I would like to make special note that the bloodletting in the mortgage industry continues to grow. More and more small lenders are seeing massive demands that they repurchase questionable loans made at the height of the housing craze. Many of these small lenders, who are required by contract to take back sour loans, will quickly fall into violation of their own loan covenants and wind up in positions of extreme weakness.
In a typical example a small regional bank might be operating on loans from a large national bank which become immediately due if the smaller bank is not profitable for two straight quarters. An astonishing number of smaller loan operations are now coasting into their second quarter of losses and so will soon be technically insolvent, dependent on the forgiveness of the big players like Merril Lynch and HSBC to continue operating.
The result of all this? It's getting hard to get loans and the housing market will be facing yet another force dragging it down.
One of the seven deadly sins, greed, is taking over on Wall Street, pushing aside any fear in the market. That’s according to the Fear & Greed Index, which recently hit an all-time high — suggesting, like many other indicators, that investors are getting a little overexcited.
The F&G index, compiled by Dresdner Kleinwort, is a risk-adjusted price momentum measure comparing global equities (as gauged by the MSCI World Index) to global bonds (represented by J.P. Morgan Chase’s index). The gauge has typically traded between +1 and -2 since its inception in 1986 — but was as low as -3 just four years ago, a sign that “the end of the world is nigh,” and therefore a time to buy stocks and sell bonds. But as the market has turned upward in recent years, the index has shot up above +2 into the “irrational exuberance” area, a sign to sell equities and buy bonds.
James Montier, research analyst at Dresdner Kleinwort in London, explained in a recent report that the F&G Index hitting an all-time high is yet more evidence that ” investors’ euphoria is truly out of control.” Of course, he wryly adds, “this warning is likely to be about as effective as yelling ‘cliff-edge’ to a herd of thundering lemmings.”
Still, he suggests that “the prudent investor should be shipping out beta and junk, and buying quality defensives.” Even better, Mr. Montier says, “holding cash seems like a good idea,” noting that U.S. mutual funds currently have a mere 3% to 4% in cash. To paraphrase Warren Buffett, he says, “holding cash is painful, but not as painful as doing something stupid.”