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Sunday, August 21, 2011

Market Thought... listen to the thunder

EU leaders, Listen to the Thunder.

I have been combing the web to see if there has been any chatter about progress with the situation in Europe.  Disappointingly there was SocGen's CEO who tried to give more rhetoric of health, and that the bank will show they are healthy during their 3rd Q results.  Unfortunately for Mr. Oudea his bank probably will not have until the end of the month to prove this.  Make no mistake, a run on his bank is happening, and the only thing masking it right now are the heavy reserves.

Then, we had Merkel who came out and said 'we will not hold policy based on markets'. Well, if she is going to say this, then they better have a plan to take care of the bank run that is happening.  The ECB is acting as temporary stability with respect to the sovereign debt market, but they will need to do more when SocGen gets nationalized.

IMO, the above is the most immediate concern for the market.  The culmination of the US debt downgrade, slowing global GDP and European bank run happening all at the same time (literally within days of each other over the last week and a half), has caused this market to collapse. Its just too much negativity to handle.  Lets take a closer look at three major issues.

1. US debt downgrade. IMO, this was and is bullshit. The US will never default on its debts.  The US has a very organized financial structure that will not allow for this to happen. The market fully understands and appreciates this, regardless of what one private company (that has already proven to be inept via their mortgage ratings) thinks. (Pushing down of the 10yr treasury yield proves this.) Also, local/state governments are acting responsible (with respect to fiscal concerns) by making cuts and paying their obligations.  The Federal Gov. is no different. Decomcracy is about debate, and finding an equilibrium. Although, the debate is hard to watch.

2. Slow global GDP. This should not have surprised anyone, and it sure was not surprising the market. Since mid-Feb the market was consolidating.  Two quarterly reports were seen, and market multiples compressed. The BRIC countries were actively taking steps to cool their over heating economies. I was active in highlighting these steps via my tumblr link 'shit happens'.   However, the global austerity by the developed countries is helping this effort, and the BRIC countries are over shooting to the downside. (most recently highlighted via Brazil's growth estimates)

Because the cooling down was successful, we will see a reversal of these efforts. (This was highlighted via China last week.) (However, it should be noted that growth is still happening. This is why the earnings of companies with secular growth trends will not be hit as severely as their multiples are suggesting.)

There has been chatter last week that emerging markets are great buying opportunities right now, but if anyone feels that way, they must also believe the US market is a buy as well, as the SP500 and BRICs are closely tied.

3. Europe. Before the potential bank run, there was sovereign debt concerns. The ECB was successful at calming the market, for the time being, by buying Spanish and Italian debt in the open market.  But once their was an indication that an Asian bank stopped overnight lending to a French bank, a real risk of a credit freeze started to spook the market.  Since then, we have seen evidence of a run, as highlighted above.  This is why the VIX has been staying elevated at such levels.

The top two concerns merit a full blown market correction, but the third is a systemic risk.  Hence the complete structural trend breakdown in the market.

To give credit to where credit is due, Europe has been acting on their sovereign debt concerns. Every country has been cutting spending, Italy even passed added cuts and tax increases to their wealthy. But obviously they are not out of the woods.

The concerning aspect of this EU bank run is that the banks will not be able to restructure sovereign debt as more capital exits the bank.  A bloomberg article over the weekend highlighted the EU banks need $600B to comply with Basel III, let alone get more capital to swallow a debt restructuring.

Europe is at a precipice to save their banks. Before this August, they were doing a good job at delaying and allowing their banks to store up capital, but that plan now is shot to hell.  Anyone willing to put money into equity markets right now is assuming the EU will not allow their banks to cause a credit freeze.  That is a big uncertainty, and causing HUGE discounts.

After seeing the damage a credit disruption can do after Lehman, I think political leaders will prevent it at any cost. (IMO, America's way of apologizing to the world for letting Lehman go under, was to pay out 100% to counter parties from AIG, not to save Goldman.)

How they handle it is up to them. Whether they infuse capital from the stability fund or nationalize the troubled banks. But the market will force action over the next two weeks.

If a credit freeze does not happen, and with the global economy chugging along (as indicated by SAP CEO and corporate spending still taking place), we are at some interesting entry points.  I took a look at a few stocks I trade, and applied current trailing multiples and their usually discounted multiples to see where they should be trading two quarters out. (look at 'sheet 2' under 'target price by end of year')

- IBM keeps a trailing PE of 12.7, its target price will be 168.4 (If a PE of 14 is allowed, its price will be 185.)
- AAPL keeps a trailing PE of 14, its target price will be 418. (If a PE of 16 is allowed, its price will be 477.)
- AXP keeps a trailing PE of 11.5, its target price will be 45.85. (If a PE of 14 is allowed, its price will be 55.58.)
- GOOG keeps a trailing PE of 16, its target price will be 528. (If a PE of 19 is allowed, its price will be 627.)

Hopefully, over the next few weeks, the world can flush out the fear of a credit freeze.

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