Monday, September 18, 2006

What's ahead for the markets?

What's ahead for the securities markets? I don't know.

The consensus wisdom of CNBC and many market commentators is that there are rough times ahead, maybe not this week or next but certainly by 2007. Primary and well known reasons are the growing imbalance in the U.S. residential housing market, higher interest rates, the potential for the inflation rate to increase, and high energy costs. These pressures could lead to a break in the resilience of U.S. consumer spending and impact both U.S. corporate profits and the health of export focused countries that both live off of the U.S. market and fund the U.S. treasury market. This scenario could be right, and if so it would lead to a decline in the U.S. equity and bond markets, and possibly to a recession.

But it seems to be human nature, at least for many media commentators and media focused securities analysts, to always stay on the "safe" side and never risk being the fool who is too optimistic, not a realist but a dreamer. The current general critique of the markets has spawned the cliche of the year often delivered with a serious look, head tilted down, peering over reading glasses and looking straight into the camera that "the consumer has been using his home like a giant ATM and it's running of cash". Even the Swiss based head of the Julius Baer International Equity Fund used almost that exact phrase in an interview in Barrons this week. Market cliches may be correct but they may be too easy.

So what's going right. What markets are solid or improving. First, look at the merger and acquisition climate. It is everything that the U.S. residential housing market is not. Mergers, acquisitions, go privates and IPO's are all on the table. Prices are generally in a zone where deals can get done, meaning the buyers see the opportunity to make a productive investment and the sellers don't see their values in the bargain basement. Longer term interest rates in the bank, bond and swap markets are still historically at reasonable levels if debt is needed, and equity markets can be receptive to paper that makes economic sense. The health of the current M&A market is underscored by the fact that bad IPO's get rejected. A healthy M&A market can lead to companies that are more focused, globally competitive, and profitable. A healthy M&A market generally does not occur in a market about to head off a cliff. (note--this comment will not address some issues of concern in the go private market, maybe at another time)

Second, look at the commercial real estate market. While there have been some rumblings recently about aggressive lending by mid-tier and small banks to middle market commericial real estate, the major market of large commercial real estate appears to be sound. In most markets occupancy levels are reasonable and debt to equity ratios are conservative when compared to the troubled late '80's early 90's. This market attracts both foreign and U.S. capital, and again the rate environment for longer term investments and projects is still attractive. No blow up on the horizon here it seems, and this has been a staple of recessions.

Third, the energy market has some positives. I'm not talking about the price of oil which, while declining at the moment and that's good news, is still at a level that puts pressure on the consumer without a doubt. But natural gas prices have declined significantly and with new supply coming onstream it is unlikely that they are going back up any time soon. 63% of American homes use natural gas for heating and last year the cost of heating those homes rose dramatically. This year it is going back down. In the aggregate, this is a meaningful bit of relief for the consumer.

What's ahead for the markets? I am only certain that the easiest interpretations are often not right, and when they are right the timing may not be near term. Uncertainty, which we surely have, can provide opportunity.


Anonymous Anonymous said...

Opportunity for gain or LOSS you should say.

12:07 PM  

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