From under pricing risk to over pricing risk

Two headlines caught my attention today.

1) AAA rated companies are no different from junk in credit default swap market.

March 6 (Bloomberg) -- Warren Buffett and Jeffrey Immelt are among a handful of chief executive officers whose companies are rated AAA. Yet Buffett’s Berkshire Hathaway Inc. and Immelt’s General Electric Co. are being treated like junk in the market for credit-default swaps.

Contracts that protect investors against a default on bonds of Omaha, Nebraska-based Berkshire, which has $25.5 billion in cash, cost as much as those of KB Home, the homebuilder that lost money for seven consecutive quarters. Credit-default swaps on the finance arm of GE, which holds $45 billion of cash, are about as expensive as those for building materials-maker Louisiana-Pacific Corp., which posted nine straight quarterly losses.

(click here to read the whole article)

Do I have any comment? No, I'm speechless. I have reasons to believe Credit Default Swap market or safe haven assets has entered euphoria stage -- bubble for lack of a better word.

2)This is the first time I heard about 36 South Investment Managers. They made 236% in last 12 months(very nice) and plan to closed it down[very smart move]. They were betting on black swan by buying long dated options in global currencies, fixed-income, equities and commodity market. If hedge-fund is taboo to you, don't worry - I don't know that well and not qualified to invest in them too. The point is they know lightning will never strike twice within a short span of time -- it is highly improbable that we will see the same magnitude of decline across assets. Deleveraging will still on going but it will be in much controlled manner.

March 6 (Bloomberg) -- 36 South Investment Managers Ltd., a New Zealand-based hedge fund firm set up by derivatives traders, will close its Black Swan Fund after it gained 236 percent in the last 12 months and start a fund that wagers on inflation.

(Click here for more)

For someone to bet on inflation, I would interpret that there is a good chance of economy recovery in later part of the year. Regular readers should know that I am waiting at maximum pessimism of anti-inflation assets to be trashed between now and end of 2009.

There is this chart I want to show you - Federal Reserve balance sheet has no doubt gone through the roof, passed well beyond 2.3 trillions but that is not the point. The balance sheet begin to contract which is a good sign of liquidity stress is improving. The wild card is the impact of bank recapitalization and bad assets write down(this is the grand finale that I have been waiting patiently). Let's see whether Fed balance sheet will continue to contract or expand. Contraction is a good sign and expansion will give us some clues how bad the inflation will show up.