Tag Archives: pessimism

Rules of Nature

The Eye of The Storm

Have you ever been in a hurricane? I have, and one of the strangest things about it is the phenomenon that happens right in the middle of the worst of the storm – the eye.

You can walk outside and literally see the stars and the branches lying askew all around you…the air feels eerie and a sense of anticipation for what is left to come fills the air.

I can’t help but think we are witnessing a similar occurrence in the markets over the last couple of weeks.

Every now and again, I will glance at the screen and see the Dow up a few hundred points, followed by an irrational headline like: “Market Rises on Hope for Shorter Recession” or some such nonsense.

But, we all know that we are only partially through the natural consequences of what we have witnessed already.

Rules of Nature

For those of you who have been reading Paranoid Bull for awhile, you probably are tired of the “shoe-to-drop” metaphor, or before that the “trainwreck in slow motion” ones, so I’ll go for another one.

We are witnessing something like the end of an Ice Age. There has been a fundamental shift in the temperature of the environment which was previously calm and unrealistically muted to risk. The molecules and atoms moved more slowly at the lower temperatures, and the over-confidence of false-statisticians suggested that this temporary cold-chill was indicative of the indefinite future.

However, as we see in the weather, one of the few things that can be certain about the future is that it will look different than the present. Also like the weather, most systems in the world move through a wide variety of states: cold, medium, hot…slow, fast, zooming.

Right now our system has gone from cold to hot, from an appearance of risk mitigation to a reality of correlated, levered and volatile risks.

As the temperature rises and glaciers melt, this has an impact throughout the ecosystem: entire landscapes are transformed as water rushes with such velocity that it crushes anything in its wake.

And once the melt has begun, there is no going back.

The People Factor

The problem with our financial system is that unlike the natural order of a post-glacial natural ecosystem, our world is inhabited by human beings who are smart enough to have some semblance of an understanding of the world, but not smart enough to recognize their own limitations.

In addition, they are driven by passions and irrationalities that cause them to build cities on piles of snow…because if it hasn’t melted yet, it won’t.

These quirks of humanity also cause us to run with the crowd, and as the chaos of the system has emerged over the last couple of months, the emotional side of human behavior – especially that of fear – has set in.

People don’t know what to do, what to expect, which direction to run, and they surely don’t know what the landscape will look like once the ice has finally completely thawed.

As a result, we are caught in a state of fits and starts, with each pundit and pseudo-intellect looking over his or her shoulder at the next quasi-intelligent one wondering what the other one is thinking.

Keep Running

In this game of chicken, however, the one who stops running first will likely be caught in the flood.

I wish there was better news, and given the stars in the sky, one can almost believe that we are through the storm.

However, don’t forget that the patterns of nature are much more powerful than any we could hypothesize…and I haven’t heard of a one-sided hurricane or a partially melted glacier yet.

But Play

But don’t run in fear. Run because it is exhilarating, and enjoy the scenery and lightness in your step as you go.

A friend of mine recently highlighted the importance of ‘play’ in life…and I think even in moments like these, while we are reacting to a change in the landscape, we can find these rose-colored lenses in all that we do.

I for one am going to try, as I stop to catch my breath before the next leg of the marathon.

Consciously Navigating Da Nile

As this article on Naked Capitalism points out, some of the smartest pessimists out there are starting to get significantly more bearish lately.

I have hesitated to to publish some of this content, but I think it is worthwhile to consider positions like the ones discussed here: Roubini Foresees Possible Market Shutdown

After the Fed, ECB,, Bank of England, and other central banks took unprecedented measures over the last month to restore liquidity and recapitalize banks, Nouriel Roubini sounded slightly less gloomy. He had deemed that the authorities has avoided a systemic financial meltdown, but a nasty, protracted recession was in the offing.

It appears that Roubini has reversed himself with his latest remarks He now says systemic risks are increasing due to hedge fund margin calls, redemptions, and liquidations, and the authorities may be forced to close financial market

Similar negativity can be found here:
The Folly Of A Depression Thesis

In short we are setting up for what looks like an even Greater Depression, perhaps something similar to the 1873 panic. While the causes would be very different in practice, in principle they seem to be the same – malinvestment caused by “easy money” that, when business conditions turn, becomes “protected” by government – leading to Depression instead of an ordinary business recession and bankruptcy of those who overextended themselves. Now, as then, we have companies that have spent incredible amounts of money to buy influence – it was recently disclosed that AIG, for example, continues to pay lobbyists in an attempt to loosen regulation even though they are now surviving on money borrowed from The Fed!

Be prepared, get out of debt and position yourself so you can survive without the use of consumer or business credit of any sort.

If you have liquid cash, you will be in a great position to pick off property and other goods that people are forced to abandon as the situation worsens. There are many people who became fabulously wealthy as a consequence of The Depression, and all of them had one thing in common – they had cash when things got really bad, and were able to pick off assets cheaply in forced sales.

The difference between 2 years ago, when I was on the same page of many of these same writers and today, is that much of today’s contagion is being driven by forced selling of assets that are far below their intrinsic value.

I am not talking about the toxicity associated with the still deteriorating real estate market, financial companies, retail-based companies, or consumer credit companies.

Rather, I am talking about the fact that the bank-debt market is trading the $60′s right now for companies that are only 2-4x levered through the bank debt. Basically this implies that many of these healthy companies will go into bankruptcy and liquidate for something like 1-2x EBITDA.

Although I seek to avoid this financial jargon here, the translation is simply this: It is absolutely positively an inaccurate reflection of reality.

I am not one to speak in absolutes, but I can tell you that there is absolutely no rationale for such a valuation for many of the companies that are being “valued” in this way.

The reason for this price-action is completely tied to the forced-selling around asset-liquidations, hedge fund failures, and other “forced” selling action. This is a classic “technical” signal in a market, and although it is important to notice these for trading purposes, it should not be mistaken for a reflection of intrinsic value.

The VIX (a measure of volatility) hit another all-time high today intraday, suggesting that people are panicked, afraid and more importantly they are *uncertain* about the future.

This uncertainty creates a space for someone to fill in the void. They need someone – actually lots of someones – to step up and fill this void of uncertainty with some words of wisdom and common sense to settle their nerves.

Thus, although I think there is a distinct possibility that the uber-bears are right. I am consciously breaking ranks with them because I firmly believe that there is finally a possibility that they might be wrong.

It could be the case that we will find a way to stem the decline in housing prices (my suggestion continues to be to renegotiate mortgages to keep people in their homes), stimulate the economy (likely through more fiscal stimulus), and ultimately find a floor for the various credit markets that are continuing to go through contracting pains.

I am *not* suggesting that you leap into equity markets unhedged, but I am suggesting (perhaps as a broken record by this point), that consciously focusing on the positive will help us determine our future trajectory from here.

The choice of how to fill this void of uncertainty is ours to make. I am choosing to deny the doom – at least for today.