All persons are hereby required to deliver on or before May 1, 1933, to a Federal Reserve bank or a branch or agency thereof or to any member bank of the Federal Reserve System all gold coin, gold bullion, and gold certificates now owned by them or coming into their ownership on or before April 28, 1933, except the following:
- Such amount of gold as may be required for legitimate and customary use in industry, profession or art within a reasonable time, including gold prior to refining and stocks of gold in reasonable amounts for the usual trade requirements of owners mining and refining such gold.
- Gold coin and gold certificates in an amount not exceeding in the aggregate $100.00 belonging to any one person; and gold coins having recognized special value to collectors of rare and unusual coins.
- Gold coin and bullion earmarked or held in trust for a recognized foreign government or foreign central bank or the Bank for International Settlements.
- Gold coin and bullion licensed for the other proper transactions (not involving hoarding) including gold coin and gold bullion imported for the re-export or held pending action on applications for export license..." Franklin D. Roosevelt, The Whitehouse April 5, 1933 20 May 2008
The comments made every time the market rallies are characterised by the ever-present optimism that we have discussed many times. I suspect that is exactly what we are witnessing currently.
The first wave of concerns created by the bursting the housing/credit bubble (and make no mistake they are two sides of the same coin) is subsiding. The optimists believe (or at least hope) that the worst is now over. Indeed the probability of a recession in 2008 has dropped to 39% on the Intrade contract!
However, from our perspective such sanguinity is likely to be misplaced. The slowdown in the US is barely starting. The charts below show that both the demand and supply for .credit. are evaporating. This effective shutdown of both sides of the market should be a serious concern for monetary policy makers, as it is one of the hallmarks of a liquidity trap situation.
Note in particular how widespread the lack of demand for credit is, as well as the supply! This isn't just about the housing market. Obviously demand for mortgages (both commercial and residential) is lacking, but so is the demand for consumer credit, and corporate credit. This doesn't bode well for the outlook.
The underlying asset adjustment is likely to have much further to run as well. The chart below shows the developments in US house prices and Japanese land prices during their bubble and burst. The point of this chart isn't to say that US prices will follow Japanese prices, but rather to illustrate the long drawn out nature of the healing that has to occur. Indeed, one client recently asked me if this was worse than the S&L crisis. To my mind it is much worse, as securitisation was part of the solution to the S&L problems, whereas it has been part of the problem in the build-up in this bubble.
Indeed, one of the lessons that should be learnt from the Japanese experience is that the banks were second round losers, a point made by Albert Edwards recently (see 3 April http://sgresearch.socgen.com/publication/strategy_update(20080403)_cc0.pdf Global Strategy Weekly). They didn't really begin to underperform the rest of the market until the second Japanese recession of its debubbling process. They really started to suffer when their consumers (Japan Inc) started to struggle.
From a market perspective, financials remain an exceptionally large component of the market itself. As the chart below shows, today's 17% of market cap may be well off the high of nearly 25% but remains a long way above the levels before this bubble started.
One of the other lessons of importance from Japan is that it is never the stocks that led you into the bubble that lead you out. For instance, in Japan's post bubble environment it was the capital-starved autos and electricals that were the winners. Just as the US market recovery after the dot com bubble wasn't led by tech but by mining, material and financials. Those deprived of capital do best in the aftermath of a bursting bubble, not those gorged on it. This argues that it isn't likely to be financials that lead us into any sustained rally.
This makes it all the harder to understand the way in which investors have been cheering the rights issues/capital raisings that financial firms have been carrying out. I recently described investors. responses to rights issues as the investment equivalent of being mugged and then turning around and saying thank you to the perpetrator (and perhaps offering to take them to the cash point and get some more money out for them).
The chart below may just give some pause for thought. It comes from a study by Capstaff et al1. They study the long-term performance of stocks conducting rights issues in the UK between 1986 and 1995. In particular, they split out the evidence in the pre 1991 and post 1991 periods. This is interesting because it reveals two different motives for a right issue. During the first period, it appears managers issued more equity to take advantage of high valuations. However, the second period reflects a more separate need for cash brought on by the last UK housing recession.
Regardless of the motive, the outcome is clear from even a cursory glance at the chart below. Rights issues are bad news for investors. The poor performance of firms conducting rights issues prior to the issue itself is clearly observable for the 1991-1995 sub-period. Even more noticeable is the increased underperformance once the rights issue is over. If history is any guide, investors cheering such issues now are likely to end up severely disappointed at the end of the day.
From our perspective, the market is enjoying a sucker's rally. The road to revulsion is likely to witness many such events, but the recession reality is only just unfolding. Far from being behind us, the worst may still be ahead!
