Tuesday, April 22, 2008

If confusion is the first step to knowledge, I must be a genius. Larry Leissner

If Mr. Leissner is right I sure am a genius!

The confusion on my part does not actually go on the long-term picture but more on the short- and medium term pattern.

The fact is that the market consensus has moved to expect Fed to be hiking by 10 bps in one years time from now, while still betting 25 bps in next weeks meeting just to safe guard the economy.

No, my confusion, goes to the pure fact of me being a Libertarian through-and-through although after listening to Soros, Kaufman and others I am beginning to see "clouds on the laissez faire horizon".

Looking back at the last 20 years and really since 1987 Soros is absolutely right this has been the biggest credit binge ever - the whole system was built on the fact that credit was readily available and if there was a crisis Greenspan and his merry men came to the rescue; 1987, 1991, 1997, 2000-2001 .....and now in 2008.

The banks created business models which took advantage of the free-flowing credit and doing the so called financial engineering (talk about contradiction in terms!) they told the investors and public at large that they had invented a money machine. Obviously now we all know, that yet again, this was not the case. The mark-t0-market effect was not duely calculated and compounded. (Read UBS story in FT this week)

Let me give you an example;

I bought a house in 2001 for let's say 5 mio. DKK, took out mortgage based on the valuation on 90% - then I kept the house for 3 years, now the "market" told me it was worth 15 mio. DKK - right.....but surely the mortgage value would be something like initial cost (5 mio) plus inflation x 2, plus replacement value plus average disposable income/ Houseprice maximum ? But no the mortgage value is and was based on the "market value" of it - fair ?

No, a tangible asset can not continue to go up merely because the market "clears" the price higher, there must be fundamental fair value around which the loan valuation is based otherwise we end with a market which is self feeding both on the upside and on the downside.

I would even argue that logically my "quick-and-dirty price" is more logical than a house rising from 5 mio to 15 mio. in 3 years? Nothing fundamentally argues for this being correct ? Am I wrong? This example is one of 1000s but a true one!

If you follow me so far - then, however, if the "market" is not the correct pricing mechanism then what is ? A bunch of useless central bankers? or some other STATE CAPITALISTIC enterprise?

Neither, the "market" needs to smarten up and make sure it does not compound positive and negative movements outside the scope of fundamental value.

Warren Buffet, Jim Roger, George Soros will all tell you the best deals they ever did was based on good fundamental value, not market timing, if that is the case then surely we got some way to for this NEW CAPITALISM to go back to normal again?

I probably argued myself into a hole, my point here is;

Every time the "market" has had trouble the central banks or governments have bailed out the system, this time it may be different. Fed has little ammunition in the bag except for doing Carry-On movies with business as usual, but the banks is in a position where IF they get their balance sheet in order they will move towards my valuation model based on FUNDAMENTALS, which mean they will lend out less and more expensive.

That's the real paradigm shift here - the credit bubble is in process of being de-leveraged - the new world is one where there has been power shift to the savers; i.e the Middle East and Asia, who will have less of a strategic angle on the US and Europe as future export growth for them is being hammered by two unavoidable factors;

1. Lower global growth - if credit is less then growth is less.
2. Rising de facto cost of producing as there "workers" demand bigger and bigger share of production cost.

If you don't believe me then check the two worst performing market this year? China and Vietnam both down more than 40% - sign of the times?

I am very open to discussion here, but the above issue is one which bother me big time, as I believe the old regime and "rules" of trading is being thrown away... and it is time to look at the world from 10.000 feet and with more than day to day glasses.

The good thing here begin, if the market moves towards normalisation on credit creation and lending standards we are in for less volatility and better growth long term as the world again allocates capital to the HIGHER MARGINAL UTILITY - and not as now to dead financial instruments in some alphabet soup no ones understand. Hopefully this will also mean that the talented young people of today will stop applying for jobs in funds like mine and move on to change the world to a better place dealing with real issues like;

Demograhics, the quickly rising population
Food, lowest production to demand in history
Energy, alternatives more needed than ever

Strategy;

FX: Still some EURUSD long, but starting to built reversal trade - if the market is right about FED being done on downside there is risk of dramatic out of the blue correction in EURUSD. My friend Drew Baptiste, Morgan Stanley, warns me it could biggest in the last 1-3 years, but new low in US dollar is ideally needed.

Still long MXN - best performing stock market, long term growth - like it....

JPY - long - still think its matter of time before new lows is coming - the anti-risk trade I know and its costly, but......

FI: Given up on upside for now - think mean reversion still the game. My model turned bullish FI last two days on mean reversion - let's see how it plays out.

EQ: Short versus the 1400-05 major trend line - may work may not - but in it.....

COM; Long grains - what a ride - that vol for you.

MTD: down like 70 bps.

More later in the week more direct market relevant.

Go Liverpool 2night.....!

Steen

2 comments:

Stig said...

Just a thought...
You are talking about a powershift of tectonic proportions...the savers will be the winners.
I agree on that. But I think (not done thinking yet) I disagree on the geographics..

The savers (in todays "equilibrium") is in the Middle East and Asia, (main value items : energy,
production and people). So the rest of the world (mostly) is the other side of the equation! My
main problem is that it is not a steady state system, changing one side will impact the other.
If we (in DK/EU/USA/RUS/JAPAN/ANZ) consume less we will use less of everything... ergo ... the
savers will be "less" savers.

So the problem is valuation - in terms of real BASIC value.

Energy : Middle East - oil/gas , immigrants sending back money.
Production : Asia - items, immigrants sending back money.

If "we" start to scale back (and we will do - demographics,debt,isolationism), we will
still have something the rest of the world need - food! If people (here) is laid-off they
tend to use less energy og the price of (unskilled) labour will likely fall. The cheap
networked (and subsidised) system of globalism will be hit by less volumne and
therefore leading to higher prices pr. unit transported.

I am about to start to reading "The Shock of the Old" ISBN:978-1861972965 ...I think some
answers can be found in that - the basics of a society have changed that much, at least we have some framework to fall back upon...


- you asked for a discussion just mine 25 øre.


Like you blog.

Best regards.
Stig.

Saxo Macro said...

Stig + love your thinking ...can u contact me direct on sj@saxobank.com pls