Even The Pros May Be Stuffing The Mattresses
By Gail Marksjarvis, Chicagotribune.Com | 29 July 2008
If you saw dark clouds drifting from St. Charles last week, they were probably coming from the dreary mood at the CFA Institute's annual investment seminar for professional investment managers. Every year, the respected chartered financial analyst investment education group brings money managers from around the world together in the Chicago area and exposes them to provocative thinkers on investment strategy and market conditions. And with most of the world's stock markets down 20 percent or more from their highs, economies slowing throughout the world, and a credit crisis toying with the flow of money, this year's speakers were gloomy.
"I am officially scared," GMO investment manager Jeremy Grantham told professionals from as far away as Abu Dhabi and Malaysia. "In 2000, we had a technology bubble. But this is massive, a massive credit crisis and a bubble in global housing, global equity and global land." Grantham is sometimes referred to as a "perma-bear" because he's a stickler about avoiding overpriced stocks. Two years ago, he warned his audience that U.S. stocks were too expensive, even after recovering most of the ground lost from the 49 percent drop to correct the bubble in technology stock prices in 2000. But back then, Grantham was cautious; not fearful. While he was avoiding U.S. stocks, he thought fast-growing emerging markets still held promise.
Now, after a tremendous surge of investor money into Asia, Latin America, Africa and the Middle East, he is concerned about the prices of those stocks, as the world works its way through what he called the "first truly global bubble." In the last few weeks, economies throughout the world have slowed sharply, and Grantham said corporate profit margins must decline as the trend continues. But he does not think investors have adjusted their expectations.
For investors expecting 7 percent annual returns in the U.S. stock market, Grantham said the price-earnings ratio would either have to go to 35, or "profit margins would have to go off the chart." The price of Standard & Poor's 500 stocks is currently about 22 times earnings. When asked by a money manager what he would buy now, Grantham said he was, "long mattresses"— jesting about the stereotypical nervous behavior of hoarding cash. He seriously suggested: "Put money into something incredibly safe, like a high-quality hedge fund."
Grantham said rather than buying stocks for the long run now, he would only "short" them, or bet that they will decline in price. He sees "nothing interesting in quality corporate bonds," and he has been shorting oil. "Commodities had a good run, but that's over," he said. Although downtrodden 'quality' mortgage-related bonds might be a good deal now because some are selling for 59 cents on the dollar, he said he wonders if the price will seem compelling if home prices fall another 20 percent or 25 percent.
He confessed to the group that "I bought my first gold last week, and I hate gold. It doesn't pay a dividend. I would only do it if I was desperate." Grantham said part of his angst comes from a lack of leadership. He criticized U.S. Treasury Secretary Henry Paulson for failing to force banks to raise capital when it was warranted two years ago. And he added: "Just imagine, we have chosen to borrow money from China so we can buy oil from the Middle East and use it to wage war in the Middle East and to pollute the planet."
Marc Faber of Marc Faber Ltd. blamed former Federal Reserve Chairman Alan Greenspan for failing to acknowledge the Fed's role in repeatedly inflating dangerous bubbles. By keeping interest rates low, "the Fed has created a bubble in everything— stocks in emerging market, real estate everywhere in the world, commodities, art," he said. "The only asset class that is down is the U.S. dollar."
Generally, when bubbles burst, the asset prices stay down for lengthy periods. Grantham isn't expecting the stock market to hit its low until 2010. [[Note: it is a universal human failing to expect the things we anticipate to occur far earlier than they actually do, because we fail adequately to take into account the effects of attempts at mitigation and other countervailing forces.: normxxx]] Farouki Majeed, the senior investment officer for asset allocation and risk management for the giant California Public Employees' Retirement System, noted that with the tech bubble bursting in 2000 and the current bear market, investors in stocks have seen virtually no return for the last 10 years. That's unusual, but typical of "boom and bust" cycles, he said.
Calpers reduced its exposure to stocks from 60 percent of the pension fund to just 54 percent this year. Faber said, "It is quite likely that the current synchronized global economic boom and the universal, all-encompassing asset bubble will lead to a colossal bust." And with commodity prices so inflated, he expects an "increase in international tensions" over resources.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Thursday, July 31, 2008
NY Governor Warns Of Crisis
New York Governor Warns Of Economic Crisis
By Mike "Mish" Shedlock | 31 July 2008
The New York Times is reporting Paterson Warns of Economic Crisis.
Era Of 'Buy Now And Pay Later, And Later' Is Over
New York is the second state in five days to declare a fiscal emergency. See Schwarzenegger Announced Intention To Slash State Workers' Pay Till Budget Passes for more on the crisis in California. The most stunning thing about Paterson's announcement is how rational it is. He is not begging Washington for handouts, asking for higher taxes, or praying for miracles. This is pretty stunning too: In June 2007, the 16 banks that pay the most on their business profits remitted $173 million to the state treasury. "This June, just a month ago, they sent us $5 million— a 97 percent decrease."
Unlike Schwarzenegger who has for years resorted to floating bond or proposing various lottery schemes to "fix" the budget, Paterson has the correct solution. Of course Schwarzenegger has at times vowed to "cut up the credit cards" but in the end has delivered nothing but promises and schemes of floating $500 billion in bonds to "rebuild California the way it needs to be rebuilt".
Can Paterson Deliver?
I hope Patterson can, but the state legislature is likely to resist all the way. However, saying these things is one thing, and doing them is another. Regardless, of whether or not all of those things happen, some forced austerity is all but assured. The same goes for California as well. And the word that describes the process best is the one word nearly everyone is in denial over: deflation.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Mike "Mish" Shedlock | 31 July 2008
The New York Times is reporting Paterson Warns of Economic Crisis.
|
Era Of 'Buy Now And Pay Later, And Later' Is Over
New York is the second state in five days to declare a fiscal emergency. See Schwarzenegger Announced Intention To Slash State Workers' Pay Till Budget Passes for more on the crisis in California. The most stunning thing about Paterson's announcement is how rational it is. He is not begging Washington for handouts, asking for higher taxes, or praying for miracles. This is pretty stunning too: In June 2007, the 16 banks that pay the most on their business profits remitted $173 million to the state treasury. "This June, just a month ago, they sent us $5 million— a 97 percent decrease."
Unlike Schwarzenegger who has for years resorted to floating bond or proposing various lottery schemes to "fix" the budget, Paterson has the correct solution. Of course Schwarzenegger has at times vowed to "cut up the credit cards" but in the end has delivered nothing but promises and schemes of floating $500 billion in bonds to "rebuild California the way it needs to be rebuilt".
Can Paterson Deliver?
I hope Patterson can, but the state legislature is likely to resist all the way. However, saying these things is one thing, and doing them is another. Regardless, of whether or not all of those things happen, some forced austerity is all but assured. The same goes for California as well. And the word that describes the process best is the one word nearly everyone is in denial over: deflation.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Wednesday, July 30, 2008
Recession-Proof Stocks?
Conventional Wisdom: Rethinking Recession-Proof Stocks
By Joshua Lipton | 30 July 2008
Or is it?
The tried-and-true strategy for stock-market investors during tough times is to move to companies making products people need: consumer staples like toothpaste and toilet paper, medicines and utilities. Forbes.com recently checked in with some market pros to see whether this time-tested game plan still holds up. Our big picture professionals by and large continue to favor the traditional game plan, though they also argue that defensive investing requires a bit of fine-tuning in the current climate. Let's start with a sector that screams "safety first"— consumer staple stocks, which provide cover during down periods in the economy and markets. Douglas Cliggott, chief investment officer at money manager Dover Management, believes consumer goods companies are still reasonable investments.
"They sell products people buy, whether they're excited or concerned about economic prospects," Cliggott says. But there is some concern that consumer-goods firms could get their profits pinched, as they struggle with higher energy and raw materials costs. Cliggott acknowledges the risk. He argues, though, that companies selling products around the world can diversify away some of these potential problems.
In Pictures: 10 Defensive Buys
"A lot of raw materials costs are in dollars, and sales are in currencies that are rising against the dollar," he says. "There is cost pressure. But there is less cost pressure for them than a firm that is primarily dollar-sales based. So it doesn't eliminate the issue. But it mitigates it." In the sector, Cliggott favors Procter & Gamble (nyse: PG).
"P&G has broad global exposure, tends to sell products people need, like diapers and toothpaste, as opposed to gadgets people want, like iPods and iPhones," Cliggott says. "Most importantly, it now has an implied earnings growth rate of less than 7%, which means its current share price is based on a medium-term EPS growth rate of less than 7%. But, during the past 10 years, P&G has averaged EPS growth of about 10.5% per year."
Cliggott is a bit more lukewarm right now on another traditional safe haven: health care, given what he calls that sector's "extremely clouded outlook." Specifically, Cliggott isn't a big fan of the large cap pharmaceuticals, citing relatively thin new drug pipelines. Cliggott isn't the only one feeling cautious. Standard & Poor's fundamental outlook for pharmaceuticals is now "neutral".
While recession-resistant drug stocks have generally outperformed during past economic downturns, S&P analyst Herman Saftlas thinks the 2008 outlook for drug stocks is clouded by uncertainty, given the impact of November's elections and research and development productivity issues. On the plus side, he does think companies with well-defined growth prospects and generous dividend yields should hold up relatively well over the coming quarters.
Free Download: Forbes Gurus' Best Investment Ideas for 2008
But the health care sector is big and broad, including not just drug stocks but also medical device makers and managed care companies. Robert Doll, vice chairman and chief investment officer of global equities at BlackRock (nyse: BLK), acknowledges the concerns, given the uncertainty about the elections and pipelines, but he still likes health care. "The stocks are cheap relative to earnings, so you need to ask yourself: Do you think those concerns are priced into these stocks? We do."
Doll favors the stability of the sector, and prefers to play the service companies, like the HMOs, because they have better pricing power and healthier balance sheets, he says. His picks here include Express Scripts (nasdaq: ESRX), Medco Health Solutions (nyse: MHS) and Aetna (nyse: AET).
Chuck Carlson, chief executive officer of Horizon Investment Services and editor of DRIP Investor, agrees. He favors managed care names like Humana (nyse: HUM) and Coventry Health Care (nyse: CVH). Carlson is less enthusiastic about another go-to defensive sector: utilities, a sector that investors ran to in 2007, attracted to steady earnings, decent dividends and solid demand. In the past 12 months, the Utilities Select Sector SPDR (amex: XLU) is up more than 8%.
"They are OK," says Carlson. "But they are pricey. They had a good year last year. Now they are stretched." Brad Sorensen, director of sector research at Charles Schwab, currently weights the utilities sector as "neutral," staying cautious, he says, because of valuations. Instead, Schwab is bullish on tech. Some pros disagree with that strategy. Jim Stack, editor of Whitefish Montana's InvesTech Research and Portfolio Strategy, points out that information technology is one of the highest risk areas in a bear market.
In a recession, Stack notes, an easy way for businesses to save money is by cutting back on technology upgrades ( See: "Forbes Gurus: Best Investment Ideas For 2008"). Schwab currently rates the tech sector "overweight" because of, at least partially, its exposure to overseas markets. "We believe that, with the weaker dollar and stronger economies worldwide, that helps them maintain profitability," Sorensen says.
Even if the U.S. economy slows down or there is even a mild recession, Sorensen argues, tech will continue to hold up well because the sector generates so much of its revenue outside of the U.S. That thesis changes if the U.S. economy takes a more pronounced nose dive. "We would then reduce our allocation to tech," Sorensen says. "But we don't forecast an extended, severe recession in the U.S. that would cause global recession." [[It's already doing so!: normxxx]]
"They [tech companies] will have earnings that hold up," Robert Doll says. "These companies learned the lessons the hard way in the tech bubble. They now have healthier balance sheets and excess cash flow." Doll likes IBM (nyse: IBM), Hewlett-Packard (nyse: HPQ) and eBay (nasdaq: EBAY) in the tech sector.
Free Download: 8 Must-Own International Stocks & Funds for 2008
Jim Swanson, chief investment strategist at MFS Investment management, says he would play tech through the software side. "Remember, that's linked directly to job creation," Swanson says. "In the emerging markets, job growth is high, running at 5% or so. A lot of them are hired in tech industries, and they need software." Pullbacks, viewed strategically, are a time to load up on stocks you want to own for the long term.
"Don't disengage," says Carlson. "There will be another bull market. So position your portfolio for that." Carlson says that now is when the smart long-term investor, the one willing to roll up his sleeves and do some work, should be able to find quality stocks at attractive valuations. "That may not pay off instantly," he says. "But, when the market does turn, you will be in the stocks you want to be in. Don't bury your head in the sand. Work hard and be in the best stocks possible. That will pay off. Maybe not now, but it definitely will later."
Free Download: 3 Best Buy ETFs for the Current Market
Another non-traditional defensive area, which was coincidentally a great buy during the last recession, is energy. Doll likes the sector. "We don't need oil prices screaming higher," Doll says. "If prices consolidate some of the gains, that is still OK for oil stocks. It's a global cyclical." His picks in the sector include Exxon Mobil (nyse: XOM) and ConocoPhillips (nyse: COP).
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Joshua Lipton | 30 July 2008
|
Or is it?
The tried-and-true strategy for stock-market investors during tough times is to move to companies making products people need: consumer staples like toothpaste and toilet paper, medicines and utilities. Forbes.com recently checked in with some market pros to see whether this time-tested game plan still holds up. Our big picture professionals by and large continue to favor the traditional game plan, though they also argue that defensive investing requires a bit of fine-tuning in the current climate. Let's start with a sector that screams "safety first"— consumer staple stocks, which provide cover during down periods in the economy and markets. Douglas Cliggott, chief investment officer at money manager Dover Management, believes consumer goods companies are still reasonable investments.
"They sell products people buy, whether they're excited or concerned about economic prospects," Cliggott says. But there is some concern that consumer-goods firms could get their profits pinched, as they struggle with higher energy and raw materials costs. Cliggott acknowledges the risk. He argues, though, that companies selling products around the world can diversify away some of these potential problems.
In Pictures: 10 Defensive Buys
"A lot of raw materials costs are in dollars, and sales are in currencies that are rising against the dollar," he says. "There is cost pressure. But there is less cost pressure for them than a firm that is primarily dollar-sales based. So it doesn't eliminate the issue. But it mitigates it." In the sector, Cliggott favors Procter & Gamble (nyse: PG).
"P&G has broad global exposure, tends to sell products people need, like diapers and toothpaste, as opposed to gadgets people want, like iPods and iPhones," Cliggott says. "Most importantly, it now has an implied earnings growth rate of less than 7%, which means its current share price is based on a medium-term EPS growth rate of less than 7%. But, during the past 10 years, P&G has averaged EPS growth of about 10.5% per year."
Cliggott is a bit more lukewarm right now on another traditional safe haven: health care, given what he calls that sector's "extremely clouded outlook." Specifically, Cliggott isn't a big fan of the large cap pharmaceuticals, citing relatively thin new drug pipelines. Cliggott isn't the only one feeling cautious. Standard & Poor's fundamental outlook for pharmaceuticals is now "neutral".
While recession-resistant drug stocks have generally outperformed during past economic downturns, S&P analyst Herman Saftlas thinks the 2008 outlook for drug stocks is clouded by uncertainty, given the impact of November's elections and research and development productivity issues. On the plus side, he does think companies with well-defined growth prospects and generous dividend yields should hold up relatively well over the coming quarters.
Free Download: Forbes Gurus' Best Investment Ideas for 2008
But the health care sector is big and broad, including not just drug stocks but also medical device makers and managed care companies. Robert Doll, vice chairman and chief investment officer of global equities at BlackRock (nyse: BLK), acknowledges the concerns, given the uncertainty about the elections and pipelines, but he still likes health care. "The stocks are cheap relative to earnings, so you need to ask yourself: Do you think those concerns are priced into these stocks? We do."
Doll favors the stability of the sector, and prefers to play the service companies, like the HMOs, because they have better pricing power and healthier balance sheets, he says. His picks here include Express Scripts (nasdaq: ESRX), Medco Health Solutions (nyse: MHS) and Aetna (nyse: AET).
Chuck Carlson, chief executive officer of Horizon Investment Services and editor of DRIP Investor, agrees. He favors managed care names like Humana (nyse: HUM) and Coventry Health Care (nyse: CVH). Carlson is less enthusiastic about another go-to defensive sector: utilities, a sector that investors ran to in 2007, attracted to steady earnings, decent dividends and solid demand. In the past 12 months, the Utilities Select Sector SPDR (amex: XLU) is up more than 8%.
"They are OK," says Carlson. "But they are pricey. They had a good year last year. Now they are stretched." Brad Sorensen, director of sector research at Charles Schwab, currently weights the utilities sector as "neutral," staying cautious, he says, because of valuations. Instead, Schwab is bullish on tech. Some pros disagree with that strategy. Jim Stack, editor of Whitefish Montana's InvesTech Research and Portfolio Strategy, points out that information technology is one of the highest risk areas in a bear market.
In a recession, Stack notes, an easy way for businesses to save money is by cutting back on technology upgrades ( See: "Forbes Gurus: Best Investment Ideas For 2008"). Schwab currently rates the tech sector "overweight" because of, at least partially, its exposure to overseas markets. "We believe that, with the weaker dollar and stronger economies worldwide, that helps them maintain profitability," Sorensen says.
Even if the U.S. economy slows down or there is even a mild recession, Sorensen argues, tech will continue to hold up well because the sector generates so much of its revenue outside of the U.S. That thesis changes if the U.S. economy takes a more pronounced nose dive. "We would then reduce our allocation to tech," Sorensen says. "But we don't forecast an extended, severe recession in the U.S. that would cause global recession." [[It's already doing so!: normxxx]]
"They [tech companies] will have earnings that hold up," Robert Doll says. "These companies learned the lessons the hard way in the tech bubble. They now have healthier balance sheets and excess cash flow." Doll likes IBM (nyse: IBM), Hewlett-Packard (nyse: HPQ) and eBay (nasdaq: EBAY) in the tech sector.
Free Download: 8 Must-Own International Stocks & Funds for 2008
Jim Swanson, chief investment strategist at MFS Investment management, says he would play tech through the software side. "Remember, that's linked directly to job creation," Swanson says. "In the emerging markets, job growth is high, running at 5% or so. A lot of them are hired in tech industries, and they need software." Pullbacks, viewed strategically, are a time to load up on stocks you want to own for the long term.
"Don't disengage," says Carlson. "There will be another bull market. So position your portfolio for that." Carlson says that now is when the smart long-term investor, the one willing to roll up his sleeves and do some work, should be able to find quality stocks at attractive valuations. "That may not pay off instantly," he says. "But, when the market does turn, you will be in the stocks you want to be in. Don't bury your head in the sand. Work hard and be in the best stocks possible. That will pay off. Maybe not now, but it definitely will later."
Free Download: 3 Best Buy ETFs for the Current Market
Another non-traditional defensive area, which was coincidentally a great buy during the last recession, is energy. Doll likes the sector. "We don't need oil prices screaming higher," Doll says. "If prices consolidate some of the gains, that is still OK for oil stocks. It's a global cyclical." His picks in the sector include Exxon Mobil (nyse: XOM) and ConocoPhillips (nyse: COP).
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Income Expert Prefers 'Preferreds'
Income Expert Prefers 'Preferreds'
By Richard Lehmann | 23 June 2008
We have been lamenting for the last few years about the shrinking supply of preferred issues for individual investors. No more; from famine we now have a feast before us.
In my Forbes/Lehmann Income Securities Advisor, I said 2008 will likely go down as the year of the preferred. Here, we look at new high-yielding preferreds from Fannie Mae (NYSE: FNM) and Bank of America (NYSE: BAC).
We are seeing large investment grade companies putting out multi-billion dollar issues and paying upwards of 8%, a yield they have not had to pay since the early 1990s. Now why would AA and A rated banks, insurance companies, finance companies and brokerage houses pay such a premium yield when they could raise capital by issuing bonds yielding more like 6%? The answer is that they need to raise ‘statutory capital’ a benchmark of the ratio of permanent capital to debt which regulated financial institutions need to have in order to maintain their license to do business.
The mortgage debt crisis and the subsequent mark to market writedowns which these financial institutions suffered impaired their regulatory capital and thus, forced all of them to seek statutory capital at the same inconvenient time. Hence, the 8% yields. This search for statutory capital is world wide and is not limited to straight preferred stock. These companies are also issuing more common stock and convertible preferreds.
In fact, these convertible preferreds that yield 8% and are being issued at a time when the stocks of these entities are depressed and represent a major buying opportunity. Fannie Mae 8.75% Series 08-1 Preferred (NYSE: FDRNP) has a par value of $50.00, a current price of $49.88 and a current yield 8.95%. On May 13, 2011 these non-cumulative preferred shares will automatically convert to 1.5408 shares of common stock if the common is at or above $32.45. If the common is at or below $27.50 the conversion rate will be 1.8182 shares. Between the two common prices, holders will receive $50.00 worth of common.
Fannie Mae, a public company operating under a federal charter, is the nation’s largest source of financing for home mortgages and is the largest non-bank financial services company in the world. The company buys loans from lenders, holding some and packaging others for resale thereby providing greater credit availability. Fannie Mae has gone through several years of investigations and Senate hearings because of questionable accounting and reporting and now they are deeply entangled in the sub prime mortgage dilemma.
The company reported for the first quarter 2008 a net loss of $2.19 billion. For the same period in 2007, they had net income of $961 million. This issue qualifies for the 15% dividend (QDI) tax. Fitch has this issue rated AA. Based solely on ratings, this issue would be ideal for low-risk investor, however, due to the uncertainty in the credit and capital markets as well as the housing market, I suggest conservative investors stand aside. Medium to high-risk investor buy this preferred at or below $52.00.
Bank of America 8.20% Series H Non-Cumulative (NYSE: BAC H) has a par value of $25.00, a current price of $24.94 and a current yield of 8.22%. The issue is rated A1/A+. Bank of America is the second largest bank in the country with 6,100 locations in 30 states. In addition to banking services BAC offers asset management and other financial and riskmanagement products, global corporate and investment banking and equity investments.
For the first quarter 2008, BAC reported net interest income of $9.99 billion and net income of $1.21 billion. For the same period last year, net interest income was $8.27 billion and net income was posted at $5.26 billion. First quarter provision for loan loss was $6.0 billion compared to $1.24 billion in 2007. This is a good issue for lowrisk income portfolios. Buy at or below $25.35.
It is likely that these securities will sell at a premium once the current financial crisis abates and the earnings of these financial organizations recover. I can’t remember the last time I got paid 8% to wait for an investment grade issuer to also deliver a capital gain. Happy days are here again. Indeed!
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Richard Lehmann | 23 June 2008
We have been lamenting for the last few years about the shrinking supply of preferred issues for individual investors. No more; from famine we now have a feast before us.
In my Forbes/Lehmann Income Securities Advisor, I said 2008 will likely go down as the year of the preferred. Here, we look at new high-yielding preferreds from Fannie Mae (NYSE: FNM) and Bank of America (NYSE: BAC).
We are seeing large investment grade companies putting out multi-billion dollar issues and paying upwards of 8%, a yield they have not had to pay since the early 1990s. Now why would AA and A rated banks, insurance companies, finance companies and brokerage houses pay such a premium yield when they could raise capital by issuing bonds yielding more like 6%? The answer is that they need to raise ‘statutory capital’ a benchmark of the ratio of permanent capital to debt which regulated financial institutions need to have in order to maintain their license to do business.
The mortgage debt crisis and the subsequent mark to market writedowns which these financial institutions suffered impaired their regulatory capital and thus, forced all of them to seek statutory capital at the same inconvenient time. Hence, the 8% yields. This search for statutory capital is world wide and is not limited to straight preferred stock. These companies are also issuing more common stock and convertible preferreds.
In fact, these convertible preferreds that yield 8% and are being issued at a time when the stocks of these entities are depressed and represent a major buying opportunity. Fannie Mae 8.75% Series 08-1 Preferred (NYSE: FDRNP) has a par value of $50.00, a current price of $49.88 and a current yield 8.95%. On May 13, 2011 these non-cumulative preferred shares will automatically convert to 1.5408 shares of common stock if the common is at or above $32.45. If the common is at or below $27.50 the conversion rate will be 1.8182 shares. Between the two common prices, holders will receive $50.00 worth of common.
Fannie Mae, a public company operating under a federal charter, is the nation’s largest source of financing for home mortgages and is the largest non-bank financial services company in the world. The company buys loans from lenders, holding some and packaging others for resale thereby providing greater credit availability. Fannie Mae has gone through several years of investigations and Senate hearings because of questionable accounting and reporting and now they are deeply entangled in the sub prime mortgage dilemma.
The company reported for the first quarter 2008 a net loss of $2.19 billion. For the same period in 2007, they had net income of $961 million. This issue qualifies for the 15% dividend (QDI) tax. Fitch has this issue rated AA. Based solely on ratings, this issue would be ideal for low-risk investor, however, due to the uncertainty in the credit and capital markets as well as the housing market, I suggest conservative investors stand aside. Medium to high-risk investor buy this preferred at or below $52.00.
Bank of America 8.20% Series H Non-Cumulative (NYSE: BAC H) has a par value of $25.00, a current price of $24.94 and a current yield of 8.22%. The issue is rated A1/A+. Bank of America is the second largest bank in the country with 6,100 locations in 30 states. In addition to banking services BAC offers asset management and other financial and riskmanagement products, global corporate and investment banking and equity investments.
For the first quarter 2008, BAC reported net interest income of $9.99 billion and net income of $1.21 billion. For the same period last year, net interest income was $8.27 billion and net income was posted at $5.26 billion. First quarter provision for loan loss was $6.0 billion compared to $1.24 billion in 2007. This is a good issue for lowrisk income portfolios. Buy at or below $25.35.
It is likely that these securities will sell at a premium once the current financial crisis abates and the earnings of these financial organizations recover. I can’t remember the last time I got paid 8% to wait for an investment grade issuer to also deliver a capital gain. Happy days are here again. Indeed!
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
NEW House Price Time Bomb
America's NEW House Price Time Bomb
By Michael Robinson | 30 July 2008
With the American housing market in its worst crisis since the Great Depression of the 1930s, President Bush is authorising new legislation to pave the way for massive new government intervention designed to slow the slide.
The intervention would come as a little known quirk of US law threatens to drive down house prices even faster. Faced with seemingly never-ending falls in the value of their properties, some American home-owners are taking radical action; they are choosing to walk away from their homes and mortgages. In May 2006, at the height of the housing boom, Karen Trainer bought a $500,000 apartment in California— with money borrowed from her bank.
By this year, Karen still owed $500,000 on her mortgage, but her apartment was worth $200,000 less. So she was deep in negative equity and, to make matters worse, the interest rate on her loan was about to increase. "I thought 'this is crazy'," Ms Trainer says. "It just does not make financial sense."
Take The Hit
As a successful professional, Karen could comfortably have managed the higher mortgage payments her bank demanded. Instead, she decided to stop her mortgage payments altogether and let her bank repossess her apartment. Her credit record will be badly damaged by the decision, but Ms Trainer expects this to recover soon. "Generally speaking, within 5 years you are about back where you were, so my husband and I decided we'll take the hit and live with it."
Over To The Bank
In California and much of the rest of America, there is a powerful incentive for homeowners such as Ms Trainer to walk away from their mortgage obligations. Though banks can repossess and sell the homes of borrowers who stop paying their mortgages, under a legal quirk originating in the Great Depression of the 1930s, banks cannot easily pursue borrowers for any balance outstanding on the main mortgage on their homes. Consequently, by walking away from her apartment, Ms Trainer has also walked away from the loss on her property. Her bank gets stuck with that.
Unthinkable Option
Traditionally in America there is a social stigma attached to those who default on their debts, which should be a deterrent to walking away from your home. But according to Susan Wachter, professor of real estate and finance at Wharton School of Business, in the depth of this crisis the social attitudes to such actions are changing. "This is the kind of conversation that's going on at cocktail parties, at swimming pools," Professor Wachter says. "And suddenly this option which was truly unthinkable in the past becomes thinkable."
Worrying Development
Ms Trainer says she feels no moral obligation to go on paying a loan on a property that is going to go on losing her money. She says her friends support her decision. "I think people are taking a more cold-hearted look at it," Ms Trainer says. "Is the bank going to pay for my retirement because I was a good girl and paid my mortgage, even though legally I didn't have to?"
Professor Wachter believes that, to date, most people have had their homes repossessed because they could not manage the repayments. [[That is, mostly the sub-prime loans.: normxxx]] The trend of people now positively choosing to walk away because it makes financial sense to do so is a worrying new development. [[It would involve virtually all of the Alt-A and Prime loans!: normxxx]] "The dangers are extraordinary," Professor Wachter says. "If all that is needed is that the house value is less than the mortgage value, there is a very large number of homeowners in the United States who are in that situation".
No Renegotiation
"This is becoming a tsunami of voluntary defaults," said Professor Nouriel Roubini, New York University, one of the first economists to warn of the dangers of the American house price boom. According to him, walking away has become commonplace. "I would say it's probably 70% of the volume of our foreclosures right now," he says. "It's a business decision for their family that the smartest thing they can do is walk away from their home." As a sign of the changing times, some 60% of borrowers do not even bother to contact their banks to attempt a renegotiation of their loan. "They stop paying and they stop talking." "They just mail in the keys and plain walk away."
Total Disaster
It is impossible to know for sure how many of the people who are now walking away from their homes could have gone on paying their mortgages. But Professor Nouriel Roubini believes the number of people positively choosing to walk away is growing rapidly.
"The losses for the financial system from people walking away could be of the order of one trillion dollars when the entire capital of the US banking system is only $1.3 trillion. You could have most of the US banking system wiped out, so this is a total disaster." Which is why it is not just US policymakers who are hoping America's new, multi-billion dollar initiative to stabilise the housing market will succeed in its aims and thus make walking away less attractive.
Because if it fails, the economic fallout could be felt far beyond America's shores.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Michael Robinson | 30 July 2008
With the American housing market in its worst crisis since the Great Depression of the 1930s, President Bush is authorising new legislation to pave the way for massive new government intervention designed to slow the slide.
The intervention would come as a little known quirk of US law threatens to drive down house prices even faster. Faced with seemingly never-ending falls in the value of their properties, some American home-owners are taking radical action; they are choosing to walk away from their homes and mortgages. In May 2006, at the height of the housing boom, Karen Trainer bought a $500,000 apartment in California— with money borrowed from her bank.
By this year, Karen still owed $500,000 on her mortgage, but her apartment was worth $200,000 less. So she was deep in negative equity and, to make matters worse, the interest rate on her loan was about to increase. "I thought 'this is crazy'," Ms Trainer says. "It just does not make financial sense."
Take The Hit
As a successful professional, Karen could comfortably have managed the higher mortgage payments her bank demanded. Instead, she decided to stop her mortgage payments altogether and let her bank repossess her apartment. Her credit record will be badly damaged by the decision, but Ms Trainer expects this to recover soon. "Generally speaking, within 5 years you are about back where you were, so my husband and I decided we'll take the hit and live with it."
Over To The Bank
In California and much of the rest of America, there is a powerful incentive for homeowners such as Ms Trainer to walk away from their mortgage obligations. Though banks can repossess and sell the homes of borrowers who stop paying their mortgages, under a legal quirk originating in the Great Depression of the 1930s, banks cannot easily pursue borrowers for any balance outstanding on the main mortgage on their homes. Consequently, by walking away from her apartment, Ms Trainer has also walked away from the loss on her property. Her bank gets stuck with that.
Unthinkable Option
Traditionally in America there is a social stigma attached to those who default on their debts, which should be a deterrent to walking away from your home. But according to Susan Wachter, professor of real estate and finance at Wharton School of Business, in the depth of this crisis the social attitudes to such actions are changing. "This is the kind of conversation that's going on at cocktail parties, at swimming pools," Professor Wachter says. "And suddenly this option which was truly unthinkable in the past becomes thinkable."
Worrying Development
Ms Trainer says she feels no moral obligation to go on paying a loan on a property that is going to go on losing her money. She says her friends support her decision. "I think people are taking a more cold-hearted look at it," Ms Trainer says. "Is the bank going to pay for my retirement because I was a good girl and paid my mortgage, even though legally I didn't have to?"
Professor Wachter believes that, to date, most people have had their homes repossessed because they could not manage the repayments. [[That is, mostly the sub-prime loans.: normxxx]] The trend of people now positively choosing to walk away because it makes financial sense to do so is a worrying new development. [[It would involve virtually all of the Alt-A and Prime loans!: normxxx]] "The dangers are extraordinary," Professor Wachter says. "If all that is needed is that the house value is less than the mortgage value, there is a very large number of homeowners in the United States who are in that situation".
No Renegotiation
"This is becoming a tsunami of voluntary defaults," said Professor Nouriel Roubini, New York University, one of the first economists to warn of the dangers of the American house price boom. According to him, walking away has become commonplace. "I would say it's probably 70% of the volume of our foreclosures right now," he says. "It's a business decision for their family that the smartest thing they can do is walk away from their home." As a sign of the changing times, some 60% of borrowers do not even bother to contact their banks to attempt a renegotiation of their loan. "They stop paying and they stop talking." "They just mail in the keys and plain walk away."
Total Disaster
It is impossible to know for sure how many of the people who are now walking away from their homes could have gone on paying their mortgages. But Professor Nouriel Roubini believes the number of people positively choosing to walk away is growing rapidly.
"The losses for the financial system from people walking away could be of the order of one trillion dollars when the entire capital of the US banking system is only $1.3 trillion. You could have most of the US banking system wiped out, so this is a total disaster." Which is why it is not just US policymakers who are hoping America's new, multi-billion dollar initiative to stabilise the housing market will succeed in its aims and thus make walking away less attractive.
Because if it fails, the economic fallout could be felt far beyond America's shores.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
"the Letter"
Investment Strategy: "the Letter"
By Jeffrey Saut | 29 July 2008
Last week I received the following letter:
I reprise this letter today because it speaks to many of the concerns investors are currently voicing. To the first point that our country is now the largest debtor nation in the world, I have no response other than to say it’s true. The nation appears to be "eating its young" as we saddle our children with ever increasing debt that is likely sinking the footings for a generational "war." Yet, the problem lies in a lack of leadership with our politicians; I mean where are the 'statesmen'?!
As Charlie Reese wrote in his excellent article "545 People Responsible for America’s Woes," "Politicians are the only people in the world who create problems and then campaign against them. Have you ever wondered, if both the Democrats and the Republicans are against deficits, why we have deficits? Have you ever wondered, if all the politicians are against inflation and high taxes, why we have inflation and high taxes?" Indeed, where are the statesmen?! Lee Iacocca actually does Charlie Reese one better when he writes:
Speaking to our letter writer’s manufacturing jobs point, an amazing thing is beginning to happen. The cheap dollar, combined with soaring transportation costs, is causing U.S. companies to bring manufacturing jobs back inside our boarders. While said movement is in the nascent stage, it should build into what our letter writer terms "productive spending" on new factories, etc. As for inflation, anyone that lives in the real world knows the government’s figures are a joke.
We have argued for some time that the "core" inflation numbers (ex-food/energy) should be totally ignored in lieu of the "headline" inflation numbers. While even the "headline" numbers understate the inflation picture, they clearly are more in sync with what’s happening in the real world. And that, ladies and gentlemen, is why we continue to avoid fixed income in favor of stocks.
Consider this, since 1968 the "headline" inflation number has averaged 4.6%. That means the cost of many of the things we buy doubles every 15 years. If a couple decides to retire at age 60, statistically one of them will live to be 90 years old. The implication is that over those 30 years they will lose 75% of their purchasing power to inflation. Plainly, fixed income will not be able to maintain your purchasing power, which is why we continue to favor stocks, preferably stocks with a dividend yield.
Late last week, however, stocks fell out of favor again as profit-taking reigned after the previous week’s huge rally. Also clouding the environment were shockingly weak economic figures from Europe, worse than expected U.S. home sales, and a prediction by PIMCO’s Bill Gross that U.S. bank losses will be at least one trillion dollars. We have warned investors that the U.S. dollar to euro exchange rate was having deleterious effects on Europe, so last week’s news should have come as no surprise.
As for homes sales and Bill Gross’ prediction, the statement– that the financial disaster won’t improve until housing prices stabilize— is now legion. Lost in the noise, however, is that while existing home sales have indeed collapsed, median prices have actually been moving "up" for the past four months ($215,100 in June versus $195,600 in February)! Whether this marks "the turn" for the economy is questionable, for while we don’t think the news will get a whole lot worse, we also have a difficult time believing it will get materially better either.
Meanwhile, the long-standing "trade" of shorting the financials and going long materials/energy has unwound rather dramatically over the past few weeks. To be sure, various financial indices rallied more than 30% in just six trading sessions, while crude oil is off 16% and natural gas has crashed 30%. We think the ferocity of the sector rotation is overdone in the near-term, which is why we recommended selling some of the financial indices we tranched into for trading purposes a few weeks ago. The quid pro quo is that last week we also recommended buying energy stocks for a short-term trade. Our vehicle of choice was the ETF ProShares Ultra Oil & Gas (DIG/$86.49).
The call for this week: According to Richard Russell, "Yesterday (7/24/08) Lowry's Selling Pressure Index rose to within one point of its July 15 all-time high. That tells me that big money has been selling into all rallies, and that's just plain bearish. Selling Pressure should be declining rapidly when the market rallies. That's not what is happening."
Still, as long as the S&P 500 (SPX/1257.76) remains above 1240, we are constructive on stocks. [[Guess you can forget that! : normxxx]]
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Jeffrey Saut | 29 July 2008
Last week I received the following letter:
|
I reprise this letter today because it speaks to many of the concerns investors are currently voicing. To the first point that our country is now the largest debtor nation in the world, I have no response other than to say it’s true. The nation appears to be "eating its young" as we saddle our children with ever increasing debt that is likely sinking the footings for a generational "war." Yet, the problem lies in a lack of leadership with our politicians; I mean where are the 'statesmen'?!
As Charlie Reese wrote in his excellent article "545 People Responsible for America’s Woes," "Politicians are the only people in the world who create problems and then campaign against them. Have you ever wondered, if both the Democrats and the Republicans are against deficits, why we have deficits? Have you ever wondered, if all the politicians are against inflation and high taxes, why we have inflation and high taxes?" Indeed, where are the statesmen?! Lee Iacocca actually does Charlie Reese one better when he writes:
|
Speaking to our letter writer’s manufacturing jobs point, an amazing thing is beginning to happen. The cheap dollar, combined with soaring transportation costs, is causing U.S. companies to bring manufacturing jobs back inside our boarders. While said movement is in the nascent stage, it should build into what our letter writer terms "productive spending" on new factories, etc. As for inflation, anyone that lives in the real world knows the government’s figures are a joke.
We have argued for some time that the "core" inflation numbers (ex-food/energy) should be totally ignored in lieu of the "headline" inflation numbers. While even the "headline" numbers understate the inflation picture, they clearly are more in sync with what’s happening in the real world. And that, ladies and gentlemen, is why we continue to avoid fixed income in favor of stocks.
Consider this, since 1968 the "headline" inflation number has averaged 4.6%. That means the cost of many of the things we buy doubles every 15 years. If a couple decides to retire at age 60, statistically one of them will live to be 90 years old. The implication is that over those 30 years they will lose 75% of their purchasing power to inflation. Plainly, fixed income will not be able to maintain your purchasing power, which is why we continue to favor stocks, preferably stocks with a dividend yield.
Late last week, however, stocks fell out of favor again as profit-taking reigned after the previous week’s huge rally. Also clouding the environment were shockingly weak economic figures from Europe, worse than expected U.S. home sales, and a prediction by PIMCO’s Bill Gross that U.S. bank losses will be at least one trillion dollars. We have warned investors that the U.S. dollar to euro exchange rate was having deleterious effects on Europe, so last week’s news should have come as no surprise.
As for homes sales and Bill Gross’ prediction, the statement– that the financial disaster won’t improve until housing prices stabilize— is now legion. Lost in the noise, however, is that while existing home sales have indeed collapsed, median prices have actually been moving "up" for the past four months ($215,100 in June versus $195,600 in February)! Whether this marks "the turn" for the economy is questionable, for while we don’t think the news will get a whole lot worse, we also have a difficult time believing it will get materially better either.
Meanwhile, the long-standing "trade" of shorting the financials and going long materials/energy has unwound rather dramatically over the past few weeks. To be sure, various financial indices rallied more than 30% in just six trading sessions, while crude oil is off 16% and natural gas has crashed 30%. We think the ferocity of the sector rotation is overdone in the near-term, which is why we recommended selling some of the financial indices we tranched into for trading purposes a few weeks ago. The quid pro quo is that last week we also recommended buying energy stocks for a short-term trade. Our vehicle of choice was the ETF ProShares Ultra Oil & Gas (DIG/$86.49).
The call for this week: According to Richard Russell, "Yesterday (7/24/08) Lowry's Selling Pressure Index rose to within one point of its July 15 all-time high. That tells me that big money has been selling into all rallies, and that's just plain bearish. Selling Pressure should be declining rapidly when the market rallies. That's not what is happening."
Still, as long as the S&P 500 (SPX/1257.76) remains above 1240, we are constructive on stocks. [[Guess you can forget that! : normxxx]]
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Dr. Doom Speaks
Dr. Doom Speaks
By John Heinzl | 29 July 2008
To say Peter Schiff is bearish is like saying Tiger Woods is an okay golfer, or China has a small problem with air quality. The president of Connecticut-based Euro Pacific Capital Inc. is so pessimistic about the U.S. economy that he lives in a rented house and keeps the vast majority of his and his clients' money outside the country, a healthy chunk of it in gold and energy stocks.
"America is finished. We are going to destroy this country. Our economy is just going to unravel," he told me yesterday. "The question is how much money is the world going to lose before it writes us off?" Apocalyptic forecasts are a dime a dozen these days, so why should anyone pay attention to Mr. Schiff? Because his past predictions have proved uncannily accurate.
When dot-com stocks with no earnings were shooting skyward in the late nineties, he was advising clients to stay away and instead putting money into the unloved energy sector, just in time for the great oil bull market. A few years later, when the housing bubble was inflating, he was warning about the dangers of reckless mortgage lending and the precarious state of Fannie Mae and Freddie Mac. "If it looks like a bubble, walks like a bubble and quacks like a bubble, it's a bubble," he wrote. That was in 2004, when speculators were still lining up to buy investment properties in Las Vegas. Ever the contrarian, Mr. Schiff made a bundle shorting the subprime mortgage sector.
So, one year into the credit crunch and with more than US$400-billion [[since raised to ~US$1.6 TRillion, give or take a half trillion: normxxx]] of mortgage losses piling up on company books, where does Dr. Doom see the U.S. economy heading now? Unfortunately, into an even deeper hole, one from which it could take years to emerge. Far from rescuing the economy from the housing debacle, the government's efforts to prop up Fannie and Freddie— which own or guarantee nearly half of the $12-trillion in outstanding U.S. mortgage debt— will only compound the problem by delaying the inevitable day of reckoning. The same goes for plans to help hundreds of thousands of homeowners refinance into more affordable mortgages.
Apart from encouraging the very moral hazard that got the U.S. into this mess in the first place, the government bailout will come with an enormous price tag in the form of soaring inflation, Mr. Schiff argues. He believes government figures vastly understate the true rate of inflation, which he estimates is now running at 10 to 12 per cent. Before long, it could be north of 20 per cent.
"The government doesn't have the balls to raise taxes. It's just going to print the money. It's going to destroy the currency," he says. During the Depression of the 1930s, at least people who held cash made out okay. Because prices were falling, their money actually bought more. But, if Mr. Schiff is right and the U.S. is heading into a period of hyperinflation, then even the most prudent savers could see their wealth eviscerated.
With the walls closing in on the U.S. economy, where is an investor to turn? Apart from gold and energy producers, which benefit from a plunging U.S. dollar, Mr. Schiff likes conservative, dividend-paying stocks such as pipelines and utilities. He's especially fond of Europe, Asia, Australia and Canada, where his holdings include Barrick Gold Corp., Goldcorp Inc., Crescent Point Energy Trust, Baytex Energy Trust and Pembina Pipeline Income Fund.
He has two words for Canadian investors thinking now is a good time to shop for bargain-priced U.S. stocks: "Stay away."
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By John Heinzl | 29 July 2008
| When CNBC or Fox needs a guest who can be counted on to deliver a thoroughly gloomy outlook for the U.S. economy, they call on "Dr. Doom." |
To say Peter Schiff is bearish is like saying Tiger Woods is an okay golfer, or China has a small problem with air quality. The president of Connecticut-based Euro Pacific Capital Inc. is so pessimistic about the U.S. economy that he lives in a rented house and keeps the vast majority of his and his clients' money outside the country, a healthy chunk of it in gold and energy stocks.
"America is finished. We are going to destroy this country. Our economy is just going to unravel," he told me yesterday. "The question is how much money is the world going to lose before it writes us off?" Apocalyptic forecasts are a dime a dozen these days, so why should anyone pay attention to Mr. Schiff? Because his past predictions have proved uncannily accurate.
When dot-com stocks with no earnings were shooting skyward in the late nineties, he was advising clients to stay away and instead putting money into the unloved energy sector, just in time for the great oil bull market. A few years later, when the housing bubble was inflating, he was warning about the dangers of reckless mortgage lending and the precarious state of Fannie Mae and Freddie Mac. "If it looks like a bubble, walks like a bubble and quacks like a bubble, it's a bubble," he wrote. That was in 2004, when speculators were still lining up to buy investment properties in Las Vegas. Ever the contrarian, Mr. Schiff made a bundle shorting the subprime mortgage sector.
So, one year into the credit crunch and with more than US$400-billion [[since raised to ~US$1.6 TRillion, give or take a half trillion: normxxx]] of mortgage losses piling up on company books, where does Dr. Doom see the U.S. economy heading now? Unfortunately, into an even deeper hole, one from which it could take years to emerge. Far from rescuing the economy from the housing debacle, the government's efforts to prop up Fannie and Freddie— which own or guarantee nearly half of the $12-trillion in outstanding U.S. mortgage debt— will only compound the problem by delaying the inevitable day of reckoning. The same goes for plans to help hundreds of thousands of homeowners refinance into more affordable mortgages.
Apart from encouraging the very moral hazard that got the U.S. into this mess in the first place, the government bailout will come with an enormous price tag in the form of soaring inflation, Mr. Schiff argues. He believes government figures vastly understate the true rate of inflation, which he estimates is now running at 10 to 12 per cent. Before long, it could be north of 20 per cent.
"The government doesn't have the balls to raise taxes. It's just going to print the money. It's going to destroy the currency," he says. During the Depression of the 1930s, at least people who held cash made out okay. Because prices were falling, their money actually bought more. But, if Mr. Schiff is right and the U.S. is heading into a period of hyperinflation, then even the most prudent savers could see their wealth eviscerated.
With the walls closing in on the U.S. economy, where is an investor to turn? Apart from gold and energy producers, which benefit from a plunging U.S. dollar, Mr. Schiff likes conservative, dividend-paying stocks such as pipelines and utilities. He's especially fond of Europe, Asia, Australia and Canada, where his holdings include Barrick Gold Corp., Goldcorp Inc., Crescent Point Energy Trust, Baytex Energy Trust and Pembina Pipeline Income Fund.
He has two words for Canadian investors thinking now is a good time to shop for bargain-priced U.S. stocks: "Stay away."
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Monday, July 28, 2008
The Past Happens Over And Over Again!
Being Street Smart: The Past Happens Over And Over Again!
Click here for a link to complete article:
By Sy Harding | 25 July 2008
Yet the world hardly ever comes to an end. The future arrives. The cycles continue. Sunny weather still follows stormy weather, winter still follows summer, spring still follows winter— every time. For investors there’s nothing more important than recognizing that business, the economy, and markets also move in cycles, not endless straight lines. Recessions follow boom times, bear markets follow bull markets, bull markets follow bear markets— every time.
There are two cycles, one of intermediate-term duration, the other longer-term, which can be of significant importance to investors. The first is the annual seasonal cycle. It has been proved beyond doubt (through 60 years of back-testing, and nine years now in real-time) [[academic studies have detected this tendency as far back as the early 17th century in English records, and in 34 of 36 countries, currently— but, unmodified by Sy's use of the MACD, it is too weak to trade: normxxx]], that the stock market makes most of its gains each year in a winter and spring favorable season, and suffers by far the majority of its corrections, crashes, and bear markets in its unfavorable summer months [[and, especially, in the months seperating the two periods: normxxx]]. I refer to the Seasonal Timing Strategy I introduced in 1999’s Riding the Bear— How to Prosper in the Coming Bear Market [[still a GREAT read, if you can get hold of a copy: normxxx]].
Over the nine years since, its total return has been more than double that of the Dow, and triple that of the money-manager’s ‘benchmark’ S&P 500. The details are on my Street Smart Report website (see above link), and in my books. But I want to use this column to discuss the longer-term cycle, since I expect it will be of more importance than usual over the next few years.
It is the Four-Year Presidential Cycle. Its history is extremely consistent. The economy and stock market tend to have serious problems in the first two years of each new presidential term, and then to be recovered and strong in the final two years of the term.
What causes the pattern? It’s clear in the history that each Administration takes heroic steps in the 2nd and 3rd year of its term to make sure the economy is strong by the time re-election time comes around. The efforts typically include higher government spending, lower interest rates, and even economic stimulus plans if necessary.
The problem is that almost always by re-election time that excessive stoking of the economic fires has created excesses, including over-priced stocks. Those excesses are then allowed to correct in the first two years of the next term, and then the cycle is repeated. Thus the historically consistent cycle takes place, of economic and market problems in the first two years of each new presidential term, followed by boom times in the final two years of each term.
History also shows that the pattern does not often occur when a president is serving his second and final term, (perhaps because his administration’s interest in the next election is not as great). For instance, no economic or market corrections took place in the first two years of the second terms of Reagan, Clinton, or Bush. (Because the excesses are not corrected in the first two years of second terms, the problems tend to come later in the term. For Reagan it was the 1987 crash in the 3rd year of his second term. For Clinton the 2000-2002 bear market began in the 4th year of his second term. For President Bush, the current bear market began last October, the 3rd year of his second term).
However, for first terms, the pattern of significant lows in the 2nd year of each term is so powerful that since at least 1918, even the conservative Dow has experienced a super rally from the low in the 2nd year to the high in the following year, its average gain in those rallies being 50%.
Now consider that no matter which candidate is elected in November, the next four-year presidential cycle will be that of a new first-term president. Then consider the conditions his administration will inherit and the likelihood they will not be solved in the first year of the term. The largest budget deficit ever, a record trade deficit, an expensive war that both candidates expect will continue well into 2010, still rising home foreclosures, an economy likely to be in recession, and so on.
Therefore, the Four-Year Presidential Cycle has me expecting the current bear market will not see its final low until sometime in 2010, the 2nd year of the next administration.
In the meantime, the annual seasonal pattern has me expecting there will be significant bear market rallies and corrections from which to make substantial profits until then. In the 2000-2002 bear market there were several bear market rallies in which the S&P 500 gained more than 20%. The Nasdaq experienced three bear market rallies, in each of which it gained more than 40%, each followed by an even larger decline.
If I am right in my expectations, buy and hold investors are likely to continue to be disappointed over the next two years, while opportunities should be exceptional for those willing to go after gains from both the upside in the bear market rallies, and from the downside when the rallies end and the next down-leg in a continuing bear market takes place.
Sy Harding publishes the financial website Street Smart Report Online, and a free morning blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear— How To Prosper In the Coming Bear Market. His latest book is Beating the Market the Easy Way— Surprising Seasonal Strategies that Double the Market's Performance.
FOR MORE STREET SMART commentaries, charts, etc. click below on Home and then the Library link.
M O R E. . .
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Click here for a link to complete article:
By Sy Harding | 25 July 2008
|
Yet the world hardly ever comes to an end. The future arrives. The cycles continue. Sunny weather still follows stormy weather, winter still follows summer, spring still follows winter— every time. For investors there’s nothing more important than recognizing that business, the economy, and markets also move in cycles, not endless straight lines. Recessions follow boom times, bear markets follow bull markets, bull markets follow bear markets— every time.
There are two cycles, one of intermediate-term duration, the other longer-term, which can be of significant importance to investors. The first is the annual seasonal cycle. It has been proved beyond doubt (through 60 years of back-testing, and nine years now in real-time) [[academic studies have detected this tendency as far back as the early 17th century in English records, and in 34 of 36 countries, currently— but, unmodified by Sy's use of the MACD, it is too weak to trade: normxxx]], that the stock market makes most of its gains each year in a winter and spring favorable season, and suffers by far the majority of its corrections, crashes, and bear markets in its unfavorable summer months [[and, especially, in the months seperating the two periods: normxxx]]. I refer to the Seasonal Timing Strategy I introduced in 1999’s Riding the Bear— How to Prosper in the Coming Bear Market [[still a GREAT read, if you can get hold of a copy: normxxx]].
Over the nine years since, its total return has been more than double that of the Dow, and triple that of the money-manager’s ‘benchmark’ S&P 500. The details are on my Street Smart Report website (see above link), and in my books. But I want to use this column to discuss the longer-term cycle, since I expect it will be of more importance than usual over the next few years.
It is the Four-Year Presidential Cycle. Its history is extremely consistent. The economy and stock market tend to have serious problems in the first two years of each new presidential term, and then to be recovered and strong in the final two years of the term.
What causes the pattern? It’s clear in the history that each Administration takes heroic steps in the 2nd and 3rd year of its term to make sure the economy is strong by the time re-election time comes around. The efforts typically include higher government spending, lower interest rates, and even economic stimulus plans if necessary.
The problem is that almost always by re-election time that excessive stoking of the economic fires has created excesses, including over-priced stocks. Those excesses are then allowed to correct in the first two years of the next term, and then the cycle is repeated. Thus the historically consistent cycle takes place, of economic and market problems in the first two years of each new presidential term, followed by boom times in the final two years of each term.
History also shows that the pattern does not often occur when a president is serving his second and final term, (perhaps because his administration’s interest in the next election is not as great). For instance, no economic or market corrections took place in the first two years of the second terms of Reagan, Clinton, or Bush. (Because the excesses are not corrected in the first two years of second terms, the problems tend to come later in the term. For Reagan it was the 1987 crash in the 3rd year of his second term. For Clinton the 2000-2002 bear market began in the 4th year of his second term. For President Bush, the current bear market began last October, the 3rd year of his second term).
However, for first terms, the pattern of significant lows in the 2nd year of each term is so powerful that since at least 1918, even the conservative Dow has experienced a super rally from the low in the 2nd year to the high in the following year, its average gain in those rallies being 50%.
Now consider that no matter which candidate is elected in November, the next four-year presidential cycle will be that of a new first-term president. Then consider the conditions his administration will inherit and the likelihood they will not be solved in the first year of the term. The largest budget deficit ever, a record trade deficit, an expensive war that both candidates expect will continue well into 2010, still rising home foreclosures, an economy likely to be in recession, and so on.
Therefore, the Four-Year Presidential Cycle has me expecting the current bear market will not see its final low until sometime in 2010, the 2nd year of the next administration.
In the meantime, the annual seasonal pattern has me expecting there will be significant bear market rallies and corrections from which to make substantial profits until then. In the 2000-2002 bear market there were several bear market rallies in which the S&P 500 gained more than 20%. The Nasdaq experienced three bear market rallies, in each of which it gained more than 40%, each followed by an even larger decline.
If I am right in my expectations, buy and hold investors are likely to continue to be disappointed over the next two years, while opportunities should be exceptional for those willing to go after gains from both the upside in the bear market rallies, and from the downside when the rallies end and the next down-leg in a continuing bear market takes place.
Sy Harding publishes the financial website Street Smart Report Online, and a free morning blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear— How To Prosper In the Coming Bear Market. His latest book is Beating the Market the Easy Way— Surprising Seasonal Strategies that Double the Market's Performance.
FOR MORE STREET SMART commentaries, charts, etc. click below on Home and then the Library link.
M O R E. . .
Normxxx
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Sunday, July 27, 2008
UK, Eurozone Horror Movie
Economic Horror Movie In Britain And Eurozone
By Mike "Mish" Shedlock | 21 July 2008 | 25 July 2008
Things are rapidly deteriorating In the US, UK, and the Eurozone. Let's take a look at a couple of top stories starting with Hundreds Of Thousands Face Job Loss In UK, says top economist. Britain's economy is tipping headlong into a recession that could last more than a year and cost hundreds of thousands of jobs, warns Professor David Blanchflower, a member of the Bank of England's interest rate committee, in an interview with the Guardian today.
Blanchflower says the Bank must cut interest rates rapidly to prevent the downturn being too painful, and thinks the UK could be in for a worse time than even the United States, where interest rates have already been slashed and taxes cut to stimulate the economy.
The economist said the recent rises in unemployment are "the tip of the iceberg". The number of people out of work and claiming benefit is 840,000 but the broader measure of unemployment is 1.6 million, 5.2% of the workforce. Blanchflower said it could climb to more than 7%— a figure that would mean several hundred thousand people losing their jobs.
His warning comes days after the chancellor acknowledged that the slowdown could be "profound" and hinted he would change the Treasury's fiscal rules as the slowing economy looks set to bust them. Today a leading thinktank, the Ernst & Young Item Club, says the economic outlook for Britain is like a "horror movie" as a result of the credit crunch and tumbling house prices.
Deflationary Hurricanes In US And UK
I agree with Blanchflower, having previously stated Deflationary Hurricanes to Hit U.S. and U.K. In fact, I believe the US is in deflation now. However, Blanchflower is mistaken if he thinks lower rates are going to be some kind of magic bullet. One look at the US should be proof enough.
Ugly Picture In Eurozone
Ambrose Evans-Pritchard is writing about European Recession Looms As Spain Crumbles. The eurozone is tipping into a deeper downturn than America itself despite the tremors in the US mortgage industry, and may already be in full recession for the first time since the launch of the single currency. Industrial production for the EMU bloc fell 1.9% in May, according to fresh Eurostat data. It is the sharpest one-month decline for the region since the exchange rate crisis in 1992. Officials in Berlin have warned that Germany's economy could contract by as much as 1.5% in the second quarter as export orders crumble.
Industrial output in both Italy and Greece has slumped 6.6% over the past year. Portugal is off 6.2%. "It is a very ugly picture: we're on maximum alert," said Emma Marcegaglia, head of Italy's business federation Confindustria. Rome is now lobbying for a "New Deal" to revive Italy's economy through massive infrastructure projects.
Jacques Cailloux, Europe economist at the Royal Bank of Scotland, said a "reverse decoupling" is now under way as Europe goes down harder than the US— just as it did after the dotcom bust. "There is loss of momentum across the board. We can't exclude a recession," he said.
Spain is now spiralling into the worst crisis since the Franco dictatorship. "The economy is in dire straits," said Dominic Bryant, Spain expert at BNP Paribas. The global economy has clearly peaked [[and is now rapidly sliding down the slippery reverse slope: normxxx]]. Clearly the US, UK, and EU are not prepared for it. Is any country?
ߧ
Normxxx
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Mike "Mish" Shedlock | 21 July 2008 | 25 July 2008
Things are rapidly deteriorating In the US, UK, and the Eurozone. Let's take a look at a couple of top stories starting with Hundreds Of Thousands Face Job Loss In UK, says top economist. Britain's economy is tipping headlong into a recession that could last more than a year and cost hundreds of thousands of jobs, warns Professor David Blanchflower, a member of the Bank of England's interest rate committee, in an interview with the Guardian today.
Blanchflower says the Bank must cut interest rates rapidly to prevent the downturn being too painful, and thinks the UK could be in for a worse time than even the United States, where interest rates have already been slashed and taxes cut to stimulate the economy.
The economist said the recent rises in unemployment are "the tip of the iceberg". The number of people out of work and claiming benefit is 840,000 but the broader measure of unemployment is 1.6 million, 5.2% of the workforce. Blanchflower said it could climb to more than 7%— a figure that would mean several hundred thousand people losing their jobs.
His warning comes days after the chancellor acknowledged that the slowdown could be "profound" and hinted he would change the Treasury's fiscal rules as the slowing economy looks set to bust them. Today a leading thinktank, the Ernst & Young Item Club, says the economic outlook for Britain is like a "horror movie" as a result of the credit crunch and tumbling house prices.
Deflationary Hurricanes In US And UK
I agree with Blanchflower, having previously stated Deflationary Hurricanes to Hit U.S. and U.K. In fact, I believe the US is in deflation now. However, Blanchflower is mistaken if he thinks lower rates are going to be some kind of magic bullet. One look at the US should be proof enough.
Ugly Picture In Eurozone
Ambrose Evans-Pritchard is writing about European Recession Looms As Spain Crumbles. The eurozone is tipping into a deeper downturn than America itself despite the tremors in the US mortgage industry, and may already be in full recession for the first time since the launch of the single currency. Industrial production for the EMU bloc fell 1.9% in May, according to fresh Eurostat data. It is the sharpest one-month decline for the region since the exchange rate crisis in 1992. Officials in Berlin have warned that Germany's economy could contract by as much as 1.5% in the second quarter as export orders crumble.
Industrial output in both Italy and Greece has slumped 6.6% over the past year. Portugal is off 6.2%. "It is a very ugly picture: we're on maximum alert," said Emma Marcegaglia, head of Italy's business federation Confindustria. Rome is now lobbying for a "New Deal" to revive Italy's economy through massive infrastructure projects.
Jacques Cailloux, Europe economist at the Royal Bank of Scotland, said a "reverse decoupling" is now under way as Europe goes down harder than the US— just as it did after the dotcom bust. "There is loss of momentum across the board. We can't exclude a recession," he said.
Spain is now spiralling into the worst crisis since the Franco dictatorship. "The economy is in dire straits," said Dominic Bryant, Spain expert at BNP Paribas. The global economy has clearly peaked [[and is now rapidly sliding down the slippery reverse slope: normxxx]]. Clearly the US, UK, and EU are not prepared for it. Is any country?
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Corporate Bond Sales Collapse
Corporate Bond Sales Collapse
By Mike "Mish" Shedlock | 21 July 2008
Last week all eyes were on the Short Squeeze In Financials, triggered by a SEC Order To Protect Those Most Responsible For Naked Shorting, and fueled by nearly everyone going ga-ga over fabricated earning reports at Wells Fargo and Citigroup.
However, most missed the quiet but extremely important action in the corporate bond market. Please consider Bond Sales Slow to $5.3 Billion as Spreads Approach March Highs.
The strong rally brought out the 'bottom callers' in financials who made an appearance for the umpteenth time. And, if oil prices keep falling, perhaps the rally will continue for a bit more on the misguided notion that lower energy prices will help the economy. They won't.
Falling oil prices will be a result of falling demand and a weakening global economy. Weakening job prospects will come on on top of it. The key point however, is the odds of a sustainable rally in the wake of such poor action in the corporate bond market is highly unlikely regardless of what oil prices do.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Mike "Mish" Shedlock | 21 July 2008
Last week all eyes were on the Short Squeeze In Financials, triggered by a SEC Order To Protect Those Most Responsible For Naked Shorting, and fueled by nearly everyone going ga-ga over fabricated earning reports at Wells Fargo and Citigroup.
However, most missed the quiet but extremely important action in the corporate bond market. Please consider Bond Sales Slow to $5.3 Billion as Spreads Approach March Highs.
|
The strong rally brought out the 'bottom callers' in financials who made an appearance for the umpteenth time. And, if oil prices keep falling, perhaps the rally will continue for a bit more on the misguided notion that lower energy prices will help the economy. They won't.
Falling oil prices will be a result of falling demand and a weakening global economy. Weakening job prospects will come on on top of it. The key point however, is the odds of a sustainable rally in the wake of such poor action in the corporate bond market is highly unlikely regardless of what oil prices do.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
$1.6 Trillion And Counting
$1.6 Trillion In Losses And Counting
By John Mauldin | 11 July 2008
It seems that with each passing month the estimates for losses in the international banking system keep rising. This time last summer the largest estimates (from credible sources), if memory serves me correct, were around $400 billion, give or take a few months. By the end of the year it was in the neighborhood of twice that. Then last quarter we saw estimates approaching $1 trillion. Last week, the number being broached was $1.6 trillion, by Bridgewater Associates, one of the top, and more credible, analytical firms in the world. In this week's letter we look at the implications of that projection, analyze recent lending patterns by banks, briefly touch on the implications of the recent unemployment numbers, and end with a few comments on the bear market. It will make for an interesting letter. Warning: remove sharp objects from your vicinity before reading.
But first, I need your help, and in return I would like to give you a link to a recent speech I gave, where I speak about what I think is the development of an important new asset class, one which will come about precisely because of the problems I am writing abut today. I have not yet written about this topic in public, and the speech has been well-received. I think you will like it. Now, as to how you can help me ...
I get to travel a lot with my daughter and business partner Tiffani (actually she runs the business) and meet new people. Over the years, she has become as fascinated as I have with their individual stories. Everyone has a story to tell or a lesson to teach. We have decided to write a book about those stories, looking at the differences in perspective between old and young, retired and working, those who are wealthy and those who aspire to wealth. What are the differences in attitudes, in work habits, in how you manage money, in how you look at the future, and a score of other items? How do all of these things correlate?
We have created a totally anonymous online survey seeking answers to these questions and more. We hope to get at least 10,000 people to fill out the survey; and we are eager to see what we find as we pore over the resulting data and engage in a lot of in-depth analysis. Are the rich really different? Is there a difference in people from Europe, Asia, Latin America, Africa, and the US? I think we will find some very interesting information. Please note: this is not just a survey for millionaires. We want everyone, of all income levels and ages, to take the survey, so we can get a true representative sample.
You can get to the survey page by clicking here. It will take about ten minutes to complete, and I think that going through the questions will make you think about your own situation. Some have told us the survey is quite thought-provoking. If you have attempted to take the survey and had problems, we think we have worked out the bugs.
At the end of the survey, you will be sent to a page with the speech. If you cannot listen to it immediately, then simply save the page or the address. And of course, you can just take the survey to help us.
Also, Tiffani and I want to do live (mostly by phone) interviews with 200 millionaires, of all shapes and sizes and locales. We will interview you for about 30 minutes, and then you can have equal time asking me anything you want. Since I will have learned a lot about you, those questions can be as detailed or as general as you like. We want at least 20% of the interviews to come from outside the US.
We will use those interviews in the book, but will attach no identifying items or real names. If we use something from your interview in the book, we will let you see it first. If you are interested in being one of the interviewees, just drop Tiffani a note at eu@2000wave.com and she will get back to you and work out the details. I am really excited about this project and even more so about working with Tiffani. We will report back to you on what we find. Thanks for your help.
$1.6 Trillion in Losses and Counting
One of the great privileges I have is getting to read a wide variety of economic research. While I get a lot of material direct from the source, I also have a wide network of people who read other sources and send me what they think is important. When Ambrose Evans-Pritchard wrote this week about a report done by Bridgewater Associates, it got my attention, and fortunately this report was sent to me by a few friends. In my book, Bridgewater is one of the top analytical groups in the world. I pay attention and give strong credence to what they write. And this report is quite sobering.
First, let's look at what Evans-Pritchard wrote in the London Telegraph:
Let's look at some of the details in the report. First, these losses are not all subprime. In fact, more than half of it is from corporate liabilities, around $800 billion. About $550 billion of the corporate losses have yet to be written off. As an example, Bridgewater estimates losses on commercial loans to be as much as $149 billion, none of which has been written off.
Better than 90% of the losses from subprime assets that are on the books have already been written off. That is good. But Bridgewater estimates that there are losses lurking in the prime and Alt-A loan portfolios that could be much bigger than the subprime problems, as those loan books are more than six times the size of the subprime. Quoting:
I could go on, but the details are not important. The bottom line is that they estimate there is at least another $1.1 trillion of losses that will have to be written off by institutions all over the developed world, including very large potential write-offs from insurance companies.Banks and investment institutions worldwide may need another $400 billion in capital infusions. But where they are going to get it is the problem.
They have burned through the usual suspects, and burned is the correct word. Any sovereign wealth fund or large investor who has put money into an investment or commercial bank has watched their investment take large losses in a very short time. How likely are they to be willing to belly back up to the bar with more money, on anything except very dilutive terms to current shareholders? The answer is obvious.
And let me be clear. There are some very large commercial and investment banks which are simply going to be absorbed, as regulators move to keep the entire system working. Bear Stearns is not a one-off deal. I think it is likely we will see at least one European bank nationalized [[UBS springs to mind.: normxxx]]. Losses the size that Bridgewater describes are beyond ugly. They are life-threatening for more than one major institution. More on this later.
Banks Start To Reduce Their Lending
Further, let's revisit a theme I have written about on several occasions over the past year. As banks incur losses, they either have to find new capital or reduce their lending in order to maintain their capital ratios, or some combination of both. And what we are seeing is that lending is starting actually to decrease.
Earlier this year lending rose as normal, even though anecdotal reports told of tightening lending standards and reduced loan lines. The tightening of standards did not seem to be affecting actual loans being made, which was odd. But this was partly illusion, as banks were taking back loans they had spun off in SIVs, taking capital away from their traditional loan business. This gave the appearance of expanding loan capacity. Evidently, this bringing back of off-book loans is now being worked through, as evidenced by this analysis by good friend and analyst par excellence Greg Weldon, who slices and dices the data to give us this view:
Click Here, or on the image, to see a larger, undistorted image.
Greg goes on to suggest that bank credit could contract a further $6-700 billion over the next nine months, which is a contraction of about 8%. Healthy economies have a rising rate of bank credit, which is one source of expansion. When banks have to reduce their lending, it reduces the growth of the economy or can put it into outright recession.
And if the Bridgewater report is anything close to right, Greg is being an optimist, which is not his normal milieu. Now, do I think worldwide credit will shrink $12 trillion, as Evans-Pritchard suggests? (Note, that was not a suggestion or conclusion by Bridgewater.) Not in my worst nightmares. Capital will be raised, and the various central banks of the world will do what is necessary to give banks the time to work through their problems.
But in the meantime, the trend toward lower lending is likely to continue. And lower lending is going to be a huge headwind for an economy that is already struggling. This week Ben Bernanke suggested that the "temporary" Term Auction Facility might be extended into 2009. Let me suggest that it will be extended into at least 2010 before it is no longer needed. Banks are going to need to be able to take their illiquid paper and convert it into liquid Treasuries against which they can make loans and continue to function.
As I have written for a long time, it is all about buying time. In 1980, every major bank in the US was technically bankrupt, as they all had large amounts of Latin American bonds in their portfolios, at a size far larger than their capitalization. When the Latin American countries started to default, if the Fed had made the banks mark their portfolios to market, it would have been a disaster of biblical proportions. There would have been no American banks left standing. The US economy would have gone into a deep depression.
Instead, with a wink and nod, they let them keep the bad bonds on their books at face value, which they all did. Then in the latter part of the decade, starting with Citibank in 1986 (cue the irony), they began one by one to write off the bad loans, but only when they had enough capital to do so. It took six years (or more) of profits and capital raising to get to where they could deal with the problems without imploding themselves and the economy of the US at the same time.
Today is only different in the details. The Fed and central banks around the world are allowing banks to buy time to work through their problems. There really is no other option. That extra $1.1 trillion that the research by Bridgewater says will have to be written off? You can take it to the bank, pardon the pun, that it will not be written off this quarter. This is going to be an ongoing process that will take several years at a minimum. Just as in 1980, the regulators are going to allow banks to write down their losses as they can, except in the most egregious of circumstances, in which case those banks will be "absorbed," à la Bear Stearns.
Treasury Secretary Paulson said Thursday that no bank is too big to fail. That is for public consumption. The fact is that there are any number of banks that are too big to fail, depending upon (and borrowing from my favorite linguist, Bill Clinton) what your definition of fail is. If by fail you mean that shareholders are wiped out, then he is correct, there is no institution too big to fail. If by fail you mean that the operations and debt obligations will be allowed to collapse, then there are institutions whose collapse would pose major systemic risk to the world markets. They cannot be allowed to collapse.
Take Freddie Mac. Please.
But in the same story, Senators Schumer and McCain both said Freddie and Fannie would not be allowed to fail. Even curmudgeonly former Fed Vice-Chairman Wayne Angell (someone whom I sincerely respect), said on CNBC yesterday that the government regulator of the GSEs (Government Sponsored Enterprises) ought to get some money from Congress to buy preferred stock and then get even larger amounts from the public through an offering of preferred stock. He said that Congress ought to learn about its responsibilities with regard to a GSE; and the public ought to realize that we are in for a long, tough fight. (He also expects the second half of 2008 to be no better than the first half, and he sees 1% growth in 2009.)
I wrote the above paragraph, and a few I deleted below, on Thursday, as I am on a plane to Las Vegas and need to finish the letter in order to attend a conference. I wrote with suggestions about how a collapse of the two Government Sponsored Enterprises might be handled. Last night, the New York Times broke a story that government officials are looking at how to go about taking over operations at Freddie and Fannie, should worse come to worst. Then this morning, the Wall Street Journal in its lead story elaborated on this theme.
The basic problem is that both Fannie and Freddie need more capital, and perhaps far more than their current market capitalization. Where to find it? What investor wants to try and catch this falling safe, without government guarantees? The Journal article quotes numerous people with various ideas about what to do. Most of their ideas will potentially cost US taxpayers.
And make no mistake. The problems with Fannie and Freddie have to be solved. They are now doing 80% of the mortgages in the US. Without them the housing market would grind to a halt quickly and housing prices would drop even beyond Gary Shilling's pessimistic views. Not to mention that the world has assumed the implicit backing of the government in buying the paper of Freddie and Fannie. How easy would it be to finance US debt if this paper was allowed to default? The implications are serious [[it's beyond serious; it's potentially mortal: normxxx]]. I understand the arguments for allowing them to fail, and I think shareholders should bear the risk they take on when buying equity.
A very reasonable idea was broached by Steve Forbes on a BizRadio program this afternoon, which Dan Frishberg graciously allowed me to co-host. He suggests breaking Fannie and Freddie into eight smaller companies, giving them whatever backing they need in the form of public financing to start business, and then cut them off to sink or swim on their own, with much tighter capitalization controls. Remember, this is one of the more free-market conservative thinkers.
The authorities are slowly losing control. All they can do is crisis manage. There are no good solutions, only expedient ones. And we must all hope they choose the best among a handful of not particularly pleasing options. Allowing the system to devolve into chaos is not an option. The Fed and whatever administration comes in will do the same as the current group, which is to buy time so that the wounds can heal, and hopefully put in place rules to prevent another such occurrence.
(Sidebar: I will go into greater detail in a later letter, but regulators need to move NOW to create a Credit Default Swaps Exchange. A problem/crisis in that unregulated market is actually a far bigger problem than the current subprime crisis. Why do you think Bear Stearns was not allowed to go into bankruptcy? There are banks that are too big to fail, despite what Paulson says for public consumption.)
There are a lot of conflicting opinions, which you can read here if you care to. Some say Fannie and Freddie will have to lose $70 billion before the regulators step in. Poole says they are insolvent now, using fair market accounting methods. I don't know, and neither do 99.9% of the shareholders. At this point Fannie and Freddie are not an investment, they are a gamble. Sitting here at Caesar's in Vegas, and reading the opinions, makes me think I have better odds at the tables below me.
I hope that when (not if!) taxpayer money is used, it is at market rates and means that shareholders are last in line, if at all, to recoup any money. For those of us who for years have called for tighter regulation and increased capitalization of the GSEs, as well as a clear removal of any government backing, implicit or explicit, being able to say "I told you so" [[in return for truckloads of taxpayer money: normxxx]] does not feel all that good. But, Freddie and Fannie cannot be allowed to go out of existence. They are too tightly wound into the core and fiber of the US economy.
What can and should happen is that shareholders bear their losses, taxpayers pick up the bill, and when they are healthy again, as they will be at some point, another public offering should be done to hopefully recoup the losses to taxpayers. Or perhaps an auction with some guarantees to a potential buyer, but a complete removal of implicit government guarantees on future loans, and higher capitalization requirements. There are any numbers of ways to lessen the ultimate cost to the taxpayer.
What I fear is that politicians will use the opportunity to prop up the mortgage markets with taxpayer guarantees and create much larger losses, which could quickly mount into the hundreds of billions if not properly dealt with. A new populist-oriented administration could find this problem on their desk as they take office. I would not want to own any stock in the financial sector. There is going to be a continual stream of write-offs over the coming year, at a minimum. Yes, some banks are better managed and will avoid the real life-threatening problems. Some will be like JP Morgan and end up with solid assets backed by government guarantees.
But which ones? Do you want to trust the analysts that have been telling you there is value in the financials at each step, all the way down? The management who insists they are in good shape, then raises capital at dilutive prices? The very people who did not see the problems to begin with, telling you that they are now solved?
The "value" that analysts optimistically see in various financial stocks is evaporating with each quarter, as they slowly write down ever more losses. With another potential $1 trillion to be written off or absorbed through earnings from profitable parts of the business, there is more pain to come. Investing in financials today is like trying to catch a falling safe.
The Ugly Muddle Through
Goldman Sachs published a report Thursday in which they suggest the most probable scenario for the next 12 months is GDP growth between -0.25% and 0.25%, or basically zero. Wayne Angell, mentioned above, expects the second half of '08 to be no better than the first half and for GDP growth to be 1%. In the Bridgewater report mentioned above, they estimate that the net worth of US-based assets is down about 13% since January 2007, a total loss of almost $8 trillion. This is hitting pension plans, corporations, and consumers, making them think twice about planned investments and expenditures.
Earnings estimates are being cut with each passing month. The P/E ratio for the S&P 500 is currently at a sporty 23. Historically, in times of rising inflation, the stock market goes through "multiple compression." That means P/E ratios fall more than earnings. If multiples fell just 20%, back to 18, which is still above long-term trends, the market would see another 20% drop from here. Even with earnings growth, the market is going to have a challenge rising in the current environment.
Sidebar: A number of you have written questioning my source for the P/E ratio, as you read or hear different numbers from what I write. You can indeed find estimates of forward P/E ratios as low as 12 a year from now. That is a lot different than the 23 I cited above.
There are two basic types of earnings that are reported. [[And, moreover, one can use forward or trailing earnings— forward earnings, being largely imaginary, are invariably higher, but see The Real P/E Ratio?.: normxxx]] One is "operating earnings," or what I call EBTBS, or Earnings Before The Bad Stuff. Then there is "reported earnings," which is what the corporations report on their tax forms. Not all that long ago, in the mid-'90s, operating earnings and reported earnings were generally in line with each other. Companies would deduct genuine one-time, unusual losses from their reported earnings to give us operating earnings. And such a system has a valid basis for existence. If something is truly one-time, maybe an investor should overlook it when evaluating the company's potential.
But then the media and analysts started using the operating earnings as the primary number [[virtually ignoring the reported, aka GAAP, earnings: normxxx]], and companies began to game the system. More and more items were considered 'one-time' [[even though regularly repeated each year, or almost each year: normxxx]]. One of the more egregious examples was when Waste Management Systems declared that painting its garbage trucks was a 'one-time extraordinary expenditure' and should be accounted as such! Today the difference between as-reported and operating earnings can be 20-40% or more. It seems there are many losses that management assures us are just 'one-time' items.
Standard and Poor's has a web page where you can see a spreadsheet of historical data and projections for both types of earnings. That is the source of my data. Analysts' estimates do tend to get brighter the further out one looks into the future [[—no one likes a wet blanket, even if correct; and an overly negative analyst may be long gone by the time his/her predictions pan out: normxxx]]. But if the growth scenarios mentioned above come about, and banks have to curtail all sorts of lending, the earnings projections are going to be way too high, as they have been for the last 12 months. That is going to mean yet more pain for the stock market.
I think it is quite likely we will see the Dow slip below 11,000. (Ok, I wrote that Thursday!) As I said on Kudlow the other night, another 10% drop in the market would take us only to the average bear market. A "9 handle" on the Dow seems quite possible, if not likely. (Note: when someone says "a 9 handle," they mean that the first number in the index or stock price is a 9. The first number is the handle.) The risk is to the downside, given the tepid potential growth of the economy.
Once Again, The BLS Numbers Paint A False Picture
I almost get tired of writing this each month, but it is important, and I will do it quickly. The unemployment number from the BLS last week showed a loss of 62,000 jobs. Private sector jobs were off by 91,000, with the government showing growth of 29,000.
But once again, the birth/death model's estimate of 'imputed' new jobs added was 177,000. As The Liscio Report noted:
Revisions to the prior two months were a negative 52,000. When they do the final numbers a few years from now, we will find that the revisions will be in the hundreds of thousands for the first half of this year. We have now had five consecutive months of downward revisions, which is typical of recessions.
Unemployment held steady at 5.5%, but that masks an underlying and growing problem. There has been a huge increase in the number of people working "part-time for economic reasons" and a large number of people who are discouraged and not looking for a job but would like one. These two categories are not counted as unemployed. If you add them into the equation, the unemployment or underemployment number goes to 10.3%! (per Greg Weldon)
As I warned above, this has not made for pleasant reading. But it is reality, and we need to deal with it.
And let me say that even given the above, I am a long-term (and even mid-term) optimist. We have to work through some serious problems, but we will [[—we always have, and sometime in the future, like stories of the Great Depression, it will make for some exciting reading: normxxx]]. Valuations are going to be low once again, and it will be time to become bullish. And researching and writing my book on how the world will change in 20 years makes me very optimistic. No one in 20 years will think of today as the "good old days." The changes that are in front of us will be amazing. So, simply take a deep breath, be conservative today, and get ready for a really wild and fun[!?!] ride.
ߧ
Normxxx
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By John Mauldin | 11 July 2008
It seems that with each passing month the estimates for losses in the international banking system keep rising. This time last summer the largest estimates (from credible sources), if memory serves me correct, were around $400 billion, give or take a few months. By the end of the year it was in the neighborhood of twice that. Then last quarter we saw estimates approaching $1 trillion. Last week, the number being broached was $1.6 trillion, by Bridgewater Associates, one of the top, and more credible, analytical firms in the world. In this week's letter we look at the implications of that projection, analyze recent lending patterns by banks, briefly touch on the implications of the recent unemployment numbers, and end with a few comments on the bear market. It will make for an interesting letter. Warning: remove sharp objects from your vicinity before reading.
But first, I need your help, and in return I would like to give you a link to a recent speech I gave, where I speak about what I think is the development of an important new asset class, one which will come about precisely because of the problems I am writing abut today. I have not yet written about this topic in public, and the speech has been well-received. I think you will like it. Now, as to how you can help me ...
I get to travel a lot with my daughter and business partner Tiffani (actually she runs the business) and meet new people. Over the years, she has become as fascinated as I have with their individual stories. Everyone has a story to tell or a lesson to teach. We have decided to write a book about those stories, looking at the differences in perspective between old and young, retired and working, those who are wealthy and those who aspire to wealth. What are the differences in attitudes, in work habits, in how you manage money, in how you look at the future, and a score of other items? How do all of these things correlate?
We have created a totally anonymous online survey seeking answers to these questions and more. We hope to get at least 10,000 people to fill out the survey; and we are eager to see what we find as we pore over the resulting data and engage in a lot of in-depth analysis. Are the rich really different? Is there a difference in people from Europe, Asia, Latin America, Africa, and the US? I think we will find some very interesting information. Please note: this is not just a survey for millionaires. We want everyone, of all income levels and ages, to take the survey, so we can get a true representative sample.
You can get to the survey page by clicking here. It will take about ten minutes to complete, and I think that going through the questions will make you think about your own situation. Some have told us the survey is quite thought-provoking. If you have attempted to take the survey and had problems, we think we have worked out the bugs.
At the end of the survey, you will be sent to a page with the speech. If you cannot listen to it immediately, then simply save the page or the address. And of course, you can just take the survey to help us.
Also, Tiffani and I want to do live (mostly by phone) interviews with 200 millionaires, of all shapes and sizes and locales. We will interview you for about 30 minutes, and then you can have equal time asking me anything you want. Since I will have learned a lot about you, those questions can be as detailed or as general as you like. We want at least 20% of the interviews to come from outside the US.
We will use those interviews in the book, but will attach no identifying items or real names. If we use something from your interview in the book, we will let you see it first. If you are interested in being one of the interviewees, just drop Tiffani a note at eu@2000wave.com and she will get back to you and work out the details. I am really excited about this project and even more so about working with Tiffani. We will report back to you on what we find. Thanks for your help.
$1.6 Trillion in Losses and Counting
One of the great privileges I have is getting to read a wide variety of economic research. While I get a lot of material direct from the source, I also have a wide network of people who read other sources and send me what they think is important. When Ambrose Evans-Pritchard wrote this week about a report done by Bridgewater Associates, it got my attention, and fortunately this report was sent to me by a few friends. In my book, Bridgewater is one of the top analytical groups in the world. I pay attention and give strong credence to what they write. And this report is quite sobering.
First, let's look at what Evans-Pritchard wrote in the London Telegraph:
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Let's look at some of the details in the report. First, these losses are not all subprime. In fact, more than half of it is from corporate liabilities, around $800 billion. About $550 billion of the corporate losses have yet to be written off. As an example, Bridgewater estimates losses on commercial loans to be as much as $149 billion, none of which has been written off.
Better than 90% of the losses from subprime assets that are on the books have already been written off. That is good. But Bridgewater estimates that there are losses lurking in the prime and Alt-A loan portfolios that could be much bigger than the subprime problems, as those loan books are more than six times the size of the subprime. Quoting:
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I could go on, but the details are not important. The bottom line is that they estimate there is at least another $1.1 trillion of losses that will have to be written off by institutions all over the developed world, including very large potential write-offs from insurance companies.Banks and investment institutions worldwide may need another $400 billion in capital infusions. But where they are going to get it is the problem.
They have burned through the usual suspects, and burned is the correct word. Any sovereign wealth fund or large investor who has put money into an investment or commercial bank has watched their investment take large losses in a very short time. How likely are they to be willing to belly back up to the bar with more money, on anything except very dilutive terms to current shareholders? The answer is obvious.
And let me be clear. There are some very large commercial and investment banks which are simply going to be absorbed, as regulators move to keep the entire system working. Bear Stearns is not a one-off deal. I think it is likely we will see at least one European bank nationalized [[UBS springs to mind.: normxxx]]. Losses the size that Bridgewater describes are beyond ugly. They are life-threatening for more than one major institution. More on this later.
Banks Start To Reduce Their Lending
Further, let's revisit a theme I have written about on several occasions over the past year. As banks incur losses, they either have to find new capital or reduce their lending in order to maintain their capital ratios, or some combination of both. And what we are seeing is that lending is starting actually to decrease.
Earlier this year lending rose as normal, even though anecdotal reports told of tightening lending standards and reduced loan lines. The tightening of standards did not seem to be affecting actual loans being made, which was odd. But this was partly illusion, as banks were taking back loans they had spun off in SIVs, taking capital away from their traditional loan business. This gave the appearance of expanding loan capacity. Evidently, this bringing back of off-book loans is now being worked through, as evidenced by this analysis by good friend and analyst par excellence Greg Weldon, who slices and dices the data to give us this view:
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Click Here, or on the image, to see a larger, undistorted image.
Greg goes on to suggest that bank credit could contract a further $6-700 billion over the next nine months, which is a contraction of about 8%. Healthy economies have a rising rate of bank credit, which is one source of expansion. When banks have to reduce their lending, it reduces the growth of the economy or can put it into outright recession.
And if the Bridgewater report is anything close to right, Greg is being an optimist, which is not his normal milieu. Now, do I think worldwide credit will shrink $12 trillion, as Evans-Pritchard suggests? (Note, that was not a suggestion or conclusion by Bridgewater.) Not in my worst nightmares. Capital will be raised, and the various central banks of the world will do what is necessary to give banks the time to work through their problems.
But in the meantime, the trend toward lower lending is likely to continue. And lower lending is going to be a huge headwind for an economy that is already struggling. This week Ben Bernanke suggested that the "temporary" Term Auction Facility might be extended into 2009. Let me suggest that it will be extended into at least 2010 before it is no longer needed. Banks are going to need to be able to take their illiquid paper and convert it into liquid Treasuries against which they can make loans and continue to function.
As I have written for a long time, it is all about buying time. In 1980, every major bank in the US was technically bankrupt, as they all had large amounts of Latin American bonds in their portfolios, at a size far larger than their capitalization. When the Latin American countries started to default, if the Fed had made the banks mark their portfolios to market, it would have been a disaster of biblical proportions. There would have been no American banks left standing. The US economy would have gone into a deep depression.
Instead, with a wink and nod, they let them keep the bad bonds on their books at face value, which they all did. Then in the latter part of the decade, starting with Citibank in 1986 (cue the irony), they began one by one to write off the bad loans, but only when they had enough capital to do so. It took six years (or more) of profits and capital raising to get to where they could deal with the problems without imploding themselves and the economy of the US at the same time.
Today is only different in the details. The Fed and central banks around the world are allowing banks to buy time to work through their problems. There really is no other option. That extra $1.1 trillion that the research by Bridgewater says will have to be written off? You can take it to the bank, pardon the pun, that it will not be written off this quarter. This is going to be an ongoing process that will take several years at a minimum. Just as in 1980, the regulators are going to allow banks to write down their losses as they can, except in the most egregious of circumstances, in which case those banks will be "absorbed," à la Bear Stearns.
Treasury Secretary Paulson said Thursday that no bank is too big to fail. That is for public consumption. The fact is that there are any number of banks that are too big to fail, depending upon (and borrowing from my favorite linguist, Bill Clinton) what your definition of fail is. If by fail you mean that shareholders are wiped out, then he is correct, there is no institution too big to fail. If by fail you mean that the operations and debt obligations will be allowed to collapse, then there are institutions whose collapse would pose major systemic risk to the world markets. They cannot be allowed to collapse.
Take Freddie Mac. Please.
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But in the same story, Senators Schumer and McCain both said Freddie and Fannie would not be allowed to fail. Even curmudgeonly former Fed Vice-Chairman Wayne Angell (someone whom I sincerely respect), said on CNBC yesterday that the government regulator of the GSEs (Government Sponsored Enterprises) ought to get some money from Congress to buy preferred stock and then get even larger amounts from the public through an offering of preferred stock. He said that Congress ought to learn about its responsibilities with regard to a GSE; and the public ought to realize that we are in for a long, tough fight. (He also expects the second half of 2008 to be no better than the first half, and he sees 1% growth in 2009.)
I wrote the above paragraph, and a few I deleted below, on Thursday, as I am on a plane to Las Vegas and need to finish the letter in order to attend a conference. I wrote with suggestions about how a collapse of the two Government Sponsored Enterprises might be handled. Last night, the New York Times broke a story that government officials are looking at how to go about taking over operations at Freddie and Fannie, should worse come to worst. Then this morning, the Wall Street Journal in its lead story elaborated on this theme.
The basic problem is that both Fannie and Freddie need more capital, and perhaps far more than their current market capitalization. Where to find it? What investor wants to try and catch this falling safe, without government guarantees? The Journal article quotes numerous people with various ideas about what to do. Most of their ideas will potentially cost US taxpayers.
And make no mistake. The problems with Fannie and Freddie have to be solved. They are now doing 80% of the mortgages in the US. Without them the housing market would grind to a halt quickly and housing prices would drop even beyond Gary Shilling's pessimistic views. Not to mention that the world has assumed the implicit backing of the government in buying the paper of Freddie and Fannie. How easy would it be to finance US debt if this paper was allowed to default? The implications are serious [[it's beyond serious; it's potentially mortal: normxxx]]. I understand the arguments for allowing them to fail, and I think shareholders should bear the risk they take on when buying equity.
A very reasonable idea was broached by Steve Forbes on a BizRadio program this afternoon, which Dan Frishberg graciously allowed me to co-host. He suggests breaking Fannie and Freddie into eight smaller companies, giving them whatever backing they need in the form of public financing to start business, and then cut them off to sink or swim on their own, with much tighter capitalization controls. Remember, this is one of the more free-market conservative thinkers.
The authorities are slowly losing control. All they can do is crisis manage. There are no good solutions, only expedient ones. And we must all hope they choose the best among a handful of not particularly pleasing options. Allowing the system to devolve into chaos is not an option. The Fed and whatever administration comes in will do the same as the current group, which is to buy time so that the wounds can heal, and hopefully put in place rules to prevent another such occurrence.
(Sidebar: I will go into greater detail in a later letter, but regulators need to move NOW to create a Credit Default Swaps Exchange. A problem/crisis in that unregulated market is actually a far bigger problem than the current subprime crisis. Why do you think Bear Stearns was not allowed to go into bankruptcy? There are banks that are too big to fail, despite what Paulson says for public consumption.)
There are a lot of conflicting opinions, which you can read here if you care to. Some say Fannie and Freddie will have to lose $70 billion before the regulators step in. Poole says they are insolvent now, using fair market accounting methods. I don't know, and neither do 99.9% of the shareholders. At this point Fannie and Freddie are not an investment, they are a gamble. Sitting here at Caesar's in Vegas, and reading the opinions, makes me think I have better odds at the tables below me.
I hope that when (not if!) taxpayer money is used, it is at market rates and means that shareholders are last in line, if at all, to recoup any money. For those of us who for years have called for tighter regulation and increased capitalization of the GSEs, as well as a clear removal of any government backing, implicit or explicit, being able to say "I told you so" [[in return for truckloads of taxpayer money: normxxx]] does not feel all that good. But, Freddie and Fannie cannot be allowed to go out of existence. They are too tightly wound into the core and fiber of the US economy.
What can and should happen is that shareholders bear their losses, taxpayers pick up the bill, and when they are healthy again, as they will be at some point, another public offering should be done to hopefully recoup the losses to taxpayers. Or perhaps an auction with some guarantees to a potential buyer, but a complete removal of implicit government guarantees on future loans, and higher capitalization requirements. There are any numbers of ways to lessen the ultimate cost to the taxpayer.
What I fear is that politicians will use the opportunity to prop up the mortgage markets with taxpayer guarantees and create much larger losses, which could quickly mount into the hundreds of billions if not properly dealt with. A new populist-oriented administration could find this problem on their desk as they take office. I would not want to own any stock in the financial sector. There is going to be a continual stream of write-offs over the coming year, at a minimum. Yes, some banks are better managed and will avoid the real life-threatening problems. Some will be like JP Morgan and end up with solid assets backed by government guarantees.
But which ones? Do you want to trust the analysts that have been telling you there is value in the financials at each step, all the way down? The management who insists they are in good shape, then raises capital at dilutive prices? The very people who did not see the problems to begin with, telling you that they are now solved?
The "value" that analysts optimistically see in various financial stocks is evaporating with each quarter, as they slowly write down ever more losses. With another potential $1 trillion to be written off or absorbed through earnings from profitable parts of the business, there is more pain to come. Investing in financials today is like trying to catch a falling safe.
The Ugly Muddle Through
Goldman Sachs published a report Thursday in which they suggest the most probable scenario for the next 12 months is GDP growth between -0.25% and 0.25%, or basically zero. Wayne Angell, mentioned above, expects the second half of '08 to be no better than the first half and for GDP growth to be 1%. In the Bridgewater report mentioned above, they estimate that the net worth of US-based assets is down about 13% since January 2007, a total loss of almost $8 trillion. This is hitting pension plans, corporations, and consumers, making them think twice about planned investments and expenditures.
Earnings estimates are being cut with each passing month. The P/E ratio for the S&P 500 is currently at a sporty 23. Historically, in times of rising inflation, the stock market goes through "multiple compression." That means P/E ratios fall more than earnings. If multiples fell just 20%, back to 18, which is still above long-term trends, the market would see another 20% drop from here. Even with earnings growth, the market is going to have a challenge rising in the current environment.
Sidebar: A number of you have written questioning my source for the P/E ratio, as you read or hear different numbers from what I write. You can indeed find estimates of forward P/E ratios as low as 12 a year from now. That is a lot different than the 23 I cited above.
There are two basic types of earnings that are reported. [[And, moreover, one can use forward or trailing earnings— forward earnings, being largely imaginary, are invariably higher, but see The Real P/E Ratio?.: normxxx]] One is "operating earnings," or what I call EBTBS, or Earnings Before The Bad Stuff. Then there is "reported earnings," which is what the corporations report on their tax forms. Not all that long ago, in the mid-'90s, operating earnings and reported earnings were generally in line with each other. Companies would deduct genuine one-time, unusual losses from their reported earnings to give us operating earnings. And such a system has a valid basis for existence. If something is truly one-time, maybe an investor should overlook it when evaluating the company's potential.
But then the media and analysts started using the operating earnings as the primary number [[virtually ignoring the reported, aka GAAP, earnings: normxxx]], and companies began to game the system. More and more items were considered 'one-time' [[even though regularly repeated each year, or almost each year: normxxx]]. One of the more egregious examples was when Waste Management Systems declared that painting its garbage trucks was a 'one-time extraordinary expenditure' and should be accounted as such! Today the difference between as-reported and operating earnings can be 20-40% or more. It seems there are many losses that management assures us are just 'one-time' items.
Standard and Poor's has a web page where you can see a spreadsheet of historical data and projections for both types of earnings. That is the source of my data. Analysts' estimates do tend to get brighter the further out one looks into the future [[—no one likes a wet blanket, even if correct; and an overly negative analyst may be long gone by the time his/her predictions pan out: normxxx]]. But if the growth scenarios mentioned above come about, and banks have to curtail all sorts of lending, the earnings projections are going to be way too high, as they have been for the last 12 months. That is going to mean yet more pain for the stock market.
I think it is quite likely we will see the Dow slip below 11,000. (Ok, I wrote that Thursday!) As I said on Kudlow the other night, another 10% drop in the market would take us only to the average bear market. A "9 handle" on the Dow seems quite possible, if not likely. (Note: when someone says "a 9 handle," they mean that the first number in the index or stock price is a 9. The first number is the handle.) The risk is to the downside, given the tepid potential growth of the economy.
Once Again, The BLS Numbers Paint A False Picture
I almost get tired of writing this each month, but it is important, and I will do it quickly. The unemployment number from the BLS last week showed a loss of 62,000 jobs. Private sector jobs were off by 91,000, with the government showing growth of 29,000.
But once again, the birth/death model's estimate of 'imputed' new jobs added was 177,000. As The Liscio Report noted:
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Revisions to the prior two months were a negative 52,000. When they do the final numbers a few years from now, we will find that the revisions will be in the hundreds of thousands for the first half of this year. We have now had five consecutive months of downward revisions, which is typical of recessions.
Unemployment held steady at 5.5%, but that masks an underlying and growing problem. There has been a huge increase in the number of people working "part-time for economic reasons" and a large number of people who are discouraged and not looking for a job but would like one. These two categories are not counted as unemployed. If you add them into the equation, the unemployment or underemployment number goes to 10.3%! (per Greg Weldon)
As I warned above, this has not made for pleasant reading. But it is reality, and we need to deal with it.
And let me say that even given the above, I am a long-term (and even mid-term) optimist. We have to work through some serious problems, but we will [[—we always have, and sometime in the future, like stories of the Great Depression, it will make for some exciting reading: normxxx]]. Valuations are going to be low once again, and it will be time to become bullish. And researching and writing my book on how the world will change in 20 years makes me very optimistic. No one in 20 years will think of today as the "good old days." The changes that are in front of us will be amazing. So, simply take a deep breath, be conservative today, and get ready for a really wild and fun[!?!] ride.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
The World Will Not End
The World Will Not End
By John Mauldin | 27 July 2008
Take A Deep Breath
It is easy to find bad news these days, and the torrent that seems to keep coming can ruin a person's summer (or winter, for my southern hemisphere readers). The credit crisis, as noted last week, is nowhere near an end. Housing, as we will see, is actually getting worse. Foreclosures, auctions, government bailouts, higher taxes, inflation, the price of energy and food— the list goes on and on.
I thought, since so many think of me as a rather bearish person, I would show you my more optimistic side. Yes, I am bearish in the short term, for reasons I have documented at length in this letter. But long-term I am a wild-eyed optimist. With all the negative news thrown at us today, why is the United States not in the midst of a deep recession? How, many of you ask, can I be so sanguine as to suggest a milder recession and a Muddle Through Economy?
First, things are somewhat different now than in the '70s and early '80s. Back then, a great deal of the US and developed world economies and their resulting employment were linked to manufacturing, which was largely geared to domestic sales. Exports were a much smaller part of the economy for most businesses. When the economy and consumption slowed down, manufacturers laid employees off rather rapidly. Unemployment would soar and a V-shaped recession would occur.
Now, the number of people employed in manufacturing is less in percentage terms than it was back then, and more of what is produced in the developed world is bought by a growing developing world. Exports from the US are booming. The number of TEUs (the large containers on ships: Twenty-foot Equivalent Units) moving through the ports of Los Angeles and Long Beach is up 23% in May year over year and up 26% since the beginning of the year. Because of the weak dollar, imports are down by 7% year to date. It is export growth that is keeping the US from sliding into the usual deep recession.
So, not only is manufacturing not down as in usual cycles, it is up quite handsomely for many products, except of course for automobiles, which are not just in a recession but facing a depression. But that growth in exports is keeping unemployment from going to 9%.
But let's take a longer-term outlook. My view has been, and is, that we are in for a period of very tepid growth that will last through at least 2009. We have to work our way through the after effects of the twin bubbles of housing and the credit crisis bursting. There is no magic Fed wand. That simply takes time. No (rational) government or Fed policy is going to change the facts on the ground (although they can make things worse). But, in the fullness of time, we will in fact get through this.
If you look back over the decades, things are getting better. Goldman Sachs estimates about 70 million people a year worldwide are entering the 'middle class' and that by 2030 two billion people will be in a far better condition than the poverty they experience today. That will also keep demand steady for all sorts of products and services produced in the developed world, even as our population (except for the US) declines.
The old joke is that a recession is when your neighbor loses his job and a depression is when you lose yours. And a rise in unemployment and lower corporate profits are no laughing matter. But the simple trend is that we will adjust and free markets in America and the world will grow, as they have always done.
Next year there will be 2.3 million weddings in the US, at an average cost of $30,000. That is $72 billion on weddings. And many of those new families start with the need to find a place to live, furnish a home, and build their nest. They'll find they 'need' all sorts of items to make their house a home. Last year a record 4.3 million babies were born in the US. Each of them will need all sorts of 'stuff'— food, education, and places to live— in (hopefully) 20-25 years.
Yes, consumers are cutting back, but they are still buying the basics. Manufact-uring in the US is starting to make a comeback, with the lower dollar and management driven to compete globally. In free-market economies, every economic slowdown is followed by a period of solid growth driven by innovation. The point is that life goes on. Births, weddings, and other celebrations, eating, living and simply enjoying friends and family. It is all part of the cycle.
The next 20 years are going to see the most powerful wave of technologically driven growth the world has ever seen. The accelerating pace of technological change did not slow down last century through multiple world wars, scores of 'minor' wars, a depression, all sorts of natural disasters, and an unbelievable amount of government folly. Why should that trend stop now?
As we add two billion people to the middle class, we are also going to bring the internet to even billions more. The explosion in information and creativity that we have seen in the last 20 years will double and double again. A small percentage of those people are going to invent amazing new technologies, new drugs, and create companies that will make life better for all of us.
That is one reason that technological growth will continue to accelerate. We will simply be throwing more people at an ever wider array of problems, and they will be able to share their discoveries at the speed of light. We are on the verge of a revolution in biotechnology that is going to truly revolutionize medicine. No one in 20 years will look back on today as the good old days. And it will probably create yet another stock market bubble [[2020 or so?: normxxx]], but that is a story for another letter.
US diplomats are talking to Iran. Iraq may actually work out. In most places of the world, most people are better off today than they were 20 years ago. There is still a lot of progress to be made, but the point is that we are making it. There is a ton of opportunity for those prepared to look for it. It may not be in the usual places, it may not be where we would like it to be, but it is there. World GDP will have roughly doubled (or more) by the end of the next decade.
Yes, I know there are a lot of problems. Really big scary ones. I write about a lot of them all the time. But go back to any year ending in 8 for the last 100 years. When were there not problems? And in most times and places, the problems were bigger. And in the next ten years? There will be lots of problems. Some will be the same old problems and some will be new. I am not certain why mankind seems to have a need to find new ways to create mischief and lose money when the old ways work so well. But those too will pass.
So, when you read about current problems— and I will point some out in the next few pages— just remember that things will work out. Markets will adjust, and the world will be a better place. Things will work out better for you as an individual if you anticipate the problems and make the proper adjustments, as much as possible, in advance. The next 20 years are going to be the most exciting time that the human race has experienced. Yes, there will be issues, but we will adjust. That is what we do. And now, let's look at some of the adjustments going on in the markets.
9% Growth in Housing or a 4% Loss?
When the news flashed on my screen that housing construction had jumped by 9%, I raised an eyebrow. That did not make sense given other data I was looking at. Immediately the media was full of talking heads and stories about the turnaround in housing and the end of the slowdown. I must admit to being a little confused.
Then we find the rest of the story. Asha Bangalore from Northern Trust actually took the time to read the details. It turns out that New York City had a change in its construction codes, and that affected what is considered a housing start in the Northeast, especially in multi-family construction, which 'jumped' 42% because of the code change. If it were not for the change, housing starts nationwide would have fallen by 4%. Because of the code change, housing starts jumped 102% in the Northeast. However, single-family starts nationwide declined 9.3% in June, to an annual rate of 647,000 units. That level of single-family starts is the lowest since January 1991. Look at the following chart from Northern Trust. Does this look like a 9% increase?
Click Here, or on the image, to see a larger, undistorted image.
More Government Statistical Fun
Each week we see a release of initial unemployment claims. This week initial claims jumped to 366,000 on a seasonally adjusted basis. But what are the real underlying numbers? Every Thursday, I get a thorough review of the actual data from John Vogel, going back and looking at trends over the past 8 years in the non-seasonally adjusted data. That can be more interesting.
This week the actual number of initial claims of unemployment was 475,954, compared to 383,839 last year (2007). And the number of actual claims has been trending up. Taking the three first weeks of the current quarter, we are still below the recession years of 2001-3; but the trend is not what you would like to see, and given the decline in consumer spending (see below) it is likely to continue to trend up.
The actual data is very 'noisy' and jumps all over the place, hence the use of 'seasonally adjusted' numbers for public consumption. Economy.com thinks the difficulty may be in accounting for auto-related plant shutdowns in the seasonally adjusted number. At right is a graph from economy.com showing where the employment problems are. Vogel speculates that employers are no longer waiting until the end of the quarter to lay personnel off but are doing it at any time in the quarter. Given the issues, it is likely we will see a rise in the number back toward the 400,000 range (SA) that we saw earlier last month. But just be aware that there can be something really different in the actual numbers. The majority of the states are seeing payroll employment drop.
Fannie and Freddie and Bears, Oh My!
Let me see if I have this straight. It is OK to short oil but not OK to short Fannie Mae? Or is it that it is OK to be long Freddie Mac but not long oil? Oh, those evil speculators. As Barry Ritholtz points out, why is it that management blames speculators when their stock is being pummeled, when the usual reason is that management made some very bad decisions?
And let's not forget the importance of rumors. We all know rumors can bring down a stock. So, let's start one. Let's start a whisper campaign that Goldman Sachs is going to have to take down $100 billion in losses next quarter, and then we can all short the stock. What would happen is that we would all lose our money when we had to cover, because there was no basis in fact.
The best way for a company to deal with short selling is to increase earnings and blow the shorts out of the water. Good management trumps rumors. This week the SEC has made it more difficult to short Fannie Mae, Freddie Mac, and other large financial firms. They are actually going to enforce the rule already on the books that says you must actually be able to deliver the shares you are shorting [[with some glaring 'exemptions': normxxx]].
'Naked' short selling has been against the rules for some time. (That is, short selling a stock that you did not actually 'borrow' in order to sell.) Institutions make rather tidy sums offering the shares they own to short sellers for a price. Making it more difficult to short Fannie or Freddie is not going to do one thing for their balance sheets, which is the real source of their problem. As former Fed governor William Poole said a few weeks ago, they are basically insolvent.
Five-year bonds sold by Fannie Mae yield 90 basis points (0.9%) more than US Treasuries of similar maturity, almost double the average over the past 10 years, according to data compiled by Bloomberg. That spread, which translates to $90,000 in extra annual interest per $10 million of bonds, exists even after Treasury Secretary Paulson signaled the US would ensure the debt is repaid by offering larger amounts of backup financing and potential capital infusions.
Fannie and Freddie are private companies where the profits go to shareholders and losses go to taxpayers. There are a lot of people (including your humble analyst) who have complained about the current set-up. Basically, they were allowed to leverage their capital beyond what even your most leveraged hedge fund would think prudent. How could the value of homes go down? Leverage up and show huge profits, pay monster salaries and bonuses to management who did nothing but increase risk, and spend $170 million on lobbyists to make sure that no one changes the rules.
Paulson had no realistic choice but to do what he did. But the true point is, he should never have had to make that choice. A real regulator would not have let them leverage their capital to the extent they did. If taxpayers have to invest one penny before shareholders are wiped out, then there is no justice. Fannie and Freddie should be broken up into several much smaller firms which are not too big too fail, their shares floated to new owners, and taxpayers should get preferred shares until they are made whole. And the implicit, but now explicit, guarantee should be taken away.
And while we are on regulators, it is time for Bernanke and Paulson and SEC chairman Cox to force the credit default swap (CDS) market to move to a regulated exchange. If there is a major risk to my happy news scenario at the beginning of this e-letter, it is the possibility of the credit default swap market collapsing. That is why Bear Stearns had to be rescued, and why other firms like them are too big to fail.
If the CDS markets were on an exchange like any futures contract, Bear could have been allowed to fail. It would have been a sad day, but the Fed would not have had to risk $30 billion. Greenspan was wrong when he said these derivatives did not need to be regulated. They are good for the markets, and I think they are necessary. But let's put them on a public exchange where there is clear transparency and the entire economy of Western Civilization is not put at risk by some cowboys who decide to leverage up.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By John Mauldin | 27 July 2008
|
Take A Deep Breath
It is easy to find bad news these days, and the torrent that seems to keep coming can ruin a person's summer (or winter, for my southern hemisphere readers). The credit crisis, as noted last week, is nowhere near an end. Housing, as we will see, is actually getting worse. Foreclosures, auctions, government bailouts, higher taxes, inflation, the price of energy and food— the list goes on and on.
I thought, since so many think of me as a rather bearish person, I would show you my more optimistic side. Yes, I am bearish in the short term, for reasons I have documented at length in this letter. But long-term I am a wild-eyed optimist. With all the negative news thrown at us today, why is the United States not in the midst of a deep recession? How, many of you ask, can I be so sanguine as to suggest a milder recession and a Muddle Through Economy?
First, things are somewhat different now than in the '70s and early '80s. Back then, a great deal of the US and developed world economies and their resulting employment were linked to manufacturing, which was largely geared to domestic sales. Exports were a much smaller part of the economy for most businesses. When the economy and consumption slowed down, manufacturers laid employees off rather rapidly. Unemployment would soar and a V-shaped recession would occur.
Now, the number of people employed in manufacturing is less in percentage terms than it was back then, and more of what is produced in the developed world is bought by a growing developing world. Exports from the US are booming. The number of TEUs (the large containers on ships: Twenty-foot Equivalent Units) moving through the ports of Los Angeles and Long Beach is up 23% in May year over year and up 26% since the beginning of the year. Because of the weak dollar, imports are down by 7% year to date. It is export growth that is keeping the US from sliding into the usual deep recession.
So, not only is manufacturing not down as in usual cycles, it is up quite handsomely for many products, except of course for automobiles, which are not just in a recession but facing a depression. But that growth in exports is keeping unemployment from going to 9%.
But let's take a longer-term outlook. My view has been, and is, that we are in for a period of very tepid growth that will last through at least 2009. We have to work our way through the after effects of the twin bubbles of housing and the credit crisis bursting. There is no magic Fed wand. That simply takes time. No (rational) government or Fed policy is going to change the facts on the ground (although they can make things worse). But, in the fullness of time, we will in fact get through this.
If you look back over the decades, things are getting better. Goldman Sachs estimates about 70 million people a year worldwide are entering the 'middle class' and that by 2030 two billion people will be in a far better condition than the poverty they experience today. That will also keep demand steady for all sorts of products and services produced in the developed world, even as our population (except for the US) declines.
The old joke is that a recession is when your neighbor loses his job and a depression is when you lose yours. And a rise in unemployment and lower corporate profits are no laughing matter. But the simple trend is that we will adjust and free markets in America and the world will grow, as they have always done.
Next year there will be 2.3 million weddings in the US, at an average cost of $30,000. That is $72 billion on weddings. And many of those new families start with the need to find a place to live, furnish a home, and build their nest. They'll find they 'need' all sorts of items to make their house a home. Last year a record 4.3 million babies were born in the US. Each of them will need all sorts of 'stuff'— food, education, and places to live— in (hopefully) 20-25 years.
Yes, consumers are cutting back, but they are still buying the basics. Manufact-uring in the US is starting to make a comeback, with the lower dollar and management driven to compete globally. In free-market economies, every economic slowdown is followed by a period of solid growth driven by innovation. The point is that life goes on. Births, weddings, and other celebrations, eating, living and simply enjoying friends and family. It is all part of the cycle.
The next 20 years are going to see the most powerful wave of technologically driven growth the world has ever seen. The accelerating pace of technological change did not slow down last century through multiple world wars, scores of 'minor' wars, a depression, all sorts of natural disasters, and an unbelievable amount of government folly. Why should that trend stop now?
As we add two billion people to the middle class, we are also going to bring the internet to even billions more. The explosion in information and creativity that we have seen in the last 20 years will double and double again. A small percentage of those people are going to invent amazing new technologies, new drugs, and create companies that will make life better for all of us.
That is one reason that technological growth will continue to accelerate. We will simply be throwing more people at an ever wider array of problems, and they will be able to share their discoveries at the speed of light. We are on the verge of a revolution in biotechnology that is going to truly revolutionize medicine. No one in 20 years will look back on today as the good old days. And it will probably create yet another stock market bubble [[2020 or so?: normxxx]], but that is a story for another letter.
US diplomats are talking to Iran. Iraq may actually work out. In most places of the world, most people are better off today than they were 20 years ago. There is still a lot of progress to be made, but the point is that we are making it. There is a ton of opportunity for those prepared to look for it. It may not be in the usual places, it may not be where we would like it to be, but it is there. World GDP will have roughly doubled (or more) by the end of the next decade.
Yes, I know there are a lot of problems. Really big scary ones. I write about a lot of them all the time. But go back to any year ending in 8 for the last 100 years. When were there not problems? And in most times and places, the problems were bigger. And in the next ten years? There will be lots of problems. Some will be the same old problems and some will be new. I am not certain why mankind seems to have a need to find new ways to create mischief and lose money when the old ways work so well. But those too will pass.
So, when you read about current problems— and I will point some out in the next few pages— just remember that things will work out. Markets will adjust, and the world will be a better place. Things will work out better for you as an individual if you anticipate the problems and make the proper adjustments, as much as possible, in advance. The next 20 years are going to be the most exciting time that the human race has experienced. Yes, there will be issues, but we will adjust. That is what we do. And now, let's look at some of the adjustments going on in the markets.
9% Growth in Housing or a 4% Loss?
When the news flashed on my screen that housing construction had jumped by 9%, I raised an eyebrow. That did not make sense given other data I was looking at. Immediately the media was full of talking heads and stories about the turnaround in housing and the end of the slowdown. I must admit to being a little confused.
Then we find the rest of the story. Asha Bangalore from Northern Trust actually took the time to read the details. It turns out that New York City had a change in its construction codes, and that affected what is considered a housing start in the Northeast, especially in multi-family construction, which 'jumped' 42% because of the code change. If it were not for the change, housing starts nationwide would have fallen by 4%. Because of the code change, housing starts jumped 102% in the Northeast. However, single-family starts nationwide declined 9.3% in June, to an annual rate of 647,000 units. That level of single-family starts is the lowest since January 1991. Look at the following chart from Northern Trust. Does this look like a 9% increase?
Click Here, or on the image, to see a larger, undistorted image.
More Government Statistical Fun
Each week we see a release of initial unemployment claims. This week initial claims jumped to 366,000 on a seasonally adjusted basis. But what are the real underlying numbers? Every Thursday, I get a thorough review of the actual data from John Vogel, going back and looking at trends over the past 8 years in the non-seasonally adjusted data. That can be more interesting.
This week the actual number of initial claims of unemployment was 475,954, compared to 383,839 last year (2007). And the number of actual claims has been trending up. Taking the three first weeks of the current quarter, we are still below the recession years of 2001-3; but the trend is not what you would like to see, and given the decline in consumer spending (see below) it is likely to continue to trend up.
The actual data is very 'noisy' and jumps all over the place, hence the use of 'seasonally adjusted' numbers for public consumption. Economy.com thinks the difficulty may be in accounting for auto-related plant shutdowns in the seasonally adjusted number. At right is a graph from economy.com showing where the employment problems are. Vogel speculates that employers are no longer waiting until the end of the quarter to lay personnel off but are doing it at any time in the quarter. Given the issues, it is likely we will see a rise in the number back toward the 400,000 range (SA) that we saw earlier last month. But just be aware that there can be something really different in the actual numbers. The majority of the states are seeing payroll employment drop.Fannie and Freddie and Bears, Oh My!
Let me see if I have this straight. It is OK to short oil but not OK to short Fannie Mae? Or is it that it is OK to be long Freddie Mac but not long oil? Oh, those evil speculators. As Barry Ritholtz points out, why is it that management blames speculators when their stock is being pummeled, when the usual reason is that management made some very bad decisions?
And let's not forget the importance of rumors. We all know rumors can bring down a stock. So, let's start one. Let's start a whisper campaign that Goldman Sachs is going to have to take down $100 billion in losses next quarter, and then we can all short the stock. What would happen is that we would all lose our money when we had to cover, because there was no basis in fact.
The best way for a company to deal with short selling is to increase earnings and blow the shorts out of the water. Good management trumps rumors. This week the SEC has made it more difficult to short Fannie Mae, Freddie Mac, and other large financial firms. They are actually going to enforce the rule already on the books that says you must actually be able to deliver the shares you are shorting [[with some glaring 'exemptions': normxxx]].
'Naked' short selling has been against the rules for some time. (That is, short selling a stock that you did not actually 'borrow' in order to sell.) Institutions make rather tidy sums offering the shares they own to short sellers for a price. Making it more difficult to short Fannie or Freddie is not going to do one thing for their balance sheets, which is the real source of their problem. As former Fed governor William Poole said a few weeks ago, they are basically insolvent.
Five-year bonds sold by Fannie Mae yield 90 basis points (0.9%) more than US Treasuries of similar maturity, almost double the average over the past 10 years, according to data compiled by Bloomberg. That spread, which translates to $90,000 in extra annual interest per $10 million of bonds, exists even after Treasury Secretary Paulson signaled the US would ensure the debt is repaid by offering larger amounts of backup financing and potential capital infusions.
| Given Paulson's guarantee, why would you buy US bonds when you can get the same guarantee and almost 1% more? |
Fannie and Freddie are private companies where the profits go to shareholders and losses go to taxpayers. There are a lot of people (including your humble analyst) who have complained about the current set-up. Basically, they were allowed to leverage their capital beyond what even your most leveraged hedge fund would think prudent. How could the value of homes go down? Leverage up and show huge profits, pay monster salaries and bonuses to management who did nothing but increase risk, and spend $170 million on lobbyists to make sure that no one changes the rules.
Paulson had no realistic choice but to do what he did. But the true point is, he should never have had to make that choice. A real regulator would not have let them leverage their capital to the extent they did. If taxpayers have to invest one penny before shareholders are wiped out, then there is no justice. Fannie and Freddie should be broken up into several much smaller firms which are not too big too fail, their shares floated to new owners, and taxpayers should get preferred shares until they are made whole. And the implicit, but now explicit, guarantee should be taken away.
And while we are on regulators, it is time for Bernanke and Paulson and SEC chairman Cox to force the credit default swap (CDS) market to move to a regulated exchange. If there is a major risk to my happy news scenario at the beginning of this e-letter, it is the possibility of the credit default swap market collapsing. That is why Bear Stearns had to be rescued, and why other firms like them are too big to fail.
If the CDS markets were on an exchange like any futures contract, Bear could have been allowed to fail. It would have been a sad day, but the Fed would not have had to risk $30 billion. Greenspan was wrong when he said these derivatives did not need to be regulated. They are good for the markets, and I think they are necessary. But let's put them on a public exchange where there is clear transparency and the entire economy of Western Civilization is not put at risk by some cowboys who decide to leverage up.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Saturday, July 26, 2008
The Next 6 Months?
Casey Files: Where Is The Economy Going In The Next 6 Months?
By Bud Conrad | 27 July 2008
As investors, the question we have to focus most of our attention on just now is what impact the credit crisis, the bursting housing bubble and the actions of the U.S. government will have on the economy and investment markets in the next six months. We have seen the Fed and the federal government move to panic mode as they try to keep the system afloat. As expected, they have cut rates, as well as having given away checks and rearranged the Federal Reserve's entire balance sheet.
The underlying problems have not been fixed with this massive bailout. There are still many credit pot holes out there and new lending remains highly constrained. Even the government tax rebate checks, rather than boosting the domestic economy, were largely absorbed by higher oil prices. The resulting cut-back in consumer spending, coupled with ongoing constrictions in lending, will cause a severe slowing of the economy.
But the much bigger implication is that the Fed is busy pouring more gasoline on the fire by fighting the collapsing housing bubble, a housing bubble created by excess liquidity, with yet more liquidity. That is the key point that should be taken from this mess. The dollar is now firmly on an even steeper slope to its ultimate demise. Other currencies will be sliding down the same slope, so another paper currency is not the answer.
This, then, is a high-level context for many of our investment recommendations in the months ahead.
Short Term Projections
1. The housing decline is not yet done, because we will need another year to unwind foreclosures in the pipeline. In addition, the exuberance shown by appraisers at the height of the housing bubble still has a long ways to go to fully deflate. What is that house on the market down the road really worth? At this point, no one knows... and no one will know until it and many others are bought by willing buyers (as opposed to unwilling lenders taking them onto their books in a foreclosure).
2. Consumers in the U.S. are not able to expand credit and are increasingly concerned about the outlook for the economy, so they will slow spending both at home and on imports.
3. The financial/banking system is far weaker than most realize. The complexity of the global system and the presence of ubiquitous interlocking financial and credit instruments and literally trillions of dollars in derivatives [[actually, on the order of about half a quadrillion dollars: normxxx]] has left the world's banks teetering on the edge.
Adding a push from behind, we have broadly rising inflation and soon the persistently higher interest rates that are the bane of fixed-income investors and financial institutions in general. As the dollar continues its fall, and the banks continue to come under pressure, the lack of confidence in these keystones of the modern financial system will deepen. Already, the Sovereign Wealth Funds that rushed in early in the credit crisis to prop up the big investment houses are now signaling that, at least for the time being, they are going to step back and watch how things shake out.
4. A slowing economy— recession— coupled with inflation, creates a condition often referred to as stagflation, presenting much bigger policy challenges for the government than one or the other alone.
5. The food crisis. Shortages of food production come from rising energy and fertilizer costs. Rising demand comes from a shift in diet, especially in emerging markets, where increasing prosperity leads the citizenry to add more protein to their diets. Important shortages in grains have arisen that don't allow for a bad crop year. Most concerning is that these shortages are occurring despite good crop production last year, an occurrence that can be blamed, in part, on the diversion of some agriculture production for ethanol and bio-diesel.
These food shortages have already contributed to a doubling and tripling in the price of grains over the last two years. But even these elevated prices have not been sufficient to offset the higher costs of the energy required to produce the crops. And, despite today's higher prices, agriculture still lags the price increases seen in many other commodities. The result of this is that the inflation rate, interest rate, food, energy and precious metals are heading higher as the dollar is debased.
Higher rates are not good for housing and stocks. In the long term, they will recover in nominal terms, though not in actual terms. That's because, while their nominal prices may return to current or near current levels, the dollars used to express their value will have much reduced purchasing power... making those assets a mediocre investment for the foreseeable future.
Finally, it is important to recognize that the world remains in the throes of a deep and serious crisis. While many analysts will express the view that the worst is over or that, after a modest downturn, things will bounce back just like they always have, our view is that what we will actually witness going forward is a fairly steady occurrence of crisis and panic. The crisis will accelerate, moving faster, even, than in previous major shifts such as that witnessed in the 1970s.
While history may find we have been too pessimistic at this point, in our view it is far better to prepare for a worsening crisis and hope that it does not materialize, than to expect business as usual.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Bud Conrad | 27 July 2008
As investors, the question we have to focus most of our attention on just now is what impact the credit crisis, the bursting housing bubble and the actions of the U.S. government will have on the economy and investment markets in the next six months. We have seen the Fed and the federal government move to panic mode as they try to keep the system afloat. As expected, they have cut rates, as well as having given away checks and rearranged the Federal Reserve's entire balance sheet.
The underlying problems have not been fixed with this massive bailout. There are still many credit pot holes out there and new lending remains highly constrained. Even the government tax rebate checks, rather than boosting the domestic economy, were largely absorbed by higher oil prices. The resulting cut-back in consumer spending, coupled with ongoing constrictions in lending, will cause a severe slowing of the economy.
But the much bigger implication is that the Fed is busy pouring more gasoline on the fire by fighting the collapsing housing bubble, a housing bubble created by excess liquidity, with yet more liquidity. That is the key point that should be taken from this mess. The dollar is now firmly on an even steeper slope to its ultimate demise. Other currencies will be sliding down the same slope, so another paper currency is not the answer.
This, then, is a high-level context for many of our investment recommendations in the months ahead.
Short Term Projections
1. The housing decline is not yet done, because we will need another year to unwind foreclosures in the pipeline. In addition, the exuberance shown by appraisers at the height of the housing bubble still has a long ways to go to fully deflate. What is that house on the market down the road really worth? At this point, no one knows... and no one will know until it and many others are bought by willing buyers (as opposed to unwilling lenders taking them onto their books in a foreclosure).
2. Consumers in the U.S. are not able to expand credit and are increasingly concerned about the outlook for the economy, so they will slow spending both at home and on imports.
3. The financial/banking system is far weaker than most realize. The complexity of the global system and the presence of ubiquitous interlocking financial and credit instruments and literally trillions of dollars in derivatives [[actually, on the order of about half a quadrillion dollars: normxxx]] has left the world's banks teetering on the edge.
Adding a push from behind, we have broadly rising inflation and soon the persistently higher interest rates that are the bane of fixed-income investors and financial institutions in general. As the dollar continues its fall, and the banks continue to come under pressure, the lack of confidence in these keystones of the modern financial system will deepen. Already, the Sovereign Wealth Funds that rushed in early in the credit crisis to prop up the big investment houses are now signaling that, at least for the time being, they are going to step back and watch how things shake out.
4. A slowing economy— recession— coupled with inflation, creates a condition often referred to as stagflation, presenting much bigger policy challenges for the government than one or the other alone.
5. The food crisis. Shortages of food production come from rising energy and fertilizer costs. Rising demand comes from a shift in diet, especially in emerging markets, where increasing prosperity leads the citizenry to add more protein to their diets. Important shortages in grains have arisen that don't allow for a bad crop year. Most concerning is that these shortages are occurring despite good crop production last year, an occurrence that can be blamed, in part, on the diversion of some agriculture production for ethanol and bio-diesel.
These food shortages have already contributed to a doubling and tripling in the price of grains over the last two years. But even these elevated prices have not been sufficient to offset the higher costs of the energy required to produce the crops. And, despite today's higher prices, agriculture still lags the price increases seen in many other commodities. The result of this is that the inflation rate, interest rate, food, energy and precious metals are heading higher as the dollar is debased.
Higher rates are not good for housing and stocks. In the long term, they will recover in nominal terms, though not in actual terms. That's because, while their nominal prices may return to current or near current levels, the dollars used to express their value will have much reduced purchasing power... making those assets a mediocre investment for the foreseeable future.
Finally, it is important to recognize that the world remains in the throes of a deep and serious crisis. While many analysts will express the view that the worst is over or that, after a modest downturn, things will bounce back just like they always have, our view is that what we will actually witness going forward is a fairly steady occurrence of crisis and panic. The crisis will accelerate, moving faster, even, than in previous major shifts such as that witnessed in the 1970s.
While history may find we have been too pessimistic at this point, in our view it is far better to prepare for a worsening crisis and hope that it does not materialize, than to expect business as usual.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Friday, July 25, 2008
A Bear Bottom? Follow The Signs.
Looking For A Bear Bottom? Follow The Contrarian Signs.
By Bruce Zaro | 25 July 2008
Everybody wants to know when the market is going to bottom out, when we can finally exhale again. I may not be prepared to sing hallelujah just yet, but I think the latest bout of climax selling has provided the opportunity for at least a nice, deep breath.
On July 17th, the Dow broke a long series of lower lows and lower highs with a bearish signal reversal, a play that often indicates stocks are poised to move higher, very quickly.
One day earlier, one of my favorite indicators of market risk levels, the New York Stock Exchange Hi-Lo Indicator, took a major stand on market movement. The NYSE Hi-Lo is a contrarian indicator that has shown good sense and dependability in calling bottoms. It measures the stocks on the NYSE reaching new highs as a percentage of all the stocks setting 52-week records— both highs and lows. On July 16th, this 28-year-old indicator recorded its lowest ever reading of 4. (Only 4% of the NYSE new 52-week highs or lows were highs.) Four? At 30, the downside is considered overextended. Readings in the rarified teens get analysts’ attention. Four is the equivalent of a multi-mega-watt spotlight shone deep into the den of a bear market, illuminating the depths.
And this wasn’t 4% of a small circle of record makers either. On that day, out of 2,764 listed issues, 1,390— fully half of the lineup— recorded new lows.
Selling, selling, selling…worry has been in the air of all the major indices. But a selling climax generally signals opportunity approaching. Look at yet another contrarian sign: a contrarian buy signal is generated when a stock or index hits a new 52-week low but closes out the week at a level higher than that of the previous Friday. Nearly 950 stocks across the US exchanges exhibited contrarian buy signals last week.
And the rebounds after past exhaustive selling bouts have been impressive. After days on which a mere 900 issues have recorded new lows, we’ve seen 3-month returns of 12.59% and 6-month returns of 16.59%.
Whether or not the market has hit rock bottom, remember that the January 2008 selling climax led to a very actionable rally that lasted until late May. As selling moves into the territory of overdone and capricious, the environment becomes favorable for investing. Of course, with the dismal headlines flashing across our screens each evening, it’s likely that market-hardened traders will be making most of the moves but sensible investors can also explore the bear’s den for treasures.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Bruce Zaro | 25 July 2008
Everybody wants to know when the market is going to bottom out, when we can finally exhale again. I may not be prepared to sing hallelujah just yet, but I think the latest bout of climax selling has provided the opportunity for at least a nice, deep breath.
On July 17th, the Dow broke a long series of lower lows and lower highs with a bearish signal reversal, a play that often indicates stocks are poised to move higher, very quickly.
One day earlier, one of my favorite indicators of market risk levels, the New York Stock Exchange Hi-Lo Indicator, took a major stand on market movement. The NYSE Hi-Lo is a contrarian indicator that has shown good sense and dependability in calling bottoms. It measures the stocks on the NYSE reaching new highs as a percentage of all the stocks setting 52-week records— both highs and lows. On July 16th, this 28-year-old indicator recorded its lowest ever reading of 4. (Only 4% of the NYSE new 52-week highs or lows were highs.) Four? At 30, the downside is considered overextended. Readings in the rarified teens get analysts’ attention. Four is the equivalent of a multi-mega-watt spotlight shone deep into the den of a bear market, illuminating the depths.
And this wasn’t 4% of a small circle of record makers either. On that day, out of 2,764 listed issues, 1,390— fully half of the lineup— recorded new lows.
Selling, selling, selling…worry has been in the air of all the major indices. But a selling climax generally signals opportunity approaching. Look at yet another contrarian sign: a contrarian buy signal is generated when a stock or index hits a new 52-week low but closes out the week at a level higher than that of the previous Friday. Nearly 950 stocks across the US exchanges exhibited contrarian buy signals last week.
And the rebounds after past exhaustive selling bouts have been impressive. After days on which a mere 900 issues have recorded new lows, we’ve seen 3-month returns of 12.59% and 6-month returns of 16.59%.
Whether or not the market has hit rock bottom, remember that the January 2008 selling climax led to a very actionable rally that lasted until late May. As selling moves into the territory of overdone and capricious, the environment becomes favorable for investing. Of course, with the dismal headlines flashing across our screens each evening, it’s likely that market-hardened traders will be making most of the moves but sensible investors can also explore the bear’s den for treasures.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
BLS BS Exposed
BLS BS Exposed: Commercial Bankruptcies Soar
By Mike "Mish" Shedlock | 20 July 2008
The McClatchy Washington Bureau is reporting Commercial bankruptcies soar, reflecting widening economic woes.
BLS BS
With the above in mind, let's take another look at my July 3rd post: Jobs Decline 6th Consecutive Months.
BLS
The BLS reported net expansion of new businesses in all but 3 of the past 15 months. January and July are months in which they partially correct for the ridiculous assumptions made in the other months. I expect a huge downward revision in the July data which will be published on August 1.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Mike "Mish" Shedlock | 20 July 2008
The McClatchy Washington Bureau is reporting Commercial bankruptcies soar, reflecting widening economic woes.
|
BLS BS
With the above in mind, let's take another look at my July 3rd post: Jobs Decline 6th Consecutive Months.
|
BLS
The BLS reported net expansion of new businesses in all but 3 of the past 15 months. January and July are months in which they partially correct for the ridiculous assumptions made in the other months. I expect a huge downward revision in the July data which will be published on August 1.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Thursday, July 24, 2008
You Know The Banking System Is Kaput When...
You Know The Banking System Is Unsound When...
By Mike "Mish" Shedlock | 24 July 2008
1. Paulson appears on Face The Nation and says "Our banking system is a safe and a sound one." If the banking system were safe and sound, everyone would know it (or at least think it). There would be no need to say it.
2. Paulson says the list of troubled banks "is a very manageable situation". The reality is there are 90 banks on the list of problem banks. Indymac was not one of them until a month before it collapsed. How many other banks will magically appear on the list a month before they collapse?
3. In a Northern Rock moment, depositors at Indymac pull out their cash. Police had to be called in to ensure order.
4. Washington Mutual (WM), another troubled bank, refused to honor Indymac cashier's checks. The irony is it makes no sense for customers to pull insured deposits out of Indymac after it went into receivership. The second irony is the last place one would want to put those funds would be Washington Mutual. Eventually Washington Mutual decided it would take those checks but with an 8 week hold. Will Washington Mutual even be around 8 weeks from now?
5. Paulson asked for "Congressional authority to buy unlimited stakes in and lend to Fannie Mae (FNM) and Freddie Mac (FRE)" just days after he said "Financial Institutions Must Be Allowed To Fail". Obviously Paulson is reporting from the 5th dimension. In some alternate universe, his statements just might make sense.
6. Former Fed Governor William Poole says "Fannie Mae, Freddie Losses Makes Them Insolvent".
7. Paulson says Fannie Mae and Freddie Mac are "essential" because they represent the only "functioning" part of the home loan market. The firms own or guarantee about half of the $12 trillion in U.S. mortgages. Is it possible to have a sound banking system when the only "functioning" part of the mortgage market is insolvent?
8. Bernanke testified before Congress on monetary policy but did not comment on either money supply or interest rates. The word "money" did not appear at all in his testimony. The only time "interest rate" appeared in his testimony was in relation to consumer credit card rates. How can you have any reasonable economic policy when the Fed chairman is scared half to death to discuss interest rates and money supply?
9. The SEC issued a protective order to protect those most responsible for naked short selling. As long as the investment banks and brokers were making money engaging in naked shorting of stocks, there was no problem. However, when the bears began using the tactic against the big financials, it became time to selectively enforce the existing regulation.
10. The Fed takes emergency actions twice during options expirations week in regards to the discount window and rate cuts.
11. The SEC takes emergency action during options expirations week regarding short sales.
12. The Fed has implemented an alphabet soup of pawn shop lending facilities whereby the Fed accepts garbage as collateral in exchange for treasuries. Those new Fed lending facilities are called the Term Auction Facility (TAF), the Term Security Lending Facility (TSLF), and the Primary Dealer Credit Facility (PDCF).
13. Citigroup (C), Lehman (LEH), Morgan Stanley(MS), Goldman Sachs (GS) and Merrill Lynch (MER) all have a huge percentage of level 3 assets. Level 3 assets are commonly known as "marked to fantasy" assets. In other words, the value of those assets is significantly if not ridiculously overvalued in comparison to what those assets would fetch on the open market. It is debatable if any of the above firms survive in their present form. Some may not survive in any form.
14. Bernanke openly solicits private equity firms to invest in banks. Is this even close to a remotely normal action for a Fed chairman to take?
15. Bear Stearns was taken over by JPMorgan (JPM) days after insuring investors it had plenty of capital. Fears are high that Lehman will suffer the same fate. Worse yet, the Fed had to guarantee the shotgun marriage between Bear Stearns and JP Morgan by providing as much as $30 billion in capital. JPMorgan is responsible for only the first 1/2 billion. Taxpayers are on the hook for all the rest. Was this a legal action for the Fed to take? Does the Fed care? [[Does anyone care?: normxxx]]
16. Citigroup needed a cash injection from Abu Dhabi and a second one elsewhere. Then, after announcing it would not need more capital, is raising still more. The latest news is Citigroup will sell $500 billion in assets. To whom? At what price?
17. Merrill Lynch raised $6.6 billion in capital from Kuwait Mizuho, announced it did not need to raise more capital, then raised more capital just weeks later.
18. Morgan Stanley sold a 9.9% equity stake to China International Corp. CEO John Mack compensated by not taking his bonus. How generous. Morgan Stanley fell from $72 to $37. Did CEO John Mack deserve a paycheck at all?
19. Bank of America (BAC) agreed to take over Countywide Financial (CFC) and twice announced Countrywide will add profits to B of A. Inquiring minds were asking "How the hell can Countrywide add to Bank of America earnings?" Here's how. Bank of America just announced it will not guarantee $38.1 billion in Countrywide debt. Questions over "Fraudulent Conveyance" are now surfacing.
20. Washington Mutual agreed to a death spiral cash infusion of $7 billion accepting an offer at $8.75 when the stock was over $13 at the time. Washington Mutual has since fallen in waterfall fashion from $40 and is now trading near $5.00 after a huge rally.
21. Shares of Ambac (ABK) fell from $90 to $2.50. Shares of MBIA (MBI) fell from $70 to $5. Sadly, the top three rating agencies kept their rating on the pair at AAA nearly all the way down. No one can believe anything the government sponsored rating agencies say.
22. In a panic set of moves, the Fed slashed interest rates from 5.25% to 2%. This was the fastest, steepest drop on record. Ironically, the Fed chairman spoke of inflation concerns the entire drop down. Bernanke clearly cannot tell the truth. He does not have to. Actions speak louder than words.
23. FDIC Chairman Sheila Bair said the FDIC is looking for ways to shore up its depleted deposit fund, including charging higher premiums on riskier brokered deposits.
24. There is roughly $6.84 Trillion in bank deposits. $2.60 Trillion of that is uninsured. There is only $53 billion in FDIC insurance to cover $6.84 Trillion in bank deposits. Indymac will eat up roughly $8 billion of that.
25. Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion. Where is the rest of the loot? The answer is in off balance sheet SIVs, imploding commercial real estate deals, Alt-A liar loans, Fannie Mae and Freddie Mac bonds, toggle bonds where debt is amazingly paid back with more debt, and all sorts of other silly (and arguably fraudulent) financial wizardry schemes that have bank and brokerage firms leveraged at 30-1 or more. Those loans cannot be paid back.
What cannot be paid back will be defaulted on. If you did not know it before, you do now. The entire US banking system is insolvent.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Mike "Mish" Shedlock | 24 July 2008
1. Paulson appears on Face The Nation and says "Our banking system is a safe and a sound one." If the banking system were safe and sound, everyone would know it (or at least think it). There would be no need to say it.
2. Paulson says the list of troubled banks "is a very manageable situation". The reality is there are 90 banks on the list of problem banks. Indymac was not one of them until a month before it collapsed. How many other banks will magically appear on the list a month before they collapse?
3. In a Northern Rock moment, depositors at Indymac pull out their cash. Police had to be called in to ensure order.
4. Washington Mutual (WM), another troubled bank, refused to honor Indymac cashier's checks. The irony is it makes no sense for customers to pull insured deposits out of Indymac after it went into receivership. The second irony is the last place one would want to put those funds would be Washington Mutual. Eventually Washington Mutual decided it would take those checks but with an 8 week hold. Will Washington Mutual even be around 8 weeks from now?
5. Paulson asked for "Congressional authority to buy unlimited stakes in and lend to Fannie Mae (FNM) and Freddie Mac (FRE)" just days after he said "Financial Institutions Must Be Allowed To Fail". Obviously Paulson is reporting from the 5th dimension. In some alternate universe, his statements just might make sense.
6. Former Fed Governor William Poole says "Fannie Mae, Freddie Losses Makes Them Insolvent".
7. Paulson says Fannie Mae and Freddie Mac are "essential" because they represent the only "functioning" part of the home loan market. The firms own or guarantee about half of the $12 trillion in U.S. mortgages. Is it possible to have a sound banking system when the only "functioning" part of the mortgage market is insolvent?
8. Bernanke testified before Congress on monetary policy but did not comment on either money supply or interest rates. The word "money" did not appear at all in his testimony. The only time "interest rate" appeared in his testimony was in relation to consumer credit card rates. How can you have any reasonable economic policy when the Fed chairman is scared half to death to discuss interest rates and money supply?
9. The SEC issued a protective order to protect those most responsible for naked short selling. As long as the investment banks and brokers were making money engaging in naked shorting of stocks, there was no problem. However, when the bears began using the tactic against the big financials, it became time to selectively enforce the existing regulation.
10. The Fed takes emergency actions twice during options expirations week in regards to the discount window and rate cuts.
11. The SEC takes emergency action during options expirations week regarding short sales.
12. The Fed has implemented an alphabet soup of pawn shop lending facilities whereby the Fed accepts garbage as collateral in exchange for treasuries. Those new Fed lending facilities are called the Term Auction Facility (TAF), the Term Security Lending Facility (TSLF), and the Primary Dealer Credit Facility (PDCF).
13. Citigroup (C), Lehman (LEH), Morgan Stanley(MS), Goldman Sachs (GS) and Merrill Lynch (MER) all have a huge percentage of level 3 assets. Level 3 assets are commonly known as "marked to fantasy" assets. In other words, the value of those assets is significantly if not ridiculously overvalued in comparison to what those assets would fetch on the open market. It is debatable if any of the above firms survive in their present form. Some may not survive in any form.
14. Bernanke openly solicits private equity firms to invest in banks. Is this even close to a remotely normal action for a Fed chairman to take?
15. Bear Stearns was taken over by JPMorgan (JPM) days after insuring investors it had plenty of capital. Fears are high that Lehman will suffer the same fate. Worse yet, the Fed had to guarantee the shotgun marriage between Bear Stearns and JP Morgan by providing as much as $30 billion in capital. JPMorgan is responsible for only the first 1/2 billion. Taxpayers are on the hook for all the rest. Was this a legal action for the Fed to take? Does the Fed care? [[Does anyone care?: normxxx]]
16. Citigroup needed a cash injection from Abu Dhabi and a second one elsewhere. Then, after announcing it would not need more capital, is raising still more. The latest news is Citigroup will sell $500 billion in assets. To whom? At what price?
17. Merrill Lynch raised $6.6 billion in capital from Kuwait Mizuho, announced it did not need to raise more capital, then raised more capital just weeks later.
18. Morgan Stanley sold a 9.9% equity stake to China International Corp. CEO John Mack compensated by not taking his bonus. How generous. Morgan Stanley fell from $72 to $37. Did CEO John Mack deserve a paycheck at all?
19. Bank of America (BAC) agreed to take over Countywide Financial (CFC) and twice announced Countrywide will add profits to B of A. Inquiring minds were asking "How the hell can Countrywide add to Bank of America earnings?" Here's how. Bank of America just announced it will not guarantee $38.1 billion in Countrywide debt. Questions over "Fraudulent Conveyance" are now surfacing.
20. Washington Mutual agreed to a death spiral cash infusion of $7 billion accepting an offer at $8.75 when the stock was over $13 at the time. Washington Mutual has since fallen in waterfall fashion from $40 and is now trading near $5.00 after a huge rally.
21. Shares of Ambac (ABK) fell from $90 to $2.50. Shares of MBIA (MBI) fell from $70 to $5. Sadly, the top three rating agencies kept their rating on the pair at AAA nearly all the way down. No one can believe anything the government sponsored rating agencies say.
22. In a panic set of moves, the Fed slashed interest rates from 5.25% to 2%. This was the fastest, steepest drop on record. Ironically, the Fed chairman spoke of inflation concerns the entire drop down. Bernanke clearly cannot tell the truth. He does not have to. Actions speak louder than words.
23. FDIC Chairman Sheila Bair said the FDIC is looking for ways to shore up its depleted deposit fund, including charging higher premiums on riskier brokered deposits.
24. There is roughly $6.84 Trillion in bank deposits. $2.60 Trillion of that is uninsured. There is only $53 billion in FDIC insurance to cover $6.84 Trillion in bank deposits. Indymac will eat up roughly $8 billion of that.
25. Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion. Where is the rest of the loot? The answer is in off balance sheet SIVs, imploding commercial real estate deals, Alt-A liar loans, Fannie Mae and Freddie Mac bonds, toggle bonds where debt is amazingly paid back with more debt, and all sorts of other silly (and arguably fraudulent) financial wizardry schemes that have bank and brokerage firms leveraged at 30-1 or more. Those loans cannot be paid back.
What cannot be paid back will be defaulted on. If you did not know it before, you do now. The entire US banking system is insolvent.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
THE BULL'S CASE
THE BULL'S CASE— Corporate Confidence: Insiders Didn't Sell Into Market's Decline In June
By Mark Hulbert, Marketwatch | 8 July 2008
ANNANDALE, Va. (MarketWatch)— One of the most bearish signals that corporate insiders can send to investors is to sell their companies' shares into a declining market. So those who pay attention to what the insiders are doing have been waiting with bated breath to see what the June data reveal about their behavior last month. Well, those data are now in, and the news is good: Insiders significantly cut back on their selling in June.
Corporate insiders, of course, are a company's officers, directors, and largest shareholders. They are required to report to the SEC any transaction they undertake involving shares of their companies' stock. Many research organizations gather that data and analyze them. One such organization is Argus Research, which publishes its findings in a weekly newsletter called the Vickers Weekly Insider Report. According to their latest issue, which was published on Monday, the average insider last week sold 1.39 of his company's shares for each one that he bought.
For insider transactions reported in the first week of June, in contrast, the sell-to-buy ratio was 2.49-to-1, according to Vickers. So in the wake of the stock market's steep decline during June, the average insider markedly cut back on the ratio of his selling relative to his buying. Though you might concede that this is an encouraging trend, you still might argue that a sell-to-buy ratio of 1.39-to-1 is bearish, since it means that the average insider is selling more of his company's shares than he is buying.
But the presupposition of this argument is mistaken: It turns out to be entirely normal for insiders to sell more than they buy. In fact, according to Vickers, the 36-year average for the insider sell-to-buy ratio is between 2-to-1 and 2.5-to-1. Furthermore, according to Nejat Seyhun, a finance professor at the University of Michigan who has closely studied insider behavior, companies' increasing use of share grants and options in recent years has probably shifted the "normal" range of the sell-to-buy ratio upward to around 6-to-1.
From That Perspective, Insiders' Recent Behavior Would Appear To Be Even More Bullish. To be sure, insiders' behavior is not a foolproof market-timing tool [[— especially short-term; they have a STRONG 'normal' tendency to buy during dips and sell during rallies: normxxx]]. They were bullish a month ago, for example, and the stock market nevertheless proceeded to fall markedly. Indeed, their behavior has been bullish throughout the decline that began last fall.
But I shouldn't have to remind anyone that there is no foolproof market-timing tool. Successful market timing over the long term requires an intelligent playing of the odds at each point along the way. And following the lead of the insiders is based on the simple notion that they know more about their companies' prospects than the rest of us. That strikes me as an intelligent bet. [[BUT, while the logic is impeccable, and works reasonably well for indivdual stocks, once the stats are suitably 'corrected' for the 'noise' (something that Thompson Financial used to do very well— until Wall Street put a stop to it), it doesn't seem to work very well for the market as a whole.: normxxx]]
Subprime Loss Estimates: Consensus Is Too Pessimistic
Walk Through The Numbers, And You'll See Why
By Thomas Brown, Bankstocks.Com | 7 July 2008
Ready? For the purposes of this discussion, let’s use as "consensus" the loss estimates lately being published by the analysts at UBS. UBS has been publishing numbers for as long as anyone on the Street, and the analysts’ work there is especially thorough. (If anything, in fact, the "real" consensus loss number might even be higher than UBS’s estimates.) At a conference call earlier this week, UBS said it believes the cumulative loss on the ABX 06-1 subprime mortgage index will come to 19.5% when all is said and done, and will be 29.6% on the ABX 06-2. As I say, that’s way too pessimistic.
I’ll explain why in a minute. First, a quick review of how we come up with our estimates. To get to expected cumulative losses, we look at the loans that comprise the ABX indices and add up a) realized losses to date, b) estimated losses from loans that are seriously (like, more than 60 days’) delinquent and real estate owned, and c) estimated losses from loans that are still current. As it happens, estimating a and b above isn’t all that hard. Essentially all of those loans will go bad, or have already. It’s just what will happen to c, the loans that are still current, that’s the area of conjecture.
Servicer Reports Filed Monthly
Anyway, as to how we come up with our numbers. Recall that each ABX index consists of 20 securitized mortgage trusts. The servicers of those trusts file reports on the 25th of each month that update the performance of the loans, through the last day of the month. The servicer reports filed June 25th capture loan performance through the end of May. We model each trust individually, then roll up the totals to arrive at a loss estimate for each ABX index.
Now to the numbers, using the a-b-c method of analysis described above.
First, the sum of the realized losses to date incurred by the 20 trusts that make up ABX 06-1 represents 2.8% of the sum of the trusts’ beginning balances. Next, we estimate losses that will come from seriously delinquent loans. We assume that 75% of loan dollars 61 to 90 days past due become real estate owned (REO), that 90% of loans 90 days past due go to REO, and 95% of loans in foreclosure go to REO. We then add these numbers to the REO total and assume 55% severity to arrive at our estimate of losses for past-due loans.
OK so far? The roll rates we assume are well above historic averages and even a little higher than what has occurred in recent months, so I feel comfortable that they’re conservative. Using these assumptions, we get to a loss rate on delinquent loans of 7.5%. Our story thus far: realized losses come to 2.8%, while "pipeline" losses on delinquent loans are another 7.5%, for a total of 10.3% in cumulative losses.
Getting to 19.5%
But UBS’s loss estimate for 06-1, remember, is 19.5%. Where will those losses come from? Well, one place they won’t come from is the loans in the trust that have already been repaid— which account for fully 58% of the index’s original balance. Rather, the 9.2% incremental losses UBS expects have to come from the loans in the trusts that are still current.
We’ve studied those loans closely. We’ve looked at their underwriters, the locations of the properties, loan-to-value ratios, levels of documentation, and borrowers’ FICOs, and have come up with an estimate that still-performing loans in the trusts will generate a cumulative loss of . . . 2.5%. That brings our estimate of total cumulative losses for 06-1 to 12.7%, rather than the 19.5% UBS expects.
Wait a minute!, I hear you saying. Losses of just 2.5% from the performing loans? That seems way, way too low.
No, it’s not. If anything, it’s likely too high. Here’s why. Remember, 61% of the beginning balance of the ABX 06-1 has either paid off or charged off, while another 14% of the original balance is 60 or more days delinquent or in REO. That leaves just 25% of the original balance as performing.
Higher Than The Loans Already Gone Bad
Again, if you assume 80% of loans 60 days past due roll all the way though to REO, and then 55% loan severity, that 2.5% loss estimate means that 22% of loans still performing will eventually go delinquent. That is a very conservative number. Why? It’s higher than the cumulative delinquency rate that has occurred already. And those loans, recall, included the weakest credits in the trust— the legions of speculators and con artists who walked away as soon as their properties were underwater.
So we’re assuming the performance of the still-current loans will turn out to be even worse than what’s already occurred with the loans that are in serious trouble and have been charged off!
So, then, what would have to happen to get to UBS’s 19.5% cumulative default rate? The bank doesn’t share the details about how it gets to its number. But we can back into it using our model, to see what their estimate implies. I do know UBS assumes severity of 60%. That would raise the cumulative losses from the past-due loans to 8.1%. That means that the loans still performing have to create an incremental 8.6% cumulative losses.
Unbelievable
Which gets us to the incredible-number portion of the discussion. If you assume an 80% roll rate and 60% severity, to get to the loss estimate UBS has in mind, 72% of the currently performing loans would have to default. That is not a typo: 72%.
I somehow don’t think that’s going to happen. As you see, the vast majority of the difference between our loss estimate for 06-1 and UBS’s boils down to how many of the loans still performing (for 2½ years!) will default. Given that the cumulative delinquency rate to date has been just 20%, and includes the frauds, speculators, and weakest credits, I have a high degree of confidence that our number, not UBS’s, will turn out to be closer to the mark.
Even so, Wall Street seems to be laboring under the impression that losses will zoom to stratospheric levels. Oh, they’ll be high, there’s no doubt about that. But even the numbers put out by relatively sober-minded analysts have essentially no chance of happening. Eventually investors will sooner or later figure that out.
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Mark Hulbert, Marketwatch | 8 July 2008
ANNANDALE, Va. (MarketWatch)— One of the most bearish signals that corporate insiders can send to investors is to sell their companies' shares into a declining market. So those who pay attention to what the insiders are doing have been waiting with bated breath to see what the June data reveal about their behavior last month. Well, those data are now in, and the news is good: Insiders significantly cut back on their selling in June.
Corporate insiders, of course, are a company's officers, directors, and largest shareholders. They are required to report to the SEC any transaction they undertake involving shares of their companies' stock. Many research organizations gather that data and analyze them. One such organization is Argus Research, which publishes its findings in a weekly newsletter called the Vickers Weekly Insider Report. According to their latest issue, which was published on Monday, the average insider last week sold 1.39 of his company's shares for each one that he bought.
For insider transactions reported in the first week of June, in contrast, the sell-to-buy ratio was 2.49-to-1, according to Vickers. So in the wake of the stock market's steep decline during June, the average insider markedly cut back on the ratio of his selling relative to his buying. Though you might concede that this is an encouraging trend, you still might argue that a sell-to-buy ratio of 1.39-to-1 is bearish, since it means that the average insider is selling more of his company's shares than he is buying.
But the presupposition of this argument is mistaken: It turns out to be entirely normal for insiders to sell more than they buy. In fact, according to Vickers, the 36-year average for the insider sell-to-buy ratio is between 2-to-1 and 2.5-to-1. Furthermore, according to Nejat Seyhun, a finance professor at the University of Michigan who has closely studied insider behavior, companies' increasing use of share grants and options in recent years has probably shifted the "normal" range of the sell-to-buy ratio upward to around 6-to-1.
From That Perspective, Insiders' Recent Behavior Would Appear To Be Even More Bullish. To be sure, insiders' behavior is not a foolproof market-timing tool [[— especially short-term; they have a STRONG 'normal' tendency to buy during dips and sell during rallies: normxxx]]. They were bullish a month ago, for example, and the stock market nevertheless proceeded to fall markedly. Indeed, their behavior has been bullish throughout the decline that began last fall.
But I shouldn't have to remind anyone that there is no foolproof market-timing tool. Successful market timing over the long term requires an intelligent playing of the odds at each point along the way. And following the lead of the insiders is based on the simple notion that they know more about their companies' prospects than the rest of us. That strikes me as an intelligent bet. [[BUT, while the logic is impeccable, and works reasonably well for indivdual stocks, once the stats are suitably 'corrected' for the 'noise' (something that Thompson Financial used to do very well— until Wall Street put a stop to it), it doesn't seem to work very well for the market as a whole.: normxxx]]
Subprime Loss Estimates: Consensus Is Too Pessimistic
Walk Through The Numbers, And You'll See Why
By Thomas Brown, Bankstocks.Com | 7 July 2008
|
Ready? For the purposes of this discussion, let’s use as "consensus" the loss estimates lately being published by the analysts at UBS. UBS has been publishing numbers for as long as anyone on the Street, and the analysts’ work there is especially thorough. (If anything, in fact, the "real" consensus loss number might even be higher than UBS’s estimates.) At a conference call earlier this week, UBS said it believes the cumulative loss on the ABX 06-1 subprime mortgage index will come to 19.5% when all is said and done, and will be 29.6% on the ABX 06-2. As I say, that’s way too pessimistic.
I’ll explain why in a minute. First, a quick review of how we come up with our estimates. To get to expected cumulative losses, we look at the loans that comprise the ABX indices and add up a) realized losses to date, b) estimated losses from loans that are seriously (like, more than 60 days’) delinquent and real estate owned, and c) estimated losses from loans that are still current. As it happens, estimating a and b above isn’t all that hard. Essentially all of those loans will go bad, or have already. It’s just what will happen to c, the loans that are still current, that’s the area of conjecture.
Servicer Reports Filed Monthly
Anyway, as to how we come up with our numbers. Recall that each ABX index consists of 20 securitized mortgage trusts. The servicers of those trusts file reports on the 25th of each month that update the performance of the loans, through the last day of the month. The servicer reports filed June 25th capture loan performance through the end of May. We model each trust individually, then roll up the totals to arrive at a loss estimate for each ABX index.
Now to the numbers, using the a-b-c method of analysis described above.
First, the sum of the realized losses to date incurred by the 20 trusts that make up ABX 06-1 represents 2.8% of the sum of the trusts’ beginning balances. Next, we estimate losses that will come from seriously delinquent loans. We assume that 75% of loan dollars 61 to 90 days past due become real estate owned (REO), that 90% of loans 90 days past due go to REO, and 95% of loans in foreclosure go to REO. We then add these numbers to the REO total and assume 55% severity to arrive at our estimate of losses for past-due loans.
OK so far? The roll rates we assume are well above historic averages and even a little higher than what has occurred in recent months, so I feel comfortable that they’re conservative. Using these assumptions, we get to a loss rate on delinquent loans of 7.5%. Our story thus far: realized losses come to 2.8%, while "pipeline" losses on delinquent loans are another 7.5%, for a total of 10.3% in cumulative losses.
Getting to 19.5%
But UBS’s loss estimate for 06-1, remember, is 19.5%. Where will those losses come from? Well, one place they won’t come from is the loans in the trust that have already been repaid— which account for fully 58% of the index’s original balance. Rather, the 9.2% incremental losses UBS expects have to come from the loans in the trusts that are still current.
We’ve studied those loans closely. We’ve looked at their underwriters, the locations of the properties, loan-to-value ratios, levels of documentation, and borrowers’ FICOs, and have come up with an estimate that still-performing loans in the trusts will generate a cumulative loss of . . . 2.5%. That brings our estimate of total cumulative losses for 06-1 to 12.7%, rather than the 19.5% UBS expects.
Wait a minute!, I hear you saying. Losses of just 2.5% from the performing loans? That seems way, way too low.
No, it’s not. If anything, it’s likely too high. Here’s why. Remember, 61% of the beginning balance of the ABX 06-1 has either paid off or charged off, while another 14% of the original balance is 60 or more days delinquent or in REO. That leaves just 25% of the original balance as performing.
Higher Than The Loans Already Gone Bad
Again, if you assume 80% of loans 60 days past due roll all the way though to REO, and then 55% loan severity, that 2.5% loss estimate means that 22% of loans still performing will eventually go delinquent. That is a very conservative number. Why? It’s higher than the cumulative delinquency rate that has occurred already. And those loans, recall, included the weakest credits in the trust— the legions of speculators and con artists who walked away as soon as their properties were underwater.
So we’re assuming the performance of the still-current loans will turn out to be even worse than what’s already occurred with the loans that are in serious trouble and have been charged off!
So, then, what would have to happen to get to UBS’s 19.5% cumulative default rate? The bank doesn’t share the details about how it gets to its number. But we can back into it using our model, to see what their estimate implies. I do know UBS assumes severity of 60%. That would raise the cumulative losses from the past-due loans to 8.1%. That means that the loans still performing have to create an incremental 8.6% cumulative losses.
Unbelievable
Which gets us to the incredible-number portion of the discussion. If you assume an 80% roll rate and 60% severity, to get to the loss estimate UBS has in mind, 72% of the currently performing loans would have to default. That is not a typo: 72%.
I somehow don’t think that’s going to happen. As you see, the vast majority of the difference between our loss estimate for 06-1 and UBS’s boils down to how many of the loans still performing (for 2½ years!) will default. Given that the cumulative delinquency rate to date has been just 20%, and includes the frauds, speculators, and weakest credits, I have a high degree of confidence that our number, not UBS’s, will turn out to be closer to the mark.
Even so, Wall Street seems to be laboring under the impression that losses will zoom to stratospheric levels. Oh, they’ll be high, there’s no doubt about that. But even the numbers put out by relatively sober-minded analysts have essentially no chance of happening. Eventually investors will sooner or later figure that out.
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
THE BEAR'S CASE
THE BEAR'S CASE— Bearish Waves From "Elliott Wave" Forecast
By Stockadvisors.Com | 9 July 2008
In January, Steve Hochberg, a leading authority on "Elliott Wave" technical analysis, had forecast that 2008 would be the "year that everything changes". His forecast called for a credit crunch, a housing collapse and a bear market. In his Elliott Wave Financial Forecast the advisor warns, "The bear market is far from over." Here, he again looks at stocks, housing and the case for deflation.
"The typical seasonal market patterns usual result in 'summer doldrums." But with a third wave lower starting to unfold, the traditional summer lull may turn into a real downside barn burner. "The Dow has broken its 34-year trendline, which confirms our bearish forecast." This trendline connected the market bottoms from December 1974 and October 2002. This break virtually eliminated any remaining bullish potential for a rise back to new highs.
"In addition, the nominal Dow, denominated in UD dollars, is now beneath its January 2000 high, leaving the stock's senior index with a loss for the past 8 years." The nominal S&P 500 and NASDAQ are down 17.5% and 53%, respectively, from their 2000 peaks, and the 'real' Dow as measured in terms of its gold value, is off by over 70%. "There certainly will be counter-trend rallies, but when they occur, they should be viewed as opportunities to add to established bearish positions."
"The recent stripping of both MBIA and Ambac's AAA ratings by Moody's came on the heels of previous downgrades by Fitch and S&P. We cannot overstate the importance of this event. Ratings on much of the debt backed by these insurers must now be cut in turn. A downgraded bond does not necessarily meant default. "But a decrease in the aggregate value of dollar-denominated debt in a credit-based economic system is deflation."
"The word on the street is 'inflation.' But there are huge holes in this widely-held assertion." For one, real estate, the #1 inflationary hedge through all prior inflations, is not rising. In fact, the fall in housing prices is the fastest on record. "The latest housing how-to books, eg, Foreclosure Investing for Dummies, captures the breadth of the belief that a decimated asset is a buying opportunity."
"Its appearance surely means that the housing debacle is hardly closer to ending than it was in January 2007 when we cited its predecessor— Flipping Houses for Dummies— as a sure sign that the downturn in housing was about to get nasty. Another inconsistency with a new era of inflation is the still-unfolding credit crisis. Inflation generally supports increased rates of credit expansion, as it allows borrowers to pay back their obligations in cheaper dollars. Currently, however, the credit bust is intensifying every day. Banks are tightening lending standards as borrowers curtail demand for new loans."
"Meanwhile, past due notices are piling up. In every sector, delinquency levels are rising. And banks are [[still : normxxx]]woefully unprepared for a flood of bad debts." When deflation rages, cash will get far more scarce and deliquencies will surge. "In a bear market, it is much safer to watch the 'knife-catching' rather than take part. The sooner that investors recognize the advantages of this approach, the more capital they will conserve and the smarter they will look at the bottom."
Bear Market: Where Do We Go From Here?
By Michael Santoli, Barron's | July 7, 2008 | 20 July 2008
Last week on the Dow's reaching "official" bear-market status with a 20% decline from a recent high is a bit like fixating on the moment that storm winds go from 73 to 74 miles per hour to formally become a hurricane. Either way, the gale is ominous, and the damage will be serious, regardless of whether the government declares an "official" disaster area afterward or not. A more practical definition of a bear market is one in which the overshoots occur to the downside. Cheap-seeming stocks keep going down, rallies are flashy but fleeting, and investors withhold the benefit of the doubt— and their capital— rather than bestow trust on the market.
As it happens, overshooting the 20% decline level has plenty of precedent. Robin Carpenter of Carpenter Analytical Services, while noting that this threshold "is arbitrary and much too 'neat' to be analytically credible," details the four prior times the S&P 500 has fallen at least 20%, dating to 1973. For no fathomable reason, or maybe no reason at all, each prior time the index fell significantly beyond that point, from 9% to— gulp!— 35% more. Looking back a bit further, the 1962 pullback went only about 5% lower. Bearing that in mind and without claiming to know precisely what it's worth, the S&P 500 now at 1262 is essentially where it gave way to appreciable rallies two prior times, in January and March.
Current conditions rhyme with, but don't perfectly echo, those earlier moments. Investor sentiment, as depicted in the usual surveys, is pretty much as sour as during those prior lows. Corporate insiders' selling has returned to rock-bottom levels. Chief Executive magazine's CEO Confidence Index is now 15% below the level of October 2002— a time when CEOs were a hunted species, remember. And the percentage of stocks under key averages and the tally of new lows— measures of how "oversold" the market is— also are in the range of prior bottoms. Retail investors are, again, pulling cash from stock funds and hoarding it.
Importantly, too, the recent momentum leaders in the fertilizer, coal and steel sectors were shellacked in the early July selloff. Weakness in leadership groups is often a prerequisite for a bounce, engendering a "no place to hide" vibe that can accompany capitulation. (Of course, these stocks can pull back an awful lot before endangering their long uptrends, and enough investors have been kicking their dogs in frustration for not owning them for so long that buyers may well step in before a deep correction takes hold.)
Set against these encouraging clues are a few large challenges. First— no less ominous for being obvious— is oil at $145 a barrel. It's up 25% since May 1, when the earlier trading lows were looking rather formidable and the market seemed to have discounted much of the soft economic and credit situations. The sheer velocity of the move has fed another major headwind: A Federal Reserve unwilling or unable to throw the market a rescue line, as it did in January and March.
Then there's the general lack of the screeching panic present the last time stocks were here. Yes, investors are evidencing deep concern, but the selling hasn't had the climactic, purgative character of the previous inflection points. The only thing more glaring than the refusal of the options market's volatility index (VIX), now near 25, to rise to the hoped-for heights of the first quarter above 30, is the constant commentary about this fact. Citigroup strategists argue that the VIX did get high enough above its 60-day average last week to hint that it was "high enough" to allow for a rebound before too long, incidentally.
If the market rushes to new lows and finally presses investors' panic buttons, it won't be because stocks are terribly expensive, or have failed to price in some recessionary risk to profits. Reasonable guesstimates imply that the S&P is now priced for 2008 earnings a good 10% below the formal consensus forecast of $92.
Leuthold Group last week, in the context of a "neutral" market view, told clients: "Our valuation models are indicating that there is not a huge amount of downside risk." Since 1945, the firm said, "70% of all bear markets bottomed out with P/E ratios around the historical median of 17.3-times normalized earnings." The market P/E on Leuthold's "normalized" profits was 17.3 at June 30. Normalized and median precedents and 70% tendencies can be useful. But they don't help in preventing those overshoots.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Stockadvisors.Com | 9 July 2008
In January, Steve Hochberg, a leading authority on "Elliott Wave" technical analysis, had forecast that 2008 would be the "year that everything changes". His forecast called for a credit crunch, a housing collapse and a bear market. In his Elliott Wave Financial Forecast the advisor warns, "The bear market is far from over." Here, he again looks at stocks, housing and the case for deflation.
"The typical seasonal market patterns usual result in 'summer doldrums." But with a third wave lower starting to unfold, the traditional summer lull may turn into a real downside barn burner. "The Dow has broken its 34-year trendline, which confirms our bearish forecast." This trendline connected the market bottoms from December 1974 and October 2002. This break virtually eliminated any remaining bullish potential for a rise back to new highs.
"In addition, the nominal Dow, denominated in UD dollars, is now beneath its January 2000 high, leaving the stock's senior index with a loss for the past 8 years." The nominal S&P 500 and NASDAQ are down 17.5% and 53%, respectively, from their 2000 peaks, and the 'real' Dow as measured in terms of its gold value, is off by over 70%. "There certainly will be counter-trend rallies, but when they occur, they should be viewed as opportunities to add to established bearish positions."
"The recent stripping of both MBIA and Ambac's AAA ratings by Moody's came on the heels of previous downgrades by Fitch and S&P. We cannot overstate the importance of this event. Ratings on much of the debt backed by these insurers must now be cut in turn. A downgraded bond does not necessarily meant default. "But a decrease in the aggregate value of dollar-denominated debt in a credit-based economic system is deflation."
"The word on the street is 'inflation.' But there are huge holes in this widely-held assertion." For one, real estate, the #1 inflationary hedge through all prior inflations, is not rising. In fact, the fall in housing prices is the fastest on record. "The latest housing how-to books, eg, Foreclosure Investing for Dummies, captures the breadth of the belief that a decimated asset is a buying opportunity."
"Its appearance surely means that the housing debacle is hardly closer to ending than it was in January 2007 when we cited its predecessor— Flipping Houses for Dummies— as a sure sign that the downturn in housing was about to get nasty. Another inconsistency with a new era of inflation is the still-unfolding credit crisis. Inflation generally supports increased rates of credit expansion, as it allows borrowers to pay back their obligations in cheaper dollars. Currently, however, the credit bust is intensifying every day. Banks are tightening lending standards as borrowers curtail demand for new loans."
"Meanwhile, past due notices are piling up. In every sector, delinquency levels are rising. And banks are [[still : normxxx]]woefully unprepared for a flood of bad debts." When deflation rages, cash will get far more scarce and deliquencies will surge. "In a bear market, it is much safer to watch the 'knife-catching' rather than take part. The sooner that investors recognize the advantages of this approach, the more capital they will conserve and the smarter they will look at the bottom."
Bear Market: Where Do We Go From Here?
By Michael Santoli, Barron's | July 7, 2008 | 20 July 2008
Last week on the Dow's reaching "official" bear-market status with a 20% decline from a recent high is a bit like fixating on the moment that storm winds go from 73 to 74 miles per hour to formally become a hurricane. Either way, the gale is ominous, and the damage will be serious, regardless of whether the government declares an "official" disaster area afterward or not. A more practical definition of a bear market is one in which the overshoots occur to the downside. Cheap-seeming stocks keep going down, rallies are flashy but fleeting, and investors withhold the benefit of the doubt— and their capital— rather than bestow trust on the market.
As it happens, overshooting the 20% decline level has plenty of precedent. Robin Carpenter of Carpenter Analytical Services, while noting that this threshold "is arbitrary and much too 'neat' to be analytically credible," details the four prior times the S&P 500 has fallen at least 20%, dating to 1973. For no fathomable reason, or maybe no reason at all, each prior time the index fell significantly beyond that point, from 9% to— gulp!— 35% more. Looking back a bit further, the 1962 pullback went only about 5% lower. Bearing that in mind and without claiming to know precisely what it's worth, the S&P 500 now at 1262 is essentially where it gave way to appreciable rallies two prior times, in January and March.
Current conditions rhyme with, but don't perfectly echo, those earlier moments. Investor sentiment, as depicted in the usual surveys, is pretty much as sour as during those prior lows. Corporate insiders' selling has returned to rock-bottom levels. Chief Executive magazine's CEO Confidence Index is now 15% below the level of October 2002— a time when CEOs were a hunted species, remember. And the percentage of stocks under key averages and the tally of new lows— measures of how "oversold" the market is— also are in the range of prior bottoms. Retail investors are, again, pulling cash from stock funds and hoarding it.
Importantly, too, the recent momentum leaders in the fertilizer, coal and steel sectors were shellacked in the early July selloff. Weakness in leadership groups is often a prerequisite for a bounce, engendering a "no place to hide" vibe that can accompany capitulation. (Of course, these stocks can pull back an awful lot before endangering their long uptrends, and enough investors have been kicking their dogs in frustration for not owning them for so long that buyers may well step in before a deep correction takes hold.)
Set against these encouraging clues are a few large challenges. First— no less ominous for being obvious— is oil at $145 a barrel. It's up 25% since May 1, when the earlier trading lows were looking rather formidable and the market seemed to have discounted much of the soft economic and credit situations. The sheer velocity of the move has fed another major headwind: A Federal Reserve unwilling or unable to throw the market a rescue line, as it did in January and March.
Then there's the general lack of the screeching panic present the last time stocks were here. Yes, investors are evidencing deep concern, but the selling hasn't had the climactic, purgative character of the previous inflection points. The only thing more glaring than the refusal of the options market's volatility index (VIX), now near 25, to rise to the hoped-for heights of the first quarter above 30, is the constant commentary about this fact. Citigroup strategists argue that the VIX did get high enough above its 60-day average last week to hint that it was "high enough" to allow for a rebound before too long, incidentally.
If the market rushes to new lows and finally presses investors' panic buttons, it won't be because stocks are terribly expensive, or have failed to price in some recessionary risk to profits. Reasonable guesstimates imply that the S&P is now priced for 2008 earnings a good 10% below the formal consensus forecast of $92.
Leuthold Group last week, in the context of a "neutral" market view, told clients: "Our valuation models are indicating that there is not a huge amount of downside risk." Since 1945, the firm said, "70% of all bear markets bottomed out with P/E ratios around the historical median of 17.3-times normalized earnings." The market P/E on Leuthold's "normalized" profits was 17.3 at June 30. Normalized and median precedents and 70% tendencies can be useful. But they don't help in preventing those overshoots.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Wednesday, July 23, 2008
He That Sells What Isn’t His‘n
Investment Strategy: "He That Sells What Isn’t His‘n"
By Jeffrey Saut | 21 July 2008
"He that sells what isn’t his‘n must buy it back or go to pris`n" is an old stock market axiom that has stood the test of time. Loosely translated, it means that if you sell a stock "short" (betting that it is going down in price), you are responsible for ANY loss incurred if that stock rallies. And, last week that old market "saw" took on new meaning when the Securities Exchange Commission (SEC) changed the rules on "naked" short-selling (see last Wednesday’s WSJ story).
Clearly, "naked" short-selling [[technically illegal for such as you or I, but not for certain Wall Street 'traders': normxxx]] has been a "dirty" little secret on Wall Street for years, but that has now changed with the revelations from the SEC. Indeed, last week the SEC changed the rules and required that "naked" short-sales, in certain securities, be settled like the majority of stock transactions. To us, this was the "lit match" for the already gasoline-layered environment in the equity markets.
Manifestly, the selling-stampede was already "long of tooth" since most such stampedes rarely last more than 30 sessions. [Recall that selling-stampedes tend to run 17 - 25 sessions with only 1 - 3 day countertrend pauses, and/or counter-trend attempts, before they exhaust themselves.] In fact, the longest "buying stampede" chronicled in our notes was the 38-session upside-stampede into the October 1987 "crash," while the longest selling-stampede occurred between May and July of 2002 and encompassed 44 sessions. Consequently, for the past few weeks we have been looking for some kind of "throwback" rally since 7-1-08 was session 30 from the DJIA’s May 19th high. As stated in our July 7th missive, "It’s not that we are turning aggressively bullish, but we think that unless the markets are in ‘crash mode,’ it is time to consider a corrective stock market rally."
Additionally, our proprietary oversold indicator was more oversold than it has been in a very long time, so the stage was set. And when the SEC changed the rules on "naked" short-sales, that "spark" lit the "gasoline" and the rest, as they say, is history. The result was an explosive rally, especially in the Financials, that began last Tuesday, lifting the Financial Select Sector SPDR (XLF/20.67) an eye-popping 13% by Thursday’s close. According to one savvy seer, that was an 11 standard deviation event (for comparison purposes, a 4 standard deviation event is an event that is supposed to occur only once every 31,000 years).
Given the SEC’s mandate, it was not surprising that the highest shorted stocks rallied the most (+15%), while the lowest shorted stocks rallied only 2%. It will be interesting, therefore, to see if last week’s "short covering" rally can sustain and broaden out this week. Whatever the outcome, we think the selling-stampede has ended. How far the rally will carry is unknowable, but we believe the equity markets have further "upside legs."
Does that mean we think this marks the end of the stock market’s and economy’s consternations? Well, not really, for while "things" may not get a whole lot worse from here, we have a difficult time believing "things" will get materially better either. Indeed, our longer-term thoughts were best summed-up in an email exchange with one particularly bright Raymond James financial advisor who emailed us last week.
The response read:
So where do we stand? We think we are the middle of the envisioned "W" shaped economic pattern. To wit, the economic "slide" began in 2007, which is the downward-sloping left side of the "W." Said slide freaked-out the politicos, as well as the Federal Reserve, causing them to take Herculean efforts in an attempt to stave off a recession. Those efforts have caused the economy to enter the upward-sloping middle part of the "W" whereby the stimulus gives participants the [false] feeling that the worse has been averted and the economy will now accelerate from here with an attendant rally in the equity markets.
Unfortunately, we doubt that will be the way things will play. Our sense remains that with the over-stimulation comes higher than expected inflation, which will eventually lead the Fed to raise interest rates and cause the economy to slow again (the downward-sloping middle right side of the "W"), or the fabled economic doubled-dip. Nevertheless, aiding our near-term positive outlook was last week’s price breakdown in crude oil.
For months we have suggested crude was likely putting in a top. That "call" was driven by our sense the politicos were going to propose legislation to force the price of crude downward in front of the elections. While we think such proposals are wrong-footed, in the near term such rhetoric can be impactful; and last week oil broke below its rising trendline in the charts. If the slide continues, and it breaks below $120/bbl, "hot money" will think the top is "in" and act accordingly. This is the reason we have been shy of the energy complex for the past few months, as well as why we have recommended rebalancing ALL energy stocks in the portfolio.
Rebalancing (read: sell partial positions) allows long-term capital gains to accrue in the portfolio, and causes cash positions to rise, giving investors the "ammunition" to take advantage of new investment opportunities as they present themselves. For the last few weeks we have suggested, "At such a potential short-term downside inflection point, what you need to buy are those companies/indices with the best relative strength characteristics and those with the worst relative strength characteristics. Since we already own those with the best characteristics, we have concentrated on those with the worst characteristics. Consequently, our vehicles of choice were financials and real estate."
The call for this week: If the decline in crude oil continues to play, it should be bullish for stocks. Indeed, just as in horseshoes and hand-grenades, all you have to be is to be "close" when attempting to "catch" a bottom in the stock market to make a lot of money if you adopt a scale-in buying approach, which is what we have attempted to do over the past few weeks! As stated two weeks ago, "What a great time to be an investor" for if you are a well prepared investor, volatility breeds opportunity.
.
Investment Strategy: "the System Will Hold Together!"
By Jeffrey Saut | 14 July 2008
That said, in my opinion these two GSEs will not be allowed to fail because the collateral damage would be global, as well as enormous, since their "paper" is held by institutions around the world. Also, allowing these GSEs to fail would accelerate the current credit crunch and send the housing complex even further into a death spiral. While some are suggesting a "conservatorship" approach under the Federal Housing Enterprises Act, we peg the probability of that as low due to capital cushion/statutory capital issues. Similarly, we think the odds of a capital infusion by the government to be low, as is the government’s implicit backing of the GSEs’ debt.
I guess bringing the GSEs on to the federal balance sheet makes some sense because assertions that would increase the government’s debt by $5.3 trillion are an overstatement. Indeed, the $5.3 trillion figure refers to the GSEs’ holdings of mortgages/loan-guarantees, which are not the same thing as liabilities. Still, such a nationalization of the GSEs would require congressional approval and that would likely take a long time [[not with the fires of Hell to spur the assorted miscreants, from congress to the administration to the Fed to ... And, it's a wonder what corners can be cut if there is no one eager to prosecute. : normxxx]]....
Our guess is the solution lies in either a private capital infusion, with certain guarantees like with Bear Stearns [[not viable; they're simply too big: normxxx]], or giving the GSEs the ability to draw on lines of credit from the Treasury Department and/or the Fed [[I believe BB has already committed to such a course: normxxx]]. In any event, I would be shocked if some action is not taken and taken quickly. Manifestly, it appears the only entities showing decent growth in the mortgage business have been Freddie and Fannie, so impinging these two behemoths in any way would worsen an already dicey environment, which was punctuated yet again by the FDIC’s seizure of IndyMac (IMB/$0.28) over the weekend.
Clearly the GSE gottcha’ of last week cast a pall over Wall Street, which was already struggling with new all-time highs in the price of crude oil. Plainly, at least so far, we have been wrong with our "call" that the politicians are going to do anything and everything in an attempt to force the price of oil lower before the elections. Last week’s price surge seemed to be driven by fears that Iran’s 2.5 million barrels per day of oil exports will be interrupted, exhausting any spare OPEC capacity. While the GSEs’ situation is worrisome, our sense is that the current market mauling is mainly about the vertiginous rise in crude’s price. Indeed, we have been adamant since the beginning of this year that the U.S. would NOT experience a recession in 2008 as defined by two negative quarters of GDP. However, we are becoming increasingly worried about 2009’s recession prospects unless crude "cracks" and cracks soon.
Indeed, the "perfect storm" seems to be having an increasing impact on the American consumer. Most recently, we have argued that what we may experience is a "W" shaped economic pattern, often referred to as a "double dip." While it’s true that as of yet we haven’t had a severe economic slide (read: recession), said recession was prevented by the herculean efforts of the Federal Reserve and the politicians.
Those efforts muted the economic slowdown, but, in my opinion, have potentially only pushed the recession further out in time. Consequently, I think we are in the middle part of the "W" pattern where participants believe the worse is behind us. Unfortunately, unless the environment changes, and changes quickly, I think we will enter the right side of the "W" pattern, resulting in a double-dip. And, maybe this is what the equity markets are sniffing out.
Speaking to the equity markets, today is session 38 in the "selling stampede," and my oversold indicator remains more oversold than it has been in decades. In last week’s letter I related that Lowry’s point spread between its Selling Pressure Index (read: supply) and its Buying Power Index (read: demand) was at 265 points at the 1974 stock market "lows." Currently, that spread is over 500 points, the largest in the 75 year history of the Lowry’s Organization, and therefore VERY oversold. Meanwhile, the Bespoke Investment group notes:
In this whipsaw environment, trading has been difficult. However, our yield theme recommendations (read: dividends) are holding up pretty well. Some of the names that play to this theme and are favorably rated by our fundamental analysts remain Linn Energy (LINE/$23.37/Outperform), Alaska Communication (ALSK/$12.22/Outperform), Embarq (EQ/$43.50/Strong Buy), Inergy (NRGY/$24.98/Strong Buy), Legacy Reserves (LGCY/$24.70/Strong Buy), Magellan (MGG/$22.51/Strong Buy), and Teekay (TOO/$19.46/Strong Buy, to name but a few.
The call for this week: Friday felt like Bear Stearns II, since the news about the GSEs broke on Friday just as with Bear Stearns. Hopefully, this week will be a déjà vu dance of the week following the Bear Stearns’ news with the financials leading the way to the upside. Yet as Michael Steinhardt recently said, "There is rarely a moment such as this where as a contrarian, one sees so many reasons technically, [and] stock market-wise, to be bullish. I can’t imagine a circumstance where a market is more available, more ripe, for a rally than this one. Still, this time it is different."
Investment Strategy: "why It’s A Great Time To Be An Investor"
By Jeffrey Saut | 10 July 2008
Memo to investors:
"The nerves mean not panicking or getting swayed by fear, at the bottom, or greed, at the top;" indeed, this is why another long-embraced mantra hangs on the wall of our office stating, "The stock market is fear, hope, and greed, only loosely connected to the business cycle!" To be sure, this is the only business where when prices are LOW they let stocks go and when prices are HIGH they want to buy. And that, ladies and gentlemen, seemed to be the mood on the Street of Dreams last week as participants "sold" at what we think feels more like the end of the envisioned selling-stampede rather than the beginning of a another new "leg" to the downside. Accordingly, we scribed a special strategy alert last Wednesday (7/2/08), one of only four such alerts we have penned over the past 10 years. It read:
Consistent with our strategy of NEVER buying an entire position all at once, we told accounts to buy a one-third trading tranche last Tuesday, another one-third tranche on Wednesday, and complete the final one-third tranche on Thursday (before the long weekend) if the equity markets took another tumble. Our strategy was based on the belief that Wall Street was, "Moving the headstones around, but not moving the graves!" Manifestly, over the past few weeks every time the "bears" have wanted to drive stocks lower they have trotted out rumors that Israel was going to bomb Iran and the Hormuz Straits would subsequently be closed. The result has been a surge in crude oil prices with an attendant stock swoon. To us, this constantly repeated rumor is getting pretty "worn." Still, given last week’s holiday-shortened, limited audience environment, the "sellers" had a vacuum in which to sell (no buyers) and the results speak for themselves.
Our stance was/is that if there were no geopolitical events over the holiday weekend, participants might just return in "buy ‘em mode" with an upside "buying vacuum." Plainly, these thoughts have been reflected in our verbal comments where we suggested what we are experiencing is a "raindrop bottom" whereby if you bought scaled "in" trading positions last week you might get "hit" by a few raindrops, but were unlikely to get very wet. So far that stance has been generally correct, which brings us to this week.
For us, this week represents a critical week. Today is day 33 in the selling-stampede, and unless we are in "crash mode," our belief is that we are making a "raindrop bottom" on a trading basis. Yet, the situation is far from a "lead pipe cinch," for as the Lowry’s organization noted in Friday’s missive:
Unfortunately, we agree with the good folks at Lowry’s about the longer-term scheme of things. In fact, we are one of the few people that wrote about the Dow Theory "sell signal" registered in November 2007, which is why we entered 2008 in a cautious mode with oversized holdings of cash. Yet, we think a tradable "low" is at hand and are positioning accounts accordingly. If we are wrong, we will be stopped-out consistent with another one of our mantras, "Better to lose face and save skin!"
As for the investing side of portfolios, we continue to embrace the dividend yield theme, and our stock recommendations that play to it, so often mentioned in these reports. We also urge you to read the addendum attached to this report. Said addendum reprises some verbal comments made by our fundamental analysts over the past few weeks. We continue to invest accordingly.
The call for this week: We began this week’s report with a quote from The Wall Street Journal that read, "The nerves mean not panicking or getting swayed by fear, at the bottom, or greed, at the top." Last November we wrote about the Dow Theory "sell signal" when prices were high yet participants wanted to "buy." Now we are writing about the Dow Theory downside non-confirmation and prices are low yet participants want to let stocks "go" (read: sell stocks).
Meanwhile, it is session 33 in the "selling stampede," our proprietary oversold indicator is more oversold than it was at the March 2003 "low" (we were bullish there as well), the spread between Lowry’s Buying Power Index (demand) and Lowry’s Selling Pressure Index (supply) is the widest in the 75-year history of Lowry’s (indicating that stocks are very, very severely oversold), corporate insiders’ selling is at rock-bottom lows, and we are seeing numerous other indices not confirming the D-J Industrial’s "downside dive." It’s not that we are turning aggressively bullish, but we think that unless the markets are in "crash mode" it is time to consider a corrective stock market rally as B.J Thomas warms up in the wings with the song "Raindrops."
Addendum:
Paul Puryear, Director Of Real Estate Research
We look for housing prices to continue to fall. In 18 countries over the past 40 years the average housing market decline has been around five years long, some have averaged seven years. Currently, the U.S. is in year three of the current cycle. Though the affordability index has improved and is back up to 100; only because of declining prices. The worst data point, at this time, is the level of inventory.
There are currently about four million houses for sale in the U.S. and about 1.5 million for rent. Inventories are continuing to build. Another negative in housing is the mortgage default rates. In the U.S. there are about 55 million mortgages and of these approximately 6.5 million are currently delinquent. Of the 6.5 million that are delinquent, about 2.5 million are in foreclosure. The subprime delinquencies have stabilized for now, but overall all loan categories are seeing increases in delinquencies.
On the REIT front, we still like defensive names. We favor commercial over residential REITs that tend to focus more on growth. Our favorites at this time are Corporate Office Properties Trust (OFC/$33.63/Outperform), Essex Property Trust (ESS/$107.61/Outperform), Kimco Realty Corporation (KIM/$34.06/Outperform), Cogdell Spencer, Inc. (CSA/$16.28/Outperform), Digital Realty Trust (DLR/$40.91/Outperform), and Washington REIT (WRE/$29.62/Outperform). These are the six names on the REIT Priority List.
Marshall Adkins, Director Of Energy Research
The Energy sector is still in a secular bull market. We are bearish on the natural gas complex. We believe speculators are correct on the current price of oil and analysts that have set lower target prices on crude oil are incorrect. Oil prices have been increasing since 2005 when OPEC decreased production by two million barrels per day. Most countries have been unable to make up this production shortfall. China only consumes what the U.S. consumed in 1900, based on per capita data.
In contrast, gas supply has been surging recently. In addition to production shortfalls, the weakness in the U.S. Dollar has quintupled the price of crude oil for the U.S. On the other hand, Europe has seen a doubling of oil prices. This shows the disparities. Most likely, drilling will continue to increase since shale is so cost competitive. For example, Barnett Shale is five to eight times more productive than average. In addition, electric consumption in the U.S. is up only 1% over the last year. This will most likely lead to record storage by August of 2008.
We are convinced that within six to nine months gas prices will take a significant downturn. Five out of seven years in the 1970s oil prices went up as the U.S. dollar went up. Therefore, there is really no argument that a strong dollar will lead to lower oil prices. Taking a look at price manipulation, the top 10 oil companies in the world own less than 4% of the world’s supply. We ask the question, "How are they manipulating it?"
They’re not. Our favorite area is Haynesville, because the costs of extraction are so low and it will continue to be drilled. Deepwater is also a great area right now— we favor Helix Energy Solutions Group, Inc (HLX/$37.71/Strong Buy), which we believe is a turnaround story. We also like National Oilwell Varco, Inc. (NOV/$85.12/Strong Buy).
Bill Fisher, Industrial And Logistics Services Analyst
Waste Connections (WCN/$31.12/Strong Buy) has increased prices by about 4% and these price increases seem to be sticking. At this time, Waste Connections is the best name in the category. Republic Services (RSG/$29.15/Strong Buy) was the best name for a period of time. We believe that money in RSG will most likely shift to WCN. 55% of Waste Connections’ business is monopolized.
Fuel expenses are hurting Waste Connections by about a nickel per share, but the company should be able to get this back with the increased prices. At this time, Waste Connections has about $500 million on its books for acquisitions. Many family-owned waste companies are in the market to sell out of fear that an election win for Obama may lead to an increase in the capital gains tax rates. In addition, if the Republic Services Group and the Allied Waste (AW/$12.44/Outperform) deal goes through, the justice department should push for divestiture. Waste Connections would be in a position to buy up some of the divested businesses.
Fuel surcharges on international shipments have hurt UPS (UPS/$59.47/Outperform). The increase in prices for premium air shipping has caused consumes to "trade down" in favor of lower cost ground shipping. Though UPS still has a 30% return on equity (ROE). With today’s (6/23/2008) hit in the stock price, UPS is trading at the same price it was approximately nine years ago. DHL is losing about $1 billion per quarter in the U.S. UPS has recently cut a deal with DHL.
John Ransom, Director Of Healthcare Research
In the healthcare area there is a lot of uncertainty due to the upcoming presidential election. Obama would be disastrous for managed care, Medicare providers, and pharmaceutical names. Stocks in these categories should be doing well in this economic environment since they are defensive, but fear of Obama winning the presidential election has hurt their performance. For the pharmaceutical names, bringing new drugs to market is no longer an easy task. Money is going back into genetic treatments. Another factor is the weaker economy, which should hurt healthcare companies. You need to look at the balance sheet, rising volumes, which is rare, a reasonable valuation, and earnings upside.
There are three names that we like. McKesson (MCK/$54.59/Strong Buy)) has 15% sales growth and 25% is healthcare IT. Compare this to Cerner Corporation (CERN/$44.22/Outperform). MCK is cheap with a tremendous amount of growth. We like this stock a lot. Amedisys (AMED/$49.03/Strong Buy) is another good choice. We estimate that Amedisys could earn approximately $4 per share in 2009. In addition, home healthcare is booming. Everyone saves money with home healthcare.
ߧ
Normxxx
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
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By Jeffrey Saut | 21 July 2008
"He that sells what isn’t his‘n must buy it back or go to pris`n" is an old stock market axiom that has stood the test of time. Loosely translated, it means that if you sell a stock "short" (betting that it is going down in price), you are responsible for ANY loss incurred if that stock rallies. And, last week that old market "saw" took on new meaning when the Securities Exchange Commission (SEC) changed the rules on "naked" short-selling (see last Wednesday’s WSJ story).
Clearly, "naked" short-selling [[technically illegal for such as you or I, but not for certain Wall Street 'traders': normxxx]] has been a "dirty" little secret on Wall Street for years, but that has now changed with the revelations from the SEC. Indeed, last week the SEC changed the rules and required that "naked" short-sales, in certain securities, be settled like the majority of stock transactions. To us, this was the "lit match" for the already gasoline-layered environment in the equity markets.
Manifestly, the selling-stampede was already "long of tooth" since most such stampedes rarely last more than 30 sessions. [Recall that selling-stampedes tend to run 17 - 25 sessions with only 1 - 3 day countertrend pauses, and/or counter-trend attempts, before they exhaust themselves.] In fact, the longest "buying stampede" chronicled in our notes was the 38-session upside-stampede into the October 1987 "crash," while the longest selling-stampede occurred between May and July of 2002 and encompassed 44 sessions. Consequently, for the past few weeks we have been looking for some kind of "throwback" rally since 7-1-08 was session 30 from the DJIA’s May 19th high. As stated in our July 7th missive, "It’s not that we are turning aggressively bullish, but we think that unless the markets are in ‘crash mode,’ it is time to consider a corrective stock market rally."
Additionally, our proprietary oversold indicator was more oversold than it has been in a very long time, so the stage was set. And when the SEC changed the rules on "naked" short-sales, that "spark" lit the "gasoline" and the rest, as they say, is history. The result was an explosive rally, especially in the Financials, that began last Tuesday, lifting the Financial Select Sector SPDR (XLF/20.67) an eye-popping 13% by Thursday’s close. According to one savvy seer, that was an 11 standard deviation event (for comparison purposes, a 4 standard deviation event is an event that is supposed to occur only once every 31,000 years).
Given the SEC’s mandate, it was not surprising that the highest shorted stocks rallied the most (+15%), while the lowest shorted stocks rallied only 2%. It will be interesting, therefore, to see if last week’s "short covering" rally can sustain and broaden out this week. Whatever the outcome, we think the selling-stampede has ended. How far the rally will carry is unknowable, but we believe the equity markets have further "upside legs."
Does that mean we think this marks the end of the stock market’s and economy’s consternations? Well, not really, for while "things" may not get a whole lot worse from here, we have a difficult time believing "things" will get materially better either. Indeed, our longer-term thoughts were best summed-up in an email exchange with one particularly bright Raymond James financial advisor who emailed us last week.
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The response read:
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So where do we stand? We think we are the middle of the envisioned "W" shaped economic pattern. To wit, the economic "slide" began in 2007, which is the downward-sloping left side of the "W." Said slide freaked-out the politicos, as well as the Federal Reserve, causing them to take Herculean efforts in an attempt to stave off a recession. Those efforts have caused the economy to enter the upward-sloping middle part of the "W" whereby the stimulus gives participants the [false] feeling that the worse has been averted and the economy will now accelerate from here with an attendant rally in the equity markets.
Unfortunately, we doubt that will be the way things will play. Our sense remains that with the over-stimulation comes higher than expected inflation, which will eventually lead the Fed to raise interest rates and cause the economy to slow again (the downward-sloping middle right side of the "W"), or the fabled economic doubled-dip. Nevertheless, aiding our near-term positive outlook was last week’s price breakdown in crude oil.
For months we have suggested crude was likely putting in a top. That "call" was driven by our sense the politicos were going to propose legislation to force the price of crude downward in front of the elections. While we think such proposals are wrong-footed, in the near term such rhetoric can be impactful; and last week oil broke below its rising trendline in the charts. If the slide continues, and it breaks below $120/bbl, "hot money" will think the top is "in" and act accordingly. This is the reason we have been shy of the energy complex for the past few months, as well as why we have recommended rebalancing ALL energy stocks in the portfolio.
Rebalancing (read: sell partial positions) allows long-term capital gains to accrue in the portfolio, and causes cash positions to rise, giving investors the "ammunition" to take advantage of new investment opportunities as they present themselves. For the last few weeks we have suggested, "At such a potential short-term downside inflection point, what you need to buy are those companies/indices with the best relative strength characteristics and those with the worst relative strength characteristics. Since we already own those with the best characteristics, we have concentrated on those with the worst characteristics. Consequently, our vehicles of choice were financials and real estate."
The call for this week: If the decline in crude oil continues to play, it should be bullish for stocks. Indeed, just as in horseshoes and hand-grenades, all you have to be is to be "close" when attempting to "catch" a bottom in the stock market to make a lot of money if you adopt a scale-in buying approach, which is what we have attempted to do over the past few weeks! As stated two weeks ago, "What a great time to be an investor" for if you are a well prepared investor, volatility breeds opportunity.
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Investment Strategy: "the System Will Hold Together!"
By Jeffrey Saut | 14 July 2008
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That said, in my opinion these two GSEs will not be allowed to fail because the collateral damage would be global, as well as enormous, since their "paper" is held by institutions around the world. Also, allowing these GSEs to fail would accelerate the current credit crunch and send the housing complex even further into a death spiral. While some are suggesting a "conservatorship" approach under the Federal Housing Enterprises Act, we peg the probability of that as low due to capital cushion/statutory capital issues. Similarly, we think the odds of a capital infusion by the government to be low, as is the government’s implicit backing of the GSEs’ debt.
I guess bringing the GSEs on to the federal balance sheet makes some sense because assertions that would increase the government’s debt by $5.3 trillion are an overstatement. Indeed, the $5.3 trillion figure refers to the GSEs’ holdings of mortgages/loan-guarantees, which are not the same thing as liabilities. Still, such a nationalization of the GSEs would require congressional approval and that would likely take a long time [[not with the fires of Hell to spur the assorted miscreants, from congress to the administration to the Fed to ... And, it's a wonder what corners can be cut if there is no one eager to prosecute. : normxxx]]....
Our guess is the solution lies in either a private capital infusion, with certain guarantees like with Bear Stearns [[not viable; they're simply too big: normxxx]], or giving the GSEs the ability to draw on lines of credit from the Treasury Department and/or the Fed [[I believe BB has already committed to such a course: normxxx]]. In any event, I would be shocked if some action is not taken and taken quickly. Manifestly, it appears the only entities showing decent growth in the mortgage business have been Freddie and Fannie, so impinging these two behemoths in any way would worsen an already dicey environment, which was punctuated yet again by the FDIC’s seizure of IndyMac (IMB/$0.28) over the weekend.
Clearly the GSE gottcha’ of last week cast a pall over Wall Street, which was already struggling with new all-time highs in the price of crude oil. Plainly, at least so far, we have been wrong with our "call" that the politicians are going to do anything and everything in an attempt to force the price of oil lower before the elections. Last week’s price surge seemed to be driven by fears that Iran’s 2.5 million barrels per day of oil exports will be interrupted, exhausting any spare OPEC capacity. While the GSEs’ situation is worrisome, our sense is that the current market mauling is mainly about the vertiginous rise in crude’s price. Indeed, we have been adamant since the beginning of this year that the U.S. would NOT experience a recession in 2008 as defined by two negative quarters of GDP. However, we are becoming increasingly worried about 2009’s recession prospects unless crude "cracks" and cracks soon.
Indeed, the "perfect storm" seems to be having an increasing impact on the American consumer. Most recently, we have argued that what we may experience is a "W" shaped economic pattern, often referred to as a "double dip." While it’s true that as of yet we haven’t had a severe economic slide (read: recession), said recession was prevented by the herculean efforts of the Federal Reserve and the politicians.
Those efforts muted the economic slowdown, but, in my opinion, have potentially only pushed the recession further out in time. Consequently, I think we are in the middle part of the "W" pattern where participants believe the worse is behind us. Unfortunately, unless the environment changes, and changes quickly, I think we will enter the right side of the "W" pattern, resulting in a double-dip. And, maybe this is what the equity markets are sniffing out.
Speaking to the equity markets, today is session 38 in the "selling stampede," and my oversold indicator remains more oversold than it has been in decades. In last week’s letter I related that Lowry’s point spread between its Selling Pressure Index (read: supply) and its Buying Power Index (read: demand) was at 265 points at the 1974 stock market "lows." Currently, that spread is over 500 points, the largest in the 75 year history of the Lowry’s Organization, and therefore VERY oversold. Meanwhile, the Bespoke Investment group notes:
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In this whipsaw environment, trading has been difficult. However, our yield theme recommendations (read: dividends) are holding up pretty well. Some of the names that play to this theme and are favorably rated by our fundamental analysts remain Linn Energy (LINE/$23.37/Outperform), Alaska Communication (ALSK/$12.22/Outperform), Embarq (EQ/$43.50/Strong Buy), Inergy (NRGY/$24.98/Strong Buy), Legacy Reserves (LGCY/$24.70/Strong Buy), Magellan (MGG/$22.51/Strong Buy), and Teekay (TOO/$19.46/Strong Buy, to name but a few.
The call for this week: Friday felt like Bear Stearns II, since the news about the GSEs broke on Friday just as with Bear Stearns. Hopefully, this week will be a déjà vu dance of the week following the Bear Stearns’ news with the financials leading the way to the upside. Yet as Michael Steinhardt recently said, "There is rarely a moment such as this where as a contrarian, one sees so many reasons technically, [and] stock market-wise, to be bullish. I can’t imagine a circumstance where a market is more available, more ripe, for a rally than this one. Still, this time it is different."
Investment Strategy: "why It’s A Great Time To Be An Investor"
By Jeffrey Saut | 10 July 2008
Memo to investors:
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"The nerves mean not panicking or getting swayed by fear, at the bottom, or greed, at the top;" indeed, this is why another long-embraced mantra hangs on the wall of our office stating, "The stock market is fear, hope, and greed, only loosely connected to the business cycle!" To be sure, this is the only business where when prices are LOW they let stocks go and when prices are HIGH they want to buy. And that, ladies and gentlemen, seemed to be the mood on the Street of Dreams last week as participants "sold" at what we think feels more like the end of the envisioned selling-stampede rather than the beginning of a another new "leg" to the downside. Accordingly, we scribed a special strategy alert last Wednesday (7/2/08), one of only four such alerts we have penned over the past 10 years. It read:
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Consistent with our strategy of NEVER buying an entire position all at once, we told accounts to buy a one-third trading tranche last Tuesday, another one-third tranche on Wednesday, and complete the final one-third tranche on Thursday (before the long weekend) if the equity markets took another tumble. Our strategy was based on the belief that Wall Street was, "Moving the headstones around, but not moving the graves!" Manifestly, over the past few weeks every time the "bears" have wanted to drive stocks lower they have trotted out rumors that Israel was going to bomb Iran and the Hormuz Straits would subsequently be closed. The result has been a surge in crude oil prices with an attendant stock swoon. To us, this constantly repeated rumor is getting pretty "worn." Still, given last week’s holiday-shortened, limited audience environment, the "sellers" had a vacuum in which to sell (no buyers) and the results speak for themselves.
Our stance was/is that if there were no geopolitical events over the holiday weekend, participants might just return in "buy ‘em mode" with an upside "buying vacuum." Plainly, these thoughts have been reflected in our verbal comments where we suggested what we are experiencing is a "raindrop bottom" whereby if you bought scaled "in" trading positions last week you might get "hit" by a few raindrops, but were unlikely to get very wet. So far that stance has been generally correct, which brings us to this week.
For us, this week represents a critical week. Today is day 33 in the selling-stampede, and unless we are in "crash mode," our belief is that we are making a "raindrop bottom" on a trading basis. Yet, the situation is far from a "lead pipe cinch," for as the Lowry’s organization noted in Friday’s missive:
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Unfortunately, we agree with the good folks at Lowry’s about the longer-term scheme of things. In fact, we are one of the few people that wrote about the Dow Theory "sell signal" registered in November 2007, which is why we entered 2008 in a cautious mode with oversized holdings of cash. Yet, we think a tradable "low" is at hand and are positioning accounts accordingly. If we are wrong, we will be stopped-out consistent with another one of our mantras, "Better to lose face and save skin!"
As for the investing side of portfolios, we continue to embrace the dividend yield theme, and our stock recommendations that play to it, so often mentioned in these reports. We also urge you to read the addendum attached to this report. Said addendum reprises some verbal comments made by our fundamental analysts over the past few weeks. We continue to invest accordingly.
The call for this week: We began this week’s report with a quote from The Wall Street Journal that read, "The nerves mean not panicking or getting swayed by fear, at the bottom, or greed, at the top." Last November we wrote about the Dow Theory "sell signal" when prices were high yet participants wanted to "buy." Now we are writing about the Dow Theory downside non-confirmation and prices are low yet participants want to let stocks "go" (read: sell stocks).
Meanwhile, it is session 33 in the "selling stampede," our proprietary oversold indicator is more oversold than it was at the March 2003 "low" (we were bullish there as well), the spread between Lowry’s Buying Power Index (demand) and Lowry’s Selling Pressure Index (supply) is the widest in the 75-year history of Lowry’s (indicating that stocks are very, very severely oversold), corporate insiders’ selling is at rock-bottom lows, and we are seeing numerous other indices not confirming the D-J Industrial’s "downside dive." It’s not that we are turning aggressively bullish, but we think that unless the markets are in "crash mode" it is time to consider a corrective stock market rally as B.J Thomas warms up in the wings with the song "Raindrops."
Addendum:
Paul Puryear, Director Of Real Estate Research
We look for housing prices to continue to fall. In 18 countries over the past 40 years the average housing market decline has been around five years long, some have averaged seven years. Currently, the U.S. is in year three of the current cycle. Though the affordability index has improved and is back up to 100; only because of declining prices. The worst data point, at this time, is the level of inventory.
There are currently about four million houses for sale in the U.S. and about 1.5 million for rent. Inventories are continuing to build. Another negative in housing is the mortgage default rates. In the U.S. there are about 55 million mortgages and of these approximately 6.5 million are currently delinquent. Of the 6.5 million that are delinquent, about 2.5 million are in foreclosure. The subprime delinquencies have stabilized for now, but overall all loan categories are seeing increases in delinquencies.
On the REIT front, we still like defensive names. We favor commercial over residential REITs that tend to focus more on growth. Our favorites at this time are Corporate Office Properties Trust (OFC/$33.63/Outperform), Essex Property Trust (ESS/$107.61/Outperform), Kimco Realty Corporation (KIM/$34.06/Outperform), Cogdell Spencer, Inc. (CSA/$16.28/Outperform), Digital Realty Trust (DLR/$40.91/Outperform), and Washington REIT (WRE/$29.62/Outperform). These are the six names on the REIT Priority List.
Marshall Adkins, Director Of Energy Research
The Energy sector is still in a secular bull market. We are bearish on the natural gas complex. We believe speculators are correct on the current price of oil and analysts that have set lower target prices on crude oil are incorrect. Oil prices have been increasing since 2005 when OPEC decreased production by two million barrels per day. Most countries have been unable to make up this production shortfall. China only consumes what the U.S. consumed in 1900, based on per capita data.
In contrast, gas supply has been surging recently. In addition to production shortfalls, the weakness in the U.S. Dollar has quintupled the price of crude oil for the U.S. On the other hand, Europe has seen a doubling of oil prices. This shows the disparities. Most likely, drilling will continue to increase since shale is so cost competitive. For example, Barnett Shale is five to eight times more productive than average. In addition, electric consumption in the U.S. is up only 1% over the last year. This will most likely lead to record storage by August of 2008.
We are convinced that within six to nine months gas prices will take a significant downturn. Five out of seven years in the 1970s oil prices went up as the U.S. dollar went up. Therefore, there is really no argument that a strong dollar will lead to lower oil prices. Taking a look at price manipulation, the top 10 oil companies in the world own less than 4% of the world’s supply. We ask the question, "How are they manipulating it?"
They’re not. Our favorite area is Haynesville, because the costs of extraction are so low and it will continue to be drilled. Deepwater is also a great area right now— we favor Helix Energy Solutions Group, Inc (HLX/$37.71/Strong Buy), which we believe is a turnaround story. We also like National Oilwell Varco, Inc. (NOV/$85.12/Strong Buy).
Bill Fisher, Industrial And Logistics Services Analyst
Waste Connections (WCN/$31.12/Strong Buy) has increased prices by about 4% and these price increases seem to be sticking. At this time, Waste Connections is the best name in the category. Republic Services (RSG/$29.15/Strong Buy) was the best name for a period of time. We believe that money in RSG will most likely shift to WCN. 55% of Waste Connections’ business is monopolized.
Fuel expenses are hurting Waste Connections by about a nickel per share, but the company should be able to get this back with the increased prices. At this time, Waste Connections has about $500 million on its books for acquisitions. Many family-owned waste companies are in the market to sell out of fear that an election win for Obama may lead to an increase in the capital gains tax rates. In addition, if the Republic Services Group and the Allied Waste (AW/$12.44/Outperform) deal goes through, the justice department should push for divestiture. Waste Connections would be in a position to buy up some of the divested businesses.
Fuel surcharges on international shipments have hurt UPS (UPS/$59.47/Outperform). The increase in prices for premium air shipping has caused consumes to "trade down" in favor of lower cost ground shipping. Though UPS still has a 30% return on equity (ROE). With today’s (6/23/2008) hit in the stock price, UPS is trading at the same price it was approximately nine years ago. DHL is losing about $1 billion per quarter in the U.S. UPS has recently cut a deal with DHL.
John Ransom, Director Of Healthcare Research
In the healthcare area there is a lot of uncertainty due to the upcoming presidential election. Obama would be disastrous for managed care, Medicare providers, and pharmaceutical names. Stocks in these categories should be doing well in this economic environment since they are defensive, but fear of Obama winning the presidential election has hurt their performance. For the pharmaceutical names, bringing new drugs to market is no longer an easy task. Money is going back into genetic treatments. Another factor is the weaker economy, which should hurt healthcare companies. You need to look at the balance sheet, rising volumes, which is rare, a reasonable valuation, and earnings upside.
There are three names that we like. McKesson (MCK/$54.59/Strong Buy)) has 15% sales growth and 25% is healthcare IT. Compare this to Cerner Corporation (CERN/$44.22/Outperform). MCK is cheap with a tremendous amount of growth. We like this stock a lot. Amedisys (AMED/$49.03/Strong Buy) is another good choice. We estimate that Amedisys could earn approximately $4 per share in 2009. In addition, home healthcare is booming. Everyone saves money with home healthcare.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
ç
The Point Of Maximum Danger
The Global Economy Is At The Point Of Maximum Danger
By Ambrose Evans-Pritchard | 21 July 2008
It feels like the summer of 1931. The world's two biggest financial institutions have had a heart attack. The global currency system is breaking down. The policy doctrines that got us into this mess are bankrupt. No world leader seems able to discern the problem, let alone forge a solution.
The International Monetary Fund has abdicated into schizophrenia. It has upgraded its 2008 world growth forecast from 3.7% to 4.1% growth, whilst warning of a[n increased] "chance of a global recession". Plainly, the IMF cannot or will not offer any useful insights.
Its "mean-reversion" model misses the entire point of this crisis, which is that central banks have pushed debt to fatal levels by holding interest too low for a generation, and now the chickens have come home to roost. True "mean-reversion" would imply debt deflation on such a scale that would, if abrupt, threaten democracy.
The risk is that these same central banks will commit a fresh error, this time overreacting to the oil spike. The European Central Bank has raised rates, warning of a '1970s wage-price spiral'. Fixated on the rear-view mirror, it is not looking through the windshield.
The eurozone is falling into recession before the US itself. Its level of credit stress is worse, if measured by Euribor or the iTraxx bond indexes. 'Core' inflation has fallen over the last year from 1.9% to 1.8%. The US may soon tip into a second leg of this crisis as the fiscal package runs out and Americans lose jobs in earnest [[but all of that stimulus by EVERYBODY, inflation be damned, will probably see us into early 2009, at least: normxxx]]. US bank credit has contracted for three months. Real US wages fell at almost 10% (annualised) over May and June. This is a ferocious squeeze for an economy already in the grip of the property and debt crunch.
No doubt the rescue of Fannie Mae and Freddie Mac— 5.3 trillion dollar pillars of America's mortgage market— stinks of moral hazard. The Treasury is to buy shares: the Fed has opened its window yet wider. Risks have been socialised. All rewards will go to capitalists [[as will all the soothing ointments: normxxx]]. Alas, no Scandinavian discipline for Wall Street. When Norway's banks fell below critical capital levels in the early 1990s, the Storting authorised seizure. Shareholders were stiffed [[not so for Bush's friends: normxxx]].
But Nordic purism in the vast universe of US credit would court fate. The Californian lender IndyMac was indeed seized after depositors panicked on the streets of Encino. The police had to restore order. This was America's Northern Rock moment.
IndyMac will deplete a tenth of the $53bn reserve of the Federal Deposit Insurance Corporation. The FDIC has some 90 "troubled" lenders on watch. IndyMac was not one of them. The awful reality is that Washington has its back to the wall. Fed chief Ben Bernanke thought the US could always get out of trouble by monetary stimulus "à l'outrance*", and letting the dollar slide. He has learned that the world is a more complicated place.
Oil has queered the pitch. So has America's fatal reliance on foreign debt. The Fannie/Freddie rescue, incidentally, has just changed the US national debt from German 'AAA' levels to Italian 'AA-' levels.
China, Russia, petro-powers and other foreign states own $985bn of US agency debt, besides holdings of US Treasuries. Purchases of Fannie/Freddie debt covered a third of the US current account deficit of $700bn over the last year. Alex Patelis from Merrill Lynch says America faces the risk of a "financing crisis" within months. Foreigners have a veto over US policy.
Japan did not have this problem during its Lost Decade. As the world's supplier of credit, it could let the yen slide. It also had a savings rate of 15%. Albert Edwards from Société Générale says this has fallen to 3% today. It has cushioned the slump. Americans are under water before they start.
My view is that a dollar crash will be averted as it becomes clearer that contagion has spread worldwide. But we are now at the point of maximum danger. Britain, Japan, and the Antipodes are stalling. Denmark is in recession. Germany contracted in the second quarter. May industrial output fell 6% in Holland and 5.5% in Sweden.
The coalitions in Belgium and Austria have just collapsed. Germany's left-right team is fraying. One German banker told me that the doctrines of "left Nazism" (Otto Strasser's group, purged by Hitler) had captured the rising Die Linke party. The Social Democrats are picking up its themes to protect their flank.
This is the healthy part of Europe. Further south, we are not far away from civic protest. BNP Paribas has just issued a hurricane alert for Spain. Finance minister Pedro Solbes said Spain is facing the "most complex" economic crisis in its history. Actually, it is very simple. The country was lulled into a trap by giveaway interest rates of 2% under EMU, leading to a current account deficit of 10% of GDP.
A manic property bubble was funded by foreigners buying 'covered' bonds and securities [[guess they got 'short-sheeted': normxxx]]. This market has dried up. Monetary policy is now being tightened into the crunch by the ECB, hence the bankruptcy last week of Martinsa-Fadesa (€5.1bn). With Franco-era labour markets (70% of wages are inflation-linked), the adjustment will occur through closure of the job marts.
China, India, East Europe and emerging Asia have all stolen growth from the future by condoning credit excess. To varying degrees, they are now being forced to pay back their own "inter-temporal overdrafts".
If we are lucky, America will start to stabilise before Asia goes down. Should our 'leaders' mismanage affairs, almost every part of the global system will go down together. Then we are in trouble.
*"A l'Outrance" means "to the utmost" in French. This term was used to describe a combat or challenge in which the opponents engaged with an intention to kill each other, as opposed to trials of skill at festivals and such, where opponents only fought for their reputation or for prizes.
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Ambrose Evans-Pritchard | 21 July 2008
It feels like the summer of 1931. The world's two biggest financial institutions have had a heart attack. The global currency system is breaking down. The policy doctrines that got us into this mess are bankrupt. No world leader seems able to discern the problem, let alone forge a solution.
The International Monetary Fund has abdicated into schizophrenia. It has upgraded its 2008 world growth forecast from 3.7% to 4.1% growth, whilst warning of a[n increased] "chance of a global recession". Plainly, the IMF cannot or will not offer any useful insights.
Its "mean-reversion" model misses the entire point of this crisis, which is that central banks have pushed debt to fatal levels by holding interest too low for a generation, and now the chickens have come home to roost. True "mean-reversion" would imply debt deflation on such a scale that would, if abrupt, threaten democracy.
The risk is that these same central banks will commit a fresh error, this time overreacting to the oil spike. The European Central Bank has raised rates, warning of a '1970s wage-price spiral'. Fixated on the rear-view mirror, it is not looking through the windshield.
The eurozone is falling into recession before the US itself. Its level of credit stress is worse, if measured by Euribor or the iTraxx bond indexes. 'Core' inflation has fallen over the last year from 1.9% to 1.8%. The US may soon tip into a second leg of this crisis as the fiscal package runs out and Americans lose jobs in earnest [[but all of that stimulus by EVERYBODY, inflation be damned, will probably see us into early 2009, at least: normxxx]]. US bank credit has contracted for three months. Real US wages fell at almost 10% (annualised) over May and June. This is a ferocious squeeze for an economy already in the grip of the property and debt crunch.
No doubt the rescue of Fannie Mae and Freddie Mac— 5.3 trillion dollar pillars of America's mortgage market— stinks of moral hazard. The Treasury is to buy shares: the Fed has opened its window yet wider. Risks have been socialised. All rewards will go to capitalists [[as will all the soothing ointments: normxxx]]. Alas, no Scandinavian discipline for Wall Street. When Norway's banks fell below critical capital levels in the early 1990s, the Storting authorised seizure. Shareholders were stiffed [[not so for Bush's friends: normxxx]].
But Nordic purism in the vast universe of US credit would court fate. The Californian lender IndyMac was indeed seized after depositors panicked on the streets of Encino. The police had to restore order. This was America's Northern Rock moment.
IndyMac will deplete a tenth of the $53bn reserve of the Federal Deposit Insurance Corporation. The FDIC has some 90 "troubled" lenders on watch. IndyMac was not one of them. The awful reality is that Washington has its back to the wall. Fed chief Ben Bernanke thought the US could always get out of trouble by monetary stimulus "à l'outrance*", and letting the dollar slide. He has learned that the world is a more complicated place.
Oil has queered the pitch. So has America's fatal reliance on foreign debt. The Fannie/Freddie rescue, incidentally, has just changed the US national debt from German 'AAA' levels to Italian 'AA-' levels.
China, Russia, petro-powers and other foreign states own $985bn of US agency debt, besides holdings of US Treasuries. Purchases of Fannie/Freddie debt covered a third of the US current account deficit of $700bn over the last year. Alex Patelis from Merrill Lynch says America faces the risk of a "financing crisis" within months. Foreigners have a veto over US policy.
Japan did not have this problem during its Lost Decade. As the world's supplier of credit, it could let the yen slide. It also had a savings rate of 15%. Albert Edwards from Société Générale says this has fallen to 3% today. It has cushioned the slump. Americans are under water before they start.
My view is that a dollar crash will be averted as it becomes clearer that contagion has spread worldwide. But we are now at the point of maximum danger. Britain, Japan, and the Antipodes are stalling. Denmark is in recession. Germany contracted in the second quarter. May industrial output fell 6% in Holland and 5.5% in Sweden.
The coalitions in Belgium and Austria have just collapsed. Germany's left-right team is fraying. One German banker told me that the doctrines of "left Nazism" (Otto Strasser's group, purged by Hitler) had captured the rising Die Linke party. The Social Democrats are picking up its themes to protect their flank.
This is the healthy part of Europe. Further south, we are not far away from civic protest. BNP Paribas has just issued a hurricane alert for Spain. Finance minister Pedro Solbes said Spain is facing the "most complex" economic crisis in its history. Actually, it is very simple. The country was lulled into a trap by giveaway interest rates of 2% under EMU, leading to a current account deficit of 10% of GDP.
A manic property bubble was funded by foreigners buying 'covered' bonds and securities [[guess they got 'short-sheeted': normxxx]]. This market has dried up. Monetary policy is now being tightened into the crunch by the ECB, hence the bankruptcy last week of Martinsa-Fadesa (€5.1bn). With Franco-era labour markets (70% of wages are inflation-linked), the adjustment will occur through closure of the job marts.
China, India, East Europe and emerging Asia have all stolen growth from the future by condoning credit excess. To varying degrees, they are now being forced to pay back their own "inter-temporal overdrafts".
If we are lucky, America will start to stabilise before Asia goes down. Should our 'leaders' mismanage affairs, almost every part of the global system will go down together. Then we are in trouble.
*"A l'Outrance" means "to the utmost" in French. This term was used to describe a combat or challenge in which the opponents engaged with an intention to kill each other, as opposed to trials of skill at festivals and such, where opponents only fought for their reputation or for prizes.
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Friday, July 18, 2008
America Is Lone Bright Spot
America Is Lone Bright Spot As Fund Managers Flee Stocks
By Ambrose Evans-Pritchard, Telegraph.co.UK | 18 July 2008
Fund managers across the world are dumping stocks and retreating to cash in a mood of extreme pessimism, fearing that the looming economic crunch is an even greater threat than inflation. The latest survey of (UK?) investors by Merrill Lynch shows that an unprecedented 41% now think that a world recession is either likely or very likely. The majority dismiss hopes of double-digit earnings growth next year as "fantasy".
"People are a lot more scared about the macro-outlook. The survey has never seen anything like this before since it began a decade ago," said David Bowers, the organiser of the report. "Recession risk has taken over from inflation risk. Fund managers believe the global economy is deteriorating so fast that a wage-spiral is never going to happen, at least in developed markets," he said. The survey is based on 191 funds managing assets worth $610bn (£305bn).
The US is emerging as the one bright spot in the global gloom, despite the credit mayhem. A net 7% of investors are overweight in US equities, clearly betting that most of the bad news is already priced into Wall Street stock prices [[Hah! But reason enough for a "summer rally": normxxx]]. The figure was negative in May [[and June!?!: normxxx]]. With the tailwind of 2% interest rates and a cheap dollar, America stands to benefit from the "first-in, first-out" principle. Others have yet to take their full punishment from the cycle. "The US has now become the country of cheap manufacturing. You've got 20% wage inflation in emerging markets so FDI (foreign direct investment) is flowing back from there," said Karen Olney, Merrill's chief European equity strategist.
The investor love affair with India, China, and Asian markets over the last nine months has turned decidedly sour. "That trade is off," said Mrs Olney. A net 75% are underweight Indian equities as the country's inflation reaches double digits. Chile (-69), Taiwan (-50), Korea (-50), Malaysia (-44) are not far behind. Mr Bowers said investors had woken up to the nasty reality that emerging markets have let rip with inflation and will now have to jam on the brakes.
Those with dollar pegs or dirty floats like China have, in effect, been "destabilised" by the US Federal Reserve's rate cuts. "These countries have used the Fed as their anchor. Rates of 2% have challenged their economic models," he said. Russia (+75) remains the darling of the emerging universe, but for how long? Almost two thirds of investors say oil is fundamentally overvalued. They appear to be hanging on to their oil and gas exposure as a late-cycle "momentum play". A net 42% think the Bank of England has kept interest rates too high given the housing slump and the consumer squeeze. Not a single respondent thinks that the UK is going to get better over the next year. They are ditching bank stocks (-83) and property (-92).
Europe is not faring much better. Some 96% think the economy will get worse over the next year, up sharply from the June survey. A majority believe inflation will fall, and a net 24% say the European Central Bank is engaging in overkill. Not surprisingly, a record 32% are now underweight eurozone equities. Few see stocks as cheap even after the rude sell-off this summer. "Investors think earnings are going into a free-fall," said Mrs Olney. "Healthcare companies offer immunity from the three horrors that are bugging investors: a rising oil price, the slowing economic cycle and the credit crisis."
Japan is sneaking back into favour after years in the wilderness, if only by default. "Japanese banks are the winner from the credit crunch. Japan now has the capacity to be the monopoly supplier of capital to the world once again," said Merrill Lynch.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
|
By Ambrose Evans-Pritchard, Telegraph.co.UK | 18 July 2008
Fund managers across the world are dumping stocks and retreating to cash in a mood of extreme pessimism, fearing that the looming economic crunch is an even greater threat than inflation. The latest survey of (UK?) investors by Merrill Lynch shows that an unprecedented 41% now think that a world recession is either likely or very likely. The majority dismiss hopes of double-digit earnings growth next year as "fantasy".
"People are a lot more scared about the macro-outlook. The survey has never seen anything like this before since it began a decade ago," said David Bowers, the organiser of the report. "Recession risk has taken over from inflation risk. Fund managers believe the global economy is deteriorating so fast that a wage-spiral is never going to happen, at least in developed markets," he said. The survey is based on 191 funds managing assets worth $610bn (£305bn).
The US is emerging as the one bright spot in the global gloom, despite the credit mayhem. A net 7% of investors are overweight in US equities, clearly betting that most of the bad news is already priced into Wall Street stock prices [[Hah! But reason enough for a "summer rally": normxxx]]. The figure was negative in May [[and June!?!: normxxx]]. With the tailwind of 2% interest rates and a cheap dollar, America stands to benefit from the "first-in, first-out" principle. Others have yet to take their full punishment from the cycle. "The US has now become the country of cheap manufacturing. You've got 20% wage inflation in emerging markets so FDI (foreign direct investment) is flowing back from there," said Karen Olney, Merrill's chief European equity strategist.
The investor love affair with India, China, and Asian markets over the last nine months has turned decidedly sour. "That trade is off," said Mrs Olney. A net 75% are underweight Indian equities as the country's inflation reaches double digits. Chile (-69), Taiwan (-50), Korea (-50), Malaysia (-44) are not far behind. Mr Bowers said investors had woken up to the nasty reality that emerging markets have let rip with inflation and will now have to jam on the brakes.
Those with dollar pegs or dirty floats like China have, in effect, been "destabilised" by the US Federal Reserve's rate cuts. "These countries have used the Fed as their anchor. Rates of 2% have challenged their economic models," he said. Russia (+75) remains the darling of the emerging universe, but for how long? Almost two thirds of investors say oil is fundamentally overvalued. They appear to be hanging on to their oil and gas exposure as a late-cycle "momentum play". A net 42% think the Bank of England has kept interest rates too high given the housing slump and the consumer squeeze. Not a single respondent thinks that the UK is going to get better over the next year. They are ditching bank stocks (-83) and property (-92).
Europe is not faring much better. Some 96% think the economy will get worse over the next year, up sharply from the June survey. A majority believe inflation will fall, and a net 24% say the European Central Bank is engaging in overkill. Not surprisingly, a record 32% are now underweight eurozone equities. Few see stocks as cheap even after the rude sell-off this summer. "Investors think earnings are going into a free-fall," said Mrs Olney. "Healthcare companies offer immunity from the three horrors that are bugging investors: a rising oil price, the slowing economic cycle and the credit crisis."
Japan is sneaking back into favour after years in the wilderness, if only by default. "Japanese banks are the winner from the credit crunch. Japan now has the capacity to be the monopoly supplier of capital to the world once again," said Merrill Lynch.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
US Faces Global Funding Crisis
US Faces Global Funding Crisis, Warns Merrill Lynch
By Ambrose Evans-Pritchard | 18 July 2008
The US Treasury is running out of time before foreign patience "snaps". Merrill Lynch has warned that the United States could face a foreign "financing crisis" within months as the full consequences of the Fannie Mae and Freddie Mac mortgage debacle spread through the world.
Draining away: The US may struggle to plug its capital gap
The country depends on Asian, Russian and Middle Eastern investors to fund much of its $700bn (£350bn) current account deficit, leaving it far more vulnerable to a collapse of confidence than Japan in the early 1990s after the Nikkei bubble burst. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.
"Japan was able to cut its interest rates to zero," said Alex Patelis, Merrill's head of international economics. "It would be very difficult for the US to do this. Foreigners will not be willing to supply the capital. Nobody knows where the limit lies." Brian Bethune, chief financial economist at Global Insight, said the US Treasury had two or three days to put real money behind its rescue plan for Fannie and Freddie or face a dangerous crisis that could spiral out of control.
"This is not the time for policy-makers to underestimate, once again, the systemic risks to the financial system and the huge damage this would impose on the economy. Bold, aggressive action is needed, and needed now," he said. Mr Bethune said the Treasury would have to inject up to $20bn in fresh capital. This in turn might draw in a further $20bn in private money. Funds on this scale should be enough to see the two agencies through any scenario short of a total meltdown in the US prime property market.
He said concerns about "moral hazard"— stoked by hard-line free-marketeers at the White House and vocal parts of the US media [[eg, the Rush Limbaughs et al. : normxxx]]— were holding up a solution. "We can't dither. The markets can be brutal. We have to break the chain of contagion before confidence is wholly destroyed." Fannie and Freddie— the world's two biggest financial institutions— make up almost half the $12 trillion US mortgage industry. But that understates their vital importance at this juncture. They are now serving as lender of last resort to the housing market, providing 80% of all new home loans.
Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt— as well as other US "government-sponsored enterprises"— is now in foreign hands. The great unknown is whether foreign patience will snap as losses mount and the dollar slides. Hiroshi Watanabe, Japan's chief regulator, rattled the markets yesterday when he urged Japanese banks and life insurance companies to treat US agency debt with caution. The two sets of institutions hold an estimated $56bn of these bonds. Mitsubishi UFJ holds $3bn. Nippon Life has $2.5bn.
But the lion's share is held by the Central Banks of China, Russia and the petro-powers. These countries could all too easily precipitate a run on the dollar in the current climate and bring the United States to its knees, should they decide that it is in their strategic interest to do so. Mr Patelis said it was unlikely that any would want to trigger a fire-sale by dumping their holdings on the market. Instead, they will probably accumulate US and Anglo-Saxon debt at a slower rate.
That alone will be enough to leave deficit countries struggling to plug the capital gap. "I don't see how the current situation can continue beyond six months," he said. Merrill Lynch said foreign governments had added $241bn of US agency debt over the past year alone as their foreign reserves exploded, accounting for a third of total financing for the US current account deficit. (They now own $985bn in all.) By most estimates, China holds around $400bn, Russia $150bn and Saudi Arabia and other Gulf states at least $200bn.
Global inflation is now intruding with a vengeance as well. Much of Asia is having to raise rates aggressively, drawing capital away from North America. This may push up yields on US Treasuries and bonds, tightening the credit screw at a time when the US is already mired in slump. Russia's deputy finance minister, Dmitry Pankin, said the collapse in the share prices of Fannie and Freddie over the past week was irrelevant because their debt has been effectively guaranteed by the US government under the rescue package.
"We don't see a reason to change anything because the rating of the debt of those agencies hasn't changed," he said. Foreign policy experts doubt that the picture is so simple. Russia is likely to use its $530bn reserves as an implicit bargaining chip in high-stakes diplomacy, perhaps to discourage the US from extending Nato membership to the Ukraine and Georgia. Vladimir Putin, now Russia's premier, has stated repeatedly that his country is engaged in a new Cold War with the United States. It is clear that Moscow would relish any chance to humiliate the United States, provided the costs of doing so were not too high for Russia itself.
China is regarded as a more reliable partner, with a greater desire for global stability. Treasury Secretary Hank Paulson has intimate relations with the Chinese elite, dating from his days at Goldman Sachs when he visited the country over 70 times. Brad Setser, from the US Council on Foreign Relations, said the Chinese have a stake in upholding Fannie and Freddie, not least to ensure that their loans are "honoured on time and in full".
David Bloom, currency chief at HSBC, said fears that regional banks could start toppling after the Fed takeover of IndyMac last week were now the biggest threat to the dollar. "We have a pure dollar sell-off," he said. "It's a hating competition: at the moment the markets hate the dollar more than they hate the euro, even though German's ZEW confidence indicator was absolutely atrocious.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Ambrose Evans-Pritchard | 18 July 2008
The US Treasury is running out of time before foreign patience "snaps". Merrill Lynch has warned that the United States could face a foreign "financing crisis" within months as the full consequences of the Fannie Mae and Freddie Mac mortgage debacle spread through the world.
Draining away: The US may struggle to plug its capital gapThe country depends on Asian, Russian and Middle Eastern investors to fund much of its $700bn (£350bn) current account deficit, leaving it far more vulnerable to a collapse of confidence than Japan in the early 1990s after the Nikkei bubble burst. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.
"Japan was able to cut its interest rates to zero," said Alex Patelis, Merrill's head of international economics. "It would be very difficult for the US to do this. Foreigners will not be willing to supply the capital. Nobody knows where the limit lies." Brian Bethune, chief financial economist at Global Insight, said the US Treasury had two or three days to put real money behind its rescue plan for Fannie and Freddie or face a dangerous crisis that could spiral out of control.
"This is not the time for policy-makers to underestimate, once again, the systemic risks to the financial system and the huge damage this would impose on the economy. Bold, aggressive action is needed, and needed now," he said. Mr Bethune said the Treasury would have to inject up to $20bn in fresh capital. This in turn might draw in a further $20bn in private money. Funds on this scale should be enough to see the two agencies through any scenario short of a total meltdown in the US prime property market.
He said concerns about "moral hazard"— stoked by hard-line free-marketeers at the White House and vocal parts of the US media [[eg, the Rush Limbaughs et al. : normxxx]]— were holding up a solution. "We can't dither. The markets can be brutal. We have to break the chain of contagion before confidence is wholly destroyed." Fannie and Freddie— the world's two biggest financial institutions— make up almost half the $12 trillion US mortgage industry. But that understates their vital importance at this juncture. They are now serving as lender of last resort to the housing market, providing 80% of all new home loans.
Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt— as well as other US "government-sponsored enterprises"— is now in foreign hands. The great unknown is whether foreign patience will snap as losses mount and the dollar slides. Hiroshi Watanabe, Japan's chief regulator, rattled the markets yesterday when he urged Japanese banks and life insurance companies to treat US agency debt with caution. The two sets of institutions hold an estimated $56bn of these bonds. Mitsubishi UFJ holds $3bn. Nippon Life has $2.5bn.
But the lion's share is held by the Central Banks of China, Russia and the petro-powers. These countries could all too easily precipitate a run on the dollar in the current climate and bring the United States to its knees, should they decide that it is in their strategic interest to do so. Mr Patelis said it was unlikely that any would want to trigger a fire-sale by dumping their holdings on the market. Instead, they will probably accumulate US and Anglo-Saxon debt at a slower rate.
That alone will be enough to leave deficit countries struggling to plug the capital gap. "I don't see how the current situation can continue beyond six months," he said. Merrill Lynch said foreign governments had added $241bn of US agency debt over the past year alone as their foreign reserves exploded, accounting for a third of total financing for the US current account deficit. (They now own $985bn in all.) By most estimates, China holds around $400bn, Russia $150bn and Saudi Arabia and other Gulf states at least $200bn.
Global inflation is now intruding with a vengeance as well. Much of Asia is having to raise rates aggressively, drawing capital away from North America. This may push up yields on US Treasuries and bonds, tightening the credit screw at a time when the US is already mired in slump. Russia's deputy finance minister, Dmitry Pankin, said the collapse in the share prices of Fannie and Freddie over the past week was irrelevant because their debt has been effectively guaranteed by the US government under the rescue package.
"We don't see a reason to change anything because the rating of the debt of those agencies hasn't changed," he said. Foreign policy experts doubt that the picture is so simple. Russia is likely to use its $530bn reserves as an implicit bargaining chip in high-stakes diplomacy, perhaps to discourage the US from extending Nato membership to the Ukraine and Georgia. Vladimir Putin, now Russia's premier, has stated repeatedly that his country is engaged in a new Cold War with the United States. It is clear that Moscow would relish any chance to humiliate the United States, provided the costs of doing so were not too high for Russia itself.
China is regarded as a more reliable partner, with a greater desire for global stability. Treasury Secretary Hank Paulson has intimate relations with the Chinese elite, dating from his days at Goldman Sachs when he visited the country over 70 times. Brad Setser, from the US Council on Foreign Relations, said the Chinese have a stake in upholding Fannie and Freddie, not least to ensure that their loans are "honoured on time and in full".
David Bloom, currency chief at HSBC, said fears that regional banks could start toppling after the Fed takeover of IndyMac last week were now the biggest threat to the dollar. "We have a pure dollar sell-off," he said. "It's a hating competition: at the moment the markets hate the dollar more than they hate the euro, even though German's ZEW confidence indicator was absolutely atrocious.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Harbinger Of Doom: European Recession Next?
European Recession Looms As Spain Crumbles
By Ambrose Evans-Pritchard | 18 July 2008
The eurozone is tipping into a deeper downturn than America itself despite the tremors in the US mortgage industry, and may already be in full recession for the first time since the launch of the single currency. Industrial production for the EMU bloc fell 1.9% in May, according to fresh Eurostat data. It is the sharpest one-month decline for the region since the exchange rate crisis in 1992. Officials in Berlin have warned that Germany's economy could contract by as much as 1.5% in the second quarter as export orders crumble.
Industrial output in both Italy and Greece has slumped 6.6% over the past year. Portugal is off 6.2%. "It is a very ugly picture: we're on maximum alert," said Emma Marcegaglia, head of Italy's business federation Confindustria. Rome is now lobbying for a "New Deal" to revive Italy's economy through massive infrastructure projects. The idea is to use bonds issued by the European Investment Bank, allowing EU states to circumvent the 3% limit on budget deficits imposed by the Maastricht Treaty.
Jacques Cailloux, Europe economist at the Royal Bank of Scotland, said a "reverse decoupling" is now under way as Europe goes down harder than the US— just as it did after the dotcom bust. "There is loss of momentum across the board. We can't exclude a recession," he said.
Spain is now spiralling into the worst crisis since the Franco dictatorship. "The economy is in dire straits," said Dominic Bryant, Spain expert at BNP Paribas. "Some of the housebuilders are going to go bust, it is as simple as that. Over 10% of Spain's economy has been building houses. This compares with 6%-7% in the US at the height of the bubble. The adjustment will be enormous," he said.
Fear haunted the Spanish property sector yesterday after the share price of developer Martinsa-Fadesa crashed by more than 50% in two days, leading to a suspension in trading by the Madrid bourse. The real estate and shopping mall group has so far failed to secure refinancing for its €5.1bn ($8.2bn) debt. The board held an emergency meeting yesterday. Finance minister Pedro Solbes said the Martinsa-Fadesa crisis was turning "more complicated" but denied that there is any risk of a chain reaction across the sector. Banco Popular is understood to be the most exposed bank.
The crunch engulfing Spain's property market is rapidly turning into a full-fledged national drama. The developers' association APCE said house prices had already fallen 15% since September. Unemployment has risen by 425,000 over the past year, reaching 9.9%. Deutsche Bank said the property crisis is more serious that the collapse in the early 1990s. It expects a 35% fall in real house prices by 2011 as the market slowly clears the vast overhang of property, now estimated at nearly 700,000 homes.
In Castilla-La Mancha— Don Quixote's region— some 69% of all houses built over the past three years are still unsold. Spain's premier, Jose Luis Zapatero, blamed the European Central Bank for making matters worse by raising interest rates into the teeth of the crisis last week. He called the move "irresponsible". More than 98% of home loans in Spain are priced off floating rates linked to Euribor, which has risen 1.45% since August.
Mr Zapatero has resorted to a fiscal boost worth 1.5% of GDP to help cushion the slump. But Spain's budget surplus is turning into a deficit as tax revenues collapse. Car sales, for instance, fell 31% in May. The Bank of Spain is concerned about the health of smaller regional lenders with heavy exposure to the mortgage market. Deputy governor Jose Vinals has called on banks to set aside more against bad debts. "Provisions need to keep rising throughout the year. Prudent coverage levels are needed to face this situation with confidence," he said.
The precipitous slide now under way in Europe has yet to cause investors to lose their ardour for the euro, but a number of analysts, including Bill Gross, head of the giant bond fund Pimco, say there is no justification for the euro's 25% to 30% 'over-valuation' against the US dollar. "We're turning incredibly bearish on the euro," said BNP Paribas. The counter argument is that the US has merely stolen growth from the future with this spring's one-off fiscal stimulus package. Dollar bears expect a nasty second leg to the crisis later this year, forcing the Fed to slash interest rates to 1% or lower.
Goldman Sachs said Europe is the "tie-breaker" for the whole global economy.
Spain Drops Reassuring Gloss As Crisis Deepens
By Ambrose Evans-Pritchard | 18 July 2008
Spain's finance minister Pedro Solbes has stunned the markets with an admission that his country faces the worst economic crisis in its history as the full effects of the property crash spread through the economy. "This crisis is the most complex we have ever lived through given the plethora of factors on the table at the same time," he told Punto Radio in Madrid, breaking with past efforts to put a reassuring gloss on events.
Mr Solbes said the Madrid bourse had suffered an "earthquake", crashing 27% since the start of June. He blamed the toxic cocktail of high oil prices, the global credit crisis and the sharp slowdown in the key export markets of North America and Germany. The comments follow this week's bankruptcy of Martinsa-Fadesa, Spain's biggest corporate failure. The property developer— with an empire of housing estates, hotels, shopping malls and hotels— collapsed after failing to refinance €5.1bn ($8bn) of debts. The company's demise was a textbook story of aggressive over-expansion at the top of the cycle, driven by high debt gearing. It has €11bn of assets.
Mr Solbes has pursued a rigorous "no bailout" policy, saying Martinsa-Fadesa took "excessive risks" and must now face the consequences. He has reportedly clashed with cabinet colleagues, who are now searching for any means to stop the downward spiral in the economy. El Pais reports that house prices crashed by 20% in the second quarter compared with a year earlier, based on 183,000 completed transactions.
The Martinsa-Fadesa collapse has sent tremors through the whole property and construction sector. The share price of giant developer Sacyr has halved over the past month. The two banks with most exposure to the Martinsa-Fadesa are Caja Madrid, at €900m, and Banco Popular, at €400m. Goldman Sachs has issued "sell" recommendations on a clutch of Spanish banks, including Bankinter, Banco Popular and Banco Sabadell, warning that the sharp turn in the credit cycle could prove worse than the recession in the early 1990s. "The consumer is more leveraged today than in any of the previous cycles," it said.
The ratings agency Standard & Poor's has not yet taken a decision on whether to downgrade Banco Popular and Caja Madrid.
In reality, this is unlikely to be the worst economic crisis in Spain's history. Philip II defaulted on his sovereign debts three times in the 16th century after he bankrupted the Spanish Empire to pay for his Counter-Reformation wars against Protestants. He crippled the Italian banking system in the process— much to the benefit of London and Amsterdam.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Ambrose Evans-Pritchard | 18 July 2008
The eurozone is tipping into a deeper downturn than America itself despite the tremors in the US mortgage industry, and may already be in full recession for the first time since the launch of the single currency. Industrial production for the EMU bloc fell 1.9% in May, according to fresh Eurostat data. It is the sharpest one-month decline for the region since the exchange rate crisis in 1992. Officials in Berlin have warned that Germany's economy could contract by as much as 1.5% in the second quarter as export orders crumble.
Industrial output in both Italy and Greece has slumped 6.6% over the past year. Portugal is off 6.2%. "It is a very ugly picture: we're on maximum alert," said Emma Marcegaglia, head of Italy's business federation Confindustria. Rome is now lobbying for a "New Deal" to revive Italy's economy through massive infrastructure projects. The idea is to use bonds issued by the European Investment Bank, allowing EU states to circumvent the 3% limit on budget deficits imposed by the Maastricht Treaty.
Jacques Cailloux, Europe economist at the Royal Bank of Scotland, said a "reverse decoupling" is now under way as Europe goes down harder than the US— just as it did after the dotcom bust. "There is loss of momentum across the board. We can't exclude a recession," he said.
Spain is now spiralling into the worst crisis since the Franco dictatorship. "The economy is in dire straits," said Dominic Bryant, Spain expert at BNP Paribas. "Some of the housebuilders are going to go bust, it is as simple as that. Over 10% of Spain's economy has been building houses. This compares with 6%-7% in the US at the height of the bubble. The adjustment will be enormous," he said.
Fear haunted the Spanish property sector yesterday after the share price of developer Martinsa-Fadesa crashed by more than 50% in two days, leading to a suspension in trading by the Madrid bourse. The real estate and shopping mall group has so far failed to secure refinancing for its €5.1bn ($8.2bn) debt. The board held an emergency meeting yesterday. Finance minister Pedro Solbes said the Martinsa-Fadesa crisis was turning "more complicated" but denied that there is any risk of a chain reaction across the sector. Banco Popular is understood to be the most exposed bank.
The crunch engulfing Spain's property market is rapidly turning into a full-fledged national drama. The developers' association APCE said house prices had already fallen 15% since September. Unemployment has risen by 425,000 over the past year, reaching 9.9%. Deutsche Bank said the property crisis is more serious that the collapse in the early 1990s. It expects a 35% fall in real house prices by 2011 as the market slowly clears the vast overhang of property, now estimated at nearly 700,000 homes.
In Castilla-La Mancha— Don Quixote's region— some 69% of all houses built over the past three years are still unsold. Spain's premier, Jose Luis Zapatero, blamed the European Central Bank for making matters worse by raising interest rates into the teeth of the crisis last week. He called the move "irresponsible". More than 98% of home loans in Spain are priced off floating rates linked to Euribor, which has risen 1.45% since August.
Mr Zapatero has resorted to a fiscal boost worth 1.5% of GDP to help cushion the slump. But Spain's budget surplus is turning into a deficit as tax revenues collapse. Car sales, for instance, fell 31% in May. The Bank of Spain is concerned about the health of smaller regional lenders with heavy exposure to the mortgage market. Deputy governor Jose Vinals has called on banks to set aside more against bad debts. "Provisions need to keep rising throughout the year. Prudent coverage levels are needed to face this situation with confidence," he said.
The precipitous slide now under way in Europe has yet to cause investors to lose their ardour for the euro, but a number of analysts, including Bill Gross, head of the giant bond fund Pimco, say there is no justification for the euro's 25% to 30% 'over-valuation' against the US dollar. "We're turning incredibly bearish on the euro," said BNP Paribas. The counter argument is that the US has merely stolen growth from the future with this spring's one-off fiscal stimulus package. Dollar bears expect a nasty second leg to the crisis later this year, forcing the Fed to slash interest rates to 1% or lower.
Goldman Sachs said Europe is the "tie-breaker" for the whole global economy.
Spain Drops Reassuring Gloss As Crisis Deepens
By Ambrose Evans-Pritchard | 18 July 2008
Spain's finance minister Pedro Solbes has stunned the markets with an admission that his country faces the worst economic crisis in its history as the full effects of the property crash spread through the economy. "This crisis is the most complex we have ever lived through given the plethora of factors on the table at the same time," he told Punto Radio in Madrid, breaking with past efforts to put a reassuring gloss on events.
Mr Solbes said the Madrid bourse had suffered an "earthquake", crashing 27% since the start of June. He blamed the toxic cocktail of high oil prices, the global credit crisis and the sharp slowdown in the key export markets of North America and Germany. The comments follow this week's bankruptcy of Martinsa-Fadesa, Spain's biggest corporate failure. The property developer— with an empire of housing estates, hotels, shopping malls and hotels— collapsed after failing to refinance €5.1bn ($8bn) of debts. The company's demise was a textbook story of aggressive over-expansion at the top of the cycle, driven by high debt gearing. It has €11bn of assets.
Mr Solbes has pursued a rigorous "no bailout" policy, saying Martinsa-Fadesa took "excessive risks" and must now face the consequences. He has reportedly clashed with cabinet colleagues, who are now searching for any means to stop the downward spiral in the economy. El Pais reports that house prices crashed by 20% in the second quarter compared with a year earlier, based on 183,000 completed transactions.
The Martinsa-Fadesa collapse has sent tremors through the whole property and construction sector. The share price of giant developer Sacyr has halved over the past month. The two banks with most exposure to the Martinsa-Fadesa are Caja Madrid, at €900m, and Banco Popular, at €400m. Goldman Sachs has issued "sell" recommendations on a clutch of Spanish banks, including Bankinter, Banco Popular and Banco Sabadell, warning that the sharp turn in the credit cycle could prove worse than the recession in the early 1990s. "The consumer is more leveraged today than in any of the previous cycles," it said.
The ratings agency Standard & Poor's has not yet taken a decision on whether to downgrade Banco Popular and Caja Madrid.
In reality, this is unlikely to be the worst economic crisis in Spain's history. Philip II defaulted on his sovereign debts three times in the 16th century after he bankrupted the Spanish Empire to pay for his Counter-Reformation wars against Protestants. He crippled the Italian banking system in the process— much to the benefit of London and Amsterdam.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Thursday, July 17, 2008
Jaws Close In
Jaws Close In On Bernanke
Or, How Bush Sandbagged The GSEs
By Julian Delasantellis, AsiaTimes | 16 July 2008
Currently, as a result of the ever-worsening crises in US housing finance, a crisis being illustrated by the absolute devastation of the shares in the US government's semi-private semi-public secondary market mortgage wholesalers Fannie Mae and Freddie Mac, and in the government seizing control of mortgage lender IndyMac in one of the largest bank failures in American history, Federal Reserve chairman Ben Bernanke must be raising his gaze to the heavens for a similar entreaty.
"Lord, give me credibility as, and the ability to be, an inflation fighter— but not quite yet." The history of the financial markets since the rescue of Bear Stearns last March 15 is similar to that of the fictional Amity Island in between the first Jaws movie, released in 1975, and its sequel, Jaws 2, from 1978.
At first, after the initial shark had been killed— after Bear Stearns had been saved by aggressive Federal Reserve intervention— everything seemed OK. The markets rallied into mid-May. I would imagine that the souvenir shops selling shark-themed toys and back scratchers on Amity's beaches did likewise. But, then, the markets rolled over: the Dow Jones Industrial Average, after topping out close to 13,200 on May 19, has since lost more than 2,000 points, or 15%. To borrow from the tagline of Jaws 2, "Just when you thought it was safe to go into the stockmarket ... "
Of course, the real danger lying in wait to devour the markets continues to be the crisis in US housing values, as it has now become obvious that the entire edifice of the US financial markets over the past few years has been built on a foundation just about as sturdy as a sandcastle on one of Amity's beaches— the inflated value of US real estate.
Yet, it had been thought that the crisis in subprime mortgages, the root of the financial crises, would leave Fanny and Freddy untouched, since both their respective charters forbade the two enterprises, called government-sponsored entities (GSEs), from investing in them. But it is truly indicative of just how pernicious and metastizing this crisis is that, after devastating all that it has come in contact with for almost a year and a half now, it now strikes deep at the heart of a target previously thought immune.
No one who has wealth or assets in any form, in any currency, is safe— you may as well consider yourself as being at least knee-deep in the shark infested waters of the financial markets. My colleague Chan Akya ably described this burgeoning crisis last week (see And now, for Fannie and Freddie, Asia Times Online, July 12.) He accurately described the possible grim consequences possibly resulting from it, especially a huge expansion of the US federal government's indebtedness, but one thing that needs to be stressed is that because of these events the fight against inflation will most likely once again be placed on the back burner.
"Roosevelt is dead!" the relentlessly rotund radio rabble-rouser Rush Limbaugh cries out every afternoon on the American airwaves, referring to Great Depression and World War II-era US president Franklin Delano Roosevelt. At first, this might seem to be something of an obsessive compulsion with the absolutely obvious, as Roosevelt took his last actual physical breath on earth in April, 1945, shortly before the Allied victory in Europe. But what is really being expressed by Limbaugh is less a declarative statement than a fervent wish that conservatism's triumphs and successes might some day, maybe today, be so overwhelming and comprehensive that, at last, the American public will begin to clamor for the dismantling of the government social safety net emplaced during the Roosevelt era and which has for so long tied the American public to the Democratic Party— and forced those 'malefactors of great wealth' to pay something towards the societal destruction they have wrought, in the form of higher taxes.
Shortly after his re-election victory in 2004, George W Bush apparently thought so, for he immediately staked his political capital on a laissez-faire free-market restructuring plan for the gem in the Roosevelt crown, old-age Social Security. That, and the unpopularity over the Iraq war, drove the Republicans from control of both branches of Congress in the 2006 mid-term elections. Former Republican Senator Rick Santorum of Pennsylvania, defeated in 2006, now probably wishes that he did not have supporters at a 2005 rally that included elderly Social Security pensioners chanting the phrase "Hey hey! Ho ho! Social Security's got to go!"
Like a fungus that dies on exposure to light, the Bush Social Security scheme was dead a few months after it was exposed. However, by then it was impossible for the general media to cover serious issues any longer— they had to come up for sweet draughts of clean and clear tabloid oxygen. Starlets were getting drunk and Brangelina was getting pregnant; both warranted more attention than what the Bush administration was doing with the rest of the government, particularly concerning the always riveting, ever-popular issue of financial markets' regulation.
Grover Norquist, the anti-government jihadist who once said that he wanted to shrink government to such a size that it could be drowned and killed in a bathtub, and his fellow zealots in the Bush administration, certainly got water under their fingernails in dealing with the GSEs. In responding to a series of accounting scandals at the agencies similar to what the rest of the private sector suffered in 2002 and 2003 (see The decline of US equity markets, Asia Times Online, May 10, 2007) Bush and Co pushed the line that these agencies, just like the rest of the government, were poor stewards of, and could not be trusted with, the public purse.
They may have aimed for a bridge too far with the attempted privatization of Social Security, but in then aiming squarely at Fannie and Freddie, which, by financing the suburbs that the GIs returning from World War ll populated en masse, influenced the shape of postwar American life as much as the automobile, the anti-government zealots were zeroing in on a very critical consolation prize. Hoping to hobble the decision making of the two housing agencies, Bush stopped making new appointments to the boards of the GSEs in 2004. He also restricted the amount they could underwrite. There were repeated calls for new regulation of Fannie and Freddie, probably just about the only calls for enhanced regulation that have come out of the US executive branch this millennium. Hearings in the then Republican-controlled Congress were laced with outrage for these two wasteful, bloated government enterprises, whose functions could obviously be carried out in a far superior fashion by the private sector.
The Internet from that era is littered with weighty think tank tomes by such reliably conservative outlets as American Enterprise Institute and Cato Institute, calling for a new, private-sector, risk-transfer mechanism that was not centered around the GSEs. As in the famous curse where the Greek gods would punish mortals by granting their every wish, the Bush free marketeers would get their every wish in the next few years, to their, and the rest of the financial markets, continuing mortification. The core of Freddie and Fannie's operations was to buy up mortgage-backed securities in the open market then either hold them to maturity or sell them back to the market as mortgage-backed securities with the US government's implied backing. Both dispositions transferred the risk of mortgage default away from the banks to Fannie and Freddie.
Up until the freeze up in the credit markets and the crash in subprime finance that occurred last summer, a new risk-transfer mechanism stood as competition in the wholesale mortgage markets. Market shills postulated that, since it did not require participation by the government, it was obviously superior. Instead of having Fannie and Freddie buy the mortgage securities, the new plan involved these being rolled up into mortgage-backed securities (MBS), then sold to other [unsuspecting] private investors, whether they be other commercial and investment banks, hedge funds, or even, as the New York Times reported last December, the city treasury of Narvik, Norway.
After they were sold off once, they were invariably sold off again and again and again, each time, due to the devastatingly alluring miracle of leverage, the original nominal amount of the mortgage being used as collateral for much larger amounts of borrowing and lending. But by not retiring the mortgages through the GSEs, whoever finally wound up with the bonds were still stuck with the risk that the mortgage holders might someday default on the loans. This eventuality was thought to be covered with an instrument called a credit default swap (CDS), in essence, a private insurance policy that the bondholder would purchase from a bank that [hopefully] would pay off in the case of a mortgage holder's default.
With the stranglehold that the Bush administration, and its threatened veto pen, had on any legislative attempts to modernize and adapt the GSEs to current times, slowly the US mortgage market began to evolve away from the purview of Fannie and Freddie.
Regulations prevented Fannie and Freddie from buying up— from "underwriting"— most subprime mortgages because these typically did not carry the substantial borrower downpayments and detailed financial documentation that the agencies' regulations required. Thus, about one third of all mortgage borrowing as the real estate boom frothed over from 2004-2006, went to the CDSs. So did the wholesale market for mortgage loans above the GSEs' statutory limits of $417,000; this meant that, by the end of the boom, even modest three-bedroom, one-bath bungalows in the coastal markets of California and the US Northeast were not longer being underwritten by Fannie and Freddie. By early 2007, as the greed crescendo peaked, Fannie and Freddie were underwriting a mere 40% of the US mortgage market, down from over 60% earlier in the decade.
The rest, of course, is the grim history of the past two years. The subprime market cracked, leading the holders of the CDSs connected with the subprime obligations to start demanding their promised payment from the specialized CDS private insurers, called "monolines". This essentially drove the monolines to the brink of bankruptcy. The shutdown of the market for credit default swaps is what lies at the heart of what we now call the credit crisis [[actually, that last is just phase II of the Credit Crisis; phase I was the shut-down/freezing of the commercial paper market where the MBS' had been traded— until their value dropped precipitously: normxxx]]. Even though they did not make many subprime mortgage loans, Fannie and Fannie still fell victim to the age's greed and arrogance. On any cul-de-sac, in any new housing development, the bankruptcy and forced foreclosure sales of the homes with the subprime mortgages are forcing down the real estate values of the rest of the homes, the ones underwritten by Fannie and Freddie, in the neighborhood.
As the US real estate market staggered and buckled before finally breaking last summer and autumn, some voices were raised advocating fighting the then still-nascent crises with greater participation by Fannie and Freddie, specifically, by allowing the two to buy more, and higher-priced, mortgages. This might have nipped the problem in the bud then, but back last year, Bush, still the free markets' ever-trustworthy troubadour, informed one and all that he would veto any legislation of that nature.
Bush finally saw the light (probably through feeling the heat that was being placed on his party's election prospects this year), and included in last winter's economic stimulus package a geographically limited, temporary increase in the GSE's statutory loan limits, in certain high priced markets, to just under US$730,000. Still, increased authority by Fannie and Freddie are key elements of the mortgage relief rescue package promoted by Democrats Representative Barney Frank and Senator Chris Dodd and now slogging through the Congress, weighed down by Republican legislative legerdemain. Bush has not said one way or another whether he will sign the bill should it reach his desk; every time he implies he might veto the bill, you can just hear the whoosh of the darts heading towards pictures of the president at John McCain's campaign headquarters.
Current reports are indicating that the GSEs are now purchasing about 80% of the new mortgages being made in the US. This is why the two's current financial difficulties, symbolized by the roughly 90% falls in the stock values of both Fannie and Freddie since last August, are so serious. Governments rush in to rescue endangered financial institutions when they are said to be "too big to fail"; if ever that was true, if ever the maxim had any real applicability, surely, with essentially the entire US housing industry now resting on the GSEs' shoulders, the US government cannot stand by disinterested as they bleed to death.
On Sunday evening, the US Treasury Department and Federal Reserve came out with a Fannie/Freddie rescue plan. President Bush was nowhere to be seen in this initiative— the Wall Street Journal reported that there were still free-market holdouts in the White House, apparently the last laissez-faire zealots left in the bunker as reality's punishing howitzers zeroed in, that opposed the deal. The initiative called for a temporary increase in what the GSEs could borrow from the Treasury, as well as increased US government equity investments in Fannie and Freddie stock. These will require authorization from Congress. For its part, the Federal Reserve announced that, for the first time, it was opening its emergency assistance facility, or discount window, designed for member banks (which the GSEs are not— they're not really "banks" at all) to the endangered pair.
Some called this a type of nationalization of the GSEs, akin to what the British government did with Northern Rock bank last year. Others noted that the rescue package did not include a full and clear expression that the US government will now stand behind the obligations of the two. Justin Fox of Time.com's Curious Capitalist blog noted that it seems that the implicit status of the US government's guarantee of the GSE's obligations has gone from "not guaranteed by the United States" to "not guaranteed by the United States, unless they really need to be". Fannie and Freddie shares, as well as the general stock market, rallied strongly on the news at the market's open on Monday, but quickly sold off.
Freddie Mac closed down 8% on the day, Fannie Mae 5%, the Dow Jones Industrial Average closed down 45 points. Perhaps the markets may be now pricing in the possibility that the Bush administration, in a last, flaming Gotterdammerung of free-market philosophy, may indeed put ideology over the fates and fortunes of the entire US financial system to prove that, indeed, no [government-backed] financial institution is too big to fail. What wasn't in the rescue package was a reduction in the interest rates the Federal Reserve uses to manage the short-term money markets, the Federal Reserve's target Federal Funds rate. That it didn't do, even though it did lower by 75 basis points that same rate for the rescue of Bear Stearns in March. The fact that it didn't on this occasion, with the potential insolvency of Fannie and Freddie posing a far greater systemic risk to the economy than the potential bankruptcy of a mere investment bank such as Bear, demonstrates much about the true dire nature of the current circumstances.
After dropping the Federal Funds Target Rate from 5.25% to 2% in eight months, starting in April the Federal Reserve looked around, and, to paraphrase Captain Renault (Claude Rains) from 1942's Casablanca, was "shocked, shocked" to find inflation going on. The standard remedy applied by central banks to an inflationary problem is a hike in interest rates, but, even with rising prices, led by surging futures prices for food and crude oil and its products, moving to the forefront of the Fed's concern since late April, Bernanke and Co have resisted pulling the trigger on a rate hike. Instead, they have resorted to attacking inflation with ever harsher and harsher language [[but they haven't used the F--- word yet!: normxxx]], culminating with the statement that followed the Fed's last meeting on June 25 that seemed to virtually guarantee a rate hike in the near future (see Bernanke's words strike false note, Asia Times Online, June 27, 2008.)
Bernanke's portion in the GSE rescue package is currently limited to the opening of the discount window. That correlates to how he has been dealing with the twin threats of inflation and financial system instability lately: let the endangered institution borrow from the Fed what it needs but limit the provision of excess liquidity to the general economy. How long can this policy bifurcation continue? [[At least until the Dems get back in.: normxxx]] The "Lex" columnist of the Financial Times, which on Saturday described Fannie and Freddie as being like "like a sweet old couple who have suddenly become unhinged and taken their neighbors hostage", also said that the crisis means that you can "forget about higher interest rates, complicating matters for central banks everywhere". This will be particularly likely if, as what seemed to happen with Fannie and Freddie's stock price on Monday, the market sees through the continuing lack of an explicit pledge to cover the GSEs' debts and starts to sell the stocks down hard once again.
Thus, the core dilemma. The market wants, and has been led to expect, higher US short-term interest rates, but with the credit crisis continuing to destroy wealth and value everywhere it goes, can the Fed really risk pulling more liquidity out of the system with a rate hike at either its upcoming August 5, or, at the very latest, its September 16 meeting? If it disappoints the markets again, if it is seen to be going back on its word, does it risk a massive loss of credibility in the US financial system, with potential huge subsequent selloffs in the US dollar and US equities? [[Credibility!?! Credibility!?! What's that?: normxxx]]
In Jaws, after it is discovered that the killer shark is still alive, shark expert Matt Hooper (Richard Dreyfus) tells Amity Police chief Martin Brody (Roy Scheider) that he has a bigger concern than just closing the beaches— "You got a bigger problem than that Martin, you still got a hell of a fish out there." Likewise, the killer shark of the credit crisis is still out there, chomping away on the flesh and sinews of the financial markets to its heart's content. The citizens of Amity finally gathered the cojones to hire shark hunter Quint (Robert Shaw) to kill the beast, but in today's totally politically dysfunctional and polarized America, it seems that the operating strategy is to let the monster continue to feed on the innocents until well satiated.
Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at juliandelasantellis@yahoo.com.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Or, How Bush Sandbagged The GSEs
By Julian Delasantellis, AsiaTimes | 16 July 2008
|
Currently, as a result of the ever-worsening crises in US housing finance, a crisis being illustrated by the absolute devastation of the shares in the US government's semi-private semi-public secondary market mortgage wholesalers Fannie Mae and Freddie Mac, and in the government seizing control of mortgage lender IndyMac in one of the largest bank failures in American history, Federal Reserve chairman Ben Bernanke must be raising his gaze to the heavens for a similar entreaty.
"Lord, give me credibility as, and the ability to be, an inflation fighter— but not quite yet." The history of the financial markets since the rescue of Bear Stearns last March 15 is similar to that of the fictional Amity Island in between the first Jaws movie, released in 1975, and its sequel, Jaws 2, from 1978.
At first, after the initial shark had been killed— after Bear Stearns had been saved by aggressive Federal Reserve intervention— everything seemed OK. The markets rallied into mid-May. I would imagine that the souvenir shops selling shark-themed toys and back scratchers on Amity's beaches did likewise. But, then, the markets rolled over: the Dow Jones Industrial Average, after topping out close to 13,200 on May 19, has since lost more than 2,000 points, or 15%. To borrow from the tagline of Jaws 2, "Just when you thought it was safe to go into the stockmarket ... "
Of course, the real danger lying in wait to devour the markets continues to be the crisis in US housing values, as it has now become obvious that the entire edifice of the US financial markets over the past few years has been built on a foundation just about as sturdy as a sandcastle on one of Amity's beaches— the inflated value of US real estate.
Yet, it had been thought that the crisis in subprime mortgages, the root of the financial crises, would leave Fanny and Freddy untouched, since both their respective charters forbade the two enterprises, called government-sponsored entities (GSEs), from investing in them. But it is truly indicative of just how pernicious and metastizing this crisis is that, after devastating all that it has come in contact with for almost a year and a half now, it now strikes deep at the heart of a target previously thought immune.
No one who has wealth or assets in any form, in any currency, is safe— you may as well consider yourself as being at least knee-deep in the shark infested waters of the financial markets. My colleague Chan Akya ably described this burgeoning crisis last week (see And now, for Fannie and Freddie, Asia Times Online, July 12.) He accurately described the possible grim consequences possibly resulting from it, especially a huge expansion of the US federal government's indebtedness, but one thing that needs to be stressed is that because of these events the fight against inflation will most likely once again be placed on the back burner.
"Roosevelt is dead!" the relentlessly rotund radio rabble-rouser Rush Limbaugh cries out every afternoon on the American airwaves, referring to Great Depression and World War II-era US president Franklin Delano Roosevelt. At first, this might seem to be something of an obsessive compulsion with the absolutely obvious, as Roosevelt took his last actual physical breath on earth in April, 1945, shortly before the Allied victory in Europe. But what is really being expressed by Limbaugh is less a declarative statement than a fervent wish that conservatism's triumphs and successes might some day, maybe today, be so overwhelming and comprehensive that, at last, the American public will begin to clamor for the dismantling of the government social safety net emplaced during the Roosevelt era and which has for so long tied the American public to the Democratic Party— and forced those 'malefactors of great wealth' to pay something towards the societal destruction they have wrought, in the form of higher taxes.
Shortly after his re-election victory in 2004, George W Bush apparently thought so, for he immediately staked his political capital on a laissez-faire free-market restructuring plan for the gem in the Roosevelt crown, old-age Social Security. That, and the unpopularity over the Iraq war, drove the Republicans from control of both branches of Congress in the 2006 mid-term elections. Former Republican Senator Rick Santorum of Pennsylvania, defeated in 2006, now probably wishes that he did not have supporters at a 2005 rally that included elderly Social Security pensioners chanting the phrase "Hey hey! Ho ho! Social Security's got to go!"
Like a fungus that dies on exposure to light, the Bush Social Security scheme was dead a few months after it was exposed. However, by then it was impossible for the general media to cover serious issues any longer— they had to come up for sweet draughts of clean and clear tabloid oxygen. Starlets were getting drunk and Brangelina was getting pregnant; both warranted more attention than what the Bush administration was doing with the rest of the government, particularly concerning the always riveting, ever-popular issue of financial markets' regulation.
Grover Norquist, the anti-government jihadist who once said that he wanted to shrink government to such a size that it could be drowned and killed in a bathtub, and his fellow zealots in the Bush administration, certainly got water under their fingernails in dealing with the GSEs. In responding to a series of accounting scandals at the agencies similar to what the rest of the private sector suffered in 2002 and 2003 (see The decline of US equity markets, Asia Times Online, May 10, 2007) Bush and Co pushed the line that these agencies, just like the rest of the government, were poor stewards of, and could not be trusted with, the public purse.
They may have aimed for a bridge too far with the attempted privatization of Social Security, but in then aiming squarely at Fannie and Freddie, which, by financing the suburbs that the GIs returning from World War ll populated en masse, influenced the shape of postwar American life as much as the automobile, the anti-government zealots were zeroing in on a very critical consolation prize. Hoping to hobble the decision making of the two housing agencies, Bush stopped making new appointments to the boards of the GSEs in 2004. He also restricted the amount they could underwrite. There were repeated calls for new regulation of Fannie and Freddie, probably just about the only calls for enhanced regulation that have come out of the US executive branch this millennium. Hearings in the then Republican-controlled Congress were laced with outrage for these two wasteful, bloated government enterprises, whose functions could obviously be carried out in a far superior fashion by the private sector.
The Internet from that era is littered with weighty think tank tomes by such reliably conservative outlets as American Enterprise Institute and Cato Institute, calling for a new, private-sector, risk-transfer mechanism that was not centered around the GSEs. As in the famous curse where the Greek gods would punish mortals by granting their every wish, the Bush free marketeers would get their every wish in the next few years, to their, and the rest of the financial markets, continuing mortification. The core of Freddie and Fannie's operations was to buy up mortgage-backed securities in the open market then either hold them to maturity or sell them back to the market as mortgage-backed securities with the US government's implied backing. Both dispositions transferred the risk of mortgage default away from the banks to Fannie and Freddie.
Up until the freeze up in the credit markets and the crash in subprime finance that occurred last summer, a new risk-transfer mechanism stood as competition in the wholesale mortgage markets. Market shills postulated that, since it did not require participation by the government, it was obviously superior. Instead of having Fannie and Freddie buy the mortgage securities, the new plan involved these being rolled up into mortgage-backed securities (MBS), then sold to other [unsuspecting] private investors, whether they be other commercial and investment banks, hedge funds, or even, as the New York Times reported last December, the city treasury of Narvik, Norway.
After they were sold off once, they were invariably sold off again and again and again, each time, due to the devastatingly alluring miracle of leverage, the original nominal amount of the mortgage being used as collateral for much larger amounts of borrowing and lending. But by not retiring the mortgages through the GSEs, whoever finally wound up with the bonds were still stuck with the risk that the mortgage holders might someday default on the loans. This eventuality was thought to be covered with an instrument called a credit default swap (CDS), in essence, a private insurance policy that the bondholder would purchase from a bank that [hopefully] would pay off in the case of a mortgage holder's default.
With the stranglehold that the Bush administration, and its threatened veto pen, had on any legislative attempts to modernize and adapt the GSEs to current times, slowly the US mortgage market began to evolve away from the purview of Fannie and Freddie.
Regulations prevented Fannie and Freddie from buying up— from "underwriting"— most subprime mortgages because these typically did not carry the substantial borrower downpayments and detailed financial documentation that the agencies' regulations required. Thus, about one third of all mortgage borrowing as the real estate boom frothed over from 2004-2006, went to the CDSs. So did the wholesale market for mortgage loans above the GSEs' statutory limits of $417,000; this meant that, by the end of the boom, even modest three-bedroom, one-bath bungalows in the coastal markets of California and the US Northeast were not longer being underwritten by Fannie and Freddie. By early 2007, as the greed crescendo peaked, Fannie and Freddie were underwriting a mere 40% of the US mortgage market, down from over 60% earlier in the decade.
The rest, of course, is the grim history of the past two years. The subprime market cracked, leading the holders of the CDSs connected with the subprime obligations to start demanding their promised payment from the specialized CDS private insurers, called "monolines". This essentially drove the monolines to the brink of bankruptcy. The shutdown of the market for credit default swaps is what lies at the heart of what we now call the credit crisis [[actually, that last is just phase II of the Credit Crisis; phase I was the shut-down/freezing of the commercial paper market where the MBS' had been traded— until their value dropped precipitously: normxxx]]. Even though they did not make many subprime mortgage loans, Fannie and Fannie still fell victim to the age's greed and arrogance. On any cul-de-sac, in any new housing development, the bankruptcy and forced foreclosure sales of the homes with the subprime mortgages are forcing down the real estate values of the rest of the homes, the ones underwritten by Fannie and Freddie, in the neighborhood.
As the US real estate market staggered and buckled before finally breaking last summer and autumn, some voices were raised advocating fighting the then still-nascent crises with greater participation by Fannie and Freddie, specifically, by allowing the two to buy more, and higher-priced, mortgages. This might have nipped the problem in the bud then, but back last year, Bush, still the free markets' ever-trustworthy troubadour, informed one and all that he would veto any legislation of that nature.
Bush finally saw the light (probably through feeling the heat that was being placed on his party's election prospects this year), and included in last winter's economic stimulus package a geographically limited, temporary increase in the GSE's statutory loan limits, in certain high priced markets, to just under US$730,000. Still, increased authority by Fannie and Freddie are key elements of the mortgage relief rescue package promoted by Democrats Representative Barney Frank and Senator Chris Dodd and now slogging through the Congress, weighed down by Republican legislative legerdemain. Bush has not said one way or another whether he will sign the bill should it reach his desk; every time he implies he might veto the bill, you can just hear the whoosh of the darts heading towards pictures of the president at John McCain's campaign headquarters.
Current reports are indicating that the GSEs are now purchasing about 80% of the new mortgages being made in the US. This is why the two's current financial difficulties, symbolized by the roughly 90% falls in the stock values of both Fannie and Freddie since last August, are so serious. Governments rush in to rescue endangered financial institutions when they are said to be "too big to fail"; if ever that was true, if ever the maxim had any real applicability, surely, with essentially the entire US housing industry now resting on the GSEs' shoulders, the US government cannot stand by disinterested as they bleed to death.
On Sunday evening, the US Treasury Department and Federal Reserve came out with a Fannie/Freddie rescue plan. President Bush was nowhere to be seen in this initiative— the Wall Street Journal reported that there were still free-market holdouts in the White House, apparently the last laissez-faire zealots left in the bunker as reality's punishing howitzers zeroed in, that opposed the deal. The initiative called for a temporary increase in what the GSEs could borrow from the Treasury, as well as increased US government equity investments in Fannie and Freddie stock. These will require authorization from Congress. For its part, the Federal Reserve announced that, for the first time, it was opening its emergency assistance facility, or discount window, designed for member banks (which the GSEs are not— they're not really "banks" at all) to the endangered pair.
Some called this a type of nationalization of the GSEs, akin to what the British government did with Northern Rock bank last year. Others noted that the rescue package did not include a full and clear expression that the US government will now stand behind the obligations of the two. Justin Fox of Time.com's Curious Capitalist blog noted that it seems that the implicit status of the US government's guarantee of the GSE's obligations has gone from "not guaranteed by the United States" to "not guaranteed by the United States, unless they really need to be". Fannie and Freddie shares, as well as the general stock market, rallied strongly on the news at the market's open on Monday, but quickly sold off.
Freddie Mac closed down 8% on the day, Fannie Mae 5%, the Dow Jones Industrial Average closed down 45 points. Perhaps the markets may be now pricing in the possibility that the Bush administration, in a last, flaming Gotterdammerung of free-market philosophy, may indeed put ideology over the fates and fortunes of the entire US financial system to prove that, indeed, no [government-backed] financial institution is too big to fail. What wasn't in the rescue package was a reduction in the interest rates the Federal Reserve uses to manage the short-term money markets, the Federal Reserve's target Federal Funds rate. That it didn't do, even though it did lower by 75 basis points that same rate for the rescue of Bear Stearns in March. The fact that it didn't on this occasion, with the potential insolvency of Fannie and Freddie posing a far greater systemic risk to the economy than the potential bankruptcy of a mere investment bank such as Bear, demonstrates much about the true dire nature of the current circumstances.
After dropping the Federal Funds Target Rate from 5.25% to 2% in eight months, starting in April the Federal Reserve looked around, and, to paraphrase Captain Renault (Claude Rains) from 1942's Casablanca, was "shocked, shocked" to find inflation going on. The standard remedy applied by central banks to an inflationary problem is a hike in interest rates, but, even with rising prices, led by surging futures prices for food and crude oil and its products, moving to the forefront of the Fed's concern since late April, Bernanke and Co have resisted pulling the trigger on a rate hike. Instead, they have resorted to attacking inflation with ever harsher and harsher language [[but they haven't used the F--- word yet!: normxxx]], culminating with the statement that followed the Fed's last meeting on June 25 that seemed to virtually guarantee a rate hike in the near future (see Bernanke's words strike false note, Asia Times Online, June 27, 2008.)
Bernanke's portion in the GSE rescue package is currently limited to the opening of the discount window. That correlates to how he has been dealing with the twin threats of inflation and financial system instability lately: let the endangered institution borrow from the Fed what it needs but limit the provision of excess liquidity to the general economy. How long can this policy bifurcation continue? [[At least until the Dems get back in.: normxxx]] The "Lex" columnist of the Financial Times, which on Saturday described Fannie and Freddie as being like "like a sweet old couple who have suddenly become unhinged and taken their neighbors hostage", also said that the crisis means that you can "forget about higher interest rates, complicating matters for central banks everywhere". This will be particularly likely if, as what seemed to happen with Fannie and Freddie's stock price on Monday, the market sees through the continuing lack of an explicit pledge to cover the GSEs' debts and starts to sell the stocks down hard once again.
Thus, the core dilemma. The market wants, and has been led to expect, higher US short-term interest rates, but with the credit crisis continuing to destroy wealth and value everywhere it goes, can the Fed really risk pulling more liquidity out of the system with a rate hike at either its upcoming August 5, or, at the very latest, its September 16 meeting? If it disappoints the markets again, if it is seen to be going back on its word, does it risk a massive loss of credibility in the US financial system, with potential huge subsequent selloffs in the US dollar and US equities? [[Credibility!?! Credibility!?! What's that?: normxxx]]
In Jaws, after it is discovered that the killer shark is still alive, shark expert Matt Hooper (Richard Dreyfus) tells Amity Police chief Martin Brody (Roy Scheider) that he has a bigger concern than just closing the beaches— "You got a bigger problem than that Martin, you still got a hell of a fish out there." Likewise, the killer shark of the credit crisis is still out there, chomping away on the flesh and sinews of the financial markets to its heart's content. The citizens of Amity finally gathered the cojones to hire shark hunter Quint (Robert Shaw) to kill the beast, but in today's totally politically dysfunctional and polarized America, it seems that the operating strategy is to let the monster continue to feed on the innocents until well satiated.
Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at juliandelasantellis@yahoo.com.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Wednesday, July 16, 2008
Outlook: High Yield Bond Market
Spotlight: The Outlook For The High Yield Bond Market
By Mark Hudoff, PIMCO | 2 July 2008
Q: Given PIMCO’s expectation for a U.S. recession over the cyclical horizon of six to 12 months, what is PIMCO’s view on the high yield market?
Hudoff: The big picture is that there are two cycles at work: a financial cycle and a real economy cycle. Usually, the financial cycle is a hostage to the real economy cycle, in a situation where excesses in the real economy feed through to excesses in the financial economy. During the typical end-of-cycle period, the real economy deteriorates, and the financial economy deflates and is forced to deleverage. High yield spreads typically reflect the movement through these two cycles: spreads will widen as defaults increase (real economy cycle), and liquidity diminishes as balance sheet repair takes hold (financial cycle). The coincidence of these cycles usually amplifies the violence of credit spread volatility during these end-of-cycle periods.
This time may be different. It appears that the traditional concurrence of the real economy–financial cycle has broken down to a degree. The excesses of subprime mortgages, structured products and leveraged buyout (LBO) lending, accelerated realization of the need for balance sheet healing in the financial economy before traditional real economy influences could be fully transmitted.
The U.S. Federal Reserve signaled a commitment to facilitate this healing process with extraordinary measures like backstopping the Bear Stearns takeover by JPMorgan and providing brokers with access to the Fed lending collateral programs. In effect, this "put option" to the financial system was intended to prevent a complete collapse in the disintermediation function. So far, the Fed and other central banks’ actions appear to have stabilized the financial system. Moreover, the actions have made it easier for the financial system to deleverage through re-capitalization.
The open question is whether the healing will be sufficiently advanced in the financial economy to dampen credit spread volatility when the traditional real economy cycle slowdown arrives. It is an important question because entry points are important in high yield. In the past, the optimal entry point in high yield had been associated with periods of realized defaults rather than those periods that involve only mounting expectations for defaults. We witnessed the volatility that increasing expectations for future defaults can have in high yield over the first three months of this year. The Fed’s actions unwound much of that in recent months. Nonetheless, we are still concerned that the real economy may slip into recession.
At this point, we view high yield as bounded by the following considerations: Fundamentals are deteriorating and access to new lending remains strained. The balance between supply and demand in high yield, while much improved compared with the daunting LBO overhang of last year, is at best neutral. Valuation, however, has greatly improved. As such, we are cautiously optimistic about prospective opportunities for high yield investors. We think we are approaching the point where realized defaults will translate into wider high yield spreads, and this in turn makes high yield a potentially compelling risk-reward proposition.
Q: Are you seeing any deterioration in corporate fundamentals yet?
Hudoff: We have started to see some signs that things are getting worse. Earnings have begun to decelerate sharply, going from expectations of modest year-over-year growth to year-over-year declines in the first half of this year. We think earnings will continue to be under pressure and full-year earnings will be flat to lower. That will likely translate into vulnerability for the stock market.
Although corporate fundamentals are starting from a relatively solid basis today compared, for example, with the late 1990s, we expect them to continue to deteriorate in lock-step with the macro economy. We also think the housing problem in the U.S. will continue to weigh on growth. It remains to be seen whether the Fed will be able to put a bottom in the housing market in the near term or if it will be a more protracted process.
Q: Corporate balance sheets have been in good shape leading up to the financial crisis. Will that help soften the blow?
Hudoff: Heading into this period of turbulence last year, corporate fundamentals were the best they’d been in over a decade. We saw some excesses develop— for example, with the frantic pace of LBOs— but in general, companies pre-funded many of their liabilities. Cash was high, debt maturities low.
The healthy state of balance sheets has certainly softened the blow of the credit crisis for many firms so far. However, with a combination of balance sheet repair for financial firms and broad de-leveraging that is translating into tighter lending standards, many corporations that need access to market-based liquidity cannot find suppliers. As a result, we think default rates are going to rise.
Q: How high do you think defaults will go?
Hudoff: In January, Moody’s reported a global default rate of 1.1%. By April, the global default rate had risen to 1.75%. We think defaults will continue to march higher over the year and reach about 5% within 12 months.
We have some models that suggest it could be higher than 5%, but those models do not accommodate the number of "covenant-light deals" which are a characteristic of this market that is different from past markets. There were a lot of bank debt and capital structures created with very loose covenants because investors were flush with cash and there was a lot of competition for yield. In fact, according to S&P, covenant-light deals accounted for about 25% of the new issue market in 2007. We think these could help stave off a rapid acceleration in defaults because the trip wires, or triggers for default, do not get thrown until later— when the company has to prepay or faces amortization or another event.
Historically, 5% is about the average default rate, according to Moody’s. So we should move from well below the average to about average within 12 months.
Q: Markets seem to be pricing in much higher defaults than the long-term average. Why the discrepancy?
Hudoff: At the depths of the market uncertainty in March, spreads in the high yield market implied default rates that were about three percentage points higher than what we expected for 2008, according to PIMCO’s calculations. The main reason was the uncertainty regarding the trajectory of the economy and how successful the Fed would be in stemming the housing and subprime mortgage problems. Effectively, before the "Fed Put" was extended to the financial system in March, the market was increasingly discounting the full real economy–financial cycle paradigm that I already discussed. Now, the markets are discounting a roughly 5% default rate, according to our model.
Q: Is there a scenario in which defaults would rise to meet market expectations?
Hudoff: If the U.S. economy slows more than expected or the disintermediation problem doesn’t get solved in the next six months or so, the risk is that defaults will get worse than we expect. Those trip wires for covenant-light deals could start to get thrown earlier than expected, in the latter part of 2008 and 2009. Under those circumstances, defaults could pick up beyond 5%.
Q: The market for new high yield issues has been very slow. What are the supply and demand dynamics right now?
Hudoff: I would characterize the technical supply and demand picture in high yield as fragile. Usually, there is a rough equilibrium in the high yield market that is established on one side with new issues and credit migration from investment grade into high yield that is reasonably offset by flows into the asset class, bond maturities or retirements and credit migration out of high yield. This balance usually translates into annual new issuance averages between $120 and $150 billion. In concept, if supply exceeds this range, spreads have to increase to draw new investors into the game.
The problem we had last year was that we had a lot more supply than demand. The LBO calendar had produced more than $200 billion in loans and about $100 billion in bonds that had to be absorbed by the high yield market given the lack of structured product and other alternative sources of demand. That represented well over two times the annual new issue supply, according to JPMorgan.
Over the last few months, through a combination of cancellations, restructurings and placements, this overhang has been reduced. We currently think there is roughly $65 billion in bonds and $95 billion in loans that still need to be distributed. This still represents a very large calendar compared to historical periods.
This supply overhang must be worked off before a sustainable rally can take place, and the process will take some time. Volatility over the past few months has prevented supply from coming to the market. In fact, the first three months of this year saw the lowest supply in the high yield market in a decade, according to Merrill Lynch data.
On the demand side, market turbulence has continued to keep the marginal buyers for bank loans— structured products— completely on the sidelines, and it is unclear when they will come back. For now, the only bidders for bank loans and high yield bonds are traditional mutual funds and real money accounts. But even those buyers are mostly sitting on the sidelines with a lot of cash, trying to preserve their capital during this volatile time.
Q: How long before buyers come back and the excess supply is absorbed?
Hudoff: We think it will take at least six to 12 months.
Q: With both fundamentals and supply/demand dynamics fairly fragile right now, have there been any positive developments in the high yield market?
Hudoff: The good news is that valuation has improved. In the high yield market, investors are compensated for taking risk by credit spreads. When spreads widen, at a certain point the spread will properly compensate an investor for taking on the risk. That is when valuation dominates fundamentals and technicals.
Q: Is it time to buy high yield?
Hudoff: Almost. The weakening fundamentals and the technical supply overhang we discussed will continue to put pressure on spreads. So the question is, when will valuation dominate the equation and compel us into high yield because we’ll be compensated for the risk? In other words, when will spreads hit their peak for the cycle?
We have gone through the math, and all of our indicators point to the second half of this year. Looking at history, the recessions in the early 1990s and the early 2000s suggest that the latter part of the year is when spreads start to turn around.
Q: Is there a potential negative scenario that could delay a turnaround in the high yield market?
Hudoff: I think about downside scenarios a lot. In its least negative form, I think the most obvious scenario involves the emergence of another downward leg to the credit crisis. The most obvious source of this would be consumer finance–related exposures and a return to balance sheet uncertainty that tests all the progress made by the Fed in shoring up confidence in the financial economy. A more difficult iteration of this scenario would involve knock-on real economy effects that translate into a deeper and more protracted economic slowdown.
Q: Given PIMCO’s outlook for high yield, how are you investing today?
Hudoff: We will remain cautious and mindful of preserving our clients’ capital, because there is still a considerable amount of uncertainty. So we will try to focus on credits— either sectors or individual securities— that may benefit from the volatility or are immune to it.
We like sectors like utilities and healthcare and names that are relatively defensive. We would try to limit our exposure to companies that are very exposed to discretionary income, such as consumer cyclicals. We are a little concerned about cyclicals overall, including heavy cyclicals, because a moderating economy is not necessarily great for a levered cyclical company.
In general, we are focusing on credits that have good asset coverage so that our downside risk is limited. We like seasoned, big, liquid names that have more proven credit histories and which we have seen pay down debt in the past. Our sweet spot is high single-B, low double-B rated securities, and although that part of the market has been under pressure lately, we believe that is just the ebb and flow of valuation.
We will be very selective in the LBO pipeline. Many bank loans and bonds that were part of leveraged buyout commitments made last year have been sitting on the balance sheets of investment banks. Those that were sold in the third and fourth quarter of last year have since declined in value. We have not really bought any new LBO issues— either loans or bonds— although we have bought some in the secondary market after their prices fell.
This is the time when a cautious approach, with a heavy asset coverage requirement, could potentially pay off.
Q: What is your view on the bank loan market apart from LBOs?
Hudoff: We like bank loans, and we have increased our allocations lately. Why? First, the sector underperformed in 2007. We have never seen this kind of volatility in the loan market. At the same time, bank loans are a higher-quality part of the high yield universe. What we have experienced in the leveraged loan markets over the last few months could be called a "black swan event"— it has been way beyond the realm of normal expectations— and we are happy to take advantage of the opportunities that this dislocation has created.
Second, we like bank loans because they tend to be the first to benefit from a turnaround in the economy. As the economy starts to improve, investors typically start to bid up bank paper. Also, when banks come back to the market as investors, bank loans will most likely be the first kind of paper they buy, and that could provide a technical boost to the market.
Finally, bank loans are priced against LIBOR and eventually LIBOR should go up. The Fed cannot cut rates forever, and the forward curve is not going down at the front end in perpetuity. At some point, the process will reverse.
Q: So bank loans would be a potential long-term investment?
Hudoff: Yes, but bank loans could also benefit sooner than we expect. If the Fed manages to restore confidence in the financial markets quickly, everyone will then become concerned about inflation. In that case, there’s a very good chance that the Fed will take back all of the easing quickly. So the same forces that pushed floaters down and made them appear very unattractive on a yield basis will make them attractive again.
Q: Thank you, Mark.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Mark Hudoff, PIMCO | 2 July 2008
|
Q: Given PIMCO’s expectation for a U.S. recession over the cyclical horizon of six to 12 months, what is PIMCO’s view on the high yield market?
Hudoff: The big picture is that there are two cycles at work: a financial cycle and a real economy cycle. Usually, the financial cycle is a hostage to the real economy cycle, in a situation where excesses in the real economy feed through to excesses in the financial economy. During the typical end-of-cycle period, the real economy deteriorates, and the financial economy deflates and is forced to deleverage. High yield spreads typically reflect the movement through these two cycles: spreads will widen as defaults increase (real economy cycle), and liquidity diminishes as balance sheet repair takes hold (financial cycle). The coincidence of these cycles usually amplifies the violence of credit spread volatility during these end-of-cycle periods.
This time may be different. It appears that the traditional concurrence of the real economy–financial cycle has broken down to a degree. The excesses of subprime mortgages, structured products and leveraged buyout (LBO) lending, accelerated realization of the need for balance sheet healing in the financial economy before traditional real economy influences could be fully transmitted.
The U.S. Federal Reserve signaled a commitment to facilitate this healing process with extraordinary measures like backstopping the Bear Stearns takeover by JPMorgan and providing brokers with access to the Fed lending collateral programs. In effect, this "put option" to the financial system was intended to prevent a complete collapse in the disintermediation function. So far, the Fed and other central banks’ actions appear to have stabilized the financial system. Moreover, the actions have made it easier for the financial system to deleverage through re-capitalization.
The open question is whether the healing will be sufficiently advanced in the financial economy to dampen credit spread volatility when the traditional real economy cycle slowdown arrives. It is an important question because entry points are important in high yield. In the past, the optimal entry point in high yield had been associated with periods of realized defaults rather than those periods that involve only mounting expectations for defaults. We witnessed the volatility that increasing expectations for future defaults can have in high yield over the first three months of this year. The Fed’s actions unwound much of that in recent months. Nonetheless, we are still concerned that the real economy may slip into recession.
At this point, we view high yield as bounded by the following considerations: Fundamentals are deteriorating and access to new lending remains strained. The balance between supply and demand in high yield, while much improved compared with the daunting LBO overhang of last year, is at best neutral. Valuation, however, has greatly improved. As such, we are cautiously optimistic about prospective opportunities for high yield investors. We think we are approaching the point where realized defaults will translate into wider high yield spreads, and this in turn makes high yield a potentially compelling risk-reward proposition.
Q: Are you seeing any deterioration in corporate fundamentals yet?
Hudoff: We have started to see some signs that things are getting worse. Earnings have begun to decelerate sharply, going from expectations of modest year-over-year growth to year-over-year declines in the first half of this year. We think earnings will continue to be under pressure and full-year earnings will be flat to lower. That will likely translate into vulnerability for the stock market.
Although corporate fundamentals are starting from a relatively solid basis today compared, for example, with the late 1990s, we expect them to continue to deteriorate in lock-step with the macro economy. We also think the housing problem in the U.S. will continue to weigh on growth. It remains to be seen whether the Fed will be able to put a bottom in the housing market in the near term or if it will be a more protracted process.
Q: Corporate balance sheets have been in good shape leading up to the financial crisis. Will that help soften the blow?
Hudoff: Heading into this period of turbulence last year, corporate fundamentals were the best they’d been in over a decade. We saw some excesses develop— for example, with the frantic pace of LBOs— but in general, companies pre-funded many of their liabilities. Cash was high, debt maturities low.
The healthy state of balance sheets has certainly softened the blow of the credit crisis for many firms so far. However, with a combination of balance sheet repair for financial firms and broad de-leveraging that is translating into tighter lending standards, many corporations that need access to market-based liquidity cannot find suppliers. As a result, we think default rates are going to rise.
Q: How high do you think defaults will go?
Hudoff: In January, Moody’s reported a global default rate of 1.1%. By April, the global default rate had risen to 1.75%. We think defaults will continue to march higher over the year and reach about 5% within 12 months.
We have some models that suggest it could be higher than 5%, but those models do not accommodate the number of "covenant-light deals" which are a characteristic of this market that is different from past markets. There were a lot of bank debt and capital structures created with very loose covenants because investors were flush with cash and there was a lot of competition for yield. In fact, according to S&P, covenant-light deals accounted for about 25% of the new issue market in 2007. We think these could help stave off a rapid acceleration in defaults because the trip wires, or triggers for default, do not get thrown until later— when the company has to prepay or faces amortization or another event.
Historically, 5% is about the average default rate, according to Moody’s. So we should move from well below the average to about average within 12 months.
Q: Markets seem to be pricing in much higher defaults than the long-term average. Why the discrepancy?
Hudoff: At the depths of the market uncertainty in March, spreads in the high yield market implied default rates that were about three percentage points higher than what we expected for 2008, according to PIMCO’s calculations. The main reason was the uncertainty regarding the trajectory of the economy and how successful the Fed would be in stemming the housing and subprime mortgage problems. Effectively, before the "Fed Put" was extended to the financial system in March, the market was increasingly discounting the full real economy–financial cycle paradigm that I already discussed. Now, the markets are discounting a roughly 5% default rate, according to our model.
Q: Is there a scenario in which defaults would rise to meet market expectations?
Hudoff: If the U.S. economy slows more than expected or the disintermediation problem doesn’t get solved in the next six months or so, the risk is that defaults will get worse than we expect. Those trip wires for covenant-light deals could start to get thrown earlier than expected, in the latter part of 2008 and 2009. Under those circumstances, defaults could pick up beyond 5%.
Q: The market for new high yield issues has been very slow. What are the supply and demand dynamics right now?
Hudoff: I would characterize the technical supply and demand picture in high yield as fragile. Usually, there is a rough equilibrium in the high yield market that is established on one side with new issues and credit migration from investment grade into high yield that is reasonably offset by flows into the asset class, bond maturities or retirements and credit migration out of high yield. This balance usually translates into annual new issuance averages between $120 and $150 billion. In concept, if supply exceeds this range, spreads have to increase to draw new investors into the game.
The problem we had last year was that we had a lot more supply than demand. The LBO calendar had produced more than $200 billion in loans and about $100 billion in bonds that had to be absorbed by the high yield market given the lack of structured product and other alternative sources of demand. That represented well over two times the annual new issue supply, according to JPMorgan.
Over the last few months, through a combination of cancellations, restructurings and placements, this overhang has been reduced. We currently think there is roughly $65 billion in bonds and $95 billion in loans that still need to be distributed. This still represents a very large calendar compared to historical periods.
This supply overhang must be worked off before a sustainable rally can take place, and the process will take some time. Volatility over the past few months has prevented supply from coming to the market. In fact, the first three months of this year saw the lowest supply in the high yield market in a decade, according to Merrill Lynch data.
On the demand side, market turbulence has continued to keep the marginal buyers for bank loans— structured products— completely on the sidelines, and it is unclear when they will come back. For now, the only bidders for bank loans and high yield bonds are traditional mutual funds and real money accounts. But even those buyers are mostly sitting on the sidelines with a lot of cash, trying to preserve their capital during this volatile time.
Q: How long before buyers come back and the excess supply is absorbed?
Hudoff: We think it will take at least six to 12 months.
Q: With both fundamentals and supply/demand dynamics fairly fragile right now, have there been any positive developments in the high yield market?
Hudoff: The good news is that valuation has improved. In the high yield market, investors are compensated for taking risk by credit spreads. When spreads widen, at a certain point the spread will properly compensate an investor for taking on the risk. That is when valuation dominates fundamentals and technicals.
Q: Is it time to buy high yield?
Hudoff: Almost. The weakening fundamentals and the technical supply overhang we discussed will continue to put pressure on spreads. So the question is, when will valuation dominate the equation and compel us into high yield because we’ll be compensated for the risk? In other words, when will spreads hit their peak for the cycle?
We have gone through the math, and all of our indicators point to the second half of this year. Looking at history, the recessions in the early 1990s and the early 2000s suggest that the latter part of the year is when spreads start to turn around.
Q: Is there a potential negative scenario that could delay a turnaround in the high yield market?
Hudoff: I think about downside scenarios a lot. In its least negative form, I think the most obvious scenario involves the emergence of another downward leg to the credit crisis. The most obvious source of this would be consumer finance–related exposures and a return to balance sheet uncertainty that tests all the progress made by the Fed in shoring up confidence in the financial economy. A more difficult iteration of this scenario would involve knock-on real economy effects that translate into a deeper and more protracted economic slowdown.
Q: Given PIMCO’s outlook for high yield, how are you investing today?
Hudoff: We will remain cautious and mindful of preserving our clients’ capital, because there is still a considerable amount of uncertainty. So we will try to focus on credits— either sectors or individual securities— that may benefit from the volatility or are immune to it.
We like sectors like utilities and healthcare and names that are relatively defensive. We would try to limit our exposure to companies that are very exposed to discretionary income, such as consumer cyclicals. We are a little concerned about cyclicals overall, including heavy cyclicals, because a moderating economy is not necessarily great for a levered cyclical company.
In general, we are focusing on credits that have good asset coverage so that our downside risk is limited. We like seasoned, big, liquid names that have more proven credit histories and which we have seen pay down debt in the past. Our sweet spot is high single-B, low double-B rated securities, and although that part of the market has been under pressure lately, we believe that is just the ebb and flow of valuation.
We will be very selective in the LBO pipeline. Many bank loans and bonds that were part of leveraged buyout commitments made last year have been sitting on the balance sheets of investment banks. Those that were sold in the third and fourth quarter of last year have since declined in value. We have not really bought any new LBO issues— either loans or bonds— although we have bought some in the secondary market after their prices fell.
This is the time when a cautious approach, with a heavy asset coverage requirement, could potentially pay off.
Q: What is your view on the bank loan market apart from LBOs?
Hudoff: We like bank loans, and we have increased our allocations lately. Why? First, the sector underperformed in 2007. We have never seen this kind of volatility in the loan market. At the same time, bank loans are a higher-quality part of the high yield universe. What we have experienced in the leveraged loan markets over the last few months could be called a "black swan event"— it has been way beyond the realm of normal expectations— and we are happy to take advantage of the opportunities that this dislocation has created.
Second, we like bank loans because they tend to be the first to benefit from a turnaround in the economy. As the economy starts to improve, investors typically start to bid up bank paper. Also, when banks come back to the market as investors, bank loans will most likely be the first kind of paper they buy, and that could provide a technical boost to the market.
Finally, bank loans are priced against LIBOR and eventually LIBOR should go up. The Fed cannot cut rates forever, and the forward curve is not going down at the front end in perpetuity. At some point, the process will reverse.
Q: So bank loans would be a potential long-term investment?
Hudoff: Yes, but bank loans could also benefit sooner than we expect. If the Fed manages to restore confidence in the financial markets quickly, everyone will then become concerned about inflation. In that case, there’s a very good chance that the Fed will take back all of the easing quickly. So the same forces that pushed floaters down and made them appear very unattractive on a yield basis will make them attractive again.
Q: Thank you, Mark.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
You Knew It Was A Bear Market When…
Mean Street: You Knew It Was A Bear Market On Wall Street When…
, Deal Journal
You knew it was a bear market on Wall Street when:
1. You received yet another "Dear John" letter from your panicking money manager that started, "As I’m sure you know, the month of June has been very challenging…" and ends with the old tease that, "It is in the most challenging of markets that the greatest opportunities appear."
2. You told your wife that the crisis on Wall Street is actually a good thing, as it will bring New York real-estate prices down and make it easier to buy a bigger place. Even though you had bought your apartment less than two years ago, you have no children, your mother (who was living with you) died early this year, and you will be lucky to get any bonus this year.
3. You didn’t have to lie to your friends anymore about the drive time from New York City to the Hamptons. With the roads empty, it finally takes that hour and 45 minutes you always pretended it did.
4. You received an eerily familiar email from your company CEO full of resolve that the firm would come out of this difficult period stronger than ever. Then you realized– it was the same email you received three months ago, but from the CEO of a different company whose stock you own, and which has since gone BK.
5. Your cubicle was moved yet again as your office floor underwent its fourth reorganization/consolidation in less than a year. Your company now occupies only a fourth of a floor in a building where previously they had occupied six floors. Since the rest of the floor has not yet been sublet— after a year— it is hauntingly empty and has a tendency to echo. (There are rumors of ghosts of old customer reps who had died at their desks being seen wandering about.) You speculated on whether it was a good sign that you were sitting closer to your boss (who had lost his private office a couple of reorgs ago) until you found out you were the only two left in the department— and you were the one closest to the photocopier.
6. You recalled how you all laughed about the pilot program to outsource banking work to India. When it went fully operational and you were told to pack your things for an 'extended overseas assignment', you stopped laughing.
7.Your company medical plan was 'improved' yet again. To 'improve' fraud detection, medical claims were now only to be paid if the CEO personally approved/signed off, in advance— you hear the backlog is two years. The company life insurance plan now only pays off if you die of an approved disease or accident. Falls from high buildings are not on the list.
8. You felt relieved that the value of all your company vested and unvested shares and options was down only 50% from its peak nine months ago. Never mind that you could have easily dumped most of the shares at prices that won’t be seen for another 10 years, if then.
9. The retirement plan was further 'simplified/enhanced' to reward loyal, long-time personnel. The company 'match' is now a function of company profits. (However, the company has not been profitable in the last three years.).
10. After months of naysaying the agriculture boom, you finally succumbed and found tremendous value in the shares of a $72 billion fertilizer company that was worth a 10th of that two years ago. The stock price has not moved since you bought it.
11. You walked around smartly reminding everyone at the firm how you had warned them that the traders would finally get their comeuppance. That is, until you remembered that the traders are still running your bank and most of Wall Street.
Yes, Virginia, there is a bear market out there.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
, Deal Journal
|
You knew it was a bear market on Wall Street when:
1. You received yet another "Dear John" letter from your panicking money manager that started, "As I’m sure you know, the month of June has been very challenging…" and ends with the old tease that, "It is in the most challenging of markets that the greatest opportunities appear."
2. You told your wife that the crisis on Wall Street is actually a good thing, as it will bring New York real-estate prices down and make it easier to buy a bigger place. Even though you had bought your apartment less than two years ago, you have no children, your mother (who was living with you) died early this year, and you will be lucky to get any bonus this year.
3. You didn’t have to lie to your friends anymore about the drive time from New York City to the Hamptons. With the roads empty, it finally takes that hour and 45 minutes you always pretended it did.
4. You received an eerily familiar email from your company CEO full of resolve that the firm would come out of this difficult period stronger than ever. Then you realized– it was the same email you received three months ago, but from the CEO of a different company whose stock you own, and which has since gone BK.
5. Your cubicle was moved yet again as your office floor underwent its fourth reorganization/consolidation in less than a year. Your company now occupies only a fourth of a floor in a building where previously they had occupied six floors. Since the rest of the floor has not yet been sublet— after a year— it is hauntingly empty and has a tendency to echo. (There are rumors of ghosts of old customer reps who had died at their desks being seen wandering about.) You speculated on whether it was a good sign that you were sitting closer to your boss (who had lost his private office a couple of reorgs ago) until you found out you were the only two left in the department— and you were the one closest to the photocopier.
6. You recalled how you all laughed about the pilot program to outsource banking work to India. When it went fully operational and you were told to pack your things for an 'extended overseas assignment', you stopped laughing.
7.Your company medical plan was 'improved' yet again. To 'improve' fraud detection, medical claims were now only to be paid if the CEO personally approved/signed off, in advance— you hear the backlog is two years. The company life insurance plan now only pays off if you die of an approved disease or accident. Falls from high buildings are not on the list.
8. You felt relieved that the value of all your company vested and unvested shares and options was down only 50% from its peak nine months ago. Never mind that you could have easily dumped most of the shares at prices that won’t be seen for another 10 years, if then.
9. The retirement plan was further 'simplified/enhanced' to reward loyal, long-time personnel. The company 'match' is now a function of company profits. (However, the company has not been profitable in the last three years.).
10. After months of naysaying the agriculture boom, you finally succumbed and found tremendous value in the shares of a $72 billion fertilizer company that was worth a 10th of that two years ago. The stock price has not moved since you bought it.
11. You walked around smartly reminding everyone at the firm how you had warned them that the traders would finally get their comeuppance. That is, until you remembered that the traders are still running your bank and most of Wall Street.
Yes, Virginia, there is a bear market out there.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
The Numbers Speak
The Numbers Speak For Themselves
By Bill Alpert | 13 July 2008
How Stock Analysis Based On Statistics And Computers Sabotaged Itself
Wall Street's quants have been forced back to the drawing board— Again. In 2007, many of these computer-skilled fund managers underperformed their liberal arts peers for the first time in almost a decade. Returns averaged 6% last year for the traditional long-short equity funds measured by Lipper, while quantitatively-managed counterparts gained less than 1%. The reversals for many quants were worst in a few days last summer that left the rest of the market relatively unscathed.
The quant crowd's lackluster season followed a triumphant era that began with the burst of the tech bubble in 2000. Applying statistics and computers to the analysis of stock prices and company financials, quants enjoyed seven years of steady outperformance [[Gee! Just like the Egyptians under Joseph.: normxxx]]. Money flowed in. By some measures, the assets under management of quants grew at twice the rate of traditionally-invested money. If you count "enhanced" index funds and brokers' proprietary trading desks, you can conclude that quants run upwards of a trillion dollars.
But hand-wringing was the order of business at a June 17 assembly at a Cipriani restaurant in Manhattan, hosted by Joseph Mezrich, who runs quantitative research for Nomura Securities International. Mezrich asked the assembled eggheads if their Golden Era was over. Most speakers thought not, but worried aloud that too many quants were using the same data and mathematical models to pile in and out of the same investments [[Gee. Whoever would have suspected? Do you think that the fact that they had all come from the same B schools, and read the same books, and worshiped the same gods had anything to do with it?: normxxx]].
"So many people were looking at the same signals," said David M. Modest, an experienced quant who most recently ran a proprietary portfolio for JPMorgan Chase.
Quants often form portfolios based on "factors," which are generic characteristics of a stock, like: price-to-earnings, improving company profits or stock price momentum. If research shows that stocks drop when company earnings come from bookkeeping accruals instead of real cashflow, a quant might buy stocks with the lowest accruals and short those with the highest. Any broad phenomenon that seems to move stocks can become a factor. But in recent years, many quants favored value factors like price-to-book, in the spirit of a 1993 study by University of Chicago professor Eugene Fama and Dartmouth professor Kenneth French that helped establish the approach.
Value investing was a fruitful style after the excesses of the dot-com mania. From 2000 to 2007, the market awarded the longest winning streak in a quarter century to stocks that were cheap relative to their book value. But the streak ended last year, when the subprime credit crisis began.
In a credit crisis, investors shun stocks of companies they think might default, even if those stocks are already cheap. And value portfolios tend to include more than their share of companies considered likely to default (basing that likelihood on their balance sheets). In a chart (reproduced at right, below), Mezrich shows that cheap stocks have only gotten cheaper in today's subprime crisis and in the 2002 scandals that sank Enron and Tyco.
The link between valuation and default risk has clobbered quants who favor value factors. In the second half of last year, growth stocks did paradoxically well even though the overall market declined. This year, momentum stocks, with uptrending prices, have been the leaders. At the Nomura meeting, and in a timely new survey sponsored by the Research Foundation of the CFA Institute, the U.S. market's style rotation from value to momentum got much of the blame for quants' mediocre performance of late.
But quants generally blame themselves for the abruptly-bad days that many suffered last summer. Markets formerly unlinked have become correlated, thanks to financial engineering— as the upper lefthand chart shows. Since around 2001, S&P 500 index options have moved in step with the spread between corporate bonds and Treasuries. One after another, asset movements have become linked: commodities, emerging-market stocks, credit-default swaps...even wheat futures.
Newly-invented derivatives and computerized hedging strategies have increased the "connectedness" of the financial system in the U.S., and indeed, the world. So when an investor suddenly sells in one market— last summer's jolt was widely attributed to Goldman Sachs' quantitative Global Alpha Fund— the selling can spread to other markets as quants respond in unanticipated ways. "We've made the financial markets incredibly complicated," Modest said [[immodestly: normxxx]].
The heightened risk from systemic repercussions has been widely debated among quants since hedge-fund veteran Richard Bookstaber made it the theme of his influential 2007 book "A Demon of Our Own Design." Bookstaber's ideas have gotten high props from Mezrich and Modest.
Last summer's sandbagging convinced many quants that their discipline has neglected its study of risk. The typical quant analyst works diligently to model stock returns, said Tony H. Elavia, an investment fund chief at New York Life, to the Nomura audience. But he then outsources the modeling of risk, which is Wall Street's term for stuff that can cause a portfolio's performance to fluctuate too widely. Risk considerations can include the covariance of a portfolio's stocks with one another [[ie, the degree to which stocks in a portfolio are NOT independnt as assumed: normxxx]] or the portfolio's unintended exposure to macroeconomic factors [[but in any case is far less susceptible to 'pure' mathematical analysis and modeling, especially at the extremes— where genuinely 'new' conditions manifest themselves: normxxx]].
Most quants subscribe to the Barra risk modeling service of Morgan Stanley spinoff MSCI (ticker: MXB). And the Barra equity risk model has been virtually unchanged for decades, say many quants, apart from its ongoing recalculation of covariances. With so much money riding on the same risk model, quants found themselves all exposed to the same stocks last summer. In the rush for the exits, the Barra models proved poor guides.
Another cause for flagellation was the excessive use of leverage by quants at hedge funds and proprietary trading desks. When a quant has found a factor that produces modest investment returns, she's often tempted to magnify those returns by using short-sale proceeds and margin loans to lever up the bet ... sometimes five— to ten-fold. Leverage came in for harsh criticism among the several dozen money managers surveyed by the CFA Institute study authors, Yale finance professor Frank J. Fabozzi and researchers from the Intertek Group in Paris, Sergio Focardi and Caroline Jonas. "Everyone is greedy," said one of the study's respondents, "and they have leveraged their strategies up to the eyeballs."
Of course, stock picking has been hard for everyone in the last year, quants and traditionalists alike. In an unsettling illustration (shown above), Mezrich shows that since 2006 fewer stocks have been outperforming the market (delivering "alpha," in Street parlance), and stock performance has become more dispersed (increasing the penalty for picking the wrong stocks) [[and making the 'right' stocks less easily identified through 'traditional' statistical measures: normxxx]].
Mezrich's research tracks the performance of 55 popular equity-ranking factors, including measures of value, growth, earnings quality, profitability, analysts' estimates and stock momentum. Unhappily, the predictive power of these factors has eroded lately— approaching the lowest level in the past 20 years, except for the tech-bubble lunacy.
Twelve months of mediocre performance isn't enough data to disprove the quants' skills (or those of any other investors). Veterans like David Modest believe that quants need merely to roll up their sleeves and find return-generating factors that haven't been widely exploited [[very interesting; but the more arcane such measures that are found, the shorter their effective lifespan is likely to be and the more likely they are to prove spurious (i.e., holding true only for the data set analyzed, but failing when that dataset is enlarged with new data); ah the woes of Wall Street— and correlational analysis!: normxxx]].
And with the extreme performance of momentum stocks lately, even the tried-and-true value factors may be due for a revival. The spread between value and momentum is now more extreme than in any period in Mezrich's 35 years of data. Quants (and many other smart investors) like to bet that extreme values will revert to historical means. A Mezrich chart (at right) shows the depth of returns to a portfolio of stocks with a low price-to-book and a low price momentum (as measured by trailing year's return minus the latest month's). A turn may be coming [[or the results may be telling us something— like the 'traditional' definitions of value may be failing: normxxx]].
Wall Street's science-class dropouts have found something not quite displeasing in the misfortunes of their quant friends. Quants themselves see plenty of improvements they'd like to make, but they don't think their scientific paradigm has crumbled.
"Is the jig up?" No, says Mezrich. "Is it harder?" Yes.
— — — — — — — — — — — — — — — — — — — —
E-Mail Comments To Mail@Barrons.Com
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Bill Alpert | 13 July 2008
How Stock Analysis Based On Statistics And Computers Sabotaged Itself
|
Wall Street's quants have been forced back to the drawing board— Again. In 2007, many of these computer-skilled fund managers underperformed their liberal arts peers for the first time in almost a decade. Returns averaged 6% last year for the traditional long-short equity funds measured by Lipper, while quantitatively-managed counterparts gained less than 1%. The reversals for many quants were worst in a few days last summer that left the rest of the market relatively unscathed.
The quant crowd's lackluster season followed a triumphant era that began with the burst of the tech bubble in 2000. Applying statistics and computers to the analysis of stock prices and company financials, quants enjoyed seven years of steady outperformance [[Gee! Just like the Egyptians under Joseph.: normxxx]]. Money flowed in. By some measures, the assets under management of quants grew at twice the rate of traditionally-invested money. If you count "enhanced" index funds and brokers' proprietary trading desks, you can conclude that quants run upwards of a trillion dollars.
But hand-wringing was the order of business at a June 17 assembly at a Cipriani restaurant in Manhattan, hosted by Joseph Mezrich, who runs quantitative research for Nomura Securities International. Mezrich asked the assembled eggheads if their Golden Era was over. Most speakers thought not, but worried aloud that too many quants were using the same data and mathematical models to pile in and out of the same investments [[Gee. Whoever would have suspected? Do you think that the fact that they had all come from the same B schools, and read the same books, and worshiped the same gods had anything to do with it?: normxxx]]."So many people were looking at the same signals," said David M. Modest, an experienced quant who most recently ran a proprietary portfolio for JPMorgan Chase.
Quants often form portfolios based on "factors," which are generic characteristics of a stock, like: price-to-earnings, improving company profits or stock price momentum. If research shows that stocks drop when company earnings come from bookkeeping accruals instead of real cashflow, a quant might buy stocks with the lowest accruals and short those with the highest. Any broad phenomenon that seems to move stocks can become a factor. But in recent years, many quants favored value factors like price-to-book, in the spirit of a 1993 study by University of Chicago professor Eugene Fama and Dartmouth professor Kenneth French that helped establish the approach.
Value investing was a fruitful style after the excesses of the dot-com mania. From 2000 to 2007, the market awarded the longest winning streak in a quarter century to stocks that were cheap relative to their book value. But the streak ended last year, when the subprime credit crisis began.
In a credit crisis, investors shun stocks of companies they think might default, even if those stocks are already cheap. And value portfolios tend to include more than their share of companies considered likely to default (basing that likelihood on their balance sheets). In a chart (reproduced at right, below), Mezrich shows that cheap stocks have only gotten cheaper in today's subprime crisis and in the 2002 scandals that sank Enron and Tyco.
The link between valuation and default risk has clobbered quants who favor value factors. In the second half of last year, growth stocks did paradoxically well even though the overall market declined. This year, momentum stocks, with uptrending prices, have been the leaders. At the Nomura meeting, and in a timely new survey sponsored by the Research Foundation of the CFA Institute, the U.S. market's style rotation from value to momentum got much of the blame for quants' mediocre performance of late.But quants generally blame themselves for the abruptly-bad days that many suffered last summer. Markets formerly unlinked have become correlated, thanks to financial engineering— as the upper lefthand chart shows. Since around 2001, S&P 500 index options have moved in step with the spread between corporate bonds and Treasuries. One after another, asset movements have become linked: commodities, emerging-market stocks, credit-default swaps...even wheat futures.
Newly-invented derivatives and computerized hedging strategies have increased the "connectedness" of the financial system in the U.S., and indeed, the world. So when an investor suddenly sells in one market— last summer's jolt was widely attributed to Goldman Sachs' quantitative Global Alpha Fund— the selling can spread to other markets as quants respond in unanticipated ways. "We've made the financial markets incredibly complicated," Modest said [[immodestly: normxxx]].
The heightened risk from systemic repercussions has been widely debated among quants since hedge-fund veteran Richard Bookstaber made it the theme of his influential 2007 book "A Demon of Our Own Design." Bookstaber's ideas have gotten high props from Mezrich and Modest.
Last summer's sandbagging convinced many quants that their discipline has neglected its study of risk. The typical quant analyst works diligently to model stock returns, said Tony H. Elavia, an investment fund chief at New York Life, to the Nomura audience. But he then outsources the modeling of risk, which is Wall Street's term for stuff that can cause a portfolio's performance to fluctuate too widely. Risk considerations can include the covariance of a portfolio's stocks with one another [[ie, the degree to which stocks in a portfolio are NOT independnt as assumed: normxxx]] or the portfolio's unintended exposure to macroeconomic factors [[but in any case is far less susceptible to 'pure' mathematical analysis and modeling, especially at the extremes— where genuinely 'new' conditions manifest themselves: normxxx]].
Most quants subscribe to the Barra risk modeling service of Morgan Stanley spinoff MSCI (ticker: MXB). And the Barra equity risk model has been virtually unchanged for decades, say many quants, apart from its ongoing recalculation of covariances. With so much money riding on the same risk model, quants found themselves all exposed to the same stocks last summer. In the rush for the exits, the Barra models proved poor guides.Another cause for flagellation was the excessive use of leverage by quants at hedge funds and proprietary trading desks. When a quant has found a factor that produces modest investment returns, she's often tempted to magnify those returns by using short-sale proceeds and margin loans to lever up the bet ... sometimes five— to ten-fold. Leverage came in for harsh criticism among the several dozen money managers surveyed by the CFA Institute study authors, Yale finance professor Frank J. Fabozzi and researchers from the Intertek Group in Paris, Sergio Focardi and Caroline Jonas. "Everyone is greedy," said one of the study's respondents, "and they have leveraged their strategies up to the eyeballs."
Of course, stock picking has been hard for everyone in the last year, quants and traditionalists alike. In an unsettling illustration (shown above), Mezrich shows that since 2006 fewer stocks have been outperforming the market (delivering "alpha," in Street parlance), and stock performance has become more dispersed (increasing the penalty for picking the wrong stocks) [[and making the 'right' stocks less easily identified through 'traditional' statistical measures: normxxx]].
Mezrich's research tracks the performance of 55 popular equity-ranking factors, including measures of value, growth, earnings quality, profitability, analysts' estimates and stock momentum. Unhappily, the predictive power of these factors has eroded lately— approaching the lowest level in the past 20 years, except for the tech-bubble lunacy.
Twelve months of mediocre performance isn't enough data to disprove the quants' skills (or those of any other investors). Veterans like David Modest believe that quants need merely to roll up their sleeves and find return-generating factors that haven't been widely exploited [[very interesting; but the more arcane such measures that are found, the shorter their effective lifespan is likely to be and the more likely they are to prove spurious (i.e., holding true only for the data set analyzed, but failing when that dataset is enlarged with new data); ah the woes of Wall Street— and correlational analysis!: normxxx]].
And with the extreme performance of momentum stocks lately, even the tried-and-true value factors may be due for a revival. The spread between value and momentum is now more extreme than in any period in Mezrich's 35 years of data. Quants (and many other smart investors) like to bet that extreme values will revert to historical means. A Mezrich chart (at right) shows the depth of returns to a portfolio of stocks with a low price-to-book and a low price momentum (as measured by trailing year's return minus the latest month's). A turn may be coming [[or the results may be telling us something— like the 'traditional' definitions of value may be failing: normxxx]].Wall Street's science-class dropouts have found something not quite displeasing in the misfortunes of their quant friends. Quants themselves see plenty of improvements they'd like to make, but they don't think their scientific paradigm has crumbled.
"Is the jig up?" No, says Mezrich. "Is it harder?" Yes.
— — — — — — — — — — — — — — — — — — — —
E-Mail Comments To Mail@Barrons.Com
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Coal's Run... Over or Not?
Coal's Run May Be Far From Over
By Jamie Dlugosch | 11 July 2008
As if someone threw a light switch, the coal sector made an abrupt turn to the downside July 2 when investors decided to cash in on huge gains. In two days of trading in advance of the Fourth of July, shares fell nearly 20% across the board. Such is life in a volatile bear market. Even the sectors that are managing to perform in this environment can get crushed at the drop of a hat.
The price for speculation is certainly increasing, but what about investing? Can investors make a buck in this environment? Our participants in Strategy Lab Open have been making more than a buck or two investing in the entire energy complex, including coal. Does the recent pullback in the group, specifically as it relates to Arch Coal (ACI), provide a buying opportunity for long-term investors?
One of our best investors, Jim Van Meerten, is skeptical and states, "If you are looking at Arch as a long term play I think you may have come to the dance too late, the big money seems to already have been made and all the big players got here way ahead of you."
Blogger Tom Armistead concurs, "Arch Coal (ACI) has been a wonderful growth story, making its way from $27.76 to as high as $77.40 over the past year. It recently sold off to the tune of 15%, closing [today] at $59.89, which raises the question whether this is a good time to try to catch the falling dagger— a question I would answer in the negative."
I would tend to agree with the above, but I think we need to be open to the possibility that coal's run is far from over. Though I agree with those who say oil is a bubble waiting to pop, I am not certain such a deflation is imminent. Even then, I am not convinced falling oil prices would be detrimental to the coal sector. Specifically, coal offers some intriguing advantages over its carbon brother. Clean-burning technology allows coal to be considered an alternative to other, more-polluting sources.
With supplies of coal plentiful in the U.S., demand for Arch's reserves can be counted on to drive future earnings. Absent that, I would be less than enthusiastic. As for the bubble talk, I would contend that an end may be down the road. Check out any other bubble over the past decade and what you will see is a significant lag between the time of its identification and its collapse. That means investors can enjoy a period whereby the risk in speculating is fairly muted. Investors relying on momentum then can increase profits by adding to positions when stock prices drop unexpectedly.
That seems to be the case with Arch. After last week's two-day correction, Citigroup raised its rating of Arch, confirming the buy-on-the-dips thesis. The fundamentals certainly suggest doing so. Russ of RD's Picks pipes up with this: "ACI fundamentals still look strong. Despite a trailing PE of over 40, the stock sells for only 11 times 2009 estimates[!?!] and those analyst estimates have been climbing steadily over the past few months." Many investors have been burned by great fundamentals that suddenly go sour when earnings collapse. That was the case with the home-building sector. Will it be the same with coal?
I don't think so.
As I mentioned above, coal demand is fairly strong. If you include the potential of coal-to-liquid technology, we could see coal usage increase even if demand for oil drops. Add in the power-generation needs of the rest of the world, and you have the ingredients for long-term gains with Arch. I would be a buyer, taking advantage of a short-term 15% correction in the stock, but I'll let blogger Russ have the last word:
"Energy stocks in general have been doing well in this tough market. Although there's no way to know for sure if that will continue, I don't see any reason for energy companies to start underperforming." Given that strength, having some energy exposure in a portfolio makes a lot of sense, and Arch is a good way to get that exposure.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Jamie Dlugosch | 11 July 2008
|
As if someone threw a light switch, the coal sector made an abrupt turn to the downside July 2 when investors decided to cash in on huge gains. In two days of trading in advance of the Fourth of July, shares fell nearly 20% across the board. Such is life in a volatile bear market. Even the sectors that are managing to perform in this environment can get crushed at the drop of a hat.
The price for speculation is certainly increasing, but what about investing? Can investors make a buck in this environment? Our participants in Strategy Lab Open have been making more than a buck or two investing in the entire energy complex, including coal. Does the recent pullback in the group, specifically as it relates to Arch Coal (ACI), provide a buying opportunity for long-term investors?
One of our best investors, Jim Van Meerten, is skeptical and states, "If you are looking at Arch as a long term play I think you may have come to the dance too late, the big money seems to already have been made and all the big players got here way ahead of you."
Blogger Tom Armistead concurs, "Arch Coal (ACI) has been a wonderful growth story, making its way from $27.76 to as high as $77.40 over the past year. It recently sold off to the tune of 15%, closing [today] at $59.89, which raises the question whether this is a good time to try to catch the falling dagger— a question I would answer in the negative."
I would tend to agree with the above, but I think we need to be open to the possibility that coal's run is far from over. Though I agree with those who say oil is a bubble waiting to pop, I am not certain such a deflation is imminent. Even then, I am not convinced falling oil prices would be detrimental to the coal sector. Specifically, coal offers some intriguing advantages over its carbon brother. Clean-burning technology allows coal to be considered an alternative to other, more-polluting sources.
With supplies of coal plentiful in the U.S., demand for Arch's reserves can be counted on to drive future earnings. Absent that, I would be less than enthusiastic. As for the bubble talk, I would contend that an end may be down the road. Check out any other bubble over the past decade and what you will see is a significant lag between the time of its identification and its collapse. That means investors can enjoy a period whereby the risk in speculating is fairly muted. Investors relying on momentum then can increase profits by adding to positions when stock prices drop unexpectedly.
That seems to be the case with Arch. After last week's two-day correction, Citigroup raised its rating of Arch, confirming the buy-on-the-dips thesis. The fundamentals certainly suggest doing so. Russ of RD's Picks pipes up with this: "ACI fundamentals still look strong. Despite a trailing PE of over 40, the stock sells for only 11 times 2009 estimates[!?!] and those analyst estimates have been climbing steadily over the past few months." Many investors have been burned by great fundamentals that suddenly go sour when earnings collapse. That was the case with the home-building sector. Will it be the same with coal?
I don't think so.
As I mentioned above, coal demand is fairly strong. If you include the potential of coal-to-liquid technology, we could see coal usage increase even if demand for oil drops. Add in the power-generation needs of the rest of the world, and you have the ingredients for long-term gains with Arch. I would be a buyer, taking advantage of a short-term 15% correction in the stock, but I'll let blogger Russ have the last word:
"Energy stocks in general have been doing well in this tough market. Although there's no way to know for sure if that will continue, I don't see any reason for energy companies to start underperforming." Given that strength, having some energy exposure in a portfolio makes a lot of sense, and Arch is a good way to get that exposure.
|
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Soros, The Man Who Cries Wolf
Soros, The Man Who Cries Wolf, Now Is Warning Of A 'Superbubble'
By Greg Ip, WSJ | 30 June 2008
Mr. Soros, the chairman of Soros Fund Management, is best-known as a speculator, philanthropist and political activist. He made a fortune by doing things such as betting against Britain's currency in 1992 and Thailand's in 1997. A Hungarian refugee, he has spent millions to promote democracy and learning in post-Soviet nations. He also has spent heavily to promote liberal causes and has been an ardent critic of President Bush.
But Mr. Soros, 77 years old, wants to be remembered most as a philosopher. Since he was a student in 1952, he has been promoting his economic theory, which he calls "reflexivity." In essence, he argues that markets don't simply reflect fundamental determinants but can change those determinants in a way that causes asset prices to go to extremes. In his latest book, "The New Paradigm for Financial Markets," he argues a "superbubble" has developed in the past 25 years and it is now collapsing.
Mr. Soros's predictions in his books have fallen far short of his track record as a hedge-fund operator. In 1987 he wrote that the world had to ditch the dollar in favor of a new international currency system or risk "financial turmoil, beggar-thy-neighbor policies leading to world-wide depression and perhaps even war." His 1998 book said, "The global capitalist system ... is coming apart at the seams." In recent interviews in Washington and New York, The Wall Street Journal asked him about his forecast— why he succeeds financially when his world view has been so wrong— and about his aspirations to be a philosopher. Excerpts:
WSJ: You've said this is the worst financial crisis since the Great Depression. Yet at its worst, the stock market was only down 18%. That doesn't seem Depression-like. Is this as bad as it gets?
Mr. Soros: I think that the decline in housing prices is going to be more precipitous and go further than people currently expect. To expect [to come] out of the recession by the end of the year, I find that inconceivable. But I can envisage a very broad range of scenarios. One would be a very prolonged world-wide recession.
I cannot imagine a replay of the '30s. But you can have a 'muddle-through' replay of the Japanese scenario— 10 years of stagnation. The employment figures are still very, very satisfactory. Part of this is due to the impact of the lower dollar in stimulating exports and partly to the very strong position of the corporate sector. The economy turned out to be structurally in very good shape.
WSJ: You argue that the crises we've experienced in the past 25 years have been, in retrospect, "testing events" that convince us the system is stable, encourage us to take even bigger risks, leading to one, cataclysmic collapse. Could this be just another testing event?
Mr. Soros: Each time the authorities saved us, that reinforced the belief that markets are self-correcting. Each time when you bail out the economy, you need to find a new motor, a new source of credit and a new instrument that allows for the credit expansion. [It's] difficult to imagine what [more] you can do when you are already lending effectively 100% on inflated house prices.
I have a record of crying wolf at these times. I did it first in "The Alchemy of Finance" [in 1987], then in "The Crisis of Global Capitalism" [in 1998] and now in this book. So it's three books predicting disaster. [But, after] the boy cried wolf three times ... the wolf really came. If we can sail through this without a recession, then the 'superbubble story' is seriously impacted ... I [will] have cried wolf again. Unfortunately, if you go into a recession, [it is not] proof of reflexivity, or vice versa.
WSJ: How is that you are rich despite your world view having been wrong so far?
Mr. Soros: I'm only rich because I know when I'm wrong.
WSJ: How do you stay levelheaded in the middle of a bubble?
Mr. Soros: I don't. I panic. The same thing applies to me as to everybody else, so I'm given to euphoria and despair. And I would say that I basically have survived by recognizing my mistakes. I very often used to get backaches due to the fact that I was wrong. Whenever you are wrong you have to fight or [take] flight. When [I] make the decision, the backache goes away. I don't always make the right decision. I sometimes cut my losses when I shouldn't.
WSJ: Is reflexivity really behind your success, or are you just a good trader?
Mr. Soros: My performance currently is not that good, but taking the longer [view] it is kind of outstanding. There are two possible explanations. One is the theory [of reflexivity] and the other is the backache. And I think it's really the combination of both because recognizing reflexivity drives you to this constant re-examination.
WSJ: Would you prefer to be remembered as a philosopher than as a successful speculator or philanthropist?
Mr. Soros: Much more. You know, people have hang-ups and that's my hang-up. The most popular reaction to my philosophy is ... success has gone to his head and he wants to be more than what he is. That's obviously a very plausible theory. Certainly being a successful fund manager gave me a platform. But I would like the ideas to be judged on their own merit. I think I'm on the verge. For the first time, this book [his 10th] is a best seller. I was asked to testify [before the Senate Commerce Committee] because a staff member read the book.
WSJ: Are you getting recognition from heavyweights in academia or policy making?
Mr. Soros: It has certainly not penetrated academia, and not policy makers either. There was an article in The Wall Street Journal about people doing research on bubbles at Princeton, so I'm going to meet with one of them. I wish I could engage in a discussion with [the Federal Reserve]. I'm waiting for a phone call. I'm [meeting with] Alan Greenspan.
WSJ: But you are quite critical of Greenspan.
Mr. Soros: Greenspan is one of the great manipulators of financial markets. I mean it in a good way. He managed [in 2001] to forestall a more serious recession. He kept interest rates [low] too long. And he did not heed the warnings that lending standards were being lowered, that deceptive practices were being used. He was too much of a market fundamentalist. He believed that if you leave it to markets, everything will be all right. That's initially self-reinforcing, but eventually self-defeating.
WSJ: Greenspan argues that the benefits of innovation are worth the occasional bubble.
Mr. Soros: This is, of course, [Joseph] Schumpeter's creative destruction idea. However ... going overboard in generating change is not necessarily a good thing. Financial innovation may not be an unmixed blessing because it really prevents proper regulation [[resulting in severe financial dislocations: normxxx]].
If you look at the 19th century, you had creative destruction going on, one financial crisis after another. But each time you had a crisis, you had an examination of what went wrong, and you put in some instrument or some institution to prevent it from happening [again]. I'm not advocating ... central planning because that's worse than [free] markets. But the regulators need to learn from the mistakes that they have made. I think it's pretty clear that you've got to accept responsibility for moderating asset bubbles. ... That involves regulating credit as well as [interest rates].
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Greg Ip, WSJ | 30 June 2008
|
Mr. Soros, the chairman of Soros Fund Management, is best-known as a speculator, philanthropist and political activist. He made a fortune by doing things such as betting against Britain's currency in 1992 and Thailand's in 1997. A Hungarian refugee, he has spent millions to promote democracy and learning in post-Soviet nations. He also has spent heavily to promote liberal causes and has been an ardent critic of President Bush.
But Mr. Soros, 77 years old, wants to be remembered most as a philosopher. Since he was a student in 1952, he has been promoting his economic theory, which he calls "reflexivity." In essence, he argues that markets don't simply reflect fundamental determinants but can change those determinants in a way that causes asset prices to go to extremes. In his latest book, "The New Paradigm for Financial Markets," he argues a "superbubble" has developed in the past 25 years and it is now collapsing.
Mr. Soros's predictions in his books have fallen far short of his track record as a hedge-fund operator. In 1987 he wrote that the world had to ditch the dollar in favor of a new international currency system or risk "financial turmoil, beggar-thy-neighbor policies leading to world-wide depression and perhaps even war." His 1998 book said, "The global capitalist system ... is coming apart at the seams." In recent interviews in Washington and New York, The Wall Street Journal asked him about his forecast— why he succeeds financially when his world view has been so wrong— and about his aspirations to be a philosopher. Excerpts:
WSJ: You've said this is the worst financial crisis since the Great Depression. Yet at its worst, the stock market was only down 18%. That doesn't seem Depression-like. Is this as bad as it gets?
Mr. Soros: I think that the decline in housing prices is going to be more precipitous and go further than people currently expect. To expect [to come] out of the recession by the end of the year, I find that inconceivable. But I can envisage a very broad range of scenarios. One would be a very prolonged world-wide recession.
I cannot imagine a replay of the '30s. But you can have a 'muddle-through' replay of the Japanese scenario— 10 years of stagnation. The employment figures are still very, very satisfactory. Part of this is due to the impact of the lower dollar in stimulating exports and partly to the very strong position of the corporate sector. The economy turned out to be structurally in very good shape.
WSJ: You argue that the crises we've experienced in the past 25 years have been, in retrospect, "testing events" that convince us the system is stable, encourage us to take even bigger risks, leading to one, cataclysmic collapse. Could this be just another testing event?
Mr. Soros: Each time the authorities saved us, that reinforced the belief that markets are self-correcting. Each time when you bail out the economy, you need to find a new motor, a new source of credit and a new instrument that allows for the credit expansion. [It's] difficult to imagine what [more] you can do when you are already lending effectively 100% on inflated house prices.
I have a record of crying wolf at these times. I did it first in "The Alchemy of Finance" [in 1987], then in "The Crisis of Global Capitalism" [in 1998] and now in this book. So it's three books predicting disaster. [But, after] the boy cried wolf three times ... the wolf really came. If we can sail through this without a recession, then the 'superbubble story' is seriously impacted ... I [will] have cried wolf again. Unfortunately, if you go into a recession, [it is not] proof of reflexivity, or vice versa.
WSJ: How is that you are rich despite your world view having been wrong so far?
Mr. Soros: I'm only rich because I know when I'm wrong.
WSJ: How do you stay levelheaded in the middle of a bubble?
Mr. Soros: I don't. I panic. The same thing applies to me as to everybody else, so I'm given to euphoria and despair. And I would say that I basically have survived by recognizing my mistakes. I very often used to get backaches due to the fact that I was wrong. Whenever you are wrong you have to fight or [take] flight. When [I] make the decision, the backache goes away. I don't always make the right decision. I sometimes cut my losses when I shouldn't.
WSJ: Is reflexivity really behind your success, or are you just a good trader?
Mr. Soros: My performance currently is not that good, but taking the longer [view] it is kind of outstanding. There are two possible explanations. One is the theory [of reflexivity] and the other is the backache. And I think it's really the combination of both because recognizing reflexivity drives you to this constant re-examination.
WSJ: Would you prefer to be remembered as a philosopher than as a successful speculator or philanthropist?
Mr. Soros: Much more. You know, people have hang-ups and that's my hang-up. The most popular reaction to my philosophy is ... success has gone to his head and he wants to be more than what he is. That's obviously a very plausible theory. Certainly being a successful fund manager gave me a platform. But I would like the ideas to be judged on their own merit. I think I'm on the verge. For the first time, this book [his 10th] is a best seller. I was asked to testify [before the Senate Commerce Committee] because a staff member read the book.
WSJ: Are you getting recognition from heavyweights in academia or policy making?
Mr. Soros: It has certainly not penetrated academia, and not policy makers either. There was an article in The Wall Street Journal about people doing research on bubbles at Princeton, so I'm going to meet with one of them. I wish I could engage in a discussion with [the Federal Reserve]. I'm waiting for a phone call. I'm [meeting with] Alan Greenspan.
WSJ: But you are quite critical of Greenspan.
Mr. Soros: Greenspan is one of the great manipulators of financial markets. I mean it in a good way. He managed [in 2001] to forestall a more serious recession. He kept interest rates [low] too long. And he did not heed the warnings that lending standards were being lowered, that deceptive practices were being used. He was too much of a market fundamentalist. He believed that if you leave it to markets, everything will be all right. That's initially self-reinforcing, but eventually self-defeating.
WSJ: Greenspan argues that the benefits of innovation are worth the occasional bubble.
Mr. Soros: This is, of course, [Joseph] Schumpeter's creative destruction idea. However ... going overboard in generating change is not necessarily a good thing. Financial innovation may not be an unmixed blessing because it really prevents proper regulation [[resulting in severe financial dislocations: normxxx]].
If you look at the 19th century, you had creative destruction going on, one financial crisis after another. But each time you had a crisis, you had an examination of what went wrong, and you put in some instrument or some institution to prevent it from happening [again]. I'm not advocating ... central planning because that's worse than [free] markets. But the regulators need to learn from the mistakes that they have made. I think it's pretty clear that you've got to accept responsibility for moderating asset bubbles. ... That involves regulating credit as well as [interest rates].
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Financial Meltdown?
The Bear's Lair: Are We Entering A Financial Meltdown?
By Martin Hutchinson | 16 July 2008
The financial crisis in the United States and worldwide entered a new phase this week, as Fannie Mae and Freddie Mac, the two huge US home loan institutions, began what appears to be a similar "death spiral" to that which claimed Bear Stearns four months ago. Fannie and Freddie are unique institutions, and will almost certainly be bailed out by the long-suffering taxpayer. However, for the first time, the specter has been raised of a general financial meltdown, such as the US managed to avoid in 1933 but Sweden succumbed to in 1991.
Sweden’s financial meltdown of 1991 involved the government guaranteeing the obligations of the entire Swedish banking system, and recapitalizing the major banks, with the sole major exception of Svenska Handelsbanken. The total cost of the rescue to Swedish taxpayers was around $10 billion, equivalent to about $1 trillion in the context of today’s US economy. The causes of the crisis would be familiar to most Americans today: misuse of off-balance sheet securitization vehicles to invest excessively in real estate and mortgage lending.
It is thus not impossible for the entire US banking system to implode. It didn’t happen in 1933 (though about a quarter of US banks failed [[mainly because the Fed was held back from the mission for which it had been created by Hoover's U.S. Treasury of Secretary Andrew W. Mellon, who "did not want to see those miscreants rescued." Thank God for Secretary William H. Woodin and FDR: normxxx]]). Because US banks in the 1920s had been relatively conservative in their lending, with many banks requiring a 50% down payment for home mortgage loans, for example, [[and rarely went beyond 5 years,: normxxx]] not so many banks were at risk of the housing collapse— which was, in any case, far more modest than today.
Stock margin lending got way out of control in 1928-29, but relatively few banks were significantly involved in that. The main problem in 1932-33 was quite simply liquidity; the Fed failed to supply adequate reserves to the banking system, so crises of confidence in individual banks led to panic withdrawals of deposits that caused the banks themselves to fail [[and, because of interbank loans, led to a crescendo of banks being toppled between 1930 and 1933— precisely the sort of panic/domino effect the Fed had been created to backstop: normxxx]].
This time around, the problem is the opposite. Whereas the Fed had been appropriately cautious in the late 1920s, so only in the [limited] area of stock margin lending [[and some speculation in the market with general bank funds: normxxx]] did the banking system get out of control, this time around the Fed has been hopelessly profligate in monetary creation for over a decade. The initial result of this profligacy, the tech bubble of 1999-2000, caused only modest problems in the banking system through telecom losses. The more recent profligacy and the housing bubble it caused have had much more serious consequences, mirroring those in Sweden leading up to 1991. The additional loosening since September has distorted the financial system further, producing a commodity price bubble that itself seems likely to have substantial further adverse consequences (one can at least argue that the earlier commodity price rise was legitimate and not a 'bubble').
Fannie and Freddie are probably toast, and about time too. Fed Chairman Ben Bernanke’s statement Friday that they can discount paper with the Fed may prolong the inevitable, but also increases its likely huge cost to taxpayers. There can be no economic justification for the government guaranteeing the great majority of the nation’s home mortgages, and the spurious "government sponsored enterprise" structure of Fannie and Freddie merely hid the likely consequences of their default. Their senior employees have been paid like Wall Street for performing a function that was economically entirely unnecessary, and they have survived for more than 50 years simply through their ability to offer lucrative consulting contracts to ex-Congressmen and other politically well-connected people.
It is thus necessary that any "rescue" for Fannie and Freddie be a euthanasia not a lifeline. They have extracted their rents from the market for too long, and have encouraged the growth of a securitized mortgage market that has proved entirely unsound because of its perverse incentives. Simply providing them with $100 billion or so of extra capital at taxpayer expense, probably structured as some economically unjustified form of subordinated debt so that the shareholders are left undiluted and allowing them to continue operating doesn’t solve the problem, it exacerbates it.
The simplest from of euthanasia for Fannie and Freddie would be a takeover by the Office of Federal Housing Oversight (OFHEO) their regulator, on the grounds that they were no longer able to operate independently. In Freddie’s case that could be carried out at any time, since the company has failed to follow through on a promise to OFHEO to raise $5.5 billion in new capital— which at Thursday’s closing share price would dilute existing shareholders by 55%. In any case, further declines in their share prices and withdrawal of funding by the bond markets are likely to cause a sufficient crisis in the next few weeks to make such a takeover inevitable if a rescue is not organized (which it shouldn’t be.)
Following a takeover, Fannie and Freddie would need to continue performing their current functions of guaranteeing home mortgages, as without such guarantees home mortgages are currently impossible to obtain. However, changes must be made to recognize the revised nature of the business. Since the new guarantees would be direct government obligations (OFHEO being an arm of the government) rather than simply implied obligations, the fees for obtaining them should be jerked sharply upwards, perhaps to 1.5% per annum on the outstanding amount of the mortgage.
That would allow mortgage finance to remain available at a cost that is still reasonable in current markets (Fannie Mae paper already pays a 0.75% premium over the government for its borrowings) but as markets recovered it would make Fannie/Freddie guaranteed mortgages highly uncompetitive against direct home loans, by far the healthiest way for housing to be financed. Together with the salary reductions outlined below, it would also begin to reimburse the unfortunate taxpayer for the gigantic costs of this non-rescue operation.
Treasury Secretary Hank Paulson has called for "covered bonds" similar to the German pfandbriefe to be used to finance housing. Since pfandbriefe, bonds issued by German banks to finance housing, remain on German bank balance sheets and retain the bank guarantee, allowing the banks only to escape the funding risk of lending for 30 years at a fixed rate, they avoid the moral hazards of the securitization markets, and are thus an attractive alternative.
To encourage their use, and to reduce the capital cost to banks of holding mortgages on balance sheet, the Basel 1 bank regulations, currently being phased out, should be retained; they allowed mortgages to carry only a 4% capital charge as against 8% for regular loans. By this and other means, the private banking sector would be encouraged to make sound home loans directly, without the unnecessary Fannie/Freddie guarantees.
The objective would be over a 5-10 year period for Fannie and Freddie to become insignificant participants in the mortgage market, after which they could be closed altogether. Meanwhile, costs in Fannie and Freddie could be cut drastically, particularly on the staffing side. Since Fannie and Freddie staff would now be government employees, they should be paid on the GS payscale, with the CEO, as a GS-15, receiving appropriate remuneration between $115,317 and $149,000, according to his years of service. Even if the CEO was able to argue himself onto the SES pay scale (after all, he has excellent Congressional contacts) he would be limited to about $205,000 in the Washington area.
Naturally many Fannie/Freddie employees would be outraged at this cut in their living standards, and would attempt to find alternative better-paid employment; I venture to suggest that few would succeed in doing so. That way, [termination/layoff] payments would be avoided while salary costs were slashed. There would be a devastating effect on the Northern Virginia housing market, where many senior Fannie/Freddie employees have overextended themselves with giant home mortgages for vulgar McMansions, but that problem too is probably survivable. More important, the now disgruntled employees would perform their job poorly, making applying for a Fannie/Freddie guarantee a bureaucratic and uncertain process, similar to negotiating with the IRS. That too should hasten their disappearance from the housing market.
Fannie and Freddie do not represent the entire US finance sector, far from it. Nevertheless their insolvency would further erode confidence in the rest of the sector, very likely leading to a cascade of death spirals among other institutions. After all the best run large non-global US bank, Wachovia, has itself got in trouble by its insanely foolish acquisition of the California mortgage lender Golden West Financial at the peak of the market in 2006, while Bank of America, the largest retail-oriented US bank, voluntarily took on more of the mess by its purchase of the diseased and probably criminal Countrywide Financial as recently as last January. Citigroup is in deep trouble in a number of areas, particularly relating to its over-enthusiasm for the discredited technique of securitization, while JP Morgan Chase CEO Jamie Dimon wrecked his credibility in May by announcing that the financial crisis was "mostly over"— presumably wishful thinking in the light of his huge holdings of dodgy Bear Stearns paper.
Only Goldman Sachs appears serenely above the fray, but don’t forget— at May 2008 its "Level 3" assets were $78 billion, more than twice its capital. Level 3 assets, you may remember, are those for which there is no market, so can be valued only by the internal mathematical models of the institution concerned. Since this arcane highly-illiquid paper is the most likely to suffer catastrophic erosion of "value" in a downturn, Goldman Sachs like Jamie Dimon must be keeping their fingers crossed that somehow this nightmare must end soon.
It needn’t; from past experience of such follies it probably has at least another year to go. Thus a total collapse of the US financial system, while hardly inevitable, is a contingency which should now be planned for [[as a natural consequence of CB ineptitude, and it should be remembered that 'those guys' are by and large paid for who they know, not what they know: normxxx]].
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By Martin Hutchinson | 16 July 2008
The financial crisis in the United States and worldwide entered a new phase this week, as Fannie Mae and Freddie Mac, the two huge US home loan institutions, began what appears to be a similar "death spiral" to that which claimed Bear Stearns four months ago. Fannie and Freddie are unique institutions, and will almost certainly be bailed out by the long-suffering taxpayer. However, for the first time, the specter has been raised of a general financial meltdown, such as the US managed to avoid in 1933 but Sweden succumbed to in 1991.
Sweden’s financial meltdown of 1991 involved the government guaranteeing the obligations of the entire Swedish banking system, and recapitalizing the major banks, with the sole major exception of Svenska Handelsbanken. The total cost of the rescue to Swedish taxpayers was around $10 billion, equivalent to about $1 trillion in the context of today’s US economy. The causes of the crisis would be familiar to most Americans today: misuse of off-balance sheet securitization vehicles to invest excessively in real estate and mortgage lending.
It is thus not impossible for the entire US banking system to implode. It didn’t happen in 1933 (though about a quarter of US banks failed [[mainly because the Fed was held back from the mission for which it had been created by Hoover's U.S. Treasury of Secretary Andrew W. Mellon, who "did not want to see those miscreants rescued." Thank God for Secretary William H. Woodin and FDR: normxxx]]). Because US banks in the 1920s had been relatively conservative in their lending, with many banks requiring a 50% down payment for home mortgage loans, for example, [[and rarely went beyond 5 years,: normxxx]] not so many banks were at risk of the housing collapse— which was, in any case, far more modest than today.
Stock margin lending got way out of control in 1928-29, but relatively few banks were significantly involved in that. The main problem in 1932-33 was quite simply liquidity; the Fed failed to supply adequate reserves to the banking system, so crises of confidence in individual banks led to panic withdrawals of deposits that caused the banks themselves to fail [[and, because of interbank loans, led to a crescendo of banks being toppled between 1930 and 1933— precisely the sort of panic/domino effect the Fed had been created to backstop: normxxx]].
This time around, the problem is the opposite. Whereas the Fed had been appropriately cautious in the late 1920s, so only in the [limited] area of stock margin lending [[and some speculation in the market with general bank funds: normxxx]] did the banking system get out of control, this time around the Fed has been hopelessly profligate in monetary creation for over a decade. The initial result of this profligacy, the tech bubble of 1999-2000, caused only modest problems in the banking system through telecom losses. The more recent profligacy and the housing bubble it caused have had much more serious consequences, mirroring those in Sweden leading up to 1991. The additional loosening since September has distorted the financial system further, producing a commodity price bubble that itself seems likely to have substantial further adverse consequences (one can at least argue that the earlier commodity price rise was legitimate and not a 'bubble').
Fannie and Freddie are probably toast, and about time too. Fed Chairman Ben Bernanke’s statement Friday that they can discount paper with the Fed may prolong the inevitable, but also increases its likely huge cost to taxpayers. There can be no economic justification for the government guaranteeing the great majority of the nation’s home mortgages, and the spurious "government sponsored enterprise" structure of Fannie and Freddie merely hid the likely consequences of their default. Their senior employees have been paid like Wall Street for performing a function that was economically entirely unnecessary, and they have survived for more than 50 years simply through their ability to offer lucrative consulting contracts to ex-Congressmen and other politically well-connected people.
It is thus necessary that any "rescue" for Fannie and Freddie be a euthanasia not a lifeline. They have extracted their rents from the market for too long, and have encouraged the growth of a securitized mortgage market that has proved entirely unsound because of its perverse incentives. Simply providing them with $100 billion or so of extra capital at taxpayer expense, probably structured as some economically unjustified form of subordinated debt so that the shareholders are left undiluted and allowing them to continue operating doesn’t solve the problem, it exacerbates it.
The simplest from of euthanasia for Fannie and Freddie would be a takeover by the Office of Federal Housing Oversight (OFHEO) their regulator, on the grounds that they were no longer able to operate independently. In Freddie’s case that could be carried out at any time, since the company has failed to follow through on a promise to OFHEO to raise $5.5 billion in new capital— which at Thursday’s closing share price would dilute existing shareholders by 55%. In any case, further declines in their share prices and withdrawal of funding by the bond markets are likely to cause a sufficient crisis in the next few weeks to make such a takeover inevitable if a rescue is not organized (which it shouldn’t be.)
Following a takeover, Fannie and Freddie would need to continue performing their current functions of guaranteeing home mortgages, as without such guarantees home mortgages are currently impossible to obtain. However, changes must be made to recognize the revised nature of the business. Since the new guarantees would be direct government obligations (OFHEO being an arm of the government) rather than simply implied obligations, the fees for obtaining them should be jerked sharply upwards, perhaps to 1.5% per annum on the outstanding amount of the mortgage.
That would allow mortgage finance to remain available at a cost that is still reasonable in current markets (Fannie Mae paper already pays a 0.75% premium over the government for its borrowings) but as markets recovered it would make Fannie/Freddie guaranteed mortgages highly uncompetitive against direct home loans, by far the healthiest way for housing to be financed. Together with the salary reductions outlined below, it would also begin to reimburse the unfortunate taxpayer for the gigantic costs of this non-rescue operation.
Treasury Secretary Hank Paulson has called for "covered bonds" similar to the German pfandbriefe to be used to finance housing. Since pfandbriefe, bonds issued by German banks to finance housing, remain on German bank balance sheets and retain the bank guarantee, allowing the banks only to escape the funding risk of lending for 30 years at a fixed rate, they avoid the moral hazards of the securitization markets, and are thus an attractive alternative.
To encourage their use, and to reduce the capital cost to banks of holding mortgages on balance sheet, the Basel 1 bank regulations, currently being phased out, should be retained; they allowed mortgages to carry only a 4% capital charge as against 8% for regular loans. By this and other means, the private banking sector would be encouraged to make sound home loans directly, without the unnecessary Fannie/Freddie guarantees.
The objective would be over a 5-10 year period for Fannie and Freddie to become insignificant participants in the mortgage market, after which they could be closed altogether. Meanwhile, costs in Fannie and Freddie could be cut drastically, particularly on the staffing side. Since Fannie and Freddie staff would now be government employees, they should be paid on the GS payscale, with the CEO, as a GS-15, receiving appropriate remuneration between $115,317 and $149,000, according to his years of service. Even if the CEO was able to argue himself onto the SES pay scale (after all, he has excellent Congressional contacts) he would be limited to about $205,000 in the Washington area.
Naturally many Fannie/Freddie employees would be outraged at this cut in their living standards, and would attempt to find alternative better-paid employment; I venture to suggest that few would succeed in doing so. That way, [termination/layoff] payments would be avoided while salary costs were slashed. There would be a devastating effect on the Northern Virginia housing market, where many senior Fannie/Freddie employees have overextended themselves with giant home mortgages for vulgar McMansions, but that problem too is probably survivable. More important, the now disgruntled employees would perform their job poorly, making applying for a Fannie/Freddie guarantee a bureaucratic and uncertain process, similar to negotiating with the IRS. That too should hasten their disappearance from the housing market.
Fannie and Freddie do not represent the entire US finance sector, far from it. Nevertheless their insolvency would further erode confidence in the rest of the sector, very likely leading to a cascade of death spirals among other institutions. After all the best run large non-global US bank, Wachovia, has itself got in trouble by its insanely foolish acquisition of the California mortgage lender Golden West Financial at the peak of the market in 2006, while Bank of America, the largest retail-oriented US bank, voluntarily took on more of the mess by its purchase of the diseased and probably criminal Countrywide Financial as recently as last January. Citigroup is in deep trouble in a number of areas, particularly relating to its over-enthusiasm for the discredited technique of securitization, while JP Morgan Chase CEO Jamie Dimon wrecked his credibility in May by announcing that the financial crisis was "mostly over"— presumably wishful thinking in the light of his huge holdings of dodgy Bear Stearns paper.
Only Goldman Sachs appears serenely above the fray, but don’t forget— at May 2008 its "Level 3" assets were $78 billion, more than twice its capital. Level 3 assets, you may remember, are those for which there is no market, so can be valued only by the internal mathematical models of the institution concerned. Since this arcane highly-illiquid paper is the most likely to suffer catastrophic erosion of "value" in a downturn, Goldman Sachs like Jamie Dimon must be keeping their fingers crossed that somehow this nightmare must end soon.
It needn’t; from past experience of such follies it probably has at least another year to go. Thus a total collapse of the US financial system, while hardly inevitable, is a contingency which should now be planned for [[as a natural consequence of CB ineptitude, and it should be remembered that 'those guys' are by and large paid for who they know, not what they know: normxxx]].
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Tuesday, July 15, 2008
Recession ==> Depression?
This Recession Could Easily Tip Into A Depression
By William Rees-Mogg, The Times.Uk | 14 July 2008
Today I am celebrating my 80th birthday, an age that seems less formidable when one has reached it than when one can see it only from afar. I was born on July 14, 1928, about 15 months before the American boom of the 1920s came to its rather abrupt end. Like everyone else, I am naturally curious to see whether the global credit crunch is going to be a brief interruption in global prosperity, or the prelude to a longer and deeper depression. But, the experiences of the 1930s makes me think that the present downturn will be relatively long and difficult.
I cannot claim to have clear memories of the 1929 Wall Street Crash, which occured when I was 1 year old, or of Britain leaving the gold standard in 1931, when I was 3 years old. I do however, remember newspaper articles about the later stages of the Depression. In the 1930s, my parents read The Times, the Financial Times and the Daily Mail. I can remember the news stories of the Jarrow march of the unemployed (that was in the UK; the US counterpart was the "Bonus March Army" of veterans of WWI). I also remember discussing with my mother a lead story which reported that farm workers' pay was to be raised 6 pence (2 new pennies, or about $0.02) to what would now be £1.50 a week (that's about $3.00 today, unadjusted for inflation). The depression was a fact of existence in the North Somerset coalfield up to the outbreak of war in 1939. Fortunately, there has only been one Great Depression in my lifetime, but there has also been a Great Inflation.
In 2006 Pickering and Chatto, which I refounded in the 1980s, had the good timing to publish a three-volume History of Financial Disasters, under the general editorship of Mark Duckenfield. His introduction to the 1929 crash on the New York Stock Exchange makes an important point: "Most of the stock market's loss in value took place in later years as the Depression deepened. Three years after its initial crash and shortly before the 1932 election, the Dow Jones Industrial Average had fallen to 34, a loss of more than 90 per cent in less than three years. The Dow did not return to its 1929 peak of 381 until a quarter of a century later at the end of 1954."
On that basis, stock markets would get back to their 2007 levels in 2032.
There are various ways of measuring a recession. These are reasonably useful when applied to minor fluctuations of the stock market, or to minor adjustments of the world economy. But the big booms and slumps need to be measured by their broader impact over time. The Great Depression can be regarded as lasting for ten years from 1929 to 1939; the Great Inflation ran for a similar period, from 1973 to 1982. Even these dates could be challenged, since both events were preceded by a build-up of debt and other warnings of trouble. Both were followed by aftershocks.
One can even argue about the correct date to take as the starting point of the present recession. It was certainly preceded by two great American bubbles, the dot-com bubble of the late 1990s and the US housing bubble of this century. On one view, the present recession began on August 7, 2007— only a year ago— when the sub-prime mortgage crisis came to the surface. That date could also be used to mark the bursting of the US housing bubble [[more accurately, the onset of the Credit Crisis— the housing 'boom' had probably peaked in the summer of 2005: normxxx]], which is still having so damaging an impact on mortgage banking.
Alternatively, one could reasonably start the present recession from the bursting of the dot-com bubble itself, which was the beginning of a bear market on Wall Street. That happened in the early months of 2000, already eight years ago. If this is a depression, it is a matter of choice whether one regards it as one or eight years old. A big inflation has many of the same consequences as a big depression. That is why many people made a dangerous mistake in the early 1970s. They saw that inflation was the immediate threat and assumed that it would raise the value of capital assets while liquidating debts. In fact, it raised interest rates on debt and actually reduced the real value of many capital assets.
The inflation of the price of oil after 1973 was accompanied by a collapse of the British property market and the insolvency of the secondary banking sector in London. It is obvious that a big depression is bad for investors; a big inflation is bad for them as well. The present recession has some characteristics which make me think that it will be a relatively long one. The recession is centred on banking and property. In an ordinary recession, one has to wait for consumers to regain their confidence, which, in turn restores the confidence of business. Now one has to wait for the bankers as well. At present, banks are too [full of anxiety] even to want to lend to each other, let alone to expand consumer credit or business loans.
This recession has produced a succession of nasty surprises. Things are always proving to be worse than anyone had expected. Last week the crisis spread to the American mortgage giants Fannie Mae and Freddie Mac, created by President Roosevelt in 1938. These are far bigger than the investment bank Bear Stearns and Northern Rock put together. They have brought the crisis from the level of billions of dollars, to the level of trillions. No doubt they will be saved because the US would be bust if they went down. But you cannot save six-trillion-dollar institutions without suffering on a large scale.
The debt crisis, the banking crisis, the property crisis, the oil crisis, the shift to Asia, the bear market in stocks, are huge global adjustments that have all come together at the same time. If my birthday does not prove to be another Black Monday on Wall Street, I shall think myself rather lucky. There is now a momentum of negative events sweeping away financial flood defences; in the 1930s that force overturned democratic governments as easily as it overturned banks.
Before we get back to balance, we may see dramatic changes in politics, as well as in business and finance.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
By William Rees-Mogg, The Times.Uk | 14 July 2008
Today I am celebrating my 80th birthday, an age that seems less formidable when one has reached it than when one can see it only from afar. I was born on July 14, 1928, about 15 months before the American boom of the 1920s came to its rather abrupt end. Like everyone else, I am naturally curious to see whether the global credit crunch is going to be a brief interruption in global prosperity, or the prelude to a longer and deeper depression. But, the experiences of the 1930s makes me think that the present downturn will be relatively long and difficult.
I cannot claim to have clear memories of the 1929 Wall Street Crash, which occured when I was 1 year old, or of Britain leaving the gold standard in 1931, when I was 3 years old. I do however, remember newspaper articles about the later stages of the Depression. In the 1930s, my parents read The Times, the Financial Times and the Daily Mail. I can remember the news stories of the Jarrow march of the unemployed (that was in the UK; the US counterpart was the "Bonus March Army" of veterans of WWI). I also remember discussing with my mother a lead story which reported that farm workers' pay was to be raised 6 pence (2 new pennies, or about $0.02) to what would now be £1.50 a week (that's about $3.00 today, unadjusted for inflation). The depression was a fact of existence in the North Somerset coalfield up to the outbreak of war in 1939. Fortunately, there has only been one Great Depression in my lifetime, but there has also been a Great Inflation.
In 2006 Pickering and Chatto, which I refounded in the 1980s, had the good timing to publish a three-volume History of Financial Disasters, under the general editorship of Mark Duckenfield. His introduction to the 1929 crash on the New York Stock Exchange makes an important point: "Most of the stock market's loss in value took place in later years as the Depression deepened. Three years after its initial crash and shortly before the 1932 election, the Dow Jones Industrial Average had fallen to 34, a loss of more than 90 per cent in less than three years. The Dow did not return to its 1929 peak of 381 until a quarter of a century later at the end of 1954."
On that basis, stock markets would get back to their 2007 levels in 2032.
There are various ways of measuring a recession. These are reasonably useful when applied to minor fluctuations of the stock market, or to minor adjustments of the world economy. But the big booms and slumps need to be measured by their broader impact over time. The Great Depression can be regarded as lasting for ten years from 1929 to 1939; the Great Inflation ran for a similar period, from 1973 to 1982. Even these dates could be challenged, since both events were preceded by a build-up of debt and other warnings of trouble. Both were followed by aftershocks.
One can even argue about the correct date to take as the starting point of the present recession. It was certainly preceded by two great American bubbles, the dot-com bubble of the late 1990s and the US housing bubble of this century. On one view, the present recession began on August 7, 2007— only a year ago— when the sub-prime mortgage crisis came to the surface. That date could also be used to mark the bursting of the US housing bubble [[more accurately, the onset of the Credit Crisis— the housing 'boom' had probably peaked in the summer of 2005: normxxx]], which is still having so damaging an impact on mortgage banking.
Alternatively, one could reasonably start the present recession from the bursting of the dot-com bubble itself, which was the beginning of a bear market on Wall Street. That happened in the early months of 2000, already eight years ago. If this is a depression, it is a matter of choice whether one regards it as one or eight years old. A big inflation has many of the same consequences as a big depression. That is why many people made a dangerous mistake in the early 1970s. They saw that inflation was the immediate threat and assumed that it would raise the value of capital assets while liquidating debts. In fact, it raised interest rates on debt and actually reduced the real value of many capital assets.
The inflation of the price of oil after 1973 was accompanied by a collapse of the British property market and the insolvency of the secondary banking sector in London. It is obvious that a big depression is bad for investors; a big inflation is bad for them as well. The present recession has some characteristics which make me think that it will be a relatively long one. The recession is centred on banking and property. In an ordinary recession, one has to wait for consumers to regain their confidence, which, in turn restores the confidence of business. Now one has to wait for the bankers as well. At present, banks are too [full of anxiety] even to want to lend to each other, let alone to expand consumer credit or business loans.
This recession has produced a succession of nasty surprises. Things are always proving to be worse than anyone had expected. Last week the crisis spread to the American mortgage giants Fannie Mae and Freddie Mac, created by President Roosevelt in 1938. These are far bigger than the investment bank Bear Stearns and Northern Rock put together. They have brought the crisis from the level of billions of dollars, to the level of trillions. No doubt they will be saved because the US would be bust if they went down. But you cannot save six-trillion-dollar institutions without suffering on a large scale.
The debt crisis, the banking crisis, the property crisis, the oil crisis, the shift to Asia, the bear market in stocks, are huge global adjustments that have all come together at the same time. If my birthday does not prove to be another Black Monday on Wall Street, I shall think myself rather lucky. There is now a momentum of negative events sweeping away financial flood defences; in the 1930s that force overturned democratic governments as easily as it overturned banks.
Before we get back to balance, we may see dramatic changes in politics, as well as in business and finance.
ߧ
Normxxx
______________
The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.
Saturday, July 12, 2008
Troubled Waters
Barron's Cover: Troubled Waters
By Lauren R. Rublin, Barron's | 16 June 2008
Midyear 2008 Roundtable Report Card
You can't trust anything these days. Take the innocent-looking tomato— delicious, nutritious and now a weapon of mass digestive destruction. Or inflation, still soothingly low, so long as you don't eat or drive. Then there's Wall Street, where humongous earnings these past few years have fed similarly humongous bonuses. Sorry, wrong numbers. Just ask Lehman Brothers, which announced last week that it will report a loss of nearly $3 billion for the second quarter, wiping out numerous periods of supposed gains. [[Wonder if that was bad for bonuses?: normxxx]]
The Barron's roundtable represents a notable exception to the current bull market in duplicity and false impressions. Year in and year out, we can trust its members— 11 of Wall Street's most insightful investment experts— to give us the straight skinny on the economy, the financial markets and dozens of individual stocks and funds, even if the truth is sometimes painful, as it has been this year.
Brad Trent: When the Roundtable last met Jan. 7 with the editors of Barron's, our distinguished panelists minced no words: This year would be difficult to dismal for the economy and stocks, as the bubbles in housing and credit unwind. So far, so good (er, bad). Most still feel that way about '08, and even '09, though a handful see the skies clearing at last, even for decimated financial and home-building shares. [[dream on! : normxxx]].
In the pages ahead, we've distilled the latest views of the Roundtable crew. We hope you're enlightened, amused and provoked by them to discover your own truths about markets. And, should you disagree with any of the opinions expressed herein, please, no tomatoes.
Bill Gross
Barron's: What a year it's been for investors— and it's only June. How do things look to you, Bill?
Gross: The economy has fooled us. Pimco expected at least a quarter of negative GDP [gross domestic product] growth, but we haven't seen it yet. We don't expect a return to normalized growth rates in the next six months, however. There still are weaknesses in housing, and housing deflation affects employment and consumption. Also, the states, which had been reluctant savers, will have to cut back because they are over budget. Growth will stay positive, but very, very low.
How will the markets deal with this?
Relatively high inflation combined with meager economic growth sends a mixed message to the bond market. With the economy down, the Federal Reserve can't raise rates to tame inflation. Yet, higher inflation means it should, or at least should be thinking about it.
What advice would you give the Fed?
The U.S. should simply stand pat. About a month ago the Fed sent a clear signal that 2% was it on the downside for rates, and that further stimulation would come from policy changes such as its liquidity provisions for Wall Street and heavy lifting from the Treasury and Congress to ease the mortgage crisis. But it's difficult to raise interest rates in the face of a housing market that is falling by double digits.
The good news for stocks is that economic growth hasn't turned negative[!?!] and that corporate profits haven't declined[!?!] A substantial portion of profits comes from outside the U.S., either through currency adjustments or greater growth in foreign markets. That said, financials play a dominant role in the market. That means lower profit margins, and lower profits. It's a tale of two stock markets.
Nonfinancial companies are doing better, you mean.
Finance companies are stinking up the joint, but the industrial economy is benefiting from a lower dollar and more exports. The railroads are doing well. The stock market might not have much upside, although foreign reserves have to go somewhere, and with oil prices at records, we're talking about an additional $500 billion of reserves generated in the past six months. That money will come to the U.S., and its owners don't want bonds. Almost by default— if you'll pardon the term— stocks are benefiting. They are the least bad choice. But be cautious: This is not a new bull market.
Your January picks— auto bonds and some closed-end funds— did well, especially relative to the market. How about a few new ideas?
Fairpoint Communications, a land-line phone company, acquired substantial properties from Verizon Communications [ticker: VZ]. Related to the deal, the dividend will fall to $1.03 from $1.59, for a yield of 11% for the next year. JPMorgan Chase has a 7.9% preferred stock due April 29, 2049. This is the crème de la crème of banks today; the Fed loves [CEO] Jamie Dimon. Why shouldn't you? This preferred can be bought for 96 cents on the dollar, for a yield of 8%-plus. Lastly, Countrywide Financial trades at a 10% discount to the price that Bank of America, its future parent, has agreed to pay in an all-stock deal. The deal will close in a few months, and Countrywide yields 10% while you wait.
Sounds like it's worth waiting. Thanks, Bill.
Oscar Schafer
Barron's: What is your second-half forecast, Oscar?
Schafer: We are in the 6th or 7th inning of losses taken on subprime and other financial instruments. But we are in the third or fourth inning of deleveraging the economy after four or five years of borrowing. Growth will remain slow as we reverse the trend of having spent more than we earned. And we haven't yet seen all the problems of the regional banks, which, although they hold less of the risky financial instruments, will have problems with customers defaulting on credit-card debt and auto loans.
Consumers will continue to be under pressure as house prices fall, mortgage-equity withdrawals decline and gas is at $4 a gallon. That's why companies like Wal-Mart Stores [WMT] are doing better than expected. The U.S. has $20 trillion in household wealth. House prices have come down 13% or 14%, so that's $2.6 trillion in wealth destruction.
Compare that to tax cuts, which have been all of $150 billion. The continuing erosion in household wealth will make consumers spend less. And the banks, with big write-offs, are constrained in lending money, even if the Fed lowers rates. The growth of the past few years was credit-driven, and credit is drying up.
How long will the deleveraging take?
It could last another 12 to 18 months. We look for companies that are somewhat immune to these problems. The further you get from housing and consumer spending, the less the impact is likely to be. If the rest of the world— China, India, Brazil— doesn't collapse, the industrial part of our economy will keep going.
Are you expecting them to collapse?
It's the $64 question. If it happens, all bets are off for the rest of the world. The stock market probably won't do much this year. There is a yin and yang between the financial sector and everything else. We'll have a standoff. As long as there aren't significant layoffs, the economy— and the stock market— will muddle along.
What stocks do well in this sort of market?
I've got two special situations. Tyco International sells for 43 a share and has a $21 billion market cap. After spinning off its health-care business into Covidien [COV] and electronics manufacturing into Tyco Electronics [TEL], the remaining Tyco is a diversified manufacturing and service company operating in several business segments. These include ADT, the nation's largest electronic-security provider; Flow Control, the largest manufacturer of flow-control products, and fire-protection, safety-products and electrical and metal-products businesses.
Tyco is significantly undervalued. The company has big opportunities to improve margins across various business segments and reduce corporate overhead. In particular, ADT's European business has operating margins less than half those in the U.S. The company is in the early stages of an operational turnaround. Also, the flow-control business is underappreciated, as its end markets— particularly oil and gas, power, waste and water— have excellent growth prospects, and it is 75% international. The growth in these end markets could continue for several years.
What do Tyco's financials look like?
The company is underlevered, with current net debt equal to EBITDA [earnings before interest, taxes, depreciation and amortization]. Tyco's businesses generate significant cash flow due to high recurring revenue, a strong service-revenue component and relatively modest capital-expenditure requirements. The company is making tuck-in acquisitions and is in the process of divesting its engineering and construction business, the proceeds of which will be reinvested and used to repurchase stock. Tyco has a great management team led by CEO Ed Breen, who can focus on the core businesses following last year's spinoffs.
Did Tyco retain a piece of the spinoffs?
No, though all the pieces are interesting. The company isn't economically sensitive; management is in control of its destiny. The stock is selling for about 6.5 times next year's estimated EBITDA, and about 11 times 2009 estimated cash earnings of just under $4 a share. Tyco could be worth in the mid-60s. If it doesn't get credit for hidden gems such as Flow Control, it could spin those off, too.
CommScope is a producer of antennas and cabling for wireless towers, data transport and cable companies. It is a leading producer in all its segments, domestically and internationally. The key to the story is the superb execution capabilities of the CommScope management team. The CEO, chief financial officer and chief operating officer have been running this company together for more than 30 years.
As an example, after acquiring Avaya's enterprise-cabling business in 2004 and doubling the revenue base, CommScope proceeded to grow its earnings per share by more than 400% from 2004 until 2007, on revenue growth of only 65%. Increased purchasing scale, manufacturing efficiencies and rationalization enabled significant operating leverage. At the end of 2007, CommScope's management embarked on its next large acquisition, buying Andrew Corp.
This is another doubling-of-revenue acquisition. Similarly, there are significant opportunities for cost synergy, including plant rationalizations, purchasing scale and the conversion of copper products to aluminum. CommScope's wireless antenna and cabling business should benefit from the rapid increase in wireless-data demand.
Where is the stock?
While the stock has run up 30% to $53 - $54 since the company reported its first quarter in April, there is at least 25% upside from current levels. Wall Street's estimate for this year is $3.36 a share. For next year, it's $4.10, and there is upside to both years' estimates. CommScope trades for 13 times '09 earnings. The market cap is $3.7 billion.
With both Tyco and CommScope, we are betting on the management, not the economy. You have to focus on management that can execute despite headwinds.
Good advice. Thanks, Oscar.
Archie Macallaster
Barron's: How's the year treating you, Archie?
MacAllaster: I have been neutral on the market for a year and a half. I've survived and my customers have survived. But these are brutal markets and you have to be careful. You wish everybody was off margin, because this is not a time to be speculating with borrowed money.
Tell that to Wall Street.
Lehman Brothers has reduced its leverage from 32 times equity to about 25 times in one quarter, which is good. But they have a long way to go. They raised $6 billion of equity and they are probably going to lose that $6 billion.
The economy has performed well if you get away from housing and the financials. Companies with foreign operations have done well. McDonald's [MCD] reported good earnings and its stock is up. I'm an optimist. The economy hasn't had a negative quarter yet, and if it does, the downturn won't be deep. I have three bank stocks to recommend.
Surely, you're joking.
If nobody loves banks, at the least they're fairly priced[!?!] The five largest banks in America have 44% - 45% of the total assets of the banking system. They have increased that percentage year after year, and it won't be long before they own more than 50%. Two [Citigroup and Wachovia] have cut their dividends, but the other three are a good investment in the next 12 to 18 months. One is conservative, one a growth company and one speculative.
JPMorgan Chase has the most conservative balance sheet and the fewest problems. The stock sells at about $37. The high for the past year was $51, the low $36. The dividend is $1.52 a share and the stock yields 4%. JPMorgan earned $4.37 a share in 2007. The estimate for '08 is $2.50. If they pay out $1.52 a share, they will earn well in excess of the dividend. There is no reason it should be cut. You don't have to hurry to buy these things because they could go down in the next month or two. But in 12 to 18 months, the stock ought to be somewhere in the neighborhood of $46 to $48.
Which is the growth company?
Wells Fargo. It has a major problem in home-equity loans, but has reserved well. The stock is about $25, and the range is $38 to $24.38. Wells has had the best growth of all the large banks for many years, and it still will. It is well run. It does three or four different kinds of business with its customers. The market has knocked its shares down too far. Wells Fargo earned $2.41 a share last year, and the estimate this year is $2 to $2.10. This, too, is well in excess of its dividend, which is $1.24 a share. The stock yields almost 5%. My earnings estimate for 2009 is $3.10 a share.
Your speculative bet must be Bank of America.
Yes, because they may cut the dividend. Bank of America offers the greatest potential. It's trading around $29, the low for the year. The high was $53. The dividend is $2.56 a share, and it yields about 8.6%. They don't have to cut the dividend, but with the yield over 8%, the market is saying they will. Bank of America's pending acquisition of Countrywide Financial has been criticized; people are worried about the size of the reserves they'll have to take against Countrywide's loans. Long term, the deal will be a positive, though it's going to take 18 months to two years.
Bank of America also owns about 20 billion shares of China Construction Bank [939.Hong Kong]. It accounts for about $15 billion of the bank's market value. The first piece they purchased becomes marketable in October. They'll sell part of it. When they do, they'll have a big profit. That will allow them to offset some of the losses, and perhaps preserve the dividend. The bank earned $3.32 a share in 2007, and that's after taking big write-offs in the fourth quarter. My estimate for this year is $2.50 to $2.60, which is about equal to the $2.56 dividend. My 18-month target is $50 to $52.
Thank you, Archie.
Scott Black
Barron's: Some of your January picks did well, including Devon Energy, Ensco and Ross Stores.
Black: You didn't have to be a genius to do well in oil stocks, given oil is $134 a barrel and gas is $12.67 per million British thermal units— well above levels earlier this year. It's like having a big wind to your back as you're sailing off Newport to Block Island. Devon Energy [DVN] also is great with the drill bit. I originally thought earnings would be around $7.50 a share. Now they could top $11. It's a good company, but the price is a lot higher now.
Ensco International [ESV] also is doing well. They still have 45 rigs— 44 jack-ups and one semi-submersible— and six semi-submersibles on the way. The upside lies in the semi-submersibles; the first will be delivered next spring. The company is almost debt-free. Earnings estimates have been ratcheting up, and the stock still sells at nine times this year's estimates.
As for Ross Stores [ROST], women like to shop. They like to buy name brands at a bargain. Ross sells name-brand merchandise at 25% to 40% off department-store prices. Comp-store sales [sales at stores open a year or more] were up 7% in May, versus estimates of 4%. I thought they would earn $2.10 to $2.12 a share. The estimates are now $2.25. But the stock— at 37, or 16 times this year's earnings— is too expensive to initiate a position.
Thanks for the update. What's ahead?
Analysts estimate the S&P 500 will earn $89.27 this year. Strategists say $79.25. If we use $84.25, which is in the middle, the P/E is 16. The market is fully valued. On a dividend-discount model, as well, it is efficient. In January and February we had the greatest opportunity to buy name-brand technology stocks since the Long Term Capital debacle in 1998. We bought Oracle [ORCL] at 12 times earnings, Texas Instruments [TXN], KLA-Tencor [KLAC], Xilinx [XLNX].
And now?
There are no more pockets of opportunity. We're ignoring consumer-discretionary stocks. Everyone is recommending financials. We aren't. We have the lowest weighting in financials since I started Delphi. The only major brokerage we own is Goldman Sachs [GS], because they seem to have weathered the storm. Elsewhere in the industry, the bloodletting continues. The meltdown in housing also is ongoing. The stock market won't get out of its own way until the banking system regains transparency. This also overhangs S&P earnings.
The unwinding of the housing bubble is killing the economy. Household net worth is dropping for the first time in five or six years. The average family income in America is $48,600. For Main Street, this is a recession. Real GDP growth in 2008 and '09 is going to be weak, at 1% to 1.5%.
That's robust compared with some estimates.
Everybody knocks [Federal Reserve Chairman] Ben Bernanke, but I give him kudos. He could have kept interest rates high and defended the dollar, and risked a massive recession. He did the right thing by cutting rates. Opening the discount window to the investment banks was smart. So was bailing out Bear Stearns. We could have had a banking crisis like 1928 and '29 if Bear had failed.
If the market thinks S&P 500 earnings can get up to $100 in 2009, as some predict, stocks will take off later this year. But if S&P earnings come in around $84-$87 this year, it is going to be a stockpicker's market. Treasuries are a fool's bet. With headline inflation at almost 4%, parking money in two-, five— or 10-year Treasuries yields a negative real return.
Where are you parking money for Delphi's clients?
We like Bolt Technology, based in Norwalk, Conn. It trades for 20, and has a market cap of $172 million. The high last year was 39.57, the low 14.67. We've been buying the stock at $18 - $19. Bolt makes a compressed-air gun for offshore seismology and has an 80% market share worldwide. It also makes underwater electrical connectors and cables, but the gun accounts for roughly 60% of sales. The company benefits from offshore seismology, and is in the sweet spot right now. Big customers include Schlumberger [SLB] and SeaBird Exploration [SBX.Norway].
For the year ending June 30, Bolt could do close to $67 million in revenue and earn about $1.65 a share. There isn't much Street guidance on '09, so I do my own. Conservatively, we have revenues going up 12%, to $75 million. Cost of sales is about 55%, and SG&A [selling, general and administrative expenses] is up 5%, to $9.6 million. Research and development spending is about $200,000. They have more than $2 a share in cash, no debt. There is about $300,000 in interest income. After taxes at 33%, you get $16.3 million in net income. Divide by 8.58 million fully diluted shares, and Bolt will earn $1.90 a share on the low end.
And on the high end?
Revenues will grow 16%, to $78 million, and they'll earn $2 a share, versus $1.65 this year. That's 20% growth and a 10 price/earnings multiple. They have a steady book of business. Schlumberger is a great company, but at a 20 P/E it is not a great value. Bolt, nobody ever heard of.
Belden, in St. Louis, isn't well known, either. It manufactures electrical cable and wire. It trades for $36 a share and there are 47 million fully diluted shares, for a $1.7 billion market cap. The high on the year was $60; the low, $30.28. I like industrial companies that have a big presence outside the U.S. Only 41% of Belden's revenue is U.S.-based. The company made acquisitions at the end of 2006, one in Germany and another in Hong Kong. Revenue guidance for '08 is around $2.25 billion. Operating margins are 12%. That gets you to about $270 million in operating income. They have $31 million in interest expense and $4 million in interest income, so before a recent acquisition, they would have made $243 million, taxed at 32%. I had them earning $3.51 on the low side and $3.68 after economies of scale. The acquisition will dilute '08 earnings by 30 cents a share. Belden is a mundane manufacturer in the right markets.
Thank you, Scott.
Marc Faber
Barron's: What do you make of '08, so far?
Faber: Measured in euros, the U.S. is down around 13%. But it has outperformed many other markets. The U.S. has many problems. One is the slowdown in credit growth. Another is recession. The statistics don't indicate the economy is in a recession, but we question the statistics.
The Federal Reserve's aggressive interest-rate cuts— to 2% from 5.25% last September— make equities relatively attractive compared to cash yields. But in the second half and the first half of 2009 it will become evident that '09 earnings for the S&P 500 won't meet consensus estimates of $110 per S&P share. Earnings instead are coming down and will stay down, and this will weigh on stocks. The recession won't be deep but it could be long. And it could be deep for corporate profits.
How much further will the market fall?
The situation is similar to 1973-74. It's water torture. We may have a rally here or there, but once investors notice that Mr. Obama has a good chance of winning the presidential election, this will be another negative for stocks. He's not going to be good for the market.
Also, the bond market's not acting well. Bond yields are higher than when the Fed cut rates between December and January. The bond market looks as though it could weaken considerably. Once interest rates go up again, that will be another strong headwind for stocks.
The U.S. is down just 8% this year in dollars. India is down 30%; China, 40%; Vietnam, down 60%. Are those markets buys at current levels?
Among emerging markets, only Mexico and Brazil have been strong. I'd get out of them. There is no hurry to buy anything in Asia, though stocks aren't expensive. Thailand, down 7%, could fall another 5% or even 10%.
Japan is the exception. The Japanese market has performed badly in the past 18 months, and stocks are low compared to cash yields. Some corporations have increased their dividends. Steel Partners' ouster of the management of Aderans Holdings [8170.Japan], a Japanese wig maker, was an important event. Pension funds and foreign investors are starting to have more power over Japanese management.
Do you still like the iShares MSCI Japan Small Cap exchange-traded fund, which you recommended in January?
Buy that, and some Japanese banks: Sumitomo Trust, Mitsubishi UFJ and Mizuho Financial. I would still go long the dollar against the euro, which is overvalued. The tightening of global liquidity and the contracting U.S. trade and current-account deficits are likely to be dollar-supportive. Mr. Bernanke does not understand anything about international economics; it's not a weak currency that leads via import prices to inflation, as he suggested, but inflated money and credit growth that leads to a weak currency.
Where is oil headed, now that it trades in the $130s?
Prices should ease a bit. It wouldn't surprise me to see oil dropping to around $80 a barrel. If you're bearish about oil in the next three months— though long-term, commodities will go higher— it's best to own Japanese stocks or airlines. A drop in oil might not help the airlines much, but sentiment toward airlines will improve considerably. Buy AMR, Lufthansa, Singapore Airlines and Japan Airlines.
And sell oil stocks?
Interestingly, they haven't done well relative to crude. One problem is declining reserves. Also, I would rather own physical commodities than commodity-related equities because resource nationalism is on the upswing. That's also true of gold, which has fallen to $870 an ounce from $1,000. The price could go down to $780 to $800 an ounce. If you have no exposure to gold, start buying it here. People are blaming speculators for the recent run-up in commodities, but they are a symptom rather than a cause of the problem. The cause lies in excess liquidity, and the Fed is responsible for that.
My last suggestion concerns steel. If world economies decelerate, the pace of building in places like China will slow, hurting demand for steel. Steel stocks have been among this year's best performers. Short U.S. Steel.
Thank you, Marc.
Mario Gabelli
Barron's: How does the big picture look to you, Mario?
Gabelli: The consumer, as we discussed in January, ran out of money and went off a cliff. Food and fuel costs have been a bigger negative than we expected. Rebate checks are hitting people's pocketbooks now, and we need another round of fiscal stimulation, focused on productivity. As for inflation, as Karl Otto Pöhl, a former president of the German Bundesbank, said, "It's like toothpaste. Once it gets out of the tube, it's very hard to put back." Inflation expectations have been accelerating. That will remain a challenge.
There will be less stress in the financial system in the second half of '08, but continuing uncertainty with regard to the underpinnings of that stress: the housing market. Likewise, the auto market needs help. A lot of auto loans are underwater because of the declining value of the cars they financed. In 2009, however, we'll be further along in correcting the housing balances, and we'll have an OK economy.
And an OK stock market?
Originally I thought the market would be flat to up 5%. It will probably close up. If the Democrats control Congress and the White House, they'll raise taxes. If you own a company, you may want to sell it and pay long-term capital gains this year. Companies may issue more special dividends over the balance of the year.
There is no question the amount of money earmarked by pension funds, endowments and others toward commodities is having an impact on prices, well beyond Chinese or Indian demand. This speculative bubble should be nipped in the bud. Margin requirements on commodities accounts must be increased or we'll have another bust.
Where do you see value these days?
We like companies with an environmental focus. Going green is good for business. We also like companies with pricing power, and we like takeovers. Strategic buyers are at center stage.
Telephone & Data Systems has a takeover angle. There are 117 million shares outstanding, the stock is $45, and the company has two businesses: wireless, through U.S. Cellular [USM], and telephone companies in rural America. TDS has about $350 million in net cash. EBITDA is $300 million. Valued at six times, that's $2 billion. With every TDS share, you get 0.61 of a share of U.S. Cellular, which trades at about $62 but is worth $100 to $120 a share. In all, you're getting $5 billion of value for free when you buy TDS at $45. Alltel or Verizon might buy U.S. Cellular, and there is speculation that TDS received a bid in the $90-a-share range. It is a potential takeover target.
Next, Tootsie Roll Industries. It has about 55 million shares. Chairman and CEO Melvin Gordon— he's 88— and his wife, Ellen, the chief operating officer— she's 76— control the voting shares, which have 10 votes each. Tootsie Roll has $120 million in cash. Revenues are flattish around $500 million, growing about 3% or 4% a year. Earnings are about a buck a share, going to $1.20. A takeout in the low $30s per share is likely. The stock sells for $26.
Who are the logical buyers?
There are many. With capital-gains taxes at 15% and likely to rise, it may be time for the Gordons to look at alternatives.
Tredegar, located in Richmond, Va., makes diaper components. The number of children 4 years old and under is going to stay flat at about 600 million for the next 30 years, but the use of diapers for incontinence is rising dramatically with the elderly population. Third-party pay is increasing. Tredegar also makes a fiber shield for flat-screen devices, and has an aluminum-products business. The company has 34.5 million shares and has been buying in its stock, which trades for 14.50.
What is the market cap?
It's $500 million. A transaction is likely here, too. Management could take the company private, or continue to shrink its capitalization. Tredegar will earn about 70 cents this year, but earnings could rise 50% in the next few years.
Herley Industries, a maker of defense electronics, also may be taken over. The stock is $15 - $16. There are 13.5 million shares outstanding. Revenues for the year ending July 31 will be about $150 million, and profits will be break-even to a small loss. Herley could earn a dollar a share in the next 12 months.
Any other ideas?
Diebold, which makes automatic-teller machines, sells for $39.50. United Technologies [UTX] bid $40 a share for Diebold, which rejected the offer. Diebold could earn about $2.35 this year, $2.85 in '09 and $3.50 in 2010. The balance sheet is in good shape. They should announce a large capitalization shrink. Self-service at banks is going to be highly sought after in Europe and Asia, and Diebold knows how to work with the banks. NCR [NCR] has terrific management and we're buying it, as well, but Diebold is our official pick.
Thanks, Mario.
Art Samberg
Barron's: What gives with this market, Art?
Samberg: The commodities market has a lot of unfinished business. The bubble isn't going to burst; it's going to continue to expand. We haven't reached the animal-spirits stage yet. This run-up is economically justified. [[Even if we have a recession?: normxxx]]
As for the stock market, a narrower and narrower list of stocks will work. We played some tech and materials names when both groups had major corrections a few months ago. But the stocks have come back, and I'm not as interested any more. The lack of serious innovation is a huge problem for the country, and it gets manifested in technology stocks. The number of interesting IPOs [initial public offerings] is tiny, and the backlog is getting even smaller.
Because there are fewer compelling technologies, or because a choppy market is inhospitable to new stocks?
The venture-capital world is moving from a focus on information technology to green investing. There aren't a lot of new, green-oriented ideas that will be significant in the short term. Health care usually is a good feeder of IPOs, but the macros there are dismal. Much of what's new in tech focuses on consumers. Those stocks are boring.
At the beginning of the year financial institutions were way overlevered. They've brought leverage down quickly, and the rate of return on capital industrywide is falling. When the unwinding ends, financials will sell at book value, not multiples of book.
So they're boring, too?
They could be boring for another two, three or four years. The market will be down this year, and next year won't be much better. It could be worse. There will be bigger problems with consumer credit and trouble in commercial lending. Before it's over, every financial institution will be embarrassed in some way. This is the mother of all credit cycles, at least in my lifetime, and that's the way they end.
Will things improve by 2010?
I'm optimistic about 2010. The U.S. will look good relative to other markets. For now, the only thing left to invest in is inflating assets— copper, natural gas, coal. I recommended Ultra Petroleum in January. We still love it. Natural gas now trades above $12 per million British thermal units, up from $7 in January. Southwestern Energy is another natural-gas play. In the first quarter a lot of commodities rallied, but the related equities didn't. You're starting to get an equity catch-up play. Because gas is rising, there's a double play.
We're big owners of Freeport McMoRan Copper & Gold. Copper used to be obtained through surface mining, but the ore grade has deteriorated and now you have go underground. There isn't enough electricity in places like Chile, and there are water-scarcity problems near many mines. Nationalization is also an issue.
We also like Xstrata, the Anglo-Swiss copper miner. They have a lot of South African coal. Eskom, the South African electric company, can't produce enough electricity, so it's hard to get this stuff out of the ground. Prices will escalate until the infrastructure is built to accommodate the market, and the rate of return improves significantly.
You've been a big fan of Companhia Vale do Rio Doce, or CVRD, the Brazilian commodity giant. Do you like it still?
It's super-cheap. I'm still recommending it. Nothing has changed. My last pick is Halliburton, which makes equipment for oil and gas exploration. The bad press surrounding Halliburton has gone away. [The company, which has close ties to Vice President Dick Cheney, was accused of profiting from government favoritism in Iraq.] I could mention almost any commodities producer: The story is the same. I'm either dead right on commodities, or dead wrong.
Here's hoping you're dead right. Thanks, Art.
Fred Hickey
Barron's: Do things still look bleak to you, Fred?
Hickey: A witch's brew is hitting the economy, including the biggest housing-market collapse in U.S. history. Home prices are declining by 14%, year over year. Oil is $135 a barrel, up almost 40% since January. Food prices are soaring, unemployment is rising and wages are stagnant. Lending standards are tightening. Auto sales are plunging. States have a budget crisis. This combination of problems is unprecedented unless you go back to 1929.
Which we're not. Are we?
Well, they haven't taken protectionist steps yet. But they're talking about it. The U.S. is in a recession. The only people who don't believe that are on Wall Street. The stock market has had a classic bear-market rally, triggered by the Federal Reserve saving the world again. Supposedly. Previously, significant declines in interest rates would lead to corresponding drops in mortgage rates. Not any more. Lending standards are tighter, and consumers have record debt and no savings. Who would want to lend to them?
Good point. How will these problems get solved?
They have to play out. Housing prices have to fall to the point where homes become affordable to the general population. So far, stocks aren't even down 20%. The market will get killed when companies admit the second-half rebound isn't going to happen.
I'm still buying gold and selling "horsemen," the most popular tech stocks. Gold hit $1,000 an ounce within a few weeks of the January Roundtable, which I expected. I slashed my position by 75%, and in March I got out of all my puts on stocks. I've been on the sidelines, though I bought tech stocks such as Microsoft [MSFT], Oracle [ORCL], EMC [EMC], Hewlett-Packard [HPQ] and Apple [AAPL]. Recently I sold them— my intention was to rent them— and re-entered my put positions.
What, specifically, are you shorting through puts?
The SOX, or Philadelphia Semiconductor Index. The severe downturn in the economy has led to lower sales of technology products. Inventories are building at wholesalers. SG Cowen recently calculated that inventories are at a five-year high. Cellphone sales have fallen 16% in Western Europe. A classic inventory correction is coming within a recession. Yet the SOX is up 20% from its lows! The SOX could correct at least to its March lows, and probably more. But don't short, except through put options.
Any longs these days?
Gold stocks have been hammered. Junior mining shares have been destroyed. Golden Star Resources isn't a junior. It has real mines, in Ghana. Yet its price is destroyed. A new CEO came on late last year from Newmont Mining [NEM], which also has big operations in Ghana. Recently he brought in a new chief operating officer, also from Newmont. Golden Star could become a takeover target, with Newmont a likely buyer.
Gold production in Ghana is expected to rise 60% this year. But it is dependent on technology. Golden Star was bringing on a new processing plant last year and ran into problems. If it can get this plant working properly, production will increase. The stock is at 3, and the market cap is $700 million. The shares could easily double. My biggest positions are in bullion. As fear returns to the market, gold will rise again. I'm buying mostly through GLD, or StreetTracks Gold Shares, an exchange-traded fund.
The horsemen continue to gallop. Research In Motion is up almost 30% since you recommended shorting it through puts in January. Are you skeptical still?
RIM has a market valuation of $75 billion, but just 1% of the cellphone market worldwide. Nokia [NOK] has a market cap of $100 billion, and a 40% market share. What kind of upside is there at this valuation?
Thanks, Fred.
Felix Zulauf
Barron's: You predicted this would be a rough year for investors, and so far, you're right. What now, Felix?
Zulauf: This bear market doesn't look like 2000-02. It is a much more drawn-out affair, but a high-risk environment. There are enough reflation efforts under way in the U.S. and enough economic momentum in other parts of the world to prevent a global recession now. The economic expansion could run another two years or more. The market will remain choppy, with a downward bias lasting three to four years, as macro liquidity deteriorates. Investors' risk appetite is lower. There isn't enough liquidity to push stocks to new highs, but there is still enough to support the dominant themes in the market.
It's a split market. Financials and consumer stocks will remain weak, and energy and agriculture-related issu
By Lauren R. Rublin, Barron's | 16 June 2008
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Midyear 2008 Roundtable Report Card
You can't trust anything these days. Take the innocent-looking tomato— delicious, nutritious and now a weapon of mass digestive destruction. Or inflation, still soothingly low, so long as you don't eat or drive. Then there's Wall Street, where humongous earnings these past few years have fed similarly humongous bonuses. Sorry, wrong numbers. Just ask Lehman Brothers, which announced last week that it will report a loss of nearly $3 billion for the second quarter, wiping out numerous periods of supposed gains. [[Wonder if that was bad for bonuses?: normxxx]]
The Barron's roundtable represents a notable exception to the current bull market in duplicity and false impressions. Year in and year out, we can trust its members— 11 of Wall Street's most insightful investment experts— to give us the straight skinny on the economy, the financial markets and dozens of individual stocks and funds, even if the truth is sometimes painful, as it has been this year.
Brad Trent: When the Roundtable last met Jan. 7 with the editors of Barron's, our distinguished panelists minced no words: This year would be difficult to dismal for the economy and stocks, as the bubbles in housing and credit unwind. So far, so good (er, bad). Most still feel that way about '08, and even '09, though a handful see the skies clearing at last, even for decimated financial and home-building shares. [[dream on! : normxxx]].
In the pages ahead, we've distilled the latest views of the Roundtable crew. We hope you're enlightened, amused and provoked by them to discover your own truths about markets. And, should you disagree with any of the opinions expressed herein, please, no tomatoes.
Bill Gross
Barron's: What a year it's been for investors— and it's only June. How do things look to you, Bill?
Gross: The economy has fooled us. Pimco expected at least a quarter of negative GDP [gross domestic product] growth, but we haven't seen it yet. We don't expect a return to normalized growth rates in the next six months, however. There still are weaknesses in housing, and housing deflation affects employment and consumption. Also, the states, which had been reluctant savers, will have to cut back because they are over budget. Growth will stay positive, but very, very low.
How will the markets deal with this?
Relatively high inflation combined with meager economic growth sends a mixed message to the bond market. With the economy down, the Federal Reserve can't raise rates to tame inflation. Yet, higher inflation means it should, or at least should be thinking about it.
What advice would you give the Fed?
The U.S. should simply stand pat. About a month ago the Fed sent a clear signal that 2% was it on the downside for rates, and that further stimulation would come from policy changes such as its liquidity provisions for Wall Street and heavy lifting from the Treasury and Congress to ease the mortgage crisis. But it's difficult to raise interest rates in the face of a housing market that is falling by double digits.
Bill Gross's Picks
Company Ticker 6/11/08 Price
FairPoint Communications FRP $7.79
Countrywide Financial CFC 4.58
6/11/08 Yield
JPMorgan Chase 7.9%, due April 2049 8.30%
Source: Bloomberg
The good news for stocks is that economic growth hasn't turned negative[!?!] and that corporate profits haven't declined[!?!] A substantial portion of profits comes from outside the U.S., either through currency adjustments or greater growth in foreign markets. That said, financials play a dominant role in the market. That means lower profit margins, and lower profits. It's a tale of two stock markets.
Nonfinancial companies are doing better, you mean.
Finance companies are stinking up the joint, but the industrial economy is benefiting from a lower dollar and more exports. The railroads are doing well. The stock market might not have much upside, although foreign reserves have to go somewhere, and with oil prices at records, we're talking about an additional $500 billion of reserves generated in the past six months. That money will come to the U.S., and its owners don't want bonds. Almost by default— if you'll pardon the term— stocks are benefiting. They are the least bad choice. But be cautious: This is not a new bull market.
Your January picks— auto bonds and some closed-end funds— did well, especially relative to the market. How about a few new ideas?
Fairpoint Communications, a land-line phone company, acquired substantial properties from Verizon Communications [ticker: VZ]. Related to the deal, the dividend will fall to $1.03 from $1.59, for a yield of 11% for the next year. JPMorgan Chase has a 7.9% preferred stock due April 29, 2049. This is the crème de la crème of banks today; the Fed loves [CEO] Jamie Dimon. Why shouldn't you? This preferred can be bought for 96 cents on the dollar, for a yield of 8%-plus. Lastly, Countrywide Financial trades at a 10% discount to the price that Bank of America, its future parent, has agreed to pay in an all-stock deal. The deal will close in a few months, and Countrywide yields 10% while you wait.
Sounds like it's worth waiting. Thanks, Bill.
Oscar Schafer
Barron's: What is your second-half forecast, Oscar?
Schafer: We are in the 6th or 7th inning of losses taken on subprime and other financial instruments. But we are in the third or fourth inning of deleveraging the economy after four or five years of borrowing. Growth will remain slow as we reverse the trend of having spent more than we earned. And we haven't yet seen all the problems of the regional banks, which, although they hold less of the risky financial instruments, will have problems with customers defaulting on credit-card debt and auto loans.
Consumers will continue to be under pressure as house prices fall, mortgage-equity withdrawals decline and gas is at $4 a gallon. That's why companies like Wal-Mart Stores [WMT] are doing better than expected. The U.S. has $20 trillion in household wealth. House prices have come down 13% or 14%, so that's $2.6 trillion in wealth destruction.
Compare that to tax cuts, which have been all of $150 billion. The continuing erosion in household wealth will make consumers spend less. And the banks, with big write-offs, are constrained in lending money, even if the Fed lowers rates. The growth of the past few years was credit-driven, and credit is drying up.
Oscar Schafer's Picks
Company Ticker 6/11/08 Price
Tyco International TYC $42.91
CommScope CTV 52.14
Source: Bloomberg
How long will the deleveraging take?
It could last another 12 to 18 months. We look for companies that are somewhat immune to these problems. The further you get from housing and consumer spending, the less the impact is likely to be. If the rest of the world— China, India, Brazil— doesn't collapse, the industrial part of our economy will keep going.
Are you expecting them to collapse?
It's the $64 question. If it happens, all bets are off for the rest of the world. The stock market probably won't do much this year. There is a yin and yang between the financial sector and everything else. We'll have a standoff. As long as there aren't significant layoffs, the economy— and the stock market— will muddle along.
What stocks do well in this sort of market?
I've got two special situations. Tyco International sells for 43 a share and has a $21 billion market cap. After spinning off its health-care business into Covidien [COV] and electronics manufacturing into Tyco Electronics [TEL], the remaining Tyco is a diversified manufacturing and service company operating in several business segments. These include ADT, the nation's largest electronic-security provider; Flow Control, the largest manufacturer of flow-control products, and fire-protection, safety-products and electrical and metal-products businesses.
Tyco is significantly undervalued. The company has big opportunities to improve margins across various business segments and reduce corporate overhead. In particular, ADT's European business has operating margins less than half those in the U.S. The company is in the early stages of an operational turnaround. Also, the flow-control business is underappreciated, as its end markets— particularly oil and gas, power, waste and water— have excellent growth prospects, and it is 75% international. The growth in these end markets could continue for several years.
What do Tyco's financials look like?
The company is underlevered, with current net debt equal to EBITDA [earnings before interest, taxes, depreciation and amortization]. Tyco's businesses generate significant cash flow due to high recurring revenue, a strong service-revenue component and relatively modest capital-expenditure requirements. The company is making tuck-in acquisitions and is in the process of divesting its engineering and construction business, the proceeds of which will be reinvested and used to repurchase stock. Tyco has a great management team led by CEO Ed Breen, who can focus on the core businesses following last year's spinoffs.
Did Tyco retain a piece of the spinoffs?
No, though all the pieces are interesting. The company isn't economically sensitive; management is in control of its destiny. The stock is selling for about 6.5 times next year's estimated EBITDA, and about 11 times 2009 estimated cash earnings of just under $4 a share. Tyco could be worth in the mid-60s. If it doesn't get credit for hidden gems such as Flow Control, it could spin those off, too.
CommScope is a producer of antennas and cabling for wireless towers, data transport and cable companies. It is a leading producer in all its segments, domestically and internationally. The key to the story is the superb execution capabilities of the CommScope management team. The CEO, chief financial officer and chief operating officer have been running this company together for more than 30 years.
As an example, after acquiring Avaya's enterprise-cabling business in 2004 and doubling the revenue base, CommScope proceeded to grow its earnings per share by more than 400% from 2004 until 2007, on revenue growth of only 65%. Increased purchasing scale, manufacturing efficiencies and rationalization enabled significant operating leverage. At the end of 2007, CommScope's management embarked on its next large acquisition, buying Andrew Corp.
This is another doubling-of-revenue acquisition. Similarly, there are significant opportunities for cost synergy, including plant rationalizations, purchasing scale and the conversion of copper products to aluminum. CommScope's wireless antenna and cabling business should benefit from the rapid increase in wireless-data demand.
Where is the stock?
While the stock has run up 30% to $53 - $54 since the company reported its first quarter in April, there is at least 25% upside from current levels. Wall Street's estimate for this year is $3.36 a share. For next year, it's $4.10, and there is upside to both years' estimates. CommScope trades for 13 times '09 earnings. The market cap is $3.7 billion.
With both Tyco and CommScope, we are betting on the management, not the economy. You have to focus on management that can execute despite headwinds.
Good advice. Thanks, Oscar.
Archie Macallaster
Barron's: How's the year treating you, Archie?
MacAllaster: I have been neutral on the market for a year and a half. I've survived and my customers have survived. But these are brutal markets and you have to be careful. You wish everybody was off margin, because this is not a time to be speculating with borrowed money.
Tell that to Wall Street.
Lehman Brothers has reduced its leverage from 32 times equity to about 25 times in one quarter, which is good. But they have a long way to go. They raised $6 billion of equity and they are probably going to lose that $6 billion.
Archie MacAllaster's Picks
Company Ticker 6/11/08 Price
JPMorgan Chase JPM $37.13
Wells Fargo WFC 25.55
Bank of America BAC 28.85
Source: Bloomberg
The economy has performed well if you get away from housing and the financials. Companies with foreign operations have done well. McDonald's [MCD] reported good earnings and its stock is up. I'm an optimist. The economy hasn't had a negative quarter yet, and if it does, the downturn won't be deep. I have three bank stocks to recommend.
Surely, you're joking.
If nobody loves banks, at the least they're fairly priced[!?!] The five largest banks in America have 44% - 45% of the total assets of the banking system. They have increased that percentage year after year, and it won't be long before they own more than 50%. Two [Citigroup and Wachovia] have cut their dividends, but the other three are a good investment in the next 12 to 18 months. One is conservative, one a growth company and one speculative.
JPMorgan Chase has the most conservative balance sheet and the fewest problems. The stock sells at about $37. The high for the past year was $51, the low $36. The dividend is $1.52 a share and the stock yields 4%. JPMorgan earned $4.37 a share in 2007. The estimate for '08 is $2.50. If they pay out $1.52 a share, they will earn well in excess of the dividend. There is no reason it should be cut. You don't have to hurry to buy these things because they could go down in the next month or two. But in 12 to 18 months, the stock ought to be somewhere in the neighborhood of $46 to $48.
Which is the growth company?
Wells Fargo. It has a major problem in home-equity loans, but has reserved well. The stock is about $25, and the range is $38 to $24.38. Wells has had the best growth of all the large banks for many years, and it still will. It is well run. It does three or four different kinds of business with its customers. The market has knocked its shares down too far. Wells Fargo earned $2.41 a share last year, and the estimate this year is $2 to $2.10. This, too, is well in excess of its dividend, which is $1.24 a share. The stock yields almost 5%. My earnings estimate for 2009 is $3.10 a share.
Your speculative bet must be Bank of America.
Yes, because they may cut the dividend. Bank of America offers the greatest potential. It's trading around $29, the low for the year. The high was $53. The dividend is $2.56 a share, and it yields about 8.6%. They don't have to cut the dividend, but with the yield over 8%, the market is saying they will. Bank of America's pending acquisition of Countrywide Financial has been criticized; people are worried about the size of the reserves they'll have to take against Countrywide's loans. Long term, the deal will be a positive, though it's going to take 18 months to two years.
Bank of America also owns about 20 billion shares of China Construction Bank [939.Hong Kong]. It accounts for about $15 billion of the bank's market value. The first piece they purchased becomes marketable in October. They'll sell part of it. When they do, they'll have a big profit. That will allow them to offset some of the losses, and perhaps preserve the dividend. The bank earned $3.32 a share in 2007, and that's after taking big write-offs in the fourth quarter. My estimate for this year is $2.50 to $2.60, which is about equal to the $2.56 dividend. My 18-month target is $50 to $52.
Thank you, Archie.
Scott Black
Barron's: Some of your January picks did well, including Devon Energy, Ensco and Ross Stores.
Black: You didn't have to be a genius to do well in oil stocks, given oil is $134 a barrel and gas is $12.67 per million British thermal units— well above levels earlier this year. It's like having a big wind to your back as you're sailing off Newport to Block Island. Devon Energy [DVN] also is great with the drill bit. I originally thought earnings would be around $7.50 a share. Now they could top $11. It's a good company, but the price is a lot higher now.
Ensco International [ESV] also is doing well. They still have 45 rigs— 44 jack-ups and one semi-submersible— and six semi-submersibles on the way. The upside lies in the semi-submersibles; the first will be delivered next spring. The company is almost debt-free. Earnings estimates have been ratcheting up, and the stock still sells at nine times this year's estimates.
Scott Black's Picks
Company Ticker 6/11/08 Price
Bolt Technology BOLT $19.68
Belden BDC 36.05
Source: Bloomberg
As for Ross Stores [ROST], women like to shop. They like to buy name brands at a bargain. Ross sells name-brand merchandise at 25% to 40% off department-store prices. Comp-store sales [sales at stores open a year or more] were up 7% in May, versus estimates of 4%. I thought they would earn $2.10 to $2.12 a share. The estimates are now $2.25. But the stock— at 37, or 16 times this year's earnings— is too expensive to initiate a position.
Thanks for the update. What's ahead?
Analysts estimate the S&P 500 will earn $89.27 this year. Strategists say $79.25. If we use $84.25, which is in the middle, the P/E is 16. The market is fully valued. On a dividend-discount model, as well, it is efficient. In January and February we had the greatest opportunity to buy name-brand technology stocks since the Long Term Capital debacle in 1998. We bought Oracle [ORCL] at 12 times earnings, Texas Instruments [TXN], KLA-Tencor [KLAC], Xilinx [XLNX].
And now?
There are no more pockets of opportunity. We're ignoring consumer-discretionary stocks. Everyone is recommending financials. We aren't. We have the lowest weighting in financials since I started Delphi. The only major brokerage we own is Goldman Sachs [GS], because they seem to have weathered the storm. Elsewhere in the industry, the bloodletting continues. The meltdown in housing also is ongoing. The stock market won't get out of its own way until the banking system regains transparency. This also overhangs S&P earnings.
The unwinding of the housing bubble is killing the economy. Household net worth is dropping for the first time in five or six years. The average family income in America is $48,600. For Main Street, this is a recession. Real GDP growth in 2008 and '09 is going to be weak, at 1% to 1.5%.
That's robust compared with some estimates.
Everybody knocks [Federal Reserve Chairman] Ben Bernanke, but I give him kudos. He could have kept interest rates high and defended the dollar, and risked a massive recession. He did the right thing by cutting rates. Opening the discount window to the investment banks was smart. So was bailing out Bear Stearns. We could have had a banking crisis like 1928 and '29 if Bear had failed.
If the market thinks S&P 500 earnings can get up to $100 in 2009, as some predict, stocks will take off later this year. But if S&P earnings come in around $84-$87 this year, it is going to be a stockpicker's market. Treasuries are a fool's bet. With headline inflation at almost 4%, parking money in two-, five— or 10-year Treasuries yields a negative real return.
Where are you parking money for Delphi's clients?
We like Bolt Technology, based in Norwalk, Conn. It trades for 20, and has a market cap of $172 million. The high last year was 39.57, the low 14.67. We've been buying the stock at $18 - $19. Bolt makes a compressed-air gun for offshore seismology and has an 80% market share worldwide. It also makes underwater electrical connectors and cables, but the gun accounts for roughly 60% of sales. The company benefits from offshore seismology, and is in the sweet spot right now. Big customers include Schlumberger [SLB] and SeaBird Exploration [SBX.Norway].
For the year ending June 30, Bolt could do close to $67 million in revenue and earn about $1.65 a share. There isn't much Street guidance on '09, so I do my own. Conservatively, we have revenues going up 12%, to $75 million. Cost of sales is about 55%, and SG&A [selling, general and administrative expenses] is up 5%, to $9.6 million. Research and development spending is about $200,000. They have more than $2 a share in cash, no debt. There is about $300,000 in interest income. After taxes at 33%, you get $16.3 million in net income. Divide by 8.58 million fully diluted shares, and Bolt will earn $1.90 a share on the low end.
And on the high end?
Revenues will grow 16%, to $78 million, and they'll earn $2 a share, versus $1.65 this year. That's 20% growth and a 10 price/earnings multiple. They have a steady book of business. Schlumberger is a great company, but at a 20 P/E it is not a great value. Bolt, nobody ever heard of.
Belden, in St. Louis, isn't well known, either. It manufactures electrical cable and wire. It trades for $36 a share and there are 47 million fully diluted shares, for a $1.7 billion market cap. The high on the year was $60; the low, $30.28. I like industrial companies that have a big presence outside the U.S. Only 41% of Belden's revenue is U.S.-based. The company made acquisitions at the end of 2006, one in Germany and another in Hong Kong. Revenue guidance for '08 is around $2.25 billion. Operating margins are 12%. That gets you to about $270 million in operating income. They have $31 million in interest expense and $4 million in interest income, so before a recent acquisition, they would have made $243 million, taxed at 32%. I had them earning $3.51 on the low side and $3.68 after economies of scale. The acquisition will dilute '08 earnings by 30 cents a share. Belden is a mundane manufacturer in the right markets.
Thank you, Scott.
Marc Faber
Barron's: What do you make of '08, so far?
Faber: Measured in euros, the U.S. is down around 13%. But it has outperformed many other markets. The U.S. has many problems. One is the slowdown in credit growth. Another is recession. The statistics don't indicate the economy is in a recession, but we question the statistics.
The Federal Reserve's aggressive interest-rate cuts— to 2% from 5.25% last September— make equities relatively attractive compared to cash yields. But in the second half and the first half of 2009 it will become evident that '09 earnings for the S&P 500 won't meet consensus estimates of $110 per S&P share. Earnings instead are coming down and will stay down, and this will weigh on stocks. The recession won't be deep but it could be long. And it could be deep for corporate profits.
How much further will the market fall?
The situation is similar to 1973-74. It's water torture. We may have a rally here or there, but once investors notice that Mr. Obama has a good chance of winning the presidential election, this will be another negative for stocks. He's not going to be good for the market.
Also, the bond market's not acting well. Bond yields are higher than when the Fed cut rates between December and January. The bond market looks as though it could weaken considerably. Once interest rates go up again, that will be another strong headwind for stocks.
Marc Faber's Picks
Investment Ticker 6/11/08 Price
Japan
iShares MSCI
Japan Small Cap SCJ $47.85
Sumitomo Trust & Banking 8403.Japan ¥840
Mitsubishi UFJ MTU $ 9.49
Mizuho Financial 8411.Japan ¥549k
Currencies
Buy the U.S. Dollar/Sell the Euro 1 euro=$1.56
Airlines
AMR AMR $ 6.09
Lufthansa DLAKY $24.30
Singapore Airlines SIA.Singapore S$15.12
Japan Airlines 9205.Japan ¥235
Short
US Steel X $172.46
Source: Bloomberg
The U.S. is down just 8% this year in dollars. India is down 30%; China, 40%; Vietnam, down 60%. Are those markets buys at current levels?
Among emerging markets, only Mexico and Brazil have been strong. I'd get out of them. There is no hurry to buy anything in Asia, though stocks aren't expensive. Thailand, down 7%, could fall another 5% or even 10%.
Japan is the exception. The Japanese market has performed badly in the past 18 months, and stocks are low compared to cash yields. Some corporations have increased their dividends. Steel Partners' ouster of the management of Aderans Holdings [8170.Japan], a Japanese wig maker, was an important event. Pension funds and foreign investors are starting to have more power over Japanese management.
Do you still like the iShares MSCI Japan Small Cap exchange-traded fund, which you recommended in January?
Buy that, and some Japanese banks: Sumitomo Trust, Mitsubishi UFJ and Mizuho Financial. I would still go long the dollar against the euro, which is overvalued. The tightening of global liquidity and the contracting U.S. trade and current-account deficits are likely to be dollar-supportive. Mr. Bernanke does not understand anything about international economics; it's not a weak currency that leads via import prices to inflation, as he suggested, but inflated money and credit growth that leads to a weak currency.
Where is oil headed, now that it trades in the $130s?
Prices should ease a bit. It wouldn't surprise me to see oil dropping to around $80 a barrel. If you're bearish about oil in the next three months— though long-term, commodities will go higher— it's best to own Japanese stocks or airlines. A drop in oil might not help the airlines much, but sentiment toward airlines will improve considerably. Buy AMR, Lufthansa, Singapore Airlines and Japan Airlines.
And sell oil stocks?
Interestingly, they haven't done well relative to crude. One problem is declining reserves. Also, I would rather own physical commodities than commodity-related equities because resource nationalism is on the upswing. That's also true of gold, which has fallen to $870 an ounce from $1,000. The price could go down to $780 to $800 an ounce. If you have no exposure to gold, start buying it here. People are blaming speculators for the recent run-up in commodities, but they are a symptom rather than a cause of the problem. The cause lies in excess liquidity, and the Fed is responsible for that.
My last suggestion concerns steel. If world economies decelerate, the pace of building in places like China will slow, hurting demand for steel. Steel stocks have been among this year's best performers. Short U.S. Steel.
Thank you, Marc.
Mario Gabelli
Barron's: How does the big picture look to you, Mario?
Gabelli: The consumer, as we discussed in January, ran out of money and went off a cliff. Food and fuel costs have been a bigger negative than we expected. Rebate checks are hitting people's pocketbooks now, and we need another round of fiscal stimulation, focused on productivity. As for inflation, as Karl Otto Pöhl, a former president of the German Bundesbank, said, "It's like toothpaste. Once it gets out of the tube, it's very hard to put back." Inflation expectations have been accelerating. That will remain a challenge.
There will be less stress in the financial system in the second half of '08, but continuing uncertainty with regard to the underpinnings of that stress: the housing market. Likewise, the auto market needs help. A lot of auto loans are underwater because of the declining value of the cars they financed. In 2009, however, we'll be further along in correcting the housing balances, and we'll have an OK economy.
And an OK stock market?
Originally I thought the market would be flat to up 5%. It will probably close up. If the Democrats control Congress and the White House, they'll raise taxes. If you own a company, you may want to sell it and pay long-term capital gains this year. Companies may issue more special dividends over the balance of the year.
Mario Gabelli's Picks
Company Ticker 6/11/08 Price
Tyco International TYC $42.91
Telephone & Data Systems TDS $47.14
Tootsie Roll Industries TR 25.67
Tredegar TG 14.19
Herley Industries HRLY 15.54
Diebold DBD 39.16
Source: Bloomberg
There is no question the amount of money earmarked by pension funds, endowments and others toward commodities is having an impact on prices, well beyond Chinese or Indian demand. This speculative bubble should be nipped in the bud. Margin requirements on commodities accounts must be increased or we'll have another bust.
Where do you see value these days?
We like companies with an environmental focus. Going green is good for business. We also like companies with pricing power, and we like takeovers. Strategic buyers are at center stage.
Telephone & Data Systems has a takeover angle. There are 117 million shares outstanding, the stock is $45, and the company has two businesses: wireless, through U.S. Cellular [USM], and telephone companies in rural America. TDS has about $350 million in net cash. EBITDA is $300 million. Valued at six times, that's $2 billion. With every TDS share, you get 0.61 of a share of U.S. Cellular, which trades at about $62 but is worth $100 to $120 a share. In all, you're getting $5 billion of value for free when you buy TDS at $45. Alltel or Verizon might buy U.S. Cellular, and there is speculation that TDS received a bid in the $90-a-share range. It is a potential takeover target.
Next, Tootsie Roll Industries. It has about 55 million shares. Chairman and CEO Melvin Gordon— he's 88— and his wife, Ellen, the chief operating officer— she's 76— control the voting shares, which have 10 votes each. Tootsie Roll has $120 million in cash. Revenues are flattish around $500 million, growing about 3% or 4% a year. Earnings are about a buck a share, going to $1.20. A takeout in the low $30s per share is likely. The stock sells for $26.
Who are the logical buyers?
There are many. With capital-gains taxes at 15% and likely to rise, it may be time for the Gordons to look at alternatives.
Tredegar, located in Richmond, Va., makes diaper components. The number of children 4 years old and under is going to stay flat at about 600 million for the next 30 years, but the use of diapers for incontinence is rising dramatically with the elderly population. Third-party pay is increasing. Tredegar also makes a fiber shield for flat-screen devices, and has an aluminum-products business. The company has 34.5 million shares and has been buying in its stock, which trades for 14.50.
What is the market cap?
It's $500 million. A transaction is likely here, too. Management could take the company private, or continue to shrink its capitalization. Tredegar will earn about 70 cents this year, but earnings could rise 50% in the next few years.
Herley Industries, a maker of defense electronics, also may be taken over. The stock is $15 - $16. There are 13.5 million shares outstanding. Revenues for the year ending July 31 will be about $150 million, and profits will be break-even to a small loss. Herley could earn a dollar a share in the next 12 months.
Any other ideas?
Diebold, which makes automatic-teller machines, sells for $39.50. United Technologies [UTX] bid $40 a share for Diebold, which rejected the offer. Diebold could earn about $2.35 this year, $2.85 in '09 and $3.50 in 2010. The balance sheet is in good shape. They should announce a large capitalization shrink. Self-service at banks is going to be highly sought after in Europe and Asia, and Diebold knows how to work with the banks. NCR [NCR] has terrific management and we're buying it, as well, but Diebold is our official pick.
Thanks, Mario.
Art Samberg
Barron's: What gives with this market, Art?
Samberg: The commodities market has a lot of unfinished business. The bubble isn't going to burst; it's going to continue to expand. We haven't reached the animal-spirits stage yet. This run-up is economically justified. [[Even if we have a recession?: normxxx]]
As for the stock market, a narrower and narrower list of stocks will work. We played some tech and materials names when both groups had major corrections a few months ago. But the stocks have come back, and I'm not as interested any more. The lack of serious innovation is a huge problem for the country, and it gets manifested in technology stocks. The number of interesting IPOs [initial public offerings] is tiny, and the backlog is getting even smaller.
Because there are fewer compelling technologies, or because a choppy market is inhospitable to new stocks?
The venture-capital world is moving from a focus on information technology to green investing. There aren't a lot of new, green-oriented ideas that will be significant in the short term. Health care usually is a good feeder of IPOs, but the macros there are dismal. Much of what's new in tech focuses on consumers. Those stocks are boring.
At the beginning of the year financial institutions were way overlevered. They've brought leverage down quickly, and the rate of return on capital industrywide is falling. When the unwinding ends, financials will sell at book value, not multiples of book.
So they're boring, too?
They could be boring for another two, three or four years. The market will be down this year, and next year won't be much better. It could be worse. There will be bigger problems with consumer credit and trouble in commercial lending. Before it's over, every financial institution will be embarrassed in some way. This is the mother of all credit cycles, at least in my lifetime, and that's the way they end.
Will things improve by 2010?
I'm optimistic about 2010. The U.S. will look good relative to other markets. For now, the only thing left to invest in is inflating assets— copper, natural gas, coal. I recommended Ultra Petroleum in January. We still love it. Natural gas now trades above $12 per million British thermal units, up from $7 in January. Southwestern Energy is another natural-gas play. In the first quarter a lot of commodities rallied, but the related equities didn't. You're starting to get an equity catch-up play. Because gas is rising, there's a double play.
We're big owners of Freeport McMoRan Copper & Gold. Copper used to be obtained through surface mining, but the ore grade has deteriorated and now you have go underground. There isn't enough electricity in places like Chile, and there are water-scarcity problems near many mines. Nationalization is also an issue.
We also like Xstrata, the Anglo-Swiss copper miner. They have a lot of South African coal. Eskom, the South African electric company, can't produce enough electricity, so it's hard to get this stuff out of the ground. Prices will escalate until the infrastructure is built to accommodate the market, and the rate of return improves significantly.
Art Samberg's Picks
Company Ticker 6/11/08 Price
Ultra Petroleum UPL $ 94.96
Southwestern Energy SWN 48.33
Freeport McMoRan Copper&Gold FCX 120.09
Xstrata XTA.UK 4035 pence
CVRD RIO $ 34.44
Halliburton HAL 49.37
Source: Bloomberg
You've been a big fan of Companhia Vale do Rio Doce, or CVRD, the Brazilian commodity giant. Do you like it still?
It's super-cheap. I'm still recommending it. Nothing has changed. My last pick is Halliburton, which makes equipment for oil and gas exploration. The bad press surrounding Halliburton has gone away. [The company, which has close ties to Vice President Dick Cheney, was accused of profiting from government favoritism in Iraq.] I could mention almost any commodities producer: The story is the same. I'm either dead right on commodities, or dead wrong.
Here's hoping you're dead right. Thanks, Art.
Fred Hickey
Barron's: Do things still look bleak to you, Fred?
Hickey: A witch's brew is hitting the economy, including the biggest housing-market collapse in U.S. history. Home prices are declining by 14%, year over year. Oil is $135 a barrel, up almost 40% since January. Food prices are soaring, unemployment is rising and wages are stagnant. Lending standards are tightening. Auto sales are plunging. States have a budget crisis. This combination of problems is unprecedented unless you go back to 1929.
Which we're not. Are we?
Well, they haven't taken protectionist steps yet. But they're talking about it. The U.S. is in a recession. The only people who don't believe that are on Wall Street. The stock market has had a classic bear-market rally, triggered by the Federal Reserve saving the world again. Supposedly. Previously, significant declines in interest rates would lead to corresponding drops in mortgage rates. Not any more. Lending standards are tighter, and consumers have record debt and no savings. Who would want to lend to them?
Good point. How will these problems get solved?
They have to play out. Housing prices have to fall to the point where homes become affordable to the general population. So far, stocks aren't even down 20%. The market will get killed when companies admit the second-half rebound isn't going to happen.
I'm still buying gold and selling "horsemen," the most popular tech stocks. Gold hit $1,000 an ounce within a few weeks of the January Roundtable, which I expected. I slashed my position by 75%, and in March I got out of all my puts on stocks. I've been on the sidelines, though I bought tech stocks such as Microsoft [MSFT], Oracle [ORCL], EMC [EMC], Hewlett-Packard [HPQ] and Apple [AAPL]. Recently I sold them— my intention was to rent them— and re-entered my put positions.
What, specifically, are you shorting through puts?
The SOX, or Philadelphia Semiconductor Index. The severe downturn in the economy has led to lower sales of technology products. Inventories are building at wholesalers. SG Cowen recently calculated that inventories are at a five-year high. Cellphone sales have fallen 16% in Western Europe. A classic inventory correction is coming within a recession. Yet the SOX is up 20% from its lows! The SOX could correct at least to its March lows, and probably more. But don't short, except through put options.
Fred Hickey's Picks
Company Ticker 6/11/08 Price
Short (via Put options only)
Phila Semiconductor Index SOX $381.68
Long
Golden Star Resources GSS 3.00
StreetTracks Gold Shares GLD 87.02
Source: Bloomberg
Any longs these days?
Gold stocks have been hammered. Junior mining shares have been destroyed. Golden Star Resources isn't a junior. It has real mines, in Ghana. Yet its price is destroyed. A new CEO came on late last year from Newmont Mining [NEM], which also has big operations in Ghana. Recently he brought in a new chief operating officer, also from Newmont. Golden Star could become a takeover target, with Newmont a likely buyer.
Gold production in Ghana is expected to rise 60% this year. But it is dependent on technology. Golden Star was bringing on a new processing plant last year and ran into problems. If it can get this plant working properly, production will increase. The stock is at 3, and the market cap is $700 million. The shares could easily double. My biggest positions are in bullion. As fear returns to the market, gold will rise again. I'm buying mostly through GLD, or StreetTracks Gold Shares, an exchange-traded fund.
The horsemen continue to gallop. Research In Motion is up almost 30% since you recommended shorting it through puts in January. Are you skeptical still?
RIM has a market valuation of $75 billion, but just 1% of the cellphone market worldwide. Nokia [NOK] has a market cap of $100 billion, and a 40% market share. What kind of upside is there at this valuation?
Thanks, Fred.
Felix Zulauf
Barron's: You predicted this would be a rough year for investors, and so far, you're right. What now, Felix?
Zulauf: This bear market doesn't look like 2000-02. It is a much more drawn-out affair, but a high-risk environment. There are enough reflation efforts under way in the U.S. and enough economic momentum in other parts of the world to prevent a global recession now. The economic expansion could run another two years or more. The market will remain choppy, with a downward bias lasting three to four years, as macro liquidity deteriorates. Investors' risk appetite is lower. There isn't enough liquidity to push stocks to new highs, but there is still enough to support the dominant themes in the market.
It's a split market. Financials and consumer stocks will remain weak, and energy and agriculture-related issu