Think, Invest! by

Wednesday, May 16, 2007

Let's be clear

- Consumer is overleveraged and hurting.
- Economy is slowing.
- Inflation is a threat, especially Ag & Energy inflation.
- There is some financial innoviation going on, but there is also a LOT of overleveraging and overlending.
- After the subprime scare, rating agencies are stepping up their game and becoming more strict.
- The LBO/Private Equity game is driving stocks higher.
- Earnings reports remain strong outside of stocks tied directly to consumers.
- Federal tax receipts are high and the deficit is declining.

What does this all mean?

As always, it's hard too tell. Certainly, there is a lot of yield chasing, and in the long term, I don't think it will pay off. As Buffett says, it's easier to get leverage than to get rid of it.

There is too much rearview-mirror investing going on here.

The future will be different than the immediate past.

My guess is that eventually (who knows when!) the LBO bubble will pop. Maybe the slowing economy will cause it to do so. Greenspan saying there is a 1 in 3 chance of a recession probably means he really believes there is a 2 in 3 chance. It would be irresponible for him to scare the markets, but he also wants to cover his ass.

If the economy slows, default rates will rise, which is scary given how tight spreads are and how much junk debt is being issued. But a lot of the debt is long term, so that should provide some cushion. The bigger threat is that of new lending being shut off, which is what is happening in the subprime market.

Personally, I think we're in the beginning stages of less liquidity and we should prepare as such, moving to higher quality names with longer maturities. I'm getting out of my more speculative bets and becoming more conservative. I'm happy to wait it out. My fear is the the Fed goes crazy with turning on the liquidity, which decreases the dollar's value and inflation, but it's hard to play both side of the fence.


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