A Trader’s Eye View: Market comment by Joe Cambria

By skepticlawyer

SL asked me to do guest post as to what’s going on in the markets and what I think will happen next (yikes)

Personally I’ve found this has been the most interesting period I have ever experienced in the financial markets. Volatility, policy adjustments and expectations have changed so much over a period of a few months … it’s absolutely breathtaking to watch. Coming from one of the steepest declines in modern stock market history we’ve also seen one of the fastest and steepest rises in stock market history.

Countless people have opined about the causes of the crash and what were the principal drivers (such as the fall of Lehman Bros) while others are even suggesting the US government’s announcement of the TARP made things worse by raising fears/uncertainty and causing the tailspin.

Ha, I have my own newly minted theory. 

All these events people are pinpointing are really missing the big picture I believe. The Fed (generic for Western central Banks) caused the crash as far as I’m concerned. It lost control of events and ended up in reactive mode….. not a good place to be in when trying to quell a crisis.

What makes me think it was the Fed?

From the very beginning of 2008 the Fed seemed reluctant to believe that anything serious was happening (other than a traditional slowdown) and didn’t appear greatly troubled by  a recession and banking system issues. Rate cuts weren’t forthcoming quickly enough and appeared penny pinching and meager. Shockingly, back in July last year both the ECB and the Fed suggested they were concerned about inflationary consequences down the track. Seeing the inflation rate breaching the top of the target range the stupid ECB actually raised interest rates by 25 basis points. It also began openly telling the markets that its new objective was the removal of direct loan assistance to the banking system by early 2009. Never wanting to be left out in the warmth, when there’s a chance of participating or initiating a huge policy error, the Japanese monetary authorities also began to talk the tough inflation talk (as if there was one).

The Fed in particular should have read the tea leaves quickly and moved interest rates down to zero as early as the 1st quarter. Instead they moved too late and finally ‘got it’ in Nov/Dec introducing all sorts of new measures that would not have been needed if they had understood the problems earlier.

In my opinion the Central Banks basically blew it. They  blew it by getting us into the crash through very low interest policy at the beginning of the decade causing asset price inflation and  then blew it by not understanding just how deep in the dung heap we were in once the correction set in. 

Stabilization took time and it was only after the bank stress tests results were announced in the US that the market began to regain some balance. This was also when the markets began to think things weren’t going to be as bad as originally thought.

It seems to me that from then on the Fed finally took back control.

What we’re seeing now, I believe, is a giant correction to the Armageddon trade. I also think there is the possibility that we will see asset prices much higher than people expect. There are still plenty of asset managers around the world that are nowhere near fully invested.

The central banks are basically panic stricken and frightened stiff (shell shocked) by acting too quickly in removing liquidity from the system. Global liquidity, or rather the oceans of liquidity, we’re currently seeing sloshing around the system is unprecedented by every measure. From banking assistance, such as easy money from the CBs at zero interest rates, collateral demands from CBs of the banks that could be seen as virtually non-existent (exaggerating, but not much), direct loans to specific firms and industry sectors, fiscal spending programs… you name it and it’s there. There has never been a period in world history like this one with so much liquidity floating about.

As a trader I like simple themes and this one happens to be a very simple theme.

Just as central banks erred in being too slow when markets were heading south, they’re also going to be too slow in taking the punch bowl away. So with my money I have placed bets on various sectors that have been doing well and I think will continue to do well in what I call this trading sweet spot.

I am continuing to place bets on technology plays, aviation (yes really), the US G4 cell network, broad GDP plays such as shipping that were beaten down heavily and pigs-can-fly trades. Pigs-can-fly trades are stocks such as the US banking sector that were massively beaten down in the crash. In fact any sector that was massively beaten down could be a great play (with care).

I also like the Asian (not Japan, in fact anything but Japan) story and see this market eventually much, much higher than its 2007 highs. Asian countries’ currencies are basically linked to the US Dollar through pegs and fixed exchange rates. Normally some adjustments are taken in currency movements however in their case they have to be taken through asset price adjustments as they continue to avoid currency appreciation.

Here’s my very big bet in the pigs-can/will-fly category.

Seeing the Fed is massively interested in reflating asset prices we will one day soon see the US banks actually mark the toxic shit that they have on their books upwards. You think I’m crazy, right? I’m not. If that does happen we will see a buying frenzy that it could be massive even from the recent huge upward correction we’ve seen in the US bank sector.

I also love biotech, however this sector is really not for the faint of heart. You need to selectively choose 20 to 30 stocks that have a story behind them and hold, as 80% will fail, 10% will do moderately well and 10% will take off like a rocket at light speed. In this sector I particularly like what I call the “fat people” sub-sector, which are firms trying to come up with genetic testing in potentially high growth areas. For example how well would a genetic test would sell if they can tell fat people what foods they should avoid so as not to develop heart problems in (early) later years. Such a test could be worth billions and the products will be offered away from the regular government controlled health insurance plans so people will buy them with their own money.

This is truly the Rambrandt of markets for people that like to go long stocks; it’s a masterpiece of a melt up. We’re seeing huge amounts of M & A activity all around the world. Toxic crap is finding bids and moving up higher, stock issuance is on a grand scale and firms are replenishing bruised balance sheets. The markets have in fact absorbed billions on billions of low-grade paper with the effect that everyone has received a bailout. It’s bailout heaven.

How long will it last? Who knows but it’s great fun as the CBs again have made even the average trader appear to be a genius.

One thing I know though: it won’t last and although I know I won’t be the first person off the Titanic, I also won’t be the last in this new Keynesian world.

In other words the Dow at 20,000 and the $100 tomato is starting to appear as a real possibility. Think about that.

24 Comments

  1. jc
    Posted October 1, 2009 at 2:34 am | Permalink

    Another sector that I think will make serious moolah is LED lighting systems. LED lights are about 1% of the market at the moment and in 10 years are expected to get towards 90-100% of new lighting sold.

    Think of the conversion households and almost every building in the west will have to make and the ramifications of the supply side of the equation.

    The carry on effect of this could be massive for the producers of LED lighting.

    Tomorrow I’ll give a spiel on why Boeing could be one of the cheapest stocks in the large cap high tech sector and why not owning this stock over the long term in a retirement account ought to be a felony conviction carrying 10 years minimum in solitary.

  2. Joseph Clark
    Posted October 1, 2009 at 11:04 am | Permalink

    Nice post jc. But isn’t the real message from this that central banks should get out of the game entirely, maybe go to fixed narrow money growth?

    My view is that people extend credit to each other because they think that the borrower will create sufficient value to repay by the time the loan is due. If they are exactly right there is no aggregate price pressure and the correct response is to do nothing.

    When credit contracted last year you think they should moved to expand narrow money, but that’s only true if the contraction was irrational. Maybe it was, I don’t know. But that kind of policy requires the central bank to second guess the market. And they don’t have a very good track record doing that.

  3. jc
    Posted October 1, 2009 at 3:18 pm | Permalink

    Hi Joseph. Damn good comment.

    Joseph:
    What I do know is that with the system we’re currently operating under they seemed to have been far too slow to open the monetary spigot and rush liquidity to where it was really needed.

    My real point is that some of the actions they took recently, or rather since Nov/Dec should have been implemented much, much earlier if they were trying to catch this falling knife, or rather this razor sharp javelin coming at them at warp speed.

    Lord knows they had enough time.

    They had instituted few liquidity support actions such as direct lending to the banks as the interbank market was closing up but it wasn’t focused actions that showed the gravity of the problems at hand.

    The real indicator about how late they were was that on the weekend of the TARP the Fed informed the congressional officials that the payments system was likely to close up the following Monday. How they let it get to that point is beyond me.

    And yes, the real message is that your proposal is far more preferable than the broken system we have now.

  4. Joseph Clark
    Posted October 1, 2009 at 11:50 pm | Permalink

    Very interesting. I’m really torn actually. On the one hand I don’t like the idea of credit crunches destroying the payment system and having us all back in caves filled with whatever baked beans we could scrounge from the supermarkets before the electricity went off. On the other hand I don’t think people would find some kind of collateral they could accept for at some yield. Money finds a way. It makes no sense to me to think of the payment system failing in the way people were worried about.

    What kind of private currency do you think would be best?

  5. jc
    Posted October 2, 2009 at 12:22 am | Permalink

    Joseph:

    Probably gold coins would do the trick. However I also think the market would decide the best private currency given just a little time.

    Mark Hill described how a private currency system could flourish with just paper money and banks acting/specializing as issuers like the Bank of Scotland when they were the issuing bank of Scottish pounds.

    HSBC had and possibly still has a partial role like that in Hong Kong.

  6. Joseph Clark
    Posted October 2, 2009 at 8:36 am | Permalink

    I think banks issuing their own notes would be best too — more flexible than gold. But it would be very interesting to see how or if they controlled the money base after they started. I guess it would all have to be rules based otherwise noone would trust them not to inflate. If I issued a currency I’d also offer inflation swaps against different asset baskets.

    I didn’t know about HSBC in HK, what’s the story?

    btw in my last I meant to write that I *do* think people would find collateral/yield. Just like they always have.

  7. jc
    Posted October 2, 2009 at 3:32 pm | Permalink

    I think the money base would be self correcting, Joseph.

    If they issued too much they would find their franchise being destroyed.

    Hk went to a peg in the 80’s and had HSBC as the currency issuer and acting as the “pegger”. If a person came to convert their HK dollars for US dolls they could go to a HSBC office and demand US.

    I honestly don’t know if this is still the case though.

    It did work.

  8. jc
    Posted October 2, 2009 at 9:51 pm | Permalink

    Joseph:

    Re the Fed and the reason i believe they caused the crash.

    We had a decent whiff of deflation for a good part of last year and early in 2009. If inflation/deflation is monetary problem then how can anyone say that the deflation we experienced was not the result of tight monetary policy before the crash?

    It seems sort of obvious to me, so what am I missing here.

  9. Joseph Clark
    Posted October 2, 2009 at 10:41 pm | Permalink

    I don’t think you’re missing anything. You speak the truth. I’m just a little extremist by thinking that the central bank should never ever ever manipulate the money supply to target prices, ever. Even in a credit crisis, even in deflation, even if the four horsemen ride. Ok, maybe then. But never ever ever otherwise.

  10. Joseph Clark
    Posted October 2, 2009 at 10:47 pm | Permalink

    even private currencies, but then I don’t think any private currency with a floating money base and without any kind of very explicit rules would survive very long. Providing a mispricing spotting service to the community can be done in the newspapers, and possibly on the internet. But it should remain that, an advisory.

    I really can’t understand why otherwise cool and insightful people, people who profess that the government should not have a role in the setting of prices, agree in principle, and in certain circumstances, the government should save the world by setting the biggest price of all.

    But like I said, I’m an extremist.

  11. John Greenfield
    Posted October 6, 2009 at 6:12 pm | Permalink

    jc/LE/SL

    Sorry, if this question is OT, but I couldn’t find a better fit.

    LE/SL

    Where would you advise, in Australia, to be the best university to complete an LLB (or JD, as they increasingly known as) combined with a Ph.D in Economics.

    In the US, JD/MBA and JD/PHD combined degrees are common, and with electives common to both degrees can shave 2 years or more off time otherwise taken.

    In Australia, I notice Uni.Melb has a JD/MBA, and UNSW a LLM/MBA, but I have not noticed any formal combined degrees at the Ph.D level. It seems the only option is to enroll in the LLB/JD and Ph.D separately.

    Any advice?

  12. John Greenfield
    Posted October 6, 2009 at 7:11 pm | Permalink

    jc

    To what extent did/does the Fed include asset inflation in itseo-making process to change interest rates? It would appear absolutely nine at all. If that is that case, what theoretical/ideological position would lead them to ignore asset inflation. And what other short-comings in their inflation rate calculations are waiting to blow uo?

  13. jc
    Posted October 6, 2009 at 7:18 pm | Permalink

    Look I used to think Melbourne was good for economics, but these days Monash has a pretty decent dept.: not totally populated with Keynesian types.

    So the choice is a difficult one,

    Melbourne is the better brand but not as good as Monash on the eco side these days I think.

    Perhaps go to Melbourne and then do a refresher course at Monash to undo all the crap you learnt at Melb. 🙂

    Law… dunno. However it would probably be out of those two again.. Melbourne and/or Monash with melb. having the better brand name.

    I got to say that I hear pretty good things about Monash these days.

  14. John Greenfield
    Posted October 6, 2009 at 7:22 pm | Permalink

    And what is this malarkey about ‘stress testing’? I helped set up a stress testing department in London for the international derivatives trading group offshoot of a global IB in 1997, using JP Morgan’s technology. Are you saying Goldman’s had not been stress-testing 24/7 over the same period?

  15. jc
    Posted October 6, 2009 at 8:32 pm | Permalink

    Sorry , what do you mean, John?

    I’m not offering any opinion about the effectiveness of the stress tests other than suggesting the markets took some optimism from the results in that the world wasn’t ending as a result of the large US banks being totally broke.

    The US markets started rallying from that point on and the large banks that needed to were able to recap easily enough after that.

  16. jc
    Posted October 6, 2009 at 8:39 pm | Permalink

    Are you saying Goldman’s had not been stress-testing 24/7 over the same period?

    No not really. In fact the real issue wasn’t with Goldman as they weren’t carrying a great deal of level 3 assets like a lot of the other jokers were.

    Level 3 are really hard to revalue crap a lot of them had on their books and the real estate loans and related securities were a huge issue too.

    I know you have often said that you think this crisis wasn’t a big deal, however it was, as I keep telling you and patiently explaining. But for some reason it doesn’t sink in and you’re starting to remind me of the liberal arts chuckle-heads you’re always criticizing for failing to understand the world 🙂

    Yes I know it hurts 🙂 and please don’t be angry as I’m just speaking the truth to power. LOL

  17. jc
    Posted October 6, 2009 at 8:41 pm | Permalink

    Look john, there were two huge moves in the assets markets.

    In November 2008 where the market quickly and frightening discounted a serious recession and in February 2009 when the market incorrectly i think from hindsight began to discount a depression.

  18. Posted October 6, 2009 at 9:26 pm | Permalink

    JG: If a university offers you a choice between an LLB and a JD on enrollment, always but always take the LLB. The JD is very often a chopped-down, three year course and does not have ‘classes’ of honours, making entry into postgraduate study or top-tier firms very difficult (you have to convince them that the course is worthwhile). There is a tendency to shove mature students (even fairly young ones, ie below 30, as I was when I did the LLB) into the JD, so make sure you investigate all your options fully.

    I would not attempt to do postgraduate study in economics without at least an undergraduate major in statistics or economics. Indeed, most universities will not let you do this. Your best option (which once again involves avoiding the JD) is to enroll in a combined BEcon/LLB degree at any of the ‘sandstones’ or Monash. You will be at university 6 years full time, but it is worth it.

  19. Posted October 7, 2009 at 1:52 am | Permalink

    Mark Hill described how a private currency system could flourish with just paper money and banks acting/specializing as issuers like the Bank of Scotland when they were the issuing bank of Scottish pounds.

    Bank of Scotland, Royal Bank of Scotland and the Clydesdale Bank (all retail banks) continue to issue paper money to this day, constrained by the rule that they have to remove the equivalent value of English notes from circulation. Trivia: Scottish law doesn’t recognise ANY paper notes as legal tender, and scottish paper currency is still issued as promissory notes.

    {waves from Edinburgh}

  20. jc
    Posted October 11, 2009 at 9:57 pm | Permalink

    Interesting, Deux. I never really knew the finer points of the peg. Thanks for explaining it.

  21. jc
    Posted October 14, 2009 at 3:58 pm | Permalink

    Received an I- Banks research today which is absolutely jaw dropping.

    Credit expansion has a hit a record. From an I-bank’s research:

    Chinese credit growth since Jan 1 this year to June 30th has been 45% of the 6 months GDP which is a record by far of any country since WW2.

    Now that is a freaking credit expansion of sorts.

    However don’t expect a crash just yet. Recall that Japan’s credit expansion of the 80’s went for a decade before the dam wall broke open.

    Let the games begin… This is hilarious if it wasn’t going to turn into a freaking mess.

  22. Posted October 14, 2009 at 7:34 pm | Permalink

    Something about deckchairs, Titanic and rearranging comes to mind…

  23. Graeme Bird
    Posted December 10, 2011 at 7:47 am | Permalink

    Another worthless post by Cambria. Here he is suggesting banker-subsidy is the answer. Subsidised loans as the solution to a problem created by subsidised loan. He’s clueless.

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