The Securities and Exchange Commission in the US is following up on this summer’s temporary ban on naked short selling of shares for the big mortgage companies, Fannie Mae and Freddie Mac. Now the shorts are really going to be squeezed - until the pips squeak.
Of more fundamental significance is the plan in the US to introduce a facility to buy the ‘bad’ assets from the banks. By relieving the banks of their unmarketable mortgage backed securities, the logjam which has effectively shut down interbank lending and driven up credit spreads quite indiscriminately right across the board, could be finally broken.
It will take a while for the financial system to repair itself but, as suggested in our last note (A beginning of the end? 15 September 2008), the end game is being played out. Barclays has agreed to buy Lehman’s good assets. Bank of America has agreed to purchase Merrill Lynch. In the UK, Lloyds has agreed to buy HBoS. The authorities on both sides on the pond are attempting to mitigate the apparently destabilizing influence of short selling and the US Government is planning to introduce a vehicle that will absorb bad assets in an effort to help banks’ balance sheets.
The central banks are continuing to assist the money markets and are set to maintain their various lending facilities. Sooner or later, probably sooner rather than later, the forces of contraction and disinflation that have been released throughout the major economies will bring more pressure on the central banks to bring down interest rates. Given that commodity prices are lower, the relevant investment background is starting to look better.
A lot is happening. I think enough of the right kinds of things are being done to restore confidence in the corporate bond and equity markets and make valuations look appealing. As the chart shows, there is value in equity markets. In my view, they are discounting an awful lot of bad news and I would expect to see some stability.
The chart below shows the FTSE 100 and the FTSE 100 excluding resources. The former fell this week to a new low for the year but the latter did not, and this is despite all the drama of the week involving the banks. If we see some follow through on today’s rebound, the FTSE 100 ex Resources could soon be challenging that upper tram line. An upward break would be indicative not only of the swing towards value but also of the market’s improving breadth and this should be positive for equity markets. Let’s wait - and let’s see!
