5 July 2007

Has the global bubble Popped

Is this the 'Big One'? Is the Bear Stearns blow-up the moment when America’s subprime debacle spills over into the global credit markets and pops the greatest bubble of all time?

Or have China, India, and Russia changed the game? Has their inclusion in the traded world economy - the “great doubling” of the global consumer base, in the words of Professor Richard Freeman – stretched the economic cycle by an extra couple of years?

Well, the coal-face analysts I talk to at Morgan Stanley, Goldman Sachs, Deutsche Bank, Barclays Capital, et al, all think there is enough liquidity to keep the global boom going well into 2008 - with Europe, Japan, and the emerging BRICs doing the heavy lifting as America takes a breather.

Most expect a nasty squall now, or soon, one that will knock another 7-8pc off stock markets, perhaps pushing America’s S&P500 down a hundred points to its 200-day moving average - currently at around 1432.

Every bull market needs mini-purges on the way. Technically, Wall Street and the Euro-bourses look wicked, with double tops and momentum indicators tipping into the graveyard (RSI, ROC, Stochastics, and MACD).

So no, the 'pros' are not yet calling the big one. But then they never do, until it happens. Such is the curse of consensus, and slavery to linear economic models. Crashes are famously non-linear.

We have clues. Alchemy’s boss Jon Moulton told the House of Commons this week that the private equity boom was “somewhere near its top.” Anthony Bolton, Britain’s Warren Buffet, told a forum in Monaco that the vast CDO and CLO debt boom was based on false models and could “collapse”.

We learn that investors in the Bear Stearns Enhanced Leveraged Fund are getting offers of just 5 cent on the dollar for their stakes. A wipe-out, in other words.

The Bear Stearns rot goes much deeper of course. When Merrill Lynch forced a fire-sale of assets, it revealed that even A-grade tranches of these CDO mortgage debt securities were worth just 85pc of face value, and the B-grades nearer zilch.

The creditors orchestrated a quick cover up, but the CDO cat is already out of bag. We now know that some $2 trillion of subprime and 'Alt A' mortgage debt is falsely priced on the books of banks and funds worldwide. Worse is surely to come. Bank of America warns that $500bn of adjustable mortgage debt in the US will be reset upwards in the second half of this year by an average 2 percentage points, and a further $700bn next year.

For now, bears are all watching the yield on that 10-year US Treasury bond – the benchmark price of world money, the Christmas Tree upon which all the other baubles hang: property booms, the emerging market bubbles, leveraged buy-outs, hedge funds and private equity, those $410 trillion in derivatives contracts (seven times global GDP) and that $2.5 trillion of debt packaged as “structured finance”.

The yield surged 65 basis points from early May to mid June to nearly 5.25pc on inflation scares, the fastest rise since 1994. Interestingly, the 94 bond shock did not in itself cause a US recession. But then the US was a very different country. There was no housing bubble, for starters.

However, it did set off the chain of events that led to Mexico’s Tequila crisis and the China bust a year later. Notice the time delay. My guess is that the latest credit crunch will set off a slow-fuse crisis in Eastern Europe, now the epicentre of speculative excess. Watch Hungary and Latvia, both current account disaster cases.

For now, the 10-year yield has since slipped back to 5.04pc. Don’t be fooled. Part of that is a fear reaction as spreads widened between quality and junk. There most certainly is a credit crunch at the low end – or a “gale force wind” in the words of SocGen’s debt guru, Suki Mann.

Just $3bn of the $20bn junk bonds planned for issue last week were actually sold. A long list of leverage buy-outs and dodgy floats have been pulled, or cancelled. Alliance Boots will have to pay 35 basis points more for the £9bn of debt required for its own jumbo buy-out by KKR.

(Strange, is it not, that victims of these bandit raids should have to pay for their own funeral pyres. Why is KKR not be raising its own debt, on its own books, or have we all lost sight of the greater morality here?.. But I digress.)

Roughly $300bn of leveraged buy-outs waiting in the pipeline will face a frosty reception, and perhaps a volley of rotten eggs. Without the takeover spree to juice the stock markets, the indexes will falter and then fall back.

Never take my rotten advice on the markets, but it might be good time to cash in a few stock gains, and rotate a little wealth into banal interest-bearing accounts. The cycle is already one year beyond its normal life. The balance of risk and reward it turning ever less friendly. Ambrose Evans-Pritchard in The Telegraph

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