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Throwing in the Towel

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Actions speak louder than words.

Yesterday I sat at the Washington luncheon speech of Ben Bernanke. We watched the stock market meltdown start about three quarters of the way through his speech. The rest of yesterday you know. Last night, the meltdown continued worldwide.

This morning we saw coordinated central bank actions aimed at massive stimulus in order to encourage growth and abate the credit crunch. The tools being applied in the monetary realm are enormous and without precedent. These tools will succeed. They are now global and will address the freeze that has infected global financial integration.

We will update our now famous chart late Thursday afternoon. On Friday morning see www.cumber.com for the graphic depiction of the Fed's new balance sheet. We are updating it as fast as we can.

Bernanke broadcast his intentions with words. He used academic language. He wore his Princeton Professor's hat. I sat there and understood his words and nuances. I also realized that those who are not skilled in the language of monetary economics would have difficulty comprehending his meaning.

My colleagues and I who were sitting at the table discussed the Fed's mechanics and how the interest rate "corridor" Bernanke described is now established. We talked about the lower bound that Bernanke mentioned and how the upper bound would be established. We speculated about how much time it would take to narrow the LIBOR-OIS spread. We talked about how the change in interest payments on bank reserves would allow the Fed to dramatically expand its balance sheet. We delved into how monetary policy can blunt a shrinking credit multiplier.

The problem for the financial markets is that Bernanke didn't say it in plain English. He used classic academic Fed speak.

In the last two weeks I have personally had conversations with numerous officials at central banks. Many of those were with officials in the Federal Reserve or the European Central Bank. Believe me; they "get it."

The communication problem is that they have difficulty expressing "it" in plain language. Yes, Virginia, there is a communication problem. We have been writing about that for several years.

But a communication problem is not a policy problem. When it comes to policy, the central banks are acting. We see it today with coordinated rate cuts. We saw it with Fed's new commercial paper facility. We saw it with doubling of the TAF auction. Think about it: the TAF expansion and the commercial paper facility are likely to be five times the initial $250 billion in Paulson's TARP. And they will be immediate. We also saw this policy coming from the technical jargon used in foreign central bankers' speeches. We saw it in the rate cuts broadcast from Hong Kong and Australia as those central banks cut rates by surprising amounts. They were the early forerunners of today's announcements.

All of this is very positive for economies and for markets.

It means maximum monetary effort will be applied to (1) mitigate the damage from the global housing and commercial real estate crises and the deepening recession and (2) abort the credit spread contagion. We believe that credit spreads are now at their widest and that the unsustainable levels are about to start a process of reversal.

Cumberland has been and continues to be a buyer of high-grade tax-free municipal bonds. Yesterday, a bond issued by the government of the state of Ohio traded below a 5.5% yield. That is a 5.5% interest rate after federal taxes and after state taxes by Ohio. At the same time the short-term Treasury bill yielded near zero.

What does this mean? It means panicked investors were forcing the liquidation of their mutual funds and fleeing into zero-interest government securities. All asset classes were being sold. The indiscriminate and emotional selling was overpowering all rational, analytical thinking. It is also the mark of a selling climax and a bottoming process.

A bottoming process is not a single point bottom. All global markets do not bottom simultaneously. All indexes do not make their lows concurrently. But they do bottom in a correlated fashion. The reason is that they were abandoned in a correlated fashion as investors decided to sell everything and run into cash.

At Cumberland, we believe the time to be opportunistic is when emotional sellers are offering bargain goods at prices which bear no reference to their underlying value. Ohio State General Obligation tax-free municipal bonds are one example. There are many others in the bond and stock markets and in the global asset classes.

It is time to scale towards a fully invested position. This morning the US stock market was down over 350 Dow points when measured by the futures market. That pricing marked a 5000-point decline in one year if we measure from the market top in October 2007.

The time to be a seller was last year. We raised some cash. In retrospect, it was not enough although we were criticized at the time for being too cautious.

Now is not the time to throw caution to the winds. But it is time to focus on the bottoming process with an eye toward buying. The perfect time to be a buyer is when the last fighter "throws the towel in the ring." You then have to be standing there to catch it. At Cumberland, we are standing in the ring and catching these sweaty, stinking towels. They are being thrown to us by sleepless and terrified investors who are running to place 100% of their money in zero-interest-rate cash.

We expect that many global markets will be higher than present levels by the end of this year. Credit spreads will be narrower. That is how it looks to us.

David R. Kotok, Chairman and Chief Investment Officer, email: david.kotok@cumber.com