People/Institutions are scared to death of equities and any
instruments with credit exposure. Only rebalancers and deep value
players are buying here. There might even be some sales from leveraged
players forced by regulators, margin desks, or "Risk control" desks.
Liquidity is at a premium.
2. But eventually momentum flattens, and yield spreads for the
survivors begin to tighten. Equities may have rallied some, but the
move is widely disbelieved. This is usually a good time to buy; even
if you do get faked out, and momentum takes another leg down,
valuation levels are pretty good, so the net isn't far below you.
3. Slowly, but persistently the equity market rallies. Momentum is
strong. The credit markets are quicker, with spreads tightening to
normal-ish levels. Bit-by-bit valuations rise until the markets are
fairly valued.
4. Momentum remains strong. Credit spreads are tight. Valuations are
high, and most value-type players have reduced their exposures.
Liquidity is cheap, and only rebalancers are selling. (This is where
we are now.)
5. The market continues to rise, but before the peak, momentum
flattens, and the market meanders. Credit spreads remain tight, but
are edgy, and maybe a little volatile. This is usually a good time to
sell. Remember, tops are often a process.
6. Cash flow proves insufficient to cover the debt at some institution
or set of institutions, and defaults ensue. Some think that the
problem is an isolated one, but search begins for where there is
additional weakness. Credit spreads widen, momentum is lousy, and
valuations fall to normal-ish levels.
7. The true size of the crisis is revealed, defaults mount, valuations
are low, credit spreads are high. A few institutions and investors
fail who you wouldn't have expected. Momentum is lousy. We are back to
part 1 of the cycle. Remember, bottoms are often an event.
Source:
Impossible Dream, Part 2
David Merkel
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