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We'll start with a trip down memory lane

Bob Hoye
Institutional Advisors
Nov 28
, 2007

Signs Of The Times:

This section will start with a trip down memory lane to visit the signposts of a year ago.

"The appetite among banks to lend ever more money to private groups shows no signs of abating and such institutions expect leverage ratios on buy-outs to keep rising. According to a survey by Deloitte about 60% of respondents expected 'the good times to keep rolling' in the debt markets, with the banks most bullish."

-Financial Times, December 1 2006

Actually, this is when the sub-prime problems began to surface.

"Lenders feeling pain as more homeowners default."

"HSBC, the world's third-largest bank, says it will be hurt by its exposure to controversial mortgages."

"It's payback time."

-Financial Post, December 7 2006

Then moving right along, it takes a long time for orthodoxy to comprehend the mechanism of a credit contraction.

"U.S. Bank stocks look 'unbeatable'

"Bank stocks are so cheap--and dividends so high--that some of the world's biggest investors now say the combination is unbeatable."

-Bloomberg, October 30 2007

In only two weeks market forces are providing another outstanding instruction on the nature of credit and liquidity.

Given a year or so of such instruction, it may get through to the more flexibly-minded policymakers, as well as Wall Street pundits.

Stock Markets: The decline from the mid October highs has been rapid and the dollar has yet to stabilize. What will happen when it does, for as we all know the recipe for Goldilocks perfection is a weak US currency?

This, of course will be revealed over the next week or so. In the meantime, it is methodical to review the technical condition of the market and it is not healthy, but this break could soon take a rest. A cyclical analysis that we have not detailed called for an important high in mid October has been calling for a low at the end of November.

Another important pattern we've mentioned is that often in a bad fall (no pun intended) the market clears the most immediate problems in November, with December being a revival month. However, the typically fall liquidity crisis would see the slump beginning in September and continuing through October. This time around, the initial panic occurred in August and the rebound continued into mid October.

From 1720 until the 1929 there were five great financial bubbles and the initial liquidity crisis occurred in the fall and this provided the Fall Model. Only the 1825 example was late in failing and the initial crisis ran into January, 1826. All were part of a long bear market and showed the same warnings in the curve and credit spreads as we have seen this year.

Admittedly, this is not a comforting picture but as the saying goes the market never accommodates the desires of the crowd. As the object of policymaking is to manipulate the crowd (in policy circles it is considered as manipulating the economy, but it is the same thing) this can be extended to "the market never accommodates the desires of policymakers".

Particularly at the end of a great financial mania.

Also there is the crash in the Shanghai market to consider. The FXI has given up more than 25% since the high of 219 at the end of October, as some important stocks have plunged by as much as 40%.

As we concluded last week, there are extremely violent forces in play and to call and trade them we will use historical examples for an overall picture, as well as reliable technical work. It is not going to be an easy journey, but for those bound by orthodoxy it may hellish - well at least until it is abandoned.

Wrap: We talked to some old-timers this week (no - I wasn't talking to myself), who are in their late 70s and have had a full career in the markets. Both say they have never seen anything like this. One had been a savvy equity manager and the other had been on the fixed-income side as a bond trader and analyst. Our response was that it is not every day that you get to see the end of a 95-year trend. This one has been in an arbitrary and unrelenting attempt to rig the markets such that nothing unpleasant is allowed to happen.

The transition is likely to be volatile and fortunately there are tools that we hope will continue to measure the excesses - either up or down.

Since 1901 (106 years):

33 Novembers when the Dow Industrials were down.
24 resulted in a December rally.
4 resulted in an unchanged market through December.
5 resulted in a continued decline through December

   (1914, '20, '30, '31 & '41)

In the meantime, this is the 25th year that we have been providing research to financial institutions and we could describe our first presentation to big mutual fund manager. In those days, $15 billion was considered big. There were 6 portfolio managers and after 45 minutes of research shown via an overhead projector and discussion it was time to close. From out of nowhere came my ending comment "Well you have seen the quality of our research - and should know that there are certain standards that our clients should have."

Someone asked "And what might they be?"

The answer was, "You must have a lot of money, a flexible approach, and above all - a sense of humour."

Tentatively, one hand went up and the question was, "Gee, can we qualify with only one of those?

Credit Spreads: In two words - getting worse. The high yield, which got out to 407 bps in August and briefly came in to 388 bps has widened to 488 bps. Sub-prime mortgage bond prices have extended their plunge to new lows.

This is the stuff that can be readily followed. And then there is all the really weird stuff that no one knows the price of, or in many cases even the name of it until it eventually comes out in an disquieting report.

We have emphatically been avoiding all risk products since April when we were looking for a seasonal turn in most credit spreads.

In early June, UBS polled 80 central bank reserve managers on their investment intentions. Some 38% said they would buy more "spread product".


-Bob Hoye
Institutional Advisors


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