Bear Market to Continue; No "Diving Saves" Occurring

We continue to wait for a set of emerging market currency collapses and debt defaults before we consider increasing our equity allocations to our "policy allocation" levels.

But we're always on the lookout for potential "diving saves" that could prevent this disaster scenario. For instance, if investors develop increasing confidence that developed market consumers will start to spend again, a floor would set in many financial markets. After all developed market consumer spending is a hallmark of the "global imbalances" that are unwinding today: artificially low emerging market currencies are supporting over-investment in those countries, lower-than-natural interest rates in developed countries, and ballooned credit and purchasing habits in developed countries.

This "system" of global imbalances has a long way to unwind. But if this unwinding process slows down -- say, if developed market mortgage rates were to decline (allowing a pickup in the housing markets and consumer confidence) -- then markets would rise significantly on the hope that the painful global deleveraging could reverse.

The problem is, banks and bank financing providers show no sign of creating an environment for declining mortgage rates. We're presenting a chart from economists at ISI. It shows that mortgage rates (top, dotted line) are still in an UPtrend, even as Treasury rates (bottom line) continue to slide. When deep recessions were avoided in the past, mortgage rates fell as treasury rates fell.

















This situation reflects many aspects of the ongoing credit crisis, which is essentially a plunge in confidence among lenders that buyers will be able to pay them back.

It's worth pointing otu that we don't think certain other "bullish indicators" for consumers will help much this time around. For instance, some economists believe that decline gasoline prices can save the consumer; we don't. Falling oil and gas prices are producing a negative feedback loop for the world's producers of these, many of whom are already the world's most vulnerable credits, such as Russia and, increasingly, the Middle East. Further commodity price reductions would trigger other major negative credit events that would further dampen global credit and demand. What's needed are improving credit conditions within the global financial system, such as with respect to mortgages -- we don't see it happening yet.