Friday, August 31, 2007
As I have said over and over the FED cannot fix credit crises. Their jobs are two fold. 1) Make sure the banking system is running smoothly. 2) Fight inflation. It's very very simple. Now when the banking system freezes, when liquidity is the issue, the FED has several tools to fight with. When the problem is a credit crises they can't do anything to solve the problem. They can prescribe some Tylenol to help ease the symptoms but they can't cure the sickness unlike with a liquidity crises. Other branches of the government can!! They can orchestrate bailouts and wave a magic wand with your and mine tax dollars to erase bad credit that was made. That is why the cut in the discount window couple of weeks ago I thought meant jack squat in the big picture. It helped ease the liquidity crises but it took none of the toxic debt out. The junk was still out there. What Bush is proposing does change things, a little. Whether you agree with it not (my thoughts should be clear) it does change things on the margin. Even more important is it signifies that the federal government is able and willing to step in to alleviate the credit crises. The reason this is important is because it is a 100% reversal from what the White House said just three weeks ago. 100%.
I have spent most of my day trying to understand GSE pass-throughs and the role of the FHA trying to understand the impact because I am ignorant to a large extent the way that all works. Here are a few points that I think I can I have gathered. Forgive me if I misstate something because like I said this was not an area of expertise for me.
1) The FHA is essentially an insurer. Typically if certain types of loans meet certain conditions the FHA will collect a guarantee fee in exchange for insuring the creditworthiness of this loan.
2) What Bush is proposing essentially lowers the standards of what FHA can insure. Essentially increasing the risk the Federal Government is taking on their books.
3) However for this to be doable it seems the FHA would have to raise the guarantee fee. What is the problem with that? Well a large portion of the loan problem is adjustable rate mortgages that are getting repriced up. Individuals could afford the 3% teaser rate but can't afford the 12% fixed rate this is adjusting up to. Will individuals be able to transfer into fixed FHA loans that will be more expensive to cover the increased guarantee fee? It is unclear if this makes it really that more affordable. Maybe a little but not much.
4) What about the prepayment penalties? Who pays for these which in some of these are loans are very high. It is unclear.
5) This does not help anyone who is underwater. In fact I have read estimates that this really only has the potential to help somewhere between 3% to 10% of troubled loans.
In general, I think we are seeing a bunch of posturing. Yes it changes things on the margin which can be very important. This was obviously masterfully orchestrated to take the attention away from the Bernake speech and be the headlines all over the United States going into a long weekend.
Does it lessen the chance of a recession? Maybe. How important is psychology in all of this. Huge. In general though after studying and reading through all of this I think it really doesn't change all that much. Reason is because the majority of these borrowers are insolvent. Helps on the margin but many homeowners are underwater. Looks much more like politics and not a solution.
I will read more and may change my opinion. We shall see. I did not rush and emotionally trade anything today. What matters is fundamentals and fundamentally I did not think the lowering of the discount window or if we lower the interest rate by 25 to 50 bips changes anything. This (even if the first move does not) has the potential to change alot though my initial take is at least initially it doesn't change much. More thoughts will be coming.
I am about to head out to the land flowing with milk and honey (College Station). So everyone have a great weekend and stick to fundamentals.
Bush will let the Federal Housing Administration, which insures mortgages for low- and middle-income borrowers, guarantee loans for delinquent borrowers, allowing them to avoid foreclosure and refinance at more favorable rates.
The change would affect borrowers who are at least 90 days behind in payments and let them stay in their homes, the administration official said.
I am an idiot, I didn't look at the papers I am signing, I am making a small salary but my covetous eyes want the big house down the street, (trumpets sounding) no fear the government will bail you out and make sure you can stay in your home even if you cannot afford it. In fact, want the yacht you neighbor has or your Corolla is not good enough but a Hummer would work, sureeeeee we will make sure you do not lose those things either if you borrow and cannot afford them. Will just take money from those acting responsibly and give it to you.
Thursday, August 30, 2007
Here are some additional interesting graphs. Comparing what a drop from the peak in July would look like compared to other bear markets. The amazing thing is we have not dropped that far. We can't even stay below 13,000 and some are acting like it is the buying opportunity of a lifetime and others are acting like the end of the world is upon us and the government needs to do something. ANYTHING!! Please, how will these same people react emotionally if the Dow drops below 12,000, 11,000 or even 10,000???
(Click on the graphs to enlarge)
Before you just throw this out as something meant only for mild curiosity, don't. "The Wisdom of Crowds" one of my all time favorite books speaks to special markets like this and how remarkably they tend to predict something. The problem is you usually never know until after the fact. Now a 50% drop in the S&P seems absurd but what about 20%? Like I said seems laughable but I would at least give it a wink keeping it in the back of your mind. Paragraph from the story reminds us of the predictive behavior some of this stuff freakishly has.
Those concerned about the worst-case scenario recalled that large put contracts were placed on airline stocks, notably American, a unit of AMR and United Airlines, in the weeks leading up to the Sept. 11, 2001 terror attacks.
Wednesday, August 29, 2007
There was a letter leaked today that was written to Senator Charles Schumer by Bernanke promising essentially to protect the markets. I wonder if it was not leaked by the FED themselves after yesterday's market fallout. All part of the PR campaign they are waging to keep everything propped up and keep from lowering rates if possible. I am telling you history is on the side of the dollar having a huge impact in all of this and the dollar has a potential of crumbling if there is a major cut in rates. Bernanke is in trouble and he is hearing it from Senators on one side and the treasury on the other.
Anyway FORGET Fundamentals, FORGET anything that we used to look at. TRADE on whatever the Fed says next.
All sort of unreal to me. Stick to fundamentals. That is what will come out sooner or later.
I have tried to make it a habit to be friends with those who can prove me wrong in something and not slow to do so. It is much more valuable for an individual to have a thought proven wrong one previously thought right than a thought they thought was right actually shown to be right. It is amazing to me however how many people in this world really would rather remain ignorant than risk being proven wrong in some belief risking some degree of embarrassment. One must constantly be challenging ones basic assumptions no matter how "mainstream" or accepted those assumed truths may be. Though I fall in this trap at times, I recognized long ago that the cost of embarrassment is not worth the cost of ignorance. Maybe that is why I annoyed most of my classmates in college because I would not hesitate to interrupt the professor and discuss something I did not understand. One's pride is a dangerous hindrance to knowledge and wisdom and a battle that must (or I am shamed to say I at least must) be fought daily.
This is a study done showing how inaccurate individuals are at self assessing one's skill set. The takeaways to finance should be obvious. It is sort of a classic in certain circles so some of you may have read it but it was brought to my attention again today and I thought I would post it. It is fairly lengthy but if you read the first two pages and the last two pages you get most of the takeaways.
A couple of quotes taken from the paper that are particularly insightful:
"Ignorance more frequently begets confidence than does knowledge." - Charles Darwin
"The quicker you realize that Amos is smarter than you, the smarter you yourself must be." - Richard Nisbett
"He who knows bests knows how little he knows." - Thomas Jefferson
Tuesday, August 28, 2007
Levitt is a company I just recently spent hours and hours on and have decided to pass. They are doing a rights offering and I thought there may be some serious hidden value in the homebuilder. I now do not think so anymore and believe management is trying to save a different investment through their right offering (its complicated and I may do a whole blog on the conclusion of not investing with the company). Anyway this clip talks about some townhomes they just put up for auction. WOW!!!
As an aside my sister is looking to buy a house in Oregon (yes I have counseled her not to) and was looking at a new house and passed. DH Horton is the homebuilder and came back with a $25k reduction in price.
These homebuilders are desperate for cash!!! I will repeat my prediction of at least two major homebuilder bankruptcies before this is over.
In the book he was talking about how early in his career he was elected as the clerk to the General Assembly. He was chosen the first time with no opposition whatsoever. When he came up for a vote again a year later a new member stood up and gave a long speech on why Mr. Franklin should not be reelected but why they should vote for someone else. Well Franklin ended up still being voted in but thought it best that he not remain enemies with this new member of the General Assembly. I will let Franklin pick it up from there.
Let me say something this new Assembly member who appeared to dislike me. He was an educated gentleman with a good-sized fortune and talents capable of gaining him great political influence over time - and this indeed happened. I thought it a bad idea to try to change his opinion of me by catering to him in a subservient fashion. Rather, I took a different route that would better preserve both our dignities. I had heard that in his personal library he had a copy of a rare and interesting book. I wrote him a note, asking whether he would do me the favor of lending me the book for a few days so that I might glance through it. He sent me it immediately, and I returned it within a week with another note, expressing my appreciation.
The next time we met in the Assembly, he spoke to me - something he had never before done - and he did so with great civility. From then on, we helped one another and our friendship continued until his death. This incident illustrates the truth of a proverb I had previously learned which states, "Expect more help from those who have once done you a favor than from those for whom you have done a favor." It also demonstrates the wisdom of taking action to remove conflict, as most other roads will tend toward escalation
That blew me out of the water. I for one had never heard that proverb in my life. It is also very counter intuitive. When people have conflicts today most try to just stay out of the way of the person they are in conflict with or try to do some special favor to get on their good side. Here Franklin found a common interest and asked for a favor instead of giving one. Sorry if no one else is as awed with that as I was but I thought the wisdom contained in those two paragraphs is priceless.
Monday, August 27, 2007
On a side note, it is not final yet but I am thinking about the name Dunamis Capital. It is one of several Greek words that mean power. Would love to hear any feedback both positive and negative. Feel free to post a comment, email me, or call me.
To doom and gloom for me but a couple of takeaways.
Like I said on Friday this is what Greenspan tried to do in the United States for two years and was unable to. Instead it has happened violently and within a few weeks.
Credit spreads on the iTraxx Crossover (a good barometer of corporate bonds) have ballooned 180 basis points since February. The cost of borrowing for most firms in Europe and North America has jumped from circa 6.5pc to 8.3pc, if they can get it.
The outcome below.
Germany’s Chamber of Industry told me yesterday that it had been flooded with distress calls from family Mittlestand firms unable to roll over credit lines. In Canada and Australia, junior mining finance has dried up almost entirely.
And of course our European friends are starting to realize the scam we pulled on them.
In a warped sense, one has to admire the cool way that Americans – who save nothing, in aggregate – tapped into the vast savings pool of thrifty Germans to finance their speculative excesses, and then left the creditors holding a chunk of the subprime losses.
If anybody could explain this to me it would be appreciated. I do not understand it at all.
Friday, August 24, 2007
Fast forward to today. Everything I am reading is bearish. The markets can not go down substantially when everyone is bearish. It is perverse logic but time and time again when market sentiment is overly bullish the market has a hard time putting together a huge push upward and when everyone is severely bearish the market has a hard time going much lower. I wonder if the market does not grind up for awhile (my official guess which is worth nothing is that we do a whole lot of nothing for a couple of months) until tighter credit makes its way through the economy. The last month did what Greenspan tried but couldn't do for 2 years. Raise the cost of borrowing. Remember treasury rates went from 1% to 5% and the spread just continued to tighten and overall cost of borrowing really didn't go up that substantially. Now almost over night the cost of borrowing especially for the fringe borrowers went up 2 to 3% essentially overnight. That takes awhile to work through the economy.
I also have to wonder if this just isn't 1998 all over again with the difference being instead of a U.S. market bubble we are on our way to an emerging market bubble that has 2 to 4 years left in it. I know I would not be short China or the rest of Asia before the Beijing Olympics. Anyway that could help prop up the U.S. economy.
Either way I think one of my favorite investors Whitney Tilson said it best in this clip http://www.youtube.com/watch?v=Oih01tIS7Yc.
“We value guys always worry and I put my worrying pretty close at the top of my worry range right now. I am not predicting Armageddon but if Armageddon does happen, a year from now we will look back and say we just saw the first two innings of it. This is what the playbook would look like. We are very liquid right now with 15 to 20% cash…..the best advice I can give to anybody is to stay away from what I call froth and nonsense, stocks with very high PE multiples”
Well said Whitney. Well said. I couldn't agree more.
Inventory was 533,000 units slightly below last year which at the current sales rate is 7.5 months of supply. Of course the Census Bureau does not include cancellations and they are at record levels. Another headline number is that average sales prices were up slightly which also should be viewed very skeptically because prices do not include builder incentives and are subject to wide revisions. Also July new home sales were 74,000 down from 83,000 last year and lowest July numbers since 2000. We are on pace to only have maybe 900,000 new home sales this year and probably less.
This is an interesting chart. Look at 1979-1980.The crash in that recession went from 700K annual new home sales to 400. Now look at 2006-2007. The figures have dropped from 1400 to just over 800. Recession maker? You know time will tell. Bubbles demand bubble outcomes. We have had a bubble outcome in the debt markets. Maybe the bubble outcome demand has been met but I would guess there is another shoe to drop.
In general the housing numbers could have been worse which is why the market is up but there is plenty to be wary about before we can truly breathe easy. I am still predicting a major home builder goes bankrupt which in my mind will be the signal to start buying homebuilders.
Thursday, August 23, 2007
I have been talking awhile about how unless you are a market nut there is no way to grasp or have an appreciation with what has gone on in the bank market, treasury market, and bond market. This helps puts it into perspective I thought. Once again how close where we to this in the equity markets?
I do not usually post this type of stuff because the majority of people who read my blog will most likely read Bill Gross monthly commentary and you don't need to see it twice but this was so jaw dropping for me that I thought in case someone hadn't read it, it should be readily available on my blog.
I couldn't believe that Bill Gross was calling for a government bailout of the homeowner. It took me a second to recompose myself before thinking through it. I am not ready to sign off on it but I think he does actually make some decent points. Definitely was a first as I have not heard that suggestion from anywhere else where the government should take a fiscal approach versus a monetary approach. Create a RMC (Reconstruction Mortgage Corporation) similar to the RTC in the early 90s and the RFC back with Roosevelt.
This is not a good deal for Countrywide other than the fact they live for another day. BoA wins big no matter what happens. Below is some comments posted on another blog that I thought captured what a sweet deal BoA got. I disagree though that BoA intention is to drive them into the ground.
The real scam here is that nobody (other than Bloomberg!) is covering the fact that this is "death spiral" financing!
This was VERY COMMON back in the tech wreck years when companies got in trouble, and it invariably wound up with the "lender" picking over the carcass for what they wanted, having secured preferential treatment in a bankruptcy.
And for those who say that the conversion terms are fixed and thus this isn't that sort of deal - wrongo. Go read the 8-K - there's that ominous (and unspecified) ability to renegotiate the conversion price.
That's the key item, and one that NOBODY is paying attention to.
Want to know what's going on? Its simple. BAC just bought the servicing business for a NEGATIVE $800 million - all they have to do is short the common to zero (which gets them $2,800m from the high aftermarket price last night), subtract out the worthless $2b, and you have a nice negative $800m balance - plus you stand in the front of the line to pick up the assets you want.
And in the meantime, or if somehow the company pulls it off? They get a Guido-style coupon during the interim.
This is a no-lose deal for BAC, no matter what happens, but their "big score" comes if they can stick the knife in Countrywide's back.
You can bet they're gonna try.
See Calpine for how this plays out....
Wednesday, August 22, 2007
REITS have been on a tear for a very long time. I think the correction to more normal levels has started and with financing drying up alot of the deals that allowed the REITs to dump there properties at continually higher prices is now gone. With the top 16 REITs in SRS having an average of a 3.4% yield that does not translate very well into much higher stock prices in my opinion. As a result I see a very small likelihood of the index going up 20+% in the next few months. Once again not a recommendation but after SRS has fallen I am now very comfortable just not worrying about it for awhile and let it go up or down over the short term.
Below are two articles that are a little outdated but I thought instructive if you want to learn more.
Tuesday, August 21, 2007
A couple of you have asked about SRS. If I lose money on this it is because I bought something I never could get my arms completely around which should be rule number one. I have searched hi and low and still cannot find what is exactly is in that index and how many stocks are in the index etc. I like the concept of the trade and will probably continue to hold it. As previously said I was already high on short exposure and so made it a relatively small position. Not that worried about it and we shall see what happens. Just a reminder my only purpose in mentioning stocks or trading ideas on here is because it helps me think things through. This is meant to be an idea generator platform only, not a buy sell recommendation platform. Many of you shoot me many different ideas weekly and I love it. I usually end up going with 1% of the ideas given to me after doing my own research but I love getting them. Investing is an art. So I mentioned MWA over a week ago. I still have not added to my position though I indicated that I may. I love the stock but have been just watching it. It is down. I am excited that it is down because that means I can buy the same assets cheaper. That will probably be a long term hold for me and though I own some all things equal I would like it to drop 50% so I can load up the boat at a ridiculous price. I mention that because you have no idea what I am doing within the portfolio or how I am trading around it. My art stroke may be completely different than when I first mentioned it So do your own research, stick to your program, look at my ideas I may briefly talk about and send me your own ideas.
Which brings me to shorting. Shorting is an integral part of my portfolio and something I somehow seem to be fairly good at despite how difficult it is. First I do not short to hedge!!!! Never have and never will. If I want to hedge I will invest in indexes or mess with options on individual holdings that I have (I do this some). I short only to make money. So many people short a large group of stocks to have short exposure for their portfolio and it seems worthless to me. If I don't make money on a short I consider it a failure. Second I never short on valuation alone. Let's say a stock is selling for $50 bucks a share and I think its intrinsic value today is $25. Great short right? WRONG! If that is the only reason you short it I think that is a horrible idea. First what will keep it from going to $75 or $100 and become even more overvalued. Second it could hypothetically stay at $50 for five years until the intrinsic value finally reaches $50. Valuation plays a part but my shorts are more event driven / theme driven. This whole homebuilding bubble has been a great theme driven play for me. It seemed obvious homebuilding was in bubble stage in the summer of 2004 when I started studying it. Didn't touch it until we already had a strong move down and it seemed obvious that the bubble was over. January 06 I started shorting homebuilders (Most were already down 20% plus). October 06 I started shorting subprime banks. March 07 I started shorting Alt A banks and July 07 I started shorting I-banks, rating agencies, and mortgage insurers. I did some research on valuation but it was more on understanding the big picture. Often times I am woefully early. My shorts in October 06 went up 20% as well as my March 07 ones. I hung in there and have been handsomely rewarded. I like shorts where the upside really is only 20 to 40% (not my upside, the stocks move up). That is where valuation comes in. I do not want to be shorting something that could potentially move up 50% or 100% so I like to already see bad news versus trying to predict bad news but where I believe alot more bad news is coming. So Jan 06 the slowdown had already started occurring. If I had tried to short when I first noticed the bubble in July of 04 I would have gotten killed. If it has that potential (the 50 to 100% move up) but the probabilities are really low I may play deep in the money puts but will not short it outright. So for instance I think I mentioned Moody's yesterday. That was a theme driven short. When I shorted it, it was selling at peak multiples. I really felt that the potential upside in the stock was very limited. I felt like I knew we would not see any great news out of borrowing land (may not see any bad news but wasn't going to see any great news) and so felt the upside in the stock was very limited. It was a great risk reward scenario in my mind. I mentioned if there was that upside I play puts. One such success is Heelys. Here I had the potential of it moving up 50% and it actually did after I shorted it. I did tons of research and looked at the numbers and thought I saw no way they could keep their growth up and felt like growth may turn negative. When I do this I usually only play deep in the money puts. I do not like speculating even with shorting. I want to be in the position that when the put expires to be able to exercise it and stay short the stock. I also hate paying premiums for options. I did this analysis with Crox as well and numerous times passed on it. So this Heelys Crox thing I think you can chalk up to luck that it worked out so well versus skill. Next themes? Well at this point if I could short the U.S. economy I would. I really think we have great odds of entering into a least a small recession. It really seems the next natural step in something that has followed a text book bubble scenario. Since you can't do that the next target for me may be luxury companies. I have taken a long look at Coach (COH). Not a recommendation and I may or may not short it. Just thinking the luxury goods market may be the next mover down. In shorting I am also much more likely to hedge my position with an out of the money call. I hate losing money even with shorts and might hedge 20 to 40% of it. Sometimes I don't just depends. Anyway as mentioned above investing is an art. To me shorting is one paintbrush out of an arsenal of many that I like to use.
Monday, August 20, 2007
Oh one interesting thing I read today was that the consumer sentiment numbers are already below where they were right before the last two recessions.
Moody's was down 8% today. This is a name I have been short for awhile. The rating agencies are in trouble. They are playing catch up left and right trying to regain their credibility. Appears pretty shot to me. James Chanos (the Buffett of the shorting world) has been short this awhile. Of course Buffett has been long the name. I previously argued that I thought Chanos was probably right in the short term and Buffett was right in the long term. Not so sure about that anymore. The rating agencies are going to have a hard time regaining their credibility after all this is over with but their moat may be expansive enough that a better alternative may not emerge. Obviously Chanos was right in the short term, we shall see if Buffett will be right in the long term. I definitely am not going to bet against him.
Speaking of shorting I plan on doing a whole post on this. Several people have asked me about it recently. The way I look at shorts is totally different than the way I decide on what to go long. You cannot short on valuation. You will get killed. My shorts are all theme and event driven or some special something that will change the market's view of a name. This compared to my longs which are extremely quantitative in nature and where I obsess on cash flow. Anyway another post for the next couple of days later.
Sunday, August 19, 2007
* 7% of 32 million U.S. Households owed more on their home than their home was worth.
* Estimated that 760,000 homes will be foreclosed on (is that proper terminology?) in 2007 and 935,000 in 2008. This compared to an average from 2000 to 2006 of 440,000. Since every estimate of this U.S housing downturn has been woefully optimistic compared to what actually has happened I would not be surprised if this one is as well.
PE Ratio using LTM Last Week, Year Ago (I can't get this to line up right)
DJIA = 15.74, 22.02
S&P 500 = 16.99, 17.44
Seems the really big boys in the DJIA have become much cheaper than the S&P 500
The market has really done a bunch of nothing the last two weeks.
Last week 2 of the 3 indexes (DJIA, S&P 500, NASDAQ) were up slightly.
This week DJIA ended down 1.2%, S&P 500 was down .5%, and the NASDAQ was down 1.6%. Grant it the volatility makes all this seems much more painful but the indexes finished above correction level as of the close Friday. The broad indexes really have not gone down all that much. My guess is this would go down as one of the shortest corrections ever if we are indeed done.
Yet the damage is worse digging into the numbers
The average S&P 500 stock was down 20% from its 52 week high and the average small cap stock was off 25%
Be wary of false rallies
Close of the NASDAQ May 31st 2000 - 3400
Close June 1st - 3582 up over 5%
Close June 2nd - 3821 up over 6%
The NASDAQ was up 18% for that week!!!!!!
Stayed around those levels for 4 months before falling all the way to 2615 by December 31st of that year.
I was perusing some old stuff and saw this on an old blog after the close June 1st 2000 - "Woo Hoo! More economic data out this morning shows the economy is slowing and stocks surged in appreciation. Some one reading this a year from now will think we are all crazy" - What a prophetic statement.
Friday, August 17, 2007
One interesting thing on the Fed's decision that I only heard briefly mentioned once was the Poole did not vote. Apparently when asked, a FED spokesman said that it was a unanimous decsion but that Mr. Poole had a prior engagement and could not make the meeting. C'MON, hear you have one of the larger credit market meltdowns in the United States in last 100 years and you can make a Bloomberg interview two days ago but cannot make a emergency Fed meeting. Sounds like Poole made his position known but the Fed wanted to make a strong statement and so Poole was conveniently busy with a prior engagement and decided not to come so the FED could be unamious. Just something interesting I heard.
I did not make a trade today. (most days I don't) The real battle for me psychologically was yesterday trying to decide if I wanted to keep my various short positions. I decided I did and so today it was like oh I am losing some money. Oh well next week is another week. The market behaved much more rationally today though. As a result my longs helped offset the losses I had on the short side.
Amazing how many bull stories come out right after a market rally like this. This is actually a pretty good one. http://www.fool.com/investing/general/2007/08/10/the-best-buying-opportunity-in-12-years.aspx I think it at least crystallizes what the true arguments and gives them a fair shake. I disagree with their conclusion but at least I thought it was more well thought out than some of the other things I read today.
Country Wide Financial. Is it to big to fail? I wonder how close it was on the brink of collapse and if that was a reason the FED was forced to move. Three weeks ago even though I was short several financial names I would have told you I thought you were crazy if you said CFC had a good chance of going bankrupt. I even thought about selling a couple of naked puts on it but decided I couldn't really get comfortable that I would be a guaranteed winner. Anyway things changed in a hurry and Countrywide was in serious trouble. No special insight here just curious if it gets special treatment because the Fed consider it to big to fail and the damage that would cause to the financial system at a time like this.
Well another week in the books. Market goes crazy and finishes down and I was able to finish about flat on the week. I'll take it though nothing to write home about. It's only money. I think I am headed out tonight or may read Benjamin Franklin's autobiography (the one that was recently redone in today's English). I need a break from the markets after a truly mental taxing week. Probably will try not to (guaranteed not to happen) think about the markets until Saturday night when I pick up a Barron's or something. No work for me though. Work is my play. I LOVE this stuff.
Thursday, August 16, 2007
Graph of the day:
I think this describes everything today. Look closely. This is E*Trade. This is a day graph!!! Not a graph over a year, 3 months, or even a month. A DAY!! At one point it was down 28% only to climb all the way back up to be ahead 2% on the day to fall back right at the close and finish down 2.58%. Are you kidding me? This is not a penny stock. This is a $6 Billion dollar company!!
There are no words to accurately describe how irrational the market was today. Pfizer which has a 5% dividend yield and a 9% free cash flow yield and the stock is down .5%. Financials shoot through the roof. Housing stocks do as well. Brookfield homes up 13% (no news that I know of and a candidate for bankruptcy in my opinion). At the same time powerhouse Microsoft was down 1%. The out of whack nature of this was even worse earlier in the day. The Russell 1000, DJIA, NASDAQ were all down over 1%. The Russell 2000 ( a huge index) was up .5%. I mean this stuff makes good fiction.
This looks almost exactly like last Friday. Same wackiness. One of my worst days before having three incredible days Monday, Tuesday, and Wednesday. It is when nothing makes sense and what is up and what is down does not make sense. Last Friday Dow was down 200 plus and finished down like 30. Same thing today except more extreme. The reason I truly believe is that quant and long/short funds are collapsing left and right. Margin calls are occurring everywhere. I have not talked to any friend at any hedge fund who is not getting margin calls. (Do have one friend who works for a hedge fund that does not use margin and obviously he is not getting any) As many of you know I for the most part do not use margin. May dip into like a percentage or two to finish out a position back when I was fully invested. (boy that was awhile ago) Where I am forced to use margin is in commodities. (Also as many of you know I am very big bull over the next few years on soft commodities) Anyway I was talking to my broker about various margin requirements and he was saying well I really do not know what the margin requirement will be. I was like what do you mean. He said well it is changing daily and sometimes hourly. If that does not tell you what these hedge funds are going through, nothing will. They are being to force to sell their biggest liquid names, Microsoft and Pfizer, and cover whatever they can. This is why you get complete wackiness.
This is really turning into the ultimate gut check. It is testing everyone's pain threshold to the ultimate maximum whether your long or short or market neutral (you would think that is what I am if you looked at my portfolio, definitely not the way it reacts on a daily basis). I am like 50% cash and my portfolio is moving more on a percentage basis day in and day out by like three fold plus than when I was 100% invested. One day you are feeling wonderful and the next day you have a gut check as everything moves against you and the market tests your mental toughness. You have got to have a fundamental view on each investment or you are going to get eaten up.
When I woke up this morning and saw the yen sky rocket I knew we were in for a tough day. Early on everything was down. I do mean everything. There is no news on the corn and soybean front. Soybeans limited down at one point. Corn and soybeans are barely tied to the economy but everyone is fleeing risk.
I think there is a very good chance we will have a decent bounce here. 3 to 5% which will tests the short resolve. I still think we have more pain ahead. I do not see whatsoever how with credit essentially evaporating nation wide how that does not severely damage the housing market causing a further chain reaction. To me the verdict has already been laid down that a recession is inevitable. To be able to stick to that view with my portfolio is going to be a massive test of will power. Of course if "normal" things start happening, like strong undervalued companies actually go up, where I am a long a few names, the test would be alot less severe. Even if I am right it probably falls under the fooled by randomness category. Someone equally in tune with the market and what is happening could come to the opposite conclusion. Whoever is right (him or me) will feel good about oneself but will him/me be truly smart or lucky?
There was one rational thing that happened today!!! Berkshire was up today 2.3%. Why did this escape irrationality. I think because hardly anyone is short it. This is the stock to be in. Not only is it already undervalued, has a balance sheet of a Roman fortress, but this could be a huge investing opportunity for Buffett.
Wednesday, August 15, 2007
On Dow Jones, that headline caught alot of what in the world? First he may have bought it before the buyout offer. That is possible but my guess is he played the merger arbitrage. People forget how versatile of an investor he is. Everyone just thinks of buy and never sell. He is extremely versatile and has done many merger arbitrage trades over his long investing career especially in the early days. He also bought up something like half of the silver market in the late 90s. He is extremely versatile. When DJ dropped below 50 I would not be surprised at all if he decided to play the arbitrage game.
Tuesday, August 14, 2007
This is one of the best things I have read in the last month. Talk about reaffirming my belief that this is a credit crises not a liquidity crunch. The most amazing thing was that this was written on June 28, 2007. Some of his statements happened verbatim the last two weeks.
1) "This report shows the following changes in underwriting standards between 1998 and 2006, with the major changes occurring in the last two or three years:
ARM % of origination's rose from 0.7% to 69.5%
Negative Amortization rose from 0% to 42.2%
Interest Only rose from 0.1% to 35.6%
Silent Seconds rose from 0.1% to 38.7%
Low Documentation rose from 57% to 79.8%
FICO scores were essentially unchanged at an average of 706."
2) "Over the next two or three years and should lead to a retrenchment in the securitization/origination industry. If our assessment is reasonably correct, mortgage credit availability will likely contract and, therefore, exacerbate the housing contraction and its effects upon the general economy."
3) "As Dan Fuss, manager of the top-performing $10.7 billion Loomis Sayles Bond Fund, recently said, “I haven’t felt this nervous about a market ever.” - this was said several months ago.
4) "The report provides a forced unwind example where an initial 5% price decline in the value of a hedge fund’s assets could lead to a forced sale of as much as 25% of its assets, assuming leverage of 4.0x (20% margin)." - Umm didn't I just see this
5) "We see little value in the domestic equity market since we view valuations as being elevated because, in our opinion, consensus profit expectations are assuming unsustainably high operating margins." - I have argued this point often
Other thoughts: SRS. It is essentially an ETF that tracks the Dow Jones Real Estate Index which is an index of reits. It does not track it as a long though but as a short and it is 2x levered. So if the index goes down 1% SRS goes up 2%. Fairly interesting if you just want broad index exposure on the short side. Thought it was interesting and not sure if I want anymore short exposure but it seems to be a good one. Reits valuations got so out of whack into '06 and into '07 that it still may have a way to go. Just look at Thornburg today. Good grief. That was actually a short I had six months ago and took a loss on to short DSL. DSL as a short has done wonderful but you can see I obviously made the wrong decision on a relative basis.
My friend sent me this paragraph in an email earlier today. It may show how sad I am that I thought this was so funny:
"I am not a statitician but the claims of 20+ sigma events last week seem quite crazy. The joke I haven't seen anyone make is that a 2 sigma event with 10x leverage is not equal to a 20 sigma event." - thanks Ron
Monday, August 13, 2007
Wal-Mart (WMT) - This has been a favorite among all types of value guys. I have dabbled in it here and there when it gets really low in its trading range but it has never been a core holding for me because I have never believed the story. This company is one of the world's greatest importers. Everyone knew the dollar was/is overvalued. As the dollar continues to weaken the price they are paying for thier retail goods goes up and they are going to have a hard time passing all those increased costs on, especially as a discounter. As a result I think they are going to have margin problems for years to come. If there was ever a larger devaluing of the Chinese Yuan compared to the U.S. Dollar watch out, Wal-Mart I think would get murdered. Yes they are the greatest retailer on earth, yes they are one of the most efficient companies on earth, yes yes yes to all the other great things you want to say about it and it may go to 60 or greater. To me though the dollar is a big factor in this company. I know the favorite line among bottom up value guys, including myself, is that we do not care about big macro picture things. Agree, but here it just seems to be screaming at an extremely high decibel level where I just have not been able to ignore it over the past 12 months.
Halliburton (HAL) - Apparently last week a large hedge fund (thought to be Goldman's) was liquidating their position. The stock got killed all week into Friday. This is a stock that has underperformed its index by quite a bit over the last six months. This combined with a large liquidation based completely on non fundamental factors makes it an interesting stock. No position in it currently but it is interesting.
Thursday, August 9, 2007
This is Leon Cooperman's quick explanation of why he is a bull. He is an investing legend and has a much longer track record than I have. My only response was that he said "bull markets do not die of old age but of excesses....Those excesses are simply not with us today." I agree that they are not with us in the equity markets but they were with us for a long time in the debt market. As briefly touched on in my blog below, a long term change in debt rates changes cost of capital and changes overall equity valuation. The impact of the debt excesses (because it appears like the excesses were indeed massive) will, in my mind, have an abnormal affect on equity valuations compared to previous credit corrections.
Anyway as a result of all these thoughts, I further raised cash cutting down some of my bigger winners that I have had for awhile. In some ways this is killing me. I am always a huge contrarian and I see all this selling and I want to buy. When I have these urges I repeat to myself over and over that this was a bubble. It's to early. This was a bubble. If this is a true credit crises than we are in for a long term correction where intrinsic value changes. (Of course it does not because intrinsic values assumes you know everything and it never changes but forces you to discover it but what I meant was the inputs we assume need to change). Margins will change and we must consider new normalized earnings. Cost of capital changes as a true credit crunch will raise it over a much longer term than a short term liquidity crunch.
Really the question becomes what will the new normal look like? I really think the big issue not really being talked about is the willingness of foreign borrows to lend to U.S. CLO's and buy mortgage back securities. I have read bits and pieces here and there discussing this but overall not much and it is here where I think the real story lies and why I lean toward credit crises. The aftershocks of a bubble can linger a long, long time. It is why large cap U.S. stocks have lagged (until recently) mid and small cap stocks since really 2001ish. Once an asset class implodes the money goes many different places and will not return for a long, long time. As I have said in previous postings and as the crises in the European banking system displayed today, it is the foreigners who are taking the disproportionate brunt of all of this. Good for us now bad for us later. The debt ratings system has to be severely discredited in international eyes. The appetite for U.S. denominated non government backed debt is currently zero and I really think will stay this way for a long time. Alot of people are comparing this to 1997/1998 or the Mexico peso crises but the difference is that we aren't being affected by the problem, we are the problem. We are not coming to the aide of people with problems we are spreading our problems. I have to think this plays into the equation somehow someway when comparing it to history. But let's just look at 1998. Financials across the board lost 50% in 3 months. We are around 20% currently maybe getting close to starting month 2. I am not talking risky financial firms in 1998, I am talking about the big boys. Citigroup, JP Morgan, Morgan Stanley. See below (click on it to blow it up)
This was really more of just a liquidity crunch for the United States but it decimated the Asian countries for years to come. Valuations were some of the cheapest in the world for years. It is thought Korean stocks still receive a discount to proper valuation for what happened 10 years ago. Carry this over to U.S. debt. How long will it be before we see what we would consider "normal" credit spreads return? It could be years. As Buffett has described in his letters and talked about numerous times we are selling off little pieces of our farm to finance our consumption desires. Well now my guess would be that to fill our consumption desires we are going to have to be paying much more for quite a long time.
I do not know, maybe I am being to bearish but as Buffett has said "It is not how much money you make in the good times but how much money you lose in the bad times" If I miss the bottom so be it.
As a side note I do believe their are all kinds of opportunities for those with the proper balance sheet. (i.e. Buffett) This is one of those times being big helps you. There are pieces of debt that have overreacted and even actual subprime debt. However, unless you have many millions of dollars, as an individual, they are essentially untouchable.
Wednesday, August 8, 2007
If you haven't read this you have got to read it!!
This write-up sums up my views very well. If everything he is saying is true it is worse than I even thought. Everything I know is true except the house price decline in the central valley in California. That seems extreme or exaggerated. Also not sure on the math for the mezzanine CLO's about the leveraging 10X to 20X and "poof making 80% of the structure rated AAA by the rating agencies." Someone would have to explain that to me and diagram it out. In general though the principal of what he is saying about all the CDO and CLO's are dead on. I had not heard of this fund but they seem to be legit and all you got to do is look at the last name of the managing partner (assuming you know who the super wealthy families of Texas are) to know he is very well connected.
On a side note, what an interesting day yesterday. The Fed really didn't go to a neutral statement like I thought they would or like the market supposedly wanted. For me this added confidence in Bernanke. Showed they are going to hold the line and protect against inflation which I think is an overall longer term danger than the short term pain felt from the housing fallout.
Tuesday, August 7, 2007
How does the current market dislocation affect our market, particularly in the medium to long term?
- For example, if it requires reducing leverage by 1-2x, for deals to clear the market, does this mean valuations on the indexes (ex - Russell 2000) should be taken in accordingly?
- What might be the impact on an existing portfolio?
A few thoughts. First of all I wouldn't really term what is going on as a market dislocation. It is to some degree but I look at the environment we have been living in the last two years as a truer market dislocation. Spreads in the credit market where non-existent. If you believed what Jeremy Grantham was saying (which I did and do) not only was the investors getting paid zero for risk in the credit market but they were actually paying to take the risk!! Liquidity was sloshing around like beer at midnight at a German wedding and things were getting done that were just insane. What we just went through in the credit markets and the housing market was a bubble just like the South Seas Bubble, just like the technology bubble and what we can expect is bubble aftershocks. In my opinion that is where the market dislocation occurred and we are getting back to normal. Now obviously things are not trading like they should as liquidity has dried up and that is somewhat of a dislocation as it is almost impossible to trade a mortgage back security but long term spreads from here I think will stay much higher than what they were 6 months ago. One of the primary reasons is who bought much of this stuff. Americans investors have gotten hurt in all of this yes but who have gotten really burned are people outside the United States. A German bank had to be bailed out by the German government. Two to three UK and Australia hedge funds are on the ropes or have to shut their doors. Do you think our big creditors (i.e. other countries in the world) will all of a sudden jump in and say eww we want to lend you money now? Not at previous rates and my guess is to some degree not at all for awhile. As a result a mortgage is going to have be funded by U.S. investors instead of foreign investors. We are entering back into what should be considered normal looking at a historical perspective but of course quite a few of investors do not have a historical perspective. My guess is we will over correct just like we did going into 2003 with the equity market.
As a result I think you will see a rise in corporate defaults to normalize levels. That has not started yet but maybe 12 months from now as companies that have continually refinanced (i.e. movie gallery) when they should have had no access to capital markets where able to extend their life by refinancing. That life line is now gone and we should see a more normalized level of default rates (for those lenders who are lucky enough to have covenants rather than see value disappear)
As far as valuations for the Russell 2000 etc a couple of thoughts on that. One is that large cap U.S. stocks I think are one of the more undervalued asset classes in the world today. I think they will easily outperform debt over the next 24 months. With that said there are some major issues. Profit margins as you probably know are at all times high. Are these normalized earnings? I would be doubtful. Of course these profit margins are that way because of the overall world deflation in labor as outsourcing has taken center stage. This has started to reverse and we are starting to enter into an inflationary world unlike three years ago. This may be several years out from reversing however. I am wary of those who think we are going to see dramatic downshift in profit margins in the next year or two. Alot of the drop we have seen in markets is the buyout discount disappearing. The takeout premium has become zero. Of course that does not really change intrinsic valuation. The leverage thing has nothing to do with valuation. It just amplifies returns (both positive and negative) for the equity holders. Dropping leverage by 1X or 2X changes true intrinsic valuation by a grand total of ZERO. (May be some slight tax differences that may change it a little) What changes intrinsic valuation is some of the things I described above. Company X wants to build a plant to grow product Y that is a positive DCF project and now they can't do it because the markets are overly skittish (I think this will correct itself before terribly long)
Depending on what the fed does the market may have bottomed. I doubt it. I think the market will probably go down from here and at least complete a true 10% correction though we may have a couple of more 200 point rallies between then and there but in general unless we have a complete unwinding (which their is some chance of that happening) the markets are not really dramatically overvalued.
So anyway back to your first question. How does the current market dislocation affect our market, particularly in the medium to long term? My answer we get back to normal (after probably swinging to abnormal on the downside) and those bank deals or mortgage deals or bond deals that were priced in the last 12 to 24 months will continue to trade a steep discount to more appropriately priced deals that get done from this point forward.
Monday, August 6, 2007
On the hedge fund front, it is so frustrating. This is going to be fairly time consuming and there are SOOOO many ideas I want to pursue right now. This market correction has created a wealth of opportunities and I feel overwhelmed. I wasted all this morning calling law firms. Have set up a couple of appointments for Wednesday when I will take a trip to Austin. Hopefully I can find one that works for me on this trip. I want to be studying 10k's and working on probability scenarios not talking to lawyers. A necessary evil I guess.
Sunday, August 5, 2007
Volcker admitted that he probably kept the rate too high for too long but it was because of the dollar issue. If the Fed were to come out on Tuesday and all of sudden lower rates by 25 or 50 bips I think the crises would move from the credit markets to the dollar. This of course sparks inflation. Despite Cramer's rant on Friday (if you have not seen it youtube Cramer: Bernanke, Wake Up. It is one of the funniest and saddest things I have seen in a long time as Cramer has a breakdown) I think lowering the discount rate would cause more problems over the longer term. The Fed I think is being forced to try and talk its way out of the crises. For that reason I do expect a dramatic change in wording on Tuesday. I believe that could lead to a 200+ point rally in the Dow from wherever the Dow is at the point of the press release. Should you try to trade on it? Heck no. Might as well put your money on black in Vegas. How successful the Fed is at truly talking down the crises and whether the rally sticks (if it even occurs) I do not have a clue. I am sure some of you are smarter than I and can figure it all out. I throw it in the too hard basket and focus on what companies will be around and flourishing in 3 years after all this is done and things normalize. We shall see.
Saturday, August 4, 2007
Many of you have asked about K-Swiss recently and I have finally gotten a chance to listen to the latest call and look through the numbers and get an opinion on it. Obviously at this point I can proudly proclaim that my thesis has been wrong, at least looking at a timing perspective. It has been a little over a year and the stock is down 20%. Fun fun. So the question becomes what do I do now? Double down, lick my wounds and sell redeploying the capital somewhere else, or do nothing. I have heard it said many times that what separates the average investor from the great ones is how one reacts when your stock pick is down 20%. Well unfortunately I have the opportunity to see how I react on several names, can anybody spell USG? (Thank goodness I am short a lot of stuff in the financial world) So looking at the basics. It looks cheap at around a 10% free cash flow yield, 6 to 7X EBITDA, 2X book and a massive war chest of nearly 300 million in cash with no debt or representing a little over $7 bucks a share. (Also on a DCF basis it looks cheap as well) Great woo hoo but let me be intellectually honest here. I could have spouted off the same numbers a year ago when the enterprise value was $800 million instead of the current $500 million. So the multiples have stayed the same while the underlying numbers have deteriorated. So your immediate thought should be value trap. Can anyone spell Eastman Kodak? This is a real possibility.
So lets recap. There should have been no doubt in anyone's mind that the domestic U.S. business in 2007 was going to be horrible and I do mean horrible and sure enough it hasn't disappointed. U.S. sales will be down 30% plus. What has caused the huge drop in stock price in the past few weeks is that international sales are slowing or "plateauing." International sales have been growing at 50% for several years now. To put this perspective 5 years ago 90%+ of the entire companies sales were U.S. sales. Now about 52% of sales are U.S. sales. Anyway U.S. sales are continuing to decline and the European sales growth are slowing which is the worst of both worlds.
When I bought this stock I knew they were going into a downturn. That has not surprised me at all. What has surprised me is the apparent length of this downturn. It looks like now second half of '08 is the earliest I can hope for in a true rebound assuming their first effort to reinvigorate their customer base actually works. If you have heard me talk about this stock you know K Swiss has done this a couple of times. The last time in 99 when the stock went from 15 to 3 in about six months. Overall revenue was down 50% (remember almost all revenue was U.S. revenue). K-Swiss reinvented (reposition is probably a better word) themselves and it went from 3 to 30 over the next few years. To continue to play the stock you have to believe the company is on the right path to reposition their brand and do the right things by controlling the supply side of the equation.
Of the people who have the most to lose primarily among them is Steven Nichols Chairman and CEO. He owns over 20% of the company and he operates it as an owner, forgoing short term pops in business performance for longer term intrinsic value creation. About 12 months ago he embarked upon a K-Swiss brand shake up. So part of my bet is on Mr. Nichols, I do like being in partnership with him in owning K-Swiss.
I am typically willing to give a company 2 to 3 years to work out their plan and we are in the midst of year 2. To sell now seems to be imprudent though I have to realize that there is the potential for a value trap as mentioned. At the same time things do not appear to be changing in the time frame I thought or hoped they would. So taking a big swing and really adding to my position doesn't necessarily seem wise either. So I have been pondering the wisest choice of action. Of course the wisest choice may be to do nothing but this could also be a great buying opportunity so the way I think I am going to move forward is sell covered calls on what I own to fund buying other calls. So I would sell Jan 08 $30 calls which are around $.35 a call and buy Jan $22.5 calls which are remarkable cheap at around $2.40. This to me does a couple of things. I can stay in the game and pay a little for the possibility to take a big swing in six months at today's prices. Gives the chance to lock in a price of $22.50 so not miss out if this turns out to be a huge buying opportunity while funding some of this through selling calls at $30 (a full 40% higher than current prices). If things really get worse in the next six months I do not lose much. In this way I am not totally being passive and just sitting there but since the picture is not anymore clear I do not have to risk throwing very much good money after bad. Am I getting to cute in all this financial engineering? Something I have thought about but because the calls are so cheap right now after this huge sell off I think it makes sense. My gut is telling me it will probably get worse before it gets better but with a massive war chest of cash they can do a lot of things to create value and with Nichols owning the majority of stock and acting like an owner with shareholder capital I am not to worried about them doing something stupid with company capital. He has quoted Buffett on the earnings call several times in talking about deworsification – doing something just to do it and being worse off because of it. Nichols has talked several times about acquisitions and I wouldn't be surprised to see something in the next six months. I wouldn't be surprised to see that have a positive reaction on the stock because it eliminates the uncertainty of what they will do with all their cash and help smooth out their financial performance lowering stupidly enough perceived risk (many of you know the problems I have with how Wall Street looks at risk and won't elaborate here) . Anyway I have many more thoughts that I can talk about if anyone has interest but that is where I think I am with this company. As I said fun times.