My Diary 390 --- Ben Bernanke vs Paul Volcker

Market Thoughts --- Ben Bernanke vs Paul Volcker

Yes, this time maybe one of the worst crisis in the history, but I still don't see the effectiveness of aggressive monetary policy in this environment.

Once again, my arguments are --- It is a confidence or trust issue if people understand what credit is? You need credibility to run the markets, but people are panic because of signals of bank's insolvency (BSC) and the latest "bidding war" number for the amount of total losses, ranging from $500 billion from Goldman Sachs, and a neat $1 trillion from uber-bear Nouriel Roubini.

The street is now expecting the next wave of credit hit --- from CRE to other personal credits, if hurting US consumer and job market, then US is dead.

How much Fed can do .... The recent Balance sheet swap arrangement is similar to the action by the bank regulators in 1980, when nearly every major bank had losses that were greater than their capital on Latin American loans crisis. The Fed then allowed the banks to carry these worthless loans on their books at full face value. It took 6 years before they started to actually write them down. But without that measure, every major bank in the US would have gone bankrupt. And technically, they were for several years. The Fed action simply bought the banks time to re-liquefy. It was the right thing to do…… and it is happening again this time … …

If history is at least the guidance and does repeats itself, then Bernanke should follow Volcker

Noted on Tuesday, March 18, 2008 4:41PM Hong Kong

Bernanke May Cut Benchmark Rate by Most Since Volcker (Update1)

2008-03-18 00:53 (New York) By Steve Matthews

March 18 (Bloomberg) -- Federal Reserve Chairman Ben S.Bernanke may be readying the deepest interest-rate cut in a generation as the central bank struggles to prevent a meltdown in financial markets and a recession.

Traders predict the Federal Open Market Committee, meeting today in Washington, will lower the overnight lending rate by a full percentage point or more, based on futures prices in Chicago. That would be the biggest reduction since 1984, when Paul Volcker led the central bank, and would bring the benchmark rate down to 2 percent.

Policy makers may promise more cuts if needed with a statement that warns of further risks to the economy as the housing recession breeds widening losses among banks and securities firms. The Fed took emergency steps over the weekend to stave off a financial panic, lowering its rate on direct loans to banks and becoming lender of last resort for Wall Street's biggest dealers in government bonds.

The Fed has moved very aggressively to deal with liquidity problems that are major,'' said former Fed Governor Lyle Gramley, now a senior adviser at Stanford Group Co. in Washington, who said today's reduction may be as much as a full percentage point. ``They need to be aggressive on the monetary policy side. This is the worst crisis we have faced in more than 50 years.''

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Some humble views to add here based on my back-envelope findings from the historical analysis……

1) YTD, we have seen HSCEI dropped by +7% in a single day three times. Since its inception on 15 July 1993, such recurrent large declines for the Index only occurred in 1994 (hyper inflation), 1997 and 1998 (Asian financial crisis) which all proved to be strong signals for multi-year bear markets.

Thus, based on the historical pattern, we may have entered into a multi-year bear market …Wouldn't be surprised to see it this time as well given the rapidly deteriorating external demand and rapidly rising domestic inflation?

2) Despite the recent sharp correction, many sectors are still trading at P/E and/or P/B levels that are on average 50-60% above their historical trough valuation. For sectors like materials, property and shipping will need some 80% decline in stock prices to do so…..An vivid example yesterday is that Nine Dragons (-40%) highlighted the risks associated with cyclicals - any disappointment in earnings, the stocks get murdered.

Thus, most stocks may still have 50-60% downside to go before they reach trough valuation. With the fragile market sentiments and weakening fundamentals, we may still far from the bottom…

3) Out of the 22 cases before yesterday's +7% one day fall, 11 times HSCEI saw positive returns (14.8% on average) and 11 times negative returns (-6.7% on average) in the following week and one month.

Thus, more selling and shorting opportunity may exist in the weeks ahead. For preferred sellers, I will pick Commodities and Financials; while for safe shelters, I will pick Telecom, Toll Roads, and Consumer Staples.

Noted on Tuesday, March 18, 2008 5:20PM Hong Kong