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Generational Dynamics Web Log for 17-Jul-2009
CIT Group bank nears bankruptcy, as Nouriel Roubini declares the worst is over

Web Log - July, 2009

CIT Group bank nears bankruptcy, as Nouriel Roubini declares the worst is over

CIT Group provides credit to almost a million small and medium sized businesses.


Delinquency rates for CIT loans <font face=Arial size=-2>(Source: WSJ)</font>
Delinquency rates for CIT loans (Source: WSJ)

The service is known as "factoring." A small business issues an invoice to a customer. The business turns the invoice receivable over to CIT, and CIT pays the business immediately, taking the risk of collecting from the customer for a small fee. But delinquency rates have been soaring since the beginning of the credit crisis, and CIT itself is no longer financially stable.

A CIT bankruptcy, which may occur as early as Friday, would freeze this source of credit to these small and medium sized businesses, creating cash crises for many of them.

CIT was bailed out in December with $2.35 billion, and there's been a week-long debate in Washington whether to bail CIT out again. Part of the debate was the question of whether the bankruptcy of CIT would pose a "systemic threat" to the world financial system, and the Treasury Dept. decided that there was no such sufficiently great threat.

Furthermore, Nouriel Roubini, the famous NYU professor who has gained worldwide acclaim for having predicted, in 2006, that the collapse of the real estate bubble would cause a recession, apparently doesn't think that there's a major problem either.

This is an interesting story because Roubini's words on Thursday are being credited as the cause of the big stock market rally on Thursday afternoon. He said that the worst of the financial crisis is over and the recession will end this year. Specifically, he said, "The freefall of the economy has stopped, There is light at the end of the tunnel. And the light at the end of the tunnel for once is not the one of an incoming train."

With the CIT Group facing bankruptcy, Roubini's statement was grabbed onto by the media as a bright spot in the news, triggering the late afternoon rally. The reaction from the media and investors was so great that Roubini felt it necessary to put out a statement claiming that he was only saying the things he's said before.

In fact, that's true. I posted a report last December entitled "Nouriel Roubini predicts recession will end in 2009."

So why did Roubini's statement on Thursday cause such a sensation? I believe it was for this reason: Last December it was relatively easy to believe that the recession would end by the end of 2009; now, in July, the end of 2009 is only five months away, and a lot fewer people believe that the recession will end by December. So Roubini's statement pushed the little Wall Street junkies into a further stock buying binge.

If Roubini isn't changing his mind, there's one person who apparently is. I wrote recently that stock market wise man Art Cashin expected the direction of the market to be clarified by Friday of this week. However, on Thursday morning, he backed off, saying that "This market is now overbought. There is a chance for a reversal. We may have to extend that checkpoint into next week." So I guess we'll just have to wait another week.

A much more sensible analysis was posted in the Generational Dynamics forum by the trader Gordo:

"If you are still long the market, I think the recent rally is a good opportunity to unload.

The positive media spin on everything this morning is pretty entertaining. The jobs report is supposedly bullish despite the fact that the actual (unadjusted) number of initial claims was 667,000 which is an increase of 86,389 from the previous week and yet this is being portrayed as an improvement. Then you have the biggest headline story about JP Morganís profits SOARING 36% or whatever, this report is even funnier when you dig into it, so they made a few bucks TRADING during the biggest short term market rally since the depression, and yet at the same time, they admit their core business is looking ill with a loan portfolio that continues to deteriorate despite all the so called green shoots. They set aside 5 TIMES the amount of so called profits from the quarter for bad loan loss reserves! HahahÖ.

Sorry I didn't give more detail yesterday, but the key reversal in the VIX along with treasury action may be signaling a stock-market peak. Iím starting to believe the market is very close to a multi-year peak right NOW. VIX managed to get back down to levels last seen in Sept. 2008, signaling complacency. The remarkable reversal in VIX yesterday could be indicating an important trend change, I expect it to move considerably higher, probably to the 40 range, as the market sells off over the next several weeks. After that I'm not sure...

It is possible that the market will not get back to current levels for a decade or more when all is said and done. Real bear markets end with single digit P/E ratios (based on peak or 10 year trailing earnings) and 6+% dividend yields, thatís the bottom line. Being long before that point is just asking for trouble, not that I donít play bounces. LOL"

The VIX is the "volatility index," and it's dropped sharply lately, indicating a great deal of complacency among investors and the media. According to Gordo, this complacency is so great that it actually serves as a sell signal to day traders. This is an obvious contrarian strategy: Whatever the herd is doing, do the opposite.

Another analyst who definitely hasn't changed his mind is ... me. Since 2002 I've been saying that we're entering a new 1930s style Great Depression, and certainly nothing has happened to make me change my mind. That forecast was based on a long-term analysis of stock market trends. (See: "How to compute the 'real value' of the stock market.") Those conclusions are just as valid today as they were in 2002.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (17-Jul-2009) Permanent Link
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