The blow-up of the UK-based Peloton Hedge Fund is the underlying force that scared markets on Friday.  This piled on the growing fear of a US recession.  We now expect there to be more follow through on Monday. 

Ron Beller, a former Goldman Sachs ¨wunderkind,¨ had this quote in his letter to his hedge fund  investors: ¨because of their own well-publicized issues, credit providers have been severely tightening terms without regard to the creditworthiness or track record of individual firms, which has……made it impossible to meet margin calls.¨   (Source: The Sunday Times)

¨Impossible to meet margin calls! ¨ This phrase strikes fear in the heart and gut of every banker.   And it means another round of testing for the central bankers who act as the lender of last resort in this highly leveraged, globally financially intertwined world.  More hedge funds are headed for collapse and all-star Goldman may now have to pay the price for its failure to be perfect.  UBS, Goldman Sachs, Merrill Lynch & Deutsche Bank are among those who loaned money to Peloton.

This European trip is quick but certainly instructive.  There’s fear here, too.   For US assets, there seems to be a buyer’s strike.  Facing currency risk and market risk, one cannot blame a European for staying on the sidelines or choosing some other investment venue than the US.   They see our markets as cheap but they are only selectively buying these bargains now.  In Europe there is fear.

Dysfunctional credit sectors continue in the US.  In fact, the more there are degrees of separation from the Fed, the more we see this dysfunction.  In Cumberland accounts last week, my colleague, John Mousseau, was able to add perfectly creditworthy, high grade, longer term tax-free Munis at about 120% yield of the taxable treasury bond.  We also found a solid A-rated Moody’s underlying credit with secondary insurance credit enhancement at a failed auction yield of 9% tax-free.  For a fully taxed American, Munis are offering a risk adjusted return that probably exceeds equities under more normal circumstances.   They haven’t been this cheap in decades.

Why are Munis so cheap?  And why are stocks cheap?  And why is the riskless 90-day T-bill yielding less than half the headline rate of inflation? 

Two reasons are clear: the first is that investors are afraid.  We now see estimates of over $3 trillion in cash sitting on the sidelines.  That is in the US.  There are similar cash reserves sitting in other currencies and also waiting for entry into other markets.   My trip here is enough to confirm it in first hand discussion.

Secondly, the traditional sources of market clearing functions are also sitting on the sidelines.  They are worried about having adequate capital.  They are refusing to commit their capital to market making positions.  So we see a buyer’s strike and forced liquidation combining to hammer the markets.

At Cumberland, we are continuing to scale into the markets.  We are selectively buying ETFs which reflect bargains and which will participate well in the inevitable and forthcoming recovery.   Our recently established over-weight position in a transportation ETF is an example. 

In the bond markets we are seizing opportunities in Munis and taxable high-grade securities where credit spreads are now so wide as to offer extraordinary bargains.  We are not buying short term treasuries.  They are priced now for extreme fear.

We expect the Fed to cut policy setting interest rates by 50 basis points on March 18th.  We may see another 50 basis point cut at the following meeting if the credit market dysfunction continues.  The Fed understands now that it cannot properly deal with strategic policy issues while there is a financial contagion underway and while there are major sectors facing credit market dysfunction.

There are large numbers of pessimists around.  Many forecast the end of the world or nearly so.  My negative and disagreeable email is approaching the peak levels I last saw in 2000.  Then we were buying 6% tax-free bonds while investors were selling them to buy Cisco and Microsoft at 100 times earnings.  The ratio of email objection is about the same now as it was then; this is one of our contrary indicators.

This time around investors are displaying the opposite emotion.  In 2000 at the peak, they had become blinded by greed.  Today, it is fear that distorts their vision.

I am scheduled to do my second CNBC interview from Paris on Monday morning at 5:40 AM, New York time.   There are more meetings scheduled and then I fly back on Tuesday:   We’ll stop now and go have a light lunch at a probable cost of $70-80.  That’s nearly double from a few years ago.

A bientot.