History repeats itself again

• Sell all shares of American Superconductor (AMSC, news, msgs)at the open.

Take a deep breath, everyone.

Let's look under the hood of this credit meltdown and the markets, tie up some loose ends and then try to clear a bit of the fog that shrouds many investors right now.

First, liquidity will eventually return to these markets.

Why? Well, because there are still trillions of dollars of capital in vast pools around the world that must seek a return. Much of that money will find its way into the credit markets.

A great example of this was the two deals e-mailed to me during the weekend.

They were "dislocation funds." Everybody wants to be like Citadel -- the group that bailed out the hedge fund firm Amaranth Advisors last year and, most recently, the hedge funds run by some ex-Harvard guys.

Billions were raised during the weekend to do what entrepreneurial capitalists should do -- take out the virtually dead bodies of those who stayed too long at the trough and make money off their bad judgments.

Capital won't sit still

This is exactly what happened in the "credit crunch" of the early '90s when Citibank almost went belly up on the bad real-estate debt in the United States and big loans to Mexico, Brazil, etc. that went "ka-boom."

Lending to small business dried up at the major banks. But capital, like nature, abhors a vacuum. The corporate bond market came to the rescue, and capital users got out of the bank line and lined up at Wall Street bond desks.

Others went to private equity funds for capital. Real-estate development funds were created to make participating loans to developers -- mostly from insurance companies.

Income-property loan securitization was pioneered at Nomura Securities by an American who saw a huge opportunity to get expensive money to real estate and hotel developers who had a growing economy and zero funds available to capitalize.

Deals that make more sense

The lesson here?

Former Federal Reserve Chairman Alan Greenspan always said that people react to the uncertainty generated by a financial market shock they way they do when they walk into a dark room.

First, they freeze. (And, boy, have we seen that!) Then they act. Some leave the room (i.e. they sell), and some get a flashlight and figure out what opportunity they missed.

Leveraged buyouts until June were routinely done at 12 times annual cash flow with debt equal to 10 times cash flow. In my day, we called that at a blended interest cost of 8%.

Now, these loans are going to be closer to 10% to 11% blended. That means you are going to have to drop your valuations to nine times cash flow (or less) and/or put up more equity to get debt down to eight times cash flow.

Will deals get done on this new basis? Sure. But the deals that do get done this time will make sense.

The credit market just raised interest rates for many borrowers by about 3% in a few months! If the Fed had done this, the Dow would be down 3,000 points!

This is what happened in the housing sector: The Fed started raising rates in 2003, but Wall Street delayed the reckoning with these newfangled "teaser rate" loans. New homeowners and people refinancing never saw the effective rate increases until last month.

It is only now that the Fed's rate hikes are affecting the "real economy."

This is what is going on in the mortgage markets: The Fed's monetary actions are finally getting priced into the capital markets about three years too late. The last thing the Fed wants to do is add more to the cost of capital or tighten monetary policy, believe me.

The Fed decided not to lower rates, but they will start to build a case for lowering rates if they see deteriorating U.S. gross domestic product (GDP) fundamentals by their Oct. 30-31 meeting. And they will.

The global growth miracle story still prevails

Several things continue to get overlooked in this credit re-pricing crunch:

• The new "theology of capitalism that is sweeping the world," to borrow a phrase from British historian Eric Hobsbawm. 3.5 billion people from Eastern Europe to the Pacific and Indian oceans are no longer living under the influence of socialism or communism.

• The transformation of the global economy to capitalism is not a three- to five-year trend. This has to be thought of in terms of the 20-, 30- and 40-year growth we saw during the 19th century Industrial Revolution, when peasant societies became industrial ones.

• Urbanization is happening all over the world, and there is no way to stop it, unless people lose faith in capitalism. But too many people are getting rich to lose faith now.

• The BRIC (Brazil, Russia, India and China) countries now represent about 20% of global GDP. The United States accounts for just 21% of world GDP -- down from 30% only 15 years ago.

• Small-but-powerful growers such as Estonia, Turkey and Bulgaria are growing 5%, 6% and 7% a year, respectively. More than 120 countries are growing at over 4% rates this year and next.

All the headlines are about China growing at 10% and India at 8% or 9%, but the rest of the developing world is growing at somewhere between 6% and 8% a year.

The upshot? The developing world has grown to represent 40% of the global GDP.

That’s where we get world GDP at 4.5% to 5.5% for the past several years. Compound that 4.5% to 5.5%, and you have got a hell of a strain on all resources and huge spikes in "middle class" infrastructure, services and goods consumption.

That is the global economic miracle. And crappy subprime loans don't matter a hoot in this picture.

This growth story doesn't give a damn about America's failed love affair with "NINJA" (No Income, No Job, No assets) home loans.

The mortgage hangover lasts till 2009

My forecast is for 2009 to mark the beginning of a sustainable recovery in the housing market. Enough new home builders will be dead, existing inventory will be sold at 20%-ish discounts and the foreclosure properties at the low end will start to be cheaper to buy than rent.

But the "pig in the python" is the variable or adjustable-rate mortgages resetting during the next 18 months. About 20% of them are subprime, which means foreclosures will continue to climb to a peak in 2008.

About 5 million people became new homeowners between 2000 and 2005; about 2 million will lose the homes they should not have qualified to buy in the first place.

Let's call it what it is: A great financial experiment that failed.

The largest portion of the adjustable-rate mortgages won't reset until next year. We have just seen $197 billion of mortgage resets through June. That is less than we will see in February and March of next year.

And the first six months of 2008 have more than the total for 2007 ($521 billion).

Moral of the story?

The total increase in payments is an estimated $42 billion, which in the big picture (especially after taxes) will not kill the U.S. economy. It will continue to be a drag of up to 0.5% a year in consumer spending.

But export growth will continue to make up the difference. The "global growth" consumers are buying lots of goods and services from American companies. How else could our GDP grow 3.25% in the second quarter with only 1.3% consumer spending growth?

A little help from the Fed -- and 10-year bond rates under 5% -- will help out, too.

Housing starts: Possibly near a bottom

In a typical housing market downturn, we see housing starts drop below 1 million in the United States. But recent research I've seen indicates that both housing starts and residential construction as a percentage of GDP are still way above what you would expect for a market bottom.

Gary Shilling, who is a good forecaster of housing development, suggests that housing starts will fall to about 1 million on an annualized basis at some point next year. I think he is right, and that will bring a lot more pain for home builders.

It's too early to bottom-fish now, but BusinessWeek's recent cover story "Bonfire of the Builders” is telling us that the bottom is near.

The bottom line

We are going to see more pressure on the consumer as mortgage-equity withdrawals continue to fall and housing-related jobs continue to drop.

Much of this drag will be made up in our economy by:

• 10% growth in exports.

• Inventory building by industry.

• Growth in healthcare spending (the $2 trillion growth engine of the U.S.-based economy).

• "Super-spender spending" -- the top 20% of earners who account for 40% of U.S. consumption.

• Baby boomers hitting their peak earnings period (age 50-59).

Yes, the economy will have the drags of falling home prices, falling new home construction and much less home equity extraction.

The good news is that most of the rest of the economy is doing well enough to offset most of the drags, and a recession is not in sight.

This, more than anything else, is why globally leveraged stocks will continue to outperform other asset classes. And why we are buyers in this market mayhem, not sellers.

Sorry for the long story, but I know many of you feel as if you are in a fog right now and need some daylight to catch your bearings.

At times like these, you need a steady hand -- not hysterical shrieking or 10-second sound bites.