Sunday, December 30, 2007
This is why you don't follow anyone blindly. I love seeing what other great investors are doing. Many of my ideas come from other great investors (I would say typically I only have 3 or 4 ideas a year I come up with completely on my own) but you have to do your own work and the investment has to pass the common sense test. Many great investors are tied into the financial markets and the same circles of thought and are susceptible to group think like anyone else. In late August and September the common thought was that financials were caught up in a liquidity crises. This Pavlovian thought was built upon many similar circumstances in the past 20 years. Only thinking truly contrarian, outside the box would have caused someone to avoid financials and recognize that this was not a liqudity crunch but a credit (solevency) crises.
I have been doing all kinds of stuff like this recently. Options are currently incredibly expensive which allows a smart buyer and seller to really take advantage and lower and raise your cost basis (depending whether you are long and short). A year ago all I did was buy options. Now all I am doing is selling them.
When used correctly options are a very powerful tool.
Friday, December 21, 2007
I see similar things happening with rating agencies (though I think they will always be around, maybe just in a different form). When the trust breaks down, why do it?
State and local borrowers are discovering that buying municipal bond insurance from MBIA Inc. and Ambac Financial Group Inc. is a waste of money.
Wisconsin sold $154.6 million of general obligation bonds last month at interest rates usually available only to borrowers with the highest credit ratings. Wall Street firms didn't require the state to insure the bonds, even though Wisconsin is graded four levels below AAA, amid signs that bond guarantors may lose their own top rankings.
This seems ridiculously low with inflation risk coming but I am not a muni expert.
When Wisconsin sold $154.6 million of bonds for highways, public buildings and water improvements on Nov. 15, it paid a yield of 3.87 percent for debt due in 2016.
Thursday, December 20, 2007
MBI press release.
The information posted on December 19, 2007 discloses no additional Multi-Sector CDO exposure. The information provides detail on the composition of MBIA's $30.6 billion Multi-Sector CDO exposure that had previously been provided in its Operating Supplement. MBIA discussed its exposure to CDO transactions with inner CDOs ("CDO-Squared") during a conference call for investors on August 2, 2007.
Standard & Poor's, Moody's and Fitch have confirmed that this information was provided to them and was taken into consideration in their recent ratings analyses. The information was also made available to Warburg Pincus prior to their entering into the previously disclosed Investment Agreement, and that agreement is not affected by this information.
Concurrent with its related rating announcement earlier today on MBIA Inc. (MBIA) and its financial guaranty subsidiaries, Fitch Ratings has placed 173,022 bond issues (172,860 municipal, 162 non-municipal) insured by MBIA on Rating Watch Negative.
Oh my goodness. Watch out money market funds.
Wednesday, December 19, 2007
Now we have everyone (for the most part) saying we are heading for some sort of a recession??? I have been agonizing over this and it has literally kept me awake. It does not makes sense. Can the masses call for a recession and one actually come?? Or does this mean a doozie of a recession is coming? Something does not jive. Equities are cheap. Dirt cheap, there is no denying that. So it is hard to get uber aggressive on shorting. At the same time I am starting to lean towards a massive recession that will blow what people think is coming away. I just can't believe the masses can get it right now when they have gotten it wrong the wholeeeee way. Maybe though. I was reading through the House of Morgan by Ron Chernow and the chapter on the 1907 panic starts out.
"The folk wisdom of Wall Street says that if a crash is widely expected, it won't occur, for a saving fear will filter through the marketplace. This was refuted in 1907, when Wall Street spent a cliff-hanging year awaiting the crash that came."
Hmmm. I found that really interesting in lite of losing sleep over my ponderings. The rest of the chapter goes on describing the events of 1907, which of all the crashes I have looked at, looks like the greatest comparison to what is happening now except on a smaller scale (that is another topic). Maybe it is possible. If we are only heading into a 2001 type slowdown you should be buying the heck out of equities. I would almost say you should be borrowing money to buy equities.
What I think this really hinges on (things are simple in life, people make them complicated) is the mortgage insurers MBIA and Ambac. If those two blow up, if that insurance becomes non existent, watch out. The truth is I believe Ambac and MBIA are almost insolvent now. The rating agencies know it but can they really downgrade them? That makes them insolvent overnight if they are not now. The longer they wait the longer there is a glimmer of hope. If one of those two firms get downgraded you are going to have mass money market funds break the buck. This will be the last straw. I don't think the U.S. government can let these two firms go belly up. Right now most of the losses for these two are paper losses. It will take 9 months or so for the real losses to really pick up steam in mass where they are having to make massive payments. The rating agencies (with probably quite a bit of behind the scenes pressure) can wait and wait and stomp up and down huffing and puffing acting like they are doing something but in the end they are desperately trying to buy time for the whole system. Maybe it will work, maybe it won't, but that I truly believe what the next 2 to 3 years hinge on. I have flipped through 6 money market annual reports holdings trying to find a safe money market fund to park cash. It doesn't exist, everything is insured by these two. One of those two don't make it and the chain reaction will be harsh and severe. They make it and this is a great time to be buying equities.
Maybe that is oversimplifying it but that is the way I see it.
Tuesday, December 18, 2007
In general he said you need to look at the bid amount and the clearing price. If it is above 4.75 he said we have liquidity problems and you can expect the Fed to potentially be aggressive in January.
Monday, December 17, 2007
An interesting thread on BNI. I do not own it and have not looked at it but there were a couple of interesting data points.
I didn't realize on a dollar basis that this is the largest stock purchase ($5 billion) that Warren Buffett has ever made.
Thursday, December 13, 2007
1) Industry selection generates on average about half of mutual fund alpha.
2) The correlation between the industry and stock components of mutual fund alpha is 0.06, indicating that the underlying selection skills are largely unrelated. In fact, 47% of sample funds underperform one aspect of selection while outperforming the other.
4) Unlike stock selection, industry selection is not subject to diminishing returns. While outperforming funds are unable to maintain strong stock selection alpha as assets increase, they do maintain strong industry selection alpha. Industries appear to provide ample opportunities for incremental investment. This lack of relationship between fund size and industry selection alpha helps explain why this alpha persists.
I have been meaning at some point to write a full post on this but haven't gotten around to it. I found this very interesting. Buffett in different ways has said many times that he looks at companies and does not care about recessions or big macro events. I think he overstates it to make a point. If you read the Charlie Munger explanation of how they got into railroads at the Wesco annual meeting, his explanation sounded almost entirely like a industry play that then drilled down to a company play. It was top down approach to an investment. I am adamant about focusing on the company. I have always thought general asset allocation for small investors who were willing to do the work was stupid; however, I have argued, at times passionately, that "don't focus on the macro" in the value world gets way to much air time. The big picture showed you at some point that financials were not the thing to touch with a ten foot pole. It didn't matter if Corus had the best management for condo banking. They are still down like 75%. It didn't matter if what Delta Financial had an unbelievable management team in the securitization world for subprime. They are sill bankrupt.
Value guys typically way under play the industry and the sector calls which is one reason I liked this little blog post so much as it gives some numbers to what I have anecdotaly argued. You made huge returns by being betting on commodities no matter what company you invested in. You lost tons of money betting long on financials no matter what company you invested in. So you lost 30% instead of 70%. Great.
So big picture thoughts? If inflation is coming, which I strongly believe it is if we don't enter a serious recession or depression (I don't think a mild U.S. recession will stop it) you better think about owning timberland. Agriculture boom still has a ways to go. REITS will continue to go down. Globalization of markets will continue (think about owning stock in major exchanges). Just to name a few.
Just an article comparing popularity searches. The only reason I bring it up is because,
Economists are debating the question fiercely, but netizens have already voted: Roughly three times as many people are searching the Internet for the word "inflation" than "recession."
Inflation combined with stagflation is coming. Watch out.
Wednesday, December 12, 2007
5. Cleveland Introduced to Deflation
According to Cleveland.com, the website for "Everything Cleveland," Cleveland Mayor Frank Jackson said the city is working to stave off a money crunch that could jeopardize large capital projects on the horizon.
A) At stake are projects ranging from roads and bridges to a $1.5 billion plan for the city's Warehouse District, all of which rely on the city's ability to borrow money.
B) "There's no room for us to borrow money," Jackson said in an interview with the Plain Dealer.
C) Why the problem?
D) Largely because declining real estate values, and successful property tax appeals by property owners, have cut into the assessed value of real estate.
E) "What I don't want is anyone to interpret this in any way to discourage investment or induce panic that the world is ending, because it's not," the mayor said.
F) No, it's not ending, it's just deflating.
Of course, plenty of questions still remain. Will it be nearly enough? Why didn't the Fed say the downside risks to the economy were more than the risks of inflation? Why couldn't the Fed persuade the Bank of England to take AAA-rated residential mortgage-backed securities from the U.S. as collateral? (The U.K. central bank, interestingly, will take U.S. credit card-backed securities -- the Brits evidently don't doubt the resilience of the U.S. consumer, even if they think house prices are falling off a cliff.)
But the biggest question has to be, what about the timing? Why on earth didn't the Fed announce this at the same time as Tuesday's rate decision? They obviously knew what was going to be announced -- the newspaper leaks from The Wall Street Journal and the Financial Times this morning meant that such a move was clearly in the cards.
What in the world is the FED doing? Do they even really know?
I have been whipsawed like everybody. I am sure you are asking why? Aren't you a long term "value" investor where the short term gyrations do not matter. The answer is yes but. The but being hugely centered on our system. It is the same type of question as what is money? What really is it? Well it is nothing unless someone else finds it valuable which is nothing unless that person has trust in whoever is backing it. In the late 1800s the trust was in individual people such as Pierport Morgan and the Rothchilds. Now the system has morphed where the trust is in institutions such as the FED and mortgage insurance and the system they manipulate. When the system breaks down, when the trust dissipates you have dominoes that can fall hitting everything else. So I had spent a decent amount of time researching shorts and longs depending on what the FED did. Isn't that irrational? Shouldn't there be an underlying intrinsic value. Once again yes but. Intrinsic value and probability scenarios are very dependent on rock hard foundation of the system. If the system breaks down value falls for most names. On shorts as I have written before I don't short on valuation but on themes. So a theme I have played for over a year has been financials working up the system. First shorting subprime, then alt A names, then prime names, then mortgage insures, and now home equity lines of credit. If the FED would have aggressively cut rates say 50 bips and cut the discount rate by 75 bips it may have been enough of a shot (at least in the short term like in August) to restore faith that the system was getting the medicine it needed. As I said yesterday I was shocked at what the FED did not because I thought it was the wrong thing to do (my fear as I have stated many times is inflation, this system needs to break down in an orderly fashion even if it casuses a recession) but because I thought they would cave to market pressure. The reaction was brutal and immediate with the market tanking. Investors and traders immediately realized this is not what the system needed and as all the excess gets unwound, down goes the stocks. I, like probably most, increased the positioning of my portfolio for a continued deterioration of the system. My longs that I really liked for the long term I ignored but started ratcheting up the short exposure for my theme based picks.
Then the FED did what it did today. It caught everyone off guard including me. It caused mass confusion. Initially it looked like all the posturing and the timing could restore faith in the system. The positives were that this was a coordinated effort that had been in the works for awhile. The FED was paying attention. So I ended up buying some of those longs that I had done work on. That was short lived. Instead, as Cramer correctly pointed out, (I can't believe I am actually referencing him positively in a post) it helped Exxon (up 2%) and hurt exactly what the FED was supposedly trying to help, financials. Why? Primarily I think it goes back to what I referred to above. The FED is speaking out of both sides of its mouth, appears confused and somewhat panicked. That hardly leads to confidence to the system and I think it actually deteriorates confidence in the system. It is in stark contrast to how Morgan stood in the panic of 1907. First the longs got burned after the FED decision yesterday then the shorts get burned after the FED news release today. In the world of finance that adds huge uncertainty. The market of course hates uncertainty which as a result increases the overall discount rate. The risk premium people will charge increases. This hardly helps the FED's overall goal in increasing liquidity and unclogging the system. For me personally it caused me (it didn't cause me, I caused me) to trade horribly as I was forced to position my portfolio and then reposition it. Finally I just gave up and tried to make it neutral compared to what I typically run when things are more normal. Either way it cost me dearly on the entry point. There are many names that I believe are very undervalued. That is in the framework of the system however and unlike 2002 the system is in danger of collapsing. In 2002 you could buy a security undervalued and the intrinsic value would most likely be eventually reached. Unfortunately looking at deeply discounted securities is more difficult because the probability of the system breaking down (black swan type breakdown) must be given a much higher probability. You are dealing with financials and debt which is what our economy, progress, and the world revolves around. A telecom bust definitely touches other areas but a banking bust touches every area.
With all this said I still reiterate my call for a recession which I have been calling for since August. History is firmly on the side of one. I still think defense is the best strategy. Also I would like to point out hotel stocks unlike retailers are not pricing in a recession. Wyndham already showed they were feeling the pain a few days ago. I was looking at it and was to slow. Others I believe will follow.
Tuesday, December 11, 2007
Excerpt taken from Seth Klarman's book Margin of Safety talking about CBOs. Change the B to a D and presto you have the exact same thing happening 17 years later.
As I have said quoting the great wise King Solomon...nothing is new under the sun.
Monday, December 10, 2007
A decent article on REITs in the NY Times over the weekend. An area I have bet against and am still short. It is becoming less clear that it is a great bet to make with the U.S. Armada firing every cannon it has to save us from our problems ignoring future collateral damage.
Sunday, December 9, 2007
Bill Gross monthly commentary is finally here. He was running late a few days more than normal. Can be read here.
The publicized and photographed overnight "runs" on Countrywide and the UK’s Northern Rock in mid-August were nothing compared to what’s taking place in the shadows of the real banking system. Credit contraction, with its inevitable companion of asset destruction, is spreading with the speed of an infectious bacterial disease.
First of all, history would point out that Fed easing cycles during prior recessionary or near recessionary economies have invariably dropped to 1% Fed Funds rates when calculated on a "real" or inflation-adjusted basis. With PCE core levels at 2%, a destination of 3% would therefore be a reasonable current target.and
Standby for a tumultuous 2008 as the market struggles to move from the shadows back into the sunlight of sounder banking and financial management, accompanied by Fed Funds levels at 3% or lower.
Several of Bill Gross comments over the past month has almost made Jeremy Grantham sound like a raging bull.
This was fairly interesting. A short look at the convoy system Japan pursued and whether Paulson SIV plan is pushing our banking system the same direction.
Thursday, December 6, 2007
First the why - political - duh. If Sept 11th never would have happened and especially Katrina the reaction may have been more muted and slower. How much criticism has the Bush administration received for slow and inadequate reaction time with various crises? Throw in the election year, the first non incumbent from the current administration not running for office in like 40 years and you have a lollapalooza effect of government trying to save the United States from any kind of normal economic pain that would normally and probably needs to be felt. (This is by the way why 5 to 10 years out I am shaking at the potential consequences. What I see as a lollapalooza in government reaction will have dire consequences later).
Second - what is he trying to accomplish. The Fed and government are desperate to slow down the decline. This is probably the one redeeming factor in all of this. The reason is because a panicky sudden reset to appropriate value can have unpredictable outcomes. If all this maneuvering really does nothing but extend the pain 3 to 5 years to a much more slower measured slowdown they will have felt like they accomplish what they were trying to accomplish. Though few will say it, everyone knows that housing prices need to get back in line with affordability and if you cause that to happen over 5 years versus 2 years you could save alot of potential problems.
Third - the outcome. In general I think this is the best attempt at something that actually may have an impact that the stooges of government have tried. It shows promise at actually doing something constructive besides just throwing money out the window hoping the right people catch it. I think it will have the affect of actually slowing things down the demise which as I said above I think would be a positive. Ironically where I think you could have the biggest backlash and unintended consequences is political. I am not convinced this is a political win for the Republicans though I have not heard anyone say otherwise. America is built on individualism and either succeeding and failing on one's own personal decisions in life. It is bred into our social DNA. Now when things go wrong we will complain and beg for a bailout and we will take it if it is handed to us but it is not something that is necessarily expected (though that is changing as the Fed continues their antics). Anyway many Americans are seeing this as vastly unfair. You can have one person not get a reset and the house next door get a reset. This does not sit well with many people even if from a utilitarian perspective it is beneficial. One of the strongest drivers of human behavior is envy. Buffet has talked about this many times. This freeze will not affect alot more people than it will have an impact on. As a result you have the potential for many more people thinking they are getting cheated or treated unfairly than people who will benefit from it. This is a recipe for alot of bad will. If I have a credit card and can't afford to pay the bill that month and have to pay a 20% interest rate and my neighbor gets help by not having to pay a higher interest rate on a contract he signed, I would be rather upset. Anyway politically I think the ingredients are there for this to actually be a big loss for the Republicans.
To summarize. The overall impact I think will be minimal besides the timing. I think it will actually benefit investors in this stuff because foreclosure is more costly than not changing the interest rate from 8% to 11. My guess is the number of foreclosures will not go down that much it will just be spread over many years. If things really pick up my understanding so far is it is not binding and so you could see the coalition fall apart. The biggest unintended consequence I think could very well be political.
What has just recently started though is the that others throughout the world have started getting boxed in by Helicopter Ben tactics and being forced into policy decisions that would probably not have been been made if it was not for America leading the way. A couple of days ago Canada was forced into a position to cut interest rates and today the Bank of England did the same. With commodity prices sky high, Canada arguably has the strongest economy it has had in years, why are they cutting rates? Well of course the Loonie is wreaking havoc. Okay well the Loonie is strengthened of course because of the economy but the August to October moon shot was because of the U.S. Fed rate cuts. Also they know what the Fed is going to do in December and are probably getting all kinds of pressure to cut rates with us so not to further destroy our currency and risk even more inflation that oh yeah "really does not exist."
Anyway this will continue a chain reaction. Others will be forced into cutting rates as liquidity is once again pumped into the system in massive proportions.
All this with, let's see, yes, the greatest global boom in the last 50 if not 100 years. When else have we had global growth north of 5% and government cutting interest rates? Anyone? Now of course America is not growing at that rate, neither is England or Canada (Canada I think is close but not exactly sure what their growth rate is).
So great what does that mean. Well currently all the liquidity is going to treasuries and ultra safe areas. When things start to clear up though and money starts flowing, who knows exactly how every note ends up being played out, but in general the liquidity will flow into areas that investors "feel" good about. The areas where they have not been burned and returning to areas that pleasure spots in their brain associate with reward. Well this is not equities. The 2000 bubble is still to fresh on investors minds. Sure the markets may go up but I would be shocked to see massive multiple expansion in the developed markets. Now the newest pain has been felt in the mortgage market and asset back security market. Even with the flood of liquidity back into the market you will not see the spread anywhere near as tight as it was 12 months ago. You may not see that for 20 years plus until the memory fades. So what does that leave?
Commodities and emerging markets. I have made tons of money this year with bets in corn and soybeans. Since August both are strongly up. Emerging markets are the same way. Many up 30% or more higher ytd. You are already seeing the groundwork being laid for a massive bubble in this area with articles talking about a new era and growth that is indefinite with the potential of China and India. What a wise man starts a fool will finish. Famous quote by somebody is more than applicable here. Resources should be going to these area. Soft commodity inventory is the tightest it has been since the 70s. China has unknown potential. This was all true in the beginning and still so. Eventually though when people finally calm down and start selling treasuries to take on some additional risk you are going to have a massive amount of capital that needs to go somewhere. Some will go into equities, even a smaller amount will go back towards debt, the bulk I believe will go towards emerging market equity markets and commodities. You will way over shoot to the upside and eventually come crashing down. This all may happen in 2 years or 10 years but I would be willing to bet alot of money that it will happen.
This of course will cause far more reaching pain than if Bernanke would avoid the political pressures of an election year and not pump money into a system that really needs to go through a recession and really needs to clean out alot of junk. It will not happen of course and we will go through the follies of every generation before us. Like I said the pain (for everybody) will be multiples higher than if we took all the dosage now.
Oh yeah, one more thing. I truly believe this is going to cause massive inflation in the Untied States. Once the election is over all the cookie jar accounting will have to start slowly being reversed. Once the flow starts it will be very difficult to stop or even slow down (look at Greenspn's efforts to raise rates from 03 to 04, really did nothing to stop the excesses in the debt market).
Truly nothing is new under the sun.
Monday, December 3, 2007
As I said last week the tone on CNBC has changed dramatically in the last few weeks with the talking heads on homebuilding related stocks.
What does all this mean when even the value guys are not actively talking about it (many of these same individuals have gotten burned, I know I look at there filings, it makes you wonder how close the bottom really is. I think I would be shocked if we are more than three months out from a bottom. The biggest risk of course is we are heading towards a 1989 Japanese metldown. This is what Prem Watsa believes. The Canadian investing guru says he is 75% to 80% in government debt which he has never been before. He would know, he lived and worked in Japan during that time.
Full article on Prem's comments here.
Was truly a great conference. I could listen to those guys for hours.
It was interesting the truly diverse opinion on the overall market. Of course the emphasis was on individual securities but overall market bias generally comes out with the type of picks. You had Leon Cooperman make a very strong argument on why currently we have a great buying opportunity in the stock market. You had David Einhorn pitch a short Lehman idea with Bill Ackmen pitch a short Ambac and MBIA suggesting that both equities are zero's. Then you had Thomas Brown pitch First Marblehead as a long idea and make a strong argument that despite billions of dollars in coming write downs that we are at a bottom for financial stocks and suggesting we are at November 1990 which started a 10 year bull market in financial stocks. After his formal presentation he suggested that Einhorn's pitch was another sign of a bottom and that he had a differing opinion on MBIA and "looking" at potentially purchasing some of the equity. He cited talking to the a board member from MBIA who was a former CFO of US Bancorp, was like a partner at Carlyle, he had another credential I don't remember who was not concerned at all. Tom said he was so optimistic it almost concerned him.
Anyway you had a wide swath of views. The crazy thing was that six of my positions were pitched. I had no idea on two of them that anybody else was even looking at them. Crazy how that works out.
I will probably post more thoughts in days to come as I process them. All in all though I am in my element listening to those guys and talking to friends about stock ideas. It was incredible.
Monday, November 26, 2007
Dang it - I knew I picked the wrong profession.
I refuse to believe sell side analysts on Wall St. can call bottoms like this. How many housing bottoms have been called from these firms. In fact it is only recently (the last two to three weeks) that it seems the tone has drastically changed when discussing housing by "talking heads" on CNBC and such. This change, in my eyes, has really been remarkable. I may be wrong but the time to buy housing stocks may be very close (still not personally buying). Anyway what we went through in housing with bottom callers I think we will go through in the financials. I saw a graph showing that S&P 500 bank index (subset of the financials) showing that it is down like 30% since August. I fully expect that to be down 50% and maybe more before this is all over.
Citigroup is already down like 3% from there call this morning in one trading day.
Tuesday, November 20, 2007
This is the second time I burst into audible laughter at reading a headline today. The above was on cbs.marketwatch a few minutes ago. Did anyone legitimately trade on the rumor that the Fed was cutting rates after two Fed chiefs spoke very strongly against cutting rates in December much less less four days later. We may indeed have an emergency rate cut but the Fed would have lost all credibility (in my mind they have very little if any left anyway) to be scheduling an emergency rate cut today.
Sometimes if you need a smile, just surf through some financial headlines.
He thinks there are many more problems to come over many years.
I kind of agree with "Ralph."
Core inflation at 1.5% to 2.0% in 2009 and 2010. Which numbers are we looking at? The doctored I am assuming. This may be right if we enter into a deep recession. It is not right with their second forecast.
Fed cuts '08 GDP to 1.8% to 2.5%.
If we do end up having that rosy scenario of growth (I firmly disagree) then inflation will be much higher.
But it goes with their overall theme. We see risk to inflation and to growth. Translated - HELPPPPP!!!
Monday, November 19, 2007
The second thing that strikes me is that over the past 20 years there have been six financial crises: October '97, 1990, which already was somewhat real estate related, late 1994, the Mexican crisis, '97 to '98, the Asian Crisis, the Russian Crisis and then the failure of long-term capital management, the hedge fund, where the Fed had to organize a bail out, not of a bank, but this time, of a hedge fund. Then, in 2000, there was the bursting of the technology/media/telecomm bubble. And the sixth one, two months ago, was the sub-prime crisis, sub-prime housing crisis.
Now, the first five crises were handled by Greenspan, who flooded the system with liquidity and the crises passed fairly quickly. The last crisis was handled by Mr. Bernanke and he took the same attitude, flooded the system with liquidity. And, the consensus today I believe, among investors, since we are almost—we are back to all time highs in the American equity market then—it’s the consensus of other investors as well, since foreign equity markets are also back to their highs. So the consensus is that the crisis has come and gone, the crisis of two months ago has come and gone.
Now, it’s almost a Pavlovian reflex because if five financial crises were handled relatively quickly with no major negative economic consequences, then the assumption has to be that the sixth one will also be handled relatively quickly and with no major economic slow down or recession. And that may very well happen and maybe the odds are pretty good that it will happen. At the same time, it seems to me that the Fed is walking a fine line. On one side of the line, cutting short some interest rates to the point where the decline in the US dollar gets disorderly, although, it’s in nobody's interest admittedly that the decline get disorderly, and/or that domestic inflation perks up.
On the other side of the line, the risk is that cuts in short-term interest rates—because the housing bubble was so gigantic—that cuts in short-term interest rates would not be enough to prevent the economy from, the American economy, from going into a major slow down or even a recession. Now again, the odds may be good that both risks will be avoided. But at the same time, you know, as Peter Bernstein says, sometimes what matters is not necessarily how low the odds are that something will happen. What matters sometimes more is what the consequences would be if that something were to happen.
I had not thought of the the Pavlovian reflex point. It had me thinking all last night.
Friday, November 16, 2007
I don't put much stock into all that other than it being one more data point but it is interesting considering the fact that the world may have started a massive delevering two to three year cycle. Animal spirits as Bill Gross calls them are going into hibernation.
Reunited Spice Girls perform at annual promenade that features more conservative lingerie styles this season.
In line with Turney's plans to be more conservative, this year's line of Victoria's Secret lingerie probably could be considered as such by viewers tuning into the show Dec. 4.
Thursday, November 15, 2007
I meant to do a post on this last night and forgot and was going to do it today but I noticed Big Picture beat me to it.
What are those reasons? Well, according to CNBC.com, Fink would only agree to take the position if Merrill was willing to give a full and complete accounting of it's subprime exposure:
Well after Fink laid down his one and only stipulation (pretty understandable if you ask me, I mean I would want to know what kind of mess I was getting into) the phone went dead. Fink apparently never heard back.
Seems logically it would be for one of two reasons.
1) The write downs are still woefully short of reality
2) There was no way to meet Fink's condition because no one at Merrill has a clue what the accounting should actually be.
Both scenarios seem very bad for investors and the markets alike.
Tuesday, November 13, 2007
Amid the gloom, analysts estimate New York-based Goldman Sachs Group Inc., Merrill, Morgan Stanley, Lehman Brothers Holdings Inc. and Bear Stearns Cos. will earn a combined $28 billion this year, down 8.3 percent from the record $30.6 billion in 2006, according to a survey by Bloomberg. Analysts currently estimate the firms' net income will reach $32 billion in 2008.
``When you look to next year, you're back to earning money once these writedowns are taken,'' said Benjamin Wallace, who helps manage $750 million at Westborough, Massachusetts-based Grimes & Co. and owns Merrill and Morgan Stanley shares.
Quick point on this. This is one reasons why I don't think financials are a screaming buys. Analysts still have not realized that the gravy train for now is over. Just because writedowns evntually will cease doesn't mean huge profits are back as volumes will takes year if not a decade to recover.
Reading this article on Goldman's call to cut back on emerging markets. What I found more interesting was their thought on the U.S. currency in relation to several currencies. Not sure if I agree or not but interesting.
For this reason, the most logical choice to bet on a decline in the price of oil would seem to be the MacroShares Oil Down Tradeable Trust DCR, which tracks the inverse performance of the long-term trend for oil. This isn't quite the same thing as tracking the inverse performance of spot oil prices, but it's still a directional play. DCR, and its twin the MacroShares Oil Up Tradeable Trust UCR, are trusts that hold short-term Treasuries and cash equivalents. They work like swaps in that when the Up Trust increases in value, it takes the money from the Down Trust.
Unfortunately, the Up Trust and the Down Trust aren't the hedges they might be because their share prices tend to trade out of line with their net asset value. As of Monday's close, the Down Trust was trading at a 73% premium to its NAV, while Up Trust was trading at a 20% discount to NAV. Robert Tull, managing director of MacroMarkets, says the products take a long-term view of the market and so aren't the best choices for investors trying to capitalize on near-term trends.
Monday, November 12, 2007
According to the latest FDIC banking profile, FDIC insured institutions currently hold a notional value of $153.8 trillion in credit derivatives. That's not a typo – though GDP itself is only about $13 trillion,
I'll reiterate my view that recessions emerge not because of a general decline in the willingness to consume, but rather because a mismatch emerges between the mix of goods and services demanded in the economy, and the mix of goods and services that the economy has been supplying. Many industries experience continued growth during recessions (even if their stocks trade somewhat lower), while other industries experience profound demand shifts. In the late 1990's, there was clear overinvestment in telecom and information technology, and these sectors suffered disproportionately during the recession that followed. In the current cycle, the overexpansion has been in housing, debt origination, and leveraged finance, so a much different group of stocks will probably be hung out to dry this time.
Thursday, November 8, 2007
The record price paid in January for the 41-story aluminum-clad office tower at 666 Fifth Avenue — $1.8 billion — was breathtaking.....
Today, however, some real estate specialists regard the 666 Fifth Avenue transaction as a textbook example of the risky practices that were prevalent before the current credit squeeze, when many loans were based not on the actual cash flow of the building from existing rents but rather on optimistic projections of what the space might command once those leases expired.....
What raised eyebrows was the financing of 666 Fifth and other buildings sold late last year and early this year, said Robert M. White Jr., the president of Real Capital Analytics, a New York research firm.
A group of lenders led by the real estate unit of Barclays Capital agreed to provide an interest-only first mortgage of $1.215 billion based on an annual cash flow of $114 million, or 1.5 times the debt service, according to a document filed with the Securities and Exchange Commission. But a footnote pointed out that the cash flow from existing rents would actually cover only 0.65 percent of the debt service. ... the building’s shortfall amounts to $5 million a month. A $100 million reserve fund was included in the debt package to cover the shortfall.
Wednesday, November 7, 2007
Jim Rogers echoed some comments I have thought the last couple of days. This credit thing is truly another bubble. After the big drop in August, some of the value guys I respect were some of the first to dip their toes in on various names. I am not saying they are wrong, but I think the industry may have been in a stealth bubble. In other words, it didn't look like a bubble because earnings was there to make valuations looks reasonable. Ahh, but these earnings were made on instruments that were no where near priced correctly. Essentially with the very low risk premium these financial firms needed to produce that many more widgets to generate income. Well this created a viscous cycle that is now unwinding.
So lets say this risk premium was really a bubble (in the fact that there was no risk premium), well the unwinding of it could really just be getting underway. As I have said, a bubble demands bubble outcomes. S&P 500 was down about 50%. NASDAQ down 80%. Homebuilders are now down about 70%. Financials are down, what, 25 to 30%? Looking at this, it seems like everything has been shrunk down to quicker reaction. The homebuilders started moving down Sept 2005 until Sept 2006. Then you had a five month rebound before crashing again. In financials you had the big move down in August into September before a very big move up and now we are crashing again. David Dreman and Bill Miller both have said bank stocks are interesting with David talking about the scare that comes along every 10 years for financials.
Maybe he is right but historically financials have been around 20% of the S&P. We moved up to 25%. Doesn't this have to correct and almost overswing before the all the clear is out? Also high yield bond spreads haven't even reached their ten year average (This was as of two weeks ago, maybe they have now) which tells me spreads in this area need to widen. From homebuilders, to building suppliers, to banks focusing on subprime, to Alt A companies, to investment banks to mortgage insurers this has spread from one to other in a classic way. It has been very predictable and when I shorted the next step I usually lost 20% on paper first before the market finally was like oh yeah the subprime guys will get hurt and oh yeah the Alt A guys will get hurt and oh yeah the mortgage insurance guys will get hurt. Duh. So isn't it a duh that credit defaults will move back towards normal, that corporate bond spreads need to widen, that this will cause further pain in various financials stocks, that the Fed will continue be forced to cut rates, and the dollar will continue to fall? Once again it seems like a classic pattern that no amount of intervention will prevent. At best it may postpone the inevitable a little longer. The trick of course is making money in all of this until the market realizes that this time is not different.
So back to financials. The market keeps wanting to say oh okay that is the worst of the bad news and it is behind us. Then the news gets worst and the stocks get beat to death and then the market says oh okay so we had a 10 billion write down and the worst is now behind us, we know it is now back to normal. For argument's sake let's say the worst news is behind us. Does that make these things a screaming buy???? I really think the answer is a no. If the losses stopped tomorrow we are not going back to "normal." The pace and the frenzy and the animal spirits, as Bill Gross calls them, are not coming back (at least in this space, watch out emerging markets). What that means is "normalized earnings" that Wall Street has stuck in their head for these guys will not be around for at least two to three years.
The blood running in the streets is a common phrase that is thrown around. http://www.marketwatch.com/news/story/mark-hulbert-citigroup-good-buy/story.aspx?guid=%7bA02F53C1-74DB-4A8A-A817-D250BC2619A1%7d&dist=bondheads write about buying Citigroup and being a contrarian investor almost challenging you to see if you are a man enough to walk the walk and start buying C. To be honest I have considered some various deep in the money calls with C and have passed. I am not convinced that blood is running in the streets. Oh sure Wall St. is acting like it is. They are howling and crying and bemoaning and begging in true Wall St. fashion, but is there true blood? Wall St. estimates on bonuses came out the last couple of days from two separate firms. One estimates it to be flat and another slightly down from last year. Um if anybody noticed last year was a record record year when it came to Wall St bonuses and your telling me blood is running in the streets is flat to slightly down bonuses? Have there been any major bankruptcies? New Century was the biggest but that was subprime related. The Wall St. crowd would like you to believe that the sky is falling (and it may indeed fall) but it hasn't yet.
The question is if we were in a bubble that was just masked by tons of volume of very low risk premium securities making valuations looks normal? If the answer is no and this is just really a 10 yr scare in financial stocks then you should be backing up the truck. If the answer is yes then I think the stocks in financials as a whole may be about (optimistically) halfway done moving down. The great thing about running a concentrated portfolio is I do not have to vote one way or the other. I can look elsewhere.
He has been as right as anyone over the last decade. I think he is right on with his credit comments.
I thought this, though short, was very interesting. I have said repeatedly that the next bubble will be in emerging markets (specifically China) and commodities. Many people are acting like China's bubble is about to pop anyday now. I think it has much longer to go and could be the bubble of all bubbles. Compared to previous bubbles it already has had a great start in a relatively short amount of time.
Sunday, November 4, 2007
I think it is different. Unless you are intimately connected, at least for me, I find it almost impossible to handicap various outcomes. I have said numerous times that hurricanes sink even the best of captains and I think no where is the danger higher of sinking great captains caught in hurricanes than in financial hurricanes. The reason is the nature of the business. Everything (unlike homebuilders or oil exploration companies) is based on confidence, trust. The world we live in is terribly dependent on credit, securitizations, derivatives, insurance, etc. If all of a sudden the trust falls apart, the system itself falls apart, it doesn't matter how good you are, you are sunk. A great example of this has been Delta Financial (DFC). I looked at this name numerous times. I read the majority of the annual report, almost bought it several times. It was cheap on every meaningful metric. If you are unfamiliar with them (very rough explanation) they originate, securitize and sell subprime loans but they originate virtually zero floating or adjustable rate mortgages. They are almost all fixed. Their management has been very conservative and stayed away from the froth nonsense of arms and teaser rates and all the other abuses that went with the bubble. They had a great management but in July into August when the hurricane hit, they still were sunk. It didn't matter, down went the ship. Why? Because the market didn't trust the system anymore. Had nothing to do with the management team or the company, the system was thrown out as untrustworthy. As a result financing was essentially cut off from them, their lifeblood, and a huge gaping hole emerged causing the ship to start sinking the stock price going from 12 to 4 in weeks. Maybe their is no permanent impairment of intrinsic value, (I think their is) but here was a great company that was very conservative with a great management team where all of a sudden the system lost all trust with all investors.
Compare this to a homebuilder like M.D.C. Holdings (MDC). I do not own it but here a is a homebuilder caught up in an equally if not bigger hurricane with equally conservative, superior management team but this company has virtually zero % chance of going bankrupt. They have tons of cash and it isn't like there won't be any homes built in America for 10 years. So here, though the price keeps drifting downward, I can handicap the downside much easier than a financial company.
It is impossible to predict "black swans" which is what makes them black swans but it seems to me in the financial system we have a greater probability than we have had in a long time of the financial system breaking down to the degree that even great companies with great management teams still are not cheap. A system wide deleveraging where you have a category 3 hurricane turn into a category catastrophic category 5 hurricane. Please understand I am not by anyway predicting this. I am just saying the probabilities are much higher than they have been in many years and I am having a terrible difficult time handicapping this when analyzing great financial companies selling at what seem to be potentially ludicrous prices. You have your $.50 (even $.20) dollars in quite a few places which appears to be very large margin of safety but like DFC that margin of safety can evaporate in mere weeks as the system completely breaks down. In my mind it is similar to technology. Very hard for guys like me to invest in technology companies because it is extremely hard to predict what the technological landscape will look like even 3 years out. Well it seems to be very difficult for me to predict what the financial system will look like even 3 weeks out right now.
Anyway, with all that said there are many opportunities and I have been thinking alot about how to reduce my risk while taking some exposure. I think I have come up with some fairly creative ways to do this and will probably work some trades in the next couple of days so will wait to talk about them until later. Just thought I would write about some of things that bounced around in my brain over and over as I put miles beneath my tires and the pavement.
Thursday, November 1, 2007
Wednesday, October 31, 2007
There is much from this I wanted to cut out because I found it amazing but it is secured so I will only type the most amazing part in my mind.
"In early September, a senior Moody's executive confirmed this suspicion at a small private dinner sponsored by one of the brokerage firms. He said, 'Moody's would never lower the credit ratings of a financial guarantor, because that would put the guarantors out of business.'"
The AAA portion of the ABX is plummeting. Enron magnitude blowups are very very possible in these insurance companies like Ambac and MBIA regardless of what rating agencies do. They may just be digging their own grave.
On a brighter note a little less than 2 hours and I am officially running my own hedge fund!! A big Texas Aggie whoop to that.
Tuesday, October 30, 2007
Let Steven A. Cohen manage money to pay off the U.S. debt.
The yuan rose the most in two years after China's central bank signaled it will allow the currency to appreciate faster to help narrow a record trade surplus and slow inflation.
As I have said I think the next great Chinese export will be inflation. I think we are at the beginning of next great inflation cycle and of course the Fed in their genius is cutting rates.
With a booming economy and inflation ticking higher, some speculators worry that Riyadh will de-peg its currency from the dollar. And they see such a step as having the effect of re-pricing oil in euros and yen. That’s because if Saudi Arabia de-pegs and does nothing else, it will be sitting on two rapidly depreciating assets: $20,000bn in oil reserves and $800bn in US dollar reserves.
Dating back to the aftermath of the oil crisis of 1973, the US negotiated the original alliance with the Saudis to assure petrodollar recycling. As oil prices have risen this decade, economists including ourselves have argued that the re-investing of oil export revenues into the US by Saudi Arabia and its neighbours has contributed to keeping interest rates low and equity valuations high. Often referred to as the “central banker” of oil, the Kingdom has proven on multiple occasions that it is focused on protecting a buoyant outlook for the global economy, as much to assure itself of a buyer as to preserve its political alliance with the United States. That usually means supplying enough oil to the market and holding spare capacity for use in the event of a disruption. Today, however, given mushrooming dollar reserves and the weakening US economy, it also means that Saudi Arabia must hold off on reserve diversification or doing anything that would initiate an attack on the dollar.
Friday, October 26, 2007
Another stupid one is Merrill as the shorts are also getting squeezed. The CEO is rumored to be on his way out and the stock is up 7%. Is Merrill worth $4.5 billion more today than yesterday because maybe they get a new CEO? O' Neal has done alot of good things at Merrill. Maybe somebody else would not have taken them down the CDO road, I don't know. All I know is Wall Street typically stumbles around like a drunken sailor but the shots of vodka must have been extra strong as Wall St can not seem to have a clue what some of these companies are worth and the stock prices zig and zag on new meaningless information when it comes to really understanding the value of the company.
Thursday, October 25, 2007
Jeremy Grantham posted his latest quarterly letter. I almost did a post on it yesterday noting how bullish he sounded (at least for him). I read it and had one of those deep feelings of something is not right. Something in the world had gotten thrown out of line. Well I pushed it aside and wasn't going to post anything until I read this http://www.thestreet.com/s/jeremy-granthams-losing-his-growl/newsanalysis/investing/10386152.html?puc=_tscana. It starts out with "They say the time to get really nervous is when the last bear turns bullish. Did that just happen?" Jeremy for sure has his bearish points but as a long time reader of his stuff the tone is much different as this article says he has the tone of a "man who is tired."
Wednesday, October 24, 2007
According to John Bogle’s research, only 35% of money managers beat the market in any given year. This number drops to 25% over 10-year periods, 10% for 25 years, and 5% over 50 year periods.
According to John Bogle’s research, managed funds average turnover rate is 110% a year versus a zero turnover from a passively owned index fund. Multiple studies have been done with results showing that low turnover investment strategies perform significantly better over time.
Mohnish Pabrai has been very successful in implementing a rule to avoid switching costs. He talks about it in Chapter 15 of his book The Dhando Investor. His rule states: “ Any stock that you buy cannot be sold at a loss within two to three years of buying it unless you can say with a high degree of certainty that current intrinsic value is less than the current price the market is offering.” Therefore, Mr. Pabrai has held stocks through significant periods of volatility; only selling before two years if he is certain intrinsic value is below the current stock price. If he is unable to assess the intrinsic value with any certainty he simply hangs on until he has a clear view of intrinsic value. His rule help him lower commissions, taxes, and most importantly they help him avoid switching out of businesses before the intrinsic value is recognized in the marketplace.
There is an increased probability of error when looking at stocks when stocks are setting new highs. Mr. Pabrai wrote an excellent article entitled “Buffett Succeeds at Nothing”, explaining how Mr. Buffett plays bridge, and Mr. Munger works on his mental models to fill the time periods of lofty security valuations. One should challenge themselves to delay decisions at least one day, as this is an effective tool to help an investor make sound decision. As Mr. Buffett states “ It is better to do nothing at all than to do something stupid.”My outlet is Yahoo spades....Finally
How often should investors review their investment positions then? Mohnish Pabrai updates his investment ideas once a quarter or whenever there is meaningful news.............This seems so infrequent in an age where data flows quickly through the internet. However, behavioral finance suggests that thirteen months is the optimal time frame to reassess one’s portfolio.
Well written Peter.
Monday, October 22, 2007
This is a great interview with Jean-Marie Eveillard, Bill Gross, and Bob Shearer. Anytime you can get all 3 in an interview together you know you are in for a treat.
Bill Gross is known for bold predictions and he made one here which I haven't heard before and that is that the Fed is close to the end of its rope and will continue cutting and that we will have a severe bear market start somewhere in 2008 when inflation starts moving up to the 4% range. I have had very similar thoughts so not going to discount it.
Either way the interview is worth 25 minutes of your time to watch.