David Merkel has a very interesting post up on where about how maximizing enhancing yield on fixed income investments.
Within that post is a very interesting discussion on who the equity/credit cycle works:
1. After a washout, valuations are low and momentum is lousy. People/Institutions are scared to death of equities and any instruments with credit exposure. Only rebalancers and deep value players are buying here. There might even be some sales from leveraged players forced by regulators, margin desks, or “Risk control” desks. Liquidity is at a premium.
2. But eventually momentum flattens, and yield spreads for the survivors begin to tighten. Equities may have rallied some, but the move is widely disbelieved. This is usually a good time to buy; even if you do get faked out, and momentum takes another leg down, valuation levels are pretty good, so the net isn’t far below you.
3. Slowly, but persistently the equity market rallies. Momentum is strong. The credit markets are quicker, with spreads tightening to normal-ish levels. Bit-by-bit valuations rise until the markets are fairly valued.
4. Momentum remains strong. Credit spreads are tight. Valuations are high, and most value-type players have reduced their exposures. Liquidity is cheap, and only rebalancers are selling. (This is where we are now.)
5. The market continues to rise, but before the peak, momentum flattens, and the market meanders. Credit spreads remain tight, but are edgy, and maybe a little volatile. This is usually a good time to sell. Remember, tops are often a process.
6. Cash flow proves insufficient to cover the debt at some institution or set of institutions, and defaults ensue. Some think that the problem is an isolated one, but search begins for where there is additional weakness. Credit spreads widen, momentum is lousy, and valuations fall to normal-ish levels.
7. The true size of the crisis is revealed, defaults mount, valuations are low, credit spreads are high. A few institutions and investors fail who you wouldn’t have expected. Momentum is lousy. We are back to part 1 of the cycle. Remember, bottoms are often an event.
The full piece is well worth your time thing morning . . .
Impossible Dream, Part 2
Aleph Blog May 13, 2011
Kicking the Can to the End of the Road By John Mauldin May 14, 2011 > The Biggest Bubble of Them All Ireland is a Different Story Kicking the Can to the End of the Road Philly, Boston, Trequanda, Kiev, Geneva and London > The Biggest Bubble of Them All This week we turn from…Read More
Category: Think Tank
Lots of interesting reading for the weekend: • Goldman’s O’Neill Sees Investors Missing Stock Rally on ‘Black Swan’ Fears (Bloomberg) • Facebook’s Stealth Attack on Google Exposes Its Own Privacy Problem (Wired) • Gloom and Doom, and How to Profit From It (Deal Book) • The Auto Industry Bailout – Still Debated But Worth Every…Read More
Posted in the Think Tank you will find a fascinating lawsuit filed by the FDIC. The Federal Deposit Insurance Corp. has accused Lender Processing Services Inc. of Jacksonville, Fla., and CoreLogic Inc. of Santa Ana, Calif., of causing $283.5 million of damages to the former Washington Mutual Inc. for failing to provide oversight of appraisal….Read More
Jill Bolte Taylor got a research opportunity few brain scientists would wish for: She had a massive stroke, and watched as her brain functions — motion, speech, self-awareness — shut down one by one. An astonishing story. Brain researcher Jill Bolte Taylor studied her own stroke as it happened — and has become a powerful…Read More
I have long been in the Swedish camp when it comes to food (meatballs with lingonberries) women (tall blondes) and financial crises (prepackaged bankruptcy, no bailouts for banks). While the Japanese have lots to offer (Sushi, Anime, and reliable cars), their approach to financial panics was to nationalize all of the debt, prop up insolvent…Read More
FusionIQ CEO and Director of Equity Research Barry Ritholtz says brace yourself for years of anemic growth as the economy recovers from a debt binge. He also slams so-called” deficit peacocks” who strut their stuff on trimming the budget but don’t really tackle the problem.
5/13/2011 3:59:49 PM
Succinct summation of week’s events: Positives: 1) UoM confidence jumps back to average level of the year as one year inflation expectations dip to 4.4% from 4.6% 2) 5 month low in mortgage rates leads to 9% jump in refi’s and 6.7% rise in purchase application 3) Germany and France lead solid Q1 GDP growth…Read More