“It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.”
--Gordon Gekko, Wall Street
2007, through all the twists and turns and credit burns, will be remembered as the year when perception caught up to reality.
In the spring, when sub-prime mortgages first entered the mainstream lexicon, the powers that be assured us they were contained
Over the summer, as the credit contagion spread, global central banks flooded the market with liquidity with hopes of drowning out an emerging chorus of concerns
As the leaves turned, our collective attention shifted from the problem itself to those we would hold to task. From Bear Stearns
(BSC) to Merrill Lynch
(MER) to Citigroup
(C), culprits were fingered as the blame game swept the Street
And now, as we reflect on what was and wonder what will be, investors are hoping the Grinch that stole Christmas will quietly orchestrate many happy returns
As we enter the final seasonal stretch of 2007, I thought we should circle back to the ten themes we mapped in January
to see how they played themselves out:Theme 1, Dollar Debasement: While a near-term rally in the dollar is possible as a function of negative sentiment, the broader trend of nationalization should continue as foreigners, particularly petrol-nations, look to denominate assets in local currencies or Euros.
The greenback began the year with a 2.5% rally, reversed lower to challenge decade lows and lifted anew starting last month (it is currently 7% lower for the year). Meanwhile, seeds of nationalization have sown in Venezuela, Bolivia, Ecuador, Russia and the Middle East.
Through the lens of "dollar devaluation vs. asset class deflation," a weaker dollar is necessary to buoy global asset classes. Displacement risk exists, however, as foreign holders continue to tire of dollar-denominated returns.
The recent bounce was a function of extreme negative sentiment as everyone from rappers to supermodels turned their back on the dollar
. The genesis of further strength may be the need to pay down debt, which is denominated in dollars and would therefore spur demand.
This evolution continues into 2008. Theme 2, Leadership Shift: Large cap should outperform small and mid-caps, on a relative basis, and energy and metals will take the leadership baton from tech and financials.
As we enter the home stretch of 2007, large cap issues are handily beating their small-cap brethren.
Energy and metals enjoyed a stunning year as financials, which are at the heart of the credit storm, took it on the chin and probed multi-year lows.
Technology performed well, albeit with narrowed leadership driven mostly by Google
(AAPL) and Research in Motion
While I still believe that energy will overtake the financials as the top weighting in the S&P
, we must watch this migration through the lens of the dollar. If the greenback continues higher, pharmaceuticals and consumer non-durables will likely enjoy relative success at the expense of commodity plays. Theme 3, The Elasticity of Debt: It's no secret that debt has powered the most recent leg of our economic "expansion" at the expense of savings and wage growth. That tipping point may come to bear as upwards of $2 trillion in adjustable rate mortgages reset in 2007.
Credit issues were front and center in 2007 as the housing market slid down the slippery slope. Fannie Mae
(FNM) and Freddie Mac
(FRE), which facilitated the velocity of money, were poster children for these problems through both their price action and accounting irregularities.
The tipping point has arrived but massive intervention is attempting to buy more time. Central bank liquidity injections, discount window collateral shifts, adjustable-rate mortgage freezes and working groups on financial markets have all been pawns in the greater game of moral hazard
While sub-prime was the first domino to fall, more ominous issues loom as the debt bubble unwinds. The other side of zero-percent financing is upon us and that could manifest through credit card delinquencies, auto loans and other forms of consumer credit deterioration. Theme 4, The Hump Back Market: The market action was fantastic into the home stretch of 2006 as positive data points were embraced and bad news was shrugged off. That momentum could continue into the front end of '07 before giving way to the weight of an unsure world.
The momentum of 2006 continued into the beginning of the year and investors enjoyed a healthy first half. And while it appears that the S&P
will all finish higher once the dust settles, the markets have traded begrudgingly since the summer.
We foresaw the weight of the unsure world and I think it’s safe to say that it has arrived. While it’s impossible to know how our path would have progressed if such aggressive policies weren’t in play, I would venture to guess that the final tally wouldn’t be as friendly.
The bulls must now take the baton of intervention and claim their fame as they’ve been given a window of opportunity and a fresh canteen of liquidity. If they can’t eventually carry the load on their own, chances are that the Hump Back Market my turn into a broken-back camel. Theme 5, The "Haves" vs. "Have Nots": We've seen this dynamic proliferate in societal circles and can expect it to manifest in the hedge fund community. If I were trading hedge funds as an asset class, I'd be long the quality and short the quantity. Remember when Fortress Investment Group
(FIG) came public?
Widespread speculation was that a parade of private equity behemoths and hedge fund deities would tap the marketplace. Indeed, as we settled into the summer
, M&A activity was on a trillion dollar run rate and Blackstone
(BX) was ready to take center stage.
We posed this question at the time: Is this the last bastion of liquidity, one that could potentially spark a blow-off phase or echo-bubble, or a clarion call that those in the know are beginning to bottleneck at the last remaining exit?
The answer seems somewhat intuitive with the benefit of hindsight. Theme 6, Commodity Consolidation: Merger & Acquisition activity should pick-up in the hard asset space as smaller niche players are absorbed in a global effort to scale.
This theme continues to play out, highlighted by the March closing of the Freeport-McMoRan
(FCX) - Phelps Dodge
(PD) alliance and BHP Billiton’s
(BHP) attempted acquisition of Rio Tinto Group
We've also seen a number of smaller alliances, which I expect to continue as players grasp for share in this underinvested arena. Theme 7, Life Stage Marketing:
Just as social networking was the catch phrase of '06, look for life stage marketing within sector verticals to emerge as the media play in the coming year.
I figured I was going to be early with this one. Still, it is through this lens that we continue to build Minyanville as a financial fitness franchise from the ABC’s to the 401(k)’s.
Whereas other media properties cut a horizontal swath across select demographics, we’ve gone vertical in our approach. This allows us to craft content for the particular needs of our audience as they climb the learning ladder and improve upon their skill-set.
With the beta launch of Minyanland
, the world’s first interactive gaming community to teach children how to earn, spend, save and give, we have now secured both sides of our content vertical.
I expect to see this trend to proliferate and manifest across a variety of industries. Theme 8, Rate Reversal: While the equal-weighted commodity index continues to tickle all-time highs and there is pressure from abroad to raise rates, look for the FOMC to lower interest rates this year to offset ARM resets and a slower growth environment.
Through the first half of the year, the FOMC tried to posture for higher rates to appease foreign holders of dollar-denominated assets. As the credit contagion spread, it became clear that they needed to shift course and tackle issues much closer to home
They now find themselves pushing water with a fork as we have inflation in things we need to power, feed, educate and insure the world and deflation in things we want, such as cell phones, plasmas and laptops.
This has set the stage for stagflation which, while gaining mindshare, remains under most mainstream radars. Theme 9, The Real Real Estate Market: As most folks monitor homebuilders as a proxy for real estate, expect the broader commercial and residential markets to accelerate their softening phase.
Through the first half of the year, the slippage in the residential market was bifurcated with the "haves" keeping a persistent bid to the high-end as the "have nots" struggled to make ends meet. That dynamic remains in place as the middle class gets squeezed from the overall equation.
As the residential malaise continues, commercial real estate has recently showed signs of strain. Centro Properties Group,
the fifth-largest owner of shopping centers in the U.S, saw it's share price fall 90% in two days as it struggled to refinance short-term debt obligations a few weeks ago.
While we'll see trading rallies in the homebuilders, I expect secular headwinds to continue both on the residential and commercial sides of the slate. And if the stock market starts to stumble, the heretofore insulated high-end will deflate in kind as a function of our finance-based economic interdependence.Theme 10, The Return of Volatility: The flush of global liquidity has dampened the relative momentum of individual stocks as reflected by implied volatilities. 2007 should see an uptick in overall market volatility.
Volatility, as measured by the VXO
, rose almost 250% at its highest point in 2007 before falling sharply in the last month. Even still, it has effectively doubled since the year began. It's the result of years of cumulative compression that was furthered by a rash of premium sellers across the equity space.
I like to use a very simple analogy when discussing volatility. Investors chasing an illiquid stock will run the price, thus creating volatility. Conversely, a flood of liquidity should be expected to dampen market volatility as supply (demand) enters the marketplace
Over the last few months—and during the last weeks in particular—global central banks have infused massive amounts of liquidity into the market, which is reflected by the sudden decline in implied volatilities.
The question going forward for volatilities and, by extension, the global financial marketplace is two-fold. First, how long it will take for investors to wean themselves off the central bank liquidity crutch? Second, and entirely more profound, what if they can’t?
It's a lot to digest as we round out the holiday season and eyeball a fresh year of flickering ticks. I don’t profess to know the answers to what lies ahead but I can offer, with confidence, that capital preservation
, debt reduction
and financial intelligence
will serve us in good stead.
On behalf of the entire Minyanville family, we wish you the healthiest, happiest and most mindful of holidays and a prosperous 2008.