Stock Market Warning - Time is Short - Credit Crunch Crisis Does Not Abate

By: Christopher_Laird

I put out an alert to subscribers as to the following. Included are some additional comments.

After the Fed cut the discount rate Friday, and after the initial exuberance Friday and Monday in Asian and EU markets, the dust settles a bit. Then people look if they can see anything through the fog.

I am not surprised the US markets are flat, and certainly, this is not a confirmation of returning confidence, particularly after the Asian markets rallied 2 - 3% Monday (Sunday night here). They are rallying again Tuesday 2%. This is not convincing to me. 

I pointed out in the NL Sunday that time is very short for confidence to return to both credit and equity markets before there is a lot of forced selling on a huge level. Developments today in the US (Monday) suggest that nothing fundamental is happening to add more time for markets to stabilize - and improve sentiment- rather just more reports of losses in funds and banks and bailouts. The US market is only barely bouncing.

The markets are only pausing to see if a rebound comes – so they can sell out big. I have stated that I expect selling into strength this week. 

There are articles out that the expectation is that, even though the Fed and other central banks lower interest rates, the combination of very tight mortgage lending in the US - and things like Jumbo loans freezing (around 400K USD) which are privately underwritten (not government sponsored/insured like Fannie Mae, etc) will cause people not to get loans, even if they wanted to buy houses. 

That will just hammer the RE market more, cause prices to drop faster than they already have, and make lenders even less willing to underwrite mortgages - and so the cycle continues. Fear sentiments are spreading in all major credit markets and are not abating (as of Monday- at least as far as analysis of the present credit situation. The equity markets will eventually reflect this.

But, as time goes on, even only a day, more pressure to relent on the whole situation and cut losses builds, and this is world wide. At some point, things will snap totally, and we could easily see 1000 point down days in Asia and the US at least, and likely huge drops in EU markets too. We have not seen a real snap yet, only a moderate equity sell off. 

That snap could come in the next several months as relentless reports of losses by funds, institutions, banks accumulate, and sour what confidence remains. We are at the end stages of the 5 year world stock bull. The credit markets are contracting, and this was a credit bubble – in everything – of historical proportions.

As I have said, recent market drops have not represented the real state of the credit markets sentiments, but people are trying to see how bad things really are. After a period of time, perhaps not more than a few days, and upon more disastrous revelations of losses, things may rapidly progress downhill. There will be progressive revelations of new bankruptcies, huge losses, as we had today two new situations, a hedge fund in England (Solent), and more in the US (KKR financial) having to reveal gigantic losses and problems. I believe we are only seeing a pause in the equity sell offs.

This kind of news will continue for months, probably even over a year, (see the ARM reset schedule) and hammer what confidence the credit markets have left. They, the individual players in credit markets, will become shell shocked soon, wondering if they are next, and just stop lending across the board. They are already hoarding cash world wide in anticipation that their own credit lines will be pulled. This is one reason the USD is strengthening in this credit crisis.

In other words, a very bad prognosis for any recovery in credit markets, corporate, mortgage, and derivatives in general. There is a very long way to go down from here. 

There is a sense that the Central banks are now in a quandary about what more they can do .

Clearly, they can lower the Fed target rate, and the others follow suit, but so much damage has been done to the credit markets and their sentiment, that I believe the CBs have now lost control of the Entire situation, and ultimately a huge world recession and stock crash is Just inevitable - and likely this year. I expect them to lower the Fed target rate, there will be a stock bounce, but it will not last in the ongoing bad news of further mortgage derivatives losses, insolvencies, flight to cash to fend off insolvencies. Credit markets will continue to deteriorate. Then comes the bad economic statistics of layoffs, dropping GDP world wide, contraction.

I mentioned that, obviously, there was the possibility that markets could react very favorably to the Fed news Friday, but I think it is reasonable -looking ahead a bit - to say the Central banks still do not have control of the credit crisis much at all. Also, they are not quite sure what they can do. That is not good at all. (This is the sense that I get from reading many comments from writers about sentiment presently in the credit markets of all kinds). 

One of the most illuminating comments is that 'uncertainty' is the real killer of credit markets. Well, we have uncertainty in spades now. Ongoing revelations of losses, bankruptcies and so on will continue for months, and just scare any remaining positive sentiments out of the markets - and just halt lending and borrowing too. The central banks can offer money at lower rates, but if sentiment is badly hit in both lenders and borrowers, then that has no effect, credit and buying collapse, and we go into deflationary scenarios and inevitable market sell offs for months. 

Here is a great article on this "The modern financial world runs on credit, so if fear rises to a level 
where fewer are willing to lend -- and fewer are brave enough to borrow -- the situation can get a lot worse before it starts improving. In my opinion, we've entered that twilight zone and it will get worse and we'll see a torrent of foreclosures over next 12 to 24 months. The \"other shoe\" will be falling for a long time, so investors should stop waiting for the markets to \"calm down.\" Instead, they should fix the roof of their financial houses. \" MarketWatch Link

And another from Bloomberg - Markets Fall on Credit Concern Link

By Christopher Laird
PrudentSquirrel.com

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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