Focus on Rumours and Financials

Rumours like the ones we saw today about trouble at SocGen are just the beginning. The three L’s of the rumour-monger are about to take front stage: liquidation, losses, litigation.

The 17% drop in the S&P 500 since the beginning of July is going to generate fund liquidations. Every holding in a funds will get rag-dolled when overall losses in the fund are in excess of 20%. The rumours of withdrawals and liquidations will cause many magnitudes more damage than the withdrawals themselves.

Losses are coming in an economy that is underperforming expectations. As Warren Buffett said: “It’s only when the tide goes out that you learn who is swimming naked.” Financials are especially vulnerable because talk and rumours of losses ALWAYS precede the real thing and cause far more damage.

Litigation is a special ‘L’ in the list because the declines now are coming on the heels of the financial crisis. We are now precisely in the window of time (3-4 years after the event) when lawsuits will peak. Talk of $40-50 billion in lawsuits hitting Bank of America related to mortgage fraud have hit. The desperation in the economy and markets is going to spark others.

We are major believers in following central banks for guidance and with what we heard from the Fed and the RBA in the past 10 days, we think the message is clear. The US is on the precipice of another recession. Now it’s time to sort out who will survive.

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