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If I had really good answers for these questions I would be
filthy, stinking rich a year from now. So much is uncertain that I'll just have
to make some educated guesses.
1) Value for S&P. I think that the SPX is highly valued now
and that earnings are going to decline at least 10% so 1,200 is probably in the
ballpark. If we have a recession, and I believe we will, declines often run
30-40% from peak value so that yields 1050-900. The sovereign wealth funds are
going to be a new factor so I think that may provide better support. On balance,
around 1,200.
2) The world economy is now built upon exponential leverage of
debt. Not just mortgages, but credit card, autos, home equity, CDO's, CLO's,
SIV's, ABS, you name it. Something which has not even surfaced is the leveraged
counter-party risk when counter-parties start defaulting ... the modern day
equivalent of the 1980's "portfolio insurance" which was thoroughly discredited
in the 1987 crash. I think that the global financial system will get it worked
out but it is going to require time, lots of time, to find where the crap and
the weak hands are and clean it up. I don't think there can or should be an
instant "fix".
3) Problem with the credit system is shrinking
liquidity. Credit holdings can not be valued due to the way credit has been
sliced and diced (horizontally and vertically) and then securitized. Not knowing
what is functional and what is not, everyone is hoarding cash. That is taking
liquidity out of the financial system much faster than the Fed can add it. A low
FF rate will do no good if no one wants to borrow.
I am about 65% cash now. I expect that the 1Q earnings reporting
season is going to see a lot of downward revisions and a lot of crap being
written off the books to clear the decks and get the problems behind. I hope
there will be some real fear and loathing in the market at that point. I expect
that write downs in some of the better financials may (eventually) be proven to
be excessive leading to future gains. 1Q won't be the end by any means but I
suspect it may be shopping time. If not 1Q, then 2Q.
Earl
At 07:37 PM 12/9/2007, you wrote:
The problem is not a few sub-prime borrowers being unable to
refi homes which they should not have purchased, the problem is that the
credit markets are dysfunctional. So what is the correct
level for the S&P in your opinion? Obviously, it isn't zero and
equally obviously it isn't where we are now so what is, (in your opinion), the
correct index level for the current conditions? Second
question: What do you believe needs to be done to cure the problem?
We are beginning to see the depth of the sub-prime problem so that is coming
into focus but what else needs to happen so the credit markets can become
functional again? Last question: What do you see as the
functionality problem with the credit markets? Is it business capital
availability or consumer credit or both? Consumers have been living on
credit cards for at least 2 decades so there is nothing new there but they have
less access to additional mortgages due to falling property values. One of
my credit card companies just raised the credit limit on my account to 34,000
and I have no balance and have never asked for an increase so it seems they
aren't limiting anything to credit worthy customers. Thanks for
your time and insight Earl, Bob
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