Monday, February 11, 2008

Look Out Below- ( Dow 7200?)

Back on October 10, 2002 The DJIA traded as low as 7151, the day before it set its closing low for this cycle at 7215. I'd give it about a 5% chance of seeing that level again.
(knowing what we know today)

For comparison, in '73-'74 the DJIA dropped 45%, in '29-'32, 89%. In this cycle the intra-day high was 14,279.96 on Oct. 11, 2007. A 45% haircut only gets us to 7854 or so.
Take this commentary with a grain of road salt.
Mr. Roubini is one of the more bearish economists, but he's sharp. This piece caused some hubub when he put it out last week. Here's a shortened ungated version, worth a read.

From Forbes:
If you get depressed easily, don't read this story. Here's one sage's prediction of a long, deep recession.

It may be time to christen a new Dr. Doom. The candidate: Nouriel Roubini, an economist at New York University's business school. He makes the old Dr. Doom, bond pessimist Henry Kaufman, look like Dr. Phil. No mincer of words, Roubini thinks a full-blown panic will scorch the global economy. He recently laid out his scenario for central bankers in Davos and had them chewing it for hours.

He thinks the immediate spark will be the collapse of bond insurers (MBIA, Ambac, FGIC and others). These insurers have guaranteed $72 billion worth of collateralized debt obligations, now crumbling in value as housing prices fall.

Cheerier sages see an economy lifting off in the second half, fueled by the Fed's rate cuts, and a rebound in the shares of bond insurers. Roubini says lower rates won't help. There are significant risks of insolvency. Here's his prediction of how it'll play out:

Bond Insurers Lose the Triple-A

At press time New York State was trying to arrange a capital infusion for the bond insurers. Roubini doesn't think it'll work, and there's no Plan B--yet. Lacking that, insurers will lose their gilt-edged rating. Then the banks (Merrill, Citi and others) that paid them for protection against default of their collateralized debt obligations will face more writedowns--well beyond the $100 billion that's been written down already. Financial losses in subprime mortgages could be $400 billion and in the whole financial system more than $1 trillion. A big bank might go under.

Contagion Spreads

Writedowns will begin percolating up from subprime mortgages to near-prime and prime mortgages, commercial real estate, auto loans, credit cards, corporate buyout loans, corporate bonds and derivatives. If leveraged banks, brokers and hedge funds should suffer $200 billion in domestic credit losses, they would have to pull back on $2 trillion in lending, according to a Goldman Sachs (nyse: GS - news - people ) analysis. Roubini says the rest of the world will "recouple" rather than decouple, as financial losses spread to other world capital markets, especially Europe. Sovereign wealth funds will not be large enough to play savior. Credit spreads will keep widening. Equities, housing, commodities, emerging market assets and the dollar will get hurt. "Cash is king in 2008," says Roubini. ...MORE