Goodbye liquidity crisis; hello economic crisis

Libor finally fell below Fed funds yesterday, signalling the end of the liquidity crisis. I guess bankers have finally realised that the Fed will do what it takes to save the financial system, and it is highly unlikely any of the major players are going to go bankrupt (I present Countrywide as an example). But the liquidity crisis, lasting as long as it did, was a major shock to the US (and most developed countries) economies, and it seems pretty likely that a recession is very close if not underway already. I know I said this a few months ago, and obviously I jumped the gun, but the data has got considerably worse since then, and many other respected players are saying the same thing. Worse (for the economy) is that general consumer and business sentiment seems to have fallen off a cliff, and it will be very hard to bring that back in the current environment. Companies continue to announce layoffs and house prices seem to be in free fall. I said in the past that I would not officially announce a recession until the PMI falls into the low 40s and the 4 week average of initial unemployment claims moves above 350k, and I will stick to that. But it does not look good.

The financial markets are telling the same story. Swap spreads have increased over the past few months and look set to move wider. EM spreads have also started to move out. Asset-back CP spreads have moved in from their nuclear holocaust levels but remain relatively wide and the yield curve is inverted once again. Treasuries yields have plummeted and the 10 year yield is now substantially less than 12 month CPI. SPX is down about 11% from its high even though we are 4 months into a Fed easing cycle -- not good. Oil and industrial metals are finally coming down in recognition of the slowing in the US. On the other hand, gold is pretty strong (though off recent highs), presumably as the market realises that the FED has no choice but to further debase the USD to save the US financial system and economy from depression.

Equities indeed fell over the past week, though the decline was relatively orderly -- no big drop as I suggested last week. As I have mentioned before, this feels very much like a bear market. There have been no really big down days (all less than 3% declines). Sentiment is interesting. Although the talk is very negative, and surveys are showing excessive bearishness, there is also a lot of people saying that the market is oversold and it is time for a relief/rebound rally. There are also a lot of people who recognise that the economy is in bad shape but refuse to see how bad, and think the Fed can still save the day. But every time the market tries to rally it falters after a relatively small move.

I remain as last week. I am waiting for a rally before adding to my short equities position. Gold stocks soared last week (as gold went over $900) for a whopping 60% gain over the past few weeks, making me slightly annoyed that I did not add to my small position. But I still believe that the rally is somewhat premature. Investors are looking around and trying to see where they can put their money that's recession proof, and gold is an easy answer. Gold has soared similarly in the past and then given the gains back in a short period. Gold will go higher over the next couple of years but the big moves will be gradual. I will wait for the current pandemonium to calm down before I increase my position. Bonds continue to perform well, but I think they can go still further as long as the yeild slide is gradual.

MARKET POSITION: EQUITIES - SHORT (9 units); GOLD - LONG (1 unit)