Why Didn't Gold Soar?
By Dr. Steve Sjuggerud | 31 October 2008
"If gold didn't soar in the last year, then when will it?" A few weeks ago, Jack Crooks asked a crowd of currency speculators why gold had fallen from over $900 to $725 in less than a month. What a great question! The crowd— a room full of gold bugs— didn't know what to think. They hadn't considered this yet.
They knew Financial Armageddon was here. Many of them had been waiting for it for decades. And they knew the only possible outcome: a soaring gold price and a crash in the dollar. Well, they got the crisis right. But they were wrong on the way to profit. The price of gold has fallen by over 25% from its highs earlier this year. And as Jack predicted back in July, the dollar has soared.
It all started because of credit, of course. Many large investors (like hedge funds) borrowed a mountain of money to speculate. But the banks called in those loans. So these funds were forced to sell their investments.
Investors who held these funds got scared and asked to get their money back. So funds got hit with a double whammy— redemption requests and the need to pay back borrowings. The funds were forced to sell, at any price. Prices of everything— including gold and gold stocks— spiraled lower.
Investors around the world, in turn, sold everything to get out of the way of falling prices. U.S. Treasuries were the one "safe" place everyone flocked to, which supported the U.S. dollar. Jack believes the dollar will continue to rise, as money comes out of assets like gold and into the world's most liquid investment... the U.S. dollar.
Jack expects the U.S. will fare far better than most of the rest of the world. This is contrary to most forecasters, who expect the U.S. economy to weaken dramatically. Jack expects the emerging markets that export heavily will get hit the worst, as the credit problems are unwound and consumer demand in America declines. Europe's recession will be much more severe than in the U.S., according to Jack, as European banks are much more exposed than the U.S. to emerging markets [[plus, remarkably, they were far more highly leveraged: AIG was "rescued" at the explicit request of the ECB, which feared a total collapse of several Eurobanks, otherwise.: normxxx]].
In the end, Jack believes "the U.S. will maintain its vast capital market advantage and will emerge from this crisis in much better shape than its competitors as a result." I've known Jack for many years. We used to sit close to each other at an investment firm, hashing out ideas. Jack is as honest as they come, and he thinks for himself. His thoughts on the dollar were right on. I don't know anyone else who thought this way.
Jack believes this trend of a higher U.S. dollar and lower gold prices will continue for longer than anyone thinks. While the Great Deleveraging continues, I believe Jack will be right about the dollar. And I believe that, once the Great Deleveraging is over, the Great Inflation will come. Gold should soar then. So I'm not selling my gold just yet.
Either way, you can always count on Jack for a different view. But think about this... if you follow the average path, you'll have average returns, at best. Extraordinary thinking can lead you to extraordinary returns.
Good investing,
Steve
Friday, October 31, 2008
Contagion Spreads To… Gulf States
Contagion Spreads To Hallowed Halls Of Oil Rich Gulf States
By Dr Joe Duarte | 27 October 2008
Nowhere To Hide As Petrodollar Insurance Fades
The regions of the world thought to be immune to the subprime crisis are finding that in a global economy, there is no where to hide when the brown stuff hits the fan. The folks, who via their sovereign funds, were supposed to save us all from the nasty subprime meltdown are having one of their own. According to The Wall Street Journal:
No kidding? Imagine that, economies financed by the price of crude oil, which have recycled their petrodollars into so called "diversified" global investments, such as stocks, bonds, and real estate, are now in the same boat as the rest of the paper dependent world. According to the Journal, even the most immune of places, Saudi Arabia and Dubai, is having trouble. The Journal reported:
There are now signs that the real estate bubble in Dubai is starting to show cracks, as Property investors "are not finding buyers,"' leading to a scenario in which "government finances" could get into trouble and basically stop the whole "debt-fueled expansion" of the world's most Go-Go property market and playground for the rich and the merely 'hoping to some day be rich'. And as usual, the problems began with excessive speculation. According to the Journal, most of Kuwait's problems began when petrodollar laden investors began to speculate in real estate and the currency markets. The local rally, also brought international money into the Gulf.
Yet, when the international money pulled out, earlier this year, Kuwait's banks were left in a bad position. Still, the Journal reports it was the currency trades that caused Kuwait the most trouble as "defaults by counterparties on bad euro-dollar derivatives contracts" took their toll.
Wall Streeters Head To Greener Pastures
Some of Wall Street's best talent is going elsewhere, with the beneficiaries being smaller firms and even those in other countries.
According to AP:
The wire service added:
So how dramatic is the situation? Some smaller boutique firms around the country are now seeing 20% of their resume's come from big investment bank talent looking for a new home. This is up from 1% of their potential workers in past years.
More important, for the firms, and for the communities where top talent relocates, are the repercussions of the new employees. According to AP:
Talk about "spreading the wealth" around.
Conclusion
The stock market continues to fall because the dominoes keep falling. The fact that petrodollars are no longer the insurance policy of all insurance policies, and that Wall Street talent is moving to areas of the country and the world that it wouldn't have given the time of day to in the past are signs of this crisis being a life changer for people. The question for investors, though, is whether this is that "blood in the streets" moment, or just another episode in a movie that seems to get new sequels on a daily basis. If you'd have asked us two weeks ago, we'd have gone for the latter as the answer. Today, though, we're just not sure.
That means that our current posture of being mostly in cash, while making a shopping list remains a good way to have it both ways but avoid pain and suffering. The next thing to watch for is what happens in Venezuela and Iran. If Kuwait and Dubai are having trouble, it seems likely that the left wing, 20th Century neanderthal, no real economy players in OPEC are in even worse trouble.
Oh yeah. Maybe they can do like Argentina wants to do and take over their population's life savings in order to preserve their hold on power. What the mainstream media is failing to address is that the current global economic crisis is now starting to center around the currency markets. That, in our opinion is a very bad sign.
Valero Energy (NYSE: VLO) Points To Even Lower Oil Prices
The refinery stocks, such as Valero Energy (NYSE: VLO) are weakening on a daily basis, suggesting that even lower crude oil prices lie ahead.
Chart Courtesy of StockCharts.com
If petrodollar countries are starting to feel the economic pinch, it stands to reason that U.S. refiners are likely to have a difficult time as the global economy slows. To be sure, slowing demand for gasoline was not too evident this weekend, as regular unleaded in the Dallas metroplex was selling below 2.40 per gallon in many places. But the facts are fairly straight, with regard to refiners. At these prices, profits will only come if they start to decrease the amount of product on the market, which is why they're likely to buy less crude.
Refiners make money when they can pass on large amounts of their costs to consumers. But, they can't gouge consumers, either, so they walk a tightrope, looking for the "just right" set of pricing circumstances, which at this point are elusive. Yet, as a value play, Valero is hard to resist, with a P/E ratio below 4 and a 3.76% dividend yield.
The company, though, had 1.6 billion dollars in cash and 7 billion of accounts receivables at the end of the last quarter, with 12 billion of debt. This means that if it collected every penny that it is owed, which is hard to fathom in this credit cycle, it would still need to sell assets if there was a run on its interests. In other words, Valero may be vulnerable in a worsening scenario, which is why despite a low P/E, there are very few takers on the shares right now.
By Dr Joe Duarte | 27 October 2008
Nowhere To Hide As Petrodollar Insurance Fades
The regions of the world thought to be immune to the subprime crisis are finding that in a global economy, there is no where to hide when the brown stuff hits the fan. The folks, who via their sovereign funds, were supposed to save us all from the nasty subprime meltdown are having one of their own. According to The Wall Street Journal:
|
No kidding? Imagine that, economies financed by the price of crude oil, which have recycled their petrodollars into so called "diversified" global investments, such as stocks, bonds, and real estate, are now in the same boat as the rest of the paper dependent world. According to the Journal, even the most immune of places, Saudi Arabia and Dubai, is having trouble. The Journal reported:
|
There are now signs that the real estate bubble in Dubai is starting to show cracks, as Property investors "are not finding buyers,"' leading to a scenario in which "government finances" could get into trouble and basically stop the whole "debt-fueled expansion" of the world's most Go-Go property market and playground for the rich and the merely 'hoping to some day be rich'. And as usual, the problems began with excessive speculation. According to the Journal, most of Kuwait's problems began when petrodollar laden investors began to speculate in real estate and the currency markets. The local rally, also brought international money into the Gulf.
Yet, when the international money pulled out, earlier this year, Kuwait's banks were left in a bad position. Still, the Journal reports it was the currency trades that caused Kuwait the most trouble as "defaults by counterparties on bad euro-dollar derivatives contracts" took their toll.
Wall Streeters Head To Greener Pastures
Some of Wall Street's best talent is going elsewhere, with the beneficiaries being smaller firms and even those in other countries.
According to AP:
|
The wire service added:
|
So how dramatic is the situation? Some smaller boutique firms around the country are now seeing 20% of their resume's come from big investment bank talent looking for a new home. This is up from 1% of their potential workers in past years.
More important, for the firms, and for the communities where top talent relocates, are the repercussions of the new employees. According to AP:
|
Talk about "spreading the wealth" around.
Conclusion
The stock market continues to fall because the dominoes keep falling. The fact that petrodollars are no longer the insurance policy of all insurance policies, and that Wall Street talent is moving to areas of the country and the world that it wouldn't have given the time of day to in the past are signs of this crisis being a life changer for people. The question for investors, though, is whether this is that "blood in the streets" moment, or just another episode in a movie that seems to get new sequels on a daily basis. If you'd have asked us two weeks ago, we'd have gone for the latter as the answer. Today, though, we're just not sure.
That means that our current posture of being mostly in cash, while making a shopping list remains a good way to have it both ways but avoid pain and suffering. The next thing to watch for is what happens in Venezuela and Iran. If Kuwait and Dubai are having trouble, it seems likely that the left wing, 20th Century neanderthal, no real economy players in OPEC are in even worse trouble.
Oh yeah. Maybe they can do like Argentina wants to do and take over their population's life savings in order to preserve their hold on power. What the mainstream media is failing to address is that the current global economic crisis is now starting to center around the currency markets. That, in our opinion is a very bad sign.
Valero Energy (NYSE: VLO) Points To Even Lower Oil Prices
The refinery stocks, such as Valero Energy (NYSE: VLO) are weakening on a daily basis, suggesting that even lower crude oil prices lie ahead.
Chart Courtesy of StockCharts.com
If petrodollar countries are starting to feel the economic pinch, it stands to reason that U.S. refiners are likely to have a difficult time as the global economy slows. To be sure, slowing demand for gasoline was not too evident this weekend, as regular unleaded in the Dallas metroplex was selling below 2.40 per gallon in many places. But the facts are fairly straight, with regard to refiners. At these prices, profits will only come if they start to decrease the amount of product on the market, which is why they're likely to buy less crude.
Refiners make money when they can pass on large amounts of their costs to consumers. But, they can't gouge consumers, either, so they walk a tightrope, looking for the "just right" set of pricing circumstances, which at this point are elusive. Yet, as a value play, Valero is hard to resist, with a P/E ratio below 4 and a 3.76% dividend yield.
The company, though, had 1.6 billion dollars in cash and 7 billion of accounts receivables at the end of the last quarter, with 12 billion of debt. This means that if it collected every penny that it is owed, which is hard to fathom in this credit cycle, it would still need to sell assets if there was a run on its interests. In other words, Valero may be vulnerable in a worsening scenario, which is why despite a low P/E, there are very few takers on the shares right now.
Wednesday, October 29, 2008
75% Returns From A 'Dividend Squeeze'
How To Get 75% Returns From A 'Dividend Squeeze'
By Tom Dyson | 29 October 2008
My professor placed his marker's cap against the whiteboard and pressed it so hard with the butt of his eraser, the cap fired into the ceiling… "This is what happens to share prices," he told the class, "when dividends rise and yields fall at the same time."
I used to work for Salomon Smith Barney, in the London office. I calculated the profits for a group of traders on a bond trading desk. After I'd calculated the daily profit and got each trader to sign off on my numbers, I reported the daily results to management.
Then at the end of every month, we'd tie all the results together and build them into the financial statements for the London office. A sloppy job would catch the attention of regulators. A cohort of auditors thumbing through paperwork on the trading floor was the last thing Salomon was looking for.
So Salomon wanted us all to be experts in accounting. The company sent us to accountancy school three nights a week. Everyone in my class came from major investment banks, hedge funds, and British industrial companies. We all worked 10-hour days for our firms and then took the Tube across London to spend another three hours discussing financial reporting standards in front of an overhead projector.
It was hell to stay awake. And the teachers knew it. So they'd make extra effort to keep our attention. One teacher, Professor Howard, loved to use physical demonstrations to explain things. One time, he passed money around the classroom to explain credits and debits… Another time, he made us act out a corporate board meeting to see if a merger was going to work. To show what happens when a stock's dividend payment rises while its dividend yield falls, he fired his pen's cap into the ceiling.
The Master Limited Partnership (MLP) Sector Is A Perfect Illustration Of Howard's Point
Right now, the Alerian MLP Index trades at 205 and pays $21.6 in dividends per year… for an annual dividend yield of 10.5%. The MLP Index has paid larger and larger distributions each year since 1996. This year, the sector is booming. Distributions from MLPs have risen almost 20% in the last 12 months. I think the boom in MLPs will continue, but to be prudent, let's assume dividends grow at only 10% per year for the next three years.
What about the dividend yield? Since 1996, the dividend yield on the MLP Index has fluctuated between 5% in times of optimism and 13% in times of pessimism. Right now, it's at 10.5%… indicating investors are fairly pessimistic toward the MLP sector.
Dividend yields swing like pendulums. They swing from overvaluation to undervaluation and back to overvaluation in multiyear cycles. In the end, they always revert back to normal levels. Sooner or later, the MLP Index's dividend yield will revert back to normal levels... say, around 8%.
So let's assume this recession blows over, investors stop panicking, and dividend yields in the MLP sector return to 8% in three years. With 10% annual dividend growth, annual dividends on the MLP Index will increase to $29 per year. A dividend payment of $29 and a dividend yield of 8% together mean the MLP Index will reach 362… an increase of 77% from today's level.
Now that was a lot of numbers, but the idea is simple: When dividend payments increase (as they will in the MLP sector) while dividend yields fall back to "normal" This phenomenon works with any security that raises dividends every year for many years in a row. To make huge gains, buy when the dividend yield is near the top of its historical range and wait for it to decline to average levels.
If you can find a company or an industry headed for a dividend squeeze, you need to jump in with both feet. The squeeze should send your stock through the ceiling.
Good investing,
Tom
P.S. To calculate a stock's historical dividend-yield range, divide historical share prices by the historical dividend using data from Yahoo Finance.
By Tom Dyson | 29 October 2008
My professor placed his marker's cap against the whiteboard and pressed it so hard with the butt of his eraser, the cap fired into the ceiling… "This is what happens to share prices," he told the class, "when dividends rise and yields fall at the same time."
I used to work for Salomon Smith Barney, in the London office. I calculated the profits for a group of traders on a bond trading desk. After I'd calculated the daily profit and got each trader to sign off on my numbers, I reported the daily results to management.
Then at the end of every month, we'd tie all the results together and build them into the financial statements for the London office. A sloppy job would catch the attention of regulators. A cohort of auditors thumbing through paperwork on the trading floor was the last thing Salomon was looking for.
So Salomon wanted us all to be experts in accounting. The company sent us to accountancy school three nights a week. Everyone in my class came from major investment banks, hedge funds, and British industrial companies. We all worked 10-hour days for our firms and then took the Tube across London to spend another three hours discussing financial reporting standards in front of an overhead projector.
It was hell to stay awake. And the teachers knew it. So they'd make extra effort to keep our attention. One teacher, Professor Howard, loved to use physical demonstrations to explain things. One time, he passed money around the classroom to explain credits and debits… Another time, he made us act out a corporate board meeting to see if a merger was going to work. To show what happens when a stock's dividend payment rises while its dividend yield falls, he fired his pen's cap into the ceiling.
The Master Limited Partnership (MLP) Sector Is A Perfect Illustration Of Howard's Point
Right now, the Alerian MLP Index trades at 205 and pays $21.6 in dividends per year… for an annual dividend yield of 10.5%. The MLP Index has paid larger and larger distributions each year since 1996. This year, the sector is booming. Distributions from MLPs have risen almost 20% in the last 12 months. I think the boom in MLPs will continue, but to be prudent, let's assume dividends grow at only 10% per year for the next three years.
What about the dividend yield? Since 1996, the dividend yield on the MLP Index has fluctuated between 5% in times of optimism and 13% in times of pessimism. Right now, it's at 10.5%… indicating investors are fairly pessimistic toward the MLP sector.
|
Dividend yields swing like pendulums. They swing from overvaluation to undervaluation and back to overvaluation in multiyear cycles. In the end, they always revert back to normal levels. Sooner or later, the MLP Index's dividend yield will revert back to normal levels... say, around 8%.
So let's assume this recession blows over, investors stop panicking, and dividend yields in the MLP sector return to 8% in three years. With 10% annual dividend growth, annual dividends on the MLP Index will increase to $29 per year. A dividend payment of $29 and a dividend yield of 8% together mean the MLP Index will reach 362… an increase of 77% from today's level.
Now that was a lot of numbers, but the idea is simple: When dividend payments increase (as they will in the MLP sector) while dividend yields fall back to "normal" This phenomenon works with any security that raises dividends every year for many years in a row. To make huge gains, buy when the dividend yield is near the top of its historical range and wait for it to decline to average levels.
If you can find a company or an industry headed for a dividend squeeze, you need to jump in with both feet. The squeeze should send your stock through the ceiling.
Good investing,
Tom
P.S. To calculate a stock's historical dividend-yield range, divide historical share prices by the historical dividend using data from Yahoo Finance.
USATodayOur view on Afghanistan: Talk to the Taliban!?!
Negotiations might help as part of broad strategy to defeat al-Qaeda.
[[Is McCain now way to the right of 'w'!?!: normxxx]]
A new, once preposterous, idea seems to be gaining ground in Washington: Negotiate with the Taliban. Yes, that's right— the fundamentalist Islamic extremists who once ruled Afghanistan, who harbored 9/11 masterminds Osama bin Laden and Ayman al-Zawahri and their terrorist training camps before the U.S. invaded Afghanistan, and who continue to be al-Qaeda's allies and protectors.
After the invasion,Taliban and al-Qaeda leaders fled to Pakistan's wild northwest region, where they launch attacks on U.S. and NATO forces in Afghanistan. U.S. intelligence agencies say any new attack on the U.S. would likely originate in the Taliban/al-Qaeda training camps in Pakistan. Yet opening communications with the Taliban is an option being considered by a range of leaders and experts, including the former U.S. commander in Iraq, Gen. David Petraeus, who's now in charge of Iraq and Afghanistan as head of Central Command.
As naive as the idea might sound, it is evidence of hard-learned pragmatism. If the Iraq and Afghanistan wars have taught anything, it's that they cannot be won by military might alone. This year's surge of U.S. troops into Iraq succeeded because it was part of a broader strategy that included working with, and paying, Sunni tribal leaders to turn against al-Qaeda in Iraq— the same leaders who had just recently been at the heart of the insurgency killing U.S. troops.
Assuming the Taliban would respond similarly is a stretch. Unlike the Iraqi Sunnis, the Taliban shares much of al-Qaeda's rigidly brutal, medieval brand of Islam. That said, a new strategy is needed for Afghanistan. In fact, Petraeus is preparing one to be ready for the new president in February. John McCain and Barack Obama both favor increasing troop levels, but neither has defined a strategy to match the one in Iraq. Nor has President Bush, even though the Afghan war is deteriorating so fast that pessimism is widespread.
Talking to the Taliban might be a long shot, but perhaps not quite as long as some suspect if the goal is simply to get its leaders to betray al-Qaeda. On Tuesday, Pakistani and Afghan political and tribal leaders agreed to establish contacts with the Taliban. Saudi Arabia has already facilitated informal talks.
Further, the Taliban is not monolithic. Reports out of Afghanistan reflect a splintering among Taliban leaders, with some offering to take part in a democratic system and allow girls to go to school. It's not unimaginable that they might, with the right pressure or incentives, help deliver al-Qaeda leaders. The point is that no options are possible unless explored.
Talking with some Taliban representatives would not be a substitute for more troops. Agreements are best forged from a position of strength, and that is not the current reality. The U.S. also would need to be clear in its priorities. Three things are non-negotiable: the capture or killing of bin Laden and Zawahri; the shutting down of camps in Pakistan; and ultimately the destruction of al-Qaeda. A full-fledged Afghan democracy, while desirable, might not be possible.
The U.S. badly needs a winning strategy in Afghanistan— one that does not cripple the U.S. economy and military for many more years in pursuit of the unattainable. Talking to the Taliban? Time to hold our noses and at least be open to the idea.
Tuesday, October 28, 2008
Time For A Reality Check
Time For A Reality Check On The Financial Markets
Click here for a link to complete article:
By John Crudele | 28 October 2008
1. The truth: Today's Fed meeting really isn't all that important.
While it's true that the Fed may drop its so-called federal funds rate to 1 percent from 1.5 percent, the move is really not very important to you and me. The interest rate at which you and I would borrow— if we were so inclined— is controlled by the financial markets, not the Fed. And our borrowing costs are likely to rise until investors get less scared about the world's finances.
2. The discount rate could also be cut. This is what the Fed charges banks for overnight loans.
The importance of a discount rate reduction at this week's gathering has also been muted because the Fed is already making money available to any financial institution that needs it, for just about any length of time. The price of that money— or the discount rate— isn't really important. It's like a soup line from the 1930s. Banks are lining up and the Fed isn't really asking any questions, except, "How much?"
3. Even if the Fed cut rates and [ALL] borrowing costs drop— which, as I said, isn't likely to happen— that still doesn't mean people will seek out loans.
When consumers were borrowing and spending like mad in the 1990s into this decade, the experts lamented that Americans weren't saving enough. Now that Americans are cutting back and this crisis may turn them into savers, the experts are complaining that they aren't borrowing enough. You just can't please everyone.
4. If the Fed cuts interest rates today, instead of tomorrow, it will be more meaningful for Wall Street and might even result in a nice-size stock rally.
Ben Bernanke's Fed surprised investors with the first in a series of rate cuts last August, but since then he's been very predictable. If he wants to shake things up, a cut one day earlier than anticipated might do it.
5. But then will come the backlash.
If Bernanke were to order up a rate reduction even 24 hours ahead of schedule, the financial markets— after initially rising— would start worrying that the economic situation might be so dire that the Fed couldn't even wait the additional day. The Fed is not only damned if it does and damned if it doesn't, it's also cursed if it does or doesn't when it should or shouldn't.
6. A coordinated rate cut with Europe and Asia would be preferable to us going it alone. And European Central Bank President Jean-Claude Trichet said yesterday that he might cut rates again at a meeting next week.
That would be nice, but the dilemma still remains: Investors will worry that if all central banks are cutting rates together, and so rapidly, then regulators must know something everyone else doesn't. So investors are liable to push rates higher because Bernanke and Trichet want them lower.
7. The same goes for interest-rate cuts that are larger than expected.
Let's say, for instance, that the Fed cuts the federal funds rate by a full point instead of the half— point that is expected. The financial markets will not worry only that the central bank is panicking but also that it is running out of room for more cuts. Technically speaking, rates can't go below zero. But in today's Brave New Financial World, I suppose the government could pay you— rather than charge you— for accepting loans. What if there's no rate cut this week? You don't want to know.
8. The economy really is sick.
Washington will report its initial third-quarter GDP figure later in the week and it'll likely show that the US economy contracted. There will be a lot of chatter about recessions, which most people still think is defined by two straight quarters of negative GDP. But that's really not the definition of a recession. A recession exists when the 'non-partisan' National Bureau of Economic Research declares one.
9. There are no good signs yet in the economy.
Everyone was cheering yesterday when the Commerce Department announced sales of new one-family homes had increased an unexpected 2.7 percent in September. But that number is really a lie. Sales on a seasonally adjusted basis increased. But if you look at the 'raw' data without the guesstimating, the Commerce Department says sales dropped 5.3 percent— from 38,000 in August to 36,000 in September. And even that number is suspicious, since the survey that the government conducts is so small that it has a margin of error of plus-or-minus 12 percent, so the 'true' raw sales figure is actually within a range of -17.3% to +6.7%!
10. Last, but not least, let's discuss the stock market.
Everyone is looking for stocks— down about 40 percent so far this year— to suddenly reach the bottom of their decline and then spring right back. It's the trampoline theory of investing. That's why so many people I'm speaking with are deciding to wait out the current market 'volatility'. But what happens if stocks hit bottom and stay there— perhaps for years? That's exactly what could happen if investors get shell-shocked enough.
Click here for a link to complete article:
By John Crudele | 28 October 2008
|
1. The truth: Today's Fed meeting really isn't all that important.
While it's true that the Fed may drop its so-called federal funds rate to 1 percent from 1.5 percent, the move is really not very important to you and me. The interest rate at which you and I would borrow— if we were so inclined— is controlled by the financial markets, not the Fed. And our borrowing costs are likely to rise until investors get less scared about the world's finances.
2. The discount rate could also be cut. This is what the Fed charges banks for overnight loans.
The importance of a discount rate reduction at this week's gathering has also been muted because the Fed is already making money available to any financial institution that needs it, for just about any length of time. The price of that money— or the discount rate— isn't really important. It's like a soup line from the 1930s. Banks are lining up and the Fed isn't really asking any questions, except, "How much?"
3. Even if the Fed cut rates and [ALL] borrowing costs drop— which, as I said, isn't likely to happen— that still doesn't mean people will seek out loans.
When consumers were borrowing and spending like mad in the 1990s into this decade, the experts lamented that Americans weren't saving enough. Now that Americans are cutting back and this crisis may turn them into savers, the experts are complaining that they aren't borrowing enough. You just can't please everyone.
4. If the Fed cuts interest rates today, instead of tomorrow, it will be more meaningful for Wall Street and might even result in a nice-size stock rally.
Ben Bernanke's Fed surprised investors with the first in a series of rate cuts last August, but since then he's been very predictable. If he wants to shake things up, a cut one day earlier than anticipated might do it.
5. But then will come the backlash.
If Bernanke were to order up a rate reduction even 24 hours ahead of schedule, the financial markets— after initially rising— would start worrying that the economic situation might be so dire that the Fed couldn't even wait the additional day. The Fed is not only damned if it does and damned if it doesn't, it's also cursed if it does or doesn't when it should or shouldn't.
6. A coordinated rate cut with Europe and Asia would be preferable to us going it alone. And European Central Bank President Jean-Claude Trichet said yesterday that he might cut rates again at a meeting next week.
That would be nice, but the dilemma still remains: Investors will worry that if all central banks are cutting rates together, and so rapidly, then regulators must know something everyone else doesn't. So investors are liable to push rates higher because Bernanke and Trichet want them lower.
7. The same goes for interest-rate cuts that are larger than expected.
Let's say, for instance, that the Fed cuts the federal funds rate by a full point instead of the half— point that is expected. The financial markets will not worry only that the central bank is panicking but also that it is running out of room for more cuts. Technically speaking, rates can't go below zero. But in today's Brave New Financial World, I suppose the government could pay you— rather than charge you— for accepting loans. What if there's no rate cut this week? You don't want to know.
8. The economy really is sick.
Washington will report its initial third-quarter GDP figure later in the week and it'll likely show that the US economy contracted. There will be a lot of chatter about recessions, which most people still think is defined by two straight quarters of negative GDP. But that's really not the definition of a recession. A recession exists when the 'non-partisan' National Bureau of Economic Research declares one.
9. There are no good signs yet in the economy.
Everyone was cheering yesterday when the Commerce Department announced sales of new one-family homes had increased an unexpected 2.7 percent in September. But that number is really a lie. Sales on a seasonally adjusted basis increased. But if you look at the 'raw' data without the guesstimating, the Commerce Department says sales dropped 5.3 percent— from 38,000 in August to 36,000 in September. And even that number is suspicious, since the survey that the government conducts is so small that it has a margin of error of plus-or-minus 12 percent, so the 'true' raw sales figure is actually within a range of -17.3% to +6.7%!
10. Last, but not least, let's discuss the stock market.
Everyone is looking for stocks— down about 40 percent so far this year— to suddenly reach the bottom of their decline and then spring right back. It's the trampoline theory of investing. That's why so many people I'm speaking with are deciding to wait out the current market 'volatility'. But what happens if stocks hit bottom and stay there— perhaps for years? That's exactly what could happen if investors get shell-shocked enough.
Pin The Tail On The Bull
Pin The Tail On The Bull
Click here for a link to complete article:
By Dan Denning | 28 October 2008
The good news is that the credit market is unfreezing. The bad news is that no one in the stock market seems to care. All the hot money being pumped out by central banks is finally starting to de-thaw the inter-bank lending market. You probably now know more about the inter-bank lending market than you ever expected or wanted to know. But the decline in the rate banks charge each other to borrow overnight (LIBOR) really just means that banks have slightly more trust in each other this week than they did last week.
Yet on Wall Street, the Dow merely convulses. The S&P 500 is down 39% year-to-date and 43% from its high last October. You’d think the de-icing of the credit market would have produced a little more joy in the stock market. But investors have other worries on their just minds now. Earnings, for one. In the bigger picture, they are wondering just how big and how deep this global recession [already conceded] is going to be. How many more layoffs will there be? How bad will it get? Judging by current stock prices, around the world, pretty bad.
Oil has slumped to less than $70. Gold to nearly $700. These are not the signs of economic vitality. Copper and aluminium are also falling by dreadful amounts. If you look at the action in these market, investors are pricing in a shocking 2009, not just a run-of-the-mill recession. Are the slumping prices of commodities an indication that inflation poses no threat?
"History shows that recessions solve inflation problems, so, much of the world is about to have their inflation problems solved— and pretty rapidly," an interest rate analyst opined recently. Maybe this analyst is correct, but OTHER history shows you can have rising prices AND a recession. That’s the good old stagflation of the 1970s.
But maybe we’re overly worried about inflation. After all, most central banks target or tolerate annual official inflation of 2% and call it "price stability." And Jeremy Grantham, who’s been bearish on stocks since at least 2003, seems to think that value will be destroyed in financial asset markets faster than new lending and credit can reflate it into a new bubble. [Grantham is the insightful founder of the investment management firm, Grantham, Mayo, Van Otterloo, and a generally acknowledged stock market seer.]
"Don’t worry at all about inflation," wrote Grantham in a note to investors. "We can all save up our worries [about that] for a couple of years from now and then really worry! Commodities may have big rallies, but the fundamentals of the next 18 months should wear them down to new two-year lows."
Grantham is dipping his toe into equity waters anyway. "At under 1000 on the S&P 500, U.S. stocks are very reasonable buys for brave value managers willing to be early. The same applies to EAFE and emerging equities at October 10th prices, but even more so. History warns, though, that new lows are more likely than not."
The S&P 500 made its bear market low in October of 2002 at 776. That’s 13.3% below yesterday’s close of 896. And should it decline to that level, it would be exactly 50% below its all time intra-day high of 1,552 (set on October 31st of last year).
By any historical standard, that’s a whopper of a bear market. So Grantham dipping a toe in now is an assumption that this bear market is roughly consistent with similar bear markets of the last 137 years. Take a look below and you’ll see what we mean.
The bear market of 2008 already ranks up there among the all time greats. The only question now is whether the bear market in stocks triggers a big enough recession in the economy that it leads to an even greater fall in stocks in the coming years. So is it 1929 [[or 1980: normxxx]]; or 1974 [[or 2002: normxxx]]?
It’s tempting to call the massed selling of stocks 'irrational'. But this is based on some investors looking at stock valuations and finding them cheap on a [history of] earnings basis, or looking at the cash on the balance sheet. But what we have right now are extremely motivated sellers. We call these sellers, "hedge fund managers." They HAVE to sell… for many different reasons. They have to sell because almost all of their leveraged bets on stocks, bonds and commodities are blowing up… which means they MUST de-lever to meet margin calls. At the same time, these guys are receiving tens of billions of dollars worth of redemption notices. So that means they have to sell even more to raise the cash to send to their investors. This is not a pleasant situation.
Normally, when a seller has to sell is a very good time to be a buyer, hence Buffett’s chest-thumping op-ed piece. But you don’t want to be a buyer just yet if there’s [substantially] more forced selling in the pipeline [[Buffet can afford to ignore another downmove of 10%, or even substantially more…: normxxx]] And that is now the key question in the market. How much leverage is left to be unwound?
Well, before the crisis hit, 'hedge' funds controlled US$2.4 trillion in investor funds. They would have used that capital to secure trillions more dollars worth of borrowings (with leverage ratios of 20-1, 50-1, and on up to 100-1). But now, all those assets purchased by 'hedge' funds with borrowed money are being liquidated. And those 'hedge' funds that were not hedged at all (long-only, but with the most massive leverage) are not long for this earth. Who are they going to take with them?
"In a fairly Darwinian manner, many hedge funds will simply disappear," Emmanuel Roman, co-chief executive officer of GLG Partners Inc., told investors at a hedge fund conference in London. "This will go down in the history books as one of the greatest fiascos of banking in 100 years."
True that.
Governments now want to regulate hedge funds. [[They want, finally, to close the 'barn door'.: normxxx]] They’ve already begun to do so by preventing them from shorting. But remember, if a hedge fund can’t short, it can’t really hedge. Performance suffers. Investor redemptions increase. The more hedge fund investors want their money back, the more that the funds must sell. In fact, only the "lock-ups" that hedge funds impose to prevent investors from getting their money back immediately are preventing an even greater pace of redemptions. So it’s easy to see how a new low in the markets is entirely possible.
Our prediction? Stock markets are going to get a hefty global bounce in November. There are at least three events on the horizon that could provide the boost. First, even if Obama is elected, you have the end of uncertainty about the U.S. election (and some highly irrational optimism that things will now indeed be different, better, and nicer). Second, you’ll get a new stimulus plan from the Democratic Congress in the U.S., which should give stocks a bit of a kick. And third, the big G20 meeting in Washington. Something that 'looks and feels good' should come from that.
Those three factors should conspire [or just provide the excuse] to produce a convincing-looking bear-market rally into Christmas. That would be like the sucker’s rally of 1929 - 1930 that preceded the stock market’s epic collapse over the ensuing two years. Or, we could be dead wrong and deleveraging may simply overwhelm everything else and take the market down to much lower lows right now, right here, without much of a bounce at all.
Stocks are very cheap. That makes them a buy. Unfortunately, they might get cheaper; much cheaper. That makes them a sell. And so we defer to the seasoned wisdom of Jeremy Grantham, an investor who is BEGINNING to buy, but fully expecting prices to fall even lower. [[Or, John Hussman, who is simply 'scaling in' as risk reduces and stock valuations go up.: normxxx]]
M O R E. . .
Click here for a link to complete article:
By Dan Denning | 28 October 2008
|
The good news is that the credit market is unfreezing. The bad news is that no one in the stock market seems to care. All the hot money being pumped out by central banks is finally starting to de-thaw the inter-bank lending market. You probably now know more about the inter-bank lending market than you ever expected or wanted to know. But the decline in the rate banks charge each other to borrow overnight (LIBOR) really just means that banks have slightly more trust in each other this week than they did last week.
Yet on Wall Street, the Dow merely convulses. The S&P 500 is down 39% year-to-date and 43% from its high last October. You’d think the de-icing of the credit market would have produced a little more joy in the stock market. But investors have other worries on their just minds now. Earnings, for one. In the bigger picture, they are wondering just how big and how deep this global recession [already conceded] is going to be. How many more layoffs will there be? How bad will it get? Judging by current stock prices, around the world, pretty bad.
Oil has slumped to less than $70. Gold to nearly $700. These are not the signs of economic vitality. Copper and aluminium are also falling by dreadful amounts. If you look at the action in these market, investors are pricing in a shocking 2009, not just a run-of-the-mill recession. Are the slumping prices of commodities an indication that inflation poses no threat?
"History shows that recessions solve inflation problems, so, much of the world is about to have their inflation problems solved— and pretty rapidly," an interest rate analyst opined recently. Maybe this analyst is correct, but OTHER history shows you can have rising prices AND a recession. That’s the good old stagflation of the 1970s.
But maybe we’re overly worried about inflation. After all, most central banks target or tolerate annual official inflation of 2% and call it "price stability." And Jeremy Grantham, who’s been bearish on stocks since at least 2003, seems to think that value will be destroyed in financial asset markets faster than new lending and credit can reflate it into a new bubble. [Grantham is the insightful founder of the investment management firm, Grantham, Mayo, Van Otterloo, and a generally acknowledged stock market seer.]
"Don’t worry at all about inflation," wrote Grantham in a note to investors. "We can all save up our worries [about that] for a couple of years from now and then really worry! Commodities may have big rallies, but the fundamentals of the next 18 months should wear them down to new two-year lows."
Grantham is dipping his toe into equity waters anyway. "At under 1000 on the S&P 500, U.S. stocks are very reasonable buys for brave value managers willing to be early. The same applies to EAFE and emerging equities at October 10th prices, but even more so. History warns, though, that new lows are more likely than not."
The S&P 500 made its bear market low in October of 2002 at 776. That’s 13.3% below yesterday’s close of 896. And should it decline to that level, it would be exactly 50% below its all time intra-day high of 1,552 (set on October 31st of last year).
By any historical standard, that’s a whopper of a bear market. So Grantham dipping a toe in now is an assumption that this bear market is roughly consistent with similar bear markets of the last 137 years. Take a look below and you’ll see what we mean.
| |
The bear market of 2008 already ranks up there among the all time greats. The only question now is whether the bear market in stocks triggers a big enough recession in the economy that it leads to an even greater fall in stocks in the coming years. So is it 1929 [[or 1980: normxxx]]; or 1974 [[or 2002: normxxx]]?
It’s tempting to call the massed selling of stocks 'irrational'. But this is based on some investors looking at stock valuations and finding them cheap on a [history of] earnings basis, or looking at the cash on the balance sheet. But what we have right now are extremely motivated sellers. We call these sellers, "hedge fund managers." They HAVE to sell… for many different reasons. They have to sell because almost all of their leveraged bets on stocks, bonds and commodities are blowing up… which means they MUST de-lever to meet margin calls. At the same time, these guys are receiving tens of billions of dollars worth of redemption notices. So that means they have to sell even more to raise the cash to send to their investors. This is not a pleasant situation.
Normally, when a seller has to sell is a very good time to be a buyer, hence Buffett’s chest-thumping op-ed piece. But you don’t want to be a buyer just yet if there’s [substantially] more forced selling in the pipeline [[Buffet can afford to ignore another downmove of 10%, or even substantially more…: normxxx]] And that is now the key question in the market. How much leverage is left to be unwound?
Well, before the crisis hit, 'hedge' funds controlled US$2.4 trillion in investor funds. They would have used that capital to secure trillions more dollars worth of borrowings (with leverage ratios of 20-1, 50-1, and on up to 100-1). But now, all those assets purchased by 'hedge' funds with borrowed money are being liquidated. And those 'hedge' funds that were not hedged at all (long-only, but with the most massive leverage) are not long for this earth. Who are they going to take with them?
"In a fairly Darwinian manner, many hedge funds will simply disappear," Emmanuel Roman, co-chief executive officer of GLG Partners Inc., told investors at a hedge fund conference in London. "This will go down in the history books as one of the greatest fiascos of banking in 100 years."
True that.
Governments now want to regulate hedge funds. [[They want, finally, to close the 'barn door'.: normxxx]] They’ve already begun to do so by preventing them from shorting. But remember, if a hedge fund can’t short, it can’t really hedge. Performance suffers. Investor redemptions increase. The more hedge fund investors want their money back, the more that the funds must sell. In fact, only the "lock-ups" that hedge funds impose to prevent investors from getting their money back immediately are preventing an even greater pace of redemptions. So it’s easy to see how a new low in the markets is entirely possible.
Our prediction? Stock markets are going to get a hefty global bounce in November. There are at least three events on the horizon that could provide the boost. First, even if Obama is elected, you have the end of uncertainty about the U.S. election (and some highly irrational optimism that things will now indeed be different, better, and nicer). Second, you’ll get a new stimulus plan from the Democratic Congress in the U.S., which should give stocks a bit of a kick. And third, the big G20 meeting in Washington. Something that 'looks and feels good' should come from that.
Those three factors should conspire [or just provide the excuse] to produce a convincing-looking bear-market rally into Christmas. That would be like the sucker’s rally of 1929 - 1930 that preceded the stock market’s epic collapse over the ensuing two years. Or, we could be dead wrong and deleveraging may simply overwhelm everything else and take the market down to much lower lows right now, right here, without much of a bounce at all.
Stocks are very cheap. That makes them a buy. Unfortunately, they might get cheaper; much cheaper. That makes them a sell. And so we defer to the seasoned wisdom of Jeremy Grantham, an investor who is BEGINNING to buy, but fully expecting prices to fall even lower. [[Or, John Hussman, who is simply 'scaling in' as risk reduces and stock valuations go up.: normxxx]]
M O R E. . .
Monday, October 27, 2008
The Third Mouse Market!?!
Investment Strategy: "the Third Mouse Market?!"
By Jeffrey Saut | 27 October 2008
Ever since the House of Representatives failed to pass the 'Paulson Plan', we have suggested that the main theme for investors was "survival." Accompanying that theme has been our mantra of trying to be the second mouse that gets the cheese because the first mouse often gets caught in the trap. To be sure, over the last four weeks most participants who have attempted to be the "first mouse," and pick the bottom, have lost money; so given last week’s wilt, we have decided a "third mouse" is what’s needed!
Since the original Dow Theory "sell signal" of September 2001, our strategy has been to manage the risk by not letting ANYTHING go more than 15% - 20% against us. This is the constant message from none other than Warren Buffett. Buffet says it wasn’t his best ideas that gave him his tremendous track record. It was having a smaller number of bad ideas that resulted in a permanent loss of capital. "We haven’t taken two steps forward and one step back. We’ve taken two steps forward and a fraction of a step back. Avoiding the catastrophes is really important."
Avoiding, and/or managing for, the catastrophes is one of the biggest secrets on Wall Street, still very few pundits ever discuss it. Anyone in the real world, however, knows that you have to manage for the "risks!" Apple producers know they are going to lose 5 or 6 apples out of every 100 to spoilage and they manage for it. Light bulb manufacturers know they will lose 2 or 3 light bulbs out of every 100 to breakage and they manage for it.
Still, in the investment business, there are very few of us that often discuss managing risk on a continuous basis. Even some of the best operators on Wall Street have recently failed to adhere to this most basic rule of investing. Indeed, for years we have idolized Ken Heebner of CGM Focus Fund fame (CGMFX/$27.40), as well as Marty Whitman who captains the Third Avenue Value Fund (TAVFX/$31.44). Both of these brilliant investors’ track records are legend; but this year, both of them are down over 45%.
Speaking to this "managing the risks" point, I read this most insightful paragraph from author, investor, and psychologist Brett Steenbager, PhD:
Yet, it is not just professional investors who have failed to manage the risk for as noted in last Thursday’s Wall Street Journal article titled "The Less Wealthy CEO," many of the country’s wealthiest CEOs are less wealthy now that their company’s share price has collapsed. Even more alarming is the number of CEOs, and corporate officers, that have been forced to sell their own company’s stock due to "margin calls," which was punctuated by Chesapeake Energy’s CEO being forced to sell 94% of his personal shares. The point of this diatribe is that asset prices are deflating worldwide! Ladies and gentlemen, these types of sequences are typical of "capitulation events" rarely seen in the scheme of things. Indeed, the stock market "low" of October 10, 2008 registered a Downside Capitulation reading not seen since 1966. As Bob Hoye wrote on 10-23-08:
Regrettably, capitulation selling begets more selling, and that is precisely what happened last week as the S&P 500 (SPX/876.77) shed another 6.78%, bringing its year-to-date loss to 40.3%. It was a democratic decline with all of the indices we follow lower for the week. In fact, the only "things" we saw higher on the week were the U.S. Dollar Index (+4.89%) and the Japanese Yen (+7.65%). The quid pro quo was that last Wednesday the British Pound suffered its worse one-day loss since Black Wednesday (September 16, 1992), when George Soros broke the Bank of England; and, the pound ended 8.45% lower last week.
Then came Friday with the preopening S&P futures locked down limit while the media trumpeted the "Bonfires of the Inanities" was coming on "no news". However, late Thursday the Federal Reserve reduced the value of Bear Stearns’ asset pool by some $2.7 billion, AIG had to increase its loan from the Fed by $7.4 billion and stated that the $122.8 billion loan may not be enough, WaMu’s Credit Default Swap portfolio settled for less than anticipated, GE said it would "tap" the Fed’s commercial paper facility, for the first time in history the 30-year "swap rate" traveled below the yield on the 30-year Treasury Bond (that should be impossible), and rumors swirled about major hedge funds in trouble.
Accordingly, the markets gapped lower early Friday morning, leaving the SPX trading more than 25% below its 50-day moving average (DMA) for the third time this month. As the good folks at the invaluable Bespoke Investment Group noted,
Clearly, the equity markets are geared for some kind of rally; and if we could ever get the typical Monday/Tuesday downside washout, we would once again try committing some trading capital. Interestingly, as Doug Cass notes,
As for the investment account, in the current environment companies that have low debt, high free cash flow, stable revenue growth, strong cash reserves on the balance sheet, and dividend yields, should fare the best. As Richard Russell observed,
10 great dividend-paying stocks
7 dynamic dividend-paying stocks
What to look for in Dividend Paying Stocks
High Dividend Stocks Counter Tough Market
Dividend Growth Investor (blog)
The call for this week: Despite all of last week’s carnage, the SPX still couldn’t take out the "capitulation low" reading of 839.80 that occurred on October 10, 2008, although today it looks like it might be broken. If not, last week’s low was at 852.85 and could be construed as a test of the October 10 low. As Walter Deemer wrote last week, "Even in 1929, the worst stock market crash of all time, the market managed to make a final low nine trading days after the 11.7% [capitulation low] record-volume decline and low of Tuesday, October 29" (see chart). Last Thursday was the ninth trading day after the recent October 10th record-volume decline and "capitulation low" reading. And then there is this Mannie Friedman quote, "When the market wants to bet that the world is coming to an end, the safe bet is to take the other side and bet the world won’t come to an end. After all, what have you got to lose?" Indeed, the "third mouse market!"
Stocks mentioned: Chesapeake Energy (CHK/$20.40/Strong Buy); American International Group (AIG/$1.70); Washington Mutual (WM/$0.06); General Electric (GE/$17.83)
Click Here, or on the image, to see a larger, undistorted image.
First Steps
By Jeffrey Saut | 20 October 2008
According to Merrill Lynch’s David Rosenberg, the passages above are the most important 'quips' from Ben Bernanke’s recent speech. Mr. Rosenberg concludes by noting:
As readers of these missives know, we have always thought the credit markets are smarter than the equity markets and therefore have been watching various credit spreads intently. The credit markets, ladies and gentlemen, will be the first "tell" as to when things will stabilize; and Mr. Bernanke is correct, "stabilization of the financial markets is a critical first step." Late last week looked to provide the "first steps" to some kind of stabilization.
For example, the November Eurodollar contract was sharply lower on Friday, as was the 3-month LIBOR interest rate. Rumors swirled that a major bank was lending heavily in the inter-bank market and the credit markets took a baby step toward thawing. We are hopeful that notion will spill over into the equity markets this week because the set-up for at least a trading bottom looks promising.
Indeed, as mentioned in previous missives, the equity markets are massively oversold and our downside day-count sequence is VERY long of tooth. Moreover, the Friday plunge of October 10th had all of the characteristics of a panic "low." If so, what typically occurs is a 1½ to 3-session sharp rally off of those "panic lows" and then the averages go right back down over the ensuing three to five sessions.
Roughly 60% of the time the averages hold above the previous low. The other 40% of the time they make lower lows, but not by much and the bottom is completed. Obviously, last Monday’s 936-point "Dow Wow" was a sharp rally that lifted the senior index some 1500-points above the previous Friday’s nadir (7882).
That strength spilled over into Tuesday morning, thus completing the perfunctory 1½-day throwback rally. From there the DJIA went straight back down into Thursday’s panic low of 8198 in what may have been a three-session slide that retested the lows of 10/10/08. If I could script it perfectly the downside retest sequence would have "timed" out into the first part of this week, but they don’t run the stock market for my benefit.
Accordingly, ever since that ill-fated Monday (9/29/08), when the House of Representatives turned down the Paulson Plan, we have told participants that the main theme is "survival." We have also suggested to "be the second mouse that gets the cheese" because the first mouse usually gets caught in the trap. Plainly, most folks who have attempted to pick the bottom over the last three weeks have lost money.
We think the odds of a bottom have increased. From a technical perspective that view is reinforced by the bottoming sequence already discussed. However, there are more fundamental factors at work.
Firstly, there is the noticeable improvement in the credit spreads. Secondly, the Fed is printing money at an unprecedented rate and money is the "oil" that makes the economic engine run. Thirdly, European leaders have taken the reins into their hands and crafted a rescue plan that makes much more sense than our ill-conceived [initial] reactive plans [[fortunately, we seem to have since shifted over to the 'European' plan: normxxx]].
Finally, there is tomorrow’s settlement for the recent Lehman credit-derivatives auction, which at nine cents on the dollar was a total bust [[settlement went off without a hitch; but hardly anyone seemed to have noticed: normxxx]] However, if tomorrow’s settlement goes off without a hitch it could soothe the markets and provide the "spark" that ignites a decent rally [[needless to say; it didn't.: normxxx]]
That said, even though the equity markets may stabilize and rally, as Mr. Bernanke notes, "even if they stabilize as we hope they will, broader economic recovery will not happen right away." Manifestly, the falloff in the economic data has been dramatic. Consumer confidence has plunged to 57.5 this month from 70.3 in September for the largest decline in the history of the data. Meanwhile, retail sales tagged a three-year low and single-family housing starts slid 12% in September to a 26-year low.
Not to be outdone, building permits skidded 8.3% on the month for a reading not seen since November of 1981; and industrial production, as well as the Philly Fed index, have come in well below forecasts. The good news comes on the commodity front, where prices have crashed. That commodity crash has ameliorated some of the inflation concerns and should allow the Fed to continue to expand its balance sheet and begin to act like a loan clearing house for many of the credit-derivatives awash in the system.
Interestingly, in theory the Federal Reserve can expand its balance sheet exponentially since it is a central bank with a sovereign currency that is NOT convertible into anything other than itself, a point Mr. Bernanke so eloquently made in his now famous "Helicopter Ben" speech of November 2002. We actual find this reassuring given the "toxic waste" that has infiltrated the country’s economic system.
In conclusion, we received a plethora of questions regarding the quote we used last week from The Wall Street Journal1 (WSJ) that there are currently one in ten listed companies trading for less than the value of the cash and marketable securities on their balance sheets. To proof test this statement we ran a similar screen and found more companies than the WSJ did. Of course the screen they must have used was similar to ours in that "net debt" on the balance sheet was excluded. When we included "net debt" we come away with a much smaller number.
Still, this exercise goes to show that "things" are overdone on the downside and people like Warren Buffett are taking notice. Verily, when investors en masse attempt to adjust their portfolios toward more conservative investments, there is a negative feedback loop that leads to a decline in the price of less liquid assets, which in turn begets even more selling pressure, causing an overshoot on the downside. And that, ladies and gentlemen, is where we are currently.
The call for today: While we have not seen a crash, what we have seen is a series of crashetts that have left us with as good a chance for a bottom as we have seen since 55 B.C., which is why we told accounts in last Tuesday’s comments that the short-term lows were "in" and they could begin a buying program in the investment account. We reiterated that stance on Friday, repeating that a bottoming sequence was at work and participants should act accordingly. Consequently, we’ll leave you with this thought from Cicero in 55 B.C.,
By Jeffrey Saut | 27 October 2008
Ever since the House of Representatives failed to pass the 'Paulson Plan', we have suggested that the main theme for investors was "survival." Accompanying that theme has been our mantra of trying to be the second mouse that gets the cheese because the first mouse often gets caught in the trap. To be sure, over the last four weeks most participants who have attempted to be the "first mouse," and pick the bottom, have lost money; so given last week’s wilt, we have decided a "third mouse" is what’s needed!
Since the original Dow Theory "sell signal" of September 2001, our strategy has been to manage the risk by not letting ANYTHING go more than 15% - 20% against us. This is the constant message from none other than Warren Buffett. Buffet says it wasn’t his best ideas that gave him his tremendous track record. It was having a smaller number of bad ideas that resulted in a permanent loss of capital. "We haven’t taken two steps forward and one step back. We’ve taken two steps forward and a fraction of a step back. Avoiding the catastrophes is really important."
Avoiding, and/or managing for, the catastrophes is one of the biggest secrets on Wall Street, still very few pundits ever discuss it. Anyone in the real world, however, knows that you have to manage for the "risks!" Apple producers know they are going to lose 5 or 6 apples out of every 100 to spoilage and they manage for it. Light bulb manufacturers know they will lose 2 or 3 light bulbs out of every 100 to breakage and they manage for it.
Still, in the investment business, there are very few of us that often discuss managing risk on a continuous basis. Even some of the best operators on Wall Street have recently failed to adhere to this most basic rule of investing. Indeed, for years we have idolized Ken Heebner of CGM Focus Fund fame (CGMFX/$27.40), as well as Marty Whitman who captains the Third Avenue Value Fund (TAVFX/$31.44). Both of these brilliant investors’ track records are legend; but this year, both of them are down over 45%.
Speaking to this "managing the risks" point, I read this most insightful paragraph from author, investor, and psychologist Brett Steenbager, PhD:
|
Yet, it is not just professional investors who have failed to manage the risk for as noted in last Thursday’s Wall Street Journal article titled "The Less Wealthy CEO," many of the country’s wealthiest CEOs are less wealthy now that their company’s share price has collapsed. Even more alarming is the number of CEOs, and corporate officers, that have been forced to sell their own company’s stock due to "margin calls," which was punctuated by Chesapeake Energy’s CEO being forced to sell 94% of his personal shares. The point of this diatribe is that asset prices are deflating worldwide! Ladies and gentlemen, these types of sequences are typical of "capitulation events" rarely seen in the scheme of things. Indeed, the stock market "low" of October 10, 2008 registered a Downside Capitulation reading not seen since 1966. As Bob Hoye wrote on 10-23-08:
|
Regrettably, capitulation selling begets more selling, and that is precisely what happened last week as the S&P 500 (SPX/876.77) shed another 6.78%, bringing its year-to-date loss to 40.3%. It was a democratic decline with all of the indices we follow lower for the week. In fact, the only "things" we saw higher on the week were the U.S. Dollar Index (+4.89%) and the Japanese Yen (+7.65%). The quid pro quo was that last Wednesday the British Pound suffered its worse one-day loss since Black Wednesday (September 16, 1992), when George Soros broke the Bank of England; and, the pound ended 8.45% lower last week.
Then came Friday with the preopening S&P futures locked down limit while the media trumpeted the "Bonfires of the Inanities" was coming on "no news". However, late Thursday the Federal Reserve reduced the value of Bear Stearns’ asset pool by some $2.7 billion, AIG had to increase its loan from the Fed by $7.4 billion and stated that the $122.8 billion loan may not be enough, WaMu’s Credit Default Swap portfolio settled for less than anticipated, GE said it would "tap" the Fed’s commercial paper facility, for the first time in history the 30-year "swap rate" traveled below the yield on the 30-year Treasury Bond (that should be impossible), and rumors swirled about major hedge funds in trouble.
Accordingly, the markets gapped lower early Friday morning, leaving the SPX trading more than 25% below its 50-day moving average (DMA) for the third time this month. As the good folks at the invaluable Bespoke Investment Group noted,
|
Clearly, the equity markets are geared for some kind of rally; and if we could ever get the typical Monday/Tuesday downside washout, we would once again try committing some trading capital. Interestingly, as Doug Cass notes,
|
As for the investment account, in the current environment companies that have low debt, high free cash flow, stable revenue growth, strong cash reserves on the balance sheet, and dividend yields, should fare the best. As Richard Russell observed,
|
10 great dividend-paying stocks 7 dynamic dividend-paying stocksWhat to look for in Dividend Paying Stocks
High Dividend Stocks Counter Tough Market
Dividend Growth Investor (blog)
The call for this week: Despite all of last week’s carnage, the SPX still couldn’t take out the "capitulation low" reading of 839.80 that occurred on October 10, 2008, although today it looks like it might be broken. If not, last week’s low was at 852.85 and could be construed as a test of the October 10 low. As Walter Deemer wrote last week, "Even in 1929, the worst stock market crash of all time, the market managed to make a final low nine trading days after the 11.7% [capitulation low] record-volume decline and low of Tuesday, October 29" (see chart). Last Thursday was the ninth trading day after the recent October 10th record-volume decline and "capitulation low" reading. And then there is this Mannie Friedman quote, "When the market wants to bet that the world is coming to an end, the safe bet is to take the other side and bet the world won’t come to an end. After all, what have you got to lose?" Indeed, the "third mouse market!"
Stocks mentioned: Chesapeake Energy (CHK/$20.40/Strong Buy); American International Group (AIG/$1.70); Washington Mutual (WM/$0.06); General Electric (GE/$17.83)
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First Steps
By Jeffrey Saut | 20 October 2008
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According to Merrill Lynch’s David Rosenberg, the passages above are the most important 'quips' from Ben Bernanke’s recent speech. Mr. Rosenberg concludes by noting:
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As readers of these missives know, we have always thought the credit markets are smarter than the equity markets and therefore have been watching various credit spreads intently. The credit markets, ladies and gentlemen, will be the first "tell" as to when things will stabilize; and Mr. Bernanke is correct, "stabilization of the financial markets is a critical first step." Late last week looked to provide the "first steps" to some kind of stabilization.
For example, the November Eurodollar contract was sharply lower on Friday, as was the 3-month LIBOR interest rate. Rumors swirled that a major bank was lending heavily in the inter-bank market and the credit markets took a baby step toward thawing. We are hopeful that notion will spill over into the equity markets this week because the set-up for at least a trading bottom looks promising.
Indeed, as mentioned in previous missives, the equity markets are massively oversold and our downside day-count sequence is VERY long of tooth. Moreover, the Friday plunge of October 10th had all of the characteristics of a panic "low." If so, what typically occurs is a 1½ to 3-session sharp rally off of those "panic lows" and then the averages go right back down over the ensuing three to five sessions.
Roughly 60% of the time the averages hold above the previous low. The other 40% of the time they make lower lows, but not by much and the bottom is completed. Obviously, last Monday’s 936-point "Dow Wow" was a sharp rally that lifted the senior index some 1500-points above the previous Friday’s nadir (7882).
That strength spilled over into Tuesday morning, thus completing the perfunctory 1½-day throwback rally. From there the DJIA went straight back down into Thursday’s panic low of 8198 in what may have been a three-session slide that retested the lows of 10/10/08. If I could script it perfectly the downside retest sequence would have "timed" out into the first part of this week, but they don’t run the stock market for my benefit.
Accordingly, ever since that ill-fated Monday (9/29/08), when the House of Representatives turned down the Paulson Plan, we have told participants that the main theme is "survival." We have also suggested to "be the second mouse that gets the cheese" because the first mouse usually gets caught in the trap. Plainly, most folks who have attempted to pick the bottom over the last three weeks have lost money.
We think the odds of a bottom have increased. From a technical perspective that view is reinforced by the bottoming sequence already discussed. However, there are more fundamental factors at work.
Firstly, there is the noticeable improvement in the credit spreads. Secondly, the Fed is printing money at an unprecedented rate and money is the "oil" that makes the economic engine run. Thirdly, European leaders have taken the reins into their hands and crafted a rescue plan that makes much more sense than our ill-conceived [initial] reactive plans [[fortunately, we seem to have since shifted over to the 'European' plan: normxxx]].
Finally, there is tomorrow’s settlement for the recent Lehman credit-derivatives auction, which at nine cents on the dollar was a total bust [[settlement went off without a hitch; but hardly anyone seemed to have noticed: normxxx]] However, if tomorrow’s settlement goes off without a hitch it could soothe the markets and provide the "spark" that ignites a decent rally [[needless to say; it didn't.: normxxx]]
That said, even though the equity markets may stabilize and rally, as Mr. Bernanke notes, "even if they stabilize as we hope they will, broader economic recovery will not happen right away." Manifestly, the falloff in the economic data has been dramatic. Consumer confidence has plunged to 57.5 this month from 70.3 in September for the largest decline in the history of the data. Meanwhile, retail sales tagged a three-year low and single-family housing starts slid 12% in September to a 26-year low.
Not to be outdone, building permits skidded 8.3% on the month for a reading not seen since November of 1981; and industrial production, as well as the Philly Fed index, have come in well below forecasts. The good news comes on the commodity front, where prices have crashed. That commodity crash has ameliorated some of the inflation concerns and should allow the Fed to continue to expand its balance sheet and begin to act like a loan clearing house for many of the credit-derivatives awash in the system.
Interestingly, in theory the Federal Reserve can expand its balance sheet exponentially since it is a central bank with a sovereign currency that is NOT convertible into anything other than itself, a point Mr. Bernanke so eloquently made in his now famous "Helicopter Ben" speech of November 2002. We actual find this reassuring given the "toxic waste" that has infiltrated the country’s economic system.
In conclusion, we received a plethora of questions regarding the quote we used last week from The Wall Street Journal1 (WSJ) that there are currently one in ten listed companies trading for less than the value of the cash and marketable securities on their balance sheets. To proof test this statement we ran a similar screen and found more companies than the WSJ did. Of course the screen they must have used was similar to ours in that "net debt" on the balance sheet was excluded. When we included "net debt" we come away with a much smaller number.
Still, this exercise goes to show that "things" are overdone on the downside and people like Warren Buffett are taking notice. Verily, when investors en masse attempt to adjust their portfolios toward more conservative investments, there is a negative feedback loop that leads to a decline in the price of less liquid assets, which in turn begets even more selling pressure, causing an overshoot on the downside. And that, ladies and gentlemen, is where we are currently.
The call for today: While we have not seen a crash, what we have seen is a series of crashetts that have left us with as good a chance for a bottom as we have seen since 55 B.C., which is why we told accounts in last Tuesday’s comments that the short-term lows were "in" and they could begin a buying program in the investment account. We reiterated that stance on Friday, repeating that a bottoming sequence was at work and participants should act accordingly. Consequently, we’ll leave you with this thought from Cicero in 55 B.C.,
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Twenty-Year Annual Average from 1900 thru 1997
Twenty-Year Annual Average from 1900 thru 1997
by 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 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.
Where To Go From Here
Deflationary Depression? Where To Go From Here
By John Lee, CFA | 24 October 2008
In September two significant events happened that will mark the month as the most financially significant in US history by far:
1. Fannie Mae and Freddie Mac were nationalized; this was no surprise as I predicted in November 2007.
2. Lehman Brothers went under. While I have said all major US banks (including Citibank, and JPMorgan), brokerages (including Goldman Sachs), and big finance companies (AIG, GE, GM, etc) are insolvent, I didn't expect that Lehman would be allowed to go under.
Paulson clearly didn't understand Lehman's involvement. Lehman is a leveraged brokerage shop that was the counterparty to trades sized in the $hundreds of billions, including interest rate swaps, commodity futures, corporate bonds, international equities and real estate loans, currency swaps, and private equities. The counterparty risk created fear and triggered domino selling [[AIG almost went under immediately and was only saved by the $85 billion 'loan' from the Fed.: normxxx]] Banks refused to lend to one another fearing the other end to be infested with Lehman's positions. Insiders claim that it could take over a decade to fully unwind Lehman's positions.
What's more, Lehman was one of the largest prime brokers to international hedge funds. Lehman's bankruptcy immediately caused wholesale panic within the hedge fund industry as funds tried to close/transfer/pull their money out of their Lehman custodian. Today over $60 billion is still locked up in Lehman's London brokerage unit. Given the leveraging nature of hedge funds, the effect on global equity markets was catastrophic as trillions of dollars were wiped off global equity markets. [[Indeed, the entire current World panic and credit market unravelling can be laid at the feet of Hank Paulson and his decision to let Lehman go BK! Up until then, it really looked as if the CBs had managed to contain things.: normxxx]]
Global Equity And Commodity Correction
With $hundreds of billions-worth of positions that need to be closed fast, we witnessed the most dramatic equity downturn outside of 1930 and 1987. Russian markets went down 70% and Nikkei, the world's second-largest equity index, is down 30% since September 1. Given that consumer spending accounts for 50% - 70% of GDP across various countries, the equity downturn caused spending pullback and thus global recession talk abounds. I believe this sudden downturn had more to do with Lehman's derivative positions and hedge funds having locked up than it did with fundamentals.
For example, demand for Oil and Copper had never slacked yet Oil and Copper prices were cut by half in 4 months. Inventory levels remained near historic lows and there was no projected slowdown in commodity demand from China, the world's largest consumer, up until then. In the financial arena, Chinese, Asian, Middle Eastern, and Latin American banks had minimal exposure to US subprime debt or to the collapse of US banks. The debt level of the Asian consumer, the key driver to the next phase of global growth, remains low.
Junior Sector And Resource Funds
The S&P TSX Ventures Index, a proxy to the junior resource sector, is down 70% to 900, from a high of 3,000 in 2008.
In September and October, 2 prominent resource funds closed: Ospraie and RAB. Both combined controlled over $3 billion in the resource junior sector. They literally owned 10% - 20% of the market and positions had to be sold. We saw classic margin-call selling. Prices of stocks were down 10% on consecutive days with small breaks in between and no rebounds. Many companies soon traded 10%, then 20%, then up to 50% below their bank cash balances. The situation clearly became irrational. Premier gold and silver producers were down 50% - 70% in 2 months.
Where To Go From Here
As of October 20, the junior market looks to have stabilized and I am convinced the correction for quality companies will not last long (i.e. maybe 6 months, less than one year for sure). This is much like the Nasdaq in 2001. Bad companies will go under, while good companies will survive and flourish.
With central banks recently pledging over $2 trillion to solve the crisis, a $750 billion bailout, more consumer stimulus, a federal deficit set to blow over $1 trillion, a continued US trade imbalance, a gigantic $10 trillion foreign reserve that is mostly yet to be diversified, and the central banks' inability to raise rates to combat inflationary pressure, I am more bullish on gold and gold equities than ever. Severe shortages of physical gold and silver at the retail level across the globe validate my belief that the supply of precious metals is dwindling fast at current prices. Reports from top Swiss vaults state they have "topped up" their metal storage space with no more capacity to spare.
There is talk of a deflationary depression, but my view strongly differs. Firstly, the money supply is exploding so prices will trend up after a brief scare. Secondly, on a global scale, the modernization of Asia and the Middle East is far from over with US $4 trillion at their disposal. Regardless of the long term picture on gold, when things are selling at 50 cents on the dollar, as some stocks are, even a brief rebound should see a recovery back to at least cash value. Whenever there is a crisis there is opportunity.
By John Lee, CFA | 24 October 2008
In September two significant events happened that will mark the month as the most financially significant in US history by far:
1. Fannie Mae and Freddie Mac were nationalized; this was no surprise as I predicted in November 2007.
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2. Lehman Brothers went under. While I have said all major US banks (including Citibank, and JPMorgan), brokerages (including Goldman Sachs), and big finance companies (AIG, GE, GM, etc) are insolvent, I didn't expect that Lehman would be allowed to go under.
Paulson clearly didn't understand Lehman's involvement. Lehman is a leveraged brokerage shop that was the counterparty to trades sized in the $hundreds of billions, including interest rate swaps, commodity futures, corporate bonds, international equities and real estate loans, currency swaps, and private equities. The counterparty risk created fear and triggered domino selling [[AIG almost went under immediately and was only saved by the $85 billion 'loan' from the Fed.: normxxx]] Banks refused to lend to one another fearing the other end to be infested with Lehman's positions. Insiders claim that it could take over a decade to fully unwind Lehman's positions.
What's more, Lehman was one of the largest prime brokers to international hedge funds. Lehman's bankruptcy immediately caused wholesale panic within the hedge fund industry as funds tried to close/transfer/pull their money out of their Lehman custodian. Today over $60 billion is still locked up in Lehman's London brokerage unit. Given the leveraging nature of hedge funds, the effect on global equity markets was catastrophic as trillions of dollars were wiped off global equity markets. [[Indeed, the entire current World panic and credit market unravelling can be laid at the feet of Hank Paulson and his decision to let Lehman go BK! Up until then, it really looked as if the CBs had managed to contain things.: normxxx]]
Global Equity And Commodity Correction
With $hundreds of billions-worth of positions that need to be closed fast, we witnessed the most dramatic equity downturn outside of 1930 and 1987. Russian markets went down 70% and Nikkei, the world's second-largest equity index, is down 30% since September 1. Given that consumer spending accounts for 50% - 70% of GDP across various countries, the equity downturn caused spending pullback and thus global recession talk abounds. I believe this sudden downturn had more to do with Lehman's derivative positions and hedge funds having locked up than it did with fundamentals.
For example, demand for Oil and Copper had never slacked yet Oil and Copper prices were cut by half in 4 months. Inventory levels remained near historic lows and there was no projected slowdown in commodity demand from China, the world's largest consumer, up until then. In the financial arena, Chinese, Asian, Middle Eastern, and Latin American banks had minimal exposure to US subprime debt or to the collapse of US banks. The debt level of the Asian consumer, the key driver to the next phase of global growth, remains low.
Junior Sector And Resource Funds
The S&P TSX Ventures Index, a proxy to the junior resource sector, is down 70% to 900, from a high of 3,000 in 2008.
In September and October, 2 prominent resource funds closed: Ospraie and RAB. Both combined controlled over $3 billion in the resource junior sector. They literally owned 10% - 20% of the market and positions had to be sold. We saw classic margin-call selling. Prices of stocks were down 10% on consecutive days with small breaks in between and no rebounds. Many companies soon traded 10%, then 20%, then up to 50% below their bank cash balances. The situation clearly became irrational. Premier gold and silver producers were down 50% - 70% in 2 months.
Where To Go From Here
As of October 20, the junior market looks to have stabilized and I am convinced the correction for quality companies will not last long (i.e. maybe 6 months, less than one year for sure). This is much like the Nasdaq in 2001. Bad companies will go under, while good companies will survive and flourish.
With central banks recently pledging over $2 trillion to solve the crisis, a $750 billion bailout, more consumer stimulus, a federal deficit set to blow over $1 trillion, a continued US trade imbalance, a gigantic $10 trillion foreign reserve that is mostly yet to be diversified, and the central banks' inability to raise rates to combat inflationary pressure, I am more bullish on gold and gold equities than ever. Severe shortages of physical gold and silver at the retail level across the globe validate my belief that the supply of precious metals is dwindling fast at current prices. Reports from top Swiss vaults state they have "topped up" their metal storage space with no more capacity to spare.
There is talk of a deflationary depression, but my view strongly differs. Firstly, the money supply is exploding so prices will trend up after a brief scare. Secondly, on a global scale, the modernization of Asia and the Middle East is far from over with US $4 trillion at their disposal. Regardless of the long term picture on gold, when things are selling at 50 cents on the dollar, as some stocks are, even a brief rebound should see a recovery back to at least cash value. Whenever there is a crisis there is opportunity.
Friday, October 24, 2008
Can We Avoid A 1930s Replay?
Do Our Rulers Know Enough To Avoid A 1930s Replay?
Events Are Moving With Lightning Speed As The Global Credit Freeze Evolves Into Something Awfully Like A Classic Trade-Depression.
By Ambrose Evans-Pritchard | 26 October 2008
"The crisis is now in full swing across the entire world," said Giulio Tremonti, Italy’s finance minister. "It is hitting the real economy, the productive forces of industry. It’s global, it’s total, and it’s everywhere," he said. Italy’s industrial output has fallen 11% in the last year. Foreign orders have dropped 13%. But we are all in much the same boat. Europe’s car sales fell 9% in September (32% in Spain). US housing starts fell to a 45-year low in September.
Last week, the International Monetary Fund had to rescue Hungary and Ukraine as contagion swept Eastern Europe. It would not surprise me if Russia itself were to tip into a downward spiral towards bankruptcy (again) and fascism (again). Russia’s foreign reserves have fallen by $67bn since August. Ural crude prices fell to $65 a barrel last week, below the budget solvency threshold of the now extravagant Russian state.
The new capitalists have to repay $47bn in foreign loans over the next two months. In Russia, oligarch fiefdoms built on leverage— Mikhail Fridman (Alfa), Oleg Deripaska (Basic Element), and Vladimir Lisin (Novolipetsk)— are lining up for state bail-outs from a $50bn rescue fund. Brazil is in free-fall as well. Sao Paolo’s Bovespa index is down a third in dollar terms in a month. Hopes that the BRIC quartet (Brazil, Russia, India, and China) would take over as the engine of world growth have proved yet another bubble delusion.
China says 53% of the country’s 3,600 toy factories have gone bust this year. Economist Andy Xie says China is at imminent risk of its own crisis after allowing over-investment to run rampant, like Japan in the 1980s. "The end is near. They’ve been keeping this house of cards going for a long time with bank support," he said. Lord (Adair) Turner, the head of Britain’s Financial Services Authority, offers soothing words. "There is no chance of a 1929-33 depression. We know how to stop it happening again," he said.
I hope Lord Turner is right, but his Olympian certainty bothers me. It assumes that the economic elites:
a) Understand what happened in the 1930s— on that score I suspect that few, other than the Fed’s Ben Bernanke [[who seems, nevertheless, to be taking his cues from Hank Paulson, who seems to be playing it by ear: normxxx]], have delved into the scholarship (sorry, Galbraith’s pot-boiler The Great Crash does not count).
b) That central banks will now jettison the dogma of 'inflation-targeting' that got us into this mess by lulling them into a false sense of security as credit growth and housing booms went mad. Will they now commit the reverse error as credit collapses?
c) Understand that non-US banks— especially Europeans— have used the 'shadow banking system' to leverage a $12 trillion (£7 trillion) spree around the world, and that this must be unwound as core bank capital shrivels away.
Yes, the Fed made frightening errors in the early 1930s by raising rates into the crisis, but they were constrained by the norms of the age: the fixed exchange system (Gold Standard), and fear of the bond markets. Are today’s central banks doing much better? The Europeans [[read: ECB President Jean-Claude Trichet: normxxx]] fell into the trap of equating this year’s oil and food spike with the events of the early 1970s.
As readers know, I view European Central Bank’s decision to raise rates to 4.25% in July— when Spain’s property market was already crashing, and Germany and Italy were already in recession— as replay of the 1930s ideological madness.
You could say the ECB also acted under the constraints of the age: its rigid inflation mandate. But I suspect that Bundesbank chief Axel Weber and German finance minister Peer Steinbruck were quite simply too arrogant to listen to anybody. Mr Steinbruck insisted that "German banks are far less vulnerable than US banks" just days before the collapse of Hypo Real with €400bn (£311bn) of liabilities. Had he not read the IMF reports showing that German and European lenders have an even thinner Tier 1 capital base than American banks?
One can only guess what French President Nicolas Sarkozy has been saying to ECB chief Jean-Claude Trichet, but he must have warned in blunt terms that Europe’s leaders would exercise their Maastricht powers to bring the bank to heel unless it slashed rates. Democracies cannot subcontract monetary policy (with all its foreign policy implications) to committees of economists in a fast-moving crisis. Those accountable to their electorates have to take charge.
Whatever occurred behind closed doors, the ECB is now tamed. It has cut rates to 3.75%, and will cut again soon, perhaps drastically. The risk is that rates have come down too late in Europe and Britain to stop a nasty dénouement, given the 18-month lag in monetary policy.
We should be thankful that President Sarkozy and Gordon Brown took action in the nick of time to save our banking systems. Their statesmanship should at least spare us mass bankruptcy and unemployment. But it will not spare us a decade-long toil of pitiful growth— or none at all— as we purge debt. The world stole prosperity from the future for year after year, with the full collusion of governments, regulators, and central banks. Now the future has arrived.
Heavy Industry: Hurting The Real Economy
The Impact Of The Financial Crisis On Some Of The Most Basic Industries
By Economist.Com | 17 October 2008
It is about as far as you can get from the woes of Wall Street: the mucky business of digging ore out of the ground, shipping it across the oceans and turning it into steel, the feedstock of industry. So the recent slump in raw-material prices and the decline in shipping costs indicate just how far-reaching the consequences of the global financial crisis will be for the real economy. Since the early summer the price of steel has fallen by 20-70% and the key rate for bulk shipping of commodities is down by more than four-fifths.
There are even stories of grain cargoes piling up in ports in the Americas. Their buyers’ letters of credit have not been honoured, because of a lack of confidence in the banks that underwrite them. At least one Australian producer has had the same problem with iron ore shipments to China. And shipowners are having trouble raising finance for new vessels.
The most spectacular reflection of falling activity has been the Baltic Dry Index (BDI), which traces prices for shipping bulk cargoes such as iron ore from producers such as Brazil and Australia to markets in America, Europe and China. The index has plunged by 85% after hitting a record high of 11,793 points in late May. It is a leading indicator of international trade and, by extension, of economic activity.
In the past couple of years the index has been driven up by the boom in China, as that economy sucks in raw materials in bulk-carrying ships and pumps out finished products, which are exported in vessels. The weakness is because of the slowing of world demand and the arrival of new capacity following the recent boom in shipbuilding. There are also signs of slowing demand for the container ships that take China’s manufactured goods to Western markets. The latest forecasts show growth in container demand falling from 15% a year to barely 5%.
Steel prices have also been falling fast from record highs. In America the price of coil steel, used to make cars and white goods, has fallen by 20% since May. The price of steel billets, which are traded on the London Metal Exchange, has tumbled by 70% since May. Steelmakers, including ArcelorMittal, the industry leader, and Russian and Chinese firms, are moving to cut production.
Although China’s iron ore imports in the first nine months of the year were up by 22% on 2007, there are fears among Australian mining firms that the cuts in Chinese steel production could presage a pause in China’s boom. Mount Gibson, an Australian producer, has given warning that stockpiles of ore are piling up in China. Iron-ore prices on the spot market have fallen by roughly half this year, to $100 a tonne or less. The prices of copper, nickel and zinc have also fallen by half or more this year, and aluminium is down by a third.
Those drops, in turn, have battered the share prices of mining companies. BHP Billiton and Rio Tinto, two giants that are big exporters of iron ore from Australia to China, say that they will not be too badly hit by falling demand. They do expect rivals with higher costs to rein in their output. To some extent, that is already happening. Ferrexpo, a Ukrainian iron-ore producer, has said it will postpone a decision about whether to expand. Rio Tinto itself has reduced output at one Chinese aluminium mill.
Alcoa, a big American aluminium firm which reported a sharp fall in profits this month, has shut a smelter in America and says it will halve its planned investments next year. Other firms have scrapped planned nickel and zinc mines. Nonetheless, the bigger mining firms are far from despair. Alberto Calderon of BHP points out that the Baltic Dry Index is extremely volatile; in his view, it is not a good indicator of the long-term prospects of the mining industry.
He expects the Chinese economy to keep growing by 6-9% a year for the next five years. Rio Tinto is even more sanguine: it does not foresee China’s growth falling below 8%. Tom Albanese, its boss, says the Chinese economy is merely "pausing for breath". Both firms point out that some metals, such as copper, are still in short supply, and that the credit crunch will only make it harder to finance new mines. By delaying expansions and squeezing marginal producers, it might actually sow the seeds for a recovery in metals prices sooner than most analysts expect. At any rate, BHP is still keen to buy Rio Tinto— an indication, presumably, that it still thinks raw materials is a good business to be in.
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.
Events Are Moving With Lightning Speed As The Global Credit Freeze Evolves Into Something Awfully Like A Classic Trade-Depression.
By Ambrose Evans-Pritchard | 26 October 2008
|
"The crisis is now in full swing across the entire world," said Giulio Tremonti, Italy’s finance minister. "It is hitting the real economy, the productive forces of industry. It’s global, it’s total, and it’s everywhere," he said. Italy’s industrial output has fallen 11% in the last year. Foreign orders have dropped 13%. But we are all in much the same boat. Europe’s car sales fell 9% in September (32% in Spain). US housing starts fell to a 45-year low in September.
Last week, the International Monetary Fund had to rescue Hungary and Ukraine as contagion swept Eastern Europe. It would not surprise me if Russia itself were to tip into a downward spiral towards bankruptcy (again) and fascism (again). Russia’s foreign reserves have fallen by $67bn since August. Ural crude prices fell to $65 a barrel last week, below the budget solvency threshold of the now extravagant Russian state.
The new capitalists have to repay $47bn in foreign loans over the next two months. In Russia, oligarch fiefdoms built on leverage— Mikhail Fridman (Alfa), Oleg Deripaska (Basic Element), and Vladimir Lisin (Novolipetsk)— are lining up for state bail-outs from a $50bn rescue fund. Brazil is in free-fall as well. Sao Paolo’s Bovespa index is down a third in dollar terms in a month. Hopes that the BRIC quartet (Brazil, Russia, India, and China) would take over as the engine of world growth have proved yet another bubble delusion.
China says 53% of the country’s 3,600 toy factories have gone bust this year. Economist Andy Xie says China is at imminent risk of its own crisis after allowing over-investment to run rampant, like Japan in the 1980s. "The end is near. They’ve been keeping this house of cards going for a long time with bank support," he said. Lord (Adair) Turner, the head of Britain’s Financial Services Authority, offers soothing words. "There is no chance of a 1929-33 depression. We know how to stop it happening again," he said.
I hope Lord Turner is right, but his Olympian certainty bothers me. It assumes that the economic elites:
a) Understand what happened in the 1930s— on that score I suspect that few, other than the Fed’s Ben Bernanke [[who seems, nevertheless, to be taking his cues from Hank Paulson, who seems to be playing it by ear: normxxx]], have delved into the scholarship (sorry, Galbraith’s pot-boiler The Great Crash does not count).
b) That central banks will now jettison the dogma of 'inflation-targeting' that got us into this mess by lulling them into a false sense of security as credit growth and housing booms went mad. Will they now commit the reverse error as credit collapses?
c) Understand that non-US banks— especially Europeans— have used the 'shadow banking system' to leverage a $12 trillion (£7 trillion) spree around the world, and that this must be unwound as core bank capital shrivels away.
Yes, the Fed made frightening errors in the early 1930s by raising rates into the crisis, but they were constrained by the norms of the age: the fixed exchange system (Gold Standard), and fear of the bond markets. Are today’s central banks doing much better? The Europeans [[read: ECB President Jean-Claude Trichet: normxxx]] fell into the trap of equating this year’s oil and food spike with the events of the early 1970s.
As readers know, I view European Central Bank’s decision to raise rates to 4.25% in July— when Spain’s property market was already crashing, and Germany and Italy were already in recession— as replay of the 1930s ideological madness.
You could say the ECB also acted under the constraints of the age: its rigid inflation mandate. But I suspect that Bundesbank chief Axel Weber and German finance minister Peer Steinbruck were quite simply too arrogant to listen to anybody. Mr Steinbruck insisted that "German banks are far less vulnerable than US banks" just days before the collapse of Hypo Real with €400bn (£311bn) of liabilities. Had he not read the IMF reports showing that German and European lenders have an even thinner Tier 1 capital base than American banks?
One can only guess what French President Nicolas Sarkozy has been saying to ECB chief Jean-Claude Trichet, but he must have warned in blunt terms that Europe’s leaders would exercise their Maastricht powers to bring the bank to heel unless it slashed rates. Democracies cannot subcontract monetary policy (with all its foreign policy implications) to committees of economists in a fast-moving crisis. Those accountable to their electorates have to take charge.
Whatever occurred behind closed doors, the ECB is now tamed. It has cut rates to 3.75%, and will cut again soon, perhaps drastically. The risk is that rates have come down too late in Europe and Britain to stop a nasty dénouement, given the 18-month lag in monetary policy.
We should be thankful that President Sarkozy and Gordon Brown took action in the nick of time to save our banking systems. Their statesmanship should at least spare us mass bankruptcy and unemployment. But it will not spare us a decade-long toil of pitiful growth— or none at all— as we purge debt. The world stole prosperity from the future for year after year, with the full collusion of governments, regulators, and central banks. Now the future has arrived.
Heavy Industry: Hurting The Real Economy
The Impact Of The Financial Crisis On Some Of The Most Basic Industries
By Economist.Com | 17 October 2008
It is about as far as you can get from the woes of Wall Street: the mucky business of digging ore out of the ground, shipping it across the oceans and turning it into steel, the feedstock of industry. So the recent slump in raw-material prices and the decline in shipping costs indicate just how far-reaching the consequences of the global financial crisis will be for the real economy. Since the early summer the price of steel has fallen by 20-70% and the key rate for bulk shipping of commodities is down by more than four-fifths.
There are even stories of grain cargoes piling up in ports in the Americas. Their buyers’ letters of credit have not been honoured, because of a lack of confidence in the banks that underwrite them. At least one Australian producer has had the same problem with iron ore shipments to China. And shipowners are having trouble raising finance for new vessels.
The most spectacular reflection of falling activity has been the Baltic Dry Index (BDI), which traces prices for shipping bulk cargoes such as iron ore from producers such as Brazil and Australia to markets in America, Europe and China. The index has plunged by 85% after hitting a record high of 11,793 points in late May. It is a leading indicator of international trade and, by extension, of economic activity.
In the past couple of years the index has been driven up by the boom in China, as that economy sucks in raw materials in bulk-carrying ships and pumps out finished products, which are exported in vessels. The weakness is because of the slowing of world demand and the arrival of new capacity following the recent boom in shipbuilding. There are also signs of slowing demand for the container ships that take China’s manufactured goods to Western markets. The latest forecasts show growth in container demand falling from 15% a year to barely 5%.
Steel prices have also been falling fast from record highs. In America the price of coil steel, used to make cars and white goods, has fallen by 20% since May. The price of steel billets, which are traded on the London Metal Exchange, has tumbled by 70% since May. Steelmakers, including ArcelorMittal, the industry leader, and Russian and Chinese firms, are moving to cut production.
Although China’s iron ore imports in the first nine months of the year were up by 22% on 2007, there are fears among Australian mining firms that the cuts in Chinese steel production could presage a pause in China’s boom. Mount Gibson, an Australian producer, has given warning that stockpiles of ore are piling up in China. Iron-ore prices on the spot market have fallen by roughly half this year, to $100 a tonne or less. The prices of copper, nickel and zinc have also fallen by half or more this year, and aluminium is down by a third.
Those drops, in turn, have battered the share prices of mining companies. BHP Billiton and Rio Tinto, two giants that are big exporters of iron ore from Australia to China, say that they will not be too badly hit by falling demand. They do expect rivals with higher costs to rein in their output. To some extent, that is already happening. Ferrexpo, a Ukrainian iron-ore producer, has said it will postpone a decision about whether to expand. Rio Tinto itself has reduced output at one Chinese aluminium mill.
Alcoa, a big American aluminium firm which reported a sharp fall in profits this month, has shut a smelter in America and says it will halve its planned investments next year. Other firms have scrapped planned nickel and zinc mines. Nonetheless, the bigger mining firms are far from despair. Alberto Calderon of BHP points out that the Baltic Dry Index is extremely volatile; in his view, it is not a good indicator of the long-term prospects of the mining industry.
He expects the Chinese economy to keep growing by 6-9% a year for the next five years. Rio Tinto is even more sanguine: it does not foresee China’s growth falling below 8%. Tom Albanese, its boss, says the Chinese economy is merely "pausing for breath". Both firms point out that some metals, such as copper, are still in short supply, and that the credit crunch will only make it harder to finance new mines. By delaying expansions and squeezing marginal producers, it might actually sow the seeds for a recovery in metals prices sooner than most analysts expect. At any rate, BHP is still keen to buy Rio Tinto— an indication, presumably, that it still thinks raw materials is a good business to be in.
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, October 23, 2008
As Everyone Exits, Insiders Arrive
As Everyone Exits, Insiders Arrive
Click here for a link to complete article:
By Dimitra Defotis, Barron's | 23 October 2008
Among the casualties of today's market rout are some prominent executives who sold shares to meet margin calls. Among the potential beneficiaries? Insiders at other companies who scooped up stock at hugely depressed valuations.Table: Shopping Spree
Some of the world's wealthiest men, including Mexican investor Carlos Slim Helú and Microsoft's (ticker: MSFT) Bill Gates, also opened their wallets, taking bigger stakes in the past month in companies they already own. So did hedge-fund manager Eddie Lampert, whose ESL Investments bought $27.6 million of AutoZone (AZO) as the stock hit a two-year low. Lampert, who controls 38% of the company, has been buying since April.
Insiders Sell Shares For Many Reasons. But They Buy For Primarily One: A Belief The Stock Is Going Up.
Both fresh purchases and the absolute level of insider ownership send a clear message, says one New York hedge-fund manager. "I love to know that it's people putting their own money at risk," he says. "It's a bullish sign if I am trying to build an investment case" for a stock.
Four weeks ago, the ratio of insider buyers to sellers was nearly even, according to InsiderScore. In the week ended Oct. 14, however, buyers trumped sellers by three to one, with much of the buying concentrated in shares of smaller companies. Insider buying was strong in shares of small regional banks and energy-exploration and pipeline concerns.
Retailers also attracted insiders, notwithstanding fears that the coming holiday season may be the worst in years for the industry. In early October, in one of the market's worst weeks on record, the CEO of discount shoe seller DSW (ticker: DSW), Jay L. Schottenstein, shoveled more than $15 million into his company's stock, paying an average of less than $12 a share; the stock now trades for $11.50. Schottenstein's confidence says something, given his retail background. He's the former CEO of American Eagle Outfitters (AEO), and sits on the boards of American Eagle and Retail Ventures (RVI), parent of Filene's Basement.
Another apparent retail fan is Slim, who invested in industrial and financial businesses during Mexico's 1980s debt crisis. In early October, a Slim-controlled trust bought nearly $11 million of Saks (SKS) stock, boosting his already significant stake in the parent of tony Saks Fifth Avenue. Saks has fallen more than 70% in the past year, to around $5 a share. Slim paid about $7 a share.
Gates continued to boost his stake in Republic Services (RSG), the waste hauler. From Aug. 5 to Sept. 29, he invested $256.7 million in Republic, at an average price near $33. Today, the stock is around $22. Waste Management (WMI) recently dropped its bid for Republic.
When a gaggle of high-ranking officers buys, that's also noteworthy. At AAR (AIR), a Chicago-area aviation and aircraft-leasing concern, the CEO and five directors picked up more than $461,000 of stock at an average of $11.86 a share, just below today's price. Insiders at many pipeline master limited partnerships were buyers in recent days (See "How to Energize Your Portfolio," Oct. 13). Robust Profit Pipelines
The Bottom Line:
During one of the market's worst periods ever, insider buyers trumped sellers by three to one. Executives are snapping up retailers, energy outfits and even small financials. Financials aren't without fans, either. Five insiders bought shares of MetLife (MET) recently, reversing a multi-year trend of planned sales. At credit-card issuer Discover Financial Services (DFS), the CEO, CFO and chief operating officer bought shares in early October at an average of $11.55 a share; the stock now trades around $10.
Buying on insiders' heels isn't a foolproof path to profits. But tracking the so-called smart money often leads to bargains.
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 Dimitra Defotis, Barron's | 23 October 2008
Among the casualties of today's market rout are some prominent executives who sold shares to meet margin calls. Among the potential beneficiaries? Insiders at other companies who scooped up stock at hugely depressed valuations.Table: Shopping Spree
Some of the world's wealthiest men, including Mexican investor Carlos Slim Helú and Microsoft's (ticker: MSFT) Bill Gates, also opened their wallets, taking bigger stakes in the past month in companies they already own. So did hedge-fund manager Eddie Lampert, whose ESL Investments bought $27.6 million of AutoZone (AZO) as the stock hit a two-year low. Lampert, who controls 38% of the company, has been buying since April.
Insiders Sell Shares For Many Reasons. But They Buy For Primarily One: A Belief The Stock Is Going Up.
Both fresh purchases and the absolute level of insider ownership send a clear message, says one New York hedge-fund manager. "I love to know that it's people putting their own money at risk," he says. "It's a bullish sign if I am trying to build an investment case" for a stock.
Four weeks ago, the ratio of insider buyers to sellers was nearly even, according to InsiderScore. In the week ended Oct. 14, however, buyers trumped sellers by three to one, with much of the buying concentrated in shares of smaller companies. Insider buying was strong in shares of small regional banks and energy-exploration and pipeline concerns.
Retailers also attracted insiders, notwithstanding fears that the coming holiday season may be the worst in years for the industry. In early October, in one of the market's worst weeks on record, the CEO of discount shoe seller DSW (ticker: DSW), Jay L. Schottenstein, shoveled more than $15 million into his company's stock, paying an average of less than $12 a share; the stock now trades for $11.50. Schottenstein's confidence says something, given his retail background. He's the former CEO of American Eagle Outfitters (AEO), and sits on the boards of American Eagle and Retail Ventures (RVI), parent of Filene's Basement.
Another apparent retail fan is Slim, who invested in industrial and financial businesses during Mexico's 1980s debt crisis. In early October, a Slim-controlled trust bought nearly $11 million of Saks (SKS) stock, boosting his already significant stake in the parent of tony Saks Fifth Avenue. Saks has fallen more than 70% in the past year, to around $5 a share. Slim paid about $7 a share.
Gates continued to boost his stake in Republic Services (RSG), the waste hauler. From Aug. 5 to Sept. 29, he invested $256.7 million in Republic, at an average price near $33. Today, the stock is around $22. Waste Management (WMI) recently dropped its bid for Republic.
When a gaggle of high-ranking officers buys, that's also noteworthy. At AAR (AIR), a Chicago-area aviation and aircraft-leasing concern, the CEO and five directors picked up more than $461,000 of stock at an average of $11.86 a share, just below today's price. Insiders at many pipeline master limited partnerships were buyers in recent days (See "How to Energize Your Portfolio," Oct. 13). Robust Profit Pipelines
The Bottom Line:
During one of the market's worst periods ever, insider buyers trumped sellers by three to one. Executives are snapping up retailers, energy outfits and even small financials. Financials aren't without fans, either. Five insiders bought shares of MetLife (MET) recently, reversing a multi-year trend of planned sales. At credit-card issuer Discover Financial Services (DFS), the CEO, CFO and chief operating officer bought shares in early October at an average of $11.55 a share; the stock now trades around $10.
Buying on insiders' heels isn't a foolproof path to profits. But tracking the so-called smart money often leads to bargains.
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.
Wednesday, October 22, 2008
Dow Nears Its 5-Year Low
Currencies In Turmoil; Dow Nears Its 5-Year Low
By Joanna Slater and Peter A. Mckay | 23 October 2008
The stock market and currency market both sent a loud warning Wednesday that investors believe the global economy is heading into a deep recession. The fears drove down currencies and stocks around the world, while the U.S. stock market touched a five-year low. The declines were broad, including most commodities. Oil dropped 7.5% to its lowest point since June 2007. Copper's price fell to its lowest level since 2005. The British pound is now trading at the same level versus the U.S. dollar as it did in 2003.
Bloomberg News/Landov
Shares fell on the New York Stock Exchange on Wednesday on concerns over a worsening world-wide economic slump.
The dollar, to which many investors retreat in times of stress, gained. So did the Japanese yen, as traders who had borrowed yen to invest elsewhere unwound those bets and sent the cash back to Japan. The Dow Jones Industrial Average posted its seventh-biggest point drop in history, tumbling 514.45 points, or 5.7%, to close at 8519.21. It is down nearly 40% from its record about a year ago.
Late in the afternoon, the Dow was trading 100 points below its lowest close of the year earlier this month, before rallying just before the close. The Dow has fallen 746 points in the past two days, reversing a burst of optimism early in the week tied to a modest loosening in the credit markets. While the lending markets continued to ease on Wednesday, weak corporate earnings combined with worries about the global economy to send U.S. stocks grinding lower in typical bear-market fashion, where gains are soon swamped by heavy selling. Even oil's steep decline, sometimes a boon to stocks, contributed to the damage, as traders focused on the drop as a sign of the global weakness.
Energy companies were among the hardest hit, falling nearly 10%, as the broad Standard & Poor's 500-stock index hit a 5½-year closing low. "The market continues to ignore anything that even looks like good news," said floor trader Ted Weisberg of Seaport Securities, a New York brokerage firm. Referring to a previous bear market that dragged on for more than a year, he added: "It's basically 1973 or 1974 all over again."
Overseas, the declines were steeper. In Argentina, stocks fell 10%, a day after the government proposed to take over private pensions. Brazil also sank 10%. In Japan, the Nikkei Stock Average dropped nearly 7% on worries that the strengthening yen would crimp exports by making Japanese goods less affordable in other nations. Markets in Asia were down Thursday morning, with the Nikkei off 6% in early trading.
European stocks were down 5% Wednesday. Stocks in emerging markets have lost more than half their value in dollar terms since they peaked in May. Particularly striking was the action in the currency market, the world's largest, with estimated volume of $3.2 trillion a day. Wednesday saw steep declines in most currencies versus the dollar, as investors continued to flee risk and as some countries seemed to teeter closer to crisis. As volatility in the currency market rises, it's a challenge to investors and companies alike.
In recent weeks, the U.S. dollar has strengthened against nearly all currencies except the yen. On Wednesday, the dollar leapt to a two-year high versus the euro, a five-year high against the British pound and a six-year high against the South African rand. Many of these currencies already had taken a beating in recent weeks, but it has intensified in recent days. On Wednesday, the rand dropped 9.5% versus the dollar, the Turkish lira fell 6.6%, the Brazilian real 5.7%, and the Polish zloty 4.9%. Hungary's forint weakened 2.9% despite an emergency move that boosted interest rates a huge three percentage points, in a bid to defend the currency.
Before the housing and credit troubles developed, emerging economies were major beneficiaries of a global environment of strong growth and a healthy appetite for risk-taking. Now that has all disappeared, leaving some countries struggling. "An enduring credit crunch and slumping global economy clearly now threatens all emerging market currencies," James Malcolm, a currency strategist at Deutsche Bank in London, wrote last week. Most vulnerable, he said, are countries that rely on foreign financing to meet their deficits and have relatively low reserves— among them Hungary, Turkey, Poland, Romania, Indonesia and Czech Republic.
But a broader group of currencies is suffering as investors withdraw money from these markets. Tumbling raw-material prices are weighing on currencies in commodity-producing nations from Latin America to South Africa to Russia. "To me, we are only in the third inning" of this selloff in emerging-market currencies, predicted Stephen Jen, global head of currency strategy at Morgan Stanley, in a note on Monday. He said the story of economic growth and financial resilience in these countries "that is so widely believed needs to be fundamentally and thoroughly scrutinized."
Nearly all commodities declined, with oil falling $5.43 a barrel to $66.75, its lowest point since June 2007— a drop of 54% since July 3. A rise in U.S. petroleum reserves, shown in weekly government data, weighed on the market along with the economic worries. Traders are looking ahead to a likely production cut by the Organization of Petroleum Exporting Countries on Friday, although many participants remain skeptical that demand will hold up in the months ahead.
"Right now the crude market is concentrating on recession fears," said Raymond Carbone, president of brokerage Paramount Options on the Nymex floor.
The dollar's rise since July is part of a reversal in longstanding investment trends that prevailed during years of plentiful borrowing, strong growth and low financial-market volatility. "Essentially, every large trade that built up a head of steam in the go-go years has blown up or is in the process of blowing up," wrote Alan Ruskin, chief international strategist at RBS Greenwich Capital, in a report to clients. "That goes for almost every asset class."
The about-face has been particularly rapid in currencies. As the U.S. dollar and the yen— both exceedingly weak during better days— have surged, formerly highflying currencies like the euro, the British pound and the Canadian dollar have fallen hard. All three have weakened more than 10% against the U.S. dollar since the start of September. "We went up the elevator and we're coming down the lift shaft," said Richard Benson of Millennium Global Investments, a London currency manager.
In part, the yen's strength is coming from the reversal of trades by manufacturers in Korea, India and elsewhere who had borrowed low-yielding yen to cover their business costs in their local currencies. The unwinding of this so-called yen-carry trade could continue to play out a while longer, said Paresh Upadhyaya, a currency-focused portfolio manager at Putnam Investments in Boston. In the credit markets on Wednesday, conditions continued to improve in bank-to-bank lending— a key barometer of whether the recent financial crisis is easing. The rate on three-month loans in dollars, known as the London Interbank Offered Rate (LIBOR), fell sharply, by 0.29 percentage point, to 3.54%.
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 Joanna Slater and Peter A. Mckay | 23 October 2008
The stock market and currency market both sent a loud warning Wednesday that investors believe the global economy is heading into a deep recession. The fears drove down currencies and stocks around the world, while the U.S. stock market touched a five-year low. The declines were broad, including most commodities. Oil dropped 7.5% to its lowest point since June 2007. Copper's price fell to its lowest level since 2005. The British pound is now trading at the same level versus the U.S. dollar as it did in 2003.
Bloomberg News/Landov Shares fell on the New York Stock Exchange on Wednesday on concerns over a worsening world-wide economic slump.
The dollar, to which many investors retreat in times of stress, gained. So did the Japanese yen, as traders who had borrowed yen to invest elsewhere unwound those bets and sent the cash back to Japan. The Dow Jones Industrial Average posted its seventh-biggest point drop in history, tumbling 514.45 points, or 5.7%, to close at 8519.21. It is down nearly 40% from its record about a year ago.
Late in the afternoon, the Dow was trading 100 points below its lowest close of the year earlier this month, before rallying just before the close. The Dow has fallen 746 points in the past two days, reversing a burst of optimism early in the week tied to a modest loosening in the credit markets. While the lending markets continued to ease on Wednesday, weak corporate earnings combined with worries about the global economy to send U.S. stocks grinding lower in typical bear-market fashion, where gains are soon swamped by heavy selling. Even oil's steep decline, sometimes a boon to stocks, contributed to the damage, as traders focused on the drop as a sign of the global weakness.
Energy companies were among the hardest hit, falling nearly 10%, as the broad Standard & Poor's 500-stock index hit a 5½-year closing low. "The market continues to ignore anything that even looks like good news," said floor trader Ted Weisberg of Seaport Securities, a New York brokerage firm. Referring to a previous bear market that dragged on for more than a year, he added: "It's basically 1973 or 1974 all over again."Overseas, the declines were steeper. In Argentina, stocks fell 10%, a day after the government proposed to take over private pensions. Brazil also sank 10%. In Japan, the Nikkei Stock Average dropped nearly 7% on worries that the strengthening yen would crimp exports by making Japanese goods less affordable in other nations. Markets in Asia were down Thursday morning, with the Nikkei off 6% in early trading.
European stocks were down 5% Wednesday. Stocks in emerging markets have lost more than half their value in dollar terms since they peaked in May. Particularly striking was the action in the currency market, the world's largest, with estimated volume of $3.2 trillion a day. Wednesday saw steep declines in most currencies versus the dollar, as investors continued to flee risk and as some countries seemed to teeter closer to crisis. As volatility in the currency market rises, it's a challenge to investors and companies alike.
In recent weeks, the U.S. dollar has strengthened against nearly all currencies except the yen. On Wednesday, the dollar leapt to a two-year high versus the euro, a five-year high against the British pound and a six-year high against the South African rand. Many of these currencies already had taken a beating in recent weeks, but it has intensified in recent days. On Wednesday, the rand dropped 9.5% versus the dollar, the Turkish lira fell 6.6%, the Brazilian real 5.7%, and the Polish zloty 4.9%. Hungary's forint weakened 2.9% despite an emergency move that boosted interest rates a huge three percentage points, in a bid to defend the currency.
Before the housing and credit troubles developed, emerging economies were major beneficiaries of a global environment of strong growth and a healthy appetite for risk-taking. Now that has all disappeared, leaving some countries struggling. "An enduring credit crunch and slumping global economy clearly now threatens all emerging market currencies," James Malcolm, a currency strategist at Deutsche Bank in London, wrote last week. Most vulnerable, he said, are countries that rely on foreign financing to meet their deficits and have relatively low reserves— among them Hungary, Turkey, Poland, Romania, Indonesia and Czech Republic.
But a broader group of currencies is suffering as investors withdraw money from these markets. Tumbling raw-material prices are weighing on currencies in commodity-producing nations from Latin America to South Africa to Russia. "To me, we are only in the third inning" of this selloff in emerging-market currencies, predicted Stephen Jen, global head of currency strategy at Morgan Stanley, in a note on Monday. He said the story of economic growth and financial resilience in these countries "that is so widely believed needs to be fundamentally and thoroughly scrutinized."
Nearly all commodities declined, with oil falling $5.43 a barrel to $66.75, its lowest point since June 2007— a drop of 54% since July 3. A rise in U.S. petroleum reserves, shown in weekly government data, weighed on the market along with the economic worries. Traders are looking ahead to a likely production cut by the Organization of Petroleum Exporting Countries on Friday, although many participants remain skeptical that demand will hold up in the months ahead.
"Right now the crude market is concentrating on recession fears," said Raymond Carbone, president of brokerage Paramount Options on the Nymex floor.
The dollar's rise since July is part of a reversal in longstanding investment trends that prevailed during years of plentiful borrowing, strong growth and low financial-market volatility. "Essentially, every large trade that built up a head of steam in the go-go years has blown up or is in the process of blowing up," wrote Alan Ruskin, chief international strategist at RBS Greenwich Capital, in a report to clients. "That goes for almost every asset class."
The about-face has been particularly rapid in currencies. As the U.S. dollar and the yen— both exceedingly weak during better days— have surged, formerly highflying currencies like the euro, the British pound and the Canadian dollar have fallen hard. All three have weakened more than 10% against the U.S. dollar since the start of September. "We went up the elevator and we're coming down the lift shaft," said Richard Benson of Millennium Global Investments, a London currency manager.
In part, the yen's strength is coming from the reversal of trades by manufacturers in Korea, India and elsewhere who had borrowed low-yielding yen to cover their business costs in their local currencies. The unwinding of this so-called yen-carry trade could continue to play out a while longer, said Paresh Upadhyaya, a currency-focused portfolio manager at Putnam Investments in Boston. In the credit markets on Wednesday, conditions continued to improve in bank-to-bank lending— a key barometer of whether the recent financial crisis is easing. The rate on three-month loans in dollars, known as the London Interbank Offered Rate (LIBOR), fell sharply, by 0.29 percentage point, to 3.54%.
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.
Bear Trap???
The Other Side Of The Trade: Bear Trap
Time And Price; There Is No Alternative
By Todd Harrison | 22 October 2008
NEW YORK (MarketWatch)— One of our favorite adages in Minyanville is to sell hope and buy despair, but the question remains whether we've seen enough fear this year. Last week, as the wheels wobbled on the financial wagon, we offered that the 2008 trading low was likely established the prior week (October 10), when the S&P (SPX) ticked at 840 and the Dow Jones Industrial Average (INDU) traded at 7880. Read MarketWatch column Following the fragile Friday retest, the market enjoyed a spirited sprint that added 150 S&P handles and 1400 Dow points in a matter of days. As psychology shifts and investors twist, we're left to wonder if the worst is behind us.
There is a massive distinction between a trading low and market bottom. All else being equal, it remains my view that the dollar must devalue or equities will decline— perhaps next year— as debt destruction manifests across the financial continuum. Read Minyanville column As traders, the destination we arrive at pales in comparison to the path that we take to get there. Therein lies the opportunity for those living in the nuts and guts trading the flickering ticks. The volatility is wicked, but disciplined risk managers are feasting on the emotional famine.
There are two sides in each trade and risk to every reward. As such, I wanted to explore five reasons why we could see lower prices still by the time we welcome 2009.
1. World, Hold On
Seeds of isolationism are sown as the going gets tough and the tough tend to their own interests. Derivatives may be financial weapons of mass destruction, but liquidity is the neutron bomb— pull the pin and it'll suck the life out of the global economy. Recently nationalized global central banks are being polarized as the dot-gov bubble bursts. Australia ruled out deposit guarantees for foreign banks and the Royal Bank of Scotland (RBS) cancelled its credit line to the National Petroleum Company of Venezuela. France's Nicolas Sarkozy proposed that each country launch sovereign wealth funds and take stakes in key industries to stop them from falling into foreign hands.
As countries fend for themselves, the risk of geopolitical turmoil is elevated. My single greatest concern is the potential for "something serious" to occur in the Middle East while the current administration is still in office.
2. Rampart
As a derivatives trader for 17 years, I understand the depth and complexity of our current conundrum. Stocks are the world's biggest thermometers, but credit is the backbone and you can't walk without your vertebrae. Classic capitulatory signs were present two weeks ago, but the credit cancer is bigger than the economic patient. There are upwards of $500 - $600 trillion 'notional' in outstanding derivative contracts and the nationalization of financial institutions transfers— but doesn't erase— that risk.
3. False Hope
Much has been written about the uptick in the credit markets being a precursor to an equity rally. While we've seen improvement in credit symptoms ranging from LIBOR to TED spreads, we've got a ways to go before conditions 'normalize'. The spread between three-month LIBOR and the targeted Fed Funds rate remains elevated at 2.33%, twice as high as it was a mere month ago. Further, credit Bears are building bets against Fannie Mae (FNM) and Freddie Mac (FRE) debt and that's disconcerting through a macro lens.
4. Swingers
When global central banks banned short sales, it was the financial equivalent of messing with Mother Nature. The resulting volatility throughout the asset class spectrum can't be viewed as constructive regardless of your directional bias. Of the 36 times the S&P has rallied 6% in a single session over the last eighty years, 32 occurred between 1929 and 1933 [[when short selling was likewise banned or strongly curtailed: normxxx]]. History doesn't always repeat but we would be wise to remember the prevailing trend during those daunting years.
5. Pickers And Grinners
During the last few weeks, high-profile pundits have emerged to proclaim a 'positive' posture toward stocks. The cast of characters ranged from the Oracle of Omaha to several well-known bears in the financial space (present company included). To paraphrase Warren Buffett [[the J.P. Morgan of the 21st century(?): normxxx]], savvy investors sell when others are greedy and buy when they're panicked. The key to that approach, however, is having the staying power to ride out the storm. As John Maynard Keynes so famously said, "markets can stay irrational far longer than you can stay solvent".
Getting Stuck By The Landing
Let's take a step back for a moment. This problem has been percolating since the back of the tech bubble. The cumulative imbalances took a long time to cook and the unwind will be equally fierce. See Minyanville column
Time and price; there is no alternative.
Entering September, we warned that either a cancer or car crash was imminent as corporate debt came due. See MarketWatch column While one could argue we've conceivably seen both, the surreal script is written in real-time. The ramifications will be far-reaching. The 1929 stock market crash didn't cause the Great Depression; the Great Depression caused the stock market to crash. That's worth noting with mainstay averages down 40% year-over-year and once-venerable institutions having been laid to rest.
Social mood and risk appetites shape financial markets. The DNA of this market— a finance-based global economy levered to the hilt and laced with derivatives— is drastically different than anything we've ever seen. That's the other side of the trade, a toxic combination that consumes the world and turns us against each other. Stick with risk management instead of reward chasing as we find our way to better days.
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.
Time And Price; There Is No Alternative
By Todd Harrison | 22 October 2008
NEW YORK (MarketWatch)— One of our favorite adages in Minyanville is to sell hope and buy despair, but the question remains whether we've seen enough fear this year. Last week, as the wheels wobbled on the financial wagon, we offered that the 2008 trading low was likely established the prior week (October 10), when the S&P (SPX) ticked at 840 and the Dow Jones Industrial Average (INDU) traded at 7880. Read MarketWatch column Following the fragile Friday retest, the market enjoyed a spirited sprint that added 150 S&P handles and 1400 Dow points in a matter of days. As psychology shifts and investors twist, we're left to wonder if the worst is behind us.
There is a massive distinction between a trading low and market bottom. All else being equal, it remains my view that the dollar must devalue or equities will decline— perhaps next year— as debt destruction manifests across the financial continuum. Read Minyanville column As traders, the destination we arrive at pales in comparison to the path that we take to get there. Therein lies the opportunity for those living in the nuts and guts trading the flickering ticks. The volatility is wicked, but disciplined risk managers are feasting on the emotional famine.
There are two sides in each trade and risk to every reward. As such, I wanted to explore five reasons why we could see lower prices still by the time we welcome 2009.
1. World, Hold On
Seeds of isolationism are sown as the going gets tough and the tough tend to their own interests. Derivatives may be financial weapons of mass destruction, but liquidity is the neutron bomb— pull the pin and it'll suck the life out of the global economy. Recently nationalized global central banks are being polarized as the dot-gov bubble bursts. Australia ruled out deposit guarantees for foreign banks and the Royal Bank of Scotland (RBS) cancelled its credit line to the National Petroleum Company of Venezuela. France's Nicolas Sarkozy proposed that each country launch sovereign wealth funds and take stakes in key industries to stop them from falling into foreign hands.
As countries fend for themselves, the risk of geopolitical turmoil is elevated. My single greatest concern is the potential for "something serious" to occur in the Middle East while the current administration is still in office.
2. Rampart
As a derivatives trader for 17 years, I understand the depth and complexity of our current conundrum. Stocks are the world's biggest thermometers, but credit is the backbone and you can't walk without your vertebrae. Classic capitulatory signs were present two weeks ago, but the credit cancer is bigger than the economic patient. There are upwards of $500 - $600 trillion 'notional' in outstanding derivative contracts and the nationalization of financial institutions transfers— but doesn't erase— that risk.
3. False Hope
Much has been written about the uptick in the credit markets being a precursor to an equity rally. While we've seen improvement in credit symptoms ranging from LIBOR to TED spreads, we've got a ways to go before conditions 'normalize'. The spread between three-month LIBOR and the targeted Fed Funds rate remains elevated at 2.33%, twice as high as it was a mere month ago. Further, credit Bears are building bets against Fannie Mae (FNM) and Freddie Mac (FRE) debt and that's disconcerting through a macro lens.
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4. Swingers
When global central banks banned short sales, it was the financial equivalent of messing with Mother Nature. The resulting volatility throughout the asset class spectrum can't be viewed as constructive regardless of your directional bias. Of the 36 times the S&P has rallied 6% in a single session over the last eighty years, 32 occurred between 1929 and 1933 [[when short selling was likewise banned or strongly curtailed: normxxx]]. History doesn't always repeat but we would be wise to remember the prevailing trend during those daunting years.
5. Pickers And Grinners
During the last few weeks, high-profile pundits have emerged to proclaim a 'positive' posture toward stocks. The cast of characters ranged from the Oracle of Omaha to several well-known bears in the financial space (present company included). To paraphrase Warren Buffett [[the J.P. Morgan of the 21st century(?): normxxx]], savvy investors sell when others are greedy and buy when they're panicked. The key to that approach, however, is having the staying power to ride out the storm. As John Maynard Keynes so famously said, "markets can stay irrational far longer than you can stay solvent".
Getting Stuck By The Landing
Let's take a step back for a moment. This problem has been percolating since the back of the tech bubble. The cumulative imbalances took a long time to cook and the unwind will be equally fierce. See Minyanville column
Time and price; there is no alternative.
Entering September, we warned that either a cancer or car crash was imminent as corporate debt came due. See MarketWatch column While one could argue we've conceivably seen both, the surreal script is written in real-time. The ramifications will be far-reaching. The 1929 stock market crash didn't cause the Great Depression; the Great Depression caused the stock market to crash. That's worth noting with mainstay averages down 40% year-over-year and once-venerable institutions having been laid to rest.
Social mood and risk appetites shape financial markets. The DNA of this market— a finance-based global economy levered to the hilt and laced with derivatives— is drastically different than anything we've ever seen. That's the other side of the trade, a toxic combination that consumes the world and turns us against each other. Stick with risk management instead of reward chasing as we find our way to better days.
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, October 21, 2008
Why Was Lehman Brothers Allowed To Fail?
Why Was Lehman Brothers Allowed To Fail?
Lehman’s Collapse ‘Could And Should Have Been Avoided’
Speech By Lorenzo Bini Smaghi, ECB | 21 October 2008
The current crisis could be the starting point for many ideas, and must certainly be subjected to extensive analysis. Today, I intend to dwell on one particular issue, which is founded on a simple question: Why was Lehman Brothers allowed to fail?
I wish to start with this question because the collapse of this investment bank on Monday, 15 September 2008 was one of the factors which turned the period of turmoil in the financial markets that started in summer 2007 into a full-blown crisis. Following the failure of Lehman Brothers, panic set in that any bank, irrespective of its size, could go bankrupt. Market participants revised their investment decisions.
The banks themselves started to fear that any of their counterparties could fail and stopped lending money to each other, causing the interbank market, which had already been under stress for months, to dry up completely. In the four weeks following the bankruptcy of Lehman Brothers, the European stock exchanges plunged by around 30%, more than the total fall recorded over the previous 12 months. The three-month Euribor spread, which measures tensions in the interbank market, more than doubled, exceeding 170 basis points.
The first steps taken by the authorities to calm the markets did not succeed in restoring confidence. This did not happen until mid-October, when a coordinated action, which took the form of substantial recourse to public funds and concerted action by the central banks, was initiated in Europe and North America.
Looking back at the events of last month, it seems clear that the failure of Lehman Brothers could have and should have been avoided. This is not just an ex-post hoc assessment, made in the light of what happened afterwards, but also an ex-ante one. It was obvious that in a crisis of confidence, such as had existed for months, the failure of a bank, even a medium-sized one, would have a contagion effect, triggering a flight from the system. This was why, in previous months, in both the United States and Europe (for example, Denmark, Germany and the United Kingdom), the authorities had intervened precisely to avoid the collapse of banks that were in difficulty (Bear Sterns, Northern Rock, IKB and Roskilde).
In the light of this assessment, it is legitimate to ask why the failure of Lehman Brothers was not prevented.
Various theories have been put forward in this regard. The one I find most credible is that there was a political veto, at the highest levels, against the use of public funds to rescue an investment bank. Indeed, right after the bank’s failure was announced, the US Secretary of the Treasury himself confirmed that, "I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers". The timing of the Lehman crisis also played a key role.
Only a few days prior, the US Treasury had taken on the sizeable debt of Fannie Mae and Freddie Mac, a decision which was criticised in the press. Straight after this step was taken, it appeared that the US Treasury did not want to be charged with using public money and practising what has been called a kind of perverse "financial socialism" [[i.e., privatizing profits, but socializing losses: normxxx]]. There is no doubt that the pressure of public opinion played a role.
We could stop here, with a negative assessment of the political decision taken by the US administration, which proved to be wrong. However, perhaps the problem might be more complex than that.
As subsequent events have shown, in particular when the first rescue package was rejected by the US Congress, opposition to providing the financial sector with public funds came not only from within the government, but also from Congress. The Members of the US Congress, many of whom face voters at the beginning of November, feared that such a decision would compromise their re-election. There was opposition to rescuing Lehman Brothers, therefore, not only from within the Administration, but also from Congress and, more broadly, from public opinion. In other words, the decision was largely the result of a democratic process. Ultimately, it was the US citizens who did not want to rescue Lehman Brothers.
This analysis is not restricted to the Lehman Brothers case alone. Even in countries where bankruptcies were successfully avoided through intervention, the decision was fiercely criticised by the respective parliaments and public opinion. In some cases, it was only possible to take the decision because immediate approval by parliament was not required. There is no denying that the conditions could have existed for letting some banks in difficulty fail had the political situation been different, for example, if elections were imminent in Europe, as in the United States.
Fortunately, this was not the case. Nevertheless, it is necessary to reflect on what might have happened. The question that needs to be asked is the following: why do democratic decision-making processes lead to the wrong decisions being taken from the point of view of the common good, not only ex-post, but also ex-ante?
The response given to justify the decision to let Lehman Brothers go bankrupt is that, for citizens in general, and for tax-payers in particular, it is not 'fair' to use public funds to bail out financial institutions which, in the preceding months and years, had accumulated massive profits for their shareholders and executives. Obviously, for those assigned the task of deciding whether or not to come to a bank’s rescue it is not an easy task to convince the electorate that losses must be nationalised, when the past profits were privatised. The rational explanation is that, without the rescue operation, the whole economy would have suffered as a result, with direct consequences for citizens and tax-payers.
Given the contagion effect which is generated following the collapse of a bank, nationalising the losses prevents an even greater evil being unleashed. The financial sector is different from other sectors, precisely owing to the systemic and contagion effects that a crisis would have on all the other sectors. It is thus in the interests of the individual citizen to support the decision to rescue a bank in difficulty, as the individual interest coincides with the public interest.
What happened, however, suggests that the rational arguments that I have just propounded do not always chime with public opinion. Again, it strikes me as interesting to ask why this should be the case.
To answer this question, it is necessary to enter the realm of the analysis of human behaviour, via the field of behavioural economics. Several laboratory experiments have been carried out, which show that, when faced with some economic choices, individuals may behave in ways that are apparently not rational. In general, it has been shown that economic agents are not only motivated by self-interest, as economists have been keen to believe, but are also motivated by considerations relating to fairness and relative conditions. According to some studies, a rise in income is only seen in a positive light if it exceeds that of the reference group; if, instead, the increase in income is less than that of the reference group, it is perceived as being an absolute loss, even if it is only relative.
One consequence of these tendencies, borne out in a number of experiments, is that individuals may even be prepared to renounce additional income, just to have a more equitable distribution of wealth within the community, particularly when this is to their advantage. Zizzo and Oswald, researchers at the Universities of Oxford and Warwick respectively, outline the results of an experiment in which the participants can pay out of their own pocket to "burn" money belonging to the other members of the group. The majority of subjects choose to do so, even if this reduces their own income. On average, it is the richest subjects who are most affected.
This line of research suggests that inequalities create tensions within given social groups and lead to backlashes. These results are consistent with recent studies which attempt to account for the "happiness" of individuals in terms of a series of parameters, including income. In this context, the Easterlin paradox is well-known. It suggests that when individuals see an increase in their income, their level of satisfaction does not necessarily rise if the increase is seen as very unequal.
This literature offers an explanation of the behaviour recently observed in our societies, namely the opposition to helping the crisis-hit financial system, because it is perceived as being richer and very much better-off. On the contrary, there is greater readiness to help other sectors of the economy, such as agriculture or the automotive industry, even though these sectors have a smaller direct impact on people’s well-being. This is probably because these sectors are perceived as being less well-off and faced with difficulties arising from exogenous factors rather than recklessness, unlike the financial sector.
It is interesting to note that such attitudes opposed to inequality have also emerged recently in the United States, where income disparities have tended to meet with greater acceptance than in Europe, as shown in studies by Alesina, Di Tella and MacCulloch. One possible explanation is that the mechanisms of upward mobility in American society, which in the past made inequality more acceptable, have ground to a halt in recent years.
In the last few years, statistical indicators have shown an increase in income disparity in most advanced countries. The Gini index, which is typically used to measure income inequalities, [6] rose in the United States from 34% at the end of the 1980s to over 36% at the start of this century. The index also increased in the United Kingdom, rising from 30% to 34%, and in the euro area, on average, where it rose from 29% to 31%. Within the euro area, the largest increases were recorded in Germany (from 26% to 34%) and Spain (from 30% to 34%), while in France and Italy the figures remained substantially unchanged (at 29% and 34% respectively).
The growing income differences recorded in the last few years have been accompanied by two other distinct phenomena. First, a progressive decline in the average rate of growth of income has been recorded in advanced countries. In per capita terms, the last decade has been the worst experienced by the United States in over 100 years, barring only the 1930s. In Europe, the slowdown has been comparable, albeit not so marked. Second, the difference seems to have mainly favoured the financial sector. For example, in the United States the profits of the financial sector have in the past five years amounted to 40% of the total profits of the corporate sector, i.e. double the average of the period 1960-2000. This is simply to report events, not to make a value judgement.
The combination of these three factors— the worsening inequality, the economic slowdown and the high profitability of the financial sector— may partly explain public opinion and the attitude of the political authorities vis-à-vis the rescue package for the financial system.
This crisis reveals that in our advanced societies, which are subject to far-reaching changes that affect people’s daily lives, the resolution of financial crises is becoming more complex, not only in terms of costs to the community, but also in terms of decision-making procedures. There is a risk that, in order to reach the democratic consensus necessary to act effectively, matters must be pushed right to the brink so that the precipice is clearly visible to most. In other words, there is a risk that a 'mistake', such as letting a bank fail, must first be committed, and the prospect [[or actuality: normxxx]] of widespread hardship must make people realise that their vital interests are at stake, before effective action can be taken successfully.
The problem is particularly acute in the case of the financial system, which is inevitably prone to instability. In particular, the financial system is typically more innovative. Since financial products cannot be patented, an institution’s ability to compete rests partly on its ability to create new products that enable it to increase returns without changing the level of risk or to diversify risk without for a given return. However, financial innovation tends to generate information asymmetries across agents, particularly between those who have created new instruments and those who buy them. Such asymmetries fuel market instability, leading to a tendency to underestimate risks until they materialise, and, subsequently, to a propensity to overestimate them when markets change direction. The procyclicality of the financial sector tends to produce a disproportionate increase in its profitability at times of economic growth and a decline during slowdowns, with self-propagation and contagion effects on the rest of the economy.
Essentially, the financial system is of systemic importance to the economy. The stability of the system is therefore in the public interest. Consequently, the system is subject to regulation and supervision. Therefore, it is somewhat problematic if rejection mechanisms develop within a society preventing effective action being taken to counter a financial crisis and contagion of the rest of the economy.
So, what is the answer?
There are some time-honoured lines of action which relate to the prevention of crises, namely better regulation and supervision, in particular at the international level, and more effective crisis resolution mechanisms. I will not dwell on these two points, which will be the subject of technical and political discussions in the coming months and years.
One new point for consideration that has emerged from this crisis relates equally to ethical, social and political aspects. In our advanced societies, which in years to come will continue to undergo periods of great transformation bringing real problems for many sectors of the population, the emergence of stark inequalities entails the risk that rational decision-making mechanisms will be blocked, in particular in crisis situations, with negative repercussions for the collective good and social cohesion. This should be solved both by governments, so that decision-making mechanisms can be adopted which allow the abovementioned problems to be overcome in a crisis, and also by the financial sector itself, which must clearly draw some lessons from recent events.
In a market economy, maximising profits and shareholders’ interests are a priority for management. They permit the efficient allocation of resources within the economy. However, when a sector such as the financial sector is of systemic importance to the functioning of the economy and is prone to instability, the objective function must be broader. It is a problem of rules, incentives and individual responsibility.
Much more work must be done on these points if we wish to avoid repeating past errors.
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.
Lehman’s Collapse ‘Could And Should Have Been Avoided’
|
Speech By Lorenzo Bini Smaghi, ECB | 21 October 2008
The current crisis could be the starting point for many ideas, and must certainly be subjected to extensive analysis. Today, I intend to dwell on one particular issue, which is founded on a simple question: Why was Lehman Brothers allowed to fail?
I wish to start with this question because the collapse of this investment bank on Monday, 15 September 2008 was one of the factors which turned the period of turmoil in the financial markets that started in summer 2007 into a full-blown crisis. Following the failure of Lehman Brothers, panic set in that any bank, irrespective of its size, could go bankrupt. Market participants revised their investment decisions.
The banks themselves started to fear that any of their counterparties could fail and stopped lending money to each other, causing the interbank market, which had already been under stress for months, to dry up completely. In the four weeks following the bankruptcy of Lehman Brothers, the European stock exchanges plunged by around 30%, more than the total fall recorded over the previous 12 months. The three-month Euribor spread, which measures tensions in the interbank market, more than doubled, exceeding 170 basis points.
The first steps taken by the authorities to calm the markets did not succeed in restoring confidence. This did not happen until mid-October, when a coordinated action, which took the form of substantial recourse to public funds and concerted action by the central banks, was initiated in Europe and North America.
Looking back at the events of last month, it seems clear that the failure of Lehman Brothers could have and should have been avoided. This is not just an ex-post hoc assessment, made in the light of what happened afterwards, but also an ex-ante one. It was obvious that in a crisis of confidence, such as had existed for months, the failure of a bank, even a medium-sized one, would have a contagion effect, triggering a flight from the system. This was why, in previous months, in both the United States and Europe (for example, Denmark, Germany and the United Kingdom), the authorities had intervened precisely to avoid the collapse of banks that were in difficulty (Bear Sterns, Northern Rock, IKB and Roskilde).
In the light of this assessment, it is legitimate to ask why the failure of Lehman Brothers was not prevented.
Various theories have been put forward in this regard. The one I find most credible is that there was a political veto, at the highest levels, against the use of public funds to rescue an investment bank. Indeed, right after the bank’s failure was announced, the US Secretary of the Treasury himself confirmed that, "I never once considered that it was appropriate to put taxpayer money on the line in resolving Lehman Brothers". The timing of the Lehman crisis also played a key role.
Only a few days prior, the US Treasury had taken on the sizeable debt of Fannie Mae and Freddie Mac, a decision which was criticised in the press. Straight after this step was taken, it appeared that the US Treasury did not want to be charged with using public money and practising what has been called a kind of perverse "financial socialism" [[i.e., privatizing profits, but socializing losses: normxxx]]. There is no doubt that the pressure of public opinion played a role.
We could stop here, with a negative assessment of the political decision taken by the US administration, which proved to be wrong. However, perhaps the problem might be more complex than that.
As subsequent events have shown, in particular when the first rescue package was rejected by the US Congress, opposition to providing the financial sector with public funds came not only from within the government, but also from Congress. The Members of the US Congress, many of whom face voters at the beginning of November, feared that such a decision would compromise their re-election. There was opposition to rescuing Lehman Brothers, therefore, not only from within the Administration, but also from Congress and, more broadly, from public opinion. In other words, the decision was largely the result of a democratic process. Ultimately, it was the US citizens who did not want to rescue Lehman Brothers.
This analysis is not restricted to the Lehman Brothers case alone. Even in countries where bankruptcies were successfully avoided through intervention, the decision was fiercely criticised by the respective parliaments and public opinion. In some cases, it was only possible to take the decision because immediate approval by parliament was not required. There is no denying that the conditions could have existed for letting some banks in difficulty fail had the political situation been different, for example, if elections were imminent in Europe, as in the United States.
Fortunately, this was not the case. Nevertheless, it is necessary to reflect on what might have happened. The question that needs to be asked is the following: why do democratic decision-making processes lead to the wrong decisions being taken from the point of view of the common good, not only ex-post, but also ex-ante?
The response given to justify the decision to let Lehman Brothers go bankrupt is that, for citizens in general, and for tax-payers in particular, it is not 'fair' to use public funds to bail out financial institutions which, in the preceding months and years, had accumulated massive profits for their shareholders and executives. Obviously, for those assigned the task of deciding whether or not to come to a bank’s rescue it is not an easy task to convince the electorate that losses must be nationalised, when the past profits were privatised. The rational explanation is that, without the rescue operation, the whole economy would have suffered as a result, with direct consequences for citizens and tax-payers.
Given the contagion effect which is generated following the collapse of a bank, nationalising the losses prevents an even greater evil being unleashed. The financial sector is different from other sectors, precisely owing to the systemic and contagion effects that a crisis would have on all the other sectors. It is thus in the interests of the individual citizen to support the decision to rescue a bank in difficulty, as the individual interest coincides with the public interest.
What happened, however, suggests that the rational arguments that I have just propounded do not always chime with public opinion. Again, it strikes me as interesting to ask why this should be the case.
To answer this question, it is necessary to enter the realm of the analysis of human behaviour, via the field of behavioural economics. Several laboratory experiments have been carried out, which show that, when faced with some economic choices, individuals may behave in ways that are apparently not rational. In general, it has been shown that economic agents are not only motivated by self-interest, as economists have been keen to believe, but are also motivated by considerations relating to fairness and relative conditions. According to some studies, a rise in income is only seen in a positive light if it exceeds that of the reference group; if, instead, the increase in income is less than that of the reference group, it is perceived as being an absolute loss, even if it is only relative.
One consequence of these tendencies, borne out in a number of experiments, is that individuals may even be prepared to renounce additional income, just to have a more equitable distribution of wealth within the community, particularly when this is to their advantage. Zizzo and Oswald, researchers at the Universities of Oxford and Warwick respectively, outline the results of an experiment in which the participants can pay out of their own pocket to "burn" money belonging to the other members of the group. The majority of subjects choose to do so, even if this reduces their own income. On average, it is the richest subjects who are most affected.
This line of research suggests that inequalities create tensions within given social groups and lead to backlashes. These results are consistent with recent studies which attempt to account for the "happiness" of individuals in terms of a series of parameters, including income. In this context, the Easterlin paradox is well-known. It suggests that when individuals see an increase in their income, their level of satisfaction does not necessarily rise if the increase is seen as very unequal.
This literature offers an explanation of the behaviour recently observed in our societies, namely the opposition to helping the crisis-hit financial system, because it is perceived as being richer and very much better-off. On the contrary, there is greater readiness to help other sectors of the economy, such as agriculture or the automotive industry, even though these sectors have a smaller direct impact on people’s well-being. This is probably because these sectors are perceived as being less well-off and faced with difficulties arising from exogenous factors rather than recklessness, unlike the financial sector.
It is interesting to note that such attitudes opposed to inequality have also emerged recently in the United States, where income disparities have tended to meet with greater acceptance than in Europe, as shown in studies by Alesina, Di Tella and MacCulloch. One possible explanation is that the mechanisms of upward mobility in American society, which in the past made inequality more acceptable, have ground to a halt in recent years.
In the last few years, statistical indicators have shown an increase in income disparity in most advanced countries. The Gini index, which is typically used to measure income inequalities, [6] rose in the United States from 34% at the end of the 1980s to over 36% at the start of this century. The index also increased in the United Kingdom, rising from 30% to 34%, and in the euro area, on average, where it rose from 29% to 31%. Within the euro area, the largest increases were recorded in Germany (from 26% to 34%) and Spain (from 30% to 34%), while in France and Italy the figures remained substantially unchanged (at 29% and 34% respectively).
The growing income differences recorded in the last few years have been accompanied by two other distinct phenomena. First, a progressive decline in the average rate of growth of income has been recorded in advanced countries. In per capita terms, the last decade has been the worst experienced by the United States in over 100 years, barring only the 1930s. In Europe, the slowdown has been comparable, albeit not so marked. Second, the difference seems to have mainly favoured the financial sector. For example, in the United States the profits of the financial sector have in the past five years amounted to 40% of the total profits of the corporate sector, i.e. double the average of the period 1960-2000. This is simply to report events, not to make a value judgement.
The combination of these three factors— the worsening inequality, the economic slowdown and the high profitability of the financial sector— may partly explain public opinion and the attitude of the political authorities vis-à-vis the rescue package for the financial system.
This crisis reveals that in our advanced societies, which are subject to far-reaching changes that affect people’s daily lives, the resolution of financial crises is becoming more complex, not only in terms of costs to the community, but also in terms of decision-making procedures. There is a risk that, in order to reach the democratic consensus necessary to act effectively, matters must be pushed right to the brink so that the precipice is clearly visible to most. In other words, there is a risk that a 'mistake', such as letting a bank fail, must first be committed, and the prospect [[or actuality: normxxx]] of widespread hardship must make people realise that their vital interests are at stake, before effective action can be taken successfully.
The problem is particularly acute in the case of the financial system, which is inevitably prone to instability. In particular, the financial system is typically more innovative. Since financial products cannot be patented, an institution’s ability to compete rests partly on its ability to create new products that enable it to increase returns without changing the level of risk or to diversify risk without for a given return. However, financial innovation tends to generate information asymmetries across agents, particularly between those who have created new instruments and those who buy them. Such asymmetries fuel market instability, leading to a tendency to underestimate risks until they materialise, and, subsequently, to a propensity to overestimate them when markets change direction. The procyclicality of the financial sector tends to produce a disproportionate increase in its profitability at times of economic growth and a decline during slowdowns, with self-propagation and contagion effects on the rest of the economy.
Essentially, the financial system is of systemic importance to the economy. The stability of the system is therefore in the public interest. Consequently, the system is subject to regulation and supervision. Therefore, it is somewhat problematic if rejection mechanisms develop within a society preventing effective action being taken to counter a financial crisis and contagion of the rest of the economy.
So, what is the answer?
There are some time-honoured lines of action which relate to the prevention of crises, namely better regulation and supervision, in particular at the international level, and more effective crisis resolution mechanisms. I will not dwell on these two points, which will be the subject of technical and political discussions in the coming months and years.
One new point for consideration that has emerged from this crisis relates equally to ethical, social and political aspects. In our advanced societies, which in years to come will continue to undergo periods of great transformation bringing real problems for many sectors of the population, the emergence of stark inequalities entails the risk that rational decision-making mechanisms will be blocked, in particular in crisis situations, with negative repercussions for the collective good and social cohesion. This should be solved both by governments, so that decision-making mechanisms can be adopted which allow the abovementioned problems to be overcome in a crisis, and also by the financial sector itself, which must clearly draw some lessons from recent events.
In a market economy, maximising profits and shareholders’ interests are a priority for management. They permit the efficient allocation of resources within the economy. However, when a sector such as the financial sector is of systemic importance to the functioning of the economy and is prone to instability, the objective function must be broader. It is a problem of rules, incentives and individual responsibility.
|
Much more work must be done on these points if we wish to avoid repeating past errors.
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.
Volcker Makes A Comeback
Volcker Makes A Comeback As Part Of Obama Brain Trust
By Monica Langley | 21 October 2008
NEW YORK— At 81 years old, former Federal Reserve chairman Paul Volcker is getting a second chance to shape his legacy with a presidential hopeful more than 30 years his junior. Mr. Volcker has emerged as a top economic adviser to Sen. Barack Obama during a presidential campaign dominated by a global financial crisis. Their growing bond is paying dividends for each.
Click Here, or on the image, to see a larger, undistorted image.
FAST FRIENDS: Sen. Barack Obama with former Fed Chairman Paul Volcker during a meeting with the senator's top economic advisers last month.
Mr. Volcker delivers gravitas and credibility to Sen. Obama, people in the Obama camp say, as well as ideas and approaches to the economic crisis. "Volcker whispering in Obama's ear will make even Republicans comfortable, because he's a hero of the right and a supporter of a strong dollar," says John Tamny, a supply-side economist and Republican.
On Tuesday, Mr. Volcker is scheduled to appear on the campaign trail with Sen. Obama for the first time. At a round-table discussion with voters in Lake Worth, Fla., he'll "give his view on the state of the economy and the credit markets, and what needs to be done to fix them," says one campaign adviser. Longtime Fed watchers are amused that Mr. Volcker, known for his muttered statements during Fed meetings in the 1980s, will be in a political role on the stump.
For Mr. Volcker, a connection with Sen. Obama could help burnish his record as Fed chairman. The cigar-chomping central banker from 1979 to 1987, he received blame for driving up interest rates and tipping the U.S. into the deepest recession since the Great Depression. But Mr. Volcker is just as well known for taming the runaway inflation of that era. His stock has risen in recent months as his gruff warnings about the risks of deregulating the financial sector have come to look prescient. His successor's reputation, meanwhile, has come under a cloud. Alan Greenspan is under criticism that the low interest rates and deregulatory ideology of his tenure contributed to today's crisis.
With nearly every day presenting a fresh financial emergency, Sen. Obama has persuaded Mr. Volcker, who travels the globe for economic meetings and occasionally disappears on fly-fishing trips, to be at the ready; Mr. Volcker now keeps a cellphone on him at all times. And though he still doesn't own a computer (his assistant prints out emails for him), he's gotten used to Sen. Obama's rapid-fire messages sent from a BlackBerry device.
The Obama-Volcker relationship continues to evolve, campaign advisers say. At the start, Sen. Obama sought advice from Mr. Volcker and other outside voices through his economic adviser, Austan Goolsbee, a 39-year-old University of Chicago professor. But starting with the demise of Bear Stearns Cos. in March and continuing today, Sen. Obama speaks directly and often with Mr. Volcker about the intricacies of the financial crisis and possible solutions. They've become "collaborators," as one aide puts it.
For example, when the U.S. Treasury put forth a plan to set up a $700 billion rescue fund to buy up toxic assets, Sen. Obama quickly backed it on the advice of Mr. Volcker. Like other prominent economists, Mr. Volcker also advocated early on for the recapitalization of banks. On this advice, Sen. Obama proposed direct equity infusions in banks in his frequent conference calls with Treasury Secretary Henry Paulson. The idea, initially rejected by Mr. Paulson, was belatedly proposed last week by the administration [[in response to a German and UK initiative on that front: normxxx]], in an effort to get banks lending again to businesses and each other.
Relying On Mr. Volcker
Sen. Obama's team of economic advisers includes two former Treasury secretaries, Robert Rubin and Lawrence Summers, and in some decisions, Mr. Volcker doesn't reign supreme. The candidate's latest proposal, for example, a $60 billion stimulus package, was initially fought by the former Fed chief on the grounds that Americans were already overspending. But he warned early that the U.S. and Europe are facing recession from the financial crisis. Still, he is unlikely to take a long-term role in any Obama administration.
For now, and going into the campaign's final weeks, aides say Sen. Obama is increasingly relying on Mr. Volcker. His staff now routinely reviews policy proposals and speeches with Mr. Volcker. Conference calls and face-to-face meetings of the Obama economic team are often reorganized to accommodate his schedule. When the team discusses the financial crisis, "The most important question to Obama: What does Paul Volcker think?" says Jason Furman, the campaign's economic-policy director.
The two men have developed an ease with each other, say aides, even as their styles appear to differ: Sen.Obama, who tends to use the Socratic method from his law-school training, examines all points of view and debates them. With a more formal and direct demeanor, Mr. Volcker likes to go straight to solutions. In last week's final presidential debate, after Republican John McCain raised questions about his rival's ties, Sen. Obama said, "Let me tell you who I associate with. On economic policy, I associate with Warren Buffett and former Fed Chairman Paul Volcker...who have shaped my ideas and who will be surrounding me in the White House."
Some Democrats have speculated that, if elected, Sen. Obama could name Mr. Volcker to a post, possibly even as Treasury secretary, for a limited time. Banking and Wall Street executives are pushing the two campaigns to name a new secretary shortly after the election to reassure markets during the transition. The Obama campaign wouldn't comment on possible appointments.
"I just want to be helpful, because I believe Sen. Obama— in his person, in his ideas and in his ability to understand and articulate both our needs and our hopes— brings the strong and fresh leadership we need," Mr. Volcker said in an interview in New York. Mr. Volcker wouldn't provide details of his policy suggestions or his personal relationship with Sen. Obama.
After leaving the Fed 20 years ago, Mr. Volcker stopped smoking cigars, became a professor at Princeton University and spent more time fly-fishing. His corner office overlooking Fifth Avenue is filled with photographs and statues of fish, as well as a pillow inscribed: "Work is for people who don't know how to fish."
Following a stint as chairman of a boutique investment-banking firm, Mr. Volcker largely steered clear of joining any Wall Street companies. He set up his own office in Rockefeller Center, where he consults for companies and governments. He has served on a few corporate boards, such as UAL Corp., Prudential Insurance Co. of America and Nestlé SA. He also participated on commissions including the United Nations committee to investigate corruption in its oil-for-food program, and an inquiry launched by Swiss banks to determine which accounts belonged to Holocaust victims.
The bond between Messrs. Obama and Volcker started with a dinner invitation. In June 2007, Mark Gallogly, co-founder of Centerbridge Partners, a New York private-investment firm, and an early supporter of Sen. Obama, invited a dozen financial executives to meet the senator, including Goldman Sachs Group Inc. President Gary Cohn, Merrill Lynch & Co. President Greg Fleming and Mr. Volcker.
Along with the invitation, Mr. Volcker received from Mr. Gallogly a "briefing package" containing some speeches by Sen. Obama and news articles about him. Mr. Volcker also read the two books written by the senator. In the private dining room at a Capitol Hill restaurant, Mr. Gallogly seated Mr. Volcker directly across from Sen. Obama, who at the time was considered a long shot to win the Democratic nomination over Sen. Hillary Clinton. Returning late that night on a flight to New York, Mr. Volcker told the group he was "genuinely impressed" with the Illinois senator.
That message was eventually passed along to Sen. Obama's advisers in New York, Michael Froman, a friend from Harvard Law School and a Citigroup Inc. executive, and Jenny Yeager, a fund-raiser. Ms. Yeager told Obama headquarters in Chicago that Mr. Volcker seemed "interested" in the candidate, but in two months no one had followed up with the ex-central banker for fund raising or anything else. When Sen. Obama's economics adviser, Mr. Goolsbee, heard about Mr. Volcker's interest, he immediately got excited. "Paul Volcker is a legend! We don't want to use his contacts for money, we want to pick his brain," he recalls saying to a campaign operative.
Starting in late summer 2007, Mr. Goolsbee had regular discussions with Mr. Volcker. He incorporated Mr. Volcker's ideas, including his early concern that the housing downturn would snowball into a larger financial crisis, into Sen. Obama's policy positions. In a September 2007 speech at Nasdaq, Sen. Obama predicted that because of oversight lapses and abusive practices that cause the public to doubt financial results, "the markets will be ravaged by a crisis in confidence."
An Early Endorsement
In early January 2008, when Sen. Clinton was pounding her rival over his lack of experience and stature, Sen. Obama phoned Mr. Volcker to ask for his endorsement. (At that time, billionaire investor Warren Buffett had refused to take sides between the Democratic contenders, saying he would support whoever got the nomination.) Mr. Volcker, a long-time Democrat who had mostly stayed out of partisan politics, nevertheless agreed, and wrote out his endorsement in longhand.
The presidential candidate's first big economic address took place in March at Cooper Union in New York. Mr. Volcker's fingerprints were evident in the speech. The onetime central banker had long been vigilant about strong regulatory oversight; as Fed chairman he rejected big banks' attempts to repeal Depression-era laws to engage in more risky practices like investment banking. New financial institutions and instruments have since led to the repeal or relaxation of those laws, and Mr. Volcker told Sen. Obama that the U.S. regulatory structure must be strengthened and updated for the 21st century.
With Mr. Volcker sitting in the front row, Sen. Obama told the audience at Cooper Union that the current financial-regulatory framework must be "revamped". He faulted deregulation for the growing economic crisis. "Our free market was never meant to be a free license to take whatever you can get, however you can get it."
Once Sen. Obama became the expected Democratic nominee in June, and the economy became the central campaign issue, his chats with Mr. Volcker picked up. Mr. Goolsbee would get emails from Sen. Obama's traveling aide Reggie Love or his senior strategist David Axelrod with the message: "BO wants to call Volcker. What's his number again?"
Emergency Meetings
In the past two months, financial crises have come one after another, picking up speed with the federal government's July effort to bolster big mortgage insurers Fannie Mae and Freddie Mac. As the contagion from the subprime mortgages and risky mortgage credit swaps threatened to topple other institutions, Sen. Obama asked for "emergency meetings" with his economic team, about a dozen advisers including Mr. Volcker and Mr. Buffett.
At the first group meeting in Washington in late July, Sen. Obama said he wanted to hear from each adviser on the worsening economic downturn and asked Mr. Volcker to go first. "The very health of the credit markets is at stake," Mr. Volcker said, according to one attendee. He urged strong action to restore confidence, particularly in the U.S. banking system.
When Sen. Obama raised the prospect of a package of spending and tax measures to "stimulate" the economy, Mr. Volcker disapproved. "Americans are [already] spending beyond their means," he told the group. A stimulus package would delay the belt-tightening and savings needed, he added, proposing instead better regulation and assistance to banks.
Laura Tyson, economics adviser for President Bill Clinton and a professor at University of California, Berkeley, disagreed. "Americans can't help but spend beyond their means because they've had no income growth while their costs on gas and food have skyrocketed." She suggested spending money to rebuild infrastructure and create jobs. Even as some others agreed with Ms. Tyson, Mr. Volcker didn't budge. Sen. Obama delayed putting out a new stimulus package, but stressed that he wanted to find the "right balance" of possible assistance.
When the bailout bill became a political football and the markets seized up, Sen. Obama called the second in-person meeting of his financial team on Sept. 26 in Miami. Mr. Volcker initially said he would have to call in because he was leaving for Europe that day. Sen. Obama, according to campaign aides, called him with a personal plea.
The next morning, the senator seated Mr. Volcker beside him, an arrangement that was photographed by the media entourage covering the campaign. Mr. Volcker told the group he had changed his mind about an economic-stimulus package due to the global recession, but he couldn't stay to hear the discussion about the approach because he had to catch a plane to Europe.
In the past two weeks, with the stock market's drastic volatility and weak economic indicators, Sen. Obama presented his $60 billion package, which contains tax cuts and spending to provide public-works jobs to struggling Americans. On Monday, Fed Chairman Ben Bernanke endorsed the idea of another stimulus package, giving a boost to Democratic lawmakers who are considering one. But congressional Republicans have so far shown little interest in a second spending bill.
By Monica Langley | 21 October 2008
NEW YORK— At 81 years old, former Federal Reserve chairman Paul Volcker is getting a second chance to shape his legacy with a presidential hopeful more than 30 years his junior. Mr. Volcker has emerged as a top economic adviser to Sen. Barack Obama during a presidential campaign dominated by a global financial crisis. Their growing bond is paying dividends for each.
Click Here, or on the image, to see a larger, undistorted image.
FAST FRIENDS: Sen. Barack Obama with former Fed Chairman Paul Volcker during a meeting with the senator's top economic advisers last month.
Mr. Volcker delivers gravitas and credibility to Sen. Obama, people in the Obama camp say, as well as ideas and approaches to the economic crisis. "Volcker whispering in Obama's ear will make even Republicans comfortable, because he's a hero of the right and a supporter of a strong dollar," says John Tamny, a supply-side economist and Republican.
On Tuesday, Mr. Volcker is scheduled to appear on the campaign trail with Sen. Obama for the first time. At a round-table discussion with voters in Lake Worth, Fla., he'll "give his view on the state of the economy and the credit markets, and what needs to be done to fix them," says one campaign adviser. Longtime Fed watchers are amused that Mr. Volcker, known for his muttered statements during Fed meetings in the 1980s, will be in a political role on the stump.
For Mr. Volcker, a connection with Sen. Obama could help burnish his record as Fed chairman. The cigar-chomping central banker from 1979 to 1987, he received blame for driving up interest rates and tipping the U.S. into the deepest recession since the Great Depression. But Mr. Volcker is just as well known for taming the runaway inflation of that era. His stock has risen in recent months as his gruff warnings about the risks of deregulating the financial sector have come to look prescient. His successor's reputation, meanwhile, has come under a cloud. Alan Greenspan is under criticism that the low interest rates and deregulatory ideology of his tenure contributed to today's crisis.
With nearly every day presenting a fresh financial emergency, Sen. Obama has persuaded Mr. Volcker, who travels the globe for economic meetings and occasionally disappears on fly-fishing trips, to be at the ready; Mr. Volcker now keeps a cellphone on him at all times. And though he still doesn't own a computer (his assistant prints out emails for him), he's gotten used to Sen. Obama's rapid-fire messages sent from a BlackBerry device.
The Obama-Volcker relationship continues to evolve, campaign advisers say. At the start, Sen. Obama sought advice from Mr. Volcker and other outside voices through his economic adviser, Austan Goolsbee, a 39-year-old University of Chicago professor. But starting with the demise of Bear Stearns Cos. in March and continuing today, Sen. Obama speaks directly and often with Mr. Volcker about the intricacies of the financial crisis and possible solutions. They've become "collaborators," as one aide puts it.
For example, when the U.S. Treasury put forth a plan to set up a $700 billion rescue fund to buy up toxic assets, Sen. Obama quickly backed it on the advice of Mr. Volcker. Like other prominent economists, Mr. Volcker also advocated early on for the recapitalization of banks. On this advice, Sen. Obama proposed direct equity infusions in banks in his frequent conference calls with Treasury Secretary Henry Paulson. The idea, initially rejected by Mr. Paulson, was belatedly proposed last week by the administration [[in response to a German and UK initiative on that front: normxxx]], in an effort to get banks lending again to businesses and each other.
Relying On Mr. Volcker
Sen. Obama's team of economic advisers includes two former Treasury secretaries, Robert Rubin and Lawrence Summers, and in some decisions, Mr. Volcker doesn't reign supreme. The candidate's latest proposal, for example, a $60 billion stimulus package, was initially fought by the former Fed chief on the grounds that Americans were already overspending. But he warned early that the U.S. and Europe are facing recession from the financial crisis. Still, he is unlikely to take a long-term role in any Obama administration.
For now, and going into the campaign's final weeks, aides say Sen. Obama is increasingly relying on Mr. Volcker. His staff now routinely reviews policy proposals and speeches with Mr. Volcker. Conference calls and face-to-face meetings of the Obama economic team are often reorganized to accommodate his schedule. When the team discusses the financial crisis, "The most important question to Obama: What does Paul Volcker think?" says Jason Furman, the campaign's economic-policy director.
The two men have developed an ease with each other, say aides, even as their styles appear to differ: Sen.Obama, who tends to use the Socratic method from his law-school training, examines all points of view and debates them. With a more formal and direct demeanor, Mr. Volcker likes to go straight to solutions. In last week's final presidential debate, after Republican John McCain raised questions about his rival's ties, Sen. Obama said, "Let me tell you who I associate with. On economic policy, I associate with Warren Buffett and former Fed Chairman Paul Volcker...who have shaped my ideas and who will be surrounding me in the White House."
Some Democrats have speculated that, if elected, Sen. Obama could name Mr. Volcker to a post, possibly even as Treasury secretary, for a limited time. Banking and Wall Street executives are pushing the two campaigns to name a new secretary shortly after the election to reassure markets during the transition. The Obama campaign wouldn't comment on possible appointments.
"I just want to be helpful, because I believe Sen. Obama— in his person, in his ideas and in his ability to understand and articulate both our needs and our hopes— brings the strong and fresh leadership we need," Mr. Volcker said in an interview in New York. Mr. Volcker wouldn't provide details of his policy suggestions or his personal relationship with Sen. Obama.
After leaving the Fed 20 years ago, Mr. Volcker stopped smoking cigars, became a professor at Princeton University and spent more time fly-fishing. His corner office overlooking Fifth Avenue is filled with photographs and statues of fish, as well as a pillow inscribed: "Work is for people who don't know how to fish."
Following a stint as chairman of a boutique investment-banking firm, Mr. Volcker largely steered clear of joining any Wall Street companies. He set up his own office in Rockefeller Center, where he consults for companies and governments. He has served on a few corporate boards, such as UAL Corp., Prudential Insurance Co. of America and Nestlé SA. He also participated on commissions including the United Nations committee to investigate corruption in its oil-for-food program, and an inquiry launched by Swiss banks to determine which accounts belonged to Holocaust victims.
The bond between Messrs. Obama and Volcker started with a dinner invitation. In June 2007, Mark Gallogly, co-founder of Centerbridge Partners, a New York private-investment firm, and an early supporter of Sen. Obama, invited a dozen financial executives to meet the senator, including Goldman Sachs Group Inc. President Gary Cohn, Merrill Lynch & Co. President Greg Fleming and Mr. Volcker.
Along with the invitation, Mr. Volcker received from Mr. Gallogly a "briefing package" containing some speeches by Sen. Obama and news articles about him. Mr. Volcker also read the two books written by the senator. In the private dining room at a Capitol Hill restaurant, Mr. Gallogly seated Mr. Volcker directly across from Sen. Obama, who at the time was considered a long shot to win the Democratic nomination over Sen. Hillary Clinton. Returning late that night on a flight to New York, Mr. Volcker told the group he was "genuinely impressed" with the Illinois senator.
That message was eventually passed along to Sen. Obama's advisers in New York, Michael Froman, a friend from Harvard Law School and a Citigroup Inc. executive, and Jenny Yeager, a fund-raiser. Ms. Yeager told Obama headquarters in Chicago that Mr. Volcker seemed "interested" in the candidate, but in two months no one had followed up with the ex-central banker for fund raising or anything else. When Sen. Obama's economics adviser, Mr. Goolsbee, heard about Mr. Volcker's interest, he immediately got excited. "Paul Volcker is a legend! We don't want to use his contacts for money, we want to pick his brain," he recalls saying to a campaign operative.
Starting in late summer 2007, Mr. Goolsbee had regular discussions with Mr. Volcker. He incorporated Mr. Volcker's ideas, including his early concern that the housing downturn would snowball into a larger financial crisis, into Sen. Obama's policy positions. In a September 2007 speech at Nasdaq, Sen. Obama predicted that because of oversight lapses and abusive practices that cause the public to doubt financial results, "the markets will be ravaged by a crisis in confidence."
An Early Endorsement
In early January 2008, when Sen. Clinton was pounding her rival over his lack of experience and stature, Sen. Obama phoned Mr. Volcker to ask for his endorsement. (At that time, billionaire investor Warren Buffett had refused to take sides between the Democratic contenders, saying he would support whoever got the nomination.) Mr. Volcker, a long-time Democrat who had mostly stayed out of partisan politics, nevertheless agreed, and wrote out his endorsement in longhand.
The presidential candidate's first big economic address took place in March at Cooper Union in New York. Mr. Volcker's fingerprints were evident in the speech. The onetime central banker had long been vigilant about strong regulatory oversight; as Fed chairman he rejected big banks' attempts to repeal Depression-era laws to engage in more risky practices like investment banking. New financial institutions and instruments have since led to the repeal or relaxation of those laws, and Mr. Volcker told Sen. Obama that the U.S. regulatory structure must be strengthened and updated for the 21st century.
With Mr. Volcker sitting in the front row, Sen. Obama told the audience at Cooper Union that the current financial-regulatory framework must be "revamped". He faulted deregulation for the growing economic crisis. "Our free market was never meant to be a free license to take whatever you can get, however you can get it."
Once Sen. Obama became the expected Democratic nominee in June, and the economy became the central campaign issue, his chats with Mr. Volcker picked up. Mr. Goolsbee would get emails from Sen. Obama's traveling aide Reggie Love or his senior strategist David Axelrod with the message: "BO wants to call Volcker. What's his number again?"
Emergency Meetings
In the past two months, financial crises have come one after another, picking up speed with the federal government's July effort to bolster big mortgage insurers Fannie Mae and Freddie Mac. As the contagion from the subprime mortgages and risky mortgage credit swaps threatened to topple other institutions, Sen. Obama asked for "emergency meetings" with his economic team, about a dozen advisers including Mr. Volcker and Mr. Buffett.
At the first group meeting in Washington in late July, Sen. Obama said he wanted to hear from each adviser on the worsening economic downturn and asked Mr. Volcker to go first. "The very health of the credit markets is at stake," Mr. Volcker said, according to one attendee. He urged strong action to restore confidence, particularly in the U.S. banking system.
When Sen. Obama raised the prospect of a package of spending and tax measures to "stimulate" the economy, Mr. Volcker disapproved. "Americans are [already] spending beyond their means," he told the group. A stimulus package would delay the belt-tightening and savings needed, he added, proposing instead better regulation and assistance to banks.
Laura Tyson, economics adviser for President Bill Clinton and a professor at University of California, Berkeley, disagreed. "Americans can't help but spend beyond their means because they've had no income growth while their costs on gas and food have skyrocketed." She suggested spending money to rebuild infrastructure and create jobs. Even as some others agreed with Ms. Tyson, Mr. Volcker didn't budge. Sen. Obama delayed putting out a new stimulus package, but stressed that he wanted to find the "right balance" of possible assistance.
When the bailout bill became a political football and the markets seized up, Sen. Obama called the second in-person meeting of his financial team on Sept. 26 in Miami. Mr. Volcker initially said he would have to call in because he was leaving for Europe that day. Sen. Obama, according to campaign aides, called him with a personal plea.
The next morning, the senator seated Mr. Volcker beside him, an arrangement that was photographed by the media entourage covering the campaign. Mr. Volcker told the group he had changed his mind about an economic-stimulus package due to the global recession, but he couldn't stay to hear the discussion about the approach because he had to catch a plane to Europe.
In the past two weeks, with the stock market's drastic volatility and weak economic indicators, Sen. Obama presented his $60 billion package, which contains tax cuts and spending to provide public-works jobs to struggling Americans. On Monday, Fed Chairman Ben Bernanke endorsed the idea of another stimulus package, giving a boost to Democratic lawmakers who are considering one. But congressional Republicans have so far shown little interest in a second spending bill.
Monday, October 20, 2008
New Crisis Remedies
France, Japan, IMF, U.S. In New Crisis Remedies
By Mike Peacock and Daniel Trotta, Reuters | 21 October 2008
LONDON/NEW YORK (Reuters)— Japan and France extended more help to banks, the IMF prepared to intervene in trouble spots around the world and the Fed devised a new plan to inject liquidity into money markets on Tuesday to curb the worldwide financial crisis. Interbank lending costs came down again, offering tentative signs of renewed confidence in the financial system, after weeks of bailouts and rescue plans appear to have cooled the worst crisis since the 1930s Great Depression.
Governments around the world have promised about $3.3 trillion to guarantee bank deposits and bank-to-bank lending, and in many cases have taken stakes in struggling banks. "The likelihood of a global catastrophe has in fact declined over the past couple of weeks," said Glenn Stevens, Australia's central bank governor. The U.S. dollar rallied to a year-and-a-half high against a basket of currencies on Tuesday as investors and companies continued to deleverage.
The stronger dollar, in turn, sent gold down nearly 4 percent and oil prices fell. Japanese stocks closed 3.3 percent higher and European shares reversed earlier gains to trade lower in the afternoon. But the Dow moved lower amid concern over U.S. earnings reports for the third quarter. U.S. chemical giant DuPont cut its 2008 earnings and major asset manager BlackRock Inc reported profits that came in below market expectations.
Some countries were still seeking help. The International Monetary Fund stood ready to help Pakistan, which said it needed up to $15 billion to avert a balance of payments crisis. Ukraine also said it was close to agreeing to measures to allow it to receive aid. Iceland as well appeared close to a deal with the IMF.
French And Japanese Plans
Shares in top French banks rose sharply after the government moved to lend 10.5 billion euros ($14.12 billion) to six banks to boost their capital reserves. In Japan, Economics Minister Kaoru Yosano said the country's big banks could get public funds if needed, as the government considered recasting a law aimed mainly at regional banks to speed the flow of finance to credit-starved small firms. "I can't see any reason why big banks should be discriminated against," Yosano told a news conference.
Analysts say major Japanese banks may not need the help, having largely avoided risky credit products. The Federal Reserve launched yet another facility to provide liquidity, pledging to fund purchases of certificates of deposit and commercial paper from money market mutual funds. "This is a very big event," Laurence Fink, the chairman and CEO of BlackRock, told a conference call.
"It will allow people like BlackRock and other money market funds to start extending our purchases of CP. ... We can take on commercial paper way beyond one day, if we want 180-day or whatever, we can buy that paper now," Fink said. There were other signs the global efforts were paying dividends. Interbank dollar, euro and sterling borrowing costs fell and spreads narrowed on Tuesday, giving further evidence that money markets— the arteries of the global financial system— continued to recover from the virtual paralysis following the demise of Lehman Brothers in mid-September.
British bank Barclays was close to issuing a 3-year note to raise at least 1 billion pounds, an indication that British government rescue plans were helping. But the crisis is not likely to end until central bank and government support is removed and bank-to-bank lending— frozen for much of the last year by uncertainty over which groups faced financial disaster— is flowing freely again.
In the meantime, the world teeters on recession. Euro zone economic growth will fall to just 0.2 percent next year with the bloc's biggest economy, Germany, stagnating, the IMF forecast on Tuesday. "Day by day, the evidence builds that we are facing a serious economic slowdown," European Commission President Jose Manuel Barroso told the European Parliament.
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 Peacock and Daniel Trotta, Reuters | 21 October 2008
|
LONDON/NEW YORK (Reuters)— Japan and France extended more help to banks, the IMF prepared to intervene in trouble spots around the world and the Fed devised a new plan to inject liquidity into money markets on Tuesday to curb the worldwide financial crisis. Interbank lending costs came down again, offering tentative signs of renewed confidence in the financial system, after weeks of bailouts and rescue plans appear to have cooled the worst crisis since the 1930s Great Depression.
Governments around the world have promised about $3.3 trillion to guarantee bank deposits and bank-to-bank lending, and in many cases have taken stakes in struggling banks. "The likelihood of a global catastrophe has in fact declined over the past couple of weeks," said Glenn Stevens, Australia's central bank governor. The U.S. dollar rallied to a year-and-a-half high against a basket of currencies on Tuesday as investors and companies continued to deleverage.
The stronger dollar, in turn, sent gold down nearly 4 percent and oil prices fell. Japanese stocks closed 3.3 percent higher and European shares reversed earlier gains to trade lower in the afternoon. But the Dow moved lower amid concern over U.S. earnings reports for the third quarter. U.S. chemical giant DuPont cut its 2008 earnings and major asset manager BlackRock Inc reported profits that came in below market expectations.
Some countries were still seeking help. The International Monetary Fund stood ready to help Pakistan, which said it needed up to $15 billion to avert a balance of payments crisis. Ukraine also said it was close to agreeing to measures to allow it to receive aid. Iceland as well appeared close to a deal with the IMF.
French And Japanese Plans
Shares in top French banks rose sharply after the government moved to lend 10.5 billion euros ($14.12 billion) to six banks to boost their capital reserves. In Japan, Economics Minister Kaoru Yosano said the country's big banks could get public funds if needed, as the government considered recasting a law aimed mainly at regional banks to speed the flow of finance to credit-starved small firms. "I can't see any reason why big banks should be discriminated against," Yosano told a news conference.
Analysts say major Japanese banks may not need the help, having largely avoided risky credit products. The Federal Reserve launched yet another facility to provide liquidity, pledging to fund purchases of certificates of deposit and commercial paper from money market mutual funds. "This is a very big event," Laurence Fink, the chairman and CEO of BlackRock, told a conference call.
"It will allow people like BlackRock and other money market funds to start extending our purchases of CP. ... We can take on commercial paper way beyond one day, if we want 180-day or whatever, we can buy that paper now," Fink said. There were other signs the global efforts were paying dividends. Interbank dollar, euro and sterling borrowing costs fell and spreads narrowed on Tuesday, giving further evidence that money markets— the arteries of the global financial system— continued to recover from the virtual paralysis following the demise of Lehman Brothers in mid-September.
British bank Barclays was close to issuing a 3-year note to raise at least 1 billion pounds, an indication that British government rescue plans were helping. But the crisis is not likely to end until central bank and government support is removed and bank-to-bank lending— frozen for much of the last year by uncertainty over which groups faced financial disaster— is flowing freely again.
In the meantime, the world teeters on recession. Euro zone economic growth will fall to just 0.2 percent next year with the bloc's biggest economy, Germany, stagnating, the IMF forecast on Tuesday. "Day by day, the evidence builds that we are facing a serious economic slowdown," European Commission President Jose Manuel Barroso told the European Parliament.
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.
Why Warren Buffett Is Right
Why Warren Buffett Is Right (And Why Nobody Cares)
Click here for a link to complete article:
By John P. Hussman, Ph.D. | 20 October 2008
Reprint Policy: All rights reserved and actively enforced.
The best way to begin this comment is to reiterate that U.S. stocks are now undervalued. I realize how unusual that might sound, given my persistent assertions during the past decade that stocks were strenuously overvalued (with a brief exception in 2003). Still, it is important to understand that a price decline of over 40% (and even more in some indices) completely changes the game. Last week, we also observed early indications of an improvement in the quality of market action, and an easing of the upward pressure on risk premiums.
In 2000, we could confidently assert that stocks would most probably deliver negative total returns over the following 10-year period. Today, we can comfortably expect 8-10% total returns even without assuming any material increase in price-to-normalized-earnings multiples. Given a modest expansion in multiples, a passive investment in the S&P 500 can be expected to achieve total returns well in excess of 10% annually.
None of this is an argument that the market has necessarily registered either a near-term or a final bear market low. Regardless of whether or not the market has established a short-term trough, one would generally expect that a decline of the magnitude we've observed would be followed several months later by a secondary decline (which may or may not take stocks to lower levels). It is also not an argument for establishing an aggressive investment stance.
We continue to hold index put option coverage under about 90% of our stockholdings, though primarily as a "stop loss" against any major continuation, rather than a defense against moderate declines. What is clear, however, is that after more than a decade of strenuous overvaluation, stocks are finally priced to deliver acceptably high long-term returns.
While it's true that the market established even deeper valuation troughs in 1974 and 1982 (near 7 times prior peak earnings, compared with the current multiple of about 11), it is important to remember that long-term Treasury yields were 8% in 1974, and 14% in 1982, compared with about 4% at present. While I've frequently argued that stock and bond yields are not related in anything near the 1-to-1 manner that the "Fed Model" suggests, it is already clear that a long-term investment in stocks here is likely to substantially outperform a long-term investment in Treasury securities over time. Even with very little adjustment for risk, U.S. stocks are likely to provide stronger long-term returns than the yields available on most corporate bonds as well.
This point is so important that I am again presenting our 10-year total return projections for the S&P 500 Index (standard methodology). The heavy line tracks actual 10-year total returns since 1950 (that line ends a decade ago for obvious reasons). The green, orange, yellow, and red lines represent the projected total returns for the S&P 500 assuming terminal valuation multiples of 20, 14 (average), 11 (median) and 7 times normalized earnings.
Click Here, or on the image, to see a larger, undistorted image.
The reason we use a variety of methods to "normalize" earnings is that 'reported' earnings are actually more volatile than stock prices themselves. In recessions, both earnings and stock prices decline, but stock prices nearly always bottom first. Year-over-year changes in reported earnings have virtually no correlation with year-over-year changes in stock prices. Despite all of that earnings volatility, long-term S&P 500 earnings can be nicely contained by a 6% growth trend connecting earnings peaks across economic cycles as far back as you care to look. Interestingly, even the enormous short-run variation in U.S. inflation rates over time has had very little impact on that long-term dynamic.
As for individual stocks (at least the stable, quality businesses), you don't liquidate just because a recession may depress earnings next quarter, or even for a few years. The main use of quarterly earnings reports is as an information signal for businesses whose future can't be adequately assessed otherwise. The better the business, the less attention you place on quarter-to-quarter earnings.
Why Warren Buffett Is Right, And Why Nobody Cares
On Friday, Warren Buffett published an editorial in the New York Times titled "Buy American. I Am." In that piece, Buffett noted,
The most interesting thing about that op-ed piece wasn't Buffett's opinion about stock valuations. He's absolutely right, in my view. Rather, it was fascinating how quick many investors were to dismiss Buffett's advice, saying either that he didn't understand how bad the economy was going to get, that he preferred to "get in early," or that he was "talking his book" and trying to bid up the value of his own investments.
Look. Buffett doesn't need the money. Virtually everything he has is now or will ultimately be committed to philanthropy. My impression is that Buffett honestly doesn't like to see investors making decisions that will damage their financial security over time. Also, a good part of his own self-concept centers on being a good allocator of capital.
If he didn't like his investment positions, he wouldn't try to talk them up. He would liquidate them. If he thought he could postpone his purchases without a high probability of missed returns from waiting, he would have waited. My guess is that Buffett is very excited about the values he has been buying up, but doesn't get wrapped up in the day-to-day fluctuations that weaken the judgment of less disciplined investors.
The most expensive resource on Wall Street is short-term comfort. Investors who constantly seek comfort over the short-term ultimately give up a fortune over the long-term. In a market economy, the most reliable source of long-term gains is to provide scarce and useful resources to others when those resources are most in demand.
At present, the most probable source of long-term returns is the willingness to provide liquidity (holding out willing bids at depressed prices in a panicked market), risk-bearing (taking on the market risk being liquidated by fearful or distressed sellers), and information (through the proper assessment of value). In my view, Buffett's willingness (and our own) to accept market risk here does all three. Though Buffett doesn't easily show his hand regarding individual purchases or the details of his calculations, he has always been very clear about what drives his assessment of value: stocks should be valued as if you were purchasing the whole business. The way you (properly) value a business is to weigh the price against the long-term stream of cash flows that you expect that business to deliver into your hands over time.
I'll say that again. The real object of concern is the long-term stream of cash flows that the company will deliver into the hands of shareholders over time (beware of companies that quietly dispose of their reported earnings through grants of stock and options to management and employees). Nearly all of the value of a stock is loaded into the "tail" of that stream— 5, 10, 20 years out and beyond. As Buffett notes,
The rush to dismiss Buffett's advice underscores the extreme level of bearishness among investors here. According to Investors Intelligence, just 22.4% of investment advisors are presently bullish. This matches the lowest extremes we've seen in decades. Extreme negativity of investors has generally been a useful contrary indicator of stock market prospects. That doesn't ensure that stocks have registered their final lows, but it contributes to a set of historically favorable conditions here.
Click Here, or on the image, to see a larger, undistorted image.
At present, we observe not only undervaluation coupled with negative sentiment, but also extreme volatility that has historically accompanied important market troughs. Similar spikes in actual (e.g. 44-day) volatility were observed in July 1962, June 1970, October 1974, December 1982, December 1987, October 1998, and September 2002, all which were associated with important market lows.
The argument for gradually increasing our stock market exposure in the past couple of weeks is not that some flag has gone up that provides certainty about a bottom. Rather, our investment discipline is to gradually increase our investment exposure in proportion to the expected return/risk profile associated with prevailing conditions of valuation and market action. Scaling our positions in proportion to the market's expected return/risk profile, based on prevailing conditions (rather than trying to forecast market turns), is the essential practice.
Buffett notes,
I have no idea whether the market will be higher or lower a month or even a year from now either, but I think I differ from Buffett on the reasons for this. Buffett's reason is that he largely disregards 'short-term' fluctuations [[which, for him, extends to "a few years": normxxx]], understanding that the market will improve before visible fundamentals do. My reason is that our market allocation is proportionate to the favorable expected return/risk profile of the prevailing Market Climate, and I have no way of knowing when that Climate will shift. When it does, we'll change our allocation. As I've said before, you don't have to forecast the future direction of the wind— you just need to regularly adjust the sails as the evidence changes.
Early Measures Of Market Action Turn Favorable
Notably, last week we observed a measurable reversal in risk premium pressures, coupled with a clear "breadth reversal" across a wide range of industries. As I've stated frequently over the years, the most important feature of market action is not the extent or duration of market movements, but their quality and uniformity. These measures can change very quickly, and long before "trend following" signals such as moving-average crossings occur.
Last week, our most sensitive measures of market action clearly reversed to a favorable condition. These don't "whipsaw" very often because they come into consideration only when market action is unusually compressed. Presently, in addition to undervaluation and extreme sentiment, we already have the beginnings of favorable market action.
That said, we don't yet have enough evidence simply to remove our hedges. The prevailing evidence is consistent with a high expected return/risk profile for stocks, but the still "early" improvement in market action and the unusual nature of the current downturn suggest that we maintain something of a "stop loss" in the form of continued put option coverage, with strike prices within a few percent below current levels. That is the position that we have established here.
The recent panic is frequently described as the "worst" since the Great Depression, but this does not imply that the outlook is similar. One of the clearest contributors to the Depression was the failure of the monetary base to expand at anywhere near the demand for base money. At present, governments have made a concerted effort to put the world awash in base money.
Neither the crisis in financials nor the current recession are surprising, but Depression talk is hyperbole. About the only surprise in recent weeks was that the broad recognition of a U.S. recession emerged at the same time as the peak of the financial crisis. That compressed what should have been two separate down-legs of a bear market into a single swan-dive. This downturn is certainly extreme, but the conditions that amplified the downward spiral in the Great Depression are largely absent here. Both at market peaks and at market troughs, investors allow their imaginations to run, almost always to their detriment.
I'll repeat what I wrote during the 2000-2002 bear market:
This is also a good time to reiterate our standard "anti-marketing" message: The Strategic Growth Fund is not a "market timing" fund. Nor is it a "bear" fund nor a "market neutral" fund. Strategic Growth is a risk-managed growth fund that is intended to accept exposure to U.S. stocks over the full market cycle, but with smaller periodic losses than a passive buy-and-hold approach [[by limiting exposure as appropriate.: normxxx]]
We gradually scale our investment exposure in proportion to the average return/risk profile that stocks have provided under similar conditions (primarily defined by valuation and market action). We make no attempt to track short-term market fluctuations. We leave "buy signals" and attempts to forecast short-term market direction to other investors, preferring to align our investment positions with the prevailing evidence about the Market Climate. My opinion is that while there is still risk that the market will decline even further, investors may be underestimating the potential for a rapid 20-25% spike higher in U.S. stocks as risk aversion collapses. That opinion doesn't drive our investment stance. Rather, both my opinion and our investment stance are driven by the objective evidence we have in hand about valuations and market action. At present, the evidence indicates that it is appropriate to accept market risk, but with something of a "stop" in the form of put option coverage close to (or a few percent below) current levels.
I won't sugar-coat the fact that we are accepting some amount of market risk here, and that this exposes us to some amount of potential loss if the market continues lower. Again, however, we continue to have a put option defense below about 90% of our stock holdings with strike prices within a few percent of current levels, which should relieve any concern about unacceptably large downside exposure. Equally important, in the event that stocks were to decline from here, I expect that there would be a strong likelihood of recovering at least to current levels on any subsequent advance. From that perspective, I expect that whatever downside we might experience as a result of a further market selloff would probably be temporary.
With the Strategic Growth Fund less than 10% below its record high, we now observe a loss of 40% or more in the major indices, extreme bearish sentiment and volatility consistent with important market lows, and a clear though still "early" improvement in our measures of market internals. It is impossible to be a successful equity investor without the willingness to accept some amount of market risk when conditions appear frightening. If anything should be clear from the bubbles of recent years, the greatest risks are not when prices are depressed, the economy is weak, and investors are frightened, but rather when prices are elevated and an unendingly positive outlook for technology, or housing, or global growth, or private equity, or emerging markets, or commodities seems all but certain.
Treasury Gets It Right
Last week, the Treasury finally got it right, announcing that it would directly provide capital to troubled financial institutions by purchasing senior preferred equity stakes. As I argued in An Open Letter to Congress Regarding the Current Financial Crisis and You Can't Rescue the Financial System if You Can't Read a Balance Sheet, this is exactly the right approach, since it operates on the liability (capital) side of the balance sheet, which is where the trouble has been. [[See also, "Paulson Panics": normxxx]] I would have preferred the Treasury to follow Bagehot's Rule (lend freely but at a high rate of interest) as opposed to the "favorable" terms that were offered. The former would have encouraged these financial companies to get off of the public's dime as soon as possible. Even so, as long as the yield on the preferred is higher than the Treasury's funding costs, the favorable terms will represent an insufficient risk premium but not a loss to the public.
Still, some amount of patience is needed, lest investors frighten themselves into thinking that this capital infusion is not working. As I wrote in a note to shareholders in the Fund News section of the website on October 15,
Overnight Libor Starting to Look Like Overnight Libor Again
With respect to the economy as a whole, I continue to believe that allowing what I've called a "property appreciation right" (PAR) would be the single best legislative change to decouple the mortgage crisis from the broader economy:
(Readers who believe this approach should be included in the general discussion are encouraged to forward the above paragraph to their representatives in Congress.)
Market Climate
As of last week, the Market Climate for stocks was characterized by favorable valuations and early evidence of favorable market action. The improved character of market action is not evident from standard "trend following" evidence such as moving-average crossings and so forth. Rather, last week we observed a very broad reversal in breadth and risk premiums. When this has occurred in the context of favorable valuations, compressed price trends, and bearish sentiment, such early reversals have often resulted in double-digit market gains over a period of weeks.
At the same time, we are maintaining something of a "stop loss" a few percent below current levels in the form of put option coverage for about 90% of our stock holdings. In doing so, we are balancing the improvement in our quantitative measures, as well as our qualitative analysis, against our tolerance for risk (we prefer investment positions that allow us to be dead wrong about everything and still not experience intolerable losses). I expect that we'll maintain some amount of put coverage at least until we observe confirming evidence from high trading volume and improvement of more conventional market internals.
Generally speaking, an intolerable loss is one that requires a heroic recovery simply to break even. From my perspective, the S&P 500 has experienced an intolerable loss, since a 42% loss requires a 70% gain just to recover. The typical market loss of about 32% in an average bear market requires a 47% gain in order to break even, leaving only bull market returns beyond that amount to contribute toward long-term progress. Downside risk should always be assessed in relation to upside potential: a 10% loss is recovered by an 11% gain, a 15% loss is recovered by an 18% gain, and a painful 20% loss is recovered by a 25% gain. Such losses in say, a short-term money market fund, would be cause for panic because gains of 18%-25% are indeed heroic propositions. In the equity markets— particularly for strategies that can be partially or fully exposed to market fluctuations— such recoveries are reasonable and even commonplace (within a matter of weeks or months) once the market has become deeply depressed.
In bonds, the fear about Depression gripping the markets had a striking result last week, as investors priced inflation-protected bonds as if the rate of inflation would be essentially zero for the next 5 years or more. Now, from the standpoint of immediate inflation risk, I have long argued that widening credit spreads have a very strong effect in suppressing inflation. At the same time, however, the enormous increase in government liabilities stemming from an ongoing budget deficit and huge financial rescue efforts is likely to result in normal if not elevated levels of inflation as the economy recovers.
As investors suddenly adopted a "deflation mindset," they dumped their inflation-protected securities with little regard to price or longer-term inflation prospects. TIPS yields soared to over 3%. From a historical perspective, it has been rare for U.S. Treasury securities to provide real yields much over about 2% annually. In the Strategic Total Return Fund [[a 'fixed income' fund: normxxx]], we shifted about 25% of the Fund into Treasury Inflation Protected Securities with a variety of maturities. We may accumulate more if real yields press even higher. As always, you scale in proportionately as the expected return/risk profile becomes favorable.
Back in April, when commodities were still advancing to new highs, I noted that,
Having closed our TIPS positions when real interest rates fell to negative levels, we closed the bulk of our precious metals positions shortly thereafter when gold soared over $1000 an ounce. It is not typical for the Fund to have the majority of its assets in Treasury bills, but that was the case through much of the summer. The weakness in commodities now having largely played itself out, the entire analysis above could now be reversed. Specifically, at the point where real interest rates stabilize or trend lower, we may observe a strengthening in commodities.
The weakness in commodities we've seen lately mirrors the surge in U.S. real interest rates and in the value of the U.S. dollar. As that upward pressure on real interest rates abates, so most probably will the downward pressure on commodity prices (as well as the upward pressure on the U.S. dollar). In addition to the Total Return Fund's positions in TIPS and short-dated Treasury securities, the Fund continues to hold about 30% of assets in a diversified group of precious metals shares, utility shares, and foreign currencies. With these markets sharply down from their highs, I believe it is appropriate for the Strategic Total Return Fund to again hold a more moderate, diversified portfolio of TIPS, short-dated Treasury securities (awaiting higher real or nominal yields to invest in longer-dated securities), precious metals shares, utilities, and foreign currencies.
Click here for a link to complete article:
By John P. Hussman, Ph.D. | 20 October 2008
Reprint Policy: All rights reserved and actively enforced.
The best way to begin this comment is to reiterate that U.S. stocks are now undervalued. I realize how unusual that might sound, given my persistent assertions during the past decade that stocks were strenuously overvalued (with a brief exception in 2003). Still, it is important to understand that a price decline of over 40% (and even more in some indices) completely changes the game. Last week, we also observed early indications of an improvement in the quality of market action, and an easing of the upward pressure on risk premiums.
In 2000, we could confidently assert that stocks would most probably deliver negative total returns over the following 10-year period. Today, we can comfortably expect 8-10% total returns even without assuming any material increase in price-to-normalized-earnings multiples. Given a modest expansion in multiples, a passive investment in the S&P 500 can be expected to achieve total returns well in excess of 10% annually.
None of this is an argument that the market has necessarily registered either a near-term or a final bear market low. Regardless of whether or not the market has established a short-term trough, one would generally expect that a decline of the magnitude we've observed would be followed several months later by a secondary decline (which may or may not take stocks to lower levels). It is also not an argument for establishing an aggressive investment stance.
We continue to hold index put option coverage under about 90% of our stockholdings, though primarily as a "stop loss" against any major continuation, rather than a defense against moderate declines. What is clear, however, is that after more than a decade of strenuous overvaluation, stocks are finally priced to deliver acceptably high long-term returns.
While it's true that the market established even deeper valuation troughs in 1974 and 1982 (near 7 times prior peak earnings, compared with the current multiple of about 11), it is important to remember that long-term Treasury yields were 8% in 1974, and 14% in 1982, compared with about 4% at present. While I've frequently argued that stock and bond yields are not related in anything near the 1-to-1 manner that the "Fed Model" suggests, it is already clear that a long-term investment in stocks here is likely to substantially outperform a long-term investment in Treasury securities over time. Even with very little adjustment for risk, U.S. stocks are likely to provide stronger long-term returns than the yields available on most corporate bonds as well.
This point is so important that I am again presenting our 10-year total return projections for the S&P 500 Index (standard methodology). The heavy line tracks actual 10-year total returns since 1950 (that line ends a decade ago for obvious reasons). The green, orange, yellow, and red lines represent the projected total returns for the S&P 500 assuming terminal valuation multiples of 20, 14 (average), 11 (median) and 7 times normalized earnings.
Click Here, or on the image, to see a larger, undistorted image.
The reason we use a variety of methods to "normalize" earnings is that 'reported' earnings are actually more volatile than stock prices themselves. In recessions, both earnings and stock prices decline, but stock prices nearly always bottom first. Year-over-year changes in reported earnings have virtually no correlation with year-over-year changes in stock prices. Despite all of that earnings volatility, long-term S&P 500 earnings can be nicely contained by a 6% growth trend connecting earnings peaks across economic cycles as far back as you care to look. Interestingly, even the enormous short-run variation in U.S. inflation rates over time has had very little impact on that long-term dynamic.
As for individual stocks (at least the stable, quality businesses), you don't liquidate just because a recession may depress earnings next quarter, or even for a few years. The main use of quarterly earnings reports is as an information signal for businesses whose future can't be adequately assessed otherwise. The better the business, the less attention you place on quarter-to-quarter earnings.
Why Warren Buffett Is Right, And Why Nobody Cares
On Friday, Warren Buffett published an editorial in the New York Times titled "Buy American. I Am." In that piece, Buffett noted,
|
The most interesting thing about that op-ed piece wasn't Buffett's opinion about stock valuations. He's absolutely right, in my view. Rather, it was fascinating how quick many investors were to dismiss Buffett's advice, saying either that he didn't understand how bad the economy was going to get, that he preferred to "get in early," or that he was "talking his book" and trying to bid up the value of his own investments.
Look. Buffett doesn't need the money. Virtually everything he has is now or will ultimately be committed to philanthropy. My impression is that Buffett honestly doesn't like to see investors making decisions that will damage their financial security over time. Also, a good part of his own self-concept centers on being a good allocator of capital.
If he didn't like his investment positions, he wouldn't try to talk them up. He would liquidate them. If he thought he could postpone his purchases without a high probability of missed returns from waiting, he would have waited. My guess is that Buffett is very excited about the values he has been buying up, but doesn't get wrapped up in the day-to-day fluctuations that weaken the judgment of less disciplined investors.
The most expensive resource on Wall Street is short-term comfort. Investors who constantly seek comfort over the short-term ultimately give up a fortune over the long-term. In a market economy, the most reliable source of long-term gains is to provide scarce and useful resources to others when those resources are most in demand.
At present, the most probable source of long-term returns is the willingness to provide liquidity (holding out willing bids at depressed prices in a panicked market), risk-bearing (taking on the market risk being liquidated by fearful or distressed sellers), and information (through the proper assessment of value). In my view, Buffett's willingness (and our own) to accept market risk here does all three. Though Buffett doesn't easily show his hand regarding individual purchases or the details of his calculations, he has always been very clear about what drives his assessment of value: stocks should be valued as if you were purchasing the whole business. The way you (properly) value a business is to weigh the price against the long-term stream of cash flows that you expect that business to deliver into your hands over time.
I'll say that again. The real object of concern is the long-term stream of cash flows that the company will deliver into the hands of shareholders over time (beware of companies that quietly dispose of their reported earnings through grants of stock and options to management and employees). Nearly all of the value of a stock is loaded into the "tail" of that stream— 5, 10, 20 years out and beyond. As Buffett notes,
|
The rush to dismiss Buffett's advice underscores the extreme level of bearishness among investors here. According to Investors Intelligence, just 22.4% of investment advisors are presently bullish. This matches the lowest extremes we've seen in decades. Extreme negativity of investors has generally been a useful contrary indicator of stock market prospects. That doesn't ensure that stocks have registered their final lows, but it contributes to a set of historically favorable conditions here.
Click Here, or on the image, to see a larger, undistorted image.
At present, we observe not only undervaluation coupled with negative sentiment, but also extreme volatility that has historically accompanied important market troughs. Similar spikes in actual (e.g. 44-day) volatility were observed in July 1962, June 1970, October 1974, December 1982, December 1987, October 1998, and September 2002, all which were associated with important market lows.
The argument for gradually increasing our stock market exposure in the past couple of weeks is not that some flag has gone up that provides certainty about a bottom. Rather, our investment discipline is to gradually increase our investment exposure in proportion to the expected return/risk profile associated with prevailing conditions of valuation and market action. Scaling our positions in proportion to the market's expected return/risk profile, based on prevailing conditions (rather than trying to forecast market turns), is the essential practice.
Buffett notes,
|
I have no idea whether the market will be higher or lower a month or even a year from now either, but I think I differ from Buffett on the reasons for this. Buffett's reason is that he largely disregards 'short-term' fluctuations [[which, for him, extends to "a few years": normxxx]], understanding that the market will improve before visible fundamentals do. My reason is that our market allocation is proportionate to the favorable expected return/risk profile of the prevailing Market Climate, and I have no way of knowing when that Climate will shift. When it does, we'll change our allocation. As I've said before, you don't have to forecast the future direction of the wind— you just need to regularly adjust the sails as the evidence changes.
Early Measures Of Market Action Turn Favorable
Notably, last week we observed a measurable reversal in risk premium pressures, coupled with a clear "breadth reversal" across a wide range of industries. As I've stated frequently over the years, the most important feature of market action is not the extent or duration of market movements, but their quality and uniformity. These measures can change very quickly, and long before "trend following" signals such as moving-average crossings occur.
Last week, our most sensitive measures of market action clearly reversed to a favorable condition. These don't "whipsaw" very often because they come into consideration only when market action is unusually compressed. Presently, in addition to undervaluation and extreme sentiment, we already have the beginnings of favorable market action.
That said, we don't yet have enough evidence simply to remove our hedges. The prevailing evidence is consistent with a high expected return/risk profile for stocks, but the still "early" improvement in market action and the unusual nature of the current downturn suggest that we maintain something of a "stop loss" in the form of continued put option coverage, with strike prices within a few percent below current levels. That is the position that we have established here.
The recent panic is frequently described as the "worst" since the Great Depression, but this does not imply that the outlook is similar. One of the clearest contributors to the Depression was the failure of the monetary base to expand at anywhere near the demand for base money. At present, governments have made a concerted effort to put the world awash in base money.
Neither the crisis in financials nor the current recession are surprising, but Depression talk is hyperbole. About the only surprise in recent weeks was that the broad recognition of a U.S. recession emerged at the same time as the peak of the financial crisis. That compressed what should have been two separate down-legs of a bear market into a single swan-dive. This downturn is certainly extreme, but the conditions that amplified the downward spiral in the Great Depression are largely absent here. Both at market peaks and at market troughs, investors allow their imaginations to run, almost always to their detriment.
I'll repeat what I wrote during the 2000-2002 bear market:
|
This is also a good time to reiterate our standard "anti-marketing" message: The Strategic Growth Fund is not a "market timing" fund. Nor is it a "bear" fund nor a "market neutral" fund. Strategic Growth is a risk-managed growth fund that is intended to accept exposure to U.S. stocks over the full market cycle, but with smaller periodic losses than a passive buy-and-hold approach [[by limiting exposure as appropriate.: normxxx]]
We gradually scale our investment exposure in proportion to the average return/risk profile that stocks have provided under similar conditions (primarily defined by valuation and market action). We make no attempt to track short-term market fluctuations. We leave "buy signals" and attempts to forecast short-term market direction to other investors, preferring to align our investment positions with the prevailing evidence about the Market Climate. My opinion is that while there is still risk that the market will decline even further, investors may be underestimating the potential for a rapid 20-25% spike higher in U.S. stocks as risk aversion collapses. That opinion doesn't drive our investment stance. Rather, both my opinion and our investment stance are driven by the objective evidence we have in hand about valuations and market action. At present, the evidence indicates that it is appropriate to accept market risk, but with something of a "stop" in the form of put option coverage close to (or a few percent below) current levels.
I won't sugar-coat the fact that we are accepting some amount of market risk here, and that this exposes us to some amount of potential loss if the market continues lower. Again, however, we continue to have a put option defense below about 90% of our stock holdings with strike prices within a few percent of current levels, which should relieve any concern about unacceptably large downside exposure. Equally important, in the event that stocks were to decline from here, I expect that there would be a strong likelihood of recovering at least to current levels on any subsequent advance. From that perspective, I expect that whatever downside we might experience as a result of a further market selloff would probably be temporary.
With the Strategic Growth Fund less than 10% below its record high, we now observe a loss of 40% or more in the major indices, extreme bearish sentiment and volatility consistent with important market lows, and a clear though still "early" improvement in our measures of market internals. It is impossible to be a successful equity investor without the willingness to accept some amount of market risk when conditions appear frightening. If anything should be clear from the bubbles of recent years, the greatest risks are not when prices are depressed, the economy is weak, and investors are frightened, but rather when prices are elevated and an unendingly positive outlook for technology, or housing, or global growth, or private equity, or emerging markets, or commodities seems all but certain.
Treasury Gets It Right
Last week, the Treasury finally got it right, announcing that it would directly provide capital to troubled financial institutions by purchasing senior preferred equity stakes. As I argued in An Open Letter to Congress Regarding the Current Financial Crisis and You Can't Rescue the Financial System if You Can't Read a Balance Sheet, this is exactly the right approach, since it operates on the liability (capital) side of the balance sheet, which is where the trouble has been. [[See also, "Paulson Panics": normxxx]] I would have preferred the Treasury to follow Bagehot's Rule (lend freely but at a high rate of interest) as opposed to the "favorable" terms that were offered. The former would have encouraged these financial companies to get off of the public's dime as soon as possible. Even so, as long as the yield on the preferred is higher than the Treasury's funding costs, the favorable terms will represent an insufficient risk premium but not a loss to the public.
Still, some amount of patience is needed, lest investors frighten themselves into thinking that this capital infusion is not working. As I wrote in a note to shareholders in the Fund News section of the website on October 15,
|
Overnight Libor Starting to Look Like Overnight Libor Again
With respect to the economy as a whole, I continue to believe that allowing what I've called a "property appreciation right" (PAR) would be the single best legislative change to decouple the mortgage crisis from the broader economy:
|
(Readers who believe this approach should be included in the general discussion are encouraged to forward the above paragraph to their representatives in Congress.)
Market Climate
As of last week, the Market Climate for stocks was characterized by favorable valuations and early evidence of favorable market action. The improved character of market action is not evident from standard "trend following" evidence such as moving-average crossings and so forth. Rather, last week we observed a very broad reversal in breadth and risk premiums. When this has occurred in the context of favorable valuations, compressed price trends, and bearish sentiment, such early reversals have often resulted in double-digit market gains over a period of weeks.
At the same time, we are maintaining something of a "stop loss" a few percent below current levels in the form of put option coverage for about 90% of our stock holdings. In doing so, we are balancing the improvement in our quantitative measures, as well as our qualitative analysis, against our tolerance for risk (we prefer investment positions that allow us to be dead wrong about everything and still not experience intolerable losses). I expect that we'll maintain some amount of put coverage at least until we observe confirming evidence from high trading volume and improvement of more conventional market internals.
Generally speaking, an intolerable loss is one that requires a heroic recovery simply to break even. From my perspective, the S&P 500 has experienced an intolerable loss, since a 42% loss requires a 70% gain just to recover. The typical market loss of about 32% in an average bear market requires a 47% gain in order to break even, leaving only bull market returns beyond that amount to contribute toward long-term progress. Downside risk should always be assessed in relation to upside potential: a 10% loss is recovered by an 11% gain, a 15% loss is recovered by an 18% gain, and a painful 20% loss is recovered by a 25% gain. Such losses in say, a short-term money market fund, would be cause for panic because gains of 18%-25% are indeed heroic propositions. In the equity markets— particularly for strategies that can be partially or fully exposed to market fluctuations— such recoveries are reasonable and even commonplace (within a matter of weeks or months) once the market has become deeply depressed.
In bonds, the fear about Depression gripping the markets had a striking result last week, as investors priced inflation-protected bonds as if the rate of inflation would be essentially zero for the next 5 years or more. Now, from the standpoint of immediate inflation risk, I have long argued that widening credit spreads have a very strong effect in suppressing inflation. At the same time, however, the enormous increase in government liabilities stemming from an ongoing budget deficit and huge financial rescue efforts is likely to result in normal if not elevated levels of inflation as the economy recovers.
As investors suddenly adopted a "deflation mindset," they dumped their inflation-protected securities with little regard to price or longer-term inflation prospects. TIPS yields soared to over 3%. From a historical perspective, it has been rare for U.S. Treasury securities to provide real yields much over about 2% annually. In the Strategic Total Return Fund [[a 'fixed income' fund: normxxx]], we shifted about 25% of the Fund into Treasury Inflation Protected Securities with a variety of maturities. We may accumulate more if real yields press even higher. As always, you scale in proportionately as the expected return/risk profile becomes favorable.
Back in April, when commodities were still advancing to new highs, I noted that,
|
Having closed our TIPS positions when real interest rates fell to negative levels, we closed the bulk of our precious metals positions shortly thereafter when gold soared over $1000 an ounce. It is not typical for the Fund to have the majority of its assets in Treasury bills, but that was the case through much of the summer. The weakness in commodities now having largely played itself out, the entire analysis above could now be reversed. Specifically, at the point where real interest rates stabilize or trend lower, we may observe a strengthening in commodities.
The weakness in commodities we've seen lately mirrors the surge in U.S. real interest rates and in the value of the U.S. dollar. As that upward pressure on real interest rates abates, so most probably will the downward pressure on commodity prices (as well as the upward pressure on the U.S. dollar). In addition to the Total Return Fund's positions in TIPS and short-dated Treasury securities, the Fund continues to hold about 30% of assets in a diversified group of precious metals shares, utility shares, and foreign currencies. With these markets sharply down from their highs, I believe it is appropriate for the Strategic Total Return Fund to again hold a more moderate, diversified portfolio of TIPS, short-dated Treasury securities (awaiting higher real or nominal yields to invest in longer-dated securities), precious metals shares, utilities, and foreign currencies.
Sunday, October 19, 2008
Paulson Panics
Financial Crisis: Paulson Panics As Uk, Germany Find Own Solution
By F. William Engdahl | 20 October 2008
www.engdahl.oilgeopolitics.net/
America's de facto Finance Czar, US Treasury Secretary Henry Paulson reached for the panic button and made a dramatic 180-degree reversal of his 'original' financial bailout plan passed only days before. On September 23 in testimony before the US Congress, Paulson, former CEO of the politically influential Wall Street investment firm, Goldman Sachs, declared his adamant opposition to the idea of the US Government taking equity stakes in troubled major banks in order to provide them capital and stabilize the frozen interbank trading market.
On October 13, that opposition to 'nationalization' collapsed. What happened to cause that sudden reverse is what interests us here. It shows the utter lack of coherency in the US financial elites approach to dealing with their home-grown securitization of risk fiasco.
The 'original' Paulson plan was widely criticized from the start among more sober US bankers and economists, including Paulson's predecessor as Treasury Secretary, Paul O'Neill who simply called the concept of using $700 billion taxpayer bailout fund to buy 'toxic debt' from banks, as 'crazy.' All critics agreed the Paulson approach was by far the most costly model and was far from guaranteed to solve the underlying problem-inadequate bank capitalization following hundreds of billions of dollars in sub-prime and other security losses.
Yet the Secretary adamantly refused to alter his plan, even after Congress rejected it in the first vote. He allowed non-related Democratic items to be glued on to his original TARP plan, a plan that gave the Treasury Secretary virtual dictatorial powers over the US finance and de facto the economy. It was referred to widely as 'the financial equivalent of the US Patriots Act'.
Then, on October 8 the unexpected took place. Gordon Brown, former British finance minister and now Prime Minister, facing a literal meltdown of the British banking system, on advice of senior staff of the Bank of England, swallowed his own opposition to bank nationalization and adopted an emergency nationalization scheme. He announced that the UK Treasury had made €64 billion available to buy bank preferred shares in eight UK banks designated by the Government as strategic. The nationalization was to be partial but effective and included a €260 billion 'special liquidity scheme' of Treasury cash to inject into the frozen inter-bank market, consisting of UK Treasury bills in exchange for less liquid bank assets as collateral.
The Relevance Of 1931
The move was a replay of the dramatic decision by the British Government in 1931. At that time, Britain and members of the British Commonwealth 'broke the rules of the game'. In September 1931, after months of debate, the UK abandoned monetary orthodoxy and unilaterally left the international Gold Standard it had rejoined in 1925.
Germany had preceded the UK, under far different circumstances, by some weeks in August 1931 by abandoning the Gold Standard. Germany, under emergency rule without Parliament under Chancellor Brüning, faced a crisis in the wake of the French decision to punish the German-Austrian economic entente. France had precipitated a banking crisis in Austria's largest bank, the Vienna Credit-Anstalt.
The role of J.P. Morgan Bank in New York, the leading private creditor of the German banking system since the end of Hyperinflation in 1923, and the Morgan controlled New York Federal Reserve under Governor George L. Harrison, was instrumental in precipitating the German banking crisis of 1931. As a condition for its stabilization loan to the Reichsbank, Harrison demanded the Reichsbank cease lending to German commercial banks. Under maximum duress, it did. The banks collapsed.
So long as it remained on the Gold Standard, a requirement of JP Morgan and the New York Federal Reserve, Germany had to prevent capital outflows and impose higher taxes and budget austerity to persuade international creditors of its credit worthiness. As German recession deepened, the government cut the social programs instituted after the war. It was the outbreak of the banking crisis in the summer of 1931 that made the German depression so severe. The collapse of the banks in central Europe had major social, psychological and political impact. The rest became tragic history.
The United States, guided by Harrison and backed up by the monetary orthodoxy of President Herbert Hoover, held bitterly to the Gold Standard until March 1933 when newly inaugurated President Roosevelt left the Gold Standard. By then, the United States economy was deep in a depression that was to be far worse than that of any country in Europe.
Paulson's Volte Face
This time around it was again England that led the break with the rules of a US financial game by swiftly nationalizing its top eight banks, starting with the Royal Bank of Scotland (RBS) on October 8, a Wednesday. [[Actually, the Republic of Ireland had already 'nationalized' its banks on October 3, the preceding Friday.: normxxx]] By that Friday, October 10 it was clear that Germany was also moving towards a national resolution of its banking problems, problems which originated in the spread of US Asset Backed Securities and Credit Default Swaps, exotic new instruments of finance which had grown up in recent years, in a totally unregulated area of bank-to-bank practice, to a nominal size of some $68 trillion.
The French Sarkozy Plan, a €300 to 400 billion 'common bailout fund' modelled loosely on the original Paulson Plan, was dead. German taxpayers simply would not pay for the excesses of French or Italian banks. It was a sea change in attitude across the EU away from a US-led global financial unity. The American Century faced catastrophe.
That was the point of Paulson's radical shift to what in the parlance of US radical free marketers was a bolt towards the dreaded 'S' word, socialization of the banking system. According to my best European banking sources, had Paulson not taken radical new action at that point, as one City of London veteran banker expressed it, 'the US banks were in danger of extinction'.
On Monday October 13 in the US Treasury, Paulson convened an emergency meeting with the heads of the nine largest US banks. According to reports from participants, Paulson handed each person a one page document to sign that they would agree to sell their stock shares in part to the US Government in return for an emergency injection of $250 billions. Paulson told them they must all sign before leaving the room. Three hours and reportedly many acrimonious arguments later, all nine had signed in the largest Government intervention into the US banking system since the Great Depression.
According to insider accounts from bankers here I spoke with and in New York, it was precisely the decision by the UK, backed by a similar if not yet so detailed plan from the German authorities which forced Paulson's Volte Face. After the fact, in a confirmation of how weak the new Federal Reserve Chairman, Ban Bernanke is in face of the domineering personality of Paulson, Bernanke mumbled to the press that he had 'all along' been in favor if the Government buying equity shares to recapitalize the banks. Why he refused to state that publicly before the Paulson Plan won the day is unclear, but it suggests the man Bush chose to succeed Alan Greenspan was chosen for his lability, not his ability nor backbone.
San Francisco Federal Reserve President, Janet Yellen remarked as well, long after it had become clear that the US Administration's position was set, that the decision to let Lehman Brothers go bankrupt without Government assistance, had been a horrible miscalculation. That Lehman Bros. bankruptcy on September 15, was the 'shock heard round the world,' which precipitated a global crisis in banking confidence resulting in the present situation. Whether Paulson and friends calculated the collapse would provide the basis to demand a US-crafted solution to the crisis remains unclear.
What is clear, is that one of the chosen 'winners' in the present US banking reorganization, JP Morgan Chase, played a nasty role in the final 'push' of Lehman Bros. over the edge. On the Friday prior to Lehman's Monday declaration of insolvency, JP Morgan Chase had 'mysteriously' withheld a $19 billion transfer that would have averted the collapse of Lehman Bros. It was an eerie echo of the nasty role played in 1931 by the House of Morgan in relation, then, to the German and European banking crisis.
After 1931 the House of Morgan never again rose to the prominent role it had held. And, it is looking increasingly likely that the successor to the bank, JP Morgan, despite the pretensions of its head, Jamie Dimon, to invincibility, may be far more modest.
The Bank Bailout's Side Effect: Rising Mortgage Costs
By Stephen Gandel | 17 October 2008
The government's effort to boost bank lending to end the credit crisis is hurting one of the areas critical to the nation's recovery: mortgage rates. In the past week, the average mortgage rate on a 30-year fixed home loan has jumped more than one half a percentage point to 6.74%, according to Bankrate.com. That might not sound like much, but it is the biggest one-week rise in the normally stable lending rate in 21 years.
Some economists say mortgage rates could soon top 7%, a level they have not seen in more than six years. "Certainly the moves the administration have made so far are not directly attacking the financial issues that affect American homeowners," says John Vogel, a finance professor at Dartmouth's Tuck School of Business. "We need to refinance million of homeowners into affordable mortgages, and if rates go up that makes that job just much harder to do."
Rising mortgage rates could also put downward pressure on housing prices, which have already dropped 20% since their peak in July of 2006, according to the S&P/Case-Shiller Home Price index. The increase in mortgage rates means that the average borrower will pay $1,296 a month in mortgage payment for a $200,000 loan. That's $100 more a month, and $1,200 more a year, than the same loan would have cost them a few weeks ago. For buyers on a budget, that means they can afford less house for the same amount of money. Conversely, sellers would have to drop their prices to attract that same buyer.
What's more, a new "Adverse Market Fee" recently instituted by lenders for borrowers with less than perfect credit (regardless of the market) could raise the cost of a loan another half a percentage point— or an additional $70 a month on that same $200,000 loan— for nearly 20% of Americans. "For individuals looking to buy a home this is going to be just one more obstacle in their way," says Barry Ziggus, who tracks housing issues for the Consumer Federation of America.
The story is worse for people in areas of the country, such as Scottsdale, AZ, or Glen Ellyn in suburban Chicago, where even modest houses can be in the $500,000 range. A $600,000 mortgage will now cost $4,319 a month, or nearly $500 more a month, and $6,000 more a year, than it did six months ago. Last month, when the government took control of mortgage giants Fannie Mae and Freddie Mac and pledged to inject $200 billion in capital into the home loan guarantors, administration officials said the moves would make it easier and cheaper for people to get home loans. Unfortunately, it hasn't worked that way. Mortgage rates fell sharply after the move, but soon reversed quickly, and are now higher than they were before the Fannie/Freddie rescue plan was launched.
The problem is that other moves the government has made to render bank debt safer has had the unintended consequence of making Fannie and Freddie's bonds less safe by comparison. So Fannie and Freddie's investors have to be compensated for the increased risk. In particular, traders say, the move in the past week by the Federal Deposit Insurance Corp. to temporarily offer unlimited deposit insurance for non-interest bearing accounts and guarantee roughly $1.4 trillion in new unsecured bank debt has caused a rush of selling of the bonds of Fannie and Freddie. That's because the FDIC's move makes bank debt more attractive at a time when traders are looking for safety. Sheila Bair, the head of the FDIC, was initially against backing this new bank debt, but eventually went along with Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson.
Lower prices (and thus higher interest rates) for Fannie and Freddie bonds make it more expensive for the government mortgage guarantors to borrow, and that means that Fannie and Freddie have less money to purchase home loans. Which means a lower supply of capital available for mortgage issuers. The result is higher mortgage rates for the average American. The higher mortgage rates have left some people wondering just what the government can do next. "Just what would you do differently," says John Weicher, a director at the Hudson Institute and a former assistant security at the U.S. Department of Housing and Urban Development. "I'm inclined to believe that the efforts we have made to help homeowners have been successful, they just haven't been enough."
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 F. William Engdahl | 20 October 2008
www.engdahl.oilgeopolitics.net/
America's de facto Finance Czar, US Treasury Secretary Henry Paulson reached for the panic button and made a dramatic 180-degree reversal of his 'original' financial bailout plan passed only days before. On September 23 in testimony before the US Congress, Paulson, former CEO of the politically influential Wall Street investment firm, Goldman Sachs, declared his adamant opposition to the idea of the US Government taking equity stakes in troubled major banks in order to provide them capital and stabilize the frozen interbank trading market.
On October 13, that opposition to 'nationalization' collapsed. What happened to cause that sudden reverse is what interests us here. It shows the utter lack of coherency in the US financial elites approach to dealing with their home-grown securitization of risk fiasco.
The 'original' Paulson plan was widely criticized from the start among more sober US bankers and economists, including Paulson's predecessor as Treasury Secretary, Paul O'Neill who simply called the concept of using $700 billion taxpayer bailout fund to buy 'toxic debt' from banks, as 'crazy.' All critics agreed the Paulson approach was by far the most costly model and was far from guaranteed to solve the underlying problem-inadequate bank capitalization following hundreds of billions of dollars in sub-prime and other security losses.
Yet the Secretary adamantly refused to alter his plan, even after Congress rejected it in the first vote. He allowed non-related Democratic items to be glued on to his original TARP plan, a plan that gave the Treasury Secretary virtual dictatorial powers over the US finance and de facto the economy. It was referred to widely as 'the financial equivalent of the US Patriots Act'.
Then, on October 8 the unexpected took place. Gordon Brown, former British finance minister and now Prime Minister, facing a literal meltdown of the British banking system, on advice of senior staff of the Bank of England, swallowed his own opposition to bank nationalization and adopted an emergency nationalization scheme. He announced that the UK Treasury had made €64 billion available to buy bank preferred shares in eight UK banks designated by the Government as strategic. The nationalization was to be partial but effective and included a €260 billion 'special liquidity scheme' of Treasury cash to inject into the frozen inter-bank market, consisting of UK Treasury bills in exchange for less liquid bank assets as collateral.
The Relevance Of 1931
The move was a replay of the dramatic decision by the British Government in 1931. At that time, Britain and members of the British Commonwealth 'broke the rules of the game'. In September 1931, after months of debate, the UK abandoned monetary orthodoxy and unilaterally left the international Gold Standard it had rejoined in 1925.
Germany had preceded the UK, under far different circumstances, by some weeks in August 1931 by abandoning the Gold Standard. Germany, under emergency rule without Parliament under Chancellor Brüning, faced a crisis in the wake of the French decision to punish the German-Austrian economic entente. France had precipitated a banking crisis in Austria's largest bank, the Vienna Credit-Anstalt.
The role of J.P. Morgan Bank in New York, the leading private creditor of the German banking system since the end of Hyperinflation in 1923, and the Morgan controlled New York Federal Reserve under Governor George L. Harrison, was instrumental in precipitating the German banking crisis of 1931. As a condition for its stabilization loan to the Reichsbank, Harrison demanded the Reichsbank cease lending to German commercial banks. Under maximum duress, it did. The banks collapsed.
So long as it remained on the Gold Standard, a requirement of JP Morgan and the New York Federal Reserve, Germany had to prevent capital outflows and impose higher taxes and budget austerity to persuade international creditors of its credit worthiness. As German recession deepened, the government cut the social programs instituted after the war. It was the outbreak of the banking crisis in the summer of 1931 that made the German depression so severe. The collapse of the banks in central Europe had major social, psychological and political impact. The rest became tragic history.
The United States, guided by Harrison and backed up by the monetary orthodoxy of President Herbert Hoover, held bitterly to the Gold Standard until March 1933 when newly inaugurated President Roosevelt left the Gold Standard. By then, the United States economy was deep in a depression that was to be far worse than that of any country in Europe.
Paulson's Volte Face
This time around it was again England that led the break with the rules of a US financial game by swiftly nationalizing its top eight banks, starting with the Royal Bank of Scotland (RBS) on October 8, a Wednesday. [[Actually, the Republic of Ireland had already 'nationalized' its banks on October 3, the preceding Friday.: normxxx]] By that Friday, October 10 it was clear that Germany was also moving towards a national resolution of its banking problems, problems which originated in the spread of US Asset Backed Securities and Credit Default Swaps, exotic new instruments of finance which had grown up in recent years, in a totally unregulated area of bank-to-bank practice, to a nominal size of some $68 trillion.
The French Sarkozy Plan, a €300 to 400 billion 'common bailout fund' modelled loosely on the original Paulson Plan, was dead. German taxpayers simply would not pay for the excesses of French or Italian banks. It was a sea change in attitude across the EU away from a US-led global financial unity. The American Century faced catastrophe.
That was the point of Paulson's radical shift to what in the parlance of US radical free marketers was a bolt towards the dreaded 'S' word, socialization of the banking system. According to my best European banking sources, had Paulson not taken radical new action at that point, as one City of London veteran banker expressed it, 'the US banks were in danger of extinction'.
On Monday October 13 in the US Treasury, Paulson convened an emergency meeting with the heads of the nine largest US banks. According to reports from participants, Paulson handed each person a one page document to sign that they would agree to sell their stock shares in part to the US Government in return for an emergency injection of $250 billions. Paulson told them they must all sign before leaving the room. Three hours and reportedly many acrimonious arguments later, all nine had signed in the largest Government intervention into the US banking system since the Great Depression.
According to insider accounts from bankers here I spoke with and in New York, it was precisely the decision by the UK, backed by a similar if not yet so detailed plan from the German authorities which forced Paulson's Volte Face. After the fact, in a confirmation of how weak the new Federal Reserve Chairman, Ban Bernanke is in face of the domineering personality of Paulson, Bernanke mumbled to the press that he had 'all along' been in favor if the Government buying equity shares to recapitalize the banks. Why he refused to state that publicly before the Paulson Plan won the day is unclear, but it suggests the man Bush chose to succeed Alan Greenspan was chosen for his lability, not his ability nor backbone.
San Francisco Federal Reserve President, Janet Yellen remarked as well, long after it had become clear that the US Administration's position was set, that the decision to let Lehman Brothers go bankrupt without Government assistance, had been a horrible miscalculation. That Lehman Bros. bankruptcy on September 15, was the 'shock heard round the world,' which precipitated a global crisis in banking confidence resulting in the present situation. Whether Paulson and friends calculated the collapse would provide the basis to demand a US-crafted solution to the crisis remains unclear.
What is clear, is that one of the chosen 'winners' in the present US banking reorganization, JP Morgan Chase, played a nasty role in the final 'push' of Lehman Bros. over the edge. On the Friday prior to Lehman's Monday declaration of insolvency, JP Morgan Chase had 'mysteriously' withheld a $19 billion transfer that would have averted the collapse of Lehman Bros. It was an eerie echo of the nasty role played in 1931 by the House of Morgan in relation, then, to the German and European banking crisis.
After 1931 the House of Morgan never again rose to the prominent role it had held. And, it is looking increasingly likely that the successor to the bank, JP Morgan, despite the pretensions of its head, Jamie Dimon, to invincibility, may be far more modest.
The Bank Bailout's Side Effect: Rising Mortgage Costs
By Stephen Gandel | 17 October 2008
The government's effort to boost bank lending to end the credit crisis is hurting one of the areas critical to the nation's recovery: mortgage rates. In the past week, the average mortgage rate on a 30-year fixed home loan has jumped more than one half a percentage point to 6.74%, according to Bankrate.com. That might not sound like much, but it is the biggest one-week rise in the normally stable lending rate in 21 years.
Some economists say mortgage rates could soon top 7%, a level they have not seen in more than six years. "Certainly the moves the administration have made so far are not directly attacking the financial issues that affect American homeowners," says John Vogel, a finance professor at Dartmouth's Tuck School of Business. "We need to refinance million of homeowners into affordable mortgages, and if rates go up that makes that job just much harder to do."
Rising mortgage rates could also put downward pressure on housing prices, which have already dropped 20% since their peak in July of 2006, according to the S&P/Case-Shiller Home Price index. The increase in mortgage rates means that the average borrower will pay $1,296 a month in mortgage payment for a $200,000 loan. That's $100 more a month, and $1,200 more a year, than the same loan would have cost them a few weeks ago. For buyers on a budget, that means they can afford less house for the same amount of money. Conversely, sellers would have to drop their prices to attract that same buyer.
What's more, a new "Adverse Market Fee" recently instituted by lenders for borrowers with less than perfect credit (regardless of the market) could raise the cost of a loan another half a percentage point— or an additional $70 a month on that same $200,000 loan— for nearly 20% of Americans. "For individuals looking to buy a home this is going to be just one more obstacle in their way," says Barry Ziggus, who tracks housing issues for the Consumer Federation of America.
The story is worse for people in areas of the country, such as Scottsdale, AZ, or Glen Ellyn in suburban Chicago, where even modest houses can be in the $500,000 range. A $600,000 mortgage will now cost $4,319 a month, or nearly $500 more a month, and $6,000 more a year, than it did six months ago. Last month, when the government took control of mortgage giants Fannie Mae and Freddie Mac and pledged to inject $200 billion in capital into the home loan guarantors, administration officials said the moves would make it easier and cheaper for people to get home loans. Unfortunately, it hasn't worked that way. Mortgage rates fell sharply after the move, but soon reversed quickly, and are now higher than they were before the Fannie/Freddie rescue plan was launched.
The problem is that other moves the government has made to render bank debt safer has had the unintended consequence of making Fannie and Freddie's bonds less safe by comparison. So Fannie and Freddie's investors have to be compensated for the increased risk. In particular, traders say, the move in the past week by the Federal Deposit Insurance Corp. to temporarily offer unlimited deposit insurance for non-interest bearing accounts and guarantee roughly $1.4 trillion in new unsecured bank debt has caused a rush of selling of the bonds of Fannie and Freddie. That's because the FDIC's move makes bank debt more attractive at a time when traders are looking for safety. Sheila Bair, the head of the FDIC, was initially against backing this new bank debt, but eventually went along with Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson.
Lower prices (and thus higher interest rates) for Fannie and Freddie bonds make it more expensive for the government mortgage guarantors to borrow, and that means that Fannie and Freddie have less money to purchase home loans. Which means a lower supply of capital available for mortgage issuers. The result is higher mortgage rates for the average American. The higher mortgage rates have left some people wondering just what the government can do next. "Just what would you do differently," says John Weicher, a director at the Hudson Institute and a former assistant security at the U.S. Department of Housing and Urban Development. "I'm inclined to believe that the efforts we have made to help homeowners have been successful, they just haven't been enough."
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.
Observations And Market Sentiment
Observations And Market Sentiment
By Teresa Lo | 14 October 2008
I’m sure traders have had a field day following the bungee jump of the equity markets.
The spike bottom we alerted members to on October 9 unfolded as expected and did its thing. At yesterday’s high, the bounce had almost reached the target of the top of the Wave 4 running triangle. The easy money is over. Rather than dwell too much on what happens tomorrow or the next day, let’s hang back and ask some important questions about the macro picture going forward.
Observation #1
In spite of what Bernanke, Volker and Paulson say, their actions— and common sense— tells you that the "liquidity problem" is a euphemism for insolvency. Maybe I’m using the term too loosely; maybe the situation doesn’t meet the technical definition, but let’s face it: the jig is up. Otherwise, why would they deviate from the original TARP plan and move to direct capital injections?
Observation #2
'Alternative investments' as an asset class is finished. Most stock and bond arbitrage strategies are either suffering from broken model syndrome or they can no longer use enough leverage to make them economic. Many funds are now 50% cash in anticipation of additional redemptions. How these funds will make it back to their high water marks is beyond me. The game is over.
Observation #3
Goldman Sachs, GE, and Morgan Stanley made a pact with the devil. In hopes of attracting private money, marquee investors exacted terms that involve paying usurious amounts of interest or dividends that will materially impact their earnings going forward. Stick a fork in dividends?
Observation #4
Most importantly, no one is talking about the real problem: the middle class, the little engine that could, is now mostly underwater. Equity evaporated but their debts are still valued at 100 cents on the dollar. Maybe banks will lend again, but to whom? Until consumers on Main Street can get their debt ratios down, where will growth come from? Hmm…
Observation #5
To top it all off, remember there was no money for anything before, not even health care, but somehow hundreds of billions of dollars have been "found" to prop up the banks? Where did all this money come from?
Historical Perspective
To sum up, no matter how we slice it, the smoke has yet to clear. Let’s just back up a moment and look at a chart.
Dow Jones Industrial Average, Present Day
By Teresa Lo | 14 October 2008
|
I’m sure traders have had a field day following the bungee jump of the equity markets. The spike bottom we alerted members to on October 9 unfolded as expected and did its thing. At yesterday’s high, the bounce had almost reached the target of the top of the Wave 4 running triangle. The easy money is over. Rather than dwell too much on what happens tomorrow or the next day, let’s hang back and ask some important questions about the macro picture going forward.
Observation #1
In spite of what Bernanke, Volker and Paulson say, their actions— and common sense— tells you that the "liquidity problem" is a euphemism for insolvency. Maybe I’m using the term too loosely; maybe the situation doesn’t meet the technical definition, but let’s face it: the jig is up. Otherwise, why would they deviate from the original TARP plan and move to direct capital injections?
- Bernanke: We’re Laying the Groundwork for Recovery
History teaches us that government engagement in times of severe financial crisis often arrives very late, usually at a point at which most financial institutions are insolvent or nearly so. In these conditions, the consequences and costs of inertia and inaction can be staggering. Fortunately, that is not the situation we face today. The Congress and the administration acted at a time when the great majority of financial institutions, though stressed by highly volatile and difficult market conditions, remain capable of fulfilling their critical function of providing new credit for our economy. - Volker: We Have the Tools to Manage the Crisis
For months, the real economy, apart from housing, had not been much affected by the developing crisis. Now, a full-scale recession appears unavoidable. Important state and local governments face deficits they may be unable to finance. Recessionary forces are apparent in other important countries and exchange rates are unstable. - Paulson Plans to Invest in ‘Thousands’ of U.S. Banks
Observation #2
'Alternative investments' as an asset class is finished. Most stock and bond arbitrage strategies are either suffering from broken model syndrome or they can no longer use enough leverage to make them economic. Many funds are now 50% cash in anticipation of additional redemptions. How these funds will make it back to their high water marks is beyond me. The game is over.
- High-Flying Hedge Fund Falls Back to Earth
But the fortunes of the hedge fund industry matter to nearly every investor big or small. In recent years, public and corporate pension funds, endowments and foundations poured money into these private investment vehicles in the hope of reaping market-beating returns. So far this year, the average hedge fund is down 17 percent, about half as much as the Standard & Poor’s 500-stock index. As losses mount, hedge fund managers are consulting lawyers to determine whether their fiduciary duty dictates that they should shut their doors, liquidate their holdings and use the proceeds to pay back investors— before the losses get worse— or stay in business and try to trade their way out of the hole. - Tudor, SAC Capital Said to Have Raised Cash as Markets Tumbled
Jones, who has been running Tudor Investment Corp.’s biggest fund for 22 years, made his move after watching the Mexican peso tumble 16 percent since the start of October, said two people with knowledge of the decisions by the Greenwich, Connecticut-based firm. Tudor manages $18 billion. Cohen, who oversees $16 billion at his SAC Capital Advisors LLC in Stamford, Connecticut, ordered traders to sell amid the worst equity rout since the 1930s, a person familiar with the firm said. The firm now holds about 50 percent of assets in cash. - Hedge Funds Concede Errors, Profess Optimism After Worst Losses
Hedge funds, which endeavor to make money whether markets rise or fall, lost an average of 4.7 percent in September, the biggest monthly decline since August 1998, according to data compiled by Hedge Fund Research Inc. … Managers have been selling assets, both to raise cash for what they expect to be a surge in year-end redemption requests and to preserve capital as market volatility has risen to record levels. … David Slager, manager of the Atticus European Fund, told investors that more than 50 percent of his fund is now in cash or U.S. Treasuries after he lost 43.5 percent so far this year.
Observation #3
Goldman Sachs, GE, and Morgan Stanley made a pact with the devil. In hopes of attracting private money, marquee investors exacted terms that involve paying usurious amounts of interest or dividends that will materially impact their earnings going forward. Stick a fork in dividends?
- Mitsubishi UFJ Gets Better Terms From Morgan Stanley
Under the revised deal, Mitsubishi UFJ receives $7.8 billion of preferred shares that convert to stock at a price of $25.25, down from the previous level of $31.25. The remaining $1.2 billion is in non-convertible preferred stock. Both classes pay a 10 percent dividend. The $900 million interest payment to Mitsubishi UFJ is about 16 percent of Morgan Stanley’s adjusted net income next year, based on the average of nine analysts’ estimates. . . . Buffett bought $5 billion of perpetual preferred stock in Goldman, the Wall Street firm that has best navigated the credit market turmoil. He also secured the right to buy an additional $5 billion of common stock at any time in the next five years. His preferred shares will pay 10 percent interest. - GE Raises $15 Billion; Buffett Gets Preferred Stake
Buffett’s Berkshire Hathaway Inc. will buy $3 billion in preferred shares that pay an annual 10 percent dividend and are callable after three years at a 10 percent premium, Fairfield, Connecticut-based GE said today in a statement. The 78-year-old investor also gets warrants to buy $3 billion of common stock with a strike price of $22.25 a share for five years.
Observation #4
Most importantly, no one is talking about the real problem: the middle class, the little engine that could, is now mostly underwater. Equity evaporated but their debts are still valued at 100 cents on the dollar. Maybe banks will lend again, but to whom? Until consumers on Main Street can get their debt ratios down, where will growth come from? Hmm…
- For consumers, the long era of easy credit may be at an end
Experts say that even when the current credit crunch eases, the nation may finally have maxed out its reliance on borrowed cash. Today’s crisis is a warning sign, they say, that consumers could be facing long-term adjustments in the way they finance their everyday lives. "I think we’re undergoing a fundamental shift from living on borrowed money to one where living within your means, saving and investing for the future comes back into vogue," said Greg McBride, senior analyst at Bankrate.com. "This entire credit crunch is a wake-up call to anybody who was attempting to borrow their way to prosperity." - U.S. says no to protectionism
Democrats also are lining up behind House Speaker Nancy Pelosi’s plan to bring lawmakers back to Capitol Hill after the Nov. 4 election to work on a second economic relief plan. The idea is "give the middle class and the average citizen the same kind of relief that we try to give the financial sector," said Democratic Rep. Barney Frank of Massachusetts, chairman of the House Financial Services Committee. Top Democrats are suggesting a $150 billion measure [[since raised to $300 billion: normxxx]] that would extend jobless benefits, provide more money for food stamps and finance some construction projects, such as rebuilding bridges and roads. It would also include either a tax rebate or tax cut.
Observation #5
To top it all off, remember there was no money for anything before, not even health care, but somehow hundreds of billions of dollars have been "found" to prop up the banks? Where did all this money come from?
Historical Perspective
To sum up, no matter how we slice it, the smoke has yet to clear. Let’s just back up a moment and look at a chart.
Dow Jones Industrial Average, Present Day
Corporate Insiders Still Majorly Bullish
Corporate Insiders Still Bullish: They've Cut Back Selling, Accelerated Buying
By Mark Hulbert, Marketwatch | 19 October 2008
ANNANDALE, Va. (MarketWatch)— Whatever else you might say about corporate insiders, they sure have the courage of their convictions. Not only have they, on balance, behaved bullishly over the last year, they have become even more bullish as the stock market has declined. By last week they had become positively exuberant. That is noteworthy. At similar stages of other bear markets in which the insiders were incorrectly bullish, the insiders were behaving much more bearishly.
Consider the latest insider data, courtesy of the Vickers Weekly Insider Report. In the week that ended Friday, according to Vickers, insiders bought nearly two shares of their companies' stock for every share they sold. That's significant, because the usual pattern, even in bull markets, is for insiders to sell more than they buy. In fact, according to Vickers, the long-term historical average is for insiders to sell between two and two and one-half shares for every share they purchase.
But not last week, the one-year anniversary of the bear market that began in October 2007. According to Vickers, insiders on average sold just 0.59 shares last week for every one that they bought. The sell-to-buy ratio was even more bullish for insiders of companies whose shares are listed on the NYSE or the AMEX: 0.37 to 1. Both of these readings are the best in nearly a decade, Vickers reports.
The comparable ratios for the week in October 2007 that included the all-time high, in contrast, were 4.0-to-1 for all companies and 1.89-to-1 for exchange-listed stocks. So, over the past year, the sell-to-buy ratio has fallen dramatically. To put that into historical context, it's worth being reminded that insiders did just the opposite during the first year of the 2000-2002 bear market. For the week that ended March 12, 2000, the week in which the NASDAQ Composite Index hit its all-time high above 5,000, the insiders' sell-to-buy ratio was 0.77-to-1. One year later— the week ending March 18, 2001, to be exact— the insiders' sell-to-buy ratio stood at 3.21-to-1.
So, even though insiders were too bullish at the March 2000 top, within one year they had markedly increased the pace of their selling. That's just the reverse of the trend over the last year. Another bullish straw in the wind, according to Vickers: Last week's particularly low sell-to-buy ratio did not result from a mere reduction in selling. The low ratio also was the result of acceleration in the pace of insider purchases.
That's significant, because the transactions that are reflected in the Vickers data are made in the open-market at the prevailing price. No one forced insiders to step up to the plate last week and buy more of their companies' shares with their own money. But they did. "It seems that insiders who were on the sidelines are now pouncing on the opportunity to add to positions as valuations have reached levels which, in some cases, have not been seen in decades," Vickers wrote.
For the record, however, I should stress that even when the insider consensus turns to be correct in forecasting the overall market's direction, it often is premature. This no doubt is due, at least in part, to the fear that insiders have of being accused of acting immediately prior to good or bad news about their companies being made public. To immunize themselves from that charge, they tend to act early. Some studies, in fact, have found that they anticipate what's happening to their companies' stock prices up to one year in advance, if not more.
So even if you are inclined to believe that the insiders are going to be right this time, it doesn't necessarily mean that the bear market that began a year ago is now over. The stock market forecast that is implicit in the current insider data is that the market will be higher in a year's time, regardless of the path that the market takes to get 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.
By Mark Hulbert, Marketwatch | 19 October 2008
ANNANDALE, Va. (MarketWatch)— Whatever else you might say about corporate insiders, they sure have the courage of their convictions. Not only have they, on balance, behaved bullishly over the last year, they have become even more bullish as the stock market has declined. By last week they had become positively exuberant. That is noteworthy. At similar stages of other bear markets in which the insiders were incorrectly bullish, the insiders were behaving much more bearishly.
Consider the latest insider data, courtesy of the Vickers Weekly Insider Report. In the week that ended Friday, according to Vickers, insiders bought nearly two shares of their companies' stock for every share they sold. That's significant, because the usual pattern, even in bull markets, is for insiders to sell more than they buy. In fact, according to Vickers, the long-term historical average is for insiders to sell between two and two and one-half shares for every share they purchase.
The comparable ratios for the week in October 2007 that included the all-time high, in contrast, were 4.0-to-1 for all companies and 1.89-to-1 for exchange-listed stocks. So, over the past year, the sell-to-buy ratio has fallen dramatically. To put that into historical context, it's worth being reminded that insiders did just the opposite during the first year of the 2000-2002 bear market. For the week that ended March 12, 2000, the week in which the NASDAQ Composite Index hit its all-time high above 5,000, the insiders' sell-to-buy ratio was 0.77-to-1. One year later— the week ending March 18, 2001, to be exact— the insiders' sell-to-buy ratio stood at 3.21-to-1.
So, even though insiders were too bullish at the March 2000 top, within one year they had markedly increased the pace of their selling. That's just the reverse of the trend over the last year. Another bullish straw in the wind, according to Vickers: Last week's particularly low sell-to-buy ratio did not result from a mere reduction in selling. The low ratio also was the result of acceleration in the pace of insider purchases.
That's significant, because the transactions that are reflected in the Vickers data are made in the open-market at the prevailing price. No one forced insiders to step up to the plate last week and buy more of their companies' shares with their own money. But they did. "It seems that insiders who were on the sidelines are now pouncing on the opportunity to add to positions as valuations have reached levels which, in some cases, have not been seen in decades," Vickers wrote.
For the record, however, I should stress that even when the insider consensus turns to be correct in forecasting the overall market's direction, it often is premature. This no doubt is due, at least in part, to the fear that insiders have of being accused of acting immediately prior to good or bad news about their companies being made public. To immunize themselves from that charge, they tend to act early. Some studies, in fact, have found that they anticipate what's happening to their companies' stock prices up to one year in advance, if not more.
So even if you are inclined to believe that the insiders are going to be right this time, it doesn't necessarily mean that the bear market that began a year ago is now over. The stock market forecast that is implicit in the current insider data is that the market will be higher in a year's time, regardless of the path that the market takes to get there.
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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, October 17, 2008
We Need Some Homebuilders To Fail
We Need Some Homebuilders To Fail
By Jim Cramer | 17 October 2008
Look, let's be honest. We have no need for new homes in this country. None. We do not need Beazer (BZH), Centex (CTX), Horton (DHI), Hovnanian (HOV) or Pulte (PHM) to be building homes.
We can't get a bottom in homes as long as Lennar (LEN), Standard Pacific (SPF) and Ryland (RYL) can still build. But build they must to be able to stay in business and meet cash flow covenants. The darned banks keep these companies alive with endless forbearance because they don't want to take a hit. The bank/housing company nexus is killing any hope that housing prices can stabilize.
Because of their need to hang on and build, we are not able to work off the inventory. We can't. I hate to root for any company's bankruptcy. But we just aren't going to get to where we have to go, which is as close to no new housing starts as possible, in order to get to the bottom and no more house price depreciation.
These homebuilding stocks have now become the enemy. With rates up and them still pumping, we are going to have another big round of price depreciation. I reiterate that housing will bottom next year. Integral to my forecast are four things:
We need all four to happen. We just lost three. We will not have a bottom unless we get no. 1.
At the time of publication, Cramer had no positions in the stocks mentioned.
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 Jim Cramer | 17 October 2008
|
Look, let's be honest. We have no need for new homes in this country. None. We do not need Beazer (BZH), Centex (CTX), Horton (DHI), Hovnanian (HOV) or Pulte (PHM) to be building homes.
We can't get a bottom in homes as long as Lennar (LEN), Standard Pacific (SPF) and Ryland (RYL) can still build. But build they must to be able to stay in business and meet cash flow covenants. The darned banks keep these companies alive with endless forbearance because they don't want to take a hit. The bank/housing company nexus is killing any hope that housing prices can stabilize.
Because of their need to hang on and build, we are not able to work off the inventory. We can't. I hate to root for any company's bankruptcy. But we just aren't going to get to where we have to go, which is as close to no new housing starts as possible, in order to get to the bottom and no more house price depreciation.
These homebuilding stocks have now become the enemy. With rates up and them still pumping, we are going to have another big round of price depreciation. I reiterate that housing will bottom next year. Integral to my forecast are four things:
- many homebuilders failing;
- tax credits to get people to buy homes;
- lower mortgage rates; and
- a 25% decline in home pricing.
We need all four to happen. We just lost three. We will not have a bottom unless we get no. 1.
At the time of publication, Cramer had no positions in the stocks mentioned.
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.
What Will/Are Foreign Investors To Do?
The "Other" Consumer Confidence Survey
By ContraryInvestor.com | October 2008
The "Other" Consumer Confidence Report...What the heck are they thinking now? You know who we mean, the 'foreign' investment community. Who else? Hopefully without wildly belaboring the point, we remain convinced that the US is ultimately going to face a funding issue down the road. Maybe not a funding issue in terms of being able to borrow funds, but rather the issue is the cost at which funds will ultimately be made available to the US.
This is exactly what we addressed when we penned the Fun With Funding discussion last month. Put yourself in the shoes of the foreign investment community. Many moons ago, you started recycling trade related dollars back into US financial assets. In essence, you were able to facilitate a little mercantilist economics. By buying US financial assets (primarily bonds) you effectively helped keep US interest rates low and enabled the relatively blinded by asset inflation US consumer borrowing and spending (on your export products).
As commodity prices rose, the BRIC nations and OPEC got into the dollar recycling game in a big way. If you remember the Fun with Funding article, one of the tables in the discussion showed us that since May of 2006, 100% of foreign purchases of US Treasuries were undertaken by Brazil, Russia, India, China and OPEC. Japan was a net seller over the period. Quite the happy circumstance...while it lasted.
But over the past seven months, the foreign community has been treated to the visual of three of the five largest US investment banks disappearing. One literally disintegrating in the night. They also watched as the largest two US residential mortgage-financing intermediaries entered Club Fed, never to be seen again in public. Let's face it, the foreign community knows Lehman had been around for 158 years. The firm had lived through a domestic civil war and a financial/economic depression.
And what eventually took it down? Granite countertops, stainless steel appliances and travertine flooring. Quite the sorry commentary. You get the point. We suggest that one of the most important consumer confidence surveys of the moment is the monthly tally of foreign purchases of US financial assets. The foreign investment community has had a front row seat in the US credit cycle drama playing out amongst Wall Street and the Fed/Treasury/Administration.
They, along with almighty Bill Gross, expressed their extreme concern over Fannie and Freddie solvency, instigating relatively immediate action. They, along with almighty Bill Gross (to the tune of $750 million) would have been hurt badly had AIG gone nose first into the tarmac without even attempting to pull the nose up before crash landing. We know in part what the foreign community has been saying, but what are they thinking at this point? To us, one of the most important questions as we move forward.
Although we know we have covered this in the past, we believe it's critical to keep an eye on foreign capital flows into US financial markets. We ALL know how important foreign capital has become to the US economic and financial system continuing to function properly. And we all know that since early this year, foreign sovereign wealth funds have gone on a buyers strike in terms of providing US companies capital amidst the ever evolving US credit crisis.
No more Saudi princes riding to the rescue? C'mon, where's their sense of humor? Let's have a quick look at the longer-term rhythm of foreign flows of capital into US financial markets. Why? Because the character of that flow is changing meaningfully as we speak. You know these numbers unfortunately come to us with a lag. As of now, data is current through July. Since that time, Lehman has passed away and Fannie and Freddie senior and sub debt securities have been rescued.
AIG has been thrown a lifeline and Merrill has crawled under the skirt of BofA. We know the foreign community was indeed getting a bit skittish about the government agencies over the summer, and that skittishness is reflected in these numbers. But what's most important to us is the rhythm of longer-term trends in the twelve month moving averages you see in each chart. In short order, let's have a look.
Clearly into the credit crisis phase of the current cycle beginning last summer, Treasuries have been the asset class of choice for the foreign community. It’s a natural. Institutionally the world has been conditioned to run to the supposed safe haven security that is perceived to be UST's. As we’re sure you saw, 90-day T-bill yields kissed .2% in trading a few weeks back in what was clearly a panic run into the short end of the Treasury market.
The safe haven asset? In spades at that yield. We can understand foreign and domestic investor behavior here, but as we have said many a time in the past, we believe there will indeed come a day when this may no longer be the case. Although one day does not a trend make, gold’s one-day price fireworks show a few weeks ago was indeed the noticeable event. We heard rumors of a large AIG short in the metal being covered, but who really knows at this point.
Although we’re guessing, if gold zooms higher from here, we’d take it as a sign the markets have lost considerable faith in the Fed and Treasury. By extension, could marginal loss of faith in the credit that is US Treasuries be far behind if this line of thinking is even near correct? Nope. No wonder there is such establishment resistance to gold as a monetary symbol.
For now, foreign flows into Treasuries, as seen above, are not a major issue point of concern, but we watch intently as we move ahead. As a quick refresher, we believe the important data point in the chart above is the twelve month moving average of purchases. We're well below record highs seen years ago, but in no way are we looking at a supposed collapse for now. One note that we'll refer back to as we conclude this discussion is that into the last US recession, the foreign community was a seller of Treasuries in aggregate.
Although the credit crisis environment in the US has taken center stage attention for now, the fallout influence of the credit crisis on the real economy, and the real world recession it will ultimately engender, is the next act to anticipate in the current drama playing out before our eyes. Will we see a repeat performance of foreign liquidation of UST's in the US recession to come? If so, it could not come at a worse time. We watch and wait.
Before moving forward, one last view of life for perspective on the importance of the foreign community to the US Treasury market. Below is a look at the character make up of Treasury holders as of the conclusion of 2Q 2008.
As we suggested in the "Fun With Funding" discussion last month, the US government balance sheet will expand meaningfully ahead. Key question being, will the pie chart we see above change in character as this balance sheet expansion occurs? Will households become big UST buyers? How about domestic banks that currently own the smallest slice of the pie?
For now, although it's clearly loose commentary cast in the heat of the moment, the "reaction" of major sections of the foreign community (Asian, European and Middle Eastern) to the proposed bailout package in the US has been well south of a resounding thumbs up. But, as always, it's not what they say, but rather what they do ahead that will be important to US funding outcomes. Let's move on to the foreign influence in the government agency market.
The fact is that the sale by the foreign community of US government agencies in July was a record. The chart below is relatively dramatic in revealing this circumstance. Certainly some of the proceeds of these sales found their way back into Treasuries. We know the foreign community was indeed "asking questions" prior to the "conservatorship" of Fannie and Freddie, despite the implicit moral hazard guarantee that had been in place for literally years.
So it’s a one off in July, we believe. But despite the one month July sale-a-thon in agency paper by the foreign sector, the longer-term trend embodied in the 12 month MA has already been telling us for some time that the foreign community is growing weary of continuing to acquire agency paper. If the July activity in agency sales isn't a ding in the side of the greater confidence ship on the part of the foreign investment contingent, we just don't know what would be characterized as such.
Who knows, now that agency paper is essentially government paper with a yield premium, foreign community perceptions may change ahead. We've seen buying in recent anecdotal data. But we’re not holding our breath. As the chart clearly shows us, the foreign community indeed was a key provocateur in funding the macro US mortgage market from the mid-1990’s through to late 2006. Will they be so obliging to do so again given what has happened to supposed quality mortgage paper in the current cycle? We’ll see.
The real and very meaningful walking away, or confidence destruction, seen in actions by the foreign community in terms of purchasing US financial assets has occurred in the corporate bond market. Without question, what you see below speaks to academic risk reduction and a very much heightened sense of currently pricing in investment risk, if you will. The drop in foreign acquisition of US corporate bonds is striking, if nothing else.
As a quick tangent, we take what we see above very seriously. Corporate bond spreads have widened very meaningfully over the last year. Whether it’s corporate Aaa versus 10 year Treasury yields, Baa credits using the same spread, or high yield corporate spreads, it is clear that meaningful change has occurred in macro credit market perceptions and pricing. In our minds, there is no way the US economy is about to reaccelerate until corporate bond spreads contract. This is a distinct and definitive message of history.
And as is more than apparent in the chart, the foreign community has been nothing short of integral in keeping US corporate bond yield spreads tight throughout the entire prior economic cycle via their very meaningful purchasing activity. The twelve-month moving average of foreign purchases of US corporate bonds is just about back to the trough of the prior cycle seen early this decade as we speak. This strikes directly at the heart of the real economy being able to fund itself as we look ahead.
The last asset class under examination is equities. Foreign investment history has been that peak exposure usually occurs at major price peaks and trough exposure at major price troughs. You know, buying high and selling low. So what else is new in terms of human behavior? Not much. Since last summer, the foreign community has lost it’s taste for US equities, as has the US public.
Funny that way. Stick a 30% off sign in a retail store and it attracts buyers immediately. Stick a 30% off sign on Wall Street and everyone avoids the place like the plague. Human nature never changes, does it? We simply need to be aware of our own faults in terms of emotional human decision making and try to "rewire" our actions and reactions.
As you can see in looking at the absolute dollar numbers, foreign purchases of US equities in terms of dollars is very small. It’s the fixed income markets where the big foreign money is invested. And to us, this is very meaningful in that, as we have said, the big issue looking ahead is how the US government and greater economy funds itself. Who provides the funds and at what cost? Critical questions.
Final chart, we promise. Total foreign flows of capital into US financial markets over the last two-plus decades. There have been very few instances of monthly net selling by the foreign community of US financial assets. July just happened to be one of those months. Not good for a greater economy that we believe faces intermediate term funding "challenges", to be tactful.
But as we’ve said looking at individual asset classes, this is not a one-month one-off experience. The declining trend in foreign purchasing of US financial assets has been happening for a year now, completely coinciding with the deteriorating credit market fundamentals in the US. The chart is clear on this statement. Does this show us what the foreign community is thinking? How could it be otherwise?
As a quick comment on historical perspective, we know the nominal dollar decline in the twelve month moving average of foreign purchases total US financial assets is meaningful. As of July, the 12 month MA has declined close to $50 billion from June of 2007. In percentage terms it's a 46% decline. In the wake of the Asian currency crisis, we saw a 51% top to bottom drop in this 12 month MA. So is the world coming to an end here and are we in uncharted waters? Not yet.
What we believe is most meaningful right now is the powerful issue of change at the margin. At the exact time macro US funding needs are increasing, one of the largest buyers/holders of US financial assets is changing their behavior at the margin. This is what we need to stay on top of, monitor monthly, and anticipate financial market and real economic outcomes based on this change.
There you have it, a very important foreign financial consumer confidence survey if we’ve ever seen one. Maybe one of the most important confidence surveys we can think of at the moment for a US financial sector and general economy increasingly in need of capital. In summation, we believe the foreign community faces the following decision points over the near term. As has been the case for many a moon now, foreign investment in US financial assets must contend with interest rate risk and currency exchange rate risk. Nothing new to see here.
But what is changing is the very important need of the US government to expand its balance sheet very meaningfully. You already know our thoughts on this. The US and really the globe is heading into a major consumer led recession that at this point, as we see it, is unavoidable. Key questions for now being duration and depth.
Will the BRIC countries' and OPEC capital reserves (the key foreign buyers of UST's over the last two years) be needed on their respective home fronts to help shore up/stimulate their own economies? If so, that's competition for a US government in need of increased funding. Lastly, there is a new monkey wrench that has been recently thrown into the total equation.
The foreign community has been treated to the new wrinkle that US authorities are now willing to "change the rules" without any prior notice. Again, at the margin this creates investment uncertainty. How are foreign entities to feel comfort in providing capital to the US financial sector when equity and preferred asset values can be essentially wiped out on a Sunday afternoon? It's no wonder the global sovereign wealth funds have been on a buyers strike.
As a quick counterpoint to what we see as enhanced risk to foreign capital committing to US assets at the moment, be sure to keep your eye on many of the major European financial institutions. In terms of the raw numbers, leverage ratios for many of Europe's largest financial behemoths make former US investment bank outfits look like choirboys and choirgirls. IF the European financial sector encounters meaningful credit issues ahead, as have their financial sector brethren in the US, we could indeed see Treasuries continue to be the safety trade of choice. A confusing time with a lot of moving parts globally as really global credit cycle reconciliation plays out? You better believe it.
Point blank, the US cannot afford to lose the confidence of the foreign investment and central banking communities in US financial asset markets. Now more than at any other time in recent memory, the US financial sector and real economy need access to relatively inexpensive foreign capital. We would just remind you of one truism we have repeated in these pages for years.
Liquidity/Capital is a coward. There’s always too much around when it’s least needed and it’s never there when needed most. One has to look no further than the US residential mortgage markets to be reminded of the importance of this comment. But unfortunately and quite inconveniently for US financial and real asset markets is the fact that as humans, we’re "wired" incorrectly. In times of stress the fight or flight mechanism takes over. You can blame the cave men and women for that one. Hey, they don’t have any capital, do they? Just checking.
Fun With Funding
By ContraryInvestor.com | September 2008
Fun With Funding...You know that for some time now we have been preaching about what we believe to be one of the most important macro themes of the moment that is deleveraging. Important both for financial market and real world economic outcomes ahead. And, whether we like it or not, it's a theme that we believe will be with us for a good while to come.
The ultimate contraction of balance sheets in the financial, household and corporate sectors will be a process, not an event, with plenty of volatility along the way. For those attempting to call interim bottoms with respect to this phenomenon as we travel along this path, as we have already seen this year and will undoubtedly continue to see again, our only comment is good luck. In the much larger picture, it was this very multi-decade expansion of private sector balance sheets in aggregate that in large measure drove corporate profits over the longer cycle.
So now that deleveraging and balance sheet shrinkage is destined to play out ahead, all as part of the natural progression of a longer term credit market cycle, the trajectory or rate of change in corporate profit growth is in question. A major issue for the financial markets, especially equities. We believe the markets are just starting to wake up to this long cycle thematic realization.
But perhaps another major issue that is not being given enough attention is the fallout consequences due to the one balance sheet not destined to shrink during this process of deleveraging we have described, and that's the balance sheet of the Federal government. While the financial markets, the household sector and in good part the corporate sector engage in long overdue deleveraging, a natural offset to avoid either the reality or perception of collapse will be the continued expansion of the government's balance sheet.
And this process of expanding the Federal balance sheet, as you know full well, has already begun in full force. For now, the de facto bail out of the GSE's and the residential mortgage bail out bill are two poster child examples of this phenomenon at the exact point of acceleration. Even the auto manufacturers have their hands out. Will it be the airlines next? Unfortunately, we expect a lot more where this came from ahead. In one sense, the government really has no choice. This is the price all US taxpayers will bear for years of regulatory self induced blindness.
Could our current set of circumstances have been avoided? Of course, but regulatory oversight simply turned a blind eye in deference to the Wall Street and credit cycle driven profit motive. Let's face it, a lot of individuals became very wealthy during the prior credit cycle mania period, now clearly seen to be at the expense of the larger US taxpayer base. Privatizing profits and socializing risk. Sounds like Russia a decade ago, no? Welcome to the USSA. As Jim Grant recently opined, "where is the outrage?" We have no idea.
Enough of the ranting and raving. Let's get to the point. As this process plays out and the Federal government is continually forced to expand its balance sheet as an offset to the leverage contraction occurring largely throughout the remainder of the economy and domestic financial markets ahead, THE big question becomes, where will the funding for this balance sheet expansion come from and what will it ultimately cost?
A question near and dear to the hearts of US taxpayers everywhere, to say nothing of the investment community. This, we believe, is now and will continue to become one of the most important questions for our investment activities. We cannot take our eye off of this ball as we move ahead. Point blank, and we could not be more serious when we ask this, will the US face a funding problem at some point?
In at least starting to address this extremely important question, it's time to head east and turn back the clock a bit for a little exercise in compare and contrast. Although no two sets of circumstances are ever identical, the US today is facing a number of major cycle issues comparable to Japan a few decades back. Post the early 1990's Japanese equity bubble collapse came the beginning of a property bubble collapse a number years later that to this day is characterized by values well below what was experienced almost two decades ago.
An important comparative phenomenon throughout the 1990's was a Japanese banking system riddled with and literally overwhelmed by bad debt. A financial system immobilized. Sound familiar? In good measure, the official US banking system, and importantly the US shadow banking system, has begun traveling down a very similar path. We expect US financial system reconciliation character to ultimately differ from the historical circumstance of the Japanese banking system as the US system will indeed recognize these losses in a more timely manner, which hopefully will mean total cycle reconciliation will not be multi-decade in nature.
The US financial and broader corporate sectors will also act to cut costs (employees) mercilessly as reconciliation plays out. Another huge differentiation factor relative to the Japanese experience. Lastly, throughout the process of leverage reconciliation in the Japanese equity market, property markets and financial system in general over the last few decades, the Japanese government expanded their balance sheet as private and financial sector balance sheets contracted. In all sincerity, we believe the conceptual parallels are very importantly similar between the Japanese experience then and the current circumstance faced by the US at present.
But standing out like the proverbial sore thumb are differences related to our important issue in this discussion - the character and circumstances surrounding the forward funding of the expansion in the government balance sheet that necessarily needs to take place. It's here where this compare and contrast exercise diverges in a very meaningful manner. Getting right to the point, with the clear benefit and clarity of hindsight, Japan was able to fund government balance sheet expansion during its period of reconciliation from internal or domestic sources.
It was not beholden to and dependent upon outside funding sources. This is THE crucial difference between Japan then and the US now. As you can see in the chart below, Japan began its decent into systemic non-governmental balance sheet reconciliation with a national savings rate near 15% in 1990. As we've shown you many a time, for all intents and purposes the US savings rate is non-existent. Quite the contrast.
Once again, in the clarity of hindsight, the initial Japanese response to the equity and, several years later, property bubble peaks and subsequent busts was to lower interest rates. Classic monetary policy 101. As the decade of the 1990's wore on, the cost of what was accelerating government spending (expansion in the government balance sheet), was indeed in very good part supported and able to be accomplished by a lower interest rate structure.
As Japanese government funding needs expanded, the cost of that funding declined. Why? It was financed internally. Just what the doctor ordered. The following chart is a proxy for longer term interest rates in Japan over the identical period covered in the chart above.
The important point and true dissimilarity with the current funding need situation in the US is that back in the early part of the 1990's, Japan as a financial and economic system had the benefit of a very high internal savings rate. Savings that were able to be tapped even within the context of a declining interest rate environment to fund the needed counter cyclical expansion of the Japanese government balance sheet. Savers were able to purchase increased issuance of government bonds.
As is clear in looking at the two charts above, savings declined along with interest rates over the entire period of the 1990's. The last, again in hindsight, benefit to the Japanese at the time was that inflation was clearly not an issue. Deflation was the issue confronted by the Japanese economy. As such, Japanese investors/savers were accepting of an ever declining nominal interest rate structure as government spending accelerated as a necessary counterpoint to contraction in the remainder of the Japanese economy.
Fast forward to the present and circumstances faced by the US could not be more different. As mentioned, current domestic internal savings is lacking completely. Set against historical context, macro US interest rates are already low. It's hard to see how they could decline meaningfully from here as they already sit near half century lows. The ten year US Treasury yield today is literally identical to what was seen in 1959. The secular decline in interest rates in the US has already taken place. In 1990, the secular decline in interest rates was still to come for Japan.
In stark contrast to Japan in 1990, today the US is crucially dependent on foreign funding and will not be the forward beneficiary of a declining cost of funds. The only way in which the US could develop its own internal funding sources for the counter cyclical Federal balance sheet expansion that necessarily needs to take place ahead, and has essentially really already started to take place, is to have the domestic savings rate accelerate markedly. And the only possibility the US has of accomplishing something like this is if domestic consumption almost literally collapses.
Japan was able to fund both ongoing consumption AND government balance expansion throughout the 1990's specifically because it already had a very significant prior period build up in internal savings which could be tapped. The US has no such asset or flexibility in funding choice. In other words, the question now becomes who will be the incremental buyer at the margin of what is surely to be increased US government bond issuance ahead? Again, unless consumption literally collapses in the US in deference to increased savings, it will not be domestic buyers. This very circumstance leaves the US much more vulnerable than were the Japanese in addressing the process of credit cycle and asset value reconciliation.
I'll Gladly Pay You Tuesday For A Hamburger Today...Let's have a quick review look at US long term capital flows. Specifically, we want to look at net foreign purchases of US financial assets. This is where we are going to see the importance and magnitude of non-domestic funding sources to overall US capital/funding needs. In the following chart we are detailing by year net foreign buying of US financial assets.
As you can see, since the middle of the 1990's, the annual number has grown from a little over $200 billion to over $1 trillion as of the end of 2007. But we believe the more important line is the blue line that details annual net foreign purchases of US financial assets as a percentage of the year over year change in total US credit market debt outstanding. The annualized number as of the first quarter of this year is 31% of total US capital/credit market needs. Please remember that Japan's need for foreign capital in 1990 was essentially zero.
As you look at the above chart, we believe one very important additional characteristic needs to be kept in mind. Over the 1995 to 2007 period, the US experienced probably the apex of long term credit cycle mania in terms of nominal dollar credit creation. Both the US banking system and Wall Street driven shadow banking system were simply working overtime to provide "funding" to the greater US economy and financial system in general.
And yes, in part that "funding" was sold to the foreign community in terms of "investments" (debt securitizations). But the data you see above measures only foreign buying of Treasury debt, agency debt, corporate debt and equities. Plenty of foreign investors also provided investment funds for CDO's, CLO's, subprime debt packages, etc. But THE important point as we look forward is that "funding" provided by the US banking system and shadow banking system is now in serious question, if not an outright freeze. Just look at the uptick in the 1Q data in the prior chart for how meaningful foreign funding has become to the US.
Although foreign buying of US financial assets in nominal dollars is falling, there has been a big up tick in the magnitude of that funding as a percentage of total credit market growth. Bottom line being? Magnitude of foreign funding for total system US capital needs will become ever more important as the banking and shadow banking system continue on the path of balance sheet repair really over the years that lay in front of us. Again, a completely dichotomous circumstance relative to Japanese situation of a few decades back.
One last point of character that we believe deserves more than a bit attention and reflection as we look ahead and contemplate the very important need of foreign capital funding to the US during the process of balance sheet reconciliation the US system as a whole must live through. Given our major thematic contention that the US Federal government balance sheet must expand ahead as an offset to private sector balance sheet contraction, just who have been the key buyers of US Treasury debt at the margin recently? Let's have a quick peek.
As you can see, we're looking back across the last two years for a bit of perspective. Traditionally the largest holder of US Treasuries has not been buying over the last few years, quite the opposite. It seems that in terms of Japan, they own enough, thank you. It's no surprise at all that China has been the largest incremental nominal dollar buyer of UST's over the last few years. Clearly the Chinese are recycling trade related dollars as well as managing their currency cross rate with the buck (printing renminbi, selling it and buying US Treasuries to support the dollar against the yuan) as their accumulation of UST's has zoomed skyward.
Maybe a bit surprisingly, the second largest buyer has been Brazil. As we mention in the chart, Russia has simply come out of nowhere to become the eighth largest owner of UST's at the present time. And as we have mentioned to you in the past, we are convinced that the UK numbers are really petro money (floating through London) in disguise. Total purchases by these folks seen in the table, inclusive of the Japanese sales, accounts for very close to 100% of the total foreign buying of US Treasuries over this period in totality.
You can see the punch line coming after looking at this table, right? Of course you can. It's the BRIC countries and petro money that has been THE key support to Treasury prices and suppressor of Treasury yields over the last two years. These are the very folks who have been "funding" the US in terms of our increasing reliance on foreign capital. So as we look ahead, we need to ask ourselves, will these very folks be so willing to continue funding the expanding US Federal balance sheet (through purchasing Treasuries), perhaps at a greatly accelerated rate as we move forward? Yes or no?
You don't need us to tell you that foreign current account surpluses in these countries that has allowed this reinvestment in Treasuries has been driven largely by two phenomenon. First is the US trade deficit in terms of consumer goods, and secondly it's commodity prices, especially as this applies to the price of energy. As you know, we have witnessed commodity and energy prices come down as of late.
Although we have not discussed this recently, the non-energy component of the US trade deficit has been contracting in recent months. No surprise at all as the US consumer remains under increasing pressure. So as we look forward, if indeed the global economy, necessarily inclusive of the BRICs, slows AND commodity prices remain relatively subdued, will the very important incremental buyers of US Treasuries seen in the table above have the financial wherewithal to continue funding US government capital needs? And potentially fund those needs at an accelerating pace?
We hope that by now you can see why we believe the forward US funding issue is so important. We believe the question mark is huge as to who will be willing to meet these funding needs during a period of greater US non-government sector balance sheet contraction. Will the US continue to be able to procure low nominal cost funding as its already very large balance sheet (liability) expands ever further by necessity in the coming period? The US faces a series of obstacles that were absent in the similar cycle reconciliation experience of Japan.
And THE primary obstacle and question mark is cost of funds. We're not preaching end of the world here. In fact, we're really not even questioning the ability of the US to procure continued foreign funding. THE critical issue looking ahead is COST OF FUNDING. At the outset we asked the question, will the US face a funding problem at some point, given that the US is beholden to foreign financing? It's the cost of funding that will be key to forward outcomes both in the real US economy and financial markets.
In the past we have suggested that perhaps THE most important chart we can think of is the long term chart of the 30 year US Treasury bond. What we have described above simply puts an exclamation point behind this thought. The following is nothing but an update of the non-logarithmic 30 year UST. To suggest the red rising bottoms trend line is important is a multi-decade understatement. Will the whole forward funding question ultimately be the straw that breaks the proverbial camel's back for the US bond market? Or in this case the back of the rising bottoms trend line?
Very quickly, we can't help but also show you the log chart. As we've done a pretty bad job of penciling in, you can see the arc in the log chart showing that from a very long term perspective, prices are "leveling out" after having accelerated for many years. It's the leveling out that is suggesting important long term change is occurring in relatively glacial, but noticeable, fashion.
You already know we'll be following the magnitude and character of foreign capital flows intensely as we move forward. We believe it will be one of the most important analytical exercises to investment decision making in the years ahead. Fun with funding ahead? Naw, it's probably not going to be much fun at all. In fact, quite the opposite.
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Normxxx
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By ContraryInvestor.com | October 2008
The "Other" Consumer Confidence Report...What the heck are they thinking now? You know who we mean, the 'foreign' investment community. Who else? Hopefully without wildly belaboring the point, we remain convinced that the US is ultimately going to face a funding issue down the road. Maybe not a funding issue in terms of being able to borrow funds, but rather the issue is the cost at which funds will ultimately be made available to the US.
This is exactly what we addressed when we penned the Fun With Funding discussion last month. Put yourself in the shoes of the foreign investment community. Many moons ago, you started recycling trade related dollars back into US financial assets. In essence, you were able to facilitate a little mercantilist economics. By buying US financial assets (primarily bonds) you effectively helped keep US interest rates low and enabled the relatively blinded by asset inflation US consumer borrowing and spending (on your export products).
As commodity prices rose, the BRIC nations and OPEC got into the dollar recycling game in a big way. If you remember the Fun with Funding article, one of the tables in the discussion showed us that since May of 2006, 100% of foreign purchases of US Treasuries were undertaken by Brazil, Russia, India, China and OPEC. Japan was a net seller over the period. Quite the happy circumstance...while it lasted.
But over the past seven months, the foreign community has been treated to the visual of three of the five largest US investment banks disappearing. One literally disintegrating in the night. They also watched as the largest two US residential mortgage-financing intermediaries entered Club Fed, never to be seen again in public. Let's face it, the foreign community knows Lehman had been around for 158 years. The firm had lived through a domestic civil war and a financial/economic depression.
And what eventually took it down? Granite countertops, stainless steel appliances and travertine flooring. Quite the sorry commentary. You get the point. We suggest that one of the most important consumer confidence surveys of the moment is the monthly tally of foreign purchases of US financial assets. The foreign investment community has had a front row seat in the US credit cycle drama playing out amongst Wall Street and the Fed/Treasury/Administration.
They, along with almighty Bill Gross, expressed their extreme concern over Fannie and Freddie solvency, instigating relatively immediate action. They, along with almighty Bill Gross (to the tune of $750 million) would have been hurt badly had AIG gone nose first into the tarmac without even attempting to pull the nose up before crash landing. We know in part what the foreign community has been saying, but what are they thinking at this point? To us, one of the most important questions as we move forward.
Although we know we have covered this in the past, we believe it's critical to keep an eye on foreign capital flows into US financial markets. We ALL know how important foreign capital has become to the US economic and financial system continuing to function properly. And we all know that since early this year, foreign sovereign wealth funds have gone on a buyers strike in terms of providing US companies capital amidst the ever evolving US credit crisis.
No more Saudi princes riding to the rescue? C'mon, where's their sense of humor? Let's have a quick look at the longer-term rhythm of foreign flows of capital into US financial markets. Why? Because the character of that flow is changing meaningfully as we speak. You know these numbers unfortunately come to us with a lag. As of now, data is current through July. Since that time, Lehman has passed away and Fannie and Freddie senior and sub debt securities have been rescued.
AIG has been thrown a lifeline and Merrill has crawled under the skirt of BofA. We know the foreign community was indeed getting a bit skittish about the government agencies over the summer, and that skittishness is reflected in these numbers. But what's most important to us is the rhythm of longer-term trends in the twelve month moving averages you see in each chart. In short order, let's have a look.
Clearly into the credit crisis phase of the current cycle beginning last summer, Treasuries have been the asset class of choice for the foreign community. It’s a natural. Institutionally the world has been conditioned to run to the supposed safe haven security that is perceived to be UST's. As we’re sure you saw, 90-day T-bill yields kissed .2% in trading a few weeks back in what was clearly a panic run into the short end of the Treasury market.
The safe haven asset? In spades at that yield. We can understand foreign and domestic investor behavior here, but as we have said many a time in the past, we believe there will indeed come a day when this may no longer be the case. Although one day does not a trend make, gold’s one-day price fireworks show a few weeks ago was indeed the noticeable event. We heard rumors of a large AIG short in the metal being covered, but who really knows at this point.
Although we’re guessing, if gold zooms higher from here, we’d take it as a sign the markets have lost considerable faith in the Fed and Treasury. By extension, could marginal loss of faith in the credit that is US Treasuries be far behind if this line of thinking is even near correct? Nope. No wonder there is such establishment resistance to gold as a monetary symbol.
For now, foreign flows into Treasuries, as seen above, are not a major issue point of concern, but we watch intently as we move ahead. As a quick refresher, we believe the important data point in the chart above is the twelve month moving average of purchases. We're well below record highs seen years ago, but in no way are we looking at a supposed collapse for now. One note that we'll refer back to as we conclude this discussion is that into the last US recession, the foreign community was a seller of Treasuries in aggregate.
Although the credit crisis environment in the US has taken center stage attention for now, the fallout influence of the credit crisis on the real economy, and the real world recession it will ultimately engender, is the next act to anticipate in the current drama playing out before our eyes. Will we see a repeat performance of foreign liquidation of UST's in the US recession to come? If so, it could not come at a worse time. We watch and wait.
Before moving forward, one last view of life for perspective on the importance of the foreign community to the US Treasury market. Below is a look at the character make up of Treasury holders as of the conclusion of 2Q 2008.
As we suggested in the "Fun With Funding" discussion last month, the US government balance sheet will expand meaningfully ahead. Key question being, will the pie chart we see above change in character as this balance sheet expansion occurs? Will households become big UST buyers? How about domestic banks that currently own the smallest slice of the pie?
For now, although it's clearly loose commentary cast in the heat of the moment, the "reaction" of major sections of the foreign community (Asian, European and Middle Eastern) to the proposed bailout package in the US has been well south of a resounding thumbs up. But, as always, it's not what they say, but rather what they do ahead that will be important to US funding outcomes. Let's move on to the foreign influence in the government agency market.
The fact is that the sale by the foreign community of US government agencies in July was a record. The chart below is relatively dramatic in revealing this circumstance. Certainly some of the proceeds of these sales found their way back into Treasuries. We know the foreign community was indeed "asking questions" prior to the "conservatorship" of Fannie and Freddie, despite the implicit moral hazard guarantee that had been in place for literally years.
So it’s a one off in July, we believe. But despite the one month July sale-a-thon in agency paper by the foreign sector, the longer-term trend embodied in the 12 month MA has already been telling us for some time that the foreign community is growing weary of continuing to acquire agency paper. If the July activity in agency sales isn't a ding in the side of the greater confidence ship on the part of the foreign investment contingent, we just don't know what would be characterized as such.
Who knows, now that agency paper is essentially government paper with a yield premium, foreign community perceptions may change ahead. We've seen buying in recent anecdotal data. But we’re not holding our breath. As the chart clearly shows us, the foreign community indeed was a key provocateur in funding the macro US mortgage market from the mid-1990’s through to late 2006. Will they be so obliging to do so again given what has happened to supposed quality mortgage paper in the current cycle? We’ll see.
The real and very meaningful walking away, or confidence destruction, seen in actions by the foreign community in terms of purchasing US financial assets has occurred in the corporate bond market. Without question, what you see below speaks to academic risk reduction and a very much heightened sense of currently pricing in investment risk, if you will. The drop in foreign acquisition of US corporate bonds is striking, if nothing else.
As a quick tangent, we take what we see above very seriously. Corporate bond spreads have widened very meaningfully over the last year. Whether it’s corporate Aaa versus 10 year Treasury yields, Baa credits using the same spread, or high yield corporate spreads, it is clear that meaningful change has occurred in macro credit market perceptions and pricing. In our minds, there is no way the US economy is about to reaccelerate until corporate bond spreads contract. This is a distinct and definitive message of history.
And as is more than apparent in the chart, the foreign community has been nothing short of integral in keeping US corporate bond yield spreads tight throughout the entire prior economic cycle via their very meaningful purchasing activity. The twelve-month moving average of foreign purchases of US corporate bonds is just about back to the trough of the prior cycle seen early this decade as we speak. This strikes directly at the heart of the real economy being able to fund itself as we look ahead.
The last asset class under examination is equities. Foreign investment history has been that peak exposure usually occurs at major price peaks and trough exposure at major price troughs. You know, buying high and selling low. So what else is new in terms of human behavior? Not much. Since last summer, the foreign community has lost it’s taste for US equities, as has the US public.
Funny that way. Stick a 30% off sign in a retail store and it attracts buyers immediately. Stick a 30% off sign on Wall Street and everyone avoids the place like the plague. Human nature never changes, does it? We simply need to be aware of our own faults in terms of emotional human decision making and try to "rewire" our actions and reactions.
As you can see in looking at the absolute dollar numbers, foreign purchases of US equities in terms of dollars is very small. It’s the fixed income markets where the big foreign money is invested. And to us, this is very meaningful in that, as we have said, the big issue looking ahead is how the US government and greater economy funds itself. Who provides the funds and at what cost? Critical questions.
Final chart, we promise. Total foreign flows of capital into US financial markets over the last two-plus decades. There have been very few instances of monthly net selling by the foreign community of US financial assets. July just happened to be one of those months. Not good for a greater economy that we believe faces intermediate term funding "challenges", to be tactful.
But as we’ve said looking at individual asset classes, this is not a one-month one-off experience. The declining trend in foreign purchasing of US financial assets has been happening for a year now, completely coinciding with the deteriorating credit market fundamentals in the US. The chart is clear on this statement. Does this show us what the foreign community is thinking? How could it be otherwise?
As a quick comment on historical perspective, we know the nominal dollar decline in the twelve month moving average of foreign purchases total US financial assets is meaningful. As of July, the 12 month MA has declined close to $50 billion from June of 2007. In percentage terms it's a 46% decline. In the wake of the Asian currency crisis, we saw a 51% top to bottom drop in this 12 month MA. So is the world coming to an end here and are we in uncharted waters? Not yet.
What we believe is most meaningful right now is the powerful issue of change at the margin. At the exact time macro US funding needs are increasing, one of the largest buyers/holders of US financial assets is changing their behavior at the margin. This is what we need to stay on top of, monitor monthly, and anticipate financial market and real economic outcomes based on this change.
There you have it, a very important foreign financial consumer confidence survey if we’ve ever seen one. Maybe one of the most important confidence surveys we can think of at the moment for a US financial sector and general economy increasingly in need of capital. In summation, we believe the foreign community faces the following decision points over the near term. As has been the case for many a moon now, foreign investment in US financial assets must contend with interest rate risk and currency exchange rate risk. Nothing new to see here.
But what is changing is the very important need of the US government to expand its balance sheet very meaningfully. You already know our thoughts on this. The US and really the globe is heading into a major consumer led recession that at this point, as we see it, is unavoidable. Key questions for now being duration and depth.
Will the BRIC countries' and OPEC capital reserves (the key foreign buyers of UST's over the last two years) be needed on their respective home fronts to help shore up/stimulate their own economies? If so, that's competition for a US government in need of increased funding. Lastly, there is a new monkey wrench that has been recently thrown into the total equation.
The foreign community has been treated to the new wrinkle that US authorities are now willing to "change the rules" without any prior notice. Again, at the margin this creates investment uncertainty. How are foreign entities to feel comfort in providing capital to the US financial sector when equity and preferred asset values can be essentially wiped out on a Sunday afternoon? It's no wonder the global sovereign wealth funds have been on a buyers strike.
As a quick counterpoint to what we see as enhanced risk to foreign capital committing to US assets at the moment, be sure to keep your eye on many of the major European financial institutions. In terms of the raw numbers, leverage ratios for many of Europe's largest financial behemoths make former US investment bank outfits look like choirboys and choirgirls. IF the European financial sector encounters meaningful credit issues ahead, as have their financial sector brethren in the US, we could indeed see Treasuries continue to be the safety trade of choice. A confusing time with a lot of moving parts globally as really global credit cycle reconciliation plays out? You better believe it.
Point blank, the US cannot afford to lose the confidence of the foreign investment and central banking communities in US financial asset markets. Now more than at any other time in recent memory, the US financial sector and real economy need access to relatively inexpensive foreign capital. We would just remind you of one truism we have repeated in these pages for years.
Liquidity/Capital is a coward. There’s always too much around when it’s least needed and it’s never there when needed most. One has to look no further than the US residential mortgage markets to be reminded of the importance of this comment. But unfortunately and quite inconveniently for US financial and real asset markets is the fact that as humans, we’re "wired" incorrectly. In times of stress the fight or flight mechanism takes over. You can blame the cave men and women for that one. Hey, they don’t have any capital, do they? Just checking.
Fun With Funding
By ContraryInvestor.com | September 2008
Fun With Funding...You know that for some time now we have been preaching about what we believe to be one of the most important macro themes of the moment that is deleveraging. Important both for financial market and real world economic outcomes ahead. And, whether we like it or not, it's a theme that we believe will be with us for a good while to come.
The ultimate contraction of balance sheets in the financial, household and corporate sectors will be a process, not an event, with plenty of volatility along the way. For those attempting to call interim bottoms with respect to this phenomenon as we travel along this path, as we have already seen this year and will undoubtedly continue to see again, our only comment is good luck. In the much larger picture, it was this very multi-decade expansion of private sector balance sheets in aggregate that in large measure drove corporate profits over the longer cycle.
So now that deleveraging and balance sheet shrinkage is destined to play out ahead, all as part of the natural progression of a longer term credit market cycle, the trajectory or rate of change in corporate profit growth is in question. A major issue for the financial markets, especially equities. We believe the markets are just starting to wake up to this long cycle thematic realization.
But perhaps another major issue that is not being given enough attention is the fallout consequences due to the one balance sheet not destined to shrink during this process of deleveraging we have described, and that's the balance sheet of the Federal government. While the financial markets, the household sector and in good part the corporate sector engage in long overdue deleveraging, a natural offset to avoid either the reality or perception of collapse will be the continued expansion of the government's balance sheet.
And this process of expanding the Federal balance sheet, as you know full well, has already begun in full force. For now, the de facto bail out of the GSE's and the residential mortgage bail out bill are two poster child examples of this phenomenon at the exact point of acceleration. Even the auto manufacturers have their hands out. Will it be the airlines next? Unfortunately, we expect a lot more where this came from ahead. In one sense, the government really has no choice. This is the price all US taxpayers will bear for years of regulatory self induced blindness.
Could our current set of circumstances have been avoided? Of course, but regulatory oversight simply turned a blind eye in deference to the Wall Street and credit cycle driven profit motive. Let's face it, a lot of individuals became very wealthy during the prior credit cycle mania period, now clearly seen to be at the expense of the larger US taxpayer base. Privatizing profits and socializing risk. Sounds like Russia a decade ago, no? Welcome to the USSA. As Jim Grant recently opined, "where is the outrage?" We have no idea.
Enough of the ranting and raving. Let's get to the point. As this process plays out and the Federal government is continually forced to expand its balance sheet as an offset to the leverage contraction occurring largely throughout the remainder of the economy and domestic financial markets ahead, THE big question becomes, where will the funding for this balance sheet expansion come from and what will it ultimately cost?
A question near and dear to the hearts of US taxpayers everywhere, to say nothing of the investment community. This, we believe, is now and will continue to become one of the most important questions for our investment activities. We cannot take our eye off of this ball as we move ahead. Point blank, and we could not be more serious when we ask this, will the US face a funding problem at some point?
In at least starting to address this extremely important question, it's time to head east and turn back the clock a bit for a little exercise in compare and contrast. Although no two sets of circumstances are ever identical, the US today is facing a number of major cycle issues comparable to Japan a few decades back. Post the early 1990's Japanese equity bubble collapse came the beginning of a property bubble collapse a number years later that to this day is characterized by values well below what was experienced almost two decades ago.
An important comparative phenomenon throughout the 1990's was a Japanese banking system riddled with and literally overwhelmed by bad debt. A financial system immobilized. Sound familiar? In good measure, the official US banking system, and importantly the US shadow banking system, has begun traveling down a very similar path. We expect US financial system reconciliation character to ultimately differ from the historical circumstance of the Japanese banking system as the US system will indeed recognize these losses in a more timely manner, which hopefully will mean total cycle reconciliation will not be multi-decade in nature.
The US financial and broader corporate sectors will also act to cut costs (employees) mercilessly as reconciliation plays out. Another huge differentiation factor relative to the Japanese experience. Lastly, throughout the process of leverage reconciliation in the Japanese equity market, property markets and financial system in general over the last few decades, the Japanese government expanded their balance sheet as private and financial sector balance sheets contracted. In all sincerity, we believe the conceptual parallels are very importantly similar between the Japanese experience then and the current circumstance faced by the US at present.
But standing out like the proverbial sore thumb are differences related to our important issue in this discussion - the character and circumstances surrounding the forward funding of the expansion in the government balance sheet that necessarily needs to take place. It's here where this compare and contrast exercise diverges in a very meaningful manner. Getting right to the point, with the clear benefit and clarity of hindsight, Japan was able to fund government balance sheet expansion during its period of reconciliation from internal or domestic sources.
It was not beholden to and dependent upon outside funding sources. This is THE crucial difference between Japan then and the US now. As you can see in the chart below, Japan began its decent into systemic non-governmental balance sheet reconciliation with a national savings rate near 15% in 1990. As we've shown you many a time, for all intents and purposes the US savings rate is non-existent. Quite the contrast.
Once again, in the clarity of hindsight, the initial Japanese response to the equity and, several years later, property bubble peaks and subsequent busts was to lower interest rates. Classic monetary policy 101. As the decade of the 1990's wore on, the cost of what was accelerating government spending (expansion in the government balance sheet), was indeed in very good part supported and able to be accomplished by a lower interest rate structure.
As Japanese government funding needs expanded, the cost of that funding declined. Why? It was financed internally. Just what the doctor ordered. The following chart is a proxy for longer term interest rates in Japan over the identical period covered in the chart above.
The important point and true dissimilarity with the current funding need situation in the US is that back in the early part of the 1990's, Japan as a financial and economic system had the benefit of a very high internal savings rate. Savings that were able to be tapped even within the context of a declining interest rate environment to fund the needed counter cyclical expansion of the Japanese government balance sheet. Savers were able to purchase increased issuance of government bonds.
As is clear in looking at the two charts above, savings declined along with interest rates over the entire period of the 1990's. The last, again in hindsight, benefit to the Japanese at the time was that inflation was clearly not an issue. Deflation was the issue confronted by the Japanese economy. As such, Japanese investors/savers were accepting of an ever declining nominal interest rate structure as government spending accelerated as a necessary counterpoint to contraction in the remainder of the Japanese economy.
Fast forward to the present and circumstances faced by the US could not be more different. As mentioned, current domestic internal savings is lacking completely. Set against historical context, macro US interest rates are already low. It's hard to see how they could decline meaningfully from here as they already sit near half century lows. The ten year US Treasury yield today is literally identical to what was seen in 1959. The secular decline in interest rates in the US has already taken place. In 1990, the secular decline in interest rates was still to come for Japan.
In stark contrast to Japan in 1990, today the US is crucially dependent on foreign funding and will not be the forward beneficiary of a declining cost of funds. The only way in which the US could develop its own internal funding sources for the counter cyclical Federal balance sheet expansion that necessarily needs to take place ahead, and has essentially really already started to take place, is to have the domestic savings rate accelerate markedly. And the only possibility the US has of accomplishing something like this is if domestic consumption almost literally collapses.
Japan was able to fund both ongoing consumption AND government balance expansion throughout the 1990's specifically because it already had a very significant prior period build up in internal savings which could be tapped. The US has no such asset or flexibility in funding choice. In other words, the question now becomes who will be the incremental buyer at the margin of what is surely to be increased US government bond issuance ahead? Again, unless consumption literally collapses in the US in deference to increased savings, it will not be domestic buyers. This very circumstance leaves the US much more vulnerable than were the Japanese in addressing the process of credit cycle and asset value reconciliation.
I'll Gladly Pay You Tuesday For A Hamburger Today...Let's have a quick review look at US long term capital flows. Specifically, we want to look at net foreign purchases of US financial assets. This is where we are going to see the importance and magnitude of non-domestic funding sources to overall US capital/funding needs. In the following chart we are detailing by year net foreign buying of US financial assets.
As you can see, since the middle of the 1990's, the annual number has grown from a little over $200 billion to over $1 trillion as of the end of 2007. But we believe the more important line is the blue line that details annual net foreign purchases of US financial assets as a percentage of the year over year change in total US credit market debt outstanding. The annualized number as of the first quarter of this year is 31% of total US capital/credit market needs. Please remember that Japan's need for foreign capital in 1990 was essentially zero.
As you look at the above chart, we believe one very important additional characteristic needs to be kept in mind. Over the 1995 to 2007 period, the US experienced probably the apex of long term credit cycle mania in terms of nominal dollar credit creation. Both the US banking system and Wall Street driven shadow banking system were simply working overtime to provide "funding" to the greater US economy and financial system in general.
And yes, in part that "funding" was sold to the foreign community in terms of "investments" (debt securitizations). But the data you see above measures only foreign buying of Treasury debt, agency debt, corporate debt and equities. Plenty of foreign investors also provided investment funds for CDO's, CLO's, subprime debt packages, etc. But THE important point as we look forward is that "funding" provided by the US banking system and shadow banking system is now in serious question, if not an outright freeze. Just look at the uptick in the 1Q data in the prior chart for how meaningful foreign funding has become to the US.
Although foreign buying of US financial assets in nominal dollars is falling, there has been a big up tick in the magnitude of that funding as a percentage of total credit market growth. Bottom line being? Magnitude of foreign funding for total system US capital needs will become ever more important as the banking and shadow banking system continue on the path of balance sheet repair really over the years that lay in front of us. Again, a completely dichotomous circumstance relative to Japanese situation of a few decades back.
One last point of character that we believe deserves more than a bit attention and reflection as we look ahead and contemplate the very important need of foreign capital funding to the US during the process of balance sheet reconciliation the US system as a whole must live through. Given our major thematic contention that the US Federal government balance sheet must expand ahead as an offset to private sector balance sheet contraction, just who have been the key buyers of US Treasury debt at the margin recently? Let's have a quick peek.
| Major Holders Of US Treasuries (billions) | |||
| Country | Current Holdings As Of June 2008 | Holdings As Of May 2006 | Difference |
| Japan | $583.8 | $636.1 | $(52.3) |
| China | 503.8 | 324.5 | 179.3 |
| UK | 280.4 | 166.2 | 114.2 |
| OPEC | 170.4 | 99.7 | 70.7 |
| Brazil | 151.6 | 32.9 | 118.7 |
| Caribbean | 122.4 | 65.2 | 57.2 |
| Russia | 65.3 | Not Even On The List | 65.3(?) |
| Total Of Above | $1,877.7 | $1,324.6 | $553.1 |
| TOTAL Foreign Holders | $2,646.5 | $2,071.4 | $575.1 |
As you can see, we're looking back across the last two years for a bit of perspective. Traditionally the largest holder of US Treasuries has not been buying over the last few years, quite the opposite. It seems that in terms of Japan, they own enough, thank you. It's no surprise at all that China has been the largest incremental nominal dollar buyer of UST's over the last few years. Clearly the Chinese are recycling trade related dollars as well as managing their currency cross rate with the buck (printing renminbi, selling it and buying US Treasuries to support the dollar against the yuan) as their accumulation of UST's has zoomed skyward.
Maybe a bit surprisingly, the second largest buyer has been Brazil. As we mention in the chart, Russia has simply come out of nowhere to become the eighth largest owner of UST's at the present time. And as we have mentioned to you in the past, we are convinced that the UK numbers are really petro money (floating through London) in disguise. Total purchases by these folks seen in the table, inclusive of the Japanese sales, accounts for very close to 100% of the total foreign buying of US Treasuries over this period in totality.
You can see the punch line coming after looking at this table, right? Of course you can. It's the BRIC countries and petro money that has been THE key support to Treasury prices and suppressor of Treasury yields over the last two years. These are the very folks who have been "funding" the US in terms of our increasing reliance on foreign capital. So as we look ahead, we need to ask ourselves, will these very folks be so willing to continue funding the expanding US Federal balance sheet (through purchasing Treasuries), perhaps at a greatly accelerated rate as we move forward? Yes or no?
You don't need us to tell you that foreign current account surpluses in these countries that has allowed this reinvestment in Treasuries has been driven largely by two phenomenon. First is the US trade deficit in terms of consumer goods, and secondly it's commodity prices, especially as this applies to the price of energy. As you know, we have witnessed commodity and energy prices come down as of late.
Although we have not discussed this recently, the non-energy component of the US trade deficit has been contracting in recent months. No surprise at all as the US consumer remains under increasing pressure. So as we look forward, if indeed the global economy, necessarily inclusive of the BRICs, slows AND commodity prices remain relatively subdued, will the very important incremental buyers of US Treasuries seen in the table above have the financial wherewithal to continue funding US government capital needs? And potentially fund those needs at an accelerating pace?
We hope that by now you can see why we believe the forward US funding issue is so important. We believe the question mark is huge as to who will be willing to meet these funding needs during a period of greater US non-government sector balance sheet contraction. Will the US continue to be able to procure low nominal cost funding as its already very large balance sheet (liability) expands ever further by necessity in the coming period? The US faces a series of obstacles that were absent in the similar cycle reconciliation experience of Japan.
And THE primary obstacle and question mark is cost of funds. We're not preaching end of the world here. In fact, we're really not even questioning the ability of the US to procure continued foreign funding. THE critical issue looking ahead is COST OF FUNDING. At the outset we asked the question, will the US face a funding problem at some point, given that the US is beholden to foreign financing? It's the cost of funding that will be key to forward outcomes both in the real US economy and financial markets.
In the past we have suggested that perhaps THE most important chart we can think of is the long term chart of the 30 year US Treasury bond. What we have described above simply puts an exclamation point behind this thought. The following is nothing but an update of the non-logarithmic 30 year UST. To suggest the red rising bottoms trend line is important is a multi-decade understatement. Will the whole forward funding question ultimately be the straw that breaks the proverbial camel's back for the US bond market? Or in this case the back of the rising bottoms trend line?
Very quickly, we can't help but also show you the log chart. As we've done a pretty bad job of penciling in, you can see the arc in the log chart showing that from a very long term perspective, prices are "leveling out" after having accelerated for many years. It's the leveling out that is suggesting important long term change is occurring in relatively glacial, but noticeable, fashion.
You already know we'll be following the magnitude and character of foreign capital flows intensely as we move forward. We believe it will be one of the most important analytical exercises to investment decision making in the years ahead. Fun with funding ahead? Naw, it's probably not going to be much fun at all. In fact, quite the opposite.
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.
We Haven't Reached Bottom Yet
Buckle Up— We Haven't Reached Bottom Yet
By Steven Pearlstein | 17 October 2008
In the wake of an unprecedented, coordinated effort by governments around the world, the global financial meltdown has been contained, at least for the moment. Amazing what you can accomplish with a mere $2 trillion! If we're lucky, the panic phase of this crisis may be over— the hoarding of cash, the tidal waves of forced selling and indiscriminate liquidation. As the various initiatives are put in place over the coming weeks, credit should begin to flow more freely again through the financial system and out to the wider economy.
There is no guarantee that the panic won't return, but certainly there is nothing that makes it inevitable. What is significant is that governments have now established that they are willing and able to do whatever is necessary to prevent the financial system from spinning out of control, which is crucial to putting a floor under investor and consumer confidence.
Do not confuse this moment of calm with a stock market bottom or a sign that a 'serious' recession has been avoided.
We are in a bear market and will be for some time. That doesn't mean that you can't have good days or even long strings of good days— what traders refer to as bear market rallies. But for a bear market to become a bull market, there needs to be some evidence that corporate profits have bottomed out and are about to take off again in response to a pickup in the economy— and at this point we're a long way from that.
Nobody should pay much attention to those economic forecasts churned out by computer models. These models are like homing pigeons— the way they are programmed, they desperately want to get things back to "normal" as quickly as possible. And because the models are based on what has happened in the past, they are almost useless in predicting how the economy will respond to extreme events, like the bursting of the biggest credit bubble in history.
A better way to think about the economic forecast is that we are at the beginning of a transition period in which our collective spending as a nation will go from roughly 6 or 7 percent more than what we produce to closer to 2 or 3 percent less than we produce, to accommodate an aging population and the need to put away some savings. That's a huge swing, and although it won't necessarily come all at once and may be accomplished through different means, there is no way to accomplish this task by producing more. We're going to have to consume less, which means a temporary[!?!] reduction in our standard of living.
Put another way, we didn't just have a housing bubble and a corporate takeover bubble and a consumer credit bubble and a commodities bubble. In time, those asset bubbles led to the creation of a bubble economy, with too many airplanes and restaurant seats and hotel rooms, too many office buildings and shopping centers, too many investment banks and media outlets dependent on advertising revenue from car companies producing too many cars and, perhaps most of all, home builders producing way too many houses. Shrinking all that back to the 'right' size is what the coming recession is all about.
It would be easier if the United States were making this adjustment alone, while most of the rest of the world continued to grow and demand more goods and services from the world's biggest exporter. But unfortunately, the rest of the global economy is also slowing because so many other countries participated, directly or indirectly, in our bubble economy.
Nobody really knows how long or how deep this recession will be. What we do know is that recessions that follow the collapse of asset bubbles tend to last longer than average— and that this was the Mother Of All Asset Bubbles— just about all assets participated. So it's a fair assumption that this recession will last through 2009 and well into 2010.
Worse still, the recession will take an additional toll on an already weakened financial system [[and rapidly imploding housing market: normxxx]]. The next shoe to drop will be the hedge funds, which are posting worst-ever losses from investments, that have led to record withdrawals. By one estimate, as many as 1,000 hedge funds could close their doors before the shakeout is over, with very negative implications for those 'big' Wall Street banks that lent them all that money to 'leverage up'[[— those banks stand to lose $25 - $50 for every dollar an investor loses: normxxx]].
Then comes commercial real estate, where values are already plummeting, vacancy rates are rising and permanent financing is difficult to find. A collapse in this sector would be particularly bad news for regional banks and insurance companies. And let's not forget all those otherwise sound companies taken over by private-equity firms and management teams that proceeded to load them up with huge debt. A prolonged recession is almost certain to cause a larger-than-expected increase in the default rates on those "leveraged loans" and junk bonds used to finance those deals, and that will be another direct hit on the major Wall Street banks.
What does all this mean?
It means that, in terms of the stock market, the Dow Jones industrial average will find its way back down near 8,000 sometime in the next few months to see whether that is the new floor, or it is somewhere even below that. "Testing the lows," as the traders say on Wall Street. It means that we're in for a lousy economy for the next couple of years requiring another big economic stimulus plan from the federal government— one that needs to be focused less on tax cuts [[and the 'elite' financiers: normxxx]] and more on helping the unemployed, preventing cutbacks in vital state and local government services, and creating jobs directly through investments in infrastructure.
And it means that the financial sector is not out of the woods, that more financial institutions will get in trouble and that another round of 'rescue' efforts could well be needed.
This thing ain't going away any time soon.
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 Steven Pearlstein | 17 October 2008
In the wake of an unprecedented, coordinated effort by governments around the world, the global financial meltdown has been contained, at least for the moment. Amazing what you can accomplish with a mere $2 trillion! If we're lucky, the panic phase of this crisis may be over— the hoarding of cash, the tidal waves of forced selling and indiscriminate liquidation. As the various initiatives are put in place over the coming weeks, credit should begin to flow more freely again through the financial system and out to the wider economy.
There is no guarantee that the panic won't return, but certainly there is nothing that makes it inevitable. What is significant is that governments have now established that they are willing and able to do whatever is necessary to prevent the financial system from spinning out of control, which is crucial to putting a floor under investor and consumer confidence.
Do not confuse this moment of calm with a stock market bottom or a sign that a 'serious' recession has been avoided.
We are in a bear market and will be for some time. That doesn't mean that you can't have good days or even long strings of good days— what traders refer to as bear market rallies. But for a bear market to become a bull market, there needs to be some evidence that corporate profits have bottomed out and are about to take off again in response to a pickup in the economy— and at this point we're a long way from that.
Nobody should pay much attention to those economic forecasts churned out by computer models. These models are like homing pigeons— the way they are programmed, they desperately want to get things back to "normal" as quickly as possible. And because the models are based on what has happened in the past, they are almost useless in predicting how the economy will respond to extreme events, like the bursting of the biggest credit bubble in history.
A better way to think about the economic forecast is that we are at the beginning of a transition period in which our collective spending as a nation will go from roughly 6 or 7 percent more than what we produce to closer to 2 or 3 percent less than we produce, to accommodate an aging population and the need to put away some savings. That's a huge swing, and although it won't necessarily come all at once and may be accomplished through different means, there is no way to accomplish this task by producing more. We're going to have to consume less, which means a temporary[!?!] reduction in our standard of living.
Put another way, we didn't just have a housing bubble and a corporate takeover bubble and a consumer credit bubble and a commodities bubble. In time, those asset bubbles led to the creation of a bubble economy, with too many airplanes and restaurant seats and hotel rooms, too many office buildings and shopping centers, too many investment banks and media outlets dependent on advertising revenue from car companies producing too many cars and, perhaps most of all, home builders producing way too many houses. Shrinking all that back to the 'right' size is what the coming recession is all about.
It would be easier if the United States were making this adjustment alone, while most of the rest of the world continued to grow and demand more goods and services from the world's biggest exporter. But unfortunately, the rest of the global economy is also slowing because so many other countries participated, directly or indirectly, in our bubble economy.
Nobody really knows how long or how deep this recession will be. What we do know is that recessions that follow the collapse of asset bubbles tend to last longer than average— and that this was the Mother Of All Asset Bubbles— just about all assets participated. So it's a fair assumption that this recession will last through 2009 and well into 2010.
Worse still, the recession will take an additional toll on an already weakened financial system [[and rapidly imploding housing market: normxxx]]. The next shoe to drop will be the hedge funds, which are posting worst-ever losses from investments, that have led to record withdrawals. By one estimate, as many as 1,000 hedge funds could close their doors before the shakeout is over, with very negative implications for those 'big' Wall Street banks that lent them all that money to 'leverage up'[[— those banks stand to lose $25 - $50 for every dollar an investor loses: normxxx]].
Then comes commercial real estate, where values are already plummeting, vacancy rates are rising and permanent financing is difficult to find. A collapse in this sector would be particularly bad news for regional banks and insurance companies. And let's not forget all those otherwise sound companies taken over by private-equity firms and management teams that proceeded to load them up with huge debt. A prolonged recession is almost certain to cause a larger-than-expected increase in the default rates on those "leveraged loans" and junk bonds used to finance those deals, and that will be another direct hit on the major Wall Street banks.
What does all this mean?
It means that, in terms of the stock market, the Dow Jones industrial average will find its way back down near 8,000 sometime in the next few months to see whether that is the new floor, or it is somewhere even below that. "Testing the lows," as the traders say on Wall Street. It means that we're in for a lousy economy for the next couple of years requiring another big economic stimulus plan from the federal government— one that needs to be focused less on tax cuts [[and the 'elite' financiers: normxxx]] and more on helping the unemployed, preventing cutbacks in vital state and local government services, and creating jobs directly through investments in infrastructure.
And it means that the financial sector is not out of the woods, that more financial institutions will get in trouble and that another round of 'rescue' efforts could well be needed.
This thing ain't going away any time soon.
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, October 16, 2008
FDIC Chief Raps 'Rescue', aka, 'Bailout'
FDIC Chief Raps 'Rescue', aka, 'Bailout', For Helping Banks Over Homeowners
By Damian Paletta, WSJ | 16 October 2008
Click Here, or on the image, to see a larger, undistorted image.
FDIC Chairman Sheila Bair after Treasury Secretary Henry Paulson announced Tuesday a plan to take stakes in banks.
WASHINGTON— Federal Deposit Insurance Corp. Chairman Sheila Bair on Wednesday criticized the federal government for failing to take more aggressive steps to prevent Americans from losing their homes, highlighting a rift between her and other senior U.S. officials over terms of the $700 billion rescue package. The government plan will help stabilize financial markets but it doesn't do enough to address home foreclosures, the root of the crisis, she said in an interview with The Wall Street Journal. "Why there's been such a political focus on making sure we're not unduly helping borrowers but then we're providing all this massive assistance at the institutional level [[with few or NO strings attached: normxxx]], I don't understand it," she said. "It's been a frustration for me."
Ms. Bair didn't single out government officials or leaders, but her criticisms brushed on decisions made by both the Bush administration and Congress. For example, she described painstaking efforts made by lawmakers in crafting the federal Hope for Homeowners program to make sure it limited resale profits for borrowers who received affordable home loans. Ms. Bair, who was nominated by the White House and confirmed by the Senate in 2006, has frequently said government and industry efforts to prevent foreclosures aren't effective enough. She has long defended her focus on consumer protection as an important role for the FDIC, which is charged with protecting bank deposits.
Her comments Wednesday came amid growing tensions with key figures in resolving the financial crisis, notably Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, according to people familiar with the matter. Defenders of the Bush administration's rescue plan say tackling problems at the heart of the banking industry, in particular the loss of public confidence in financial institutions, is the government's primary responsibility. Officials say the freezing up of many financial markets threatens consumers and businesses by choking off the credit that is the lifeblood of the economy.
"We just did a massive bill that does a lot for homeowners," said White House spokesman Tony Fratto. "You are always going to have different views on some specifics on policy. But I think we're all trying to pull in the same direction." Ms. Bair's comments are expected to provide new fodder for critics of the government's response to the financial crisis, especially among those who say it has done too little to help families falling behind in their mortgage payments. "I support all the measures; I've been a part of all the measures that have been taken," she said. "But we're attacking it at the institution level as opposed to the borrower level, and it's the borrowers defaulting. That is what's causing the distress at the institution level. So why not tackle the borrower problem?"
Increasing Power
The FDIC has accumulated increasing power as it has become a central player in the government's rescue plan. In recent weeks, it has handled some of the largest bank failures in U.S. history, and now is charged with guaranteeing not only consumer bank deposits but new debt issued by companies. That move, announced Tuesday, was part of a broader series of efforts to get credit flowing again. Ms. Bair has argued the plan should have a bigger focus on homeowners, whose travails are at the heart of the current crisis. Until home prices stop falling, financial markets and the economy are unlikely to stabilize. "This agency, probably as much as anybody, given our genesis in the Depression, has a sense of purpose now perhaps more than any other agency," Ms. Bair said.
Former FDIC Chairman William Isaac said he agreed. "One of the things we need to do is slow down foreclosures," he said. "The chairman of the FDIC, who has to pick up a lot of the pieces when banks fail, is certainly entitled to make such a statement." Ms. Bair and the FDIC are central to the government's plan to stabilize the banking sector. The agency is temporarily offering unlimited deposit insurance for non-interest bearing accounts and guaranteeing roughly $1.4 trillion in new unsecured bank debt.
Negotiations over details of the deal proved tense, with U.S. officials rushing to catch up with their foreign counterparts and the U.S. stock markets reeling. Last week, Ms. Bair met Messrs. Paulson and Bernanke and the two men tried to convince her to offer the debt guarantees to a broad range of institutions and a wide range of debt, according to people familiar with the matter.
Ms. Bair, who declined to comment on the meeting, was initially resistant and eventually sought a formal legal opinion over whether such measures would be valid, according to people familiar with the matter. A day after the discussions, she sent a memo to the Treasury secretary and Fed chairman proposing a compromise. Rather than guarantee bank debts up to 100% of their value, she proposed guaranteeing them up to 90% of their value. The debt guarantees were eventually limited to 100% of unsecured debt issued by June 30 with three years or less of maturities.
Multiple Efforts
The federal government has launched multiple efforts since last year to help homeowners rework distressed mortgages. The programs, which have been largely voluntary for the mortgage industry, have done little to reverse the trend of rising foreclosures. Falling home prices in some areas have continued putting pressure on banks and homeowners. A giant program created by Congress this summer to help homeowners started just two weeks ago. The agency's growing role has given her views a more prominent platform after spending much of this year arguing her point from the sidelines.
Ms. Bair, a one-time Republican congressional candidate and children's book author, had suggested direct action to modify mortgages en masse before many other regulators in Washington. In April, she pitched a plan that would authorize the Treasury Department to make loans to as many as one million homeowners to minimize foreclosures. In July, after failed thrift IndyMac Bancorp Inc. reopened its doors under FDIC control, the agency said it would halt foreclosures on the mortgages it owned and would try to modify loans for struggling homeowners.
Her stance has led to tangles with government officials, including a disagreement with White House Chief of Staff Joshua Bolten, a longtime colleague. She wrote a newspaper article about using government money to help homeowners avoid foreclosure, without running it by the White House. Ms. Bair declined to comment on the exchange. "We are an independent agency, and we've been talking about this a long time," she said. Speaking on behalf of Mr. Bolten, the White House spokesman, Mr. Fratto, said: "Josh thinks very highly of Sheila, and thinks she's doing a terrific job at FDIC."
The public role of the FDIC, which was created during the Great Depression, comes and goes in waves. It had a huge presence during the savings-and-loan crisis of the 1980s and 1990s, and has re-emerged as a crucial player. Ms. Bair was one of the regulators who sat across the table from top bank executives Monday at the Treasury Department when the final details were unveiled.
"The decisions we're making are historic," she said. "How many times can you be in public service when you know that the decisions you make will go into history books? How will future generations judge what we're doing? I think about that a lot." Her term as chairman of the FDIC lasts until mid-2011 and her term on the FDIC board lasts until 2013. Ms. Bair said she would stay in her role if the new president wanted her to remain. If she leaves, she said, she would likely return to academia.
By Damian Paletta, WSJ | 16 October 2008
Click Here, or on the image, to see a larger, undistorted image.
FDIC Chairman Sheila Bair after Treasury Secretary Henry Paulson announced Tuesday a plan to take stakes in banks.
WASHINGTON— Federal Deposit Insurance Corp. Chairman Sheila Bair on Wednesday criticized the federal government for failing to take more aggressive steps to prevent Americans from losing their homes, highlighting a rift between her and other senior U.S. officials over terms of the $700 billion rescue package. The government plan will help stabilize financial markets but it doesn't do enough to address home foreclosures, the root of the crisis, she said in an interview with The Wall Street Journal. "Why there's been such a political focus on making sure we're not unduly helping borrowers but then we're providing all this massive assistance at the institutional level [[with few or NO strings attached: normxxx]], I don't understand it," she said. "It's been a frustration for me."
Ms. Bair didn't single out government officials or leaders, but her criticisms brushed on decisions made by both the Bush administration and Congress. For example, she described painstaking efforts made by lawmakers in crafting the federal Hope for Homeowners program to make sure it limited resale profits for borrowers who received affordable home loans. Ms. Bair, who was nominated by the White House and confirmed by the Senate in 2006, has frequently said government and industry efforts to prevent foreclosures aren't effective enough. She has long defended her focus on consumer protection as an important role for the FDIC, which is charged with protecting bank deposits.
Her comments Wednesday came amid growing tensions with key figures in resolving the financial crisis, notably Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, according to people familiar with the matter. Defenders of the Bush administration's rescue plan say tackling problems at the heart of the banking industry, in particular the loss of public confidence in financial institutions, is the government's primary responsibility. Officials say the freezing up of many financial markets threatens consumers and businesses by choking off the credit that is the lifeblood of the economy.
"We just did a massive bill that does a lot for homeowners," said White House spokesman Tony Fratto. "You are always going to have different views on some specifics on policy. But I think we're all trying to pull in the same direction." Ms. Bair's comments are expected to provide new fodder for critics of the government's response to the financial crisis, especially among those who say it has done too little to help families falling behind in their mortgage payments. "I support all the measures; I've been a part of all the measures that have been taken," she said. "But we're attacking it at the institution level as opposed to the borrower level, and it's the borrowers defaulting. That is what's causing the distress at the institution level. So why not tackle the borrower problem?"
Increasing Power
The FDIC has accumulated increasing power as it has become a central player in the government's rescue plan. In recent weeks, it has handled some of the largest bank failures in U.S. history, and now is charged with guaranteeing not only consumer bank deposits but new debt issued by companies. That move, announced Tuesday, was part of a broader series of efforts to get credit flowing again. Ms. Bair has argued the plan should have a bigger focus on homeowners, whose travails are at the heart of the current crisis. Until home prices stop falling, financial markets and the economy are unlikely to stabilize. "This agency, probably as much as anybody, given our genesis in the Depression, has a sense of purpose now perhaps more than any other agency," Ms. Bair said.
Former FDIC Chairman William Isaac said he agreed. "One of the things we need to do is slow down foreclosures," he said. "The chairman of the FDIC, who has to pick up a lot of the pieces when banks fail, is certainly entitled to make such a statement." Ms. Bair and the FDIC are central to the government's plan to stabilize the banking sector. The agency is temporarily offering unlimited deposit insurance for non-interest bearing accounts and guaranteeing roughly $1.4 trillion in new unsecured bank debt.
Negotiations over details of the deal proved tense, with U.S. officials rushing to catch up with their foreign counterparts and the U.S. stock markets reeling. Last week, Ms. Bair met Messrs. Paulson and Bernanke and the two men tried to convince her to offer the debt guarantees to a broad range of institutions and a wide range of debt, according to people familiar with the matter.
Ms. Bair, who declined to comment on the meeting, was initially resistant and eventually sought a formal legal opinion over whether such measures would be valid, according to people familiar with the matter. A day after the discussions, she sent a memo to the Treasury secretary and Fed chairman proposing a compromise. Rather than guarantee bank debts up to 100% of their value, she proposed guaranteeing them up to 90% of their value. The debt guarantees were eventually limited to 100% of unsecured debt issued by June 30 with three years or less of maturities.
Multiple Efforts
The federal government has launched multiple efforts since last year to help homeowners rework distressed mortgages. The programs, which have been largely voluntary for the mortgage industry, have done little to reverse the trend of rising foreclosures. Falling home prices in some areas have continued putting pressure on banks and homeowners. A giant program created by Congress this summer to help homeowners started just two weeks ago. The agency's growing role has given her views a more prominent platform after spending much of this year arguing her point from the sidelines.
Ms. Bair, a one-time Republican congressional candidate and children's book author, had suggested direct action to modify mortgages en masse before many other regulators in Washington. In April, she pitched a plan that would authorize the Treasury Department to make loans to as many as one million homeowners to minimize foreclosures. In July, after failed thrift IndyMac Bancorp Inc. reopened its doors under FDIC control, the agency said it would halt foreclosures on the mortgages it owned and would try to modify loans for struggling homeowners.
Her stance has led to tangles with government officials, including a disagreement with White House Chief of Staff Joshua Bolten, a longtime colleague. She wrote a newspaper article about using government money to help homeowners avoid foreclosure, without running it by the White House. Ms. Bair declined to comment on the exchange. "We are an independent agency, and we've been talking about this a long time," she said. Speaking on behalf of Mr. Bolten, the White House spokesman, Mr. Fratto, said: "Josh thinks very highly of Sheila, and thinks she's doing a terrific job at FDIC."
The public role of the FDIC, which was created during the Great Depression, comes and goes in waves. It had a huge presence during the savings-and-loan crisis of the 1980s and 1990s, and has re-emerged as a crucial player. Ms. Bair was one of the regulators who sat across the table from top bank executives Monday at the Treasury Department when the final details were unveiled.
"The decisions we're making are historic," she said. "How many times can you be in public service when you know that the decisions you make will go into history books? How will future generations judge what we're doing? I think about that a lot." Her term as chairman of the FDIC lasts until mid-2011 and her term on the FDIC board lasts until 2013. Ms. Bair said she would stay in her role if the new president wanted her to remain. If she leaves, she said, she would likely return to academia.
Wednesday, October 15, 2008
I Will Survive
Investment Strategy: "I Will Survive"
By Jeffrey Saut | 13 October 2008
I had so many requests to "write up" last Tuesday’s verbal strategy comments that I decided to do so this morning. Additionally, I am leaving on a speaking tour that was arranged some nine months ago and therefore these will likely be the only strategy comments for the week. And we begin this morning’s comments with a quote from an author, stock market historian, analyst, and portfolio manager, the brilliant Peter Bernstein:
Clearly we were wrong in thinking the lows for the year were "in" back in mid-September. That belief was driven by the sense that our elected leaders would rise to the level of statesmen and pass the original Paulson "Rescue Plan." Silly us, we should have known better, having lived inside the D.C. beltway. Since that ill-fated Monday (9/29/08) our strategy has been one of survival. "Survival" . . . yep, that’s the right word, for in markets like these the main theme is to survive!
Indeed, participants should remember that it is the second mouse that gets the cheese, not the first, since the first mouse often gets caught in the trap; or as Charles Dow lamented, "the successful investor has to be able to let two, out of every three, potential money making opportunities pass them by." Verily, those investors/traders that have attempted to pick the "bottom" since September 29th have for the most part lost money; and that caused us to recall Saut’s rule number four. To wit, "99% of the time, when the best bargains came, I had already spent my cash!"
This rule was formulated when I began buying banks/thrifts in January of 1982. By May of that year, I was out of money when the truly "give away" prices presented themselves in June, July, and August. With this rule in mind, for the past few weeks we have been telling accounts to be the second "mouse" and conserve cash until we are more convinced of a market bottom, for if we don’t bottom soon, we are likely in "crash mode."
Clearly the setup appears right for a bottom with our proprietary oversold indicator almost as oversold as it was at the 1974 stock market low, the Volatility Index (VIX/69.95) at fear levels not seen since the 1987 crash, our downside day-count sequence long of tooth at session 29 (selling stampedes rarely go more than 30 sessions), and the coupe de gráce— the "screamer" telling investors to sell everything last week. Ladies and gentlemen, the time to sell and raise cash was at last year’s end, not here. Of course, with the DJIA having just made a new all-time high in October of 2007, investors’ mindsets were clearly NOT in sell mode. That mindset was just as wrong back then as today’s ubiquitous wrong-footed mindset to selling everything. As our friend, portfolio manager Vitaliy Katsenelson, noted in the Denver Post:
Reinforcing Vitaliy’s comments was this quip from The Wall Street Journal (as paraphrased by me), "There are [currently] 876 companies trading below cash. In 1932 Benjamin Graham calculated there were 1 in 12 companies trading below cash, today there is 1 in 10." No wonder Warren Buffett is opening his "checkbook" and buying stocks. Of course the Oracle of Omaha is not only focusing on "franchise" types of companies, but situations where there is a substantial dividend yield. Clearly we agree with that strategy, for over the past year our main theme has been clean balance sheets, decent fundamentals, and a dividend yield.
Speaking to these points, Raymond James’ research department is publishing a report later today that highlights some of the best yield ideas compiled from our analysts. These ideas range from Master Limited Partnerships (MLPs), Real Estate Investment Trust (REITs), and convertible preferreds/bonds; to fixed income, closed-end funds and Exchange Traded Funds (ETFs). In addition to these ideas, we have our own "shopping list" using names like Eli Lilly (LLY/$31.36), and DuPont (DD/$33.40), which are positively rated by fundamental analysts at our correspondent research firm.
As for the equity markets, they became unglued last week as participants worried about Friday’s auction of Lehman Brothers’ Credit Default Swaps (CDSs), which ended up garnering only 8.625 cents on the dollar. The result left the DJIA down 18.15% on the week for its second worst weekly drubbing in its 112-year history (the worst was 18.47% the week of 7/22/33). Moreover, the senior index is down 40% over the trailing 12 months, causing one market maven to reflect on the second worst stock market crash in history.
The decline began in March of 1937 and ended 12 months later for a 386-day loss of 49.1%. It was a democratic decline where stocks, bonds, and commodities all crumbled, leaving investors nowhere to "hide" (sound familiar?). As now, the authorities tried many maneuvers to stem the slide (like lowering margin requirements, etc.), but it was all to no avail, and eventually the financial fiasco rolled into the real economy with the collapse of industrial production.
Typically such a downside skein goes something like this. First, you see analysts lowering their earnings estimates for companies. Second, you see a reduction in the inventories companies are carrying. And third, there is a collapse in industrial production, causing the economy to bottom-out and subsequently recover. Unfortunately, with analysts’ operating earnings’ estimates for 2009 on the S&P 500 at an absurdly high $104.15, we have not even completed stage one.
Nevertheless, given the aforementioned metrics, and the fact that last Monday, Tuesday, and Thursday all qualified as 90% Downside Days (a very rare weekly occurrence whereby points lost, and downside volume, were both skewed 90% to the downside), we think the equity markets have a high probability of bottoming this week. That sense is also reinforced by the MACD Indicator, which is at levels not seen since the November 2002 markets lows. The only question in our mind is how that bottom is formed. Does it come in the form of a "selling dry up," or does it come in the shape of a "crash?" However it occurs, chance favors the prepared mind and participants should ready their "shopping lists" and map out their strategy, for as Sun Tzu wrote 26 centuries ago, "Strategy without tactics is the slowest route to victory. "Tactics without strategy is the noise before defeat."
The call for this week: Appropriately, the National Debt Clock at Times Square ran out of digits this week while trying to record the country’s $10.2 trillion shortfall. A like amount of money has been eviscerated in the various markets recently, yet now is NOT the time to sell. As our friend Woody Dorsey of Market Semiotics notes in this week’s Barron’s, "This is not the time to sell. If possible, it is better to just watch and not act or even better, step away until Tuesday. Purgation can be over at any time and be followed by a reprieve rally as occurred after September 26, 2001." Indeed, be the second mouse that gets the cheese!
"Confidence Game"
October 6, 2008
"Confidence" is defined as, "faith or belief that one will act in a right, proper, or effective way." But, confidence can be fleeting. As Fed Governor Kevin Warsh stated:
Since the Ides of March, triggered by the collapse of Bear Stearns, confidence has clearly been waning. In September that waning turned into a "confidence crash" when the Treasury Department nationalized Mac and Mae. As stated in previous missives, it wasn’t that these GSEs didn’t need to be bailed out, they did, but it was the structure of said bailout that caused a confidence collapse.
Indeed, in previous bailouts the government has left an equity stub for shareholders, allowing them to participate in the survival, and eventual recovery, of the company (think: Chrysler, Lockheed, etc.). This time, however, the equity holders were wiped-out even after being told by Secretary Paulson that everything would be okay with Fannie (FNM/$1.34) and Freddie (FRE/$1.49), as well as their preferred shares. Ladies and gentlemen, the structure of this bailout is historic, as well as a game changer, causing international investors to ask us:
"Why would ANY rational investor commit capital to a situation whereby if things didn’t go the right way, the government might come in and totally wipe you out?!"
Clearly a valid question, and one we can’t answer. A few weeks later another unanswerable question was raised when the Federal Reserve decided to let one of its primary dealers, namely Lehman (LEHMQ/$0.17), go bankrupt. At the time the "spin" was that at $80 - $90 billion the cost of rescuing Lehman was just too large. But, during that very same week the government bailed out American International Group (AIG/$3.86) to the tune of $85 billion; AIG was not even a primary Treasury dealer!
The Lehman collapse triggered a sequence of credit market events that caused certain money market funds to suspend redemptions and/or redeem funds at less than 100 cents on the dollar. When the media trumpeted the money market machinations, it sparked a "run" on select banks, causing a domino effect that toppled a number of banks.
With the confidence crisis now in full regale, the politicians sprung into action spurred by the $700 billion Paulson Plan. The original rescue plan was written on three pages. It was subsequently rewritten by the House of Representatives to some 100 pages. Still, if the plan would have been passed last Monday, our sense is the DJIA would be 1000 to 2000 points higher than where it now resides.
However, our elected nimnods couldn’t rise to the status of "statesmen," but rather played politics and defeated the bill, leading to last Monday’s 777-point Dow Dive. Shocked by that loss of more than $1 trillion in stock market capitalization, the politicos quickly reconsidered their decision as rumors swirled of a newly crafted rescue plan. Those rumors drove a 485-point Dow Wow on Tuesday.
That plan materialized on Thursday with a 400-page rescue plan loaded with more than $100 billion of self-aggrandizing 'ornaments' (i.e. pork barrel "earmarks") for rum distillers, movie producers, wooden arrow manufactures, stock-car racers, etc., causing most of the electorate to lose any last vistage of confidence in our politicians amid cries, "Our elected ignoramuses should be ashamed!" With confidence in our financial institutions, our economy, and now our politicians in total shreds, we told accounts on Wednesday/Thursday that even if the re-crafted rescue plan was passed there would likely be only a brief rally in the equity markets followed by a subsequent sell-off.
In fact, we suggested that once the markets get to this stage, they don’t usually end without a "pornographic plunge" type of hour. Regrettably, we got the brief rally when the rescue plan passed on Friday, followed the sell-off, and this morning [Monday, October 6] it looks as if we will get the "pornographic plunge." Verily, what a difference a week makes, for if the original rescue plan had been passed, our sense is the equity markets would be substantially higher than where they currently are.
Yet in this business what you see is what you get and trading accounts should have been "stopped out" of remaining trading positions in last Monday’s meltdown, as noted in Tuesday’s verbal strategy comments. Clearly, we were wrong that the "lows" of two weeks ago (9/18/08) would prove to be "the lows" for the year. That error rests on the fact that we were also wrong in our assumption the initial rescue package would pass because it HAD to pass.
So where does this leave us? Well, last Monday’s "melt" (DJIA -777) turned out to be yet another 90% Downside Day (total point and volume was skewed 90% to the downside), while Tuesday’s triumph (DJIA +485) didn’t qualify as a 90% Upside Day. Moreover by the end of the week, out of the 98 sub-sectors in the S&P 500’s sector analysis, only one was positive on the week, namely the Nondurable Household Sector, on which we have been bullish. In the past such negative sector metrics have been associated with tradable stock market "lows."
Further, our proprietary oversold indicator is now more oversold than it has been in decades. Additionally, according to our "day count" thesis, we are now at day 24 in the downside skein. Historically, such skeins typically do not last more than 17 to 25 sessions before they exhaust themselves on the downside. Traders, therefore, should take heart that we are near a downside inflection point, unless this is indeed a "crash" (which we doubt).
Another metric worth watching, since this is a "lending crisis," is the Libor to Overnight Index Swap-spread (Libor/OIS-spread), which tagged an historic 276 basis points "wide" late last week. Any narrowing in this spread should be viewed as a positive since it would imply banks are beginning to lend to each other again.
The call for this week [October 6]: Well, we arrived at the office at 5:30 a.m. only to see the S&P 500 preopening futures down 33 points amid news out of Europe of an expanding banking/credit crisis. This morning’s swoon comes on the back of Friday’s Flop, which turned out to be yet another Dow Theory "sell signal" like the one we wrote about last November. Meanwhile, the three-month Libor/OIS-spread is at 295 bp "wide" and with the U.S., as well as Europe, going into a recession the environment is pretty dour. However, things "felt" equally dour post 9/11/01, yet the S&P 500 (SPX/1099.23) bottomed and rallied 24% over the following three months.
Consequently, once again I think we are approaching a downside inflection point; and, trading accounts should conduct themselves accordingly. More conservative accounts might wish to consider some of the closed-end funds eviscerated by this month’s hedge fund liquidation like: BlackRock Strategic Dividend (BDT/$9.95); BlackRock Enhanced Dividend Achievers (BDJ/$8.89); and Eaton Vance Tax-Advantaged Global Dividend Income (ETG/$13.79), all of which have blue-chip portfolios with yields; and, all of which are selling at substantial discounts to net asset value (NAV). Clearly, these recommendations are like buying the indices at a substantial discount, as well as in keeping with our dividend theme. As for this week [October 6], it’s kiss and tell time.
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 | 13 October 2008
|
I had so many requests to "write up" last Tuesday’s verbal strategy comments that I decided to do so this morning. Additionally, I am leaving on a speaking tour that was arranged some nine months ago and therefore these will likely be the only strategy comments for the week. And we begin this morning’s comments with a quote from an author, stock market historian, analyst, and portfolio manager, the brilliant Peter Bernstein:
|
Clearly we were wrong in thinking the lows for the year were "in" back in mid-September. That belief was driven by the sense that our elected leaders would rise to the level of statesmen and pass the original Paulson "Rescue Plan." Silly us, we should have known better, having lived inside the D.C. beltway. Since that ill-fated Monday (9/29/08) our strategy has been one of survival. "Survival" . . . yep, that’s the right word, for in markets like these the main theme is to survive!
Indeed, participants should remember that it is the second mouse that gets the cheese, not the first, since the first mouse often gets caught in the trap; or as Charles Dow lamented, "the successful investor has to be able to let two, out of every three, potential money making opportunities pass them by." Verily, those investors/traders that have attempted to pick the "bottom" since September 29th have for the most part lost money; and that caused us to recall Saut’s rule number four. To wit, "99% of the time, when the best bargains came, I had already spent my cash!"
This rule was formulated when I began buying banks/thrifts in January of 1982. By May of that year, I was out of money when the truly "give away" prices presented themselves in June, July, and August. With this rule in mind, for the past few weeks we have been telling accounts to be the second "mouse" and conserve cash until we are more convinced of a market bottom, for if we don’t bottom soon, we are likely in "crash mode."
Clearly the setup appears right for a bottom with our proprietary oversold indicator almost as oversold as it was at the 1974 stock market low, the Volatility Index (VIX/69.95) at fear levels not seen since the 1987 crash, our downside day-count sequence long of tooth at session 29 (selling stampedes rarely go more than 30 sessions), and the coupe de gráce— the "screamer" telling investors to sell everything last week. Ladies and gentlemen, the time to sell and raise cash was at last year’s end, not here. Of course, with the DJIA having just made a new all-time high in October of 2007, investors’ mindsets were clearly NOT in sell mode. That mindset was just as wrong back then as today’s ubiquitous wrong-footed mindset to selling everything. As our friend, portfolio manager Vitaliy Katsenelson, noted in the Denver Post:
|
Reinforcing Vitaliy’s comments was this quip from The Wall Street Journal (as paraphrased by me), "There are [currently] 876 companies trading below cash. In 1932 Benjamin Graham calculated there were 1 in 12 companies trading below cash, today there is 1 in 10." No wonder Warren Buffett is opening his "checkbook" and buying stocks. Of course the Oracle of Omaha is not only focusing on "franchise" types of companies, but situations where there is a substantial dividend yield. Clearly we agree with that strategy, for over the past year our main theme has been clean balance sheets, decent fundamentals, and a dividend yield.
Speaking to these points, Raymond James’ research department is publishing a report later today that highlights some of the best yield ideas compiled from our analysts. These ideas range from Master Limited Partnerships (MLPs), Real Estate Investment Trust (REITs), and convertible preferreds/bonds; to fixed income, closed-end funds and Exchange Traded Funds (ETFs). In addition to these ideas, we have our own "shopping list" using names like Eli Lilly (LLY/$31.36), and DuPont (DD/$33.40), which are positively rated by fundamental analysts at our correspondent research firm.
As for the equity markets, they became unglued last week as participants worried about Friday’s auction of Lehman Brothers’ Credit Default Swaps (CDSs), which ended up garnering only 8.625 cents on the dollar. The result left the DJIA down 18.15% on the week for its second worst weekly drubbing in its 112-year history (the worst was 18.47% the week of 7/22/33). Moreover, the senior index is down 40% over the trailing 12 months, causing one market maven to reflect on the second worst stock market crash in history.
The decline began in March of 1937 and ended 12 months later for a 386-day loss of 49.1%. It was a democratic decline where stocks, bonds, and commodities all crumbled, leaving investors nowhere to "hide" (sound familiar?). As now, the authorities tried many maneuvers to stem the slide (like lowering margin requirements, etc.), but it was all to no avail, and eventually the financial fiasco rolled into the real economy with the collapse of industrial production.
Typically such a downside skein goes something like this. First, you see analysts lowering their earnings estimates for companies. Second, you see a reduction in the inventories companies are carrying. And third, there is a collapse in industrial production, causing the economy to bottom-out and subsequently recover. Unfortunately, with analysts’ operating earnings’ estimates for 2009 on the S&P 500 at an absurdly high $104.15, we have not even completed stage one.
Nevertheless, given the aforementioned metrics, and the fact that last Monday, Tuesday, and Thursday all qualified as 90% Downside Days (a very rare weekly occurrence whereby points lost, and downside volume, were both skewed 90% to the downside), we think the equity markets have a high probability of bottoming this week. That sense is also reinforced by the MACD Indicator, which is at levels not seen since the November 2002 markets lows. The only question in our mind is how that bottom is formed. Does it come in the form of a "selling dry up," or does it come in the shape of a "crash?" However it occurs, chance favors the prepared mind and participants should ready their "shopping lists" and map out their strategy, for as Sun Tzu wrote 26 centuries ago, "Strategy without tactics is the slowest route to victory. "Tactics without strategy is the noise before defeat."
The call for this week: Appropriately, the National Debt Clock at Times Square ran out of digits this week while trying to record the country’s $10.2 trillion shortfall. A like amount of money has been eviscerated in the various markets recently, yet now is NOT the time to sell. As our friend Woody Dorsey of Market Semiotics notes in this week’s Barron’s, "This is not the time to sell. If possible, it is better to just watch and not act or even better, step away until Tuesday. Purgation can be over at any time and be followed by a reprieve rally as occurred after September 26, 2001." Indeed, be the second mouse that gets the cheese!
"Confidence Game"
October 6, 2008
"Confidence" is defined as, "faith or belief that one will act in a right, proper, or effective way." But, confidence can be fleeting. As Fed Governor Kevin Warsh stated:
|
Since the Ides of March, triggered by the collapse of Bear Stearns, confidence has clearly been waning. In September that waning turned into a "confidence crash" when the Treasury Department nationalized Mac and Mae. As stated in previous missives, it wasn’t that these GSEs didn’t need to be bailed out, they did, but it was the structure of said bailout that caused a confidence collapse.
Indeed, in previous bailouts the government has left an equity stub for shareholders, allowing them to participate in the survival, and eventual recovery, of the company (think: Chrysler, Lockheed, etc.). This time, however, the equity holders were wiped-out even after being told by Secretary Paulson that everything would be okay with Fannie (FNM/$1.34) and Freddie (FRE/$1.49), as well as their preferred shares. Ladies and gentlemen, the structure of this bailout is historic, as well as a game changer, causing international investors to ask us:
"Why would ANY rational investor commit capital to a situation whereby if things didn’t go the right way, the government might come in and totally wipe you out?!"
Clearly a valid question, and one we can’t answer. A few weeks later another unanswerable question was raised when the Federal Reserve decided to let one of its primary dealers, namely Lehman (LEHMQ/$0.17), go bankrupt. At the time the "spin" was that at $80 - $90 billion the cost of rescuing Lehman was just too large. But, during that very same week the government bailed out American International Group (AIG/$3.86) to the tune of $85 billion; AIG was not even a primary Treasury dealer!
The Lehman collapse triggered a sequence of credit market events that caused certain money market funds to suspend redemptions and/or redeem funds at less than 100 cents on the dollar. When the media trumpeted the money market machinations, it sparked a "run" on select banks, causing a domino effect that toppled a number of banks.
With the confidence crisis now in full regale, the politicians sprung into action spurred by the $700 billion Paulson Plan. The original rescue plan was written on three pages. It was subsequently rewritten by the House of Representatives to some 100 pages. Still, if the plan would have been passed last Monday, our sense is the DJIA would be 1000 to 2000 points higher than where it now resides.
However, our elected nimnods couldn’t rise to the status of "statesmen," but rather played politics and defeated the bill, leading to last Monday’s 777-point Dow Dive. Shocked by that loss of more than $1 trillion in stock market capitalization, the politicos quickly reconsidered their decision as rumors swirled of a newly crafted rescue plan. Those rumors drove a 485-point Dow Wow on Tuesday.
That plan materialized on Thursday with a 400-page rescue plan loaded with more than $100 billion of self-aggrandizing 'ornaments' (i.e. pork barrel "earmarks") for rum distillers, movie producers, wooden arrow manufactures, stock-car racers, etc., causing most of the electorate to lose any last vistage of confidence in our politicians amid cries, "Our elected ignoramuses should be ashamed!" With confidence in our financial institutions, our economy, and now our politicians in total shreds, we told accounts on Wednesday/Thursday that even if the re-crafted rescue plan was passed there would likely be only a brief rally in the equity markets followed by a subsequent sell-off.
In fact, we suggested that once the markets get to this stage, they don’t usually end without a "pornographic plunge" type of hour. Regrettably, we got the brief rally when the rescue plan passed on Friday, followed the sell-off, and this morning [Monday, October 6] it looks as if we will get the "pornographic plunge." Verily, what a difference a week makes, for if the original rescue plan had been passed, our sense is the equity markets would be substantially higher than where they currently are.
Yet in this business what you see is what you get and trading accounts should have been "stopped out" of remaining trading positions in last Monday’s meltdown, as noted in Tuesday’s verbal strategy comments. Clearly, we were wrong that the "lows" of two weeks ago (9/18/08) would prove to be "the lows" for the year. That error rests on the fact that we were also wrong in our assumption the initial rescue package would pass because it HAD to pass.
So where does this leave us? Well, last Monday’s "melt" (DJIA -777) turned out to be yet another 90% Downside Day (total point and volume was skewed 90% to the downside), while Tuesday’s triumph (DJIA +485) didn’t qualify as a 90% Upside Day. Moreover by the end of the week, out of the 98 sub-sectors in the S&P 500’s sector analysis, only one was positive on the week, namely the Nondurable Household Sector, on which we have been bullish. In the past such negative sector metrics have been associated with tradable stock market "lows."
Further, our proprietary oversold indicator is now more oversold than it has been in decades. Additionally, according to our "day count" thesis, we are now at day 24 in the downside skein. Historically, such skeins typically do not last more than 17 to 25 sessions before they exhaust themselves on the downside. Traders, therefore, should take heart that we are near a downside inflection point, unless this is indeed a "crash" (which we doubt).
Another metric worth watching, since this is a "lending crisis," is the Libor to Overnight Index Swap-spread (Libor/OIS-spread), which tagged an historic 276 basis points "wide" late last week. Any narrowing in this spread should be viewed as a positive since it would imply banks are beginning to lend to each other again.
The call for this week [October 6]: Well, we arrived at the office at 5:30 a.m. only to see the S&P 500 preopening futures down 33 points amid news out of Europe of an expanding banking/credit crisis. This morning’s swoon comes on the back of Friday’s Flop, which turned out to be yet another Dow Theory "sell signal" like the one we wrote about last November. Meanwhile, the three-month Libor/OIS-spread is at 295 bp "wide" and with the U.S., as well as Europe, going into a recession the environment is pretty dour. However, things "felt" equally dour post 9/11/01, yet the S&P 500 (SPX/1099.23) bottomed and rallied 24% over the following three months.
Consequently, once again I think we are approaching a downside inflection point; and, trading accounts should conduct themselves accordingly. More conservative accounts might wish to consider some of the closed-end funds eviscerated by this month’s hedge fund liquidation like: BlackRock Strategic Dividend (BDT/$9.95); BlackRock Enhanced Dividend Achievers (BDJ/$8.89); and Eaton Vance Tax-Advantaged Global Dividend Income (ETG/$13.79), all of which have blue-chip portfolios with yields; and, all of which are selling at substantial discounts to net asset value (NAV). Clearly, these recommendations are like buying the indices at a substantial discount, as well as in keeping with our dividend theme. As for this week [October 6], it’s kiss and tell time.
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.
Traders' Paradise; Investors Beware
Traders' Paradise, But Investors Beware
By Bennet Sedacca | 15 October 2008
How Did We Get into This Mess?
The question I get asked the most lately is "How on Earth did we get into this mess in the first place?" The answer, to me, plain and simple, is GREED. I have stated numerous times that markets world-wide, throughout centuries are dominated by individuals that cannot seem to shake the two simplest of emotions— fear and greed. Markets tend to overshoot in both directions as investors experience fear and greed and it is also why I live by the mantra of "Buy from the fearful and sell to the greedy."
In my own lifetime, I can trace the evolution of this greed back to a fateful day on May 1, 1975, otherwise known as May Day. Until that day, stock brokers charged a fixed commission on all transactions: There was no negotiation. In order to promote competition, the SEC ended the fixed schedule commissions which had been in place since the signing of the Buttonwood Agreement in 1792, the origins of the New York Stock Exchange. It is believed that over the next few weeks, commission rates dropped in half.
This was a wonderful event for investors, but a black day for Wall Street as one of their chief sources of revenue had now started down the road of deflation.
When I began my career as a retail stock broker in 1981, commission rates were still rather high and with interest rates in the mid to high teens: even bond commissions were very high. In fact, the very first bond trade of my career was a sale of $25,000 Sayreville, New Jersey School District municipal bonds, and I was paid a $750 commission (3%). As my career transitioned to institutional sales and trading, markets became more transparent and commission rates plummeted even further.
I recall my last transaction on the "sell side" in 1997 of $25 million of US Treasury Notes for a commission of $250. Talk about deflation. You can imagine that there is not much incentive to live in a world where you trade $25 million of securities, assume the inherent risks of a trade failing or a mistake being made, and only be paid $250 for that risk. This was no longer a wonderful way to spend my day.
Brokerage firms saw this trend developing and began transitioning the traditional stock broker into "financial advisors". Financial advisors would typically advise their clients to diversify their portfolios into various styles using a group of pre-screened investment managers in "wrap accounts." So rather than charge commissions on individual securities, 'managed portfolios' were concocted to 'diversify' their client’s holdings and still be able to charge fees as high as 3% per year.
As an aside, a couple of the wrap program trading desks were my clients while I was an institutional salesman and to be frank, I was never that impressed with what I saw being done for clients, which led me to becoming a Registered Investment Advisor in 1997. To me, the wrap programs looked an awful lot like a bunch of "mutual funds in drag"— except with a higher cost structure.
In addition, there were closed end funds which are just publicly traded mutual funds that raise a fixed amount of capital through an IPO and whose shares then trade as a stock on a listed exchange. But closed end funds carry commissions and fees that equate to as much as 7% percent of the initial Net Asset Value, which means that the investor paying the IPO price was left with about 93% of their money at work on Day 1.
On top of the 7% in fees, the funds were often leveraged by 50% in order to enhance the yield via sales of Auction Rate Preferred Stock (ARS), the very same vehicle that stranded so many investors earlier this year and that we commented on back in February and that so many brokerage firms have settled lawsuits on lately for vast amounts of money.
In June of last year, I highlighted the structure of closed end funds and the dangers that lurked. Now that these dangers have exposed themselves and the prices have gone through a massive correction, we are now finding many opportunities as my firm begins to buy a few select closed end funds that trade at as much as 40 percent discounts to NAV. We may be early, but buying distressed assets at huge yields at huge discounts to NAV is my cup of tea.
So I suppose one might say that I am slowly becoming more bullish in very specific areas and this is a matter of price, and because we have the cash when others sell more out of fear rather than due to a rational investment decision.
In summary, we can trace the lineage of this greed back much further than sub-prime even just in our lifetime, and even though it wasn’t the originator of that deadly sin known as greed, the brokerage industry helped mightily to get us to the point we now find ourselves in. The traditional revenue streams dried up and yields dropped far enough to entice [ordinarily prudent] investors, both individuals and institutions, to stretch for yield— to ignore prudence, and succumb to ever greater amounts of greed.
Where We Are Now
Once traditional Investment products fell by the wayside, investment banks found more and more esoteric vehicles to create and distribute. As the housing market entered its parabolic state, lending standards fell dramatically. In May 2005, banks were warned about their lending practices from the OCC (Office of the Comptroller of the Currency), Federal Reserve, FDIC, Office of Thrift Supervision and the National Credit Union Administration (Home Equity Lending Guidance to Banks). Despite this, many banks continued to lend in a reckless manner that ended with the bursting of the housing bubble.
If it were not bad enough that the loans were being made in the first place, Wall Street was then encouraged by the SEC in early 2006 to lever their balance sheets up to 30 - 40x shareholder equity, up from a more traditional 3 - 4x shareholder equity. And in this push to higher leverage, the world of esoteric CDO’s (Collateralized Debt Obligations) was born. With interest rates and credit spreads at historically low levels, it should come as no surprise that the underlying investments that were carved up into these CDO’s turned out to be horrible investments, even though they were huge sources of income for brokerage firms.
These practices would come back to bite brokers in their hind quarters. I'm not overly surprised to see that there are now exactly 0 investment banks left in this country that are not either part of a bank, converted into a bank, or have gone bankrupt. Greed is a horrible thing and it caught up to all of the investment banks. All one need do is take a look at a chart of the AMEX Securities Broker/Dealer Index to get a sense of just how bad it has been for this industry.
The typical CDO structure of an Asset-backed Securities deal is shown below. In its simplest form, a CDO takes the cash flows from the assets (let’s use sub-prime mortgages as the "assets" in this example) and distributes them in turn to the creditors of the structure on a preferred basis. The senior creditors receive all of the initial cash flow on a priority basis and therefore received the lowest yield. Lower priority creditors received the last amounts of an uncertain cash flow and were in turn given higher 'expected' returns. As the assets on the left side become progressively "impaired" (seriously delinquent, foreclosed or in receivership), the higher grade 'tranches' become impaired or downgraded and then lose value, in turn.
.jpg)
What you must remember is that when one takes the lowest quality assets, sub-prime mortgages, and then levers them up and carves them up for the sole benefit of the broker/dealer, greed can play a vicious role. Risk does not magically disappear, but instead is magnified and hidden in plain sight behind the elaborate structures. Unfortunately, when these structures stop working, there can be severe consequences for the owners of these securities; banks, brokers, hedge funds, mutual funds, credit unions, insurance companies etc. [[Apparently, those bond rating firms 'forgot'…: normxxx]]
The availability of these 'structures' to soak up low quality mortgages, enticed mortgage originators to make ever more lousy loans, and it should come as no surprise that issuance of these 'sub-prime' loans peaked in 2006 as a percentage of all mortgage originations. See a chart of Subprime Mortgage Originations as a % of Total Originations.
What followed all of the leverage and all of poor lending has been a spike in delinquency rates at both the subprime and prime level, as depicted in the chart below. This is now spreading to the commercial real estate space and to virtually all other areas of credit. See a chart of Mortgage Delinquency Rates.
The Credit Crisis is picking up steam— at a level that frightens even the most cautious investors (yours truly included). It seems that each weekend, we see more government intervention/intrusion/nationalization (as I write this, the UK has just been forced to inject liquidity into the Royal Bank of Scotland and HBOS, 2 of Britain’s largest banks). Whether it is Fannie Mae (FNM) and Freddie Mac (FRE) being nationalized at American taxpayers' expense, a $700 billion "bailout" of US banks, or Treasury Secretary Paulson suggesting he merely wants 'to inject' liquidity directly into US banks since banks will not do business with each other or lend, the 'solution' appears to be the same. Mr. Paulson apparently thinks that using the money of "We the People", without limit, will surely solve the problem. [[Several adages come to mind here: one is, "When you discover yourself at the bottom of a very deep pit, STOP DIGGING!" Also, "One definition of insanity is to repeat the same thing over and over but expect different results!: normxxx]]
Investors have needs. Dreyfus has solutions.
To be sure, this reeks of socialism and is 'delaying' the "business cycle" as I used to understand it. In my humble opinion, the longer the cycle is delayed, the longer it will take for confidence to be regained in the system, not the opposite, as government officials mistakenly seem to believe. After all, haven’t they noticed that every time they intervene/intrude, the credit markets and equity markets sell off right in their face? I certainly have noticed this, which leads me to the conclusion that intervention/intrusion is the absolute worst direction in which to go.
I say let markets be markets, let those that have made mistakes, suffer, and let those that have sinned, pay for their sins. But not with my money. I have spent my adult life, being prudent, saving money, investing wisely (most of the time) and being prudent with other people’s money. It should be my choice if I want to own impaired CDO’s, Fannie/Freddie/AIG and a bunch of impaired bank stocks, not the choice of the Fed, the Treasury, or the Congress.
Perhaps injecting equity into banks around the world will encourage them to lend, perhaps not. More likely, it may be the cushion necessary to allow banks to write down/write off assets and return to lending. The question that lurks in my mind is lend to whom? Consumers have over-consumed for so long that I wonder if freer credit will actually allow the economy to grow.
Why Have Stock Prices Fallen So Quickly?
The pace and severity of the decline in global stock prices has taken many by surprise. I have to admit that although I have maintained a target for the S & P 500 of 500 - 650 for quite a while now, I too have been a bit surprised by the speed at which the avalanche of stock prices has taken place. Then again, I have stated for months that we were living in a world of a Tale of Two Markets, where the credit markets were dying a slow death and the stock market proceeded merrily along in apparent ignorance. So it is my opinion that the stock market has simply caught up to the credit market, a market with little liquidity and loads of assets for sale due to mutual and hedge fund redemptions in addition to margin calls.
The chart below of the S&P 500 says it all— the uptrend from the 1982 was broken and support line after support line has been broken. It is said that, "in bear markets, support exists to be broken." The next line in the sand is in the 750 - 775 area, the area that was the bottom of the previous bear market low in late 2002— early 2003. But if that support line is broken, it brings into view the uptrend line from the 1974 low in the 500 - 550 area. I have no idea if this will occur or if markets will bounce from historically oversold conditions, but will stand by and watch. Please note that we do not currently maintain a position in the S&P, neither long nor short. See a Long Term Chart of S & P 500 in logarithmic terms.
Summary— What would it Take For Me to Turn Bullish on Equities?
When I consider the bullet points above, I think of the lyrics at the outset of this piece from my teenager days. I believe that the markets have not been permitted to react on their own in a traditional manner since at least 1997 and the later Greenspan days. Instead, we suffer from chronic dependence on a Fed/ECB/Treasury that [understandably] seems far more interested in asset price increases than they do in 'price stability' and normal business cycles.
Government officials have the fight of their life on their hands and it appears that each time they intervene it delays the ultimate economic outcome, and possibly even reduces the bottom in equity prices further than I can imagine. [[Currently, they are trying to staunch the hemorrhaging of tens to hundreds of trillions of dollars in "credit money" with sums that are still vastly below $10 trillion.: normxxx]]
The avalanche in equity prices has begun and when I think of the amount of assets that have been lost in so short a period of time, I shudder. Pension plans around the globe are now woefully underfunded. In addition, mutual funds and hedge fund redemptions will continue into year-end. See also, Global systemic crisis – End of 2008: Pension funds go off the rails
Earnings estimates will fall dramatically, unless credit spreads and LIBOR normalize quickly. We are possibly about to enter a period of substantially higher tax rates on high wage earners. Margin clerks are busy asking traders to sell, and mutual funds and 401(k) plans have liquidity and credit problems. Credit issues are now spreading to commercial and construction loans— not to mention rising credit card delinquencies. Unemployment is certain to increase further and many more jobs will be lost to emerging markets.
The point here is not to depress anyone or to sound like a spoil-sport. Instead, we must face the issues at hand and deal with them in a fashion that is not a constant "Band-Aid." The only way stocks could be deemed "cheap" here is if we believe the Wall Street S&P 500 estimates of 2008 estimates of $75 per share. We actually think 2009 earnings will come in around the $55-60 range, at best, which would suggest an index price target (if a "normal secular bear market bottom" P/E ratio of 8 to 10 times earnings) that coincides with the price on my S&P 500 chart of 500 — 600.
Bounces along the way are inevitable, but for a true bottom to be put in place, some more work needs to be done to the downside. This may be a trader's paradise, but investors beware.
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 Bennet Sedacca | 15 October 2008
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How Did We Get into This Mess?
The question I get asked the most lately is "How on Earth did we get into this mess in the first place?" The answer, to me, plain and simple, is GREED. I have stated numerous times that markets world-wide, throughout centuries are dominated by individuals that cannot seem to shake the two simplest of emotions— fear and greed. Markets tend to overshoot in both directions as investors experience fear and greed and it is also why I live by the mantra of "Buy from the fearful and sell to the greedy."
In my own lifetime, I can trace the evolution of this greed back to a fateful day on May 1, 1975, otherwise known as May Day. Until that day, stock brokers charged a fixed commission on all transactions: There was no negotiation. In order to promote competition, the SEC ended the fixed schedule commissions which had been in place since the signing of the Buttonwood Agreement in 1792, the origins of the New York Stock Exchange. It is believed that over the next few weeks, commission rates dropped in half.
This was a wonderful event for investors, but a black day for Wall Street as one of their chief sources of revenue had now started down the road of deflation.
When I began my career as a retail stock broker in 1981, commission rates were still rather high and with interest rates in the mid to high teens: even bond commissions were very high. In fact, the very first bond trade of my career was a sale of $25,000 Sayreville, New Jersey School District municipal bonds, and I was paid a $750 commission (3%). As my career transitioned to institutional sales and trading, markets became more transparent and commission rates plummeted even further.
I recall my last transaction on the "sell side" in 1997 of $25 million of US Treasury Notes for a commission of $250. Talk about deflation. You can imagine that there is not much incentive to live in a world where you trade $25 million of securities, assume the inherent risks of a trade failing or a mistake being made, and only be paid $250 for that risk. This was no longer a wonderful way to spend my day.
Brokerage firms saw this trend developing and began transitioning the traditional stock broker into "financial advisors". Financial advisors would typically advise their clients to diversify their portfolios into various styles using a group of pre-screened investment managers in "wrap accounts." So rather than charge commissions on individual securities, 'managed portfolios' were concocted to 'diversify' their client’s holdings and still be able to charge fees as high as 3% per year.
As an aside, a couple of the wrap program trading desks were my clients while I was an institutional salesman and to be frank, I was never that impressed with what I saw being done for clients, which led me to becoming a Registered Investment Advisor in 1997. To me, the wrap programs looked an awful lot like a bunch of "mutual funds in drag"— except with a higher cost structure.
In addition, there were closed end funds which are just publicly traded mutual funds that raise a fixed amount of capital through an IPO and whose shares then trade as a stock on a listed exchange. But closed end funds carry commissions and fees that equate to as much as 7% percent of the initial Net Asset Value, which means that the investor paying the IPO price was left with about 93% of their money at work on Day 1.
On top of the 7% in fees, the funds were often leveraged by 50% in order to enhance the yield via sales of Auction Rate Preferred Stock (ARS), the very same vehicle that stranded so many investors earlier this year and that we commented on back in February and that so many brokerage firms have settled lawsuits on lately for vast amounts of money.
In June of last year, I highlighted the structure of closed end funds and the dangers that lurked. Now that these dangers have exposed themselves and the prices have gone through a massive correction, we are now finding many opportunities as my firm begins to buy a few select closed end funds that trade at as much as 40 percent discounts to NAV. We may be early, but buying distressed assets at huge yields at huge discounts to NAV is my cup of tea.
So I suppose one might say that I am slowly becoming more bullish in very specific areas and this is a matter of price, and because we have the cash when others sell more out of fear rather than due to a rational investment decision.
In summary, we can trace the lineage of this greed back much further than sub-prime even just in our lifetime, and even though it wasn’t the originator of that deadly sin known as greed, the brokerage industry helped mightily to get us to the point we now find ourselves in. The traditional revenue streams dried up and yields dropped far enough to entice [ordinarily prudent] investors, both individuals and institutions, to stretch for yield— to ignore prudence, and succumb to ever greater amounts of greed.
Where We Are Now
Once traditional Investment products fell by the wayside, investment banks found more and more esoteric vehicles to create and distribute. As the housing market entered its parabolic state, lending standards fell dramatically. In May 2005, banks were warned about their lending practices from the OCC (Office of the Comptroller of the Currency), Federal Reserve, FDIC, Office of Thrift Supervision and the National Credit Union Administration (Home Equity Lending Guidance to Banks). Despite this, many banks continued to lend in a reckless manner that ended with the bursting of the housing bubble.
If it were not bad enough that the loans were being made in the first place, Wall Street was then encouraged by the SEC in early 2006 to lever their balance sheets up to 30 - 40x shareholder equity, up from a more traditional 3 - 4x shareholder equity. And in this push to higher leverage, the world of esoteric CDO’s (Collateralized Debt Obligations) was born. With interest rates and credit spreads at historically low levels, it should come as no surprise that the underlying investments that were carved up into these CDO’s turned out to be horrible investments, even though they were huge sources of income for brokerage firms.
These practices would come back to bite brokers in their hind quarters. I'm not overly surprised to see that there are now exactly 0 investment banks left in this country that are not either part of a bank, converted into a bank, or have gone bankrupt. Greed is a horrible thing and it caught up to all of the investment banks. All one need do is take a look at a chart of the AMEX Securities Broker/Dealer Index to get a sense of just how bad it has been for this industry.
.jpg){kind=link}
The typical CDO structure of an Asset-backed Securities deal is shown below. In its simplest form, a CDO takes the cash flows from the assets (let’s use sub-prime mortgages as the "assets" in this example) and distributes them in turn to the creditors of the structure on a preferred basis. The senior creditors receive all of the initial cash flow on a priority basis and therefore received the lowest yield. Lower priority creditors received the last amounts of an uncertain cash flow and were in turn given higher 'expected' returns. As the assets on the left side become progressively "impaired" (seriously delinquent, foreclosed or in receivership), the higher grade 'tranches' become impaired or downgraded and then lose value, in turn.
|
What you must remember is that when one takes the lowest quality assets, sub-prime mortgages, and then levers them up and carves them up for the sole benefit of the broker/dealer, greed can play a vicious role. Risk does not magically disappear, but instead is magnified and hidden in plain sight behind the elaborate structures. Unfortunately, when these structures stop working, there can be severe consequences for the owners of these securities; banks, brokers, hedge funds, mutual funds, credit unions, insurance companies etc. [[Apparently, those bond rating firms 'forgot'…: normxxx]]
The availability of these 'structures' to soak up low quality mortgages, enticed mortgage originators to make ever more lousy loans, and it should come as no surprise that issuance of these 'sub-prime' loans peaked in 2006 as a percentage of all mortgage originations. See a chart of Subprime Mortgage Originations as a % of Total Originations.
.jpg){kind=link}
What followed all of the leverage and all of poor lending has been a spike in delinquency rates at both the subprime and prime level, as depicted in the chart below. This is now spreading to the commercial real estate space and to virtually all other areas of credit. See a chart of Mortgage Delinquency Rates.
.jpg){kind=link}
The Credit Crisis is picking up steam— at a level that frightens even the most cautious investors (yours truly included). It seems that each weekend, we see more government intervention/intrusion/nationalization (as I write this, the UK has just been forced to inject liquidity into the Royal Bank of Scotland and HBOS, 2 of Britain’s largest banks). Whether it is Fannie Mae (FNM) and Freddie Mac (FRE) being nationalized at American taxpayers' expense, a $700 billion "bailout" of US banks, or Treasury Secretary Paulson suggesting he merely wants 'to inject' liquidity directly into US banks since banks will not do business with each other or lend, the 'solution' appears to be the same. Mr. Paulson apparently thinks that using the money of "We the People", without limit, will surely solve the problem. [[Several adages come to mind here: one is, "When you discover yourself at the bottom of a very deep pit, STOP DIGGING!" Also, "One definition of insanity is to repeat the same thing over and over but expect different results!: normxxx]]
Investors have needs. Dreyfus has solutions.
To be sure, this reeks of socialism and is 'delaying' the "business cycle" as I used to understand it. In my humble opinion, the longer the cycle is delayed, the longer it will take for confidence to be regained in the system, not the opposite, as government officials mistakenly seem to believe. After all, haven’t they noticed that every time they intervene/intrude, the credit markets and equity markets sell off right in their face? I certainly have noticed this, which leads me to the conclusion that intervention/intrusion is the absolute worst direction in which to go.
I say let markets be markets, let those that have made mistakes, suffer, and let those that have sinned, pay for their sins. But not with my money. I have spent my adult life, being prudent, saving money, investing wisely (most of the time) and being prudent with other people’s money. It should be my choice if I want to own impaired CDO’s, Fannie/Freddie/AIG and a bunch of impaired bank stocks, not the choice of the Fed, the Treasury, or the Congress.
Perhaps injecting equity into banks around the world will encourage them to lend, perhaps not. More likely, it may be the cushion necessary to allow banks to write down/write off assets and return to lending. The question that lurks in my mind is lend to whom? Consumers have over-consumed for so long that I wonder if freer credit will actually allow the economy to grow.
Why Have Stock Prices Fallen So Quickly?
The pace and severity of the decline in global stock prices has taken many by surprise. I have to admit that although I have maintained a target for the S & P 500 of 500 - 650 for quite a while now, I too have been a bit surprised by the speed at which the avalanche of stock prices has taken place. Then again, I have stated for months that we were living in a world of a Tale of Two Markets, where the credit markets were dying a slow death and the stock market proceeded merrily along in apparent ignorance. So it is my opinion that the stock market has simply caught up to the credit market, a market with little liquidity and loads of assets for sale due to mutual and hedge fund redemptions in addition to margin calls.
The chart below of the S&P 500 says it all— the uptrend from the 1982 was broken and support line after support line has been broken. It is said that, "in bear markets, support exists to be broken." The next line in the sand is in the 750 - 775 area, the area that was the bottom of the previous bear market low in late 2002— early 2003. But if that support line is broken, it brings into view the uptrend line from the 1974 low in the 500 - 550 area. I have no idea if this will occur or if markets will bounce from historically oversold conditions, but will stand by and watch. Please note that we do not currently maintain a position in the S&P, neither long nor short. See a Long Term Chart of S & P 500 in logarithmic terms.
Summary— What would it Take For Me to Turn Bullish on Equities?
- Credit markets need to normalize and spreads tighten.
- Allow markets to function without government intervention/intrusion.
- Equity valuations need to become oversold, not just stock prices.
- A return to ‘Social Darwinism’— allow the weak to fail.
- A rise in the personal savings rate, even at the expense of recession.
- Leverage reduced at the corporate and consumer level.
- Presidential cycle to reach a low (October 2010).
- LIBOR to normalize.
- Most importantly, we need time to heal the market, not just price.
When I consider the bullet points above, I think of the lyrics at the outset of this piece from my teenager days. I believe that the markets have not been permitted to react on their own in a traditional manner since at least 1997 and the later Greenspan days. Instead, we suffer from chronic dependence on a Fed/ECB/Treasury that [understandably] seems far more interested in asset price increases than they do in 'price stability' and normal business cycles.
Government officials have the fight of their life on their hands and it appears that each time they intervene it delays the ultimate economic outcome, and possibly even reduces the bottom in equity prices further than I can imagine. [[Currently, they are trying to staunch the hemorrhaging of tens to hundreds of trillions of dollars in "credit money" with sums that are still vastly below $10 trillion.: normxxx]]
The avalanche in equity prices has begun and when I think of the amount of assets that have been lost in so short a period of time, I shudder. Pension plans around the globe are now woefully underfunded. In addition, mutual funds and hedge fund redemptions will continue into year-end. See also, Global systemic crisis – End of 2008: Pension funds go off the rails
Earnings estimates will fall dramatically, unless credit spreads and LIBOR normalize quickly. We are possibly about to enter a period of substantially higher tax rates on high wage earners. Margin clerks are busy asking traders to sell, and mutual funds and 401(k) plans have liquidity and credit problems. Credit issues are now spreading to commercial and construction loans— not to mention rising credit card delinquencies. Unemployment is certain to increase further and many more jobs will be lost to emerging markets.
The point here is not to depress anyone or to sound like a spoil-sport. Instead, we must face the issues at hand and deal with them in a fashion that is not a constant "Band-Aid." The only way stocks could be deemed "cheap" here is if we believe the Wall Street S&P 500 estimates of 2008 estimates of $75 per share. We actually think 2009 earnings will come in around the $55-60 range, at best, which would suggest an index price target (if a "normal secular bear market bottom" P/E ratio of 8 to 10 times earnings) that coincides with the price on my S&P 500 chart of 500 — 600.
Bounces along the way are inevitable, but for a true bottom to be put in place, some more work needs to be done to the downside. This may be a trader's paradise, but investors beware.
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.
Commentary & Community Chat
Commentary & Community Chat
By Bill Cara | 15 October 2008
The airwaves are now full of chatter. Everybody in the media, it seems, has a position on the economy and direction of the market. That’s good, but how much of it makes sense is a different matter. Let me just say that the most devious schemes in the history of the world share common elements with those most noble. One thing I know is that most of the sales talk— pro or con, honest or deceitful— has an element of truth, which pushes and pulls the owners and managers of capital such that extreme volatility is the result. What you all need then is a sniffer that filters out the nonsense and, whether contrived or random, the noise of the market.
The deeper you stick your nose into it, the more you will smell some good, some bad. You will need to have full control of your senses to help you work though to the conclusions that will help you make decisions that prove to be successful in the time frames that are important to you. However, the nonsense and noise out there is what I know holds you back. My point today is that you need to calm down in a world gone crazy. Tough maybe— but you can do it.
I have turned bullish, generally, but this community also recognizes my [ongoing] concerns and cautious approach. I have warned that the consumer sector [all parts] will continue to suffer from the "no tickee" syndrome. That’s what happens when job layoffs and credit withdrawals and underwater mortgages become primary issues in the lives of tens of millions of people who recently were being told, "… you are richer than you think". Until the people start to look ahead to the day when they will come home with tickee, traders have to avoid the consumer sectors.
No tickee means no new car, washing machine, wardrobe, computer or vacation in Bahamas. It means too many people need social services like food banks to help them make it through the week, wondering how they’ll make it next week. Banks will not be much help to the people at this point, because they are already working overtime merely to collect payments on existing loans so they won’t have to then try to collect the assets that were put up as security for those loans. Until this crisis passes, it’s also not a good time to be investing in the banks. Not yet at least, but trillions of dollars, euros, pounds, yen, and yuan being transferred from government to banks makes sense, looking forward.
The headlines today ring out "Global recession fears". But, yes, I am bullish, overall. Unabashedly so.
Prices have fallen to a point where long-term values are all over the board. I looked at a debt-free company last night that has much more than twice the cash per share in its treasury than the last price of its stock on the market. What’s wrong with that picture other than we’re at the transition from Bear to Bull, and the Bear has taken that stock down -90% from its 52-week high.
I see lots of that kind of thing. I always do at the end of Bear markets. It’s also a time I hear that business will never recover; that the economy will fall deeper into a massive recession, yada, yada.
Yes, times are tough, and will be tough for a while yet, but there are good values on the market, and smart traders are snapping them up. Do you recall a couple years ago that I opined here that the market would be close to the cycle bottom when Warren Buffett started to invest the mega-billions of the cash at Berkshire-Hathaway? This value seeker has recently invested mega billions.
Most, but not all, the values in the market today are in the energy, basic materials, industrials and technology sectors. BUT, we need to avoid the companies in these sectors that have high debt and those that rely on high consumer turnover to meet their debt service.
If you happen to like financial services, and would look at a Canadian company that one of my colleagues likes a lot, have a look at Home Capital Group Inc (HCG.TO C$26.45) on the Toronto Exchange. This is a financial services company that is prudently managed through thick and thin. There are many fundamentally sound companies like this in Canada and the US. You just need to do your "home" work to find them.
Tough times ahead, yes! But there is relief on the way from governments around the world, the likes of which the world has never seen in its history. There is also going to be regulation that will turn the present system on its head. Finally, the reflation policies of governments today will mitigate the damage done by Humungous Bank & Broker and will lead to economic recovery tomorrow. [[Eventually; some time next year, probably. But first we have to salve over tens and even hundreds of trillions of dollars of derivatives fast 'evaporating' from the system with CB infusions that MERELY amount to $trillions!: normxxx]]
I no longer see the glass as half empty. I did that when going through the market topping process one and two years ago. Now that prices have plummeted, and great values abound, I see the glass half full.
You too need to consider the possibility. Have a good day.
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 Cara | 15 October 2008
The airwaves are now full of chatter. Everybody in the media, it seems, has a position on the economy and direction of the market. That’s good, but how much of it makes sense is a different matter. Let me just say that the most devious schemes in the history of the world share common elements with those most noble. One thing I know is that most of the sales talk— pro or con, honest or deceitful— has an element of truth, which pushes and pulls the owners and managers of capital such that extreme volatility is the result. What you all need then is a sniffer that filters out the nonsense and, whether contrived or random, the noise of the market.
The deeper you stick your nose into it, the more you will smell some good, some bad. You will need to have full control of your senses to help you work though to the conclusions that will help you make decisions that prove to be successful in the time frames that are important to you. However, the nonsense and noise out there is what I know holds you back. My point today is that you need to calm down in a world gone crazy. Tough maybe— but you can do it.
I have turned bullish, generally, but this community also recognizes my [ongoing] concerns and cautious approach. I have warned that the consumer sector [all parts] will continue to suffer from the "no tickee" syndrome. That’s what happens when job layoffs and credit withdrawals and underwater mortgages become primary issues in the lives of tens of millions of people who recently were being told, "… you are richer than you think". Until the people start to look ahead to the day when they will come home with tickee, traders have to avoid the consumer sectors.
No tickee means no new car, washing machine, wardrobe, computer or vacation in Bahamas. It means too many people need social services like food banks to help them make it through the week, wondering how they’ll make it next week. Banks will not be much help to the people at this point, because they are already working overtime merely to collect payments on existing loans so they won’t have to then try to collect the assets that were put up as security for those loans. Until this crisis passes, it’s also not a good time to be investing in the banks. Not yet at least, but trillions of dollars, euros, pounds, yen, and yuan being transferred from government to banks makes sense, looking forward.
The headlines today ring out "Global recession fears". But, yes, I am bullish, overall. Unabashedly so.
Prices have fallen to a point where long-term values are all over the board. I looked at a debt-free company last night that has much more than twice the cash per share in its treasury than the last price of its stock on the market. What’s wrong with that picture other than we’re at the transition from Bear to Bull, and the Bear has taken that stock down -90% from its 52-week high.
I see lots of that kind of thing. I always do at the end of Bear markets. It’s also a time I hear that business will never recover; that the economy will fall deeper into a massive recession, yada, yada.
Yes, times are tough, and will be tough for a while yet, but there are good values on the market, and smart traders are snapping them up. Do you recall a couple years ago that I opined here that the market would be close to the cycle bottom when Warren Buffett started to invest the mega-billions of the cash at Berkshire-Hathaway? This value seeker has recently invested mega billions.
Most, but not all, the values in the market today are in the energy, basic materials, industrials and technology sectors. BUT, we need to avoid the companies in these sectors that have high debt and those that rely on high consumer turnover to meet their debt service.
If you happen to like financial services, and would look at a Canadian company that one of my colleagues likes a lot, have a look at Home Capital Group Inc (HCG.TO C$26.45) on the Toronto Exchange. This is a financial services company that is prudently managed through thick and thin. There are many fundamentally sound companies like this in Canada and the US. You just need to do your "home" work to find them.
Tough times ahead, yes! But there is relief on the way from governments around the world, the likes of which the world has never seen in its history. There is also going to be regulation that will turn the present system on its head. Finally, the reflation policies of governments today will mitigate the damage done by Humungous Bank & Broker and will lead to economic recovery tomorrow. [[Eventually; some time next year, probably. But first we have to salve over tens and even hundreds of trillions of dollars of derivatives fast 'evaporating' from the system with CB infusions that MERELY amount to $trillions!: normxxx]]
I no longer see the glass as half empty. I did that when going through the market topping process one and two years ago. Now that prices have plummeted, and great values abound, I see the glass half full.
You too need to consider the possibility. Have a good day.
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.
Commentary & Community Chat
Commentary & Community Chat
By Bill Cara | 15 October 2008
The airwaves are now full of chatter. Everybody in the media, it seems, has a position on the economy and direction of the market. That’s good, but how much of it makes sense is a different matter. Let me just say that the most devious schemes in the history of the world share common elements with those most noble. One thing I know is that most of the sales talk— pro or con, honest or deceitful— has an element of truth, which pushes and pulls the owners and managers of capital such that extreme volatility is the result. What you all need then is a sniffer that filters out the nonsense and, whether contrived or random, the noise of the market.
The deeper you stick your nose into it, the more you will smell some good, some bad. You will need to have full control of your senses to help you work though to the conclusions that will help you make decisions that prove to be successful in the time frames that are important to you. However, the nonsense and noise out there is what I know holds you back. My point today is that you need to calm down in a world gone crazy. Tough maybe— but you can do it.
I have turned bullish, generally, but this community also recognizes my concerns and cautious approach. I have warned that the consumer sector will continue to suffer from the "no tickee" syndrome. That’s what happens when job layoffs and credit withdrawals and underwater mortgages become primary issues in the lives of tens of millions of people who recently were being told, "… you are richer than you think". Until the people start to look ahead to the day when they will come home with tickee, traders have to avoid the consumer sectors.
No tickee means no new car, washing machine, wardrobe, computer or vacation in Bahamas. It means too many people need social services like food banks to help them make it through this week wondering how they’ll make it next week. Banks will not be much help to the people at this point, because they are already working overtime to collect payments on existing loans so they won’t have to then try to collect the assets that were put up as security for those loans. Until this crisis passes, it’s also not a good time to be investing in the banks. Not yet at least, but trillions of dollars, euros, pounds, yen, and yuan being transferred from government to banks makes sense, look forward.
The headlines today ring out "Global recession fears". But, yes, I am bullish, overall. Unabashedly so.
Prices have fallen to a point where long-term values are all over the board. I looked at a debt-free company last night that has much more than twice the cash per share in its treasury than the last price of its stock on the market. What’s wrong with that picture other than we’re at the transition from Bear to Bull, and the Bear has taken that stock down -90% from its 52-week high.
I see lots of that kind of thing. I always do at the end of Bear markets. It’s also a time I hear that business will never recover; that the economy will fall deeper into a massive recession, yada, yada.
Yes, times are tough, and will be tough for a while yet, but there are good values on the market, and smart traders are snapping them up. Do you recall a couple years ago that I opined here that the market would be close to the cycle bottom when Warren Buffett started to invest the mega-billions of the cash at Berkshire-Hathaway? This value seeker has recently invested mega billions.
Most, but not all, the values in the market today are in the energy, basic materials, industrials and technology sectors. But, we need to avoid the companies in these sectors that have high debt and those that rely on high consumer turnover to meet their debt service.
If you happen to like financial services, and would look at a Canadian company that one of my colleagues likes a lot, have a look at Home Capital Group Inc (HCG.TO C$26.45) on the Toronto Exchange. This is a financial services company that is prudently managed through thick and thin. There are many fundamentally sound companies like this in Canada and the US. You just need to do your "home" work to find them.
Tough times ahead, yes! But there is relief on the way from governments around the world, the likes of which the world has never seen in its history. There is also going to be regulation that will turn the present system on its head. Finally, the reflation policies of governments today will mitigate the damage done by Humungous Bank & Broker and will lead to economic recovery tomorrow.
I no longer see the glass as half empty. I did that when going through the market topping process one and two years ago. Now that prices have plummeted, and great values abound, I see the glass half full.
You too need to consider the possibility. Have a good day.
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 Cara | 15 October 2008
The airwaves are now full of chatter. Everybody in the media, it seems, has a position on the economy and direction of the market. That’s good, but how much of it makes sense is a different matter. Let me just say that the most devious schemes in the history of the world share common elements with those most noble. One thing I know is that most of the sales talk— pro or con, honest or deceitful— has an element of truth, which pushes and pulls the owners and managers of capital such that extreme volatility is the result. What you all need then is a sniffer that filters out the nonsense and, whether contrived or random, the noise of the market.
The deeper you stick your nose into it, the more you will smell some good, some bad. You will need to have full control of your senses to help you work though to the conclusions that will help you make decisions that prove to be successful in the time frames that are important to you. However, the nonsense and noise out there is what I know holds you back. My point today is that you need to calm down in a world gone crazy. Tough maybe— but you can do it.
I have turned bullish, generally, but this community also recognizes my concerns and cautious approach. I have warned that the consumer sector will continue to suffer from the "no tickee" syndrome. That’s what happens when job layoffs and credit withdrawals and underwater mortgages become primary issues in the lives of tens of millions of people who recently were being told, "… you are richer than you think". Until the people start to look ahead to the day when they will come home with tickee, traders have to avoid the consumer sectors.
No tickee means no new car, washing machine, wardrobe, computer or vacation in Bahamas. It means too many people need social services like food banks to help them make it through this week wondering how they’ll make it next week. Banks will not be much help to the people at this point, because they are already working overtime to collect payments on existing loans so they won’t have to then try to collect the assets that were put up as security for those loans. Until this crisis passes, it’s also not a good time to be investing in the banks. Not yet at least, but trillions of dollars, euros, pounds, yen, and yuan being transferred from government to banks makes sense, look forward.
The headlines today ring out "Global recession fears". But, yes, I am bullish, overall. Unabashedly so.
Prices have fallen to a point where long-term values are all over the board. I looked at a debt-free company last night that has much more than twice the cash per share in its treasury than the last price of its stock on the market. What’s wrong with that picture other than we’re at the transition from Bear to Bull, and the Bear has taken that stock down -90% from its 52-week high.
I see lots of that kind of thing. I always do at the end of Bear markets. It’s also a time I hear that business will never recover; that the economy will fall deeper into a massive recession, yada, yada.
Yes, times are tough, and will be tough for a while yet, but there are good values on the market, and smart traders are snapping them up. Do you recall a couple years ago that I opined here that the market would be close to the cycle bottom when Warren Buffett started to invest the mega-billions of the cash at Berkshire-Hathaway? This value seeker has recently invested mega billions.
Most, but not all, the values in the market today are in the energy, basic materials, industrials and technology sectors. But, we need to avoid the companies in these sectors that have high debt and those that rely on high consumer turnover to meet their debt service.
If you happen to like financial services, and would look at a Canadian company that one of my colleagues likes a lot, have a look at Home Capital Group Inc (HCG.TO C$26.45) on the Toronto Exchange. This is a financial services company that is prudently managed through thick and thin. There are many fundamentally sound companies like this in Canada and the US. You just need to do your "home" work to find them.
Tough times ahead, yes! But there is relief on the way from governments around the world, the likes of which the world has never seen in its history. There is also going to be regulation that will turn the present system on its head. Finally, the reflation policies of governments today will mitigate the damage done by Humungous Bank & Broker and will lead to economic recovery tomorrow.
I no longer see the glass as half empty. I did that when going through the market topping process one and two years ago. Now that prices have plummeted, and great values abound, I see the glass half full.
You too need to consider the possibility. Have a good day.
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, October 14, 2008
CBs Favour Gold
Central Banks Favour Gold Amid Credit Crisis
By Jan Harvey, Reuters | October 2008
LONDON— Sales of gold by European central banks are likely to be lower than expected over the next year as the global banking crisis boosts bullion's appeal as a "safe" reserve asset. And banks elsewhere in the world, most notably in Asia and the Middle East, may even become buyers of gold in an attempt to diversify their reserves away from the U.S. dollar, analysts say. Under the terms of the Central Bank Gold Agreement, signed in 1999 by key European institutions including Germany's Bundesbank and the European Central Bank and renewed in 2004, members can sell up to 500 tonnes of gold a year.
But in the fourth year of the latest agreement, which ended recently, sales fell well short of this ceiling, to just over 357 tonnes. With banks worried by the outlook for the financial sector, sales could be even lower in the final year of the pact. "Given the damage done to a lot of other paper assets that were formerly considered secure, there will be greater risk aversion among central banks," said Philip Klapwijk, executive chairman of metals consultancy GFMS. "This will only boost gold's status within central bank reserves."
A key reason why central banks want to hold onto gold is the instability of their most common reserve asset, the dollar. The U.S. currency slipped to record lows against the euro earlier this year, and although it has since taken on a firmer tone, doubts remain over its outlook. "Gold assets have moved up in value in euro terms whereas dollar assets have fallen considerably," Mr. Klapwijk said. "There has been a reassessment of gold given developments in last few years."
Aside from the pressures associated with the current financial crisis, with a number of European central banks now having completed previously announced sales programs, analysts say a dip in selling is to be expected. Germany's Bundesbank, with the second largest gold reserves in the world after the U.S. Federal Reserve, said this week it would make no gold sales over the next 12 months, aside from a small sale already agreed with its finance ministry. The Swiss National Bank also said on Monday it had completed the sale of 250 tonnes of gold it announced last June, and had no plans for further sales.
The correction in the gold price from the all-time high of $1,030.80 (U.S.) an ounce it hit in March is also relieving some of the pressure on banks to sell gold to rebalance their reserves. "One reason people had been selling was because the gold price had risen and therefore the reserve value, relative to foreign exchange, had increased," said RBS Global Banking & Markets commodity strategist Nick Moore. "There was some selling pressure in order to rebalance reserves back to levels people were comfortable with."
"The fall in the gold price from over $1,000 puts us in a situation where the percentage of gold as a proportion of banks' reserves will be lower, so that will take some pressure off for rebalancing," he added. CBGA signatories aside, some central banks are more likely to be buyers than sellers of gold as the outlook for financial markets and the dollar stays rocky, analysts say. These purchases are most likely to come from Asian and Middle Eastern central banks looking to diversify their dollar assets into gold than their European counterparts.
"Central banks flush with dollars in Asia and the Middle East may try to diversify into gold," said Calyon metals analyst Robin Bhar. "The argument in favour of that may have been made stronger by recent events, which may encourage more diversification away from depreciating currencies."
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 Jan Harvey, Reuters | October 2008
LONDON— Sales of gold by European central banks are likely to be lower than expected over the next year as the global banking crisis boosts bullion's appeal as a "safe" reserve asset. And banks elsewhere in the world, most notably in Asia and the Middle East, may even become buyers of gold in an attempt to diversify their reserves away from the U.S. dollar, analysts say. Under the terms of the Central Bank Gold Agreement, signed in 1999 by key European institutions including Germany's Bundesbank and the European Central Bank and renewed in 2004, members can sell up to 500 tonnes of gold a year.
But in the fourth year of the latest agreement, which ended recently, sales fell well short of this ceiling, to just over 357 tonnes. With banks worried by the outlook for the financial sector, sales could be even lower in the final year of the pact. "Given the damage done to a lot of other paper assets that were formerly considered secure, there will be greater risk aversion among central banks," said Philip Klapwijk, executive chairman of metals consultancy GFMS. "This will only boost gold's status within central bank reserves."
A key reason why central banks want to hold onto gold is the instability of their most common reserve asset, the dollar. The U.S. currency slipped to record lows against the euro earlier this year, and although it has since taken on a firmer tone, doubts remain over its outlook. "Gold assets have moved up in value in euro terms whereas dollar assets have fallen considerably," Mr. Klapwijk said. "There has been a reassessment of gold given developments in last few years."
Aside from the pressures associated with the current financial crisis, with a number of European central banks now having completed previously announced sales programs, analysts say a dip in selling is to be expected. Germany's Bundesbank, with the second largest gold reserves in the world after the U.S. Federal Reserve, said this week it would make no gold sales over the next 12 months, aside from a small sale already agreed with its finance ministry. The Swiss National Bank also said on Monday it had completed the sale of 250 tonnes of gold it announced last June, and had no plans for further sales.
The correction in the gold price from the all-time high of $1,030.80 (U.S.) an ounce it hit in March is also relieving some of the pressure on banks to sell gold to rebalance their reserves. "One reason people had been selling was because the gold price had risen and therefore the reserve value, relative to foreign exchange, had increased," said RBS Global Banking & Markets commodity strategist Nick Moore. "There was some selling pressure in order to rebalance reserves back to levels people were comfortable with."
"The fall in the gold price from over $1,000 puts us in a situation where the percentage of gold as a proportion of banks' reserves will be lower, so that will take some pressure off for rebalancing," he added. CBGA signatories aside, some central banks are more likely to be buyers than sellers of gold as the outlook for financial markets and the dollar stays rocky, analysts say. These purchases are most likely to come from Asian and Middle Eastern central banks looking to diversify their dollar assets into gold than their European counterparts.
"Central banks flush with dollars in Asia and the Middle East may try to diversify into gold," said Calyon metals analyst Robin Bhar. "The argument in favour of that may have been made stronger by recent events, which may encourage more diversification away from depreciating currencies."
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, October 11, 2008
G7 Action Plan!?!
Finance Chiefs Endorse G7 Action Plan
By Lesley Wroughton | 11 October 2008 (Latest)
WASHINGTON (Reuters)— Finance leaders from the International Monetary Fund's 185 member countries late Saturday endorsed a plan announced by major economies to chart a course out of the credit crisis. The International Monetary and Financial Committee (IMFC), chaired by Egyptian Finance Minister Youssef Boutros-Ghali, called for "exceptional vigilance, coordination, and readiness to take bold action" to address the crisis. Boutros-Ghali said that all 185 IMF member countries, including emerging and developing economies, supported the Group of Seven plan. [[BUT, how about taking 'bold action'!?!: normxxx]]
"We are committed to the plan[!?!] of action," Boutros-Ghali said. "This is an essential element for restoring confidence." The G7 on Friday vowed 'to take all necessary steps' to unfreeze credit markets and ensure banks can raise money, but offered no collective course of action to avert a deep global recession. IMF Managing Director Dominique Strauss-Kahn said the committee agreed the IMF should take the lead in looking more in depth at what went wrong and coordinate with other institutions. [[Fiddling while Rome burns!?!: normxxx]]
He said the fund was the right forum for the job, given its universal membership, and that the IMF stood ready with resources to help any country facing financial difficulties due to the crisis. The IMF cautioned that emerging economies may experience spillover effects from the financial crisis and it was important that they preserve economic stability. "For these reasons, it is critically important that collaborative action be coordinated between advanced and emerging economies," the panel said. In advanced economies, policies need to provide "essential stimulus in the face of the risk of a pronounced economic downturn, as confidence in the financial system is restored."
IMF Warns Of Financial Meltdown
WASHINGTON/COLOMBEY-LES-DEUX-EGLISES, France (Reuters)— The IMF warned early Saturday that the global financial system was on the brink of meltdown, while France and Germany pushed ahead with a pan-European crisis response to try to prevent the worst global downturn in decades. At a joint news conference, French President Nicolas Sarkozy and German Chancellor Angela Merkel said they had "prepared a certain number of decisions" to present at a Sunday meeting of European leaders as they work feverishly to restore blocked credit markets to working order.
The United States appealed for patience, but the International Monetary Fund stressed that time was running short after leading industrialized nations failed to agree on concrete measures to end the crisis at a meeting on Friday. "Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown," IMF chief Dominique Strauss-Kahn said.
President George W. Bush huddled with Group of Seven economic chiefs and officials from the IMF and World Bank, and said top industrial nations grasped the gravity of the crisis and 'would work together' to solve it. "I'm confident that the world's major economies can overcome the challenges we face," Bush said, adding that Washington was working as fast as possible to implement a $700 billion financial bailout package approved a week ago.
"The benefits will not be realized overnight, but as these actions take effect, they will help restore stability to our markets and confidence to our financial institutions." Confidence has been in short supply and panic has swept through global markets, driving stocks to a five-year low on Friday and prompting banks to hoard cash. That has choked off lending to businesses and households, threatening to turn a global economic slowdown into a dangerously deep recession.
U.S. Treasury Secretary Henry Paulson said risks to the global economy were "the most serious and challenging in recent memory."
European Unity
An emergency meeting of euro zone leaders on Sunday will discuss a bank rescue package, taking a British initiative to guarantee lending between banks as a reference point, a source close to the French presidency said. France's Sarkozy said euro zone countries were working on a joint solution, but declined to provide specifics. He planned to meet with British Prime Minister Gordon Brown shortly before Sunday's euro zone gathering.
Britain's rescue plan, launched last week, makes available 50 billion pounds ($86 billion) of taxpayers' money for injection into its banks and, crucially, calls for underwriting interbank lending, which has all but frozen around the globe. Germany was also considering injecting capital into its banks, (German Prime Minister) Merkel said on Saturday. The world's 'rich' nations vowed on Friday to take all necessary steps to unfreeze credit markets and ensure banks can raise money— but they offered no specifics on a collective course of action to avert the recession threat.
In a surprisingly brief statement after a 3-1/2 hour meeting, the G7— the United States, Britain, Canada, France, Germany, Italy and Japan— stopped short of backing the British interbank lending guarantee, something many on Wall Street saw as vital to end growing market panic. [[Still trying to nickel and dime TEOTWAWKI!: normxxx]] Kenneth Rogoff, a Harvard University professor and former IMF chief economist, said the G7 would have served better adopting some version of the British plan so that banks could feel confident enough to loosen their grip on lending.
"Saying that they'll take all steps necessary leaves hanging the question of whether they know what is best and necessary," he told Reuters. "It was a signature moment for the G7. I think markets are going to be very disappointed." European Central Bank President Jean-Claude Trichet said markets needed time to digest a series of dramatic steps taken by world central banks in recent days, including pouring billions of dollars into financial markets and lowering interest rates in the broadest coordinated cut on record.
Working Around The Clock
U.S. Treasury's Paulson said it was "naive" to think that the G7 would endorse a one-size-fits-all approach to ending the credit crisis because there were major differences between the countries and their financial systems. He said the Bush administration was scrambling to put together a plan to buy direct stakes in American banks to shore up balance sheets riddled with heavy credit losses from the 14-month crisis that began with failing U.S. mortgage loans.
"We're going to do it as we can do it in a proper way that will be effective. Trust me, we're not wasting time, we're working around the clock," Paulson said late on Friday after the G7 meeting broke up. But even as Paulson and his fellow finance ministers insisted that they were working as fast as possible, there were signs the economy was credit-starved and deteriorating fast.
The U.S. auto sector has been particularly hard-hit. General Motors has had talks with smaller rival Chrysler LLC about a merger that would combine the No. 1 and No. 3 American automakers at a time when both are struggling to cut costs and shore up cash, according to a source briefed on the matter. Financial weekly Barron's reported that GM was preparing to approach the U.S. Federal Reserve about borrowing money directly from the central bank because the logjam in credit markets had shut it out of other kinds of borrowing.
By Lesley Wroughton | 11 October 2008 (Latest)
WASHINGTON (Reuters)— Finance leaders from the International Monetary Fund's 185 member countries late Saturday endorsed a plan announced by major economies to chart a course out of the credit crisis. The International Monetary and Financial Committee (IMFC), chaired by Egyptian Finance Minister Youssef Boutros-Ghali, called for "exceptional vigilance, coordination, and readiness to take bold action" to address the crisis. Boutros-Ghali said that all 185 IMF member countries, including emerging and developing economies, supported the Group of Seven plan. [[BUT, how about taking 'bold action'!?!: normxxx]]
"We are committed to the plan[!?!] of action," Boutros-Ghali said. "This is an essential element for restoring confidence." The G7 on Friday vowed 'to take all necessary steps' to unfreeze credit markets and ensure banks can raise money, but offered no collective course of action to avert a deep global recession. IMF Managing Director Dominique Strauss-Kahn said the committee agreed the IMF should take the lead in looking more in depth at what went wrong and coordinate with other institutions. [[Fiddling while Rome burns!?!: normxxx]]
He said the fund was the right forum for the job, given its universal membership, and that the IMF stood ready with resources to help any country facing financial difficulties due to the crisis. The IMF cautioned that emerging economies may experience spillover effects from the financial crisis and it was important that they preserve economic stability. "For these reasons, it is critically important that collaborative action be coordinated between advanced and emerging economies," the panel said. In advanced economies, policies need to provide "essential stimulus in the face of the risk of a pronounced economic downturn, as confidence in the financial system is restored."
IMF Warns Of Financial Meltdown
WASHINGTON/COLOMBEY-LES-DEUX-EGLISES, France (Reuters)— The IMF warned early Saturday that the global financial system was on the brink of meltdown, while France and Germany pushed ahead with a pan-European crisis response to try to prevent the worst global downturn in decades. At a joint news conference, French President Nicolas Sarkozy and German Chancellor Angela Merkel said they had "prepared a certain number of decisions" to present at a Sunday meeting of European leaders as they work feverishly to restore blocked credit markets to working order.
The United States appealed for patience, but the International Monetary Fund stressed that time was running short after leading industrialized nations failed to agree on concrete measures to end the crisis at a meeting on Friday. "Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown," IMF chief Dominique Strauss-Kahn said.
President George W. Bush huddled with Group of Seven economic chiefs and officials from the IMF and World Bank, and said top industrial nations grasped the gravity of the crisis and 'would work together' to solve it. "I'm confident that the world's major economies can overcome the challenges we face," Bush said, adding that Washington was working as fast as possible to implement a $700 billion financial bailout package approved a week ago.
"The benefits will not be realized overnight, but as these actions take effect, they will help restore stability to our markets and confidence to our financial institutions." Confidence has been in short supply and panic has swept through global markets, driving stocks to a five-year low on Friday and prompting banks to hoard cash. That has choked off lending to businesses and households, threatening to turn a global economic slowdown into a dangerously deep recession.
U.S. Treasury Secretary Henry Paulson said risks to the global economy were "the most serious and challenging in recent memory."
European Unity
An emergency meeting of euro zone leaders on Sunday will discuss a bank rescue package, taking a British initiative to guarantee lending between banks as a reference point, a source close to the French presidency said. France's Sarkozy said euro zone countries were working on a joint solution, but declined to provide specifics. He planned to meet with British Prime Minister Gordon Brown shortly before Sunday's euro zone gathering.
Britain's rescue plan, launched last week, makes available 50 billion pounds ($86 billion) of taxpayers' money for injection into its banks and, crucially, calls for underwriting interbank lending, which has all but frozen around the globe. Germany was also considering injecting capital into its banks, (German Prime Minister) Merkel said on Saturday. The world's 'rich' nations vowed on Friday to take all necessary steps to unfreeze credit markets and ensure banks can raise money— but they offered no specifics on a collective course of action to avert the recession threat.
In a surprisingly brief statement after a 3-1/2 hour meeting, the G7— the United States, Britain, Canada, France, Germany, Italy and Japan— stopped short of backing the British interbank lending guarantee, something many on Wall Street saw as vital to end growing market panic. [[Still trying to nickel and dime TEOTWAWKI!: normxxx]] Kenneth Rogoff, a Harvard University professor and former IMF chief economist, said the G7 would have served better adopting some version of the British plan so that banks could feel confident enough to loosen their grip on lending.
"Saying that they'll take all steps necessary leaves hanging the question of whether they know what is best and necessary," he told Reuters. "It was a signature moment for the G7. I think markets are going to be very disappointed." European Central Bank President Jean-Claude Trichet said markets needed time to digest a series of dramatic steps taken by world central banks in recent days, including pouring billions of dollars into financial markets and lowering interest rates in the broadest coordinated cut on record.
Working Around The Clock
U.S. Treasury's Paulson said it was "naive" to think that the G7 would endorse a one-size-fits-all approach to ending the credit crisis because there were major differences between the countries and their financial systems. He said the Bush administration was scrambling to put together a plan to buy direct stakes in American banks to shore up balance sheets riddled with heavy credit losses from the 14-month crisis that began with failing U.S. mortgage loans.
"We're going to do it as we can do it in a proper way that will be effective. Trust me, we're not wasting time, we're working around the clock," Paulson said late on Friday after the G7 meeting broke up. But even as Paulson and his fellow finance ministers insisted that they were working as fast as possible, there were signs the economy was credit-starved and deteriorating fast.
The U.S. auto sector has been particularly hard-hit. General Motors has had talks with smaller rival Chrysler LLC about a merger that would combine the No. 1 and No. 3 American automakers at a time when both are struggling to cut costs and shore up cash, according to a source briefed on the matter. Financial weekly Barron's reported that GM was preparing to approach the U.S. Federal Reserve about borrowing money directly from the central bank because the logjam in credit markets had shut it out of other kinds of borrowing.
TEOTWAWKI!
Daily Report And Commentary, Saturday
Click here for a link to complete article:
By Bill Cara | 11 October 2008
Just how bad are things? Bloomberg summed it up this way:
'Leaders of the world' will now attempt to rewrite the rules of international finance [[over a week-end! : normxxx]], and may have to shut the capital markets for a time to accomplish this, says a G-7 leader. Finally; a responsible politician has admitted the system is broke and must be replaced.
Where else have you been reading that a General Agreement on Currencies would be needed before global leaders could go on about their business of building a new financial system? Yes, if you search this site in the window on the sidebar, you will find at least 180 citations for General Agreement on Currencies. You will not find that anywhere else you look, at least not until today.
Moreover, who else in the Wall Street Journal, as early as June 2006, was warning of this disaster, while others demanded that markets run free? My arguments were laughed at. But; who among these skeptics is laughing now?
Who else has been opining that since he was hired by the White House every move by the Treasury Secretary Henry Paulson has been an unmitigated disaster for the ordinary people, calling it, from the beginning, ‘Paulson’s Folly’?
The world has arrived at precisely that point that I strongly argued it would, inevitably, with then current practices, over the past three years would be the result of a bankers’ 'self-regulatory' system run amok. The world must put an end to financial 'self-regulation' and conflict of interest dealings [[aka, 'self-dealing' or double-dealing: normxxx]] by bankers [[and others in the financial community, eg, brokers: normxxx]]. Now!
I will not write a Saturday Report today because this financial system is finished. What happened yesterday illustrates that markets no longer work as value discovery mechanisms. But, yes, I will cover Friday’s destruction in Sunday’s Week In Review, and I will also attempt to answer your fears and concerns.
Moreover, I will restate why the system is broke, what surely needs to be done to replace it, and why many of the key people in charge today— the central bankers and the Wall St bankers who have been recruited into the Office of the Treasury Department— must not be allowed to make the most important decisions in the history of the world.
For now I will just publish the automated portion of my Report. Since it is the people’s capital— your portfolios, your Funds, your pensions— that has been destroyed over the past one, two, four, and 52-weeks, it is important that you face up to your naïveté and/or your denial. Trust me; your banker is never going to make that statement.
In fact there is, in Canada, the ludicrous, ubiquitous, TV commercials of ScotiaBank ("You’re richer than you think you are!") that tell you all you need to know of just how morally corrupt many bankers have become and why those at the source of the global financial crisis cannot be trusted to be part of the decision-making group that develops a solution that meets the needs of the people.
Let’s get the foxes out of the henhouse, now! Get yourself in the proper frame of mind to do so by scanning the 15 tables at the bottom of this report. It ought to be enough to make you sick.
Daily Report For Friday Morning, 10 October 2008
Markets Re-Cap, Friday
The last hour of a trading session is typically the most important because, in times of pressure, it best shows us whether the emotional bias of traders is one of fear or greed. Yesterday the loss of -350 points in the important DJIA index in the final hour showed extreme fear [[as panicked selling by funds fearing redemptions overwhelmed the PPT, aka, the Plunge Protection Team: normxxx]]. This morning that fear showed up in the form of panic as pre-market opening orders sold the DJIA index down about -700 points within minutes.
The core of the issue now is whether the US automobile industry can survive the present credit market crisis that has effectively shut off credit to everybody, including the buyers of cars and trucks, because of the failure of many banks. [[Unfortunately, it really IS true, "as GM goes, so goes the nation!": normxxx]]
At precisely 3:00pm ET yesterday, General Motors (GM) was trading at $5.57— a huge loss from $13.00 (57%) in just the past three weeks [[not to mention a maximum value of nearly $100 in late '99 — early 2000, and over $40 about a year ago: normxxx]]. But in the final hour, GM stock plunged a further -16.5% to $4.65, eventually closing at $4.89. GM now has a market capitalization of just $2.7 billion, but as of June 30 had a $20 billion deficit on its balance sheet and an underfunded pension liability of -33.1 billion.
If markets were truly 'free', GM would be forced to declare bankruptcy, from which there would be no hope for recovery. Ford Motor and Chrysler are in the same position. The Federal government needs to nationalize these companies immediately along with the top five to ten banks to protect a couple of million workers— the most important in America today because if these jobs are lost there surely will be depression.
That is the state of the union today [[and, indeed, of the entire world! : normxxx]]
Yesterday and overnight, the losses on the international equity markets were massive, including in NY where the DJIA (-678.91 -7.33% to 8579.19), S&P 500 (-75.02 -7.62% to 909.92) and NASDAQ Composite (-95.21 -5.47% to 1645.12) were smashed. The Toronto Composite (-456.13 -4.54% to 9600.18) was hammered as Canada’s top two financial companies (RY -11.1% and MFC -18.5%) plunged on selling from foreign investors under immense duress. The Venture Board (-30.97 (-2.89%) to 1041.67) actually slowed its descent, having been down almost -20% in the prior three days.
In NY, the best performing sector (XLK) was down -3.32%, largely because of the positive earnings report from IBM. All sectors were bad, but Energy (XLE -14.4%) and Financials (-10.4%) were worst hit. In the Financials, the Banks ($BKX -11.9%) and Broker-Dealers ($XBD -12.3%) took immense losses for a single day.
In fact, while not compacted into a single trading session like Black Monday October 19, 1987, the past few days this week has been every bit as bad. Yesterday alone, the global equity index (Dow world index) dropped -4.2%. So this crisis is a global one.
Overnight today, the Asia-Pacific equity markets were also smashed: All-Ords of Australia (-8.20% to 3939.5); Shanghai Composite (-3.57% to 2000.6), Hong Kong (-7.19% to 14796.9), India Sensex 30 (-7.07% to 10527.9), and Japan’s Nikkei 225 (-9.62% to 8276.4). Over just three days, the Nikkei Dow has plunged -20%.
In Europe at 8:52am ET, the French CAC (-8.61%), German DAX (-9.02%) and UK FTSE 100 (-8.24%) were crashing, awaiting the dire opening in NY.
The $USD soared yesterday +0.49% to 81.25 and is up this morning in the futures to 81.97. The $CDW (Cdn Loonie) plunged -2.33% to 86.95 after dropping -1.67% the previous day and almost -2% over the two days before that. The Loonie’s fortunes are tied to the Western Canada oil patch, which is being smashed as Crude Oil prices plunge. Those prices are plunging because the banks have called the loans of speculation based hedge funds. Now there are margin calls. The leverage in futures trading leads to such a result where Crude Oil has fallen from $147 to under $82 from just mid-July.
The inter-relationships in capital market trading are now quite obvious.
Yesterday Crude Oil dropped -$1.81/bbl to $86.62, but the futures this morning had crashed to $81.85. That move has strengthened the $USD to 81.97, and taken the bloom (for a short time) off the precious metals. $GOLD contracts yesterday (starting late in the previous day’s session) sold down -$20.00/oz to 886.50. Later gold rallied to well over 900.
In the spot market this morning, the precious metals have backed down from overnight highs (in brackets) to be— early to noonish Friday— (9:10am ET) for gold, palladium, platinum and silver: 907.03 (931.70), 190.5 (201), 1009 (1024), and 11.46 (12.24). Volatility here is extreme.
The DJIA futures were at 8320 at 9:10am ET, fully 1000 points down from yesterday morning. The DJIA this morning opened down almost -700 points in 5 minutes. The selling wave continues. In fact this is a tsunami. BUT, this selling wave continues to present incredibly good buying opportunities, in my opinion.
Comments & Outlook, Friday Morning
Morgan Stanley (MS) and Goldman Sachs (GS) a week ago filed to become banks, which required their moving from a position of over 30 to 1 leverage to well under 10 to 1. That deleveraging process is now killing hedge funds and [[even conservatively : normxxx]] margined clients, forcing them to sell securities and futures positions, which is greatly exaggerating the market crash.
For this reason, ie, to allow deleveraging to go as smoothly as possible, there was recently a period where short-selling was not permitted in many stocks. The monetary authorities, however, misjudged the impact the Morgan Stanley and Goldman Sachs decisions would have on capital markets. At the point where investment banks were deciding to become commercial banks, under the protection of the Fed, the bail-out package legislated by Washington was found already to be inadequate.
The market has since been in an all-out rout.
The Treasury Secretary, who is the last person who should be managing a solution because these investment bankers are his friends and former colleagues, has now deemed the advisability of using Treasury capital to buy preferred shares of the banks. Doing so would be the worst possible decision for the government [[and everybody but the bankers and their 'fellow-travellers': normxxx]]. Bank failures would happen in any event because the system is broke.
Believing that certain industries like banks and automobile manufacturing are critical to the future of the American economy, the federal government must immediately backstop the potential failure of the largest companies in those industries, however weak they might be.
As I see it, the government, and not the Fed [[and probably NOT Paulson, who should recuse himself: normxxx]], must open a window of opportunity where— until the end of 2008— there will be a bid to buy all the common stock that any leading company (from a select list) chooses to sell to bring order to their balance sheet. Selling control shares to government should be at the discretion of the company directors, but in my view those directors who reject the offer and who later fail in their duty to protect the employees and vendors with other means should be considered at fault [[and subject to at least pecuniary damages: normxxx]] should those companies fail.
What this means, of course, is that the US government must take emergency action to 'nationalize' those economically crucial companies that can no longer survive on their own. It also means that the present bondholders and shareholders of those companies have probably lost their financial stake. The offset however is that the public treasury will earn back a very significant return when the economy stabilizes and comes back to good health. With effective legislation, those profits would later be distributed back to the taxpayer, which would be worked back into the economy.
The action I recommend is the ultimate back-stop in a crisis where the financial system has failed. Everybody wants 'free' markets, and in time they will get them if the proper legislation is put in place [[but only if the more drastic action is taken today: normxxx]]. …private investors who today put further capital into any company that relies on a smoothly functioning credit market system are fools. The system has failed and needs to be replaced.
That reminds me of the joke of the Scottish regiment which, after the regimental condom used by all had broken, held a vote on whether to repair or replace. This is no time to make stupid, petty decisions; the current financial system needs to be replaced.
The capital market, however, can survive if only legislators can remove the control that bankers have over it. There are [[fundamental: normxxx]] values out there still in the Energy and Basic Materials companies, and other like companies, some of which are trading at 1 to 2 times annual cash flow. Others can be bought literally for the net cash on their balance sheet. There are industrial companies that make essential products that continue to build their order book. There are healthcare companies like Genentech, Pfizer and Merck, for example, that will continue to manufacture essential products.
This is a time, while legislators are replacing the failed financial system, to be investing long-term capital in those parts of the market I recommend. [[Capital you are unlikely to need for 5 - 10 years or so! : normxxx]]
M O R E. . .
See also
Lessons From the Trader Wizard
by Bill Cara.
Sarah Barham, Carol Bonnett , Eleanor Bramah Editors.
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 Bill Cara | 11 October 2008
|
|
Just how bad are things? Bloomberg summed it up this way:
|
'Leaders of the world' will now attempt to rewrite the rules of international finance [[over a week-end! : normxxx]], and may have to shut the capital markets for a time to accomplish this, says a G-7 leader. Finally; a responsible politician has admitted the system is broke and must be replaced.
Where else have you been reading that a General Agreement on Currencies would be needed before global leaders could go on about their business of building a new financial system? Yes, if you search this site in the window on the sidebar, you will find at least 180 citations for General Agreement on Currencies. You will not find that anywhere else you look, at least not until today.
Moreover, who else in the Wall Street Journal, as early as June 2006, was warning of this disaster, while others demanded that markets run free? My arguments were laughed at. But; who among these skeptics is laughing now?
Who else has been opining that since he was hired by the White House every move by the Treasury Secretary Henry Paulson has been an unmitigated disaster for the ordinary people, calling it, from the beginning, ‘Paulson’s Folly’?
The world has arrived at precisely that point that I strongly argued it would, inevitably, with then current practices, over the past three years would be the result of a bankers’ 'self-regulatory' system run amok. The world must put an end to financial 'self-regulation' and conflict of interest dealings [[aka, 'self-dealing' or double-dealing: normxxx]] by bankers [[and others in the financial community, eg, brokers: normxxx]]. Now!
I will not write a Saturday Report today because this financial system is finished. What happened yesterday illustrates that markets no longer work as value discovery mechanisms. But, yes, I will cover Friday’s destruction in Sunday’s Week In Review, and I will also attempt to answer your fears and concerns.
Moreover, I will restate why the system is broke, what surely needs to be done to replace it, and why many of the key people in charge today— the central bankers and the Wall St bankers who have been recruited into the Office of the Treasury Department— must not be allowed to make the most important decisions in the history of the world.
For now I will just publish the automated portion of my Report. Since it is the people’s capital— your portfolios, your Funds, your pensions— that has been destroyed over the past one, two, four, and 52-weeks, it is important that you face up to your naïveté and/or your denial. Trust me; your banker is never going to make that statement.
In fact there is, in Canada, the ludicrous, ubiquitous, TV commercials of ScotiaBank ("You’re richer than you think you are!") that tell you all you need to know of just how morally corrupt many bankers have become and why those at the source of the global financial crisis cannot be trusted to be part of the decision-making group that develops a solution that meets the needs of the people.
Let’s get the foxes out of the henhouse, now! Get yourself in the proper frame of mind to do so by scanning the 15 tables at the bottom of this report. It ought to be enough to make you sick.
Daily Report For Friday Morning, 10 October 2008
Markets Re-Cap, Friday
The last hour of a trading session is typically the most important because, in times of pressure, it best shows us whether the emotional bias of traders is one of fear or greed. Yesterday the loss of -350 points in the important DJIA index in the final hour showed extreme fear [[as panicked selling by funds fearing redemptions overwhelmed the PPT, aka, the Plunge Protection Team: normxxx]]. This morning that fear showed up in the form of panic as pre-market opening orders sold the DJIA index down about -700 points within minutes.
The core of the issue now is whether the US automobile industry can survive the present credit market crisis that has effectively shut off credit to everybody, including the buyers of cars and trucks, because of the failure of many banks. [[Unfortunately, it really IS true, "as GM goes, so goes the nation!": normxxx]]
At precisely 3:00pm ET yesterday, General Motors (GM) was trading at $5.57— a huge loss from $13.00 (57%) in just the past three weeks [[not to mention a maximum value of nearly $100 in late '99 — early 2000, and over $40 about a year ago: normxxx]]. But in the final hour, GM stock plunged a further -16.5% to $4.65, eventually closing at $4.89. GM now has a market capitalization of just $2.7 billion, but as of June 30 had a $20 billion deficit on its balance sheet and an underfunded pension liability of -33.1 billion.
If markets were truly 'free', GM would be forced to declare bankruptcy, from which there would be no hope for recovery. Ford Motor and Chrysler are in the same position. The Federal government needs to nationalize these companies immediately along with the top five to ten banks to protect a couple of million workers— the most important in America today because if these jobs are lost there surely will be depression.
That is the state of the union today [[and, indeed, of the entire world! : normxxx]]
Yesterday and overnight, the losses on the international equity markets were massive, including in NY where the DJIA (-678.91 -7.33% to 8579.19), S&P 500 (-75.02 -7.62% to 909.92) and NASDAQ Composite (-95.21 -5.47% to 1645.12) were smashed. The Toronto Composite (-456.13 -4.54% to 9600.18) was hammered as Canada’s top two financial companies (RY -11.1% and MFC -18.5%) plunged on selling from foreign investors under immense duress. The Venture Board (-30.97 (-2.89%) to 1041.67) actually slowed its descent, having been down almost -20% in the prior three days.
In NY, the best performing sector (XLK) was down -3.32%, largely because of the positive earnings report from IBM. All sectors were bad, but Energy (XLE -14.4%) and Financials (-10.4%) were worst hit. In the Financials, the Banks ($BKX -11.9%) and Broker-Dealers ($XBD -12.3%) took immense losses for a single day.
In fact, while not compacted into a single trading session like Black Monday October 19, 1987, the past few days this week has been every bit as bad. Yesterday alone, the global equity index (Dow world index) dropped -4.2%. So this crisis is a global one.
Overnight today, the Asia-Pacific equity markets were also smashed: All-Ords of Australia (-8.20% to 3939.5); Shanghai Composite (-3.57% to 2000.6), Hong Kong (-7.19% to 14796.9), India Sensex 30 (-7.07% to 10527.9), and Japan’s Nikkei 225 (-9.62% to 8276.4). Over just three days, the Nikkei Dow has plunged -20%.
In Europe at 8:52am ET, the French CAC (-8.61%), German DAX (-9.02%) and UK FTSE 100 (-8.24%) were crashing, awaiting the dire opening in NY.
The $USD soared yesterday +0.49% to 81.25 and is up this morning in the futures to 81.97. The $CDW (Cdn Loonie) plunged -2.33% to 86.95 after dropping -1.67% the previous day and almost -2% over the two days before that. The Loonie’s fortunes are tied to the Western Canada oil patch, which is being smashed as Crude Oil prices plunge. Those prices are plunging because the banks have called the loans of speculation based hedge funds. Now there are margin calls. The leverage in futures trading leads to such a result where Crude Oil has fallen from $147 to under $82 from just mid-July.
The inter-relationships in capital market trading are now quite obvious.
Yesterday Crude Oil dropped -$1.81/bbl to $86.62, but the futures this morning had crashed to $81.85. That move has strengthened the $USD to 81.97, and taken the bloom (for a short time) off the precious metals. $GOLD contracts yesterday (starting late in the previous day’s session) sold down -$20.00/oz to 886.50. Later gold rallied to well over 900.
In the spot market this morning, the precious metals have backed down from overnight highs (in brackets) to be— early to noonish Friday— (9:10am ET) for gold, palladium, platinum and silver: 907.03 (931.70), 190.5 (201), 1009 (1024), and 11.46 (12.24). Volatility here is extreme.
The DJIA futures were at 8320 at 9:10am ET, fully 1000 points down from yesterday morning. The DJIA this morning opened down almost -700 points in 5 minutes. The selling wave continues. In fact this is a tsunami. BUT, this selling wave continues to present incredibly good buying opportunities, in my opinion.
|
Comments & Outlook, Friday Morning
Morgan Stanley (MS) and Goldman Sachs (GS) a week ago filed to become banks, which required their moving from a position of over 30 to 1 leverage to well under 10 to 1. That deleveraging process is now killing hedge funds and [[even conservatively : normxxx]] margined clients, forcing them to sell securities and futures positions, which is greatly exaggerating the market crash.
For this reason, ie, to allow deleveraging to go as smoothly as possible, there was recently a period where short-selling was not permitted in many stocks. The monetary authorities, however, misjudged the impact the Morgan Stanley and Goldman Sachs decisions would have on capital markets. At the point where investment banks were deciding to become commercial banks, under the protection of the Fed, the bail-out package legislated by Washington was found already to be inadequate.
The market has since been in an all-out rout.
The Treasury Secretary, who is the last person who should be managing a solution because these investment bankers are his friends and former colleagues, has now deemed the advisability of using Treasury capital to buy preferred shares of the banks. Doing so would be the worst possible decision for the government [[and everybody but the bankers and their 'fellow-travellers': normxxx]]. Bank failures would happen in any event because the system is broke.
Believing that certain industries like banks and automobile manufacturing are critical to the future of the American economy, the federal government must immediately backstop the potential failure of the largest companies in those industries, however weak they might be.
As I see it, the government, and not the Fed [[and probably NOT Paulson, who should recuse himself: normxxx]], must open a window of opportunity where— until the end of 2008— there will be a bid to buy all the common stock that any leading company (from a select list) chooses to sell to bring order to their balance sheet. Selling control shares to government should be at the discretion of the company directors, but in my view those directors who reject the offer and who later fail in their duty to protect the employees and vendors with other means should be considered at fault [[and subject to at least pecuniary damages: normxxx]] should those companies fail.
What this means, of course, is that the US government must take emergency action to 'nationalize' those economically crucial companies that can no longer survive on their own. It also means that the present bondholders and shareholders of those companies have probably lost their financial stake. The offset however is that the public treasury will earn back a very significant return when the economy stabilizes and comes back to good health. With effective legislation, those profits would later be distributed back to the taxpayer, which would be worked back into the economy.
|
The action I recommend is the ultimate back-stop in a crisis where the financial system has failed. Everybody wants 'free' markets, and in time they will get them if the proper legislation is put in place [[but only if the more drastic action is taken today: normxxx]]. …private investors who today put further capital into any company that relies on a smoothly functioning credit market system are fools. The system has failed and needs to be replaced.
That reminds me of the joke of the Scottish regiment which, after the regimental condom used by all had broken, held a vote on whether to repair or replace. This is no time to make stupid, petty decisions; the current financial system needs to be replaced.
The capital market, however, can survive if only legislators can remove the control that bankers have over it. There are [[fundamental: normxxx]] values out there still in the Energy and Basic Materials companies, and other like companies, some of which are trading at 1 to 2 times annual cash flow. Others can be bought literally for the net cash on their balance sheet. There are industrial companies that make essential products that continue to build their order book. There are healthcare companies like Genentech, Pfizer and Merck, for example, that will continue to manufacture essential products.
This is a time, while legislators are replacing the failed financial system, to be investing long-term capital in those parts of the market I recommend. [[Capital you are unlikely to need for 5 - 10 years or so! : normxxx]]
M O R E. . .
See also
Lessons From the Trader Wizardby Bill Cara.
Sarah Barham, Carol Bonnett , Eleanor Bramah Editors.
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, October 10, 2008
Consumer Confidence Survey
The "Other" Consumer Confidence Survey
By ContraryInvestor.com | October 2008
The "Other" Consumer Confidence Report...What the heck are they thinking now? You know who we mean, the 'foreign' investment community. Who else? Hopefully without wildly belaboring the point, we remain convinced that the US is ultimately going to face a funding issue down the road. Maybe not a funding issue in terms of being able to borrow funds, but rather the issue is the cost at which funds will ultimately be made available to the US.
This is exactly what we addressed when we penned the Fun With Funding discussion last month. Put yourself in the shoes of the foreign investment community. Many moons ago, you started recycling trade related dollars back into US financial assets. In essence, you were able to facilitate a little mercantilist economics. By buying US financial assets (primarily bonds) you effectively helped keep US interest rates low and enabled the relatively blinded by asset inflation US consumer borrowing and spending (on your export products).
As commodity prices rose, the BRIC nations and OPEC got into the dollar recycling game in a big way. If you remember the Fun with Funding article, one of the tables in the discussion showed us that since May of 2006, 100% of foreign purchases of US Treasuries were undertaken by Brazil, Russia, India, China and OPEC. Japan was a net seller over the period. Quite the happy circumstance...while it lasted.
But over the past seven months, the foreign community has been treated to the visual of three of the five largest US investment banks disappearing. One literally disintegrating in the night. They also watched as the largest two US residential mortgage-financing intermediaries entered Club Fed, never to be seen again in public. Let's face it, the foreign community knows Lehman had been around for 158 years. The firm had lived through a domestic civil war and a financial/economic depression.
And what eventually took it down? Granite countertops, stainless steel appliances and travertine flooring. Quite the sorry commentary. You get the point. We suggest that one of the most important consumer confidence surveys of the moment is the monthly tally of foreign purchases of US financial assets. The foreign investment community has had a front row seat in the US credit cycle drama playing out amongst Wall Street and the Fed/Treasury/Administration.
They, along with almighty Bill Gross, expressed their extreme concern over Fannie and Freddie solvency, instigating relatively immediate action. They, along with almighty Bill Gross (to the tune of $750 million) would have been hurt badly had AIG gone nose first into the tarmac without even attempting to pull the nose up before crash landing. We know in part what the foreign community has been saying, but what are they thinking at this point? To us, one of the most important questions as we move forward.
Although we know we have covered this in the past, we believe it's critical to keep an eye on foreign capital flows into US financial markets. We ALL know how important foreign capital has become to the US economic and financial system continuing to function properly. And we all know that since early this year, foreign sovereign wealth funds have gone on a buyers strike in terms of providing US companies capital amidst the ever evolving US credit crisis.
No more Saudi princes riding to the rescue? C'mon, where's their sense of humor? Let's have a quick look at the longer-term rhythm of foreign flows of capital into US financial markets. Why? Because the character of that flow is changing meaningfully as we speak. You know these numbers unfortunately come to us with a lag. As of now, data is current through July. Since that time, Lehman has passed away and Fannie and Freddie senior and sub debt securities have been rescued.
AIG has been thrown a lifeline and Merrill has crawled under the skirt of BofA. We know the foreign community was indeed getting a bit skittish about the government agencies over the summer, and that skittishness is reflected in these numbers. But what's most important to us is the rhythm of longer-term trends in the twelve month moving averages you see in each chart. In short order, let's have a look.
Clearly into the credit crisis phase of the current cycle beginning last summer, Treasuries have been the asset class of choice for the foreign community. It’s a natural. Institutionally the world has been conditioned to run to the supposed safe haven security that is perceived to be UST's. As we’re sure you saw, 90-day T-bill yields kissed .2% in trading a few weeks back in what was clearly a panic run into the short end of the Treasury market.
The safe haven asset? In spades at that yield. We can understand foreign and domestic investor behavior here, but as we have said many a time in the past, we believe there will indeed come a day when this may no longer be the case. Although one day does not a trend make, gold’s one-day price fireworks show a few weeks ago was indeed the noticeable event. We heard rumors of a large AIG short in the metal being covered, but who really knows at this point.
Although we’re guessing, if gold zooms higher from here, we’d take it as a sign the markets have lost considerable faith in the Fed and Treasury. By extension, could marginal loss of faith in the credit that is US Treasuries be far behind if this line of thinking is even near correct? Nope. No wonder there is such establishment resistance to gold as a monetary symbol.
For now, foreign flows into Treasuries, as seen above, are not a major issue point of concern, but we watch intently as we move ahead. As a quick refresher, we believe the important data point in the chart above is the twelve month moving average of purchases. We're well below record highs seen years ago, but in no way are we looking at a supposed collapse for now. One note that we'll refer back to as we conclude this discussion is that into the last US recession, the foreign community was a seller of Treasuries in aggregate.
Although the credit crisis environment in the US has taken center stage attention for now, the fallout influence of the credit crisis on the real economy, and the real world recession it will ultimately engender, is the next act to anticipate in the current drama playing out before our eyes. Will we see a repeat performance of foreign liquidation of UST's in the US recession to come? If so, it could not come at a worse time. We watch and wait.
Before moving forward, one last view of life for perspective on the importance of the foreign community to the US Treasury market. Below is a look at the character make up of Treasury holders as of the conclusion of 2Q 2008.
As we suggested in the "Fun With Funding" discussion last month, the US government balance sheet will expand meaningfully ahead. Key question being, will the pie chart we see above change in character as this balance sheet expansion occurs? Will households become big UST buyers? How about domestic banks that currently own the smallest slice of the pie?
For now, although it's clearly loose commentary cast in the heat of the moment, the "reaction" of major sections of the foreign community (Asian, European and Middle Eastern) to the proposed bailout package in the US has been well south of a resounding thumbs up. But, as always, it's not what they say, but rather what they do ahead that will be important to US funding outcomes. Let's move on to the foreign influence in the government agency market.
The fact is that the sale by the foreign community of US government agencies in July was a record. The chart below is relatively dramatic in revealing this circumstance. Certainly some of the proceeds of these sales found their way back into Treasuries. We know the foreign community was indeed "asking questions" prior to the "conservatorship" of Fannie and Freddie, despite the implicit moral hazard guarantee that had been in place for literally years.
So it’s a one off in July, we believe. But despite the one month July sale-a-thon in agency paper by the foreign sector, the longer-term trend embodied in the 12 month MA has already been telling us for some time that the foreign community is growing weary of continuing to acquire agency paper. If the July activity in agency sales isn't a ding in the side of the greater confidence ship on the part of the foreign investment contingent, we just don't know what would be characterized as such.
Who knows, now that agency paper is essentially government paper with a yield premium, foreign community percpetions may change ahead. We've seen buying in recent anecdotal data. But we’re not holding our breath. As the chart clearly shows us, the foreign community indeed was a key provocateur in funding the macro US mortgage market from the mid-1990’s through to late 2006. Will they be so obliging to do so again given what has happened to supposed quality mortgage paper in the current cycle? We’ll see.
The real and very meaningful walking away, or confidence destruction, seen in actions by the foreign community in terms of purchasing US financial assets has occurred in the corporate bond market. Without question, what you see below speaks to academic risk reduction and a very much heightened sense of currently pricing in investment risk, if you will. The drop in foreign acquisition of US corporate bonds is striking, if nothing else.
As a quick tangent, we take what we see above very seriously. Corporate bond spreads have widened very meaningfully over the last year. Whether it’s corporate Aaa versus 10 year Treasury yields, Baa credits using the same spread, or high yield corporate spreads, it is clear that meaningful change has occurred in macro credit market perceptions and pricing. In our minds, there is no way the US economy is about to reaccelerate until corporate bond spreads contract. This is a distinct and definitive message of history.
And as is more than apparent in the chart, the foreign community has been nothing short of integral in keeping US corporate bond yield spreads tight throughout the entire prior economic cycle via their very meaningful purchasing activity. The twelve-month moving average of foreign purchases of US corporate bonds is just about back to the trough of the prior cycle seen early this decade as we speak. This strikes directly at the heart of the real economy being able to fund itself as we look ahead.
The last asset class under examination is equities. Foreign investment history has been that peak exposure usually occurs at major price peaks and trough exposure at major price troughs. You know, buying high and selling low. So what else is new in terms of human behavior? Not much. Since last summer, the foreign community has lost it’s taste for US equities, as has the US public.
Funny that way. Stick a 30% off sign in a retail store and it attracts buyers immediately. Stick a 30% off sign on Wall Street and everyone avoids the place like the plague. Human nature never changes, does it? We simply need to be aware of our own faults in terms of emotional human decision making and try to "rewire" our actions and reactions.
As you can see in looking at the absolute dollar numbers, foreign purchases of US equities in terms of dollars is very small. It’s the fixed income markets where the big foreign money is invested. And to us, this is very meaningful in that, as we have said, the big issue looking ahead is how the US government and greater economy funds itself. Who provides the funds and at what cost? Critical questions.
Final chart, we promise. Total foreign flows of capital into US financial markets over the last two-plus decades. There have been very few instances of monthly net selling by the foreign community of US financial assets. July just happened to be one of those months. Not good for a greater economy that we believe faces intermediate term funding "challenges", to be tactful.
But as we’ve said looking at individual asset classes, this is not a one-month one-off experience. The declining trend in foreign purchasing of US financial assets has been happening for a year now, completely coinciding with the deteriorating credit market fundamentals in the US. The chart is clear on this statement. Does this show us what the foreign community is thinking? How could it be otherwise?
As a quick comment on historical perspective, we know the nominal dollar decline in the twelve month moving average of foreign purchases total US financial assets is meaningful. As of July, the 12 month MA has declined close to $50 B from June of 2007. In percentage terms it's a 46% decline. In the wake of the Asian currency crisis, we saw a 51% top to bottom drop in this 12 month MA. So is the world coming to an end here and are we in uncharted waters? Not yet.
What we believe is most meaningful right now is the powerful issue of change at the margin. At the exact time macro US funding needs are increasing, one of the largest buyers/holders of US financial assets is changing their behavior at the margin. This is what we need to stay on top of, monitor monthly, and anticipate financial market and real economic outcomes based on this change.
There you have it, a very important foreign financial consumer confidence survey if we’ve ever seen one. Maybe one of the most important confidence surveys we can think of at the moment for a US financial sector and general economy increasingly in need of capital. In summation, we believe the foreign community faces the following decision points over the near term. As has been the case for many a moon now, foreign investment in US financial assets must contend with interest rate risk and currency exchange rate risk. Nothing new to see here.
But what is changing is the very important need of the US government to expand its balance sheet very meaningfully. You already know our thoughts on this. Third, the US and really the globe is heading into a major consumer led recession that at this point, as we see it, is unavoidable. Key questions for now being duration and depth.
Will the BRIC countries' and OPEC capital reserves (the key foreign buyers of UST's over the last two years) be needed on their respective home fronts to help shore up/stimulate their own economies? If so, that's competition for a US government in need of increased funding. Lastly, there is a new monkey wrench that has been recently thrown into the total equation.
The foreign community has been treated to the new wrinkle that US authorities are now willing to "change the rules" without any prior notice. Again, at the margin this creates investment uncertainty. How are foreign entities to feel comfort in providing capital to the US financial sector when equity and preferred asset values can be essentially wiped out on a Sunday afternoon? It's no wonder the global sovereign wealth funds have been on a buyers strike.
As a quick counterpoint to what we see as enhanced risk to foreign capital committing to US assets at the moment, be sure to keep your eye on many of the major European financial institutions. In terms of the raw numbers, leverage ratios for many of Europe's largest financial behemoths make former US investment bank outfits look like choirboys and choirgirls. IF the European financial sector encounters meaningful credit issues ahead, as have their financial sector brethren in the US, we could indeed see Treasuries continue to be the safety trade of choice. A confusing time with a lot of moving parts globally as really global credit cycle reconciliation plays out? You better believe it.
Point blank, the US cannot afford to lose the confidence of the foreign investment and
By ContraryInvestor.com | October 2008
The "Other" Consumer Confidence Report...What the heck are they thinking now? You know who we mean, the 'foreign' investment community. Who else? Hopefully without wildly belaboring the point, we remain convinced that the US is ultimately going to face a funding issue down the road. Maybe not a funding issue in terms of being able to borrow funds, but rather the issue is the cost at which funds will ultimately be made available to the US.
This is exactly what we addressed when we penned the Fun With Funding discussion last month. Put yourself in the shoes of the foreign investment community. Many moons ago, you started recycling trade related dollars back into US financial assets. In essence, you were able to facilitate a little mercantilist economics. By buying US financial assets (primarily bonds) you effectively helped keep US interest rates low and enabled the relatively blinded by asset inflation US consumer borrowing and spending (on your export products).
As commodity prices rose, the BRIC nations and OPEC got into the dollar recycling game in a big way. If you remember the Fun with Funding article, one of the tables in the discussion showed us that since May of 2006, 100% of foreign purchases of US Treasuries were undertaken by Brazil, Russia, India, China and OPEC. Japan was a net seller over the period. Quite the happy circumstance...while it lasted.
But over the past seven months, the foreign community has been treated to the visual of three of the five largest US investment banks disappearing. One literally disintegrating in the night. They also watched as the largest two US residential mortgage-financing intermediaries entered Club Fed, never to be seen again in public. Let's face it, the foreign community knows Lehman had been around for 158 years. The firm had lived through a domestic civil war and a financial/economic depression.
And what eventually took it down? Granite countertops, stainless steel appliances and travertine flooring. Quite the sorry commentary. You get the point. We suggest that one of the most important consumer confidence surveys of the moment is the monthly tally of foreign purchases of US financial assets. The foreign investment community has had a front row seat in the US credit cycle drama playing out amongst Wall Street and the Fed/Treasury/Administration.
They, along with almighty Bill Gross, expressed their extreme concern over Fannie and Freddie solvency, instigating relatively immediate action. They, along with almighty Bill Gross (to the tune of $750 million) would have been hurt badly had AIG gone nose first into the tarmac without even attempting to pull the nose up before crash landing. We know in part what the foreign community has been saying, but what are they thinking at this point? To us, one of the most important questions as we move forward.
Although we know we have covered this in the past, we believe it's critical to keep an eye on foreign capital flows into US financial markets. We ALL know how important foreign capital has become to the US economic and financial system continuing to function properly. And we all know that since early this year, foreign sovereign wealth funds have gone on a buyers strike in terms of providing US companies capital amidst the ever evolving US credit crisis.
No more Saudi princes riding to the rescue? C'mon, where's their sense of humor? Let's have a quick look at the longer-term rhythm of foreign flows of capital into US financial markets. Why? Because the character of that flow is changing meaningfully as we speak. You know these numbers unfortunately come to us with a lag. As of now, data is current through July. Since that time, Lehman has passed away and Fannie and Freddie senior and sub debt securities have been rescued.
AIG has been thrown a lifeline and Merrill has crawled under the skirt of BofA. We know the foreign community was indeed getting a bit skittish about the government agencies over the summer, and that skittishness is reflected in these numbers. But what's most important to us is the rhythm of longer-term trends in the twelve month moving averages you see in each chart. In short order, let's have a look.
Clearly into the credit crisis phase of the current cycle beginning last summer, Treasuries have been the asset class of choice for the foreign community. It’s a natural. Institutionally the world has been conditioned to run to the supposed safe haven security that is perceived to be UST's. As we’re sure you saw, 90-day T-bill yields kissed .2% in trading a few weeks back in what was clearly a panic run into the short end of the Treasury market.
The safe haven asset? In spades at that yield. We can understand foreign and domestic investor behavior here, but as we have said many a time in the past, we believe there will indeed come a day when this may no longer be the case. Although one day does not a trend make, gold’s one-day price fireworks show a few weeks ago was indeed the noticeable event. We heard rumors of a large AIG short in the metal being covered, but who really knows at this point.
Although we’re guessing, if gold zooms higher from here, we’d take it as a sign the markets have lost considerable faith in the Fed and Treasury. By extension, could marginal loss of faith in the credit that is US Treasuries be far behind if this line of thinking is even near correct? Nope. No wonder there is such establishment resistance to gold as a monetary symbol.
For now, foreign flows into Treasuries, as seen above, are not a major issue point of concern, but we watch intently as we move ahead. As a quick refresher, we believe the important data point in the chart above is the twelve month moving average of purchases. We're well below record highs seen years ago, but in no way are we looking at a supposed collapse for now. One note that we'll refer back to as we conclude this discussion is that into the last US recession, the foreign community was a seller of Treasuries in aggregate.
Although the credit crisis environment in the US has taken center stage attention for now, the fallout influence of the credit crisis on the real economy, and the real world recession it will ultimately engender, is the next act to anticipate in the current drama playing out before our eyes. Will we see a repeat performance of foreign liquidation of UST's in the US recession to come? If so, it could not come at a worse time. We watch and wait.
Before moving forward, one last view of life for perspective on the importance of the foreign community to the US Treasury market. Below is a look at the character make up of Treasury holders as of the conclusion of 2Q 2008.
As we suggested in the "Fun With Funding" discussion last month, the US government balance sheet will expand meaningfully ahead. Key question being, will the pie chart we see above change in character as this balance sheet expansion occurs? Will households become big UST buyers? How about domestic banks that currently own the smallest slice of the pie?
For now, although it's clearly loose commentary cast in the heat of the moment, the "reaction" of major sections of the foreign community (Asian, European and Middle Eastern) to the proposed bailout package in the US has been well south of a resounding thumbs up. But, as always, it's not what they say, but rather what they do ahead that will be important to US funding outcomes. Let's move on to the foreign influence in the government agency market.
The fact is that the sale by the foreign community of US government agencies in July was a record. The chart below is relatively dramatic in revealing this circumstance. Certainly some of the proceeds of these sales found their way back into Treasuries. We know the foreign community was indeed "asking questions" prior to the "conservatorship" of Fannie and Freddie, despite the implicit moral hazard guarantee that had been in place for literally years.
So it’s a one off in July, we believe. But despite the one month July sale-a-thon in agency paper by the foreign sector, the longer-term trend embodied in the 12 month MA has already been telling us for some time that the foreign community is growing weary of continuing to acquire agency paper. If the July activity in agency sales isn't a ding in the side of the greater confidence ship on the part of the foreign investment contingent, we just don't know what would be characterized as such.
Who knows, now that agency paper is essentially government paper with a yield premium, foreign community percpetions may change ahead. We've seen buying in recent anecdotal data. But we’re not holding our breath. As the chart clearly shows us, the foreign community indeed was a key provocateur in funding the macro US mortgage market from the mid-1990’s through to late 2006. Will they be so obliging to do so again given what has happened to supposed quality mortgage paper in the current cycle? We’ll see.
The real and very meaningful walking away, or confidence destruction, seen in actions by the foreign community in terms of purchasing US financial assets has occurred in the corporate bond market. Without question, what you see below speaks to academic risk reduction and a very much heightened sense of currently pricing in investment risk, if you will. The drop in foreign acquisition of US corporate bonds is striking, if nothing else.
As a quick tangent, we take what we see above very seriously. Corporate bond spreads have widened very meaningfully over the last year. Whether it’s corporate Aaa versus 10 year Treasury yields, Baa credits using the same spread, or high yield corporate spreads, it is clear that meaningful change has occurred in macro credit market perceptions and pricing. In our minds, there is no way the US economy is about to reaccelerate until corporate bond spreads contract. This is a distinct and definitive message of history.
And as is more than apparent in the chart, the foreign community has been nothing short of integral in keeping US corporate bond yield spreads tight throughout the entire prior economic cycle via their very meaningful purchasing activity. The twelve-month moving average of foreign purchases of US corporate bonds is just about back to the trough of the prior cycle seen early this decade as we speak. This strikes directly at the heart of the real economy being able to fund itself as we look ahead.
The last asset class under examination is equities. Foreign investment history has been that peak exposure usually occurs at major price peaks and trough exposure at major price troughs. You know, buying high and selling low. So what else is new in terms of human behavior? Not much. Since last summer, the foreign community has lost it’s taste for US equities, as has the US public.
Funny that way. Stick a 30% off sign in a retail store and it attracts buyers immediately. Stick a 30% off sign on Wall Street and everyone avoids the place like the plague. Human nature never changes, does it? We simply need to be aware of our own faults in terms of emotional human decision making and try to "rewire" our actions and reactions.
As you can see in looking at the absolute dollar numbers, foreign purchases of US equities in terms of dollars is very small. It’s the fixed income markets where the big foreign money is invested. And to us, this is very meaningful in that, as we have said, the big issue looking ahead is how the US government and greater economy funds itself. Who provides the funds and at what cost? Critical questions.
Final chart, we promise. Total foreign flows of capital into US financial markets over the last two-plus decades. There have been very few instances of monthly net selling by the foreign community of US financial assets. July just happened to be one of those months. Not good for a greater economy that we believe faces intermediate term funding "challenges", to be tactful.
But as we’ve said looking at individual asset classes, this is not a one-month one-off experience. The declining trend in foreign purchasing of US financial assets has been happening for a year now, completely coinciding with the deteriorating credit market fundamentals in the US. The chart is clear on this statement. Does this show us what the foreign community is thinking? How could it be otherwise?
As a quick comment on historical perspective, we know the nominal dollar decline in the twelve month moving average of foreign purchases total US financial assets is meaningful. As of July, the 12 month MA has declined close to $50 B from June of 2007. In percentage terms it's a 46% decline. In the wake of the Asian currency crisis, we saw a 51% top to bottom drop in this 12 month MA. So is the world coming to an end here and are we in uncharted waters? Not yet.
What we believe is most meaningful right now is the powerful issue of change at the margin. At the exact time macro US funding needs are increasing, one of the largest buyers/holders of US financial assets is changing their behavior at the margin. This is what we need to stay on top of, monitor monthly, and anticipate financial market and real economic outcomes based on this change.
There you have it, a very important foreign financial consumer confidence survey if we’ve ever seen one. Maybe one of the most important confidence surveys we can think of at the moment for a US financial sector and general economy increasingly in need of capital. In summation, we believe the foreign community faces the following decision points over the near term. As has been the case for many a moon now, foreign investment in US financial assets must contend with interest rate risk and currency exchange rate risk. Nothing new to see here.
But what is changing is the very important need of the US government to expand its balance sheet very meaningfully. You already know our thoughts on this. Third, the US and really the globe is heading into a major consumer led recession that at this point, as we see it, is unavoidable. Key questions for now being duration and depth.
Will the BRIC countries' and OPEC capital reserves (the key foreign buyers of UST's over the last two years) be needed on their respective home fronts to help shore up/stimulate their own economies? If so, that's competition for a US government in need of increased funding. Lastly, there is a new monkey wrench that has been recently thrown into the total equation.
The foreign community has been treated to the new wrinkle that US authorities are now willing to "change the rules" without any prior notice. Again, at the margin this creates investment uncertainty. How are foreign entities to feel comfort in providing capital to the US financial sector when equity and preferred asset values can be essentially wiped out on a Sunday afternoon? It's no wonder the global sovereign wealth funds have been on a buyers strike.
As a quick counterpoint to what we see as enhanced risk to foreign capital committing to US assets at the moment, be sure to keep your eye on many of the major European financial institutions. In terms of the raw numbers, leverage ratios for many of Europe's largest financial behemoths make former US investment bank outfits look like choirboys and choirgirls. IF the European financial sector encounters meaningful credit issues ahead, as have their financial sector brethren in the US, we could indeed see Treasuries continue to be the safety trade of choice. A confusing time with a lot of moving parts globally as really global credit cycle reconciliation plays out? You better believe it.
Point blank, the US cannot afford to lose the confidence of the foreign investment and