Monday Morning Melt-Down, Global Edition

The Nikkei is at a 26-year low.

One quarter of a century’s progress wiped out in 12 months.  More importantly, an entire generation’s savings have been wiped out and that’s a ripple that will travel through the economy for quite some time.  Of course, it’s not just Japan, this is a global destruction of capital that is reaching a tipping point (as I noted in the weekend post) that can lead to a decade of misery.  In the US, people who were living off the interest or dividend payments from their retirement holdings are forced to liquidate them, alongside the hedge funds, as the monthly payments are no longer enough to pay the mortgage.  So the fixed income consumers cannot "ride out" this bear market – they are forced to sell, even if it is a bottom.

Also being forced to sell are carry traders, people who for years have been using the very low BOJ rates to borrow money and invest it overseas.  One side effect of the global meltdown is the relatively stable Japanese banks have caused the Yen to rise to a 13-year high and that cycle is fueled by the same carry traders who demand more Yen as they convert their rapidly depreciating foreign assets into something they can pay back the Japanese banks with.  Since the interest rates in Japan are near zero, we may be nowhere near the end of this cycle as investors are playing a very dangerous game where they have an asset that has lost 20% (pretty much any US stock or corporate bond) so they cash out 20% of it in order to make the low-interest payments in Japan while hoping the remaining 64% rebounds enough to put them back in the black.  Should the situation deteriorate further, suddenly the Japanese banks will be facing Trillions in defaults as the tail end of those investments are found to be wanting.

Meanwhile, the Japanese market – from a fundamental standpoint – is clearly oversold with the Topix Index (the broad market indicator) trading at 0.89 times book value.   That means the companies would be worth more if liquidated than what they are currently trading for!  “I would think the next big move is up, not down,” said John Alkire, chief investment officer, at Morgan Stanley Asset & Investment Trust Management Co. in Tokyo. “We are most likely at a phase in this cycle where greed will likely soon replace fear.”

This weekend, the G-7 finance leaders singled out the yen, saying its recent "excessive volatility" threatens the global economy and financial system. "We continue to monitor markets closely, and cooperate as appropriate," the statement said. "Some players had speculated before the market opened that governments may intervene as early as today, so the statement disappointed us because it suggests that authorities are still a few steps away from actually selling the yen," said Hiroshi Maeba, senior dealer at Nomura Securities. "Under these unusual market conditions, we know that authorities are concerned about the yen’s rise because everybody is concerned about it. What we need is an actual intervention."

The G7 announcement came out pre-market (midnight EST) and caused the spike in the above Nikkei picture but lack of actual action led to massive disappointment and a sell-off that had the Nikkei finishing the day down 6.4% (50% worse than the mid-day image) while the Hang Seng fell 12.7%, stopping at the 11,000 mark but generally saved only by the bell after a 5-day, 4,500-point (30%) decline.  Hong Kong’s drop came DESPITE an injection of $7.75Bn by their Central Bank.  "Funds continue to offload their holdings due to redemption purposes and this is not going to end in the near term," said Louis Wong, research head at Phillip Securities in Hong Kong.  The Shanghai composite also fell 7.35%, to 175 and only South Korea bucked the trend with a 0.8% gain as the Central Bank over there lowered rates by 0.75%, it’s biggest one-day decline ever.  In addition to the deepest cut on record to the main interest rate, the BOK also slashed its credit loan rate to commercial banks by three-quarters of a point to 2.5%. That special, low-interest rate is now sharply lower than the main rate, now 4.5%.  

European stocks fell near the 5% rule this morning and are skating along the 4% line ahead of the US open (8am).  The IMF is lending $16.5Bn to shore up the Ukraine but Spain’s unemployment rate continues to climb, now at a 4-year high 11.33%, up another point for the quarter.  Private-sector business activity in the euro-zone economy fell to its weakest level for at least 10 years in October, according to data from Markit.  The preliminary estimate of the composite purchasing managers index for the euro zone — a measure of total private-sector output — fell to 44.6 in October from 46.9 in September, the lowest level since the series began in July 1998.  "We are wallowing around in the sea of unknown. Until the capital market situation is eased and the money comes out of governments into the banking system we are not going to see anything different. Recession remains on everyone’s lips and is the top concern," said Howard Wheeldon, strategist at BGC Partners.

"It is difficult to see what could change the strongly risk-adverse mood in the market this week," said Sebastien Barbe, senior economist at Calyon. "A lot of uncertainty remains. Economic data this week should confirm a scenario of lasting recession in both the U.S. and EU and the bad news flow about the financial sector does not seem to be drying up."  Even Asia is not immune and economists are starting to use the "R" word over there as well.

One bit of bad news that is not going away yet is the multi-Trillion dollar fiasco in the CDO market (excellently summarized here by Money Matters) which threatens to swamp all possible bailout efforts with the sheer volume of potential liabilities, more than enough to crush any single bank or even government should the worst-case scenarios play out.  Our worst-case scenario in the US, as I said this weekend, is increasing job losses and, unfortunately, there is ample evidence that that tide is far from turning.  According to the WSJ: "A rash of new job data show the labor market is now the worst it’s been since the two prior recessions in 2001 and the early 1990s. One of the starkest indicators is that the number of people who have been unemployed for 27 weeks or more reached two million in September. That’s 21% of the total unemployed, and approaching the prior peaks of about 23% in 2003 and 1992. The prospects of these job seekers grow dimmer as layoffs spread beyond the financial, home-building and auto industries."

Also in September, companies saw 2,269 mass layoffs — in which at least 50 people are let go at once — more than at any time since September 2001. And while the unemployment rate is at a five-year high at 6.1%, a broader measure of weakness that includes people who have stopped looking for work or whose hours have been cut to part-time is 11% — the highest in 15 years.  The longer people are out of work, the more they rely on government help, which can create huge strains on public agencies.

Huge strains will also be placed on retailers this quarter as a BDO Seidman survey finds that companies expect same-store sales to fall 2.7% this holiday season despite 88% of the executives surveyed saying they plan to offer more discounts this year.   "Retail executives are expecting this to be the toughest holiday season in more than 15 years," said Doug Hart, a partner in BDO Seidman’s retail and consumer products practice. The pessimism is "pretty broad across all the categories," except at discounters, which typically do well in an economic downturn.  That’s WMT for those of you brave enough to buy a stock.  The 2010 $50s are $10.55 and you can sell the Nov $50s for $4.30 (earnings are 11/13), which is not a bad way to start a long-term spread.

It’s going to be a rough morning but keep in mind this is the first Monday in a long time that hasn’t been accompanied by some form of massive government bailout so – PERHAPS – it will give us a chance to see where the bottom really is as it’s been 2 months since Monday wasn’t the high point of the week and that is NOT a healthy market!  We’ll be hoping to, at worst, retest our lows and put in some kind of floor for the week at around 8,500.  It’s a pathetic level to have to hope for, but it sure does beat the alternative!  There is no change in our strategy, we are still bottom fishing until we do break below the lows – there’s a lot of bad news already baked into these levels and it’s finally time to see if we can hold it together without additional infusions of capital (of course, the Fed is widely expected to cut on Wednesday).

Already (9am) I see the futures improving.  Let’s hope that follows through and we are not the only bargain hunters out there.  The technical traders would love to see us make a bottom test but they were denied on Friday and they may be denied again today so it’s going to be very interesting this morning but there is nothing bullish about it until we get back over that 8,800 mark on the Dow and, of course, there is a lot of anticipation of a big Fed cut baked in.  There’s a lot of cash on the sidelines but is it enough to overwhelm the sellers as the month winds down?