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No Credit for Financials, Part 1


And the stock market will be next.

This is the first installment in a 2-part series. Part 2 can be found here.

The chief lesson of the Depression should never be forgotten. Even our liberty-loving American people will sacrifice their freedom and their democratic principles if their security and their very lives are threatened by another breakdown of our free enterprise system. We can no more afford another general depression than we can afford another total war, if democracy is to survive.

-Agnes E. Meyer, U.S. Journalist (1953)

"Are we there yet?" is about as common a phrase as one can imagine. We've either said it or heard our children ask it during a long car trip. Obviously, this piece isn't about car trips, but about the secular economic and market cycle that we're currently living through. Many say that we've hit bottom in equities, and that the worst of the credit crisis is behind us. Everyone's entitled to their opinion; I've certainly made mine rather clear over the past few years, particularly of late.

When I survey the economic landscape and business owners, review economic data, and study the credit market, I continue to come up with the same answer: We're not there yet. In fact, I've never seen the credit market, economic data and the stock market at such odds in my career.

What I mean by that is this: Given the data and given the state of the credit market, the stock market is the most over-valued it's been in my career.

And yes, that includes 2000, when the secular bear market in stocks began. At least in 2000, the credit market was operating normally, many stocks were actually cheap, the wonderful world of Credit Default Swaps (CDS), Collateralized Debt Obligations (CDOs) and other esoteric securities were in their infancy.

So, even adjusted for all this, I'm the most risk-averse I've been since entering this business in 1981. Note that I'm not bearish just to be bearish; I'm an optimist at heart. But the data laid out in front of me is so pervasively bad that we have no choice but to be cautious.

At Atlantic Advisors, we remain nearly devoid of equities, as we have been since the post-Bear Stearns rally. Sure, we could miss a rally going forward, but, as absolute-return investors, we're okay with earning fat coupons on GNMAs.

At Atlantic, we may actually express the view in a long-dated put-option position, or in some other bearish position, and always with defined risk. So when I ask myself, "Are we there yet?" -- where "there" means the point at which we can take on loads of risk -- I continue to get a resounding NO.

I look forward to the day that we can. Bull markets, even for cautious guys like me, are an awful lot more fun than this!

Inflation and Interest Rates: Why the Disconnect?

We've seen year-over-year consumer prices (CPI) and producer prices (PPI) -- including food and energy -- soar of late. But Treasury yields have remained stubbornly low. I may not agree with the market's assessment of where Treasury yields sit, but as they say, "The reaction to the news is more important than the news itself."

Year-over-year CPI sits at 5.6% while the 10-year Treasury sits at 3.84%, for a real return of minus1.76%, the lowest it's been since the late 1970s. Year-over-PPI sits at 9.2%, producing a "real return" of minus 5.36% - also a multi-decade low.

Click to enlarge

But there certainly must be a reason why Treasury yields remain stubbornly low. In the graph above, note that the red line (10-year minus CPI) tends to act inversely to the level of CPI itself. Perhaps the market's telling us that CPI has peaked and is about to reverse course - and even turn negative.

Perhaps the aversion to credit is forcing more and more money into Treasuries. Even more likely, as foreigners recycle our deficit in our Treasury bills and notes (they now own nearly 58% or all marketable Treasuries), one can make the case that supply is shrinking.

Considering that foreigners are slowing their purchasing of corporate bonds after getting killed by them in the last year or so, one can see why Treasury yields remain stubbornly low. I'm not the type to argue with the market and short Treasuries just because they appear expensive. Rather, I respect the price action.
No positions in stocks mentioned.

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