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.