No Silver Lining Yet

Sept 8. 2008.

In November 2007 we called the recession and said it would last at least until 2010. This is now fast becoming the view of mainstream economist. We said massive revaluations were ahead and that this would cause a major credit contraction. This credit contraction is a major reversal of the easy money regime that has been going on since Reagan in 1982, and reaching froth levels after 9/11 with interest rates bottoming out at 1%.
This is no small matter, this is a real reversal. This is not just another short lived recession in the continued climb towards even higher peaks. This is a turn of the trend, something that will need years to unfold and therefore will last for years. We really can not tel if this will take a minimum of 2-3 years or much much longer.

Eventually a bottom will be reached and a new credit induced boom started. But this is still far far off. It is so far off that we here at Farmann can not even yet see this event in the horizon. When we do see the silver lining in the horizon we will let you know. We know intellectually that is is there, but we can not see it happening.

Inflating is what central banks do. And inflating is what they will eventually do again. The crack up boom is still not here, but it might arrive in our lifetime.

Sometime after this reversal of the credit cycle has plaid out and there has been significant creative destruction in the financial industry the foundation for new credit growth is laid.

On August 26 we said that Fannie May and Freddie Mac would eventually have to be nationalized. Today on September 10 they where nationalized. It seems they are doing it the Norwegian way leaving the original shareholders with nothing. Anyone who bet against this lost all.

The markets will boom today from the bailout of Freddie and Fannie. Many will think the worst is over and put their faith in the federal governments ability to fix.

We see it the other way around, this bailout is symptomatic of the rot in the industry. It will not be possible to bail out everyone, the industry and the trouble is just way to big for that to happen.

We will be watching very very carefully now. It might be time to short the markets now, but we would rather wait and see what this false bailout boom can do. Perhaps the feds even have another card up their sleeve that gives the markets another lift. The trick is to wait until the odds are clearly in our favour.

We are convinced this is a major bust, this is not just a short lived recession.
We are still convinced this contraction has a long way to go. The bust will be in relation to the boom.
We are convinced the Dow Jones will go below 10 000.
We are convinced the big three US automakers will file for bankruptcy.
We are convinced that dozens of smaller US banks will go belly up.
We are convinced one, two or three major banks will go belly up. This will shake the markets hard.
We are convinced tens of thousands of more people in the financial industries on Wall Street and the City of London will be fired.
We are convinced savings in the US will go dramatically up and that demand for discretionary spending will fall considerably.
Falling demand for discretionary spending will impact corporate profits hard.
We are convinced inflation will go up.
We are convinced interest rates will go up.
Falling demand and higher interest rates will hurt corporate profits and lower valuations considerably.
We are convinced US housing has at least another 10-20% to fall, wiping out enormous amounts of equity in personal saving and on institutional balance sheets.
We are convinced the dollar will fall.

Looking forward as dozens of small US banks will fail, and one, two or three big ones will fail. They will be bailed out. As it will all unfold over some time there will be time to recapitalize the FDIC as this unfolds.

This all will take time.

Maybe we see a silver of recovery and hope at the next Olympics in London, maybe even that is too early. If the recovery has not yet come by then people will have capitulated and the entire sentiment of the capital markets and among ordinary citizens will have changed dramatically.
We are still fundamentally in a boom mentality, convinced that a continued boom is the natural way for things to be. Loosing this faith will take time and come at very high emotional cost.

Remember that there are plenty of people, in fact most people, who have vested interest in making this seem like a short lived recession. There are plenty of people who know that their only hope is for this to be short lived, they therefore play it that way. It is the only way they can play it, or give up.

So the unfolding will take some time.

A friend who capitalized a handful of million listened to Norwegian investment adviser Peter Warren the other night, he claimed to see opportunity now. He claimed he could see this bottoming out and was prepared for bottom fishing, picking up assets on the cheap. We like Peter Warren and have been following him for 20 years. He has excellent understanding of risk.
We agree that some assets are starting to look cheap. But this is a game of stacking the odds in ones favor.
Peter Warren is probably seeing risk coming down. That is, as markets fall, and risk increases – the risk of further risk increases goes down. The further we fall, the less there is to fall further. The bottom is somewhere. What is happening is that overpricing and over capitalization of assets are coming down. What this model might not pick up is how far below intrinsic value assets might fall. We might be approaching a normalized baseline, but we can not at this point tell how far below baseline the markets will fall.
We believe there will be times that stack the odds even more clearly in our favor. We believe the the chances of things getting considerable worse and thus cheaper is far more likely than the bottom being anytime soon and us missing out on the boat by not going full in now. Cash is scarce now, but it will be even more scarce shortly. We have not yet reached the maximum scarcity of cash.

This truly is a reversal of the credit cycle. No one knows how severe this will turn out to be and how long. Betting on any one time as being the bottom is taking a huge risk.

We advice to wait and see some more.

Oslo, Norway. September 8. 2008

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