Large write offs at several high profile financial companies have weighed on the markets in recent days. These major financial blunders are a reminder that there are no free lunches. Unless you're living in La La Land, someone always pays when a bubble bursts.
A review of economic history shows that slowdowns and recessions are almost always accompanied by some type of financial catastrophe. To us and anyone who has taken Accounting 101, this is perfectly logical. If an asset bubble is pricked, an equal amount of air must escape from the other side of the balance sheet. Financiers will be vetted.
When the technology bubble burst, equity holders were left holding the bag. You, me and anyone who owned the NASDAQ bore the brunt of the pain. Now the housing industry has burst. This time, those holding liabilities are under the most pressure. In spite of attempts to securitize and offload questionable credits, a handful of commercial and investment banks are suffering the greatest wounds.
In the end, we still believe that the damage will be relatively self contained to a few sectors and that it won't lead to a full blown, economy-wide recession. The global markets are extremely resilient in this regard. For those who lived directly in La La Land, however, the hangover will feel very bad. It always does.
For us, this still means staying underweight the financials and home builders.