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Strength from Weakness

By, 12/19/2007

Story Highlights:

  • Recent market developments such as special central bank debt auctions and cash infusions from sovereign wealth funds are increasingly seen as a demonstration of a collapsing credit system.
  • In fact, these events are demonstrations of the strength of today's global capital markets, which will likely result in net credit crunch effects far less than anticipated.

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It's often tough to recognize underlying strength where surface weakness abounds.

MarketMinder is fond of speaking broadly about concepts like globalization and the accelerating pace of capital markets' development. These are major positives for today's economy in our view.

Yet, in light of 2007's ongoing credit morass, it's often tough to see how powerfully these principles are working today. There's been precious little recognition of the demonstrated versatility and durability of capital markets to ballast credit market weakness, but today's news provides a number of great examples.

Morgan Stanley reports Huge 4th-Quarter Loss
Associated Press, MSNBC.com
http://www.msnbc.msn.com/id/22324581/
(Editor's Note: MarketMinder does NOT recommend individual securities; the below is simply an example of a broader theme we wish to highlight.)

Financial titan Morgan Stanley disappointed big-time today with a wider-than-expected loss, mostly due to asset write-downs tied to subprime debt. This isn't anything new—plenty of the big boys have done the same this year, and surely there are more to come.

What's fascinating is that—just ten years ago—a result like this would probably take more than a few big corporations down. As in bankrupt. Kaput. So far, not one major financial institution has gone under due to credit woes! In the context of real, true crises, this is almost unprecedented.

Why hasn't anyone tanked yet? (And, probably won't by the way.) One big reason is the huge interconnectedness of global capital markets. Morgan Stanley got a much-needed cash infusion from a sovereign wealth fund—from China no less! You remember China, the once pure-red communist land that played the role of villain to the free world? Well, China's so deeply ingrained in today's markets, they're the seizing opportunity (like cold-blooded capitalists, no less!) and contributing excess global liquidity where it's needed. Who would have ever thought China would be the grease for a squeaky financial wheel?

Sovereign Wealth Funds Strike Again
David Ellis and Grace Wong, CNNMoney.com
http://money.cnn.com/2007/12/19/markets/sovereign_funds/index.htm?postversion=2007121909

Yep, they struck again alright. Sovereign wealth funds sniffed out a great opportunity and lent cash to others who needed it. Seems pretty darn positive to us…seems pretty darn free market-like to us too. This is evidence of incredible capital markets dynamism and stability. Just ten years ago none of this was possible and Morgan Stanley might have either been bailed out by the feds or simply forced to shutter its windows for good. Instead, the global economy provided stability.

But that's not all! Central banks around the world are demonstrating in new and innovative ways they can provide support.

Cheap Money Is ECB's Answer
Joellen Perry and Carrick Mollenkamp, The Wall Street Journal
http://online.wsj.com/article/SB119798032590236705.html?mod=todays_us_page_one

Earlier this week the European Central Bank (ECB) provided "unlimited funds" to financial institutions at below market rates in order to ease pressure in European money markets through yearend. The bank ended up lending €348.6 billion (or, about $502.7 billion) to the money markets at 4.21% for a two week term. This is about double the size of a normal ECB auction of this kind.

Obviously, this represents an enormous addition of funds by the ECB. In fact, it's unprecedented. But unprecedented events aren't necessarily bad. Innovation is most often defined by the unprecedented. That's how capital markets developed. Again, years ago it's unlikely such measures would have been conceived let alone implemented.

On a much smaller scale, the Fed followed suit:

Fed's Lends $20 Billion in Funds at Yield of 4.65%
Liz Capo McCormick, Bloomberg
http://www.bloomberg.com/apps/news?pid=20601087&sid=aFplA_bwSyeU&refer=home

The Fed released the results of its widely publicized Term Auction Facility held on Monday, doing its part in the multinational central bank action disclosed last week. These funds, amounting to about $20 billion, were offered at a discount to the Fed's "discount rate," which is actually higher than its standard inter-bank overnight Fed funds rate.

Many folks will see these developments in the wrong light—as frightening proof credit markets are collapsing. But they're signs of durability in today's global market, not portents of cataclysm. The Fed has taken an innovative approach to providing short-term liquidity not including new regulation or permanent, market-hindering measures. That's a good thing.

But, it doesn't mean we should be excited about it either. Turbulence in the credit markets creates heightened risk aversion in stock markets—a likely reason for the year's second-half turmoil.

But what matters most is that fears are far outstripping legitimate concerns. There's much strength in today's weakness. The above demonstrations of strong capital markets are helping to prove as much. Fundamentally, stocks remain very attractive. The innovation and interconnectedness of today's global markets will help make today's credit turbulence far less severe than feared.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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