“Investors debated overnight whether the global credit crisis had peaked, but with Deutsche Bank and Merrill Lynch financial results looming large Wall Street remained jittery,” explains Reuters this morning. Stocks everywhere have rallied since late August. The ASX 200 closed at a record high of 6,659 while stocks in Asia, Europe, and America all rose on anticipation that more rate cuts from the Fed are on the way.
Yesterday the Dow paused and lost 40 points, as if rethinking the logic of the rise. It would be unusual for a rampaging bull market to begin on the foundations of an epic collapse in the credit markets. How can a phoenix rise from the ashes before it’s been consumed in fire? But that’s really the question today isn’t it? Not about the phoenix, but about the bear. Can you have a bear market in credit and still have a bull market in stocks?
The bullish scenario is that the worst is over in subprime. Although it was bad, it wasn’t end of the world. “We can’t tell if new sources of asset panic will arise given the surprises so far. Nearly driving over a cliff and veering away provides a completely different outcome than going over it,” said Steven Wieting of Citigroup. So it was near miss, according to some.
A simpler explanation is that the money no longer going into short-term bonds is going into stocks. In other words, the bear market in credit is fully consistent with the bull market in stocks, at least in terms of money flow. Investors have given up on high-risk, high yield debt and moved on to high-risk, no yield stocks. The weight of money into the market has created a self-fulfilling bull market.
So stocks have become a great lifeboat. But they’ve been taking on investors awfully fast. How much upside is left? You’d expect valuations to become an issue at some point. But that point is probably after 7,000 on the ASX 200. With not much to choose from in other assets, stocks are the only game in the global village right now…unless you are sifting through the rubble of the CDO market.
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Hans Blix on 3 October 2007:
"…unless you are sifting through the rubble of the CDO market."
That I am. There could still be a gem amounst the rocks.
Comment by Coffee Addict on 4 October 2007:
Dan
I would like to say I have no understanding about what is going on but I am paid to care.
Hundreds of thousands of "Forrest Gump" style investors, spectators and neither know nor care. I wish them well but there is no way (I know of) to decouple the credit and equity markets. All that separates the two markets is maybe a 12 month time lag.
In the movie, Forrest made a fortune out of a natural disaster then invested all his money in that little fruit company called Apple Inc, a company that easily outpaced the 1987 correction. Those who follow in Forrest’s footsteps may not be lucky.
Poorly educated investors and inexperienced, commission driven advisors place a ridiculous level of assurance on historic accounting data, not withstanding the fact that the information value of this information can be dubious. Better advisors and investors tend to look to early indicators of performance rather than annually reported results but alas they appear to be few. Why stop the bulls from having a party while they are having fun!
Milton Friedman once talked about the velocity of money. He was half right. Money invested directly in economic activity goes around the globe much faster (to create more wealth) than money sitting in cheque accounts and government bonds. As easy credit and structured debt products facilitated much of the velocity it would be reasonable to anticipate the converse is also true. The velocity of money will clearly fall if volume of easy money available for higher risk ventures declines. What Friedman didn’t clearly take into account was the momentum of money that is mass x velocity. ( http://en.wikipedia.org/wiki/Momentum ) . The cheap money has resulted in enormous level of financial momentum that like a freight train will require considerable distance to low down – even if it derails.
Back to Forrest, there will be companies with something new and innovative (like Apple and Microsoft in the mid 80’s) that will perform in most market conditions. The trick is in picking which companies will be winners before all the other Gumps get to hear about it.
Other strategies won't work in the current market.
Comment by Coffee Addict on 4 October 2007:
Hans is absolutely correct. And the big banks are gobbling some of the opportunities up as you read this.
In addition the securitised credit market will regain "some" of its old momentum as soon as issuing insitutions get around to
Comment by anon on 4 October 2007:
Lately, it's like being in the eye of a hurricane.
Things seem OK - but they aren't.