A Slow Motion Train Wreck or a Minksy Moment?

There are a few investment professionals whose market commentary and quarterly/annual writings I read religiously in order to get a dose of perspective on the current state of the markets. Among those sages are Warren Buffett, Bill Gross and Jeremy Grantham. Due to their successful investing prowess and long track record I give their thoughts more weight than any of the market pundits and bloggers. I also enjoy reading a blog written by NYU economist Nouriel Roubini. Though not an investor himself he is very knowledgeable and good at detecting risks in the financial system.

Recently both Grantham (pictured above) and Roubini have been quite bearish. Grantham, who manages $150 billion at Grantham, Mayo, Van Otterloo & Co. LLC, describes the current market as a "slow motion train wreck" and sees the biggest opportunity in "anti-risk." Roubini sees the current market as the peak of a Minsky Credit Cycle and sees the credit crisis as worse than the LTCM meltdown. I encourage all of my readers to read both pieces. Grantham's quarterly newsletter can be read here. You may have to register to view Grantham's piece, though it should only take you a few minutes. Roubini's blog post can be read here.

Grantham's musings are quite somber. He starts out with a discussion of tax rates and excesses in private equity (much like Bill Gross did a few weeks back) but then goes on to discuss where he sees opportunity in the markets. Being a "perma-bear" it is not surprising that Grantham sees opportunity in "anti-risk," a more nuanced version of a flight to quality. Here are the highlights from his quarterly newsletter entitled "The Blackstone Peak and the Turning of the Worms":

• "What we have to worry about is whether we are reaching a broad-based level of financial metal fatigue in which bolt after bolt will fail with ultimately disastrous consequences"
• "The odds of failure rise but they probably don’t become high until October 2008. At that time, a new administration with its new broom and new taxes and new antipathy to the financial world's rich, coupled with tighter credit and credit problems, we will have a very typical time, based on history, to have a bear market, and I for one am betting on it."
• "In 40 years I believe I have been offered three obvious and extreme opportunities to make or at least save money . . . the third great opportunity is now upon us in my opinion, and that is anti-risk."
• "In 5 years I expect that at least one major “bank” (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private equity firms in existence today will have simply ceased to exist."
• "I have often been too bearish about the U.S. equity markets in the last 12 years (although bullish on emerging equity markets), but I think it is fair to say that my language has almost never been this dire. The feeling I have today is that of watching a very slow motion train wreck.*"
  

Roubini's (pictured to the right) blog post today is scary though perhaps a little less dire than Grantham's newsletter. Roubini predicts a "hard landing" for the economy but doesn't provide a lot of guidance for investors. Here are some highlights:

• "the current market turmoil is much worse than the liquidity crisis experienced by the US and the global economy in the 1998 LTCM episode. "
• "Today we do not have only a liquidity crisis like in 1998; we also have a insolvency/debt crisis among a variety of borrowers that overborrowed excessively during the boom phase of the latest Minsky Credit Bubble."
• "if you take a bunch of to be defaulted subprime and near prime mortgages and you repackage them into RMBS and then these RMBS are repackaged into various tranches of CDO, the rating agencies may be using magic voodoo to turn those junk BBB- mortgages into AAA tranches of CDO; but this is only voodoo as the underlying assets are going to be defaulted on."
• "The risks of a systemic crisis are rising: liquidity injections and lender of last resort bail out of insolvent borrowers - however necessary and unavoidable during a liquidity panic- will not work; it will only postpone and exacerbate the eventual and unavoidable insolvencies."

Neither of these articles hold good news, particularly if you are still bullish. But, remember that it is incredibly healthy as an investor to have a healthy dose of fear. There is a reason that Warren Buffett's search for an investor to replace himself starts and ends with being aware of risk:

"Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions."

Successful investing is as much about avoiding serious risks as it is about spotting serious opportunities. Such advice is timely right now as we watch some incredibly skilled investors and the black box models they create get "blind-sided" by current market gyrations.