I did a series of interviews with the Moneyshow network last week. The first is available here: Price Risk High.
Yesterday John Hussman's weekly letter elaborates nicely on some of the concerns I have mentioned in recent interviews and the key hurdles haunting risk markets and bullish hopes from here.
“The real concern from my perspective remains the potential for a second wave of delinquencies beginning in data as of the first quarter of 2010 and extending well into 2011. While we've seen some suggestions that many Alt-A and Option-ARM loans have already been modified, the premise of this argument is problematic since it is also true that about three-quarters of modified mortgages go on to default a second time, and few of these modifications result in substantial alterations in principal or interest payments beyond 12 months.
In short, my impression is that investors are deluding themselves about the solvency of the banking system. People learned in the 1930's that when you don't require the reported value of assets to have a clear and tangible link to the value that the assets would have in liquidation, bad things happen. Yet this is what regulatory and accounting rules are allowing for the banking system at present. While I do believe that bank depositors are safe to the extent of FDIC guarantees, my impression is that the banking system is still quietly insolvent.”
The bad debts being glossed over in the banking systems (and governments) of the world today are a major systemic risk. But even if we set this issue aside and assume a miracle solution will allow the system to gradually hobble back to health without any further blow ups, the point remains that stock valuations today promise to be as stubbournly unrewarding to investors over the next 7-10 years as they have been over the last 10 years:
“Presently, a normalization of valuations, not to extreme undervaluation but simply a reversion to post-war, non-bubble norms, would imply an average annual return for the S&P 500 of just 2.97% over the coming 5 year period.
This outcome is not dependent on whether or not we observe a second set of credit strains, but is instead baked into the cake as a predictable result of prevailing valuations. The risk of further credit strains simply adds an additional layer of concern here. Investors have chased risky securities over the past year to the point where the risk premium for default risk has eroded to the levels we saw at the peak of the credit bubble in 2007. My sense is that this is a mistake that will be painfully corrected. Investors now rely on a sustained economic recovery and the absence of any additional credit strains – and even then would be likely to achieve only tepid long-term returns from these levels.”