On a normal day in a normal market on a normal planet in a normal universe, you might spend your Monday going about your normal business. Buy low. Sell high. Digest the data. Drink some coffee.
We do not live in normal times, which is too bad, because it seems like a pretty nice first working day of March here in Melbourne. Later this week the Reserve Bank of Australia meets on interest rates. It will have to decide if bad news in the rest of the world (a revised 6.5% contraction in fourth quarter U.S. GDP, for example) is enough to lower rates for 3.25%–or if it has time to wait and see.
Later in the week, we’ll all learn how Australia’s economy did in the fourth quarter. By then, though, it could be old news. “Dozens of freighters carrying Australian iron ore are stalled outside Chinese ports amid a collapse in demand for steel, dashing hopes that Chinese industrial demand will protect Australia from the worst of the global recession,” reports David Uren in today’s Australian.
“Australian market teeters on precipice,” adds Susannah Moran, also from today’s Oz. Friday’s action on Wall Street sent U.S. stocks back down to twelve-year lows. It was the worst February since 1933. That’s sent the Aussie futures even lower. It now looks like a dead cinch that the ASX/200 it is going to bust below 3,300 and explore what lies below.
Yeah. That’s a hefty dose of bad news to start the week. In fact, it’s so bad, it’s exactly the sort of thing that would make us start to wonder if stocks are going to make a bottom soon. The point of maximum anxiety/pessimism is usually the bottom. But maybe we aren’t quite there yet.
Warren Buffet doesn’t think so. In his annual letter to Berkshire Hathaway shareholders, he wrote that, the U.S. “economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.”
Nope. The market can bottom even as the economy free falls. That doesn’t mean the market will take off like a rocket. But it does mean the best time to buy stocks will be when no one wants anything to do with them. We reckon that time could be later this year-given just how bad things will get in the real economy.
The ban on short-selling of financial stocks in Australia is set to expire this Friday. Will ASIC and the ASX extend it? As ugly as it might be, lifting the ban might allow the market to reach the bottom more swiftly, wherever that might be. Shorts would come in and target whatever firms they view as most exposed. What then?
You’d see a big fall in the banks and listed property trusts (though they’ve both already had a horrid twelve months). Then you might see the shorts cover. This would be the bottom.
Perhaps it’s not that neat and tidy. But we would say that without shorting, you can’t have a short covering rally. Instead, you shamble on to lower lows.
Here’s some good news, though. The RBA reports that personal borrowing levels fell by 0.2 percent in January. It was the eighth month in a row that personal credit is contracted in Australia. A return to living beneath your means? Hmm. Maybe it’s becoming fashionable to be thrifty!
“It’s not realistic when you say that failure must be allowed,” a friend told us this weekend.
“Because everyone will fail. It’s not as if there are just a handful of bad apples in the barrel. The whole thing is interconnected. It’s like an apple pie really, where all the apples are mixed in the same filling.”
“Uh…you’re going to have to explain.”
“Okay look. If a firm makes a bad bet on a product, like, say, vegemite flavoured toothpaste, and it doesn’t fly off the shelves, that’s a fairly contained risk. If the firm fails then its creditors, shareholders, and employees are out of work. But it doesn’t spread.”
“Okay. But that sounds like awful toothpaste. Doesn’t it deserve to fail?”
“That’s not the point. The point is with the banking system, everybody is counterparty. One default by one firm becomes a systemic problem because everybody owes everybody. Take AIG.”
“You take them. I don’t want anything to do with them.”
“That’s too bad. Because you’re going to own them before this is all over. You keep bashing AIG for hoovering up government capital. But the Feds saw what happened with Lehman. AIG sold insurance against bond defaults. But it’s in big trouble on its credit default swap portfolio. And if AIG gets downgraded or becomes insolvent, then its counterparties face billions in worthless insurance policies against default in other credit risks.”
“So you’re saying you can’t let any single firm like AIG, Citi, or Bank of America fail because if one fails we all fail?”
“Yes. The failure wouldn’t just punish the bad banks, it would punish everyone. Credit would lock up. The economy would cease to function.”
“How do you know that’s what would happen?”
“Well, I don’t. But that is the nature of the system we have. We are all dependent on one another. We can’t allow anyone to fail or we’ll all fail.”
“So what you’re saying is that we must at all costs preserve a system that’s brought us to the brink of financial ruin, because the alternative is financial ruin?”
“Well, no. I wouldn’t put it that way.”
“How would you put it then?”
“Well what would you do? What’s your big plan? You just want to let things fall apart and see what happens? That would be a disaster. We can’t afford that risk.”
“There are a lot of things we can’t afford at the moment. But that doesn’t seem to be stopping anyone from spending anyway…”
To be continued…
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