It ain't over til it's over

So, did you enjoy yesterday's calm, rational, and frankly boring markets? Spoos only managed an 8% daily range.....this stuff is child's play!

So the zillion dollar question is whether we are now on the long road to recovery. While it's true that short term sentiment always swings to extremes, it's also the case that we have the small matter of a global recession to navigate, with the concomitant hit to growth and earnings.

To get a perspective on recent history, Macro Man has recently been re-reading Barton Biggs' Hedgehogging. While the anecdotes and thoughts on portfolio construction are consistent with what you'll get from most books of this type, Macro Man is reading the book because it contains a snapshot of Biggs' and others' views on equities in late 2004 and 2005.

What is remarkable is the number of managers who are quoted as looking for an eventual relapse in US equities back towards 2002 lows. Obviously, such an out-turn is coming to pass before our very eyes.

Biggs also included a chart on previous financial market bubbles and how the price action played out in the year before and after the peak. Macro Man has updated the chart, using monthly data, and added a new bubble (oil) to the mix. The message, based on previous bubbles, is not to expect a massive rally over the next year.
On a more real-time basis, the fallout from the current crisis brings fresh pain to light seemingly every day. In Ireland, the government has hiked taxes across the board and even taken a pay cut (thereby downgrading an Irish ministerial post from a boondoggle to a sinecure.) Charlie Haughey must be rolling over in his grave!

We're also seeing the falloout from the crisis broaden in terms of markets. Most countries/markets/strategies that have depended on credit to fund growth in recent years have been decimated. An obvious exception has been Eastern Europe, which has weakened in recent weeks, but only back towards end-of-2007 levels.

Of the CEE-4, Hungary is clearly the most vulnerable. Its housing market has famously been financed via Swiss franc mortgages; the door to that particular liquidity tap is in the process of being slammed shut. Rumours have started to swirl that Hungary will approach that venerable dinosaur, the IMF, for assistance, as it lacks the domestic fiscal ability to fund a bail-out.
That today's cheap dollar funding in Europe (the 1 week "unlimited dollar" tender was offered at 2.277%) hasn't prevented European equities is another ominous sign that the correction may be over almost as soon as it's started.

That's the thing about a bear market: it ain't over til it's over.
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Lemmiwinks
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October 15, 2008 at 10:36 AM ×

Its true, that the Hungarian housing market has been financed in previous years dominantly from EUR and CHF denominated loans, however the real estate market was rather subdued, prices have been stagnant for years, there is no bubble here compared to Slovakia, Rumania or the Baltics especially, in which countries the role of foreign financing was similar. Loan policies are very conservative and "backward", LTV ratios are typically around 70%, no securtization.
Therefore the Hungarian banking sector is very stable, banks are very liquid so dont expect anything close to Icelands bank failures.
The vulnerability of Hungary comes from the huge public and external debt and the oversized welfare state which is overtaxing the economy. Also the only driver of economic growth is the export sector mostly consisting of outsourced service and manufacturing centers of multinational companies.
So expect a long and painful recession but no default. HUngary has not defaulted since WWII and wont do it now, when the external indebtedness is somewhat better than in 95, 89 or 82, where the economy was much weaker and less integrated.

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normal being
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October 15, 2008 at 11:07 AM ×

lemmiwinks: "the Baltics especially"

I hear a lot about the Baltics recently.
Is this only smoke or is there a nice little fire?

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Anonymous
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October 15, 2008 at 11:07 AM ×

Interesting read and on a slightly off topic but related to your piece I would add this

Last year Irish ministerial salaries were increased between 25k and 38k, despite the 10% PR paycut, they have actually a net rise in salary - Irish public servants believe in maintaining their purchasing power.

Irish Taoiseach(PM) makes EUR 310k per annum no doubt to the envy of both George & Gordan who are on less.

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Lemmiwinks
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October 15, 2008 at 11:13 AM ×

I dont know much about the Baltics, but they had growth rates around 10%, huge CA deficit (double digits of GDP) fully financed by Skandinavian banks, a huge credit bubble, I have heard anectdotes about "SMS loans" (yes you could apply in a mobile phone message).

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Sean Maher
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October 15, 2008 at 11:47 AM ×

Charlie Haughey never lived on his official salary, those bespoke Charvet shirts were paid for by property developers grateful by judicious land rezoning, and AIB never called in his expansive overdraft. Plus ca change...agree re test of 2002 lows, but maybe not until the New Year; my long bets last week have paid off nicely. As Barton Biggs says, condensed lunacy...

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bengt
admin
October 15, 2008 at 12:05 PM ×

Anyone interested in the Baltic story can turn here; http://easterneuropeeconomy.blogspot.com/ for more info.

The Baltic/Scandibanks combo could be headline news soon, IMF are looking to extend aid to the Baltics while Swedish banks report next week.

Swedbank CEO more or less marked Swed shares a buy in an interview yesterday, downplaying the whole Baltic credit thingey. And isn't that always a good sign? :)

This sucker could go down...

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panicof2008
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October 15, 2008 at 12:13 PM ×

House market in Poland has been primarily financed with CHF mortgages as well. At least 60% of all mortgages here are 30+ years, CHF, ARM. I am truly amazed as my co-citizens engage deeper and deeper in what seems to be a financially huge (properties are way overvalued and the bubble is about to burst), nationwide forex/credit speculation. Plain scary. And we are no California, when a lender forecloses he can (and will) take the debtor's last shirt.

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dblwyo
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October 15, 2008 at 1:05 PM ×

Jim Jubak (a popular US fin columnist on MSN) outlines a reasonable scenario in my mind of a bear market rally followed by the setting in of reality leading to a major downturn thru late '09 and into '10 followed by a long and drugged out "recovery". Jives with my own take on the economy. IMHO the US is facing a much more severe recession than anybody's planning for - similar to say '75 at least - that will be in the doldrums much longer. Nobody in business is or has prepared and is just starting their emergency prep work (as a management consultant I've been talking myself blue to warn about the tsunami and been ignored). And S&P earnings are for $103, or 37% growth in '09. More likely and perhaps still optimistic is $65. If low growth PEs in the 8-12 range are appropriate you do the math. And bear in mind analysts get their estimates bottom-up from management. Still enormous self-deception out there.

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Anonymous
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October 15, 2008 at 1:38 PM ×

MM, you omitted 2 rolling bubbles from your list in A-shares and my personal favourite, exchanges, as exemplified by MV1X Index.

Currently like L Z8 9500/25/37 broken fly basis trade, another idea in short sterling that will have to wait til I've finished full size,USDCAD topside and going to have an investigation of how prohibitively expensive Brazil swaptions will be.

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Anonymous
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October 15, 2008 at 1:41 PM ×

MM-

Perhaps this is comment would better follow another post but I'll make it here since you brought up oil as the latest in a long line of bubble assets. Everything I've read says to expect deflation and price declines in commodities. However, If everyone around the world is printing money as fast as they can won't that ultimately be supportive? The latest actions are going to have an impact on the numerator in the USD/Barrel equation. Do you think that will be large enough to offset failing demand.

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Macro Man
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October 15, 2008 at 1:43 PM ×

Anon @ 1.38, Good point on A shares (though of course that is a primarily domestic phenomenon.

I am actually the other way on the basis...will I do think it will narrow next year, my core view is that cash hoarding near year end will lead to a widening, regardless of the size of the bazooka that's deployed. You can't legislate for human behaviour!

On Brazilian swaptions, I have a few in the book...I think they are cheap (at least the ones I have got.) The biggest problem with them is that you have a long BRL position via the translation into dollar settlement.

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Anonymous
admin
October 15, 2008 at 2:28 PM ×

MM, valid point on basis although I believe authorities are in throw something til it sticks mode. I had been perusing the EDZ8 97.125/96.5 PS, will give further consideration.

Good luck and thanks for the excellent blog.

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vandalsstolemyhandle
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October 15, 2008 at 2:59 PM ×

Re the basis, don't underestimate the power of moral suasion:

Ring Ring

"Money Market"
"This is the US Treasury. Where do you guys see 3m LIBOR tomorrow."
"We're seeing it around 4.55%"
"Well, we see it more like 4.25%"
etc.

cheapest intervention they could ever make, and with everyone fixated on LIBOR now, certainly seems like VFM.

And before anyone gets up in arms, term LIBOR is all a fiction anyway at mom; who's to say that the Feds can't nationalise the fiction-writing business?

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Macro Man
admin
October 15, 2008 at 3:02 PM ×

vandal, it would be a neat trick to nationalize the British Bankers' Association.

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vandalsstolemyhandle
admin
October 15, 2008 at 3:04 PM ×

MM, they're not twisting the BBA's arm, they're twisting the contributors'.

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Macro Man
admin
October 15, 2008 at 3:08 PM ×

I see what you're saying, but US banks are in a minority of the contributors. Maybe the UST can tell Norinchukin Bank where it's London dollar rate is...but presumably they then can't complain when the japanese intervene and buy 300 billion USD/JPY....

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vandalsstolemyhandle
admin
October 15, 2008 at 3:20 PM ×

It would probably take some global co-ordinated moral suasion.

After all that we've seen in recent times, why not. Hundreds of billions here, hundreds of billions there; what's a couple of phone calls going to cost. If I was in the Treasury, this is exactly what I'd be doing. And there are not too many banks out there that can raise a middle finger to the authorities at the moment.

Will it happen? Probably not. But it gives me (yet) another reason to steer clear of the short-dated bases.

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Macro Man
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October 15, 2008 at 3:30 PM ×

I hear ya. The stuff I have on are legacy trades from before the time that everything went nuclear. Zero delta, way out of the money stuff that is worth a couple of ticks just in case short stg converges with LIBOR rather than vice versa.

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Anonymous
admin
October 15, 2008 at 4:18 PM ×

Worries about Hungarian economy grow

http://www.ft.com/cms/s/0/271a803c-9a9c-11dd-bfd8-000077b07658.html

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Anonymous
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October 15, 2008 at 7:58 PM ×

Slightly off this blog but can anyone explain the charts in the FT page 17 today...

Does the chart titled "US financial sector losses" depict regular loans on the left and those securitised on the right? Or are they both securitised instruments?

Ultimately what I'd like to understand is how sub-prime mortgage loan losses are relatively small verses CDO's..Is it just a volume thing or does it reflect a better pricing of risk?

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Anonymous
admin
October 15, 2008 at 8:06 PM ×

Here is a link :-

http://www.ft.com/cms/s/0/0fd36eac-99fc-11dd-960e-000077b07658.html

Or does the chart show actual losses on loans whilst mark to market values/losses on CDS's etc..

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