I'm all at sea

[sassa]

In The Australian today(18/08) Terry McCrann says-Hugely importantly,neither our RBA or the Fed has any intention of compromising good monetary policy by cutting the official rate to bail out the imprudent or the greedy.That's absolutely critical to emerging from this(sub-prime mess) healthy and ready to go.
The Fed cut the official rate and immediately the markets react very favourably in both Europe and America.
So,is this an unhealthy move that will have future implications to inflation and growth of the economy in America and impact on the world markets as a whole?

George Magnus at UBS in the London Times today(19/08) predicts that the recovery on Friday may stabilise for a week or two.......it is almost fair to say that the Fed is powerless to arrest the trend of the deleveraging of the markets.This will spawn a long tail of problems and casualties.The fall could be 20%-30% in the equities market.
Albert Edwards of Dresdner Kleinwort estimates there is a 40% chance of a recession in the U.S.
Citigroup analyst Keith Horowitz says-the credit crunch could cost JPMorgan Chase about $1.4b.of second half profit because of loans it cannot sell.
Horowitz claims that JPMorgan is stuck with $40.8b.of LBO debt while GoldmanSachs is holding $31.9b.
JPMorgan declined to comment on the report published on July 26.The situation is likely to have worsened since the report was put out.

 

[theasxgorilla]

ASXG

Do I have to join up to read that link? Could you give us a rundown?

Oliver has been around for a while. His longevity in the industry is proof that being wrong doesn't hamper your career.

I must have cached login creditials, I thought it was publicly accessible. He's got little about himself in his profile. It was the job title that got me:

* Head of Investors and Chief Economist at AMP Capital Investors

I bet he attracts quite an audience at dinner parties.

 

[theasxgorilla]

Could some of the posters here please critique the article by Dr. Oliver instead of just calling him a muppet.

He has an enormous vested interest in having investors keep their money in the market. Investors always look to words of wisdom and specific indications about what will happen next from authorities like Doc Ollie. The facts stand that he has as little clue about what is going to happen next as the rest of us...that he has the guts to put his forecasts in the public domain with numbers and dates is admirable, for the courage it takes if nothing else. Notwithstanding, forecasting is Muppet territory.

 

[ADoyle]

He has an enormous vested interest in having investors keep their money in the market. Investors always look to words of wisdom and specific indications about what will happen next from authorities like Doc Ollie. The facts stand that he has as little clue about what is going to happen next as the rest of us...that he has the guts to put his forecasts in the public domain with numbers and dates is admirable, for the courage it takes if nothing else. Notwithstanding, forecasting is Muppet territory.

Thanks for taking the time to reply asxg,

By that definition a few of the doomsayers here might be similarly categorized then.

I agree that he has a vested interest and was bound to come down on the positive side but he does make some valid points about the similarities and differences to the scenario in '98 in my opinion. Whether he gives the risks appropriate weight or not would appear to be the debateable but at least this is an easily understood potted summary of the current situation without the hysteria that some 'authorities' both amateur and professional are prone too ATM.

 

[ghotib]

Thanks for link-an educating article.One thing perplexes me.Gittins(quote)-"It( Reserve Bank or Fed) lowers rates when it wants to encourage demand."
The Fed lowers the discount rate at which Banks can borrow.Banks are there to lend to individuals,companies,investors(hedge funds,dare I say it)etc.Do they pass on the borrowing rate cut to their customers thus fueling inflation?

I think that's right, but we don't always call it that. The Reserve Bank's charter is to keep the rate of inflation (i.e. the rate at which the economy is growing) within a range - lower than the range is just as much a problem as higher than the range. If the rate of growth is too low, the Reserve cuts interest rates so that money costs less and more can be spent. The effect is to fuel inflation, but it's not generally called that until inflation gets near the Reserve's upper limit. Till then it's encouraging growth.

Somebody please correct me if I'm wrong. I'm finding lots of unknown unknowns at the moment

Ghoti

 

[dhukka]

Could some of the posters here please critique the article by Dr. Oliver instead of just calling him a muppet.
It seems a well balanced read with a conclusion drawn from arguments on both sides.
BTW this is my first post and I would like to thank all contributers here for their input, it it much appreciated.

I think one of the biggest problems I have with this article is the idea that stocks are not expensive based on historical comparisons of forward P/E's. It has been a generally accepted practice to use forward P/E's - that is earnings one year out in determining relative market values since the 1980's.

The BIG PICTURE has a post today with a graphic from the Wall Street Journal showing that the P/E of the S&P500 has not reached the levels of 1987 or 1998.

However as this article demonstrates the notion that stocks are reasonably priced based on forward P/E's is grounded on floored assumptions: Below is the guts of the conclusion:

Now, to the issue of P/E ratios based on forward operating earnings. As noted above, it's clear that forward operating earnings are generally much higher than the record level for trailing net earnings to-date, and of course, record earnings are always equal to or higher than raw trailing earnings.

Investors are used to the idea that “normal” P/E ratios are typically in the range of 14 to 16. But as Cliff Asness of AQR has repeatedly stressed, those norms are based on raw trailing earnings. If you calculate P/E ratios based on earnings figures that are higher, you clearly obtain lower P/E ratios.

As it happens, the long-term historical norm for the P/E ratio based on forward operating earnings would be about 12.

It gets worse. Currently, profit margins are at the highest level in history, which further reduces the P/E multiple we observe. If investors wish to use that observed P/E ratio as their standard of value without normalizing for profit margins, they should be aware that they are implicitly assuming that profit margins will remain at current levels indefinitely.

That assumption is hard to support. Historically, profit margins have been highly cyclical. But it's important to understand the argument here. I am not arguing that stocks are vulnerable because profit margins are going to come down, so earnings are going to come down, so stocks are going to follow earnings lower. No. There is virtually no correlation between year-over-year movements in earnings and year-over-year movements in stock prices. The argument isn't about the near term direction of earnings.

Rather, the argument is about the long-term valuation of stocks. If an investor is going to use the current level of earnings to determine the reasonable price to pay for a long-term asset, it had better be true that those earnings represent a normal and sustainable level of profit. You wouldn't buy a lemonade stand by extrapolating the profits it earns in August.

The following chart presents the ratio of forward operating earnings to S&P 500 revenues (net profit margins are even more volatile).

You'll notice that prior to 1995, there were only a few instances when operating profit margins exceeded 8%. At those points, prior to the late-1990's bubble, the forward operating P/E for the S&P 500 averaged just 8. That's not a typo.

Investors appear eager to “scoop up” so-called “bargains” on the belief that stocks are “cheap relative to bonds.” All of this is predicated on the belief that profit margins will remain at record highs, that the Fed Model is correct, and that P/E ratios based on extremely elevated measures of earnings should be evaluated based on norms for much more restrained measures of earnings.

That's not investing. It's speculation. And it's speculation that runs entirely counter to historical evidence. While an improvement in market internals might provide reason to speculate modestly on the basis of market action, there is no investment merit in current market valuations. Again, we do not need stocks to become “fairly valued” or undervalued in order to remove most or all of our hedges, but in the absence of reasonable valuation, we do need constructive market internals (short of extremely overbought or overbullish conditions).

Look at the composition of S&P 500 earnings. Financials currently make up about 25% of the S&P 500 market capitalization, but close to 40% of the earnings. Wages and salaries as a fraction of U.S. corporate profits have rarely been lower. Irresponsible lending and suppressed labor costs have been strong contributors to S&P 500 earnings in recent years thanks to a massive leveraging cycle – financial profits exploded, while wage demands stayed low because it was easy to spend out of home equity withdrawals and strong real-estate gains. But these are not permanent factors, and it is dangerous to value stocks as if recent profit margins will endure in perpetuity.

Based on daily closing prices, the S&P 500 has not even experienced a 10% correction, yet the recent decline has been characterized as if investors are acting “like the world is about to end.” This is not the pinnacle of human irrationality, but in fact, quite a shallow selloff from a historical standpoint. The fact that Wall Street is branding it otherwise is evidence that investors have completely forgotten how deep the market's losses can periodically become.

Hussman puts out a note each week which is always interesting reading

 

[wayneL]

I think one of the biggest problems I have with this article is the idea that stocks are not expensive based on historical comparisons of forward P/E's. It has been a generally accepted practice to use forward P/E's - that is earnings one year out in determining relative market values since the 1980's.

The BIG PICTURE has a post today with a graphic from the Wall Street Journal showing that the P/E of the S&P500 has not reached the levels of 1987 or 1998.

However as this article demonstrates the notion that stocks are reasonably priced based on forward P/E's is grounded on floored assumptions: Below is the guts of the conclusion:



Hussman puts out a note each week which is always interesting reading

Well said that man!

 

[numbercruncher]

Great article dhukka, id actually read the same one some where recently, its a good heads up.


Seems everythings leveraged now a days hey, P/E multiples included

 

[wayneL]

Check short treasury yields:

It was the biggest decline in Treasury Bill yield since World War II (there is no charts of that period). It’s 65 year record that we saw today