I hope you were strapped in for the week-long rollercoaster ride that began after the Federal Reserve’s interest rate announcement on Tuesday.
The 25-basis-point rate cuts failed to satisfy the market and the Dow’s 300-point drop proved it. In fact, investors showed a strong distaste for anything remotely risky — stocks and high-yielding currencies plunged, the yen rallied, and the commodity-dollars (Canada, Australia and New Zealand) sank.
Investors finally gave up hope that liquidity would return.
The Markets Practically Shouted,
“We Wanted a 50-Point Cut!”
Then came Wednesday. Even before U.S. markets opened up the day, breaking news energized traders’ moods: A complexly orchestrated scheme involving five global central banks had been worked out.
The scheme, coordinated between the Federal Reserve, Bank of Canada, Bank of England, European Central Bank and Swiss National Bank, is to lend out $40+ billion in separate auctions at rates significantly below the Fed’s discount rate.
Investors initially hailed this plan as the solution to all the market’s problems. They figured banks would no longer be humiliated by relying on the Fed for bailout money … no longer would financial institutions be reluctant to lend money to consumers and businesses … and no longer would the threat of a U.S. recession breathe down our necks.
But the attitude quickly changed from euphoria to gloom. Reason: Everyone stepped back to reality and concluded …
The Problems Run Far Too Deep
For Central Bank Ingenuity to Solve!
Banks have gotten themselves into trouble by investing in complicated bundles of bad debt. And even though central banks intend to direct their organized bailout right where the biggest threats exist, the proposed plan — $40 billion plus a few other perks — won’t be enough to clean up this mess.
|Five major central banks pitched their bailout plan … but the markets didn’t buy it!|
We’re dealing with masses of confusing debt-backed derivatives. Indeed, that’s how this whole mess got started. Rocket scientists in white lab coats created the most complex investments they could dream up and lumped them into the investment category of derivatives.
Turns out, these investments act a lot differently in the real world than the derivatives we previously had.
In fact, the mechanics are so out of touch with reality that investors are stuck with investments they don’t understand. No one is really sure how big this problem is!
Recent estimates of likely U.S. banking write-offs from mortgage-based derivatives are as much as $450 billion. But I think that’s low. Reason: According to Morgan Stanley, total derivatives outstanding at the end of 2006 reached $415 trillion. Yes, that’s trillion with a T!
That represents 7.9 times the whole world’s gross domestic product! So you can see how $40 billion from central banks is just a drop in the bucket.
Meanwhile, the questions concerning subprime losses and related investments are many, the answers are few, and the potential for conditions to worsen will not change with a simple auction.
Banks are reluctant to lend money because they need to stockpile it right now. In the event that conditions do worsen, banks need to have capital on-hand to cover their investments should they blow up.
It’ll take a lot more action for banks to get back to doing what banks do best — lending money.
The bottom line is this: There are at least hundreds of billions of dollars of bad debt sitting on the balance sheets of institutions everywhere. No matter how much external liquidity is provided by the Fed and others — it’s still bad debt.
Market Action Tells Me Now
Is Not the Time for Big Bets
The fact that markets sold off this week, despite the Fed’s intervention, shows that conditions are horrible and an easy fix isn’t in the cards.
Three Megaforces That Could Make You Rich!
At this very moment, we are witnessing a natural resource explosion of massive global dimensions …
Nearly every resource under the sun is surging in value — gold busting through the $800 level … silver up 18% … platinum, 33% … oil nearly reaching $100, its highest level ever … and more.
Of course, corrections — sometimes moderate, sometimes sharp — are inevitable. But they’re bound to be short-lived as three megaforces come together to drive the biggest natural resources boom of all time …
After all, analysts and economists from all over are starting to understand the seriousness of the credit crisis. And obviously, so are global central banks. It’s only a matter of time before the risk is too much to bear for investors, too. Just because they’ve been finding a way to ignore it, doesn’t mean it’s not there!
Sure, another round of coordinated liquidity pumping from the big five central banks could be around the corner, but until then you need to take what the markets give you.
Given that fact, there’s a developing trend that I want to alert you to: The possibility of a bounce in the U.S. dollar.
If global investors are spooked, they may start to abandon the idea that global growth will continue on track. And as confidence in growth wanes, I expect U.S.-based international investors to take some money off the table and bring it back home to hide.
Since their hiding place is short-term U.S. Treasury paper, they’ll also be buying the dollar.
I think now is the time to keep your bets small and most of your powder dry because we may be entering a whole new phase in the market cycle. Stay tuned!
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