Global: Crash anatomy - and what to do about it (2)
Summary
A while back we suggested that October was going to treat markets badly. We were not too far off the mark: the start to November has not been stellar.
Last night, we attended an unusually hands-on dinner during which a very mature economist of a leading financial group (sorry, we cannot disclose) was telling us about this sub-prime mush. He was able to tack numbers on to it - and to give us a feel for when Wall Street well could crack.
We then go on to tell you how to save your money - and which sector in particular to keep avoiding.
Topics Covered
1. How deep is deep?
2. When will the Wall Street crack occur?
3. How to save money off this idea
Background
1. How deep is deep?
We are led to believe that the sub-prime (SP) mortgage market is "worth" about USD 1.3 trillion.
But that figure is misleading: it is only the tip of the iceberg.
Here is how such mortgages have been chopped and diced:
- The SP mortgages have been combined into Mortgage Backed Securities (MBSs);
- These MBSs, in turn, have been packaged into Collateralized Debt Obligations (CDOs);
- These CDOs have then been divided into tranches, whereby 80% are rated "AAA" and so on, with 4% being parked in the "BBB" lot;
- These BBB CDOs have been re-packaged into CDOs to the power of 2 (CDO2s) instruments, and
- These CDO2s, in turn, have been carved into various tranches: 75% of them are designated as being of "AAA" quality, and 4% gets rated as "BBB".
If you not confused, re-read the above alphabet spaghetti and get confused!
Logically, how can 75% of the CDOs rated "BBB" in step three all of a sudden get a "AAA" rating in the CDO2 instrument?
All that this means is that nobody can measure just how deep this dormant volcano is. Eminent Alan Greenspan states that USD 900 billion of sub-prime mortgages have been securitized into fixed income instruments, but that only "covers" step one in the above table.
2. When will the Wall Street crack occur?
We had forecast this October. Well, we were not too far off the mark, given end of month gyrations on Wall Street. But hardly a crash. So we have toned down our stridency, to "crack".
I asked when would all of this sub-prime mush turn into reporting realities. The economist hosting the dinner suggested that corporates' Q407 results would become public knowledge within three to four months, i.e. from February - March 2008. My guess is that the first quarter of 2008 will be particularly messy: this is when traders start discounting future occurrences. Once we get the first wounded reporting the extent of their damages, Wall Street will go wildly bearish. Add to this our view that this will worsen the The Economic Time™ in America even more, and you have plenty of downhill runs...
3. How to Save Money Off This Idea
Lighten-up on your US exposure. Except for tech stocks: as a Chinese friend of mine taught me at lunch today, these are like "consumer staples": people need tech such as search engines, regardless of what the economy does. You could argue that when things head south, search engine traffic heads north...
By sector, we keep advising to avoid banks. Also add to this: mortgage-related finance companies.
While we do maintain that America will fall strongly, buy on dips in China, Hong Kong, India and Malaysia: there, The Economic Time™ is all right.
