Gold News

Stocks vs. the credit crunch

How might world stock markets behave as the global credit crunch wears on...?

"I'VE BEEN in the markets for more than 30 years and I have never seen such a complete dislocation between the equity and debt markets," says Citigroup's head of investment research Bruce Rolph in the Financial Review.

   It's the most intriguing question in finance now. Does the collapse of the credit bubble mean falling stock prices or not?

   "It's like we are all on the Titanic headed towards the iceberg. Except the bond guys are in the engine room trying to figure out if there are enough life jackets in case we hit an iceberg, while the equity guys are on the fourth floor sipping martinis," adds Kumar Palghat, the managing director at Kapstream Capital.

   "One of the two markets is wrong," he adds. But are life jackets normally kept in the engine room?

   Mr.Palghat's point is well-taken, jokes aside. It's the question no one quite knows the answer to right now. It's like that tree falling in the forest. If no one hears it, does it make a sound? If the credit market continues to implode, will it matter to stocks?

   The answer, we think, is that it will matter to some stocks more than others. Lehman, Bear, Goldman, and Morgan all report earnings this week. They will tell the markets how much money subprime and the resulting credit-market freeze has cost them.

   Hopefully they will be honest. They will probably own up to trading losses.

   Whether or not they are willing (or can) mark down the value of securitized assets...we'll see. Goldman is up 16% from its 52-week low, Lehman 15%, Merrill 8.2%, and Morgan a healthy 23%. The market reckons the worst is behind us. A nasty surprise could change that reckoning.

   By the way, of course a tree makes a sound when it falls in the forest. An event doesn't require an observer in order to be a fact. In our younger days, we'd spend most of Saturday morning in a room secured against the invasion of all natural light. But just because we couldn't see the sunrise didn't mean the sun was still asleep too.

   Things happen all the time which we neither see nor have any knowledge of. It's what we do when we find out they've happened that matters.

   Take stock picking going forward. Knowing what we know about credit conditions, it's safe to say that businesses that don't rely on the capital markets for their funding are less vulnerable than investment banks. It's funny if you really think about it and break down what it means.

   Businesses that don't borrow a lot of money in order to make money should be relatively better off. Pretty simple, isn't it? Business models built on low-borrowing costs may be "selected against" in this new credit environment, if you don't mind us using Darwinian terms.

   What we're seeing is the collapse of a whole era of fictitious capitalism built on debt. Thank god. But it isn't over yet. Not by a long stretch.

   Meanwhile, anyone who owns assets that went up because credit was cheap should be prepared for falling asset values. This is what we call debt deflation. The Gold Price might deflate too, for a while.

   But the money supply is rising faster than the supply of gold. That remains bullish for Gold Investment, we think. And gold, of course, doesn't owe anyone anything.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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