This blog post originally appeared on RealMoney Silver on Oct. 6 at 8:26 a.m. EDT.
I simply must go.
Baby, it's cold outside.
The answer is no.
Ooh baby, it's cold outside.
This welcome has been.
I'm lucky that you dropped in.
So nice and warm.
Look out the window at that storm
My sister will be suspicious.
Man, your lips look so delicious.
My brother will be there at the door.
Waves upon a tropical shore.
My maiden aunt's mind is vicious.
Gosh, your lips look delicious.
Well maybe just a half a drink more.
Never such a blizzard before. -- Frank Loesser, "Baby, It's Cold Outside"
Baby, it's bad out there, as disorder remains the order of the day.
In searching for a song that embraces the
, the song, "Baby, It's Cold Outside" immediately came to my mind. It was originally introduced in the 1949 film
, but its incarnations were as varied as they were splendid to listen to --
There are only a few parallels in stock market history that have resembled the stock market crash of 2008.
The proximate causes are varied:
- an absence of regulatory supervision (and lending due diligence);
- gluttonous public and private sectors' accumulation of debt;
- the proliferation of un- or under-regulated financial weapons of mass destruction (of a derivative kind) in the emerging shadow banking industry;
- a worldwide credit contagion (which debunked the decoupling theory); and
- an asymmetric "heads I win, tails I win" Wall Street and hedge fund compensation structure.
All of these factors have come home to roost, and with them, the world's equity markets have cratered and our credit markets have seized up.
Planet Krypton and the Stock Market Explode
Brainiac: on Krypton's imminent destruction If the council knew the truth, they would put me to work on an evacuation plan, a meaningless effort given the time remaining. Jor-El: How long? Brainiac: Hours ... this world has seen its last sunrise. -- Superman
The Edge, my trading diary available exclusively on
, has documented the slow-motion economic and credit crash repeatedly for almost three years. Back in late 2007, I
my concerns regarding the emerging world credit problems, a levered consumer and a levered hedge fund community.
Over the past two years, other naysayers (like myself), including Nouriel Roubini, David Tice, Bill Fleckenstein and Jim Chanos (among others), were vilified as Cassandras by most -- despite our documented (and substantive) warnings of impending doom (of a housing and credit kind). Like Jor-El's (Superman's scientist father) forebodings regarding the horrific fate of his beloved
, many market participants responded with a "see no evil, hear no evil"
. They remained ensconced on Planet Krypton, staying long stocks and concentrated in the crowded space of market leaders (mostly of a materials and energy kind), while Jor-El
(and saved) his son Kal-El in a rocketship to Planet Earth and the short sellers stayed their course.
The Great Hedge Fund Unwind
"I sent the club a wire stating, Please accept my resignation. I don't want to belong to any club that will accept me as a member." -- Groucho Marx
The economic impact of the debt and derivative buildup as well as an almost coordinated push by hedge funds into the popular and crowded commodities and energy trades (from 2005 to mid 2008) is now causing irreparable damage to the markets and to the investment returns, serving to force many of those hedge-hoggers to collectively panic in an attempt to preserve capital (and, in some cases, their businesses). The massive sell orders from the hedge fund cabal, many of whom saw the glass half-full and dismissed the concerns expressed by the splenetic minority have
in recent weeks -- despite the appearance of emerging stock market values.
Even some of the most sizeable and prestigious hedge funds, which have delivered a decade or more of impressive performance, are faced with large investment losses and client redemptions that could undercut their very existence. This is leading to the "great hedge fund unwind," a vicious vortex of selling that, for now, is unresponsive to the possible relief found in rescue packages or in expansive monetary or fiscal initiatives.
It Was Different This Time
The wild and windy night
That the rain washed away
Has left a pool of tears
Crying for the day.
Why leave me standing here?
Let me know the way.-- The Beatles, " The Long and Winding Road"
It truly was
: Stocks were not, as the case has been for a decade, a buy on dips. Mr. Market has left a pool of tears, and it will be a long, winding and difficult road back to the restoration of stock market health. The investment, economic, political and social implications of the market and economic turmoil will be legion and broadly felt for years.
Here are some of the changes I see.
- Credit markets will be slow to normalize. Credit markets remain in disrepair. The commercial paper market (i.e., the straw that stirs our economy) is imploding, Libor is elevated, and (bid-only) capital and credit is nearly unattainable. Even those that can get capital, such as Goldman Sachs (GS) - Get Report and General Electric (GE) - Get Report are paying up for it. The outgrowth of the bursting of the housing and credit bubbles will be a lengthy period of deleveraging, so a normalized credit market is, at best, probably six to 12 months away.
- Credit availability will continue to be constrained. The pendulum of credit, which moved to the extreme (read: plentiful) prior to the recent travails, has, not surprisingly, moved toward the opposite end of the scale (read: unavailable). When one combines the still capital short position of the banking industry with a deteriorating loan-loss cycle that stem from the economic downturn, the suggestion is that credit will be dispensed gingerly. Lending institutions will err on the side of "prudence" in their pursuit of re-accumulating internally generated capital, leaving a recovery in credit availability six to 12 months away as well.
- The sharp drop in global stock markets will accelerate the depth of the worldwide recession. My baseline assumption is for a protracted economic recession, which continues far longer (into late 2009/early 2010) and deeper than most expect. As well, corporate profit expectations remain far too elevated. I have long written that, as home prices began to descend, the stock market would assume a more critical role in the domestic economy than ever. But relying on higher stock prices to sustain economic growth was a slippery slope for both the economy and for investors. I opined that far too much could go wrong, and we are now falling down the slippery slope that I cautioned about more than a year ago. Going forward, many economists are failing to account for the marked impact that lower stock prices will have on consumer confidence, households net worths and on the real economy.
- Investor apathy and disinterest lie ahead. As I have feared, the consequences of the credit morass (among other things) will likely be a growing distrust of Wall Street and of politicians as well as a nearly unprecedented apathy and disinterest in investing, which could extend for years. For some time to come, inflows into mutual and hedge funds will no longer provide support to equities; a period of substandard investment returns (at best) seems a likely outcome.
- Social unrest and demands for change seem likely. The Bearded Prophet of the Apocalypse's gravest predictions of social discontent and rising crime may come to pass and could permanently alter our society's very fabric. There is now little question in my mind that the Democrats will take power in January 2009.
"The stock market is filled with individuals who know the price of everything but the value of nothing." -- Philip Fisher
Directly ahead of us likely lies a
in which emotion, volatility, indecision and the great hedge fund unwind might overwhelm fundamental considerations. Under the circumstances of a market that is hard to game, those who are convicted (long or short) might be victims of Mr. Market, and those who are opportunistic and facile could reap Mr. Market's rewards.
The deterioration in investor sentiment and confidence is probably one of the most significant short-term factors affecting our markets. Historically, fear and panic (and wild daily and intraday stock market moves) are usually important preconditions to a bottom, and, frankly, so are hastily crafted band-aid policy decisions. For instance, the institution of a ban on short-selling of selected companies by the
. In addition to turning the playing field around, the ban has likely contributed to a deterioration of the liquidity in our markets and, quite possibly, in the unintended consequence of lower stock prices.
How to Play It
"I've had a perfectly wonderful evening. But this wasn't it." -- Groucho Marx
As I have consistently written, the next several years will be characterized by inconsistent growth, which corporate managers (no longer the recipients of easy credit and pricing power) and investment managers will find difficult to navigate.
The way for most investors to cope with crisis is to stay out of the crisis. Despite unprecedented short-term trading opportunities, my consistent advice is that investors/traders should err on the side of conservatism as, for now,
'Cause, baby, it's cold outside.
Doug Kass writes daily for
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At the time of publication, Kass and/or his funds had no positions in the stocks mentioned, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.