Vigilant Investments Advisors, LLC.

Tsunami Warning

In the last six months we have seen more volatility in the equity markets around the world than we have seen in the history of the equity markets as we know them.   Extreme volatility happens in the markets at market tops and market bottoms. 

Hint: this isn’t the top…

Although this is the process of creating a bottom in the financial markets of the world, the fallout from the bottoming process is still to be felt for years to come.  In the past few months, short term lending between banks came to a screeching halt.  The commercial paper market completely fell apart in the wake of the Lehman Brothers bankruptcy. 

Despite the efforts of the Federal Reserve and Treasury to infuse these markets with trillions of dollars of liquidity, the money, in many cases, is not flowing to the businesses and industries that need it.  The result of this shortage of available credit will have profound effects on the long term economic growth around the world. 

The primary effects are felt by the large banks and large companies that use billions of dollars of short term borrowing to fund working capital for the large scale operations.  What has yet to be seen are the secondary and tertiary effects that may have a greater impact on individuals and households.

During this period of cash infusion by the Federal Reserve and the Treasury, banks are compelled to lend because they have accepted funds from the government.  The challenge is for the banks to find companies worthy of the funding.  In a world where all companies are asking to borrow money, and when the banks have recently been burned by lending to non-creditworthy institutions, the banks will tend to lend to companies that they have already lent to and where other banks are also lending to the same institutions.

This concentration of loaned funds causes a wave of borrowed money to enter into some companies and a drought of funding for other companies.  In effect the banks will collude, unofficially, to lend to those institutions that, in the end, will not need the money but will be able to pay the money back.  After all, they will reason, if we are going to be wrong, we do not want to be the only ones to be wrong and to have lent money to these institutions or to this industry.

Ultimately, some companies will receive funds and some will not.  Those that receive funds will receive funds in excess, from many institutions and will have the benefit of having funds while some of their competitors will not.  Those that are not able to receive funds will be at a severe disadvantage in the competitive landscape and will tend to lose market share and sell out to those that do have funding.

This wave of excess funding will propel some companies forward and will completely crush those that are not well funded.  Those that have funds will ride the tsunami; those that don’t have access to capital will be crushed by the tsunami.