How Low Can You Go

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Parkway Record’s “Limbo” and “Twist” LP records set off a national dance craze forty years ago. Its signature lyrics were: “How low can you go?” Just as the dancer who bends the lowest in limbo party wins, we wonder if today’s stocks are winning by gyrating to a dance akin to the “Limbo Party.”

The present “How Low Can You Go?” craze sweeping the nation pertains to the ubiquity of creative (and complex) credit products and services that pervade corporate and particularly consumer spending. 

The signature of this craze in the financial markets becomes:

“How low can an upfront collateral commitment go for a lendee to secure capital from a lendor?

On the consumer side, Bonner cites ‘interest-only’ mortgages in 50%  of new Jumbo mortgages and nearly 90% being ARMs (adjustable rate mortgages). [1]  On the corporate side, investors have implemented a negative real interest rate investment strategy for the better part of two years. The easy credit phenomenon could very well be international in nature as we recently adjusted our expectations for possible volatility in China due to unorthodox financing schemes in use there. Our April 2005 news bulletin highlighting China was pulled from the press after our eyes beheld new reports providing forensic analysis of the financing that fuels China’s red-hot economic growth.

It was Johnson who said the defining characteristic of a society is the self-descriptive observation that a society never got around to saying about itself. If one were to ask the person “on the street” what exactly is it that the United States will be known for 100 years hence, one supposes the answers would come flying at you…

…Computer Technology: how technology made people’s lives easier
…Bio-Medical Advances: how people lived longer with life saving technology
…Democracy: how the world avoided a major World War…etc.

 
All are viable candidates. But let us direct your attention to our candidate of choice:

…Easy Finance: how people increasingly enjoyed lower collateral requirements to acquire consumer and corporate niceties.

Lo, it is not our intent to denounce or mock this self-descriptive trend. Au contraire!  At present, most would prefer today’s easy credit environment to the 1930’s style of mass unemployment and economic malaise that befell the US. It IS our intent to finger the stealthy nature of this easy credit craze and investment opportunities which may come with it.

Without any quantitative support to submit for inspection, we might proffer to say that the easy credit trend may last longer than most would expect. After the Federal Reserve began raising rates, our work led us to calculate that if historical trends held, rate hikes would end at the March 22, 2005 Fed meeting.  Of course at this point, further rate hikes (at least in to June 2005 meeting) appear likely although Federal Reserve meeting minutes indicate members have recently discussed hike termination.  To be sure, easy credit financing’s lifespan is finite; yet the first law of motion tells us that an object [trend] in motion tends to remain in motion unless an external force is applied to it. [2]

Now before we draw the ire of those patiently listening to our suppositions who can instantly bury us with an avalanche of warnings throughout economic history (complete with the ensuing disasters) made by those who abandoned a policy of thrift and solvency, there’s the twist [no Chubby Checker pun intended] to our presumption. That is to say, our work tends to support the notion that those that will benefit from the easy credit craze are those who can maintain high credit standing throughout.  A glance at current research indicates a preference towards a moderate weight to a host of sectors; including natural resources, fixed income, health care, defense, international, et al.

One more potential irony is: volatility may be part and parcel of a strategy incorporating high credit quality company investment.  Note the first six months of this year has presented investors with some of the most violent, albeit contained, market swings in recent memory. Attention to capital preservation should not be overlooked.

In the end, Market Bulls hope that the easy credit’s party extends longer than that of the Limbo Party’s.  Callahan notes that the Limbo Party record label was losing money two years after the record’s release and the label company was de-listed by the New York Stock Exchange five years after the release of Limbo Party. [3]  We can hope the NYSE listed stocks in today’s finance sector do not meet the same short fate.

Sources

1.  Per Bonner, ‘Attention! Deficit Disorder’, Daily Reckoning, May 17, 2005
2. Per Serway, Physics, Saunders Golden Sunburst Series, 1983, p. 68
3. Per Callahan, Edwards and Eyries, “The Cameo-Parkway Story,” August 6, 2003

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