Bank analyst Charles Peabody -- a mainstream guy and not normally a proponent of "doom and gloom" -- says liquidity is insufficient to support financial sssets at anywhere near current prices. Projects a CRASH in financial service stocks this fall.
Charles Peabody
Mitchell Securites
It's “Liquidity” - Stupid
July 29, 1999
The concern has spread to Wall Street's senior executive suites.
Douglas A. Warner, chairman and chief executive of big New York bank J.P. Morgan & Co., says even the bond market's most
high-quality sectors are jittery. “Liquid markets like agencies, high-grade corporates and mortgage-backed securities are showing
reliable indications of increased investor nervousness,” he says. Some indicators of investors' unwillingness to take on risk, he
says, “are in uncharted territory.” - WSJ, 7/29/99, page C1.
Over the past several weeks, I have explored the implications of a number of chart patterns, whether they be widening credit
spreads, rising nominal rates, strengthening currencies, etc. The bottom line conclusion of all these charts was that there is
insufficient liquidity to support U.S financial assets at current price levels. For the first time in many years, it seems that U.S.
financial assets are getting competition for liquidity from other geographies and other asset classes. In short, the strengthening yen
versus the U.S. dollar and the Euro (in the face of massive intervention) reflects, in part, capital flight back to Japan. The
doubling of oil prices, the rise in real estate prices and the surge in the Journal of Commerce index are indicative of fund flows
into hard assets (again at the expense of financial assets).
The mirror image of these chart patterns can be found in the rise in nominal U.S. rates, concomitant with a widening of credit
spreads. The growth in the U.S. has been a debt-induced, consumption-led expansion. However, if the liquidity that fueled the
leverage on both the consumer and corporate sectors' balance sheets should draw increasing competition from other asset classes,
then something has to give - either rates go a lot higher or the debt dependent expansion will slow. For the moment I am betting
on the former. I, therefore, still expect that there will be a severe dislocation in interest-rate sensitive products that will cause
significant earnings disappointments amongst the major multi-national banks, brokerage firms and mortgage-related equity
securities.
I also expect that the upcoming correction in financial stocks is most likely to occur in a more violent fashion (i.e., a crash
scenario) than that of last fall. And while there may be a tradable bounce after the upcoming interest-rate related crash (just as there
was after the capital markets led correction last fall), it should soon be greeted by a deteriorating credit quality cycle that will
extend the long-term bear market in bank stocks. In short, after this next down leg, I suspect that more and more bank analysts
and investors will come to the realization that a secular bear market that started in the spring/summer of 1998 is well under way. |
