A Roller Coaster Week

The fall of Investment Banking icon Lehman was potrayed as an unavoidable event - afterall Capitalism depended on efficiency (or was it, that it achieved efficiency?). So weak participants had to fail. But the chain reaction to that event was possibly poorly expected. The events over the last one year plus, when so many banks/institutions failed, have led to markets getting increasingly nervours. Banks had not been trusting each other and markets had become shallow. Remember that the top Central Bankers have been providing liquidity against all forms of collateral and cajoling banks to keep the money markets well oiled. The fall of Lehman suggested things could worsen and more would succumb in the black hole. Afterall, if everyone was in the same business and carried the same stocks how long could one hold on when prices were falling. Markets had smelt blood and they began looking for more - as stocks were short sold and CDS rates pushed up by panicking protection buyers they threatened the institutions. No institution was now safe. This is the sort of panic reaction that brought out rescue calls - Paulson and Bernanke donned on "socialist" hats and quickly nationalised AIG (80% control). Across the world short selling was severely controlled - so we have multi-year single day rallies in stocks at the weekend. Whew! - What a roller coaster. Suddenly we have bullish calls on stock markets! Before, we begin to invest in stock markets let us stop to think -
The steps were necessary regardless of whether it was capitalism or socialism that ruled the US and the rest of the West. Remember Russia closed down its markets for days. When panic strikes, Regulators and governments have no choice of isms. They have to act.
The funding of the US banks by the Treasury will surely bring back relief for some time. But, in that time it will rear a few doubts such as, what sort of regulation or control does the US have, how strong/weak are the banks, and arising from these and other concerns, markets will ask again - should they short the dollar? Surely, this thought cannot be regulated away! The pullback of the markets is exactly a relief reaction-it will not alter anything. Of course, I do not ignore the large positive impact that has been so carefully co-ordinated into the markets will pay positive dividends. But, it may not give us the insurance against a repeat of carnage. Why?
Sovereign funds and others will be looking around for stronger currencies (i.e., economies). Here they will find very few options and that is likely to come to the rescue of the dollar for some time. The European and Japanese economies do not excite anyone. In any case, as the latest episode has proved once more, the US is quick on its feet. Cynics may say the US policy makers cannot afford to be lazy and lose the attraction of the dollar. But, the US will take time to get its economy up again and more failures (and rate cuts) cannot be wished away. Since, EUR and GBP have no strong economic strength to back them up, currencies in Asia may beckon.
Asian economies seem to be holding out well so far. Have their higher growth rates cushioned them or is it their closed economies? Meanwhile, debate rages - Asia has succeeded because it has been careful in not letting their markets become gambling dens, the Regulators have been more careful in deregulating and the rest. They will self-congratulate themselves on their better management (is it better luck?) and as their economies seem destined to generate stronger growth their relative position should become stronger. But, what happens to their currencies? Don't forget that they basked in the big rush of dollars as the Investment Bankers set up offices and desperately tried to invest in their countries? With capital flows likely to come off how long before the party poops in Asia as well? If their Central Banks don't buy the dollars what about the reserves and the liquidity releases that kept rates low? A small club of Asian economies that have the luxury of large current account surpluses seem the ones whose currencies will remain strong. The currencies of those with weak current accounts should remain weak as Capital should remain scarce for some time. And, if foreign capital is not chasing the stock markets of Asia, what about their PE ratios?
So, would you buy Asian Stocks? I would not until PEs fall further.
See you next week!