March 13, 2008

Economy: Where We Go From Here

It's not good.

1.  I was wrong about the dollar, which continues to fall, but more important than laughing at me is understanding why I was wrong.  I could not believe that the Fed, the government, would allow bank closures, would allow the dollar to fall further by waiting too late to cut rates.  I was wrong.  I should have suspected, though, when in the summer the Fed unanimously agreed not to cut rates, seeing no danger to the economy-- they thought everything would be contained to subprime mortgages.

But any human on this planet knows there is nothing more recessionary than losing your house, except possibly losing your job and your house, or a government policy to kill off all daughters and losing your house.

So I made a bet in common sense, in pride.  Wrong.  No banks have failed yet, but it is generally assumed Bear Stearns is in real danger of evaporating.  You should probably hide your daughters.

2.  I was right about GOOG, 520 was the top.  Unfortunately, the PE is still 33, and has to fall to about 25 (see #5).  So another 20% drop in price is to be expected, though continued (but slower) growth will offset this.  See you at 400.

3.  Oil is too high.  It will fall fast and hard, by which I mean fast and hard.  Certainly there are long term demand concerns, which means we'll never see $50 again.  But when oil rises 20% but the refiners fall 20% (see VLO), that disconnect means that the oil price isn't related to use, but to speculation.  See you at $90.

4.  A good rule of thumb I just invented is that people will a spend little more for lattes than they will for gas.  I know Brazil is supposed to have a large and delicious crop in 2008, but I don't care.  I am drinking more coffee, and the Chinese are going to need more as well, if they're going to keep working to to put lead paint on all their exports.  Coffee is cyclical, so wait for a pullback, but see you at 175/lb (that's cents, yo.) 

5. You say, well, what about the $200 billion the Fed just lent out ?  Great.  Where was that money 6 months ago?  Here's how it plays out: you have $400B in bad loans.  Say that they end up being worth half, so $200B.  Banks leverage the money to loan, 5x or 10x, so that $200B loss translates to maybe a $1T that doesn't get lent out, that doesn't make it to the economy.  Experts have approximated this to be a fall in GDP of about 1.5% (pessimistically.)  Interestingly, as a bad as the housing market collapse is for some homeowners (Inland Empire), it is much worse for the banks/brokers, who (also) have to bear the burden of the losses.

See you June 2009.

(long GOOG call, refiners)


You are very seriously unde... (Below threshold)

March 14, 2008 2:40 PM | Posted by asphaltjesus: | Reply

You are very seriously under-estimating a couple of economic issues:

1. Banks failing
Bear Stearns has been rescued (nationalized) by the Fed, less so JPMChase. The Fed strong-armed the surviving banks because they all know the shock to their operations would be way, way more harmful if they let Bear Stearns fail. What's unclear is exactly how many other banks/funds/etc the fed have nationalized. Some transparency by the Fed is required here.

2. Asset Pricing
The fed's last action didn't inject more capital into the system. They became a lender of last resort for many more institutions than just the big banks. Will they pay the Fed back? Doubtful. Why would an institution want the debt of unknown quality or value they put up as collateral back?

Paying for the over-valuation of all kinds of debt instruments has just been shifted to the American people because the losses will be absorbed by the Fed. The Fed will bear the cost of discovering what these assets are actually worth when they finally find a buyer for them.

Alone's response: I mostly agree with you, except the Fed, by its slow reaction (and ongoing inaction) won't absorb all of those losses. We will.

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Spoke too soon: today it w... (Below threshold)

March 14, 2008 11:29 PM | Posted by Alone: | Reply

Spoke too soon: today it was announced that the govt, through JP Morgan, would bail out Bear Stearns. No, it won't work.

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That was fast. Bear Stearn... (Below threshold)

March 19, 2008 7:08 AM | Posted by Alone: | Reply

That was fast. Bear Stearns collapses; GOOG goes to 414; and maybe the dollar hit a bottom? Who knows. Fed decides to do what it should have done 6 months ago, and we may have bottomed. Seriously. Not that we're going higher, but at least we know where the bottom is. Though remember the old saying I just made up: there's no such thing as a triple bottom, only a failed double bottom.

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Considering the disproporti... (Below threshold)

March 28, 2008 4:47 PM | Posted by Joseph Bergevin: | Reply

Considering the disproportinate percentage of GDP represented by financials (which is a very recent phenomena), it's probably wise to assume the economy isn't going to impress anyone for a good while. Investment houses have wrung every cent out of cheap money that they could through extreme leveraging, cursory risk assessment, and innovative accounting. This worked for a while, but eventually their zeal for growth outstripped any real world ability to underlie the prices. Everyone has woken up from that party with a hangover and are swearing off the sauce for now. We've enjoyed the fruits of our next decade of asset appreciation within the first several years of that decade, and there's not much to do but wait out the rest of it without further gains (or deflate to the norm before that).

What fascinates me is that markets are human, and thus sufficiently unpredictable. Even though we've made a mess of things, the US still worries foreign investors less than, say, India or Brazil. We're a large country with a relatively long history of financial accountability, and people are prone to deal with the devil they know relative to one they don't.

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If you haven't already seen... (Below threshold)

April 2, 2008 12:35 PM | Posted by Lexi: | Reply

If you haven't already seen this, you may think it is funny, from The Friendly Athiest re: The Church of Google.

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