Good Evening: As 2008 bumps, grinds, and otherwise limps its way to a close, various asset markets can be expected to trade in narrow ranges. The economic news continues to be startlingly poor, but the faintest rays of hope may be dawning in the credit markets. Since credit led the way both up and down during this wreckage-strewn cycle, it will have to show real signs of recovery before junior securities in the capital structure (a.k.a. equities) can truly regain their footing. The Fed’s decision to go “All In” will help, but management at Credit Suisse may have found a way that could, if widely adopted on the Street, put private hands to work along side so many public ones.
Whether here in the U.S., Europe, or in previously unstoppable Asia, the economic news continues to disappoint — only to be met with continued policy responses ranging from interest rate cuts and stimulus packages to outright bailouts. Unfortunately, policy moves effect changes in economic activity with the proverbial long and variable lags. Market participants are therefore stuck in a purgatory-like investment climate. Wanting to believe in the future, they are faced with a doubt-laden present. Today’s economic statistics in the U.S. are a case in point. Consumer sentiment offered a mildly positive surprise, with a nice uptick in “future expectations”. But new and existing home sales reports for November were frightfully weak (see Merrill’s take below). Since housing has been at the epicenter of the great market shakeout of 2008, the news of falling volumes and falling prices — despite falling mortgage rates — bodes ill for those straining to see a V-shaped recovery on the horizon.
And yet, markets don’t always oblige those looking to trade off of current information. There is no disputing that the data we’ve seen since the November 21 bottom in stock prices has only become more dire, but here the S&P sits, some 16% above those lows. Perhaps equities are holding in relatively well because many large players (hedge funds and mutual funds) are largely on the sidelines, leaving bargain hunters to duel it out with tax loss sellers. It’s also possible, however, that a nascent halt to the 18 month long decline in certain credit-related securities and a fall in equity volatilities is also causing investors to refrain from reaching for too many sell tickets (see below).
As long as the S&P 500 remains above 841 (the October 10 lows) on a closing basis, then most investors will probably continue to give equities the benefit of the doubt. But, given that those doubts remain considerable, any close below 841 accompanied by a spike in the VIX back above 50 might just give the sellers the upper hand into year end. After opening a bit higher in New York this morning, stocks went sideways to lower for most of the rest of the session. The major averages went out not too far from their lows of the day, and most of them declined by 1% or so. Treasurys were mixed after an “OK” 5 year auction, while the dollar index was little changed. Commodity prices, too, were mixed, as each major sector saw advances interspersed with declines. The CRB index slipped 0.5%.
So what, aside from the Fed saying “buy ’em” to various and sundry forms of private indebtedness, might help restart the borrowing and lending upon which our capitalist system so heavily depends? The answer is a long one, but it boils down to confidence. If private investors start to feel the downward spiral we’re still experiencing will be somehow be arrested, then they might start nibbling at all the values on offer in the world of credit. This process might — repeat, might — be gaining a toe hold right now. Not only is the TED spread contracting, but some of the publicly traded, credit-oriented funds I track have stopped going down. Some are even on the rise. If these upticks continue, and if more securities “clear” by moving from weak hands to strong ones, then the stage will be set for a rekindling of actual lending and borrowing.
One small source of optimism on this front came from last week’s announcement by Credit Suisse that it would move some troubled assets off its books and place them into a pool funded by employee bonuses (see below). Securitization, the process of pooling income producing assets and issuing layers of interest bearing liabilities against them, took flight until mid 2007. One of the flaws inherent in the securitization process is that middle men between mortgage borrowers (homeowners) and their lenders (the capital markets) didn’t have a stake in the risks they were bundling and peddling. By effectively shifting some of these troubled assets off their balance sheet and into the employee bonus pool, Credit Suisse has perhaps offered a clever (if only partial) solution to what currently so ails many financial institutions. The details (i.e. pricing at transfer) still need some work, but this solution essentially is the old TARP — writ small. Think of it: formerly “toxic” assets move off the CS balance sheet and are replaced by the cash once set aside for employee compensation.
Voila! CS cleanses its balance sheet and employees get a stake in a long term pool of assets for which “marked to market” means little. Aside from helping to heal the bank, Credit Suisse is in fact also helping to return some appreciation of risk among its senior employees by mandating the retention of said risk among those who previously received bonuses for creating these securities in the first place. It’s brilliant. The publicly funded TARP Wall Street once clamored for can now be a product of their own, private creation! Never has force-feeding senior employees a heaping helping of their own cooking been such a good idea. Of course, this laudable example won’t matter much unless other banks copy Credit Suisse and set about cleansing themselves in similar fashion. Then again, as the credit crisis of 2008 proves only too well, aping one another is a Wall Street tradition. Maybe there is hope yet! Jack McHugh