Well Wall Street had a very interesting day with not surprising news that housing sales have declined and overrated companies not being able to receive loans to conduct new M&A activities. As a result, the retail investor has been spun into a panic causing an investor-induced correction that has spread all over the American financial markets and now to the rest of the world as I write this.
Some of the more longer-term investors see this as a golden opportunity to cherry-pick various stocks, ETFs, and mutual funds while others are simply making the panicked flight into the bond market. If the market was behaving rationally and driven by rational investors we should see the bulk of this market meltdown contained largely in the financial sector and in the housing stocks. However, we are seeing price drops across the board in organistions with low debt such as Berkshire Hathaway, profitable companies such as Toyota, companies that contain durable competitive advantages such as PepsiCo, and even companies that are far removed from the credit meltdown such as ExxonMobil.
It’s really interesting because at the end of the day, people will still need insurance, still drink Pepsi, get Priuses, and even pump for gas. It’s really interesting to see bankruptcies from a small but sizable segment of Americans who should not have received loans in the first place and weak companies who could not secure funding is causing such a global panic at this time. I understand that the Chinese markets had a similar downturn in late February because Chinese investors were overreacting to increased regulations for investing, which caused a national panic that spread to the world. We are seeing a similar effect in these coming weeks from investor induced panic.
For those who are still panicking over the subprime meltdown, I would like you to know that the problem is real. Just face it: the subprime problem will drive the real estate industry into a downtown in its economic cycle and some mortgage brokers I have spoken to advised me to prepare for the long-haul during this part of the cycle. Despite this, these brokers have taken measures to prepare for the housing slump and will be ready to receive new customers when they reach the uptrend in a few years. They say this has happened when the tech bubble burst, and especially after the anxiety from 9/11 so they are aware of how to get by this housing slump.
Many people who receive subprime loans should never received them in the first place because they are either financially irresponsible or lack the stability needed to pay off those loans. Some examples are of the borrowers’ fault lies in cases of lifestyle inflation where these borrowers would simply use their loans to purchases goods that they simply cannot afford based on their current lifestyle or in many cases simply taking out a loan they will not pay at all. It is also the fault of companies who are willing to lend money to these people are extremely high interest rates knowing these people have poor credit histories and for using sometimes misleading ads to give out loans.
The documentary “Maxed Out” explored some of their predatory practises such as tricking a retarded family into switching over to a high-interest loan or using bullying tactics to get their debtors to make small payments. Relying on such questionable individuals for annuity streams is really a weak business model if you examine the lifestyles and actual finances of these subprime borrowers. It is simply irrational to expect a borrower with a poor history of credit, and rejected by normal creditors to repay their subprime loans along with lucrative interest when these same people usually don’t have the means to do so.
So because the retail investors thinks we’re going into a new Great Depression, they begin selling every stock they have and move the cash over to bonds or banks. In turn the rest of the market overreacts and we have an investor-induced correction that see sharp declines in equities that are far removed from the subprime/credit debacle such as Coca-Cola, Gillette, Johnson & Johnson and even Honda (companies that are generally low in debt and profitable). These conditions make it ideal for the savvy investor to cherry pick some good buys.
I doubt there will be a panic on the levels of a depression seeing that there are regulations in place that would deter from such problems. We have a more interconnected world that allows for both gains and losses to be spread around. We have a Federal Reserve Chair who is a scholar of the Great Depression working to reduce inflation. Most of all, only a small segment of the American population is being extremely incompetent with credit.
The immediate scenario following today’s sharp declines are as follows:
1. We are in the process of going into a long bear market with little to no overall growth.
2. This is just an isolated incident that will gradually go away in the coming months.
3. We have an even bigger decline in the following business day as the financial contagion spreads.
Let’s just hope that it’s just scenario 1 since scenario 2 is being disproved in the foreign markets as I type this while scenario 3 means we are all royally fucked for the short-term.