The Great Deleveraging

[HenryTo]

Similar views from Peter Bernstein regarding our longer-term credit/economic outlook in this weekend's commentary:

http://www.investorsinsight.com/otb_va_print.aspx?EditionID=670

[dknoester]

Kirk's take on the market:

"Waiting For An Edge

Monday, September 15, 2008 at 12:24 PM

A number of you are probably wondering what I’m doing on a day like today.

Truthfully, I’m doing very little. I spent the majority of the morning catching up on my reading from the weekend (another link post is coming up), keeping my eyes on a few of my real-time scans, and not much else. While I kind of figured we would see the market try to fade the gap down (most of the gaps have been faded with relative consistency of late), after that I couldn’t really find an edge since I’m not seeing any new setups and none of my price alerts have been triggered.

For what it is worth, my bias into this week is to want the market to wipe out this morning’s rebound and break those July lows so we can clear out the stops lurking below that would set up another counter-trend rip. However, once again the Fed has thrown a monkey wrench into that plan with another rate cut looming large tomorrow. Indeed, we trade in interesting times.

In addition, I should also point out that even with all of the ups and downs we’ve seen, we’re not even oversold enough (I’d like to see another sub-20 reading in the T2108) that it makes sense to put money to work just based on the factor alone. Yes, we’re a bit better off than we were a couple of weeks ago, but it may not be enough:



Bottom line, I’m trying to be patient here and the fact that I’m not seeing anything actionable now makes it easier than it normally would given the current headlines we read today. I’m letting the price alerts do the heavy lifting and without any triggers, I can feel ok about sitting on my hands."

DK
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Be careful while stuffing your pockets not to lose your pants!!

[robo]

[Suomodo]

No idea, my memory goes only 3 years ... I doubt anyone can predict a crash ... it is an outlier and very unprobable especially in modest to low valuations. If crash not probable under any other scenario we are seeing veeery oversold readings now ..

But I think the rally in stocks since 2003 did not include public, and it did not reach overvaluations.. this crisis was thus very expected one ... talked all over about it since at least 2006.

[rffrydr]

Mr. Modo--why do you think the PC ratios are so tame relative to '02?
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Today is the Tomorrow you worried about Yesterday!

[Suomodo]

I added last 10% of my funds at SPX 1215... ) Fed will be proactive tommorow I suppose 50 bp is more probable than 25bp ...

Option exspiration can give us a boost .. Seems promising ...

[rffrydr]

I thought we'd make 1180....I'm in.
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Today is the Tomorrow you worried about Yesterday!

[Suomodo]

VIX spikes over 30, P/C ration 1,45 .. if we survive today i.e. SPX over 1200 this is the bottom ... for at least two months.....

[rffrydr]

Yeah, funny...yet then comes the 70billion backup consortia

http://online.wsj.com/article/SB122144631339134981.html?mod=mktw
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Today is the Tomorrow you worried about Yesterday!

[diesel]

I love this quote:

[rffrydr]

Miller Tabek discounting the selloff:

http://ftalphaville.ft.com/blog/2008/09/15/15846/hang-on-tony-crescenzi-says-its-time-to-look-forward-not-back/
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Today is the Tomorrow you worried about Yesterday!

[HenryTo]

Fed expands lending facilities to alleviate short-term funding needs as a response to unwinding Lehman's trading positions. The temporary/revised facilities are expected to encompass equities for collateral purposes:

http://online.wsj.com/article/SB122143939332934501.html?mod=special_coverage

[rffrydr]

Fitch said that prime and subprime auto ABS performance indices produced higher delinquency and annualized net losses (ANL) in July. The ANL was 1.42% up 15% from June and 94% from a year ago. Subprime ANL were 6.56% in July up 16.5% m/m and 45% year over year. Delinquencies were up 30% from July. The wholesale vehicle market did show signs of stabilization in July, but Fitch was not expecting a structural improvement.
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Today is the Tomorrow you worried about Yesterday!

[rffrydr]

Don't like it? Wait a couple hours: the Korean/Lehman tie-up back on the table and RBA cut with the carry currencies taking it on the chin...almost two years carry in a few weeks. Throw crude down limit now.

Don't forget that the GSEs are now profit machines. Take away Oil and the Miners and money will HAVE to start flowing back to the financials. It pays not to forget the debt matures and HAS to be reinvested. There's alot coming in a couple of weeks. $80 dollar crude and many things will be forgotten.
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Today is the Tomorrow you worried about Yesterday!

[HenryTo]

Crude oil is down more than $6 as I am typing this and yet many developed and emerging markets have continued to take it on the chin. US futures are still down, while the Nikkei was down more than 250 points at last count. Korea has been and is still actively intervening in the FX markets to prop up the Won.

The bad thing is that there is still a lot of leverage within the global system - and this is further compounded by the fact that much of the world is still short the US Dollar and the Japanese Yen (e.g. Korean households that took out mortgages denominated in Yen or Chinese savers here in the US who bought New Zealand Kiwi dollar-denominated CDs) - two currencies which have exhibited a long strength over the last six weeks. Worse yet, there is still ample room for these two currencies to rise.

In order for the world to avoid a more painful episode of general deleveraging, the US and Japanese will need to supply more liquidity. As mentioned in this weekend's commentary, the "best bang for the buck" is still a bailout package for the GSEs. With respect to Japan, it now looks like the new PM (Taro Aso?) is more ready to feed liquidity to the Japanese economy than Fukuda. Both these events should be immensely bullish for the global financial markets - should/once they come to pass.

[HenryTo]

As discussed here many times before, look for banks' ROEs to decline dramatically and stay low going forward:
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Wed, 20 Aug, 14:54 GMT

ANALYSIS Banks' returns come back to earth, maybe for good

Fall of structured finance and regulatory pressure over capital reserves likely to mark end period of 20-30 percent ROE.

LONDON (Thomson IM) - A slump in lucrative structured finance business and regulators' demanding bigger capital reserves mean stratospheric profitability at banks is gone, possibly forever.

The credit crunch has hammered the return on equity (ROE) of many banks, particularly those in Europe and the United States, since the second half of 2007, and those returns may never recover to pre-crisis levels.

'Will the fantastic returns of 2006-early 2007 come back? It's really doubtful. It was a unique environment where each and every asset class appreciated so it was very difficult to do anything wrong,' said Bernd Ackermann, an analyst in rating agency Standard & Poor's financial institutions group.

In 2006, the top 10 banking ROEs ranged from 23.9 percent to 35.5 percent, with the average ROE at 13.6 percent, according to the Boston Consulting Group.

'Much of that (ROE levels) relates to capital ... what equity will be required in the next cycle,' said David Fanger, an investment banking analyst at rating agency Moody's.

Last year -- split neatly into a record first half and a sharply slowing second half -- banks' after-tax profits fell for the first time since 2003 and their average ROE declined to 13 percent, but that was propped up by exceptional returns at some banks, mostly from emerging markets.

'Until last year, we'd had a 25-year run of low interest rates, excessive liquidity, particularly post-9/11, low inflation and relatively good economic growth,' said Neil Dwane, chief investment officer in Europe for RCM, an investment unit of German insurer Allianz <ALVG.DE>.


REGULATION, REGULATION, REGULATION

Regulators will require banks to set aside more capital than before for risks other than that of default, such as potential losses due to a credit rating agency downgrade or due to a change in the price of an equity instrument.

'Does that permanently diminish ROEs? It may very well,' Fanger said.

The high ROE levels enjoyed by banks in 2006-07 are gone for good, Dwane said. 'In two-three years these businesses will be regulated and as exciting as utilities.'

Large banks across the world, such as Merrill Lynch <MER.N>, UBS <UBSN.VX> and Citigroup <C.N>, and other financial firms have written down $408 billion since the crisis hit, pressuring their ROE, a key benchmark for shareholders to measure profitability. [ID:nLC357494]

UBS's and Citigroup's ROE dipped into negative territory this year, compared to high positive returns last year. JPMorgan analyst Kian Abouhossein estimates that measure next year will still be considerably below the pre-crisis levels, or around 20 percent for UBS and around 11 percent for Citigroup.

According to S&P, Goldman Sachs <GS.N> posted ROE of over 30 percent in 2006. JPMorgan sees that figure at around 19 percent by the end of 2009.

ROE reveals how much profit a company generates with the money shareholders have invested. It is defined as after-tax profit divided by total equity -- so the higher the percentage, the more profitable the company.

S&P expects investment banking revenues to drop 20-30 percent this year on 2007, excluding writedowns.

'For 2009, I wouldn't say that this will improve dramatically,' S&P's Ackermann said.


FIASCO

Also pressuring slowing income at banks is the loss of a rich seam of revenue from structured products, which became a major contributor to the subprime fiasco because their complex nature made it hard to assess risks and value.

Demand has evaporated for asset-backed securities and collateralised debt obligations (CDOs), after the market for such debt repackagings froze in the wake of the blow-up in the market for U.S. subprime mortgages.

While structured finance may pick up in the future, products are likely to be simplified, subject to intense scrutiny and in all likelihood less profitable, analysts say.

And it is already costing banks more to satisfy investors as they look for higher dividends to compensate for the risks of investing in banks just as their share prices drop.

'Involuntary balance sheet expansion, higher funding costs and the need for stronger capital ratios are likely to result in a permanently lower return on equity for the industry,' Citi analysts said in a note on UK banks.