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More Pain Ahead

Published on September 17, 2008

More Pain Ahead

September 17, 2008

This is one forecast I want to be wrong. I would like to be wrong as this doesn’t paint a good picture of broader economy. If general economy is bad, it’s tough time for everyone including me and I don’t want to forecast tough times. This post is available to only those who are blog members (blog registration is free).

Here is how the chain started- First home prices’ bubble busted (still spiraling downward), two of the 4 solid wall street pillars who weathered big crises including the great depression, are now history, corporate profits are slowing, massive job cuts are being announced in “already tough” job market due to financial plus other lagging sectors and the stock market is sinking slowly which in turn will affect the consumer spending. That’s where my concern is. I gained more confidence in my hypothesis when I read similar views by respected Richard Russell of Dow Theory Letters.

According to him –

And I’m very much afraid that the next phase is going to be a pull back in spending, particularly discretionary spending, by the US public. Jobs will be difficult to find, the word will spread, if you’ve lost your job, you’re not going to find another one at the same level of pay (if you find one at all). This will have an impact on retail sales, and US imports (which will have international implications for the exports of foreign companies, remember, the US is buyer to the world). In this atmosphere, the big money, as I see it, will be made by wealthy speculators who will buy up foreclosed housings at bargain prices, often below the cost of replacement. Everything now depends on people being able to finance what they own, and this takes income and cash. The two rarest items around will be just that — cash and income. The great danger as I look ahead is that the bearish trends will feed on themselves. Frightened people dump their stocks for cash, the result is a sinking stock market. A sinking stock market further frightens people and pushes them to sell (“get me out at any cost”). When I tell people that the correct posture now should be cash and gold coins, they look at me as though I was crazy. That reaction makes me worry.

There is shortage of funds, everyone knows it and that’s one of the reasons Lehman Brothers was allowed to fail because China and others probably signaled that they wouldn’t put up money so easily especially after having their hands burned. By the way I still don’t understand why Bank of America will pay such a huge premium for Merrill Lynch? A smart business person knew that after Lehman’s failure you could have easily picked-up Merrill Lynch even cheaper than it was trading for. I can’t seem to find an intelligent answer; probably I am too naïve and they are smarter that’s why I am writing a tiny blog and they are raking millions at these companies even though their shareholder’s value is eroding day by day. Another respected fellow blogger Jim of The Kingsland report has even tougher views on this transaction-

We now despise Bank of America (BAC) following its purchase of greatly despised (by us) Merrill Lynch. They’re liars (not a revelation, I know). The new company would be a scam. On the conference call this morning BAC’s Lewis said they went through Merrill holdings “very carefully”. Huh? Later at the news conference Thain and Lewis said the “light bulb” moment flashed in their brains on Saturday to do a deal. Fascinating that BAC could go over Merrill so carefully in less than 24 hours!

He goes on to share Goldman’s view:

“Bank of America’s purchase of Merrill provides long term opportunity for accretion. That said the combined entity will be thin on capital as we estimate that pro-forma tangible common could fall to about 2.5%, while Tier 1 would be about 7.3%. This compares to a peer average of 4.2% tangible common and 8.5% Tier 1. On both metrics, pro-forma BAC would have the lowest ratio among peers. Moreover, while the deal may be accretive long term it also raises the cost of capital – consider BAC’s CDS spreads have widened and S&P has downgraded BAC senior debt. In addition, the need for a BAC shareholder vote presents risk to deal closing.”

Moving forward, here is an important piece of news that I would like you to pay some attention (though it hardly got any attention from mainstream media). According to a report from China daily, “China, which holds a fifth of its currency reserves in Fannie Mae and Freddie Mac debt, may cut the portion held in US dollars”, according to China International Capital Corp (CICC), one of the nation’s biggest investment banks. China held $447.5 billion of US agency bonds as of June 2008, according to the CICC calculations using disclosures by the US Treasury. It is likely to reduce the portion of reserves in dollar assets from the current 60 percent by purchasing more non-dollar assets with new reserves, he said.

There is just too much going on. If you are not sure making sense of what’s going on and can’t monitor the market close and can’t go trough the pains of losses, better stay out of the game. There will be lot of opportunities to make money again. Preserve your capital. Bear markets are not the easy ones to handle.
As there is a saying-

In bear markets, the winner is the one who loses the least.

Monday was a tough day with huge volume. These days may very well be dead cat bounce along the downward move. But then again, these are hard times and 200-300points has no meaning. Markets can literally move on any “significant” news.

Trade carefully, Trade Profitably, OP

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