If the post Bear Stearns bailout can last nine weeks, the Fannie Mae and Freddie Mac bailout rally is likely to be shorter than that. It remains uncertain if it represents a definitive bottom for financial risks. According to Moody’s, the global issuer-weighted speculative default rate rose 20bps to 2.65% in August, an increase from 2.45% in the prior month and up 121bps since the same month last year. This is the ninth consecutive monthly increase in the global speculative grade default rate and the rating agency now forecasts a 4.9% default rate by the end of this year.
The injection by the Treasury of up to US$100bn each into Fannie and Freddie is one more signals that the
According to some estimates that come to my attention, it will take about another 2 ½ years to absorb the excess housing inventory. House prices may need to adjust another 12-15% before housing affordability to make it attractive. In my own opinion, the de-leveraging process has hardly started in the
Based on these observations, the S&P 500 is facing a downside risk of 5.5-10.1% from current 1,267. Corporate earnings are still 8% above trend in the
In essence, I remain conservative because of the high inventory of unsold houses, large delinquency pipelines, fairly tight underwriting standards, and weak macroeconomic fundamentals related to the health of the consumer.
I think the dollar has large net long speculative positions and remain a net seller in current rally.
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