The fact that rating agencies are struggling to come to grips with the seemingly unending stream of guidance reports from the corporate and sovereign sectors can by itself justify an unequivocal sell-on-rallies market call. Because hardly any of the recent reports in the public domain have been founded in a sustainable interpretation of the size and length of the global recession. More importantly, none of the reports state how earnings will be impacted by the all-encompassing deleveraging process currently under way.
The surprising 150 basis point rate cut by the Bank of England on Thursday is perhaps the best indicator of overall uncertainty (and extreme caution) in an environment where the real value of family incomes worldwide (particularly in the emerging markets) are either declining in the face of higher food and energy prices or are being seriously threatened by job quality, or both. And the case to trade short is best made in a scenario where guidance documents are, at best, based on assumptions which themselves are subject to rapid change within the prism of economic data in forthcoming weeks and months.
That said, a credible sell-on-rallies call needs to be premised on specifics which can be challenged, where necessary, by cogent contrarian opinion. Those specifics are:
- The urgent requirement for a downward adjustments in asset valuations in virtually all the emerging markets (EEM, EEB and ILF)), particularly in countries like Brazil (EWZ), Russia (RSX) and India (INP);
- The influence of the rather inefficient deleveraging mechanisms in the developing countries on the balance sheets of American corporations who rely on foreign sources for more than 30% of their revenues, corporations like General Electric (GE) and Citigroup (C);
- The fact that this deleveraging is an unprecedented event, defying analysts who believe in cyclical trends and who are thus engaged in picking the bottom.
Leverage works wonders when there is widespread optimism about the shape of tomorrow. But deleveraging wrecks havoc in the midst of recessionary conditions. The sell-on-rallies proposition is not only supported by the sorry state of the third world. Within the United States itself, there is still no recognition of a critical underlying fact: with few exceptions, all classes of loans (including mortgages) are heavily under-priced.
For instance, if the compelling benchmark+CDS price logic is applied to lending, 15-year mortgages should be priced well above 9%, not below 6%. Under-priced loans imply leverage, since they fail to fully take into account potential delinquencies and default ratios. Of course, a few socialist measures, like government interference in the housing market, can destroy that argument altogether; but, at the end of the day, socialism is no substitute for pricing realities.
In the meanwhile, authorities in the emerging markets continue to generate statistics designed to show that they have contained the trend towards absolute chaos. But it is worth remembering that many such statistics are meant almost exclusively for public (political) consumption, not for institutional and retail investors who are risking money.
