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Commentary

Remarkable Upmove, but the credit crisis isn’t over.

Firstly – fantastic upmove. In the last week, the markets have gone up some ridiculous 18%. Which is good, because a bounce was expected. There are a number of “reasons” for it – including the government vote, whatever. The reasons are always available after the fact.

Excellent move now, and where do we stand? We’re still below the 200 day moving average – which is somewhere around 4800 on the Nifty. So technically, we should hit somewhere around that before we start the slow grind downwards again.

We’re still going down, I think.

The U.S. problems aren’t topping just yet. From Calculated Risk, it seems mortgage rates for loans are now reaching the 7.8% mark for “jumbo” loans.

Some of these people could just about make a 0% interest payment (i.e. only principal) for the last two years. Now they are expected to pay principal + 7.8% interest. This has literally taken their monthly payments up 25% or more, and given that their houses have lost more than 25% in value, and they have very little or no down payment, these guys are bound to default. I remember reading that most “resets” – the end of the zero interest period – was set to June/July 2008.

This means this is the last quarter that the big banks are going to have “decent” results. Freddie Mac and Fannie Mae are fairly screwed; they have $5 trillion worth mortgages, many of which are defaulting, some say the hit may end up being nearly $1 trillion. (read the comments here). They have shareholder equity of some $80bn together – means they have like leverage of 60 to 1. The other part of the money is debt, some of which is held by China and Russia, who hold it as part of their forex reserves (in FannieMae/FreddieMac bonds).

To give you an idea of what a trillion dollars is – that is the GDP of India. That is more than the market capitalisation of all the stocks on the NSE, put together. Obviously that is a lot of money. The US has just passed a bill giving the government a blank cheque to save the GSEs (as the Freddie/Fannie types are called) – meaning the government can lend them more money or buy their shares. Either ways they aren’t going to let the debt get hurt – that means they will protect bondholders as much as they can. The stocks are likely to end up going to zero.

If that happens or not, the GSEs are going to be loath to take on more MBS or mortgage bonds. That increases the cost of carry for the banks who perhaps have hoped FRE/FNM would buy the mortgage bonds of the loans the banks carried – and the increased cost of carry will impact the retail interest rate, which means they are going to hurt the homeowner more – simply put, they’ll jack up rates, people who were ok to pay will suddenly not become ok, and thus, more foreclosures.

The other impact is a falling dollar. Not against the euro, which is as screwed as a region and a currency going forward. But against Japanese Yen, Indian Rupee and most importantly against the Middle east currencies. The US may be a great country but there’s no way it can literally double the national debt without flushing some value out of the dollar.

Inflation will soon no longer be a concern, I think. The issue will be deflation. And while I hope that concern is limited to the US, it is very likely to spread to Europe soon. This is going to be a bigger crisis than I thought – deflation is not easy to fight.

Given all this I have little hope that the Indian markets will stand out as a knight in shining armour. Our growth story needs a recession just to be a growth story going forward. But I am trying to brace myself for a lousy two years ahead, and would focus on “income” strategies rather than “capital appreciation”.

If you are reading this blog you are already the 1% of the population which is not going to be ultra affected – a recession affects the poor first, and then the affluent – and your biggest problem might be stuff like no one giving you a decent rate loan to buy a house, or the lack of enough shops in the mall nearby. But for many people it is likely to be a matter of survival, and in the political theatre of today I would expect even a violent impact – think of a “Sena” attacking anyone who seems well off. I hope it doesn’t get to that, but I am watching out for signs of right wing activity.

One thing I am very happy though. The stupid left is out of the government. Yay. Unfortunately it changes very little; this is like playing cricket without a crotch guard – you are focussed more on protecting your vitals than on scoring runs. We aren’t going to see much in the next year – perhaps a little here and there, but the big policy decisions will have to wait for the next round of idiots.

  • Anonymous says:

    >Good analysis. Anecdotally though, it seems like the herd has already given up on stocks. My trusty “overhear-people-in-coffee-shops” indicator was flashing a sell signal at 21,000 when all I overheard was people bragging about notional profits. Nowadays I hear them talk about FMPs, debt funds and even (gasp) liquid funds.

    I agree about your macro analysis, but maybe the stock market bottom is closer than it seems ?

  • Siddharth says:

    >Dead cat bounce?? Nope….>Leapt

    About recession, was talking with my friend in foundry industry from Kolhapur. He wa ssaying the orders has already been dried upto 25% and more problems with the electricity availability. Foundry sector is the first place to get hit, and can be a good indicator of whats in future?
    secondly farmers wont be happy if the monsoon doesnt brings good harvest. (If farmers dont have money and grains to feed anybody then!!) Good excuse for politicians to import grains with hefty commissions in swiss a/c's.

    just for info UK's chancellor Mr Darling said last week that he doesnt have any spare money to spend anymore?? Northern Rock must have sucked all that surplus??
    regards

  • Crick_Love says:

    >DOW took a huge cut last night and it is way below 11400 now. It is only a matter of time for it to head to 10k.. As I write this, Nifty is down 75 pts in Singapore and euphoria of UPA victory and left being out, is OUT. For all practical purposes, this rally is dead and we might see 3900 before July and 2900 in the near term..all IMO..and of course I have been dead wrong before.. As Deepak has been saying, I can stomach, one fast deep dive but prolonged agony is another story and we are headed there, inevitably. There might be the odd spell of good news but it will far outweigh the bad news !! As far as the bottom, don’t even attempt it – one will get million opportunities for buying at the bottom since there are going to be new bottoms, every 10 days

  • Kannan says:

    >Deepak,

    Nice analysis. The Rupee breached 42 mark today. Didn’t see the trend where Rupee going up when Sensex is failling before. Is it because of falling oil price?

    thanks

    Kannan

  • Px says:

    >Very interesting post this
    First what would be the impact of the external + internal problems in india

    What kind of strategy are u formulation / following other than ur systems trading? Do post more stuff on fundamental analysis and sectors / pics

    We have a drought looming ahead in India as the rains have almost failed this time – Mumbai is facing a water cut and e/c cut is looming large as thane vashi etc are already facing 5/6 hr cuts!
    My hunch is that Delhi Politicians will push more dole and freebees in an attempt to increase election prospects in the next 6 mths.

  • Deepak Shenoy says:

    >anon: good point 🙂 people are bearish. but the lack of noise isn’t perhaps as positive an indicator as too much noise is for a fall.

    Siddharth: Yeah, the economy is showing signs of weakness. the worldwide credit crisis is going to make things worse, along with a predicted drought and lack of power to cities.

    crick_love: thanks and yes, your points are sound.

    px: Nofundamentals. I don’t know why but I don’t feel its the right time for it…though one call I would love to take is a short to take advantage of weakness.