Rethinking of market issues

During school holiday short break, our family gathers together doing some very simple things yet satisfaction is perfect 10. We work as a team on printed free Sudoku from the Internet and newspaper cutting. Sudoku has always been absorbing, set us free from rat race, makes time become irrelevant. We have so much fun. The young ones are much sharper and beaten me hands down. I conceded defeat gladly. We dropped by Taiping Zoo. Animal population seems the be shrinking, not as many compared to about 5-6 year ago. Fortunately, our Alex the lion king is still strong but a little bit over-weight. We remembered there were two Pooh sun bears but saw only one. There used to be a big flock of birds and animals in Savannah section, again it's seems to be a lot lesser compared to the last trip. We could not see any kangaroo, though the tag remains in tact. Hoping things will not deteriorate further even though this is much better than Ampang Zoo negara. Getting tired of outside food decided to cook ourselves home-cooked food Ampang yong tau foo, hand-minced Tenggiri fish meat with lots of garlic, onion, and some special ingredients. Yummy and no worry of cholesterol as we have been generous with ourselves deep fried with olive oil.

Playing Sudoku reminds me of Occam's razor rule.

(Wikipedia)Occam's Razor, also Ockham's Razor,[1] is a principle attributed to the 14th-century English logician and Franciscan friar, William of Ockham. The principle states that the explanation of any phenomenon should make as few assumptions as possible, eliminating those that make no difference in the observable predictions of the explanatory hypothesis or theory. The principle is often expressed in Latin as the lex parsimoniae ("law of parsimony", "law of economy", or "law of succinctness"): entia non sunt multiplicanda praeter necessitatem, roughly translated as "entities must not be multiplied beyond necessity."

If I were to apply Occam's principle, after eliminating a lot of noises, three important issues affecting investment strategy:

(1) Will the Fed wins this war on deflation ?



Short answer - YES ! The market thinks inflation will be the end result -- huge jump on Philadelphia Gold and Silver index and also inflation protected bond TIPS but S & P 500 muted -- on the day (March 19) the Fed announced to buy $ 1 trillion in Treasurys and mortgage-backed securities.

The Fed balance sheet dropped to US $ 1.8 trillion but rebounds back to US $ 2.04 trillion as of March 18, 09. Bill Gross thinks it may eventually hitting $ 5 - 6 trillion(click here to read more)

The fact that the Fed throwing so much money in the system suggest this debacle is far from over.

(2) Have financial and housing sectors stabilized?



If the market is a perfect discounting machine, both sectors have a bounce but has not been very affirmative.

The argument is though banks are profitable at the operating level but toxic assets are off-balance sheet items and there is no way you can declare victory now. The uncertainty will remain so long the toxic assets are not being removed. However, painting with a broad brush stroke labeling all banks are insolvent are wrong. The banks will build up their capital pretty rapidly as soon as they stop paying dividend.



Based on Roubini scenario, there will be more money needed for bailout but OK under IMF's scenario or compromise of Dr. Doom with IMF's sanguine scenario.

iCapital wrote a few good pieces analyzing the US credit problems. This table sums up quite nicely on implications of refusing to write-down the toxic assets quickly - slow growth, cost tax payer more money and prolong recovery.



Even the Fed wins the deflation war and averting a mini or "great depression", property price will not go back to pre-bubble level. Banks are still far from healthy level in next 2 - 3 years. Stablizing ? Probably. Rapid recovery ? No.

US housing inventory overhang ? On short to medium term

(WSJ -- By RICHARD S. LEFRAK and A. GARY SHILLING)The federal bailout forces taxpayers to subsidize overextended homeowners who bet on ever-rising house prices and used their abodes as ATMs, and it doesn't get to the basic problem -- the huge inventory of excess houses. We estimate that 2.4 million houses over and above normal working inventories are left over from the 1996-2005 housing bubble. That's a lot, considering the long-term average annual construction of 1.5 million single- and multi-family units.

Excess inventory is the mortal enemy of house prices, which have already fallen 27% since the peak in early 2006. We predict another 14% drop through the end of 2010 if nothing is done to eliminate the surplus.

Doing nothing to eliminate the excess inventory might well push the recession through 2010 and into a depression. Declining home values, for example, are eliminating the home equity that has funded oversized consumer spending for years.

Long-term outlook may not be as bleak and may not been as bad as Japan as it still have population growth of around 0.88%. Consider also demand from immigrants. 5 - 7 years from now will be OK.

(3) Will US $ tanks?



Weak US $ implies a few things -

(i) the end of de-leveraging.

(ii) abandoning US $ means there are better alternatives out there. Euro, British pound, Swiss Franc, Yen or even Asian currencies are not supported by stronger economic fundamentals. Don't forget ECB, Japan and Britain are also carry out quantitative easing.

(iii) nobody wants to buy US Treasuries.

(iv) there is no need of liquidity haven.

(v) the Fed printing money will destroy US $.

(vi) commodities going to rebound - more fear of cutting consumer spending power. This is going to export inflation to emerging economies causing more severe economy contractions.

(vii) It's a spur of moment. When they regain consciousness, US $ is still going to be OK.

Just to sum up, the Fed will win the war on deflation, inflation will show up in 2010and beyond. Banking sector uncertainty will persist. Housing sector is not yet recovers. US $ is going to be stronger that most think in 2009 but I cannot say so beyond 2010.