Enzio's Clock

Background

1. Trigger 1 : Monoline downgrades or disposals

US markets rose in the last 30 minutes of trading on Friday because CNBC announced a possible Ambac bail-out. Wow, now we really are getting movements based on "fundamentals", would you not agree? Sounds to me like the market is starting to grab at straws?

No, I do not mean to lump the possible bail-out candidates, including Citibank, in with a bunch of straws. But I do know that these groups are thinking of bail-outs in order to protect their own books - and to make money.

All of which suggest that if they do take over, then the likes of Ambac will have to dispose of lots of its "assets".

If it does not shed its junk, it either gets downgraded - or there is no bail-out. After all, why would the groups volunteering to bail Ambac out want to be saddled with the very issues that has made Ambac a bail-out candidate?

2. Trigger 2: Earnings downgrades

We are not alone in suggesting that with The Economic Time™ clearly worsening in America, the earnings of her corporations have to slide. All the more so once the market accepts that stagflation is well underway. So quite where otherwise really bright analysts at major sell-side houses come up with a 15% increase in corporate profits this year beats me. Other than resources companies and perhaps consumer staples and health care, I don't see that number as turning into reality.

Instead, what I suggest is that at some point, some great U.S. company that derives the bulk of its earnings in the United States itself announces disastrous profits prospects to the market. The market, happily running on "straws" such as "planned" bail-outs, panics because of this slam from left field.

3. Trigger 3: Non-US bank crashes

Another scenario is that non-U.S. banks start looking sheepishly into eyes of the press when they start announcing how their greed has exposed them to sub-prime gyrations.

We have just edited and revised parts of our recent piece on credit recessions. As a rule of thumb: when Japan's banks cleaned-up their balance sheets from 1/98 - 7/03, and when German banks did this from 9/00 - 3/04,

• lending contracted for four years, and during this time
• the stock market fell by 40%

On 30th December 2007 we suggested that you short the U.S. and international financial sectors. Stick with this advice. There have to be more "Northern Wrecks" out there waiting to happen... Then there are sharks circling the likes of Mitsubishi UFJ Financial Group, Credit Agricole, SocGen, ANZ, IKB.... Just don't become a distressed asset yourself by leaving your money in such houses!

4. The S&L false parallel

"Ah", you say, "but what about the US Savings and Loan (S&L) crises? During these, the U.S. stock market actually tripled from 1986 - 1995: the S&P 500 index zoomed from 212 (1/85) to 616 (12/95). So shouldn't I be buying into market weakness?" We want to study this more, but can give you five immediate reasons why the stock market went up - not down:

• No excess demand for money. In Japan, bank lending contracted for about five years, bottoming-out at an annual rate of -4.7% in July, 2003. In Germany, lending contracted by about four years, bottoming-out at an annual rate of -3.1% in April, 2004. But during the S&L crisis, aggregate bank lending never contracted! Lending growth decelerated, but it kept crawling along. Indeed, it "bottomed" at an annual growth rate of +2.5% in May, 2002!;
• No international dimension. We are unaware that the US S&L crises caused global waves. But, we have warned for some time that non-US banks are getting caught staring in the headlights, and just mentioned this as a possible trigger to the next market tumble. We are surprised with what equanimity the globe has taken bad news emanating from such prestigious houses as UBS, Credit Suisse and the like. But the real mess has to be with the less prestigious houses, and news on their avarice will start coming out of the closet, the worse that The Economic Time™ gets globally;
• Government bail-out. At the time, the U.S. government bailed the S&Ls out. No such thing today under the Bush administration. Yes, he has introduced an election-year-driven stimulus package of $140 billion, but we are unaware of any government bail-out proposals today. Thus, the private sector is providing damage control - and will be driven by profits, not by policy and politics. This suggests, as with credit recessions, that the sub-prime mess will inflict greater collateral damage than the S&L crises possibly could: this time, the private sector is in charge;
  
• Small potatoes. The ultimate cost of the bail out was US$ 160.1 billion in 1996 dollars. Earlier on we suggested that the total cost of the current mess in America alone is in the region of $ 1 trillion (consisting of sub-prime: $325 billion + credit cards: $325 billion + credit default swaps: $250 billion). So: how does the S&L government bail-out in today's dollars compare to the current bonfire of the avarice? Twelve years have elapsed from 1996 - 2007. If we compound the original bail-out cost of $160.1 billion by each year's average, annual inflation rate, we arrive at a "current" dollar value (of the 1996 S&L bail-out) of $218 billion . That is one fifth the current value that we have calculated for the current sub-prime mess, and
  
• "Dark matter". My friend John Berthelsen of AsiaSentinel mentioned this to me only yesterday, so put it and his fine online newspaper on your radar screen. According to Wikipedia, "In astrophysics and cosmology, dark matter is a hypothetical form of matter of unknown composition that does not emit or reflect enough electromagnetic radiation to be observed directly, but whose presence can be inferred from gravitational effects on visible matter." Well, according to John, "dark matter" represents stocks - quoted and not quoted - that investment banks trade amongst each other and outside of the market. So the market does not know what is going on in this "speak easy" i-bank world.Draw your own parallels to its lack of "electromagnetic radiation" and its pervasive "gravitational effects"... hello sub-prime mess!

So don't take cold comfort from the S&L crisis. There are at least five good reasons why the market kept rising: Today's Goliath dwarfs yesteryear's David!

Thus, we stick with our long held view that Prof. Kindleberger's "panic" stage will set in by this June. Until then, our Economic Time Fund's market short (SDS:US) will keep under-performing. So what? We are just watching greed morph into fear...

5. How to Make Money Off This Idea

1. Always consult your financial adviser first.
2. Buy what our fund owns, a short ETF on the US market: "Ultra Short S&P500 ProShares", SDS:US
3. Keep shorting these financial sector ETFs:
• In America: "Financial Select Sector SPDR", XLF:US
• In Germany: "i shares DJ Stoxx 600 Financial Services DE", SXFPEX:GR