Sunday, September 26, 2010

Dueling investors - boom and bust scenarios

Friday's post described a perplexing situation, at least here. Both equity markets reflecting optimism and safe haven markets reflecting pessimism have been on the rise. There are many arguments on either side of this debate with money being put on the line. Choosing two on each side is the topic here.

First, on the equity market case, investors see significant upside due to the potential for robust M&A markets. Many corporations have significant cash hoards that are sitting idle as they wait for more certainty in the economic outlook and in the regulatory environment. For corporations in this position, banks and investors would be willing lenders in supplementing any expenditure that can be justified. As targets, many smaller corporations have less certain financial positions and do not have international distribution networks to leverage their product strengths. With the large corporates able and willing and the small corporates in a position where a solid premium could be attractive, the big could get bigger and stronger. Stock prices will benefit.

Second on equities, there is so much to be done when markets turn. Emerging markets are investing in infrastructure and building large consumer classes. U.S. infrastructure rebuilding will soon not be a choice - look at the levee falling apart in Wisconsin as I write. When confidence begins to turn and growth opportunities come into focus, equity markets will turn hard and fast and up. Institutional investors who want to keep their jobs cannot afford to on the sidelines.

As for the safe haven investor case, those investors loading up on gold and U.S. treasuries among other more tangible assets, what possible disaster could be discussed. Here are the two. First there is the almost too obvious potential some type of cataclysm in the Middle East. We live with that always it seems, but in some ways we appear to be back to a more fragile situation. More on that in another post, but anything major there would trash the stock market and send safe haven investments skyrocketing.

Second for the safe haven rationale, '08/'09 reminded us that financial crises are alive and well as possibilities. My favorite, wrong word!, achilles heel is the money market fund industry. Money market funds hold huge amounts of consumer and small business assets and are yielding almost nothing. In fact, they are being partially subsidized by the fund industry as fees are being waived to keep from breaking the buck. There is no margin for error. Any surprise collapse of a major corporate or banking institution, say a significant European bank, could push some funds over the edge and panic would ensue. If it were a number of funds, and not just one like in '08, we would get a test of the back office providers as well that could really get scary. Credit would freeze, financial stocks would collapse, others would follow. That brighten your day?


Anonymous kleon said...

but we'll probably keep muddlin' along, no extremes. only fringe people are looking for boom or bust. boring banks are the beneficiaries.

12:36 PM  

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