Posted on 11/19/2002 4:29:57 PM PST by rohry
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Market WrapUp for the Week Week in Graphs Storm Watch Geopolitical News Energy Precious Metals Raw Materials Tuesday, November 19, 2002 Headlines & Indicators Trouble Brewing in Venezuela Oil & Terrorism in the Middle East
If attacked, Iraq may choose to destroy its oil fields. During the Gulf War Iraqs army set fire to Kuwaits oil fields. It took almost a full year to extinguish the oil well fires, removing 2 million barrels of oil per day from production. Rebuilding the industry took another three years. In addition to attacking facilities, the worlds oil flows could become disrupted through bottling up or attacking oil flowing through the worlds choke points in the following locations: Straits of Hormuz, Suez Canal, Bosporus Straits, and Malacca Straits (not shown). There have been conflicts between states and terrorist actions in these regions that have been steadily increasing over the last five years. In 1995 there was a conflict between Yemen and Entrea over control of the shipping lanes around the Greater Hanish Island. Terrorists have several options at their disposal including explosives, weapons of mass destruction, and chemical and biological weapons. In the words of Neal Adams, an oil industry firefighter, Terrorism has no rules and, as such, cant be defined by a society based on rules. Neal Adams new book, Terrorism & Oil, is a warning of the risks that now confront the oil industry, which is the lifeblood of western economies. It is a highly recommended read for financial professionals and most Americans who take cheap energy for granted. The book will be published shortly in December and is included in the FSO Current Reading list. Sector Breakdown? Greenspan Speaks on International Risk Management International financial issues have so engaged us at the Federal reserve over the past year. [Translation, crises from Enron, WorldCom, Argentina, Brazil, and now Venezuela.] The development of our paradigms for containing risk has emphasized dispersion of risks to those willing, and presumably able, to bear it. If risk is dispersed, shocks to the overall economic system will be better absorbed and less likely to create cascading failures that could threaten financial stability. [Alan, please review J.P. Morgans derivative book. Risk has become concentrated in the hands of a few key players in the U.S. -- Morgan, Citigroup, and Bank America.] The broad success of that paradigm seemed to be most evident in the United States over the past 2 1/2 years. Despite the draining impact of a loss of $8 trillion of stock market wealth, a sharp contraction in capital investment and, of course, the tragic events of September 11, 2001, our economy is still growing. Importantly, despite significant losses, no major U.S. financial institution has been driven to default. Similar observations pertain to too much of the rest of the world but to a somewhat lesser extent than to the United States. [$8 trillion in losses is viewed as a success. No mention of the housing bubble or mortgage bubble that replaced the stock market bubble. The fed, in Alans view, is incapable of knowing when bubbles exist.] The wide-ranging development of markets in securitized bank loans, credit card receivables, and commercial and residential mortgages has been a major contributor to the dispersion of risk in recent decades both domestically and internationally. These markets have tailored the risks associated with such assets to the preferences of a broader spectrum of investors. Especially important in the United States have been the flexibility and the size of the secondary mortgage market. Since early 2000, this market has facilitated the large debt-financed extraction of home equity that, in turn, has been so critical in supporting consumer outlays in the United States throughout the recent period of cyclical stress. This market's flexibility has been particularly enhanced by extensive use of interest rate swaps and options to hedge maturity mismatches and prepayment risk. Financial derivatives, more generally, have grown at a phenomenal pace over the past fifteen years. Conceptual advances in pricing options and other complex financial products, along with improvements in computer and telecommunications technologies, have significantly lowered the costs of, and expanded the opportunities for, hedging risks that were not readily deflected in earlier decades. Moreover, the counterparty credit risk associated with the use of derivative instruments has been mitigated by legally enforceable netting and through the growing use of collateral agreements. These increasingly complex financial instruments have especially contributed, particularly over the past couple of stressful years, to the development of a far more flexible, efficient, and resilient financial system than existed just a quarter-century ago. [The offloading of risk on to the financial markets is not discussed. The double-digit growth in derivatives, the concentration of that market in just a few hands, the expansion of the debt of GSEs is seen as "innovation," not as a risk.] However, compared with decades past, banks now have significantly more capital with which to absorb shocks, and they employ improved systems for managing credit risk. In conjunction with this improvement, both as cause and effect, banks have more tools at their disposal with which to transfer credit risk and, in so doing, to disperse credit risk more broadly through the financial system. Some of these tools, such as loan syndications, loan sales, and pooled asset securitizations, are relatively straightforward and transparent. More recently, instruments that are more complex and less transparent--such as credit default swaps, collateralized debt obligations, and credit-linked notes--have been developed and their use has grown very rapidly in recent years. The result? Improved credit-risk management together with more and better risk-management tools appear to have significantly reduced loan concentrations in telecommunications and, indeed, other areas and the associated stress on banks and other financial institutions. [Once again the offloading of credit risk through the financial system on to the portfolios of pension funds, insurance companies and in hedge funds is considered prudent. Tell that to Calpers which lost hundreds of millions in WorldCom and Enron.] The market for credit derivatives has grown in prominence not only because of its ability to disperse risk but also because of the information it contributes to enhanced risk management by banks and other financial intermediaries. Credit default swaps, for example, are priced to reflect the probability of the net loss from the default of an ever-broadening array of borrowers, both financial and nonfinancial. As the market for credit default swaps expands and deepens, the collective knowledge held by market participants is exactly reflected in the prices of these derivative instruments. They offer significant supplementary information about credit risk to a bank's loan officer, for example, who heretofore had to rely mainly on in-house credit analysis. To be sure, loan officers have always looked to the market prices of the stocks and bonds of a potential borrower for guidance, but none directly answered the key question for any prospective loan: What is the probable net loss in a given time frame? Credit default swaps, of course, do just that and presumably in the process embody all relevant market prices of the financial instruments issued by potential borrowers. Price trends of default swaps have been particularly sensitive to concerns about corporate governance in recent months. The perceived risk of default of both financial and nonfinancial firms has risen markedly in the wake of company-threatening scandals, though levels remain moderate for most. [No mention of widening credit spreads or rising swap premiums. Next the warning.] Derivatives, by construction, are highly leveraged, a condition that is both a large benefit and an Achilles' heel More fundamentally, we should recognize that if we choose to enjoy the advantages of a system of leveraged financial intermediaries, the burden of managing risk in the financial system will not lie with the private sector alone. Leveraging always carries with it the remote possibility of a chain reaction, a cascading sequence of defaults that will culminate in financial implosion if it proceeds unchecked. Only a central bank, with its unlimited power to create money, can with a high probability thwart such a process before it becomes destructive. Hence, central banks have, of necessity, been drawn into becoming lenders of last resort. [Who ultimately pays for it?] If private financial institutions have to absorb all financial risk, then the degree to which they can leverage will be limited, the financial sector smaller, and its contribution to the economy more limited. On the other hand, if central banks effectively insulate private institutions from the largest potential losses, however incurred, increased laxity could threaten a major drain on taxpayers, excess creation of money by the central bank, or both. In the end, we would be faced with a severe misallocation of real capital. In practice, the policy choice of how much, if any, extreme market risk should be absorbed by government authorities is complex. Yet central bankers make this decision every day, either explicitly, or implicitly through inadvertence. Moreover, we can never know for sure whether the decisions we make are appropriate. The question is not whether our actions are seen to have been necessary in retrospect; the absence of a fire does not mean that we should not have paid for fire insurance. Rather, the question is whether, ex ante, the probability of a systemic collapse was sufficient to warrant intervention. Often, we cannot wait to see whether, in hindsight, the problem will be judged to have been an isolated event and largely benign. [Benign? I rest my case for systemic risk. What is needed here is a one-arm economist. Read the complete text yourself. link ] Todays Markets Within the market natural gas stocks, drug, defense and consumer stocks rose; while retail and tech stocks took a drubbing. Volume came in at 1.32 billion on the NYSE and 1.62 billion on the NASDAQ. Losers beat out winners by 18-14 on the NYSE and by 19-14 on the NASDAQ. The VIX inched up by .25 to 31.36 and the VXN continues to fall dropping 2.57 to 45.52. The drop in the VIX and the VXN, declining volume, and a falling advance/decline line indicate the weakness in this current rally. You need to have strong breadth and volume in order to have a sustainable rally. Both have been conspicuously absent in this rally. The CBOE put/call ratio has also been falling showing growing complacency. Outside the NASDAQ, the S&P 500 and the Dow have failed to surpass their November 6th and 7th highs. Even the NASDAQ has tried three times and failed to penetrate resistance at 1425. Momentum has been steadily declining, which is not a good sign. More so when you consider that a half point rate cut by the Fed and a Republican victory in the election has failed to generate much of a response in the markets. This is evident in the charts of the S&P 500 and the Dow. The NASDAQ may also be joining this trend with yesterday and todays breakdown. This time of the year is seasonally a strong period for the market. However, there remain no major catalysts to move stocks higher. Whats next? Maybe the Fed will start buying stocks. Keep your eyes on the dollar, gold, the CRB and the bond market. Overseas Markets Japan's Topix stock index declined as Mizuho Holdings Inc. and UFJ Holdings Inc. plunged to record lows on concern the government will seize the nation's weakest lenders. The Topix closed at an 18-year low for the third day in four. The index's 5.2% drop this month, the world's worst in local-currency terms, has eroded the value of banks' shareholdings and made it more likely lenders will need a bailout after new rules for counting bad loans are outlined this month. The Topix lost 0.8% to 817.09. Bond Market |
Funny, Alan warned us numerous times that the stock market was overvalued. There is no housing bubble, except maybe in a few specific locations.
It's shop until you drop around here. Car traffic is horrendous. Stores are packed. A rising tide of optimism toward ANWR oil development and the natural gas pipeline. Is there a fiscal crisis at the home level? Doesn't look that way.
Keep an open mind.
Richard W.
If the federal reserve is stealing so much wealth, why don't you just buy some bank stock a get a piece of the action, afterall the member banks own the federal reserve.
Besides the irrational exuberance comment Greenspan made when stocks were about 7,000, Greenspan repeatedly warned about the over-value of the market through March 2000.
You are just not looking at the big picture. It is deficit spending and devaluation of the dollar that is killing us.
Bank shareholders are no different than other holders of paper assets. Being a little investor means nothing. The real money is either in management or the hot money that sells (Enron/Global Crossing) and leaves the little guy holding the bag.
Richard W.
More recently, that nitwit said that he couldn't even recognize a bubble. Old "Boom and Bust" is a man for all occasions -- a real CYA type of guy. While he is warning of high valuations, he's pumping more liquidity into the economy.
Richard W.
What does that have to do with 'the currency fiat system is stealing your wealth'?
......these charts surprised me...I would have thought WMT and HD would have been doing well considering the times....HD is especially puzzling....seems like folks would want to tackle home improvement themselves rather than calling a contractor.....I was in Home Depot on Sunday and they featured massive displays of new power tools for Christmas.....
As always thanks Rohry, and good luck to all! [especially us ants]
Stonewalls, who is going to tackle our dripping kitchen sink this week.
It may not be a bubble after the style of the Florida real estate bubble of the 1920s. However: (1) Given how little equity many "home owners" really have a 10 to 20 percent decline would have a sizeable percentage of them upside down, on fire and unable to sell without coughing up a bunch of cash; (2) A slight up tick in interest rates would push housing afordability down big time [for the consequence see "1"]; (3) Demographics are no longer on the side of the homeowner ... soon enough boomers will want to unload their mini mansions; (4) Fannie and Freddie are both getting some well deserved scrutiny and without piles of new housing credit the housing market is in deep doo doo; and (5) Can't miss investments at some point always miss. :<)
I'll bet you were never very good at "fill in the blank" exams, were you?
Richard W.
Are they real shoppers or just lurkers?
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