period with real economy worries distorting the reality of abundant investment capital, the global growth story, and increasingly attractive valuation levels. It appears to be a matter of time when reality bites again, this time to the upside.

click on image to enlarge