My other third is in Japanese equities, not something to brag about, I admit (Matt reminded me yesterday that the Topix index just hit a 26-year low). Incidentally, want to know where the Dow or the S&P; 500 was trading in 1983? Not far out of triple digits for the Dow, and not far out of double digits for the S&P.; If the Japanese equity market can retrace the whole 1980s bull market, why not the US as well?
Now I’m beginning to sound like Bob Prechter, who has long forecasted that the Dow would go back below 1000 (more on him below).
But the point I was trying to make in my last blog was that plenty of defaults are already priced into markets. The question is now how bad they are going to be, what recovery value debt holders will get and whether equity holders will be left with anything at all. And it won’t just be banks – the iTraxx Crossover index is telling us at current levels that over half the names in it will default, one prominent credit-focussed blogger is calling for a massive wave of commercial REIT defaults, insurance companies may be the next crisis point (incidentally, did you see that AIG just came back for its fourth chunk of government cash in five months?), automakers are basically bust already…and it looks increasingly as if sovereign defaults will be the credit crisis endgame.
So investors have to cope with the tricky task of working out whether the terrible news already implicit in credit spreads is bad enough, or whether things can indeed get worse. Incidentally, Marco Montanari, head of fixed income ETFs at db x-trackers in London, told me yesterday that they have seen large inflows into the long versions of their iTraxx credit ETFs over the last month as investors are betting on the former. Very few are invested in the inverse credit ETFs, which would profit if things get even worse, and which have been great performers over the last eighteen months. I’m not sure if that one-way sentiment is actually bullish for the credit markets, but that’s what the money flows have been.
To complicate things further you have governments intervening inconsistently, illogically, in fact in blind panic. Meanwhile, taxpayers are starting to get mighty annoyed at the prospect of decades of paying for the mismanagement of financial institutions.
So to succeed in the current market environment as an investor you need the skills of a hedge fund capital market arbitrage specialist, adept at valuing companies’ equity against preference shares, senior and subordinated debt, and government bonds, you need to be able to second-guess what foolish scheme the politicians will think up next, civil unrest looms, and you have to brave the worst economic data on record.
Now with all this dire news around you might become a true contrarian, say that things can’t get much worse and assert that we must be near an equity market bottom, or at least the start of a major bear market rally. In fact that’s exactly what “Dow 1000” Prechter said yesterday, apparently. I have a little pension cash to invest and I might top up my Japan position. But I’m still sticking with my bullion!