Market Catalysts

The S&P trades at 750.78 right now. Less than a week ago the intraday low was 666.79. That is…. (zwei hin, vier im Sinn, fuenf hinter’m Ohrlaeppchen, drei zwischen den Zehen…) 12.5% in a week. The media is full of positive reports on how things may take off. I got this msg from our coverage at Merrill:

THE TONE AND DIRECTION OF THE MARKETS REMAIN LINKED TO THE INVESTMENT COMMUNITIES VIEW OF THE BANKS, AND FOR NOW NEWS STORIES OF GOOD FIRST QTR EARNINGS AND POTENTIAL ADJUSTMENTS TO THE MARK TO MARKET ACCOUNTING HAVE HELPED ALOT. WE'LL SEE!”

In my mind that pretty much hits the nail on the head, except for I don’t see this quite as positively. People are sick of the continued pain and want to believe in a rally. I think that there are still too many systemic risks. In my mind the recent rally is due to:

a) mark to market rumors--buy the rumor sell the fact

b) Citi (and by now I guess BoA and JPMorgan (?) headlines of profitable first quarter, which are likely misleading. Citigroup claiming that it is profitable (pre write-downs, mind you) does not make a summer. Will there really not be any more writedowns? Have accountants really priced in increasing mortgage delinquencies due to ever-rising unemployment? I have a hard time believing that.

c) oversold levels after a week of straight declines. 666 was really low after the mkt had just collapsed.

So while you might be able to make money if you’re good at timing the market (unlike me!) I don’t think this holds. Incidentally, gold tells the same story as it keeps rising after dips.

pound vs dollar

My friend Sitar asks me to explain in non-techincal terms why the pound dropped so much against the dollar. The two easiest explanations here are the following:

a) The biggest industry in the UK is banking. Banking as a whole is not particularly profitable and currently banks are particularly precariously perched. We have seen what can happen when Bear was force-married to JPMorgan and when Lehman went bust. In the US a lot of initiatives have been... errrrr... initiated to deal with struggling banks. For example:
- The Fed has aggresively cut interest rates. That makes the yield curve nice and steep. Essentially that is just a way of saying that long-term interest rates are high while short-term rates are low. Banks can borrow at ST rates and lend to you and me at LT rates. The difference is theirs to keep. So steepening the yield curve makes banks more profitable.
- Treasury has injected billions of capital into banks with the (inappropriately named) Troubled Asset Relief Program (TARP.) So banks have gotten a lot of help that may (emphasis on _may_) enable them to weather the storm.
- The Fed and Treasury have issued guaranteed for losses on certain assets that banks own.
In the UK banks have, as to date, not received as much support. Making the British economy very vulnerable to a sharp slowdown, quite possibly sharper than in the US where a lot of the pain has already been borne. If an economy grows slower investments in that economy tend to be less profitable. I.e. I am not going to buy British pounds to either buy British stocks or to directly open a factory or something if I don't think I'll get a good return on that investment. The reduced demand for the pound from that side drives down how much people value the pound vis-a-vis other currencies.... including the dollar.

b) In the general climate of risk aversion that is hitting capital markets these days--people are just afraid to put their money in anything but the safest assets--many people sell off what they have and either stuff their money in the mattress or invest it in the safest of safe assets... for better or worse still United States Treasury bonds. Since such a large proportion of the world's investments come from the US a repatriation of capital (i.e. selling off your stocks in Brazil, exchanging your reals back to dollars and putting the money in your safe) means that many currencies decline versus the dollar as demand for the dollar goes up.

This is a very peculiar phenomenon. Mostly, if a country is facing an imminent economic crisis its currency will decline as investors pull out of the country. In this case, however, as the US crisis deepens it makes US investors more jittery about their returns while simultaneously weakening _other_ economies. These are the two biggest reasons why the pound and other currencies are weakening against the dollar even though the US is in such bad shape.