June 2007

What happened this week:

  • Panic at CDO markets
  • Panic at junk bonds markets
  • Panic at ABX.HE markets
  • Panic at CDX markets
  • Strangely, no panic at CMBX markets yet
  • First signs that already announced LBO deals are cracking
  • Failure of Blackstone IPO
  • Secondary market for CDO is drying up
  • Executives at New York-based S&P, Moody’s and Fitch say they are waiting until foreclosure sales show that the collateral backing the bonds has declined enough to create losses before lowering ratings on some of the $6.65 trillion in outstanding mortgage-backed debt
  • Savings rate fell to -1.4% in May, while it was firmly above -1% in Q1. I suppose people depend on their investments and savings for spending. Watch out those investments as S&P500 is cracking

What to watch next week:

  • It’s hard to track how fast the CDO crisis unfolds and how badly it will hit. I usually watch CDS charts on markit.com as a shadow of what’s going on
  • Stocks broke many technical indicators this week. I suppose the Q3 will start on the wrong foot 🙂

This is how it looks like:

ABX-HE-A 07-1

Or like this:


This is a panic splash, now wait when the wave comes, later

Fed decision to keep rates at 5.25% with accompanied text “Moreover, the high level of resource utilization has the potential to sustain those pressures” could be translated into human readable form as:

We’ll cut rates as soon as unemployment goes above 4.8% or so

The total market cap of outstanding credit derivative instruments is estimated to be over 30 trillion dollars. Credit default swaps are a substantial part of this market, though it is not totally clear how to measure the market cap of CDS, as when the CDS is initially issued no money are changing hands, the protection seller just signs his electronic name on the contract.

This is why watching CDS is extremely important and gives timely warnings. This is our favorite residential mortgage ABX.HE index:


We are well below February panic levels. Then corporate CDS – CDX.NA:


And finally commercial real estate CMBX-NA:


The last week losses are pretty substantial. For example, ABX-HE-A 07-1 lost about 600 bp in one week, while the coupon is 64bp. It means about 9 years of income are lost in 5 days. Of course, the magnitude and speed of the collapse is less than the February panic, but absolute levels where CDO are traded now are impossibly low.

I like catchy titles – but yes, what I’m presenting here is the most important chart out there (click to enlarge):


What it shows is the ratio of total return of commodities spot prices by the total return of a basket of treasury bonds.

You can say that this is an ultimate inflation/deflation metric. Commodities measure inflation, treasuries are the best during deflationary periods. When the trend is up – it is inflation. When down – deflation.

We had a brief and violent deflationary period from October 2000 to November 2001. Then we had a long and clear inflationary period from November 2001 to June 2006. The most strong market rally started around April 2003 – exactly the time when the 300 DMA crossed up through 500 DMA. Then short and violent deflation from July to October 2006.

Then, what all market pundits told us, we started the next inflationary trend, which culminated in June 14, when the inflation index jumped through 300 & 500 DMA.

What I’m saying it was just a bull trap. Today is the day when the ratio dropped back down trough 300 & 500 DMA. Give it another two weeks and 300 DMA will cross down through 500 DMA, starting the next violent deflationary period.

It’s hard to say if current condition is closer to December 2000 or April 2001, but I do not expect the history to repeat itself exactly each time.

What is clear is that the immediate future of economy and markets must rhyme with 2001 and 2002 more than with any of the past 10 years.

Fasten your seatbelts and enjoy the ride! 🙂

The stock price just fell below $31, which is an IPO price. Everyone who invested money at private placement are in the red and all their money are locked, they are not allowed to sell.

I think Blackstone is a king of junk. They own over 50 corporations and they issued hundreds of billions of junk bonds to finance those acquisitions. And they have to pay the interest.

What’s next? I don’t think Blackstone is doomed, they raised good cash at IPO and they will use it to pay the bills. But what happens next is a dramatic restructuring and cost-cutting in all those 50 corporations, which employ (as I recall) over 200,000 people. We’ll probably see 50,000 layoffs pretty soon, which is a lot.

I just read an article that is trying to predict the future directions of S&P 500 index. The enormous work made by David Petch will probably give you a much better than coin flip chance to invest properly. I would say 60% chance. But there is a 40% chance to lose.

I look to this slightly different. The S&P500 index is composed of 500 great companies. Or maybe 450 great companies. They are doing all sort of things: from mining metals to sitting on portfolio of investments. Some of them are on track to find cure for cancer or find gold in Oklahoma. No matter what the state of economy is, that kind of accomplishment will benefit that stock a lot. It could be enough to move the whole index above some key resistance point and trigger another rally, even if economy is doing very bad at the moment.

So what I mean is that I’m not very sure the chart of any major index will give you a clear picture on where we are going. If you need to find a road you may climb a big tree. But if you fly to the moon you may get a little bit too much of information to find that road.

I think you get a little bit more of timely information if you look at the charts of sectors within and outside S&P500. How financials are doing? Transports? Telecoms? Small banks? Junk bonds? Plotting those sectors against S&P500 could be much more informative than just looking at $SPX alone.

Good luck!

Addition: For example, Google shows a lot of strength. This stock has its own reasons to rise, no matter what is the current state of economy, most likely because it is anticipated that Google is taking business from Microsoft. Besides, as someone said on capitalstool.com: Pigmen use GOOG to prop-up fraudexes.

So, instead of looking at $SPX (S&P500), I would rather look at the new index, S&P499, or $ABG – which means anything but Google.

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