Where do we go from here?

WEST COVINA, California -As all of you who are paying attention probably already know, the US House of Representatives has voted down a bill to authorize as much as $700 billion for the purchase of the so-called “toxic” mortgages. As a result, major US equity market indices were down between 7-9% today.

It is easy to stop there and not look at the root of this slide. But I won’t.

The root cause of market volatility is uncertainty. Markets hate uncertainty because it does not allow for the formulation of reasonable assumptions to try to justify asset prices. This is where we find ourselves in – a situation where no one knows what the end game is.

So, where do we go from here?

Two possible directions would be (1) an alternative bail-out bill is crafted and rushed to Congress for approval and (2) the markets are allowed to sort out this mess.

The first option is the more likely direction of the two that I mention. I just can’t see Congress not doing anything to try to hammer out another compromise bill. Voters may not have liked the first bail-out bill but they will probably like less the idea of their elected representatives leaving everything to the markets. As this bill is negotiated, the markets will remain volatile throughout this period. It will remain so until the specifics of this new package are nailed down and people will have a chance to assess the likelihood of its success in resolving the current mess.

The second option will see more financial institution failures, personal and corporate bankruptcies, the continued rise of unemployment and a decline in consumer spending. The Fed, in concert with the rest of the world’s Central Banks, will try to mitigate and stem the effects of these events by infusing even more money into the markets but these efforts will be overwhelmed by negative sentiment from everything else that will likely happen.

Regardless of which path we eventually take, it is important to note that the markets, at some point, will come to a reasonable estimation as to the degree of damage these “toxic” mortgages will have. This point will come sooner than when the actual losses are written off, before all of the institutional failures end and before we actually see all the negative effects of this crisis. At that point, markets will likely enter a period of even more weakness before stabilizing and beginning the long road to recovery.

This point will come before the actual recovery of the general economy, probably 12-18 months before. So if we are looking at maybe 3 years before all of these consequences plays out, we may be looking at least another year before we see some kind of relative market stability, not to mention recovery. There will be plenty of opportunities to find value in the markets before that but be prepared for what should turn out to be a very interesting (to put it mildly) ride.

Advertisements


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s