Posted by Karl Denninger
By Scott Lanman and Craig Torres
Jan. 7 (Bloomberg) — U.S. regulators including the Federal
Reserve warned banks to guard against possible losses from an
end to low interest rates and reduce exposure or raise capital
“In the current environment of historically low short-term
interest rates, it is important for institutions to have robust
processes for measuring and, where necessary, mitigating their
exposure to potential increases in interest rates,” the Federal
Financial Institutions Examination Council, which includes the
Fed, Federal Deposit Insurance Corp. and other agencies, said in
a statement today.
Let me point out a few things.
We have never seen a crash and rebound in US stock market history like what we have just experienced, except once. That “once” was 1929/1930. What followed next was a grueling grind – not a crash, but a grind that never ended, and in which the market lost more than 80% of it’s value. Those who argue “the bigger the dive the bigger the bounce” forget that the only true comparison against what we have just seen was in fact the prelude to a grinding 90%+ overall decline.
If you believe in “long wave” cycles – that is, Kondratieff cycles, we have precisely followed the several-hundred-year long pattern though its latest incarnation, with the 1982-2000ish period being “Autumn.” Winter follows fall. These cycles seem to happen mostly because all (or essentially all) of the people who lived through the last cycle’s horrors are dead. Unless we have found a way to break a cycle that has endured far longer than our nation, we’re right where we should be – which incidentally aligns with what happened in 1929/30 as well. This means that while there may be ups and downs we have not bottomed – not by a long shot – no matter what people tell you.
Interest rates can only go up from zero. That should be obvious. Rising rates are not positive for equities and multiple expansion.
The Financials are getting a tremendous bid the last few days, presumably on the premise that “employment is at least somewhat stabilizing.” With zero short rates and a steep yield curve, this means they make a lot of money. But rates cannot stay where they are if in fact the economy is recovering, and if the long end rises it will choke off housing.
At the same time people are rotating into a sector The Fed and regulators just said will be forced to constrain its profits people are fleeing the stocks (tech) that have been on a tear. This is exactly backward based on the news flow. Are The Fed and Regulators lying or is the “optimism” incredibly misplaced (and even stupid if they’re rotating out of winners for what were just announced would be losers!)
P/Es are at record levels. Yes, that’s on “as reported” 12 month trailing, and it is down materially since one of the two “disaster quarters” is now gone. But even with the other gone (which it will be in another month) we will be trading at somewhere around 40 or 50x earnings, an utterly unsupportable level and above where we were in 1999 – just before the entire market fell apart. Even on “operating earnings” we’re trading at 24 times – outrageously overvalued from a historical perspective.
We also have the BIS calling in bankers to warn them that they’ve changed nothing in their behavior (gee, really?) and China making a serious attempt to pop their property bubble (must be nice to actually pay attention to such things, eh?)
For today, “party on Garth” in equities.
Let me simply remind people that what got me writing The Market Ticker was this event – something that I missed the signs of because I was overly complacent, just as people are being right now.
That was 2006 and into 2007, remember?
Straight up – right up until it wasn’t, and 60 SPX points came off in one day. That warning (and mine when I started writing) was ignored by a whole lot of people too who thought it was a “blip.”
Uh, no, it was a warning and those who failed to heed it got their heads handed to them.
Don’t worry folks, it can’t happen again. Remember, The Fed has our back, just as they did in 2006 when they told us there was nothing to worry about in the summer when we got the swoon (remember that? I do – and bought into it!)
The picture now is actually worse than it was in early 2007. In early 2007 we had solid employment, we still had a reasonable housing market although it had slowed some, GDP was positive and we had just come off a GREAT Christmas season with extraordinary profits and sales. In addition we were running ~350 billion in deficits, not $1.6 trillion (estimated for FY10) nor did we have to roll and issue over $2 trillion of treasury debt (to someone!) in the next 12 months.
Now we have the regulators issuing formal warnings about bank liquidity and interest rate risk (no really, you think that might be an issue with that sort of issue behavior?) while at the same time formal liquidity support in the form of monetization along with stimulus spending is slipping away – the source of the liquidity that fueled the rally from March.
Ignore all this if you’re brave – or stupid.
PIMCO isn’t. Bill Gross sees the same thing I see.