Tuesday, September 30, 2008
What is really concerning to me is the constant bombardment on market mechanisms taking away precious information from investors. First it was short trading. Banning shorts which provides information in itself. Friends have asked me what I think about the put call ratio and the VIX. My response, I don't know. Without shorts everything is blown out of having significance. The normal sign posts of bottoms and tops are at best flickering lights. Is the VIX astronomically high or are investors paying up for the only type of insurance they can buy, put premium? Then it was the government setting the clearing price in the bailout which may or may not be accurate. Now it is the attack on fair market accounting. Most of you will probably disagree with me but I really think fair market accounting is a good thing and does not carry much blame for the current situation. Blaming the shorts obviously didn't work, the market still went down so now we have to blame something else besides the obvious and so we might as well blame the accounting. The banks have been playing games with the accounting anyway with many balance sheets looking much better than they actually are. Now you are going to make it much more difficult than it already is to try and figure out what is on the balance sheet of a bank? Now that adds confidence. I think in 50 years people will be writing about what is going on and the destruction of information and be like what were those idiots thinking. The problems are obvious but people keep wanting to point to something else. It is absurd.
I think we will continue to bounce around. With the destruction of information and the destruction of market participants, volume is going to continue to dry up which will push down the equilibrium fair intrinsic value of stocks as people demand a greater premium for less liquidity and the inability to hedge easily. In my opinion the bailout plan is a bad plan anyway though something needs to be done. It will be something the hope buyers will be able to latch onto for a small period of time. The patient is dying, the city is burning, and how long the economy can put up with the stresses we are seeing in the stock market is yet to be seen. Many people forget the lag on tighter credit. Bulls constantly throw in your face the time lag in rate cuts reaching the economy. Well shouldn't there be the same time lag in liquidity drying up? The clock is ticking as more of Rome continues to burn.
David Abrams recently visited campus as part of the Wharton Investment Management Club's Speaker Series. Abrams runs Abrams Capital, an investment partnership he founded in 1999 that now has $2.5 billion of assets under management. Prior to founding Abrams Capital, Abrams spent ten years at the Baupost Group, à la Seth Klarman. Since inception, Abrams Capital has achieved compounded returns to limited partners in excess of 20%.
David Abrams will tell you that studying Shakespeare and being able to distinguish cheap art from the expensive can help you to be a better investor. He will speak to you of insights and intellectualism. And he is - no wonder - a man who tries to "leave a fair amount of time everyday to read and think." Abrams is clearly and refreshingly different. He attended Penn as an undergrad, but while many of his peers were studying discounted cash flows and the efficient market hypothesis at Wharton, Abrams was working towards a degree from the College of Arts and Sciences at Penn, where literature and a deep understanding human behavior were more de rigueur.
Sunday, September 28, 2008
Without the bailout's imminent passage and fear exhaustion in the markets, I would normally be thinking rally right about now but there are so many cross currents that such a call is hard to make and I am leaning the other direction.
The hedge fund fiasco partly caused by the SEC I think is really going to pick up steam in October which could put alot of pressure on equities from a technical standpoint. Also this credit crunch is finally making it's way on Main Street and it is coming with a roar. Fertilizer companies were down 5 to 15% on Friday as a result of speculation that farmers can't get credit to buy fertilizer. That is beyond scary. Your talking world wide famine consequences if that doesn't change. Today I talked to my brother in law who is in charge of research and design for the U.S. largest bow and arrow manufacturer and in the past month they have just gotten walloped with tightening credit standards in lines they are allowed for their customers. Sonic announced on Friday that GE Capital will not be making any new loans to the restaurant firm. Main Street is now in the cross hairs.
The U.S. futures which were pointing up are now pointing to a solid lower open. Won't the lawmakers be upset if all their effort is met with a dramatic sell off in the stock market this week. That should be an interesting conversation with constituents as they point to saving their 401k and the U.S. economy with the bailout as the DOW spirals downward.
The U.S. government has essentially propped up the stock market for two weeks now (it has been weak scaffolding holding it up at best) but now what do you do? This could get really ugly.
Thursday, September 25, 2008
Which brings me to more Asia news. Yesterday there were pictures of the third largest bank in Hong Kong experiencing a bank run with people lined up for blocks trying to get there money out. Here Yu Yongding, a former advisor to the Chinese central bank, is calling for quick action to avoid a panic sell of U.S. debt. Oh my goodness what would such a panic sell do to the U.S.?
Japan, China and other holders of U.S. government debt must quickly reach an agreement to prevent panic sales leading to a global financial collapse, said Yu Yongding, a former adviser to the Chinese central bank.
``We are in the same boat, we must cooperate,'' Yu said in an interview in Beijing on Sept. 23. ``If there's no selling in a panicked way, then China willingly can continue to provide our financial support by continuing to hold U.S. assets.''
An agreement is needed so that no nation rushes to sell, ``causing a collapse,'' Yu said. Japan is the biggest owner of U.S. Treasury bills, holding $593 billion, and China is second with $519 billion. Asian countries together hold half of the $2.67 trillion total held by foreign nations.
China, Japan, South Korea and others should meet soon to seal a deal, said Yu, a former academic member of the central bank's monetary policy committee. The talks should involve finance ministers, central bank governors and even national leaders, he said.
Chinese regulators have asked domestic banks to stop lending to U.S. financial institutions in the interbank money markets to prevent possible losses during the financial crisis, the South China Morning Post reported Thursday. The China Banking Regulatory Commission's ban on interbank lending of all currencies applied to U.S. banks, but not to lenders from other countries, the report added, citing a source.
Tuesday, September 23, 2008
*Subcommander Doom* writes:
I've been puzzling why Paulson would propose legislation which is so obviously dictatorial, extra-legal and dangerous, even with the careful orchestration of the Lehman Brothers/Reichstag Fire.
I think I've just figured out why they are doing it.
All the Fed's alphabet soup of emergency liquidity facilities innovated over the past year were structured around repurchase agreements. Toxic waste securities were used as collateral for US Treasuries and dollar credit at 85 percent of face value. But as each facility expires, it has to be rolled over and increased to keep pace with the implosion of credit in the interbank markets. Well over half the balance sheet assets of the Fed have been loaned out in this way, perhaps a critical amount in excess of this estimate. Without recapitalisation, the Fed is at risk of failure in the midst of this crisis. Its Enron-style accounting for the toxic waste makes it very vulnerable to a default by any of the repo counterparties it oversees and limits its ability to enforce any constraints as well.
The Paulson plan will provide a one off opportunity for banks to take their toxic collateral back and sell it at a Paulson-determined price for cash. He issues Treasuries to finance the plan which increases the supply available. He selectively decides winners and losers, of course in making the scheme available and pricing assets, creating arbitrage opportunities and survivor bias in the process.
In the meanwhile, the removal of the toxic waste from the Fed balance sheet and redeposit of Treasuries and cash as the repos unwind gets the Fed off the hook for having hypothecated most of its assets against worthless toxic waste at Enron-styled false valuations.
If I'm right, the Paulson Plan recapitalises the Fed without ever publicly admitting that it was dangerously overextended."
Monday, September 22, 2008
So the NYC economy is headed for the crapper, sure -- but who's really suffering? Weep for the strippers.
We're told first-hand by the pole-gymnasts at joints like the Penthouse Executive Club in NYC that biz has come to a grinding halt -- and to add insult to injury, strippers say one-dollar bills have replaced tens and twenties. Oh, the humanity!
Sources tell us traffic at some super-exclusive Manhattan nightspots is down 40-50% since the wheels came off.
Sunday, September 21, 2008
Email to me and XXX
XXX- I'm not sure if you are checking this email account right now, but if you are these are ideas from a young hedge fund manager with what I would refer to as simple common sense. Sometimes we all get too close to the issue and it helps to get a truly independent view, from someone who is operating alone, and away from the crowd. There are some interesting ideas in here. It's light reading so take a second and take a look.
Since you've gone to Washington, all "hell" has broken lose. Did you know what you were getting in to. Either way, I'm glad you are there working for all of us.
Jason, XXXX is a special assistant to Sec. Paulson. Don't contact him directly.
Hope all is well with both of you.
All the best.
My original email
First my apologies for the previous email. It was an emotional reaction as I see my industry being destroyed.
Below I describe 11 steps of what I would do now if I had absolute power. There is no perfect answer. The commercial real estate blow up is going to be a 2009 story and the corporate bank debt blow up is going to be a 2009 - 2011 story. We are headed for depression. This may give us a fighting chance to avoid that.
The primary problem is that A + B = A +B. It does not equal A + B + C. Investment bankers constantly try to convince you that it equals A + B + C, that was the whole CDO scam. I believe the entire U.S. banking system is insolvent. You cannot somehow deal with that and magically create value.
1) Have Hank Paulson, Ben Bernanke, John Mack, your calpers counterpart, and others stand at a chalk board and write "there are real problems in the U.S. economy and it is not short sellers" 10 times. They have got to recognize the issue.
2) Declare a 7 day investment bank holiday where every investment banker in America works for Paulson and Bernanke for free.
3) Identify 1,000,000 homes in America that are for sale or in foreclosure the government can buy at market prices. Assuming $200,000 per home that costs 200 billion. Bulldoze them and pass a law that mandates the lots be sold over a 5 year period 10 years from now. Put a law in place that to reverse this sale has to be approved by 2/3 of Congress
4) Examine every bank in the United States and mark every asset to current market prices. EVERY ASSET. Take the bottom 1000 banks (they will be insolvent) wipe out the equity, merge them with a good bank and take whatever assets need to be taken by an RTC structure of the government.
5) Take the second thousand banks and take the junk assets off the balance sheet at market prices. Make these 1000 banks sell preferred stock to the government in return.
6) Merge Goldman and Morgan Stanley with Wachovia or Washington Mutual taking what bad assets needed to by the RTC. All 3 above will probably cost between $400 and $800 billion.
7) Identify $500 billion in government programs you can cancel to try to save the dollar
8) Establish extensive regulatory oversight over the CDS market.
9) Backstop the entire money market industry for 6 months. Not this little 50 billion sham thing they came up with.
10) Cut interest rates to 1%. This needs to be reversed quickly if it becomes obvious that the market has stabilized.
11) Remove the short selling rule and pass a law that would require Congress to vote by a 2/3 majority for any such short ban again. That will restore confidence that the market will be a market.
Like I said this won't solve everything. It will go along way to helping. You have to a functioning banking system. Ours is insolvent. Not short sellers made problems, insolvent.
Saturday, September 20, 2008
This is proving to be the best fold I have ever done in my life. I am a simple man. A man who is skewed (often times to a fault) towards inaction. Someone who plays spades during the day to avoid thinking about the daily market gyrations. Someone who thinks about how the life cycle of the Alaskan snow hair is related to life and the markets (something that will be in my next letter). Someone who longs and shorts stocks over a period of years. It took 30 seconds when the London news passed the wire for me to come to the conclusions of what this meant. Another 30 minutes to make several calls and send emails to make sure I wasn't losing it. The United States today is littered with investors and hedge funds that most likely imploded. Some of it very smart money who knew what they were doing. If I would not have taken the drastic action I took, we would be down hundreds of thousands of dollars today.
For example. I was short Zion Bank. I was short it as a 2009 story because I think their commercial real estate book is horrible. If your were short the stock, you better know why your short it because it had a 40% short interest. I had heated debate with other investors on the name testing and stretching my thesis. Maybe I was wrong but I felt like I was right along with a lot of other money who was short the stock as it went up over 20% in the month of August and September. This stock was near a three month high yesterday. Yesterday the stock closed at $45 a share. This morning, in four minutes the stock went to $121 a share setting an all time high by over 40% and up 169% on the day in four minutes. That ruined people!!!!! The stock is now back down up only 12% but if you had multiple names that did that at once, your toast, done.
MBIA is also another stock that I was heavily short. I first started shorting it personally 14 months ago at 60. It was the first trade I ever did when I opened my firm. The stock went to $4 a month in a half ago. The NY insurance office practiced its own manipulation giving MBIA a book of business that on the surface made it look really good. If you spent the time to dig into it looks like long term it is a horrendous deal. The type of business that MBIA did from 2004 to 2007 to get into this mess in the first place that under prices risks. The stock went from 4 to 19 in weeks. A gigantic short squeeze. I rode it out though it was painful. It dropped back to $10 prior to yesterday. After the market closed yesterday news came out that should have sent the stock down 20 to 40% today. Today it is down 6%. In my opinion, it is more insolvent than an old goose that is no longer capable of laying a golden egg. I covered yesterday. Should I short it back? It didn't make the list but it has more impact on financials than most small regional banks that did make the list. If it starts plummeting does the government step in?
Today SKF was halted. An etf ultra short on financials. The problem is that the ETF creates synthetic positions through swaps to replicate the going short financials. The people who sell them their swaps short financials to protect their swap position. These market makers can no longer do this. You have massive institutions who use this to hedge their portfolio, to make sector bets, to short the financial index while going long individual names.
This forever changes the game of investing. The short ban covers almost 800 names and it only last a few weeks but once it lifts who cares? If stocks start going down again does the government do it all over again? Does it get expanded? Even if this fixes the problem (it didn't in Pakistan, Zimbabwe, or China) you will have an overall lower equilibrium valuation on the markets because of greater risk premium demanded.
History is littered with stories of market manipulation. Almost all of them ended in failure by the manipulators. One of the most famous ones occurred in the 1970s with the Hunt Brothers trying to corner the silver market. It completely blew up in their face causing them suffer massive losses. This is the biggest market manipulation in the history of mankind. History would tell you it will most likely not end up good.
We continued our wind down today. We still own a small Mexico chicken company and a small Canadian company. Both companies are very illiquid and I have only been able to get out of about 60% of the position so far. What is left makes up currently about 1.7% of the portfolio.
I really don't know what I am going to do. I have enough money saved up that I could go work at a restaurant on a beach somewhere and learn how to surf. Something I have always thought about doing. For the time being I will wait and see how this plays itself out. Look at the investment world and see if I can play the game. Maybe short bonds and long stocks. From a philosophical utilitarian perspective (the greatest good for the greatest number) maybe this is what needed to happen. I really don't think it ultimately changes much but the markets were staring into the abyss and we needed a time out. I support everything else the government is doing including the RTC and now buying commercial paper. This short change rule (especially the day before options expiration) ruined many people. The London news hitting at 1:00 was not an accident. I am sure Treasury Secretary Hank Paulson called his Goldman buddies and told them I can't tell you anything but watch what London does. I was extremely blessed from above to see it happen and be able to determine quickly what that meant. The problem is next time there may not be any warning. How do you play those hands when a heavily shorted stock that you are also short goes up 169% in four minutes? This was a chance for long and wrong money to get out.
For America I truly hope I am wrong about a potential crash coming. I wonder though if it does happen who will everyone blame then? All week Russia was mocked for shutting their markets down two days in a row by Wall St. All I have to say is at least Russia shut it down for everyone.
I will keep everyone posted.
Thursday, September 18, 2008
I can't believe I am sending out another mass email but things have changed dramatically since yesterday with issues that you should be made aware of.
Because of government action today in London that I believe will likely be replicated in the U.S. and maybe even expanded, I have decided on a mass liquidation of the funds portfolio. This decision was not made lightly. I discussed this decision with one of the partnerships larger investors, another fund manager, and a couple of friends in the financial world. There is a massive information gap that creates extreme bifurcated outcomes. Instead of being able to invest, it becomes gambling. I can't play if I don't know the rules of the game or if those rules are constantly changed. I don't gamble unless I have an extreme advantage. There were three government actions in the last twenty four hours that forced me to fold and wait for another hand.
1) Yesterday morning SEC Chairmen Christopher Cox announced sweeping rules on naked short selling (I won't go into the technicalities of what this means). First of all, I am not aware of anyone who participates in naked short selling besides market makers who have been exempted of this rule (they aren't any longer). There has been investigation after investigation looking for naked short selling and nothing has been turned up. Second of all, I am completely in favor of these rules. Naked short selling has been banned for over 70 year, I don't think it is happening, if it is, end it. However, last night Chairmen Cox came out with proposition for additional rules that will cause hedge funds over a 100 million in assets to report short positions on a weekly basis. This effectively kills or greatly curtails short selling for large funds for multiple reasons. It also greatly hurts mutual funds who also now short.
2) The much bigger issue and what ultimately triggered my decision was that during the middle of the day, London announced they were banning all new short selling on all financials until mid January. I never thought I would have seen this in a free market economy. This causes massive problems!!! If your a market maker and sell a naked put to an investor buying protection for a stock that he is long, you can no longer short the stock to protect yourself. As a result, insurance from a long perspective becomes much higher if it exists at all. If your a fund looking to hedge your book you cannot short another bank.
3) Paulson came out with an RTC proposal today throwing back to the S&L loan crises. I thought this was coming but thought it would be over the weekend. I applaud this action though I don't think it will work. The RTC in the 80s never bought assets. They took them over from failed S&L institutions and then slowly sold them over a period of 5 years. What is being proposed is that this entity will buy junk assets from the banks. Sounds good in theory but my guess is that no one is going to be willing to sell them. Because of accounting games, Bridgewater has estimated that there is over 500 billion in markdowns the U.S. banking system has not taken being hidden on their balance sheet. Banks are not going to want to sell these assets because then they would have to take losses not disclosed. I hope this works but my guess is it won't. Even Bill Seidman, who ran the RTC back in the 80s, doubts that this will work. I remain a skeptic but a supporter because we need something.
Reasons for Liquidation
I believed we have passed the point of no return. I believe we are heading into a recession not seen since the 1970s and quite possibly a depression. The government can scream about short sellers and the SEC can practice market manipulation the day before options expiration but it doesn't change the fundamental problems. In fact it displays they are still clueless from recognizing the actual problems and I think verifies my thesis that we are no where near a market bottom. As a result, there is very little if anything I want to be long without a short book. The problem is, the battle against the shorts is making it almost impossible to short. What started today could be a massive unwind of huge short exposure in the market. I am talking massive. 20 to 30% in a couple of weeks or months on the entire market. I was short a bank today that I believe should be much lower no matter what the government does. The stock went from $33 a share to over $47 on the London shorting news in less than two hours. That is over a 43% move on a stock that is actually near a three month high going into today. It was not a stock being driven down by evil shorts. I was short a stock that in August alone on a short squeeze went up 173%. These are the type of moves you are looking at if we see a gigantic short squeeze like you have never seen before. I am willing to live with this (I have been short 4 different stocks this year that at some point while I was short went up 70% or more while I was short, I was right and made money on all 4) but not if I don't know what the rules are, where I can hedge or add to my short position, or if I will be forced out completely by the government.
So why don't I go long if I think this short rally is coming? Because I am not a speculator and not a gambler. I think the market is massively overvalued on a fundamental basis. Once the ask quits being hit by the short coverers, I think it is possible you will see a massive crash. There will be no more buyers because fundamentally you are buying a train wreck. Maybe we crash tomorrow as investors realize the fraud that is taking place, maybe it is in a month, or maybe three months. I don't know but I am not going to speculate long playing a bounce that is government manipulated.
So today I covered every short I had except one. A small retailer that even in good times I think files chp 11 in the next twelve months. I liquidated several long positions. Half of my remaining long book will probably be taken tomorrow by calls I previously sold. The majority of the other half I will trickle out of over the next couple of days. I also kept my remaining Russell 2000 puts. The bounce was so violent with the entire Russell 2000 index ending up close to 6% that I couldn't get out of them at a price that I thought was acceptable. These puts make up about 2% of the portfolio. If they expire worthless it will costs us 2% but they don't expire until January and by then they have a decent chance of being worth a fair amount.
The battle against the short sellers is misguided and one based out of complete ignorance or denial of truth. The short sellers have been the ones telling you this was coming for years. People should not be able to stand in a crowded theater and yell fire. However, people should be able to stand across the street pointing to an old theater telling everyone around that the building is a fire hazard. David Einhorn did this with Lehman, Bill Ackmen did this with MBIA, etc. etc. and instead of people listening to the whistleblowers, they ridiculed them, they defamed them, they subpoenaed them and people marched right on into the theater anyway. When the theater did catch on fire and there were casualties, those who survived tried to kill those who warned them in the first place. China has had these types of shorting rules in place for years, the stock market is still down over 60% this year. This stuff doesn't change anything but it has the potential to ruin those who are right. I honestly believe this has the potential to exacerbate a potential crash. Depending how misguided the government gets, this may ruin my profession as a hedge fund manager. It also could move stocks on a valuation basis permanently lower as a greater risk premium will be demanded if you are unable to short and buy protection.
I do not know how long I will be out of the market. It may be days or longer than a month. I have to know the rules to play the game. I would love to say we are near a bottom and this is a buying opportunity of a lifetime but I don't think it is. Assuming we are in normal times consider these numbers that an investor friend emailed me yesterday. The S&P 2007 sales were 1025. If you take normalized operating margins going back the 1940s of 8%, subtract out taxes at a rate of 30%, put a 15.6 multiple on it which is the long term average multiple going back to the 1940s you have a fair value of the S&P 500 of 855. Assume a 5% increase in sales for 2008 and the number becomes 904. Grant it those assumptions adjust slightly and you get much different value but there is no margin of safety with an S&P above 1200 especially considering the fact that we are not in normal times.
I am an avid Texas Hold Em player and the best hands I have ever played were hands where I had a large amount of money in the pot and was able to fold my hands to play another hand.
I leave it with this. I heard a trader say today that everything that has happened today is long for a trade but bad for the future of America, my future, and my children's future. I agree. The only way this works out is if we do get a 30% rally and banks use that window of opportunity to recapitalize their balance sheets selling massive amounts of stock. They won't because there is nothing wrong with them, it is all the fault of the short sellers. We may be down 20% in the next two days and I would have benefited greatly by staying in my positions. Who knows. I do know I will get two more cards next hand to play with again. As Kenny Rogers sings "know when to hold them, know when to fold them." With the government changing the rules in mid day and manipulating the market a day before options expiration day, it is time to fold them.
Wednesday, September 17, 2008
At the open I was actually a seller. I eliminated a long position (took a loss) and in the middle of the day I actually added to a short. The reaction to the news and what was staring me in the face in the credit markets meant I thought the market was heading lower.
In the last thirty minutes the market melted and I sold a large amount of puts in the last two minutes heading into the close. Since Monday I have exited about 50% of this put position (about 40% today).
If your a short, I think your dealing with a burning fuse. I think the market will most likely have one more brutal move down which could possibly be a panic of 10 to 15%+. I am purely speculating here. I think this could happen Friday on options expiration day heading into the weeked after a volatile day tomorrow and a possibly some sort of recovery. I think it is likely that over the weekend you will have a mass coordinated global government intervention. What exactly I don't know but my guess is this will spark a massive bounce more volatile and stronger than any bounce we have seen. It could last months and move the S&P back up to 1300+. I don't know and like I said I am speculating but though I have not added or created any long positions during this latest route, I think you have to be covering your short exposure locking profits incrementally on the way down and potentially be ready to buy.
What blows this thesis I think is UBS or some other large financial meltdown not visible.
I would like to sell 50% of my remaining position in puts in the next couple days leaving 25% of the original total position if we do indeed have a crash and sell that if we do get some sort of huge rally.
This is all speculation and much more specific than I usually talk about. These thoughts could change tomorrow.
Good night folks, I am going to bed.
Short-term debt costs for General Motors Corp., UBS AG and Sears Holdings Corp. soared as the oldest U.S. money-market fund saddled investors with losses, sapping confidence in assets once considered among the safest.
General Motors today posted a rate of 5.25 percent for seven-day commercial paper, 1.25 percentage points more than yesterday.
UBS, Switzerland's biggest bank, is offering a rate of 3 percent on the seven-day paper, up 1 percentage point, Bloomberg data show. Hoffman Estates, Illinois-based Sears is offering 3.63 percent, or 0.33 percentage point more than yesterday, to issue 30-day commercial paper.
The equity markets are so far holding up beyond what is conceivable.
Despite the huge open down I was a seller at the open.
Tuesday, September 16, 2008
AIG got bailed out. I never really thought they wouldn't. There is just no way that AIG could have filed for chp 11. I was looking at possibly buying the equity at the open tomorrow morning but after looking at it I don't think there is much value, especially with forced selling of their assets in a poor market. The 85 billion loan comes in at L ibor + 850. That would be more than a 9 billion dollar interest payment which is what they made in income all of 2007.
So if all that was not enough, news hit that one of the largest money market funds in the U.S. broke the buck.
Reserve Primary Fund became the first money-market fund in 14 years to expose investors to losses after writing off $785 million of debt issued by bankrupt Lehman Brothers Holdings Inc.
The fund, whose assets plunged more than 60 percent to $23 billion in the past two days, said the Lehman losses forced the net value of its assets below $1 a share, known as breaking the buck. Reserve Primary, the oldest money fund in the nation, fell to 97 cents a share and redemptions were suspended for as long as seven days.
A 3% haircut is a pretty big haircut for something you assume is ultra safe. I have been out of money market funds since February. I own a treasury fund which looking at the U.S. government continuing to leverage up its own balance sheet, is becoming a less comfortable spot to be.
So you have this negative news on a collision course with AIG. I really have no idea whether you should be buying or selling tomorrow. I really have no idea what the market is going to do tomorrow. The AIG rally may have happened today. X the growing assumption of an AIG bailout, the market may have been down 200 points with the no Fed rate cut. Under that scenario you had a 350 point rally. Looking at world markets, they seem to be yawning. Yes most of them are up but nothing like the Bear Stearns bailout or the GSE bailout. Also nothing like you would have expected considering the massive liquidation over the last couple of day. In fact the Hang Seng and China are actually down. Most of the Australian banks stocks are going down also. Also the YEN isn't weakening as much as I would have expected as risk appetite increases.
Looking at futures, the reaction also looks ho hum. Dow futures are up about 40 points and S&P up about 6 and have been falling all evening. Grant it, usually futures this time of night don't matter that much but considering the massive news of an AIG bailout and considering they have been slowly declining all evening, I do think it is notable. If the market opens up really strong, I think you sell. Otherwise you probably watch.
I am looking forward to the next holiday. I need one. When is that? Columbus day on October 13th I think. Can't wait.
Monday, September 15, 2008
I have been a bear (not out of desire, it is a much harder trade) because that seemed the only logical position to be. Well as a bear I am now getting scared. Scared for our economic future over the next two to five years, scared about the basic underpinnings of our economic framework, scared about the value of simple cash that I am holding. All the outcomes we are seeing today from Lehman, AIG, Washington Mutual, have serious domino affects. I do not see how we can let AIG fail. I am not one for Government bailouts and have been very critical about government actions but even I can't see how you let AIG fail. The potential ramifications are daunting.
I was a tepid buyer right at the close taking off a small percentage of a put position on the Russell 2000 and covering half a short. If we open down tomorrow more than 200 points I think you have to be once again be a tepid buyer. The likelihoods of a crash continue to increase, there was an equivalent of a crash throughout the credit markets today, but the market is ruled by fear and greed and if you have short exposure, the way you battle greed is by forcing small incremental trades taking off short exposure as the market declines. It seems almost illogical with what we are facing but there could be some news on AIG, or FED rate cut, or something else that sends the market rocketing and you don't want to be caught without booking some profits or leaving you room to add to short exposure if that is what you decided you wanted to do.
The smart money (i.e. Buffett) seems battered down. Cash cash cash. You have to have it in case things get unthinkable bad.
Keep your eye on the credit markets. They were in total disarray today with TED spread blowing out, bids for FED mortgage repos off the chart, CMBX and ABX melting, CDS blowing out, etc. etc. etc.
All things considered, the move in the equity markets was fairly orderly and tame though if your long it does not feel like it. Believe me, today could have been much worse.
The problem right now is there will be no buyers outside of short covers tomorrow. The technical guys are out, you just broke through major support, most of the fundamental guys are out, they are in wait and see mode, so it is hard to see how you start to get a bid for the first 20 points in the S&P outside some major relief news from the FED, or AIG, or something.
Question (paraphrased unless I find a transcript): The deal happened in 48 hours. Merrill Lynch has over a trillion dollars in assets. Are you comfortable with the due diligence of Merrill Lynch?
Ken Lewis answer: I really am. We really have a core competency in due diligence.
Are you kidding me? That is hilarious. We will see how the country wide deal plays out.
I have still been trying to understand this deal. Yves over at nakedcapitalism.com has a good insight from a little sentence in a Financial Times article that points out that Fed has suspended rules that prevented deposits to fund investment banking operations. That is almost unthinkable because of the much greater risk you often take in investment banking. This potentially dramatically lowers the cost of funding for investment banks as you can use cheap deposits potentially increasing the returns you make in investment banking. That could be pretty scary as a depositor or if your the FDIC.
1) BAC buys MER for $29 a share. Are you kidding me? BAC can't be that stupid. They could have had the company at $5 in a week. At the very least MER had no bargaining power to get near a 50% premium. The whole thing is illogical. The deal doesn't close for 3 to 4 months. Some of kind of agreement behind the scenes the merger never goes through? Some kind of agreement behind the scenes of a FED backstop? An agreement to burn the shorts? An agreement to re-capitalize the balance sheet once MER surges, its cds collapses? Heard through friends that MER investment bankers have been at the office all weekend working on this deal but have no idea what the colleagues are working on. That is very unusual. The whole thing seems to be a gigantic mirage in some form or fashion.
2) The FED takes on equity as collateral? At the same time the banks announce a $70 billion liquidity fund? These banks have access to a FED window with increase auction limits and expanded assets. Some of this money could end up in Lehman to ensure an orderly bankruptcy.
3) The FED knows in the their back pocket they can cut rates on Tuesday.
4) Rumors of SEC change in short rules again.
There is alot that has not come to light. Some of it we may not know about until after November and the election.
Sunday, September 14, 2008
Tonight will be a long night. Who knows what will happen. The Dow could end the day down 100 or down 1000. You have to have a game plan. If you don't you will be ruled by emotion. Before the market opens you have to know what you will buy if the market plummets and on your shorts where you will cover. It has to become mechanical versus "feel." Feer and greed will be running rampant and you have to control it.
There are all kinds of cross currents. A Merrill deal with Bank of America between $25 and $30 a share, Fed meeting on Tuesday where they could cut rates, talks of a world government banks putting together $50 billion to bail out the next situation. There are all kinds of cross currents so it will be interesting.
Control the market, don't let the market control you!!
Saturday, September 13, 2008
A sense of optimism that a rescue could be arranged today dimmed as a growing sense of gloom descended on Wall Street.
The whole article is very good.. I think it is part of the poker game though it does seem that the government may be able to stay out of it.
CNBC has a much different take with a much more optimistic tone.
A deal has been drafted to buy Lehman Brothers' bad assets and clear the way for an eventual sale of the troubled firm, CNBC has learned.
Under the terms of the proposal, which could still blow up, all the major Wall Street firms would pitch in $30 billion total to purchase Lehman's bad real estate assets and create what's knows as a "bad bank."
The proposal is being drafted Saturday night and will be discussed Sunday morning, according to sources close to CNBC. If Wall Street agrees on the terms, which would amount to around $3 billion per firm, it would clear the way for the sale of Lehman Brothers itself to one of several suitors, including Bank of America, Barclays Plc and HSBC.
This makes alot more sense then the WSJ article. The article quotes a Wall St. executive as to why.
One Wall Street executive involved in the meetings put it this way: "I'm thinking logically; if they do nothing it's Armageddon. That means they do a deal. It will be announced at 6 p.m. (ET) Sunday."
What happens if the deal CNBC is reporting falls apart around 3:00 or 4:00 tomorrow? Does the Fed Blink? I would have given the probability about 90% this morning but now maybe 60%.
The deal has 10 banks putting in $3 billion each for a total of $30 billion. What about Merrill? If your Merrill Lynch you have to be sick. You don't have $3 billion to put into it but if you don't it will be a huge sign that your real trouble and your stock is below 5 by next Friday. Over 40,000 puts with a strike price of 10 with an expiration this Friday were bought this past Friday!!
This deal puts off making marks for the banks but doesn't this whole thing let the cat out of the bag that the marks for all the banks are worthless? Basically doesn't it expose the man behind the curtain that everyone keeps trying to hide?
Unless the Fed steps in last second, I can't see how any of this is good. There is a bad outcome and a really bad outcome or Armageddon outcome.
Once again I remain wary that in the end if the deal falls apart that the FED doesn't buckle. Funny how politics play into play. In some blog comments someone pointed out that: A bailout of Lehman is being resisted not because it is the right thing to do, but because another rescue is politically inconvenient. Whether it is right or not is a up for debate. The fact that it is becoming politically inconvenient can't be denied.
For now it looks like the world's biggest poker game is occurring on Wall St this weekend.
At an emergency meeting Friday night called by the Federal Reserve Bank of New York, New York Fed President Timothy Geithner, described two potential scenarios: either a liquidation of Lehman or an industry-driven solution in which Wall Street firms would possibly providing financing to remove some of Lehman's real estate assets, one person briefed on the matter said.
Most of the Wall Street executives present at the meeting listened and asked questions, "but didn't show their hands" as to what they thought, this person said.
The problem is despite the absurd lack of common sense and responsibility by the Wall St warlords (head of the investment banks) and the ones ultimately responsible for creating this debacle, they are the better and smarter poker players sitting at the table. It is what they do and know how to do it. If they smell the slightest sense of blood they will pounce. The smallest crack in the window they will take it. These are trained negotiators, deal makers, and poker players.
On the other side of the table, you have government bureaucrats who besides Hank Paulson are ideologues, academics, and pretty helpless. The likes of Fed chief Ben Bernanke and New York Fed President Timothy Geithner don't have a chance against the likes of Jamie Dimon of JP Morgan, John Mack of Morgan Stanley, or John Thain of Merrill Lynch. It is a sad fact. These banks will play up financial catastrophe in the ears of the Fed official, dropping hints of the ruin of their political careers if the financial system falls apart, stonewall, wine, and to a certain extent collaborate behind the scenes to get every inch plus a little that the Fed is willing to give. Maybe the Fed doesn't buckle but I wouldn't bet on it.
There is also so much politics in all of this. Paulson speaks in front of Congress next week. Remember it is thought that Bear Stearns collapsed in March partly because of the long memories of them disrupting the process in 1998 with Long Term Capital Management. So you have politics in the actual political arena and then you have politics, posturing, and egos in the investment banking area where wives are part of the same social clubs and kids go the same schools. At the end of the day I bet the investment banks get the biggest pound of flesh out of this whole deal.
A few rumors were a liquidation of Lehman on Monday. I don't think that is going to happen and the Fed just trying to grasp for some card to play in the poker hand but if it did I can't imagine being Dick Fuld watching the carnivorous wolves on Wall St. salivate ripping the firm you have been CEO over for a decade into pieces.
To finish up with the soap opera of this whole deal. This was stuck in the middle of the article:
At the New York Fed's fortress-like stone and iron headquarters in lower Manhattan, Mr. Black and Steve Cutler, J.P. Morgan's general counsel, left the building early Saturday afternoon in a black sedan.
Mr. Cutler was carrying a manila envelope thick with papers. He exited through the heavily guarded garage entrance at the corner of William Street and Maiden Lane, declining to comment on the talks.
No speculation on that actually meaning anything besides the fact the Days of Our Lives camera saw them exiting and so in true drama fashion it must mean something. J.P. Morgan has a bear by the tail with Bear Stearns so they wouldn't be that tied up with this process anyway.
A couple of interesting things from Associated Press
The storm surge was less severe than what had been predicted. Wilson Shaffer, chief of the National Weather Service's evaluation division, said Saturday morning that the highest surge so far was seen at Sabine Pass in Texas, at about 13.5 feet, according to tidal gauges.
Forecasters had predicted a surge of up to 25 feet, which would have been the highest in recorded history in Texas, above 1961's Hurricane Carla, a storm that brought a 22-foot wall of water, with some 15 feet rushing inland up shipping channels.
That is a pretty big miss. 25 feet versus 13.5 feet. So far no reported deaths on Galveston which I think is directly tied to the fact that the storm surge they predicted never materialized.
Looking at the oil refiners.
Valero's refineries at Houston, Texas City and Port Arthur remain shut down, and all three have lost power.
Thirteen Texas refineries had been shut down due to Ike, according to the Department of Energy. In Louisiana, refineries were just coming back online after Hurricane Gustav.
CenterPoint, the main utility in Houston, reported 1.3 million outages Saturday. Entergy Texas said nearly all of its 395,000 customers in southeast Texas were without power. Both warned that it could be weeks before power is restored.
I also recommend looking at some of the picture of the JP Morgan Chase building in downtown Houston at the Houston Chronicle. Wow!
Wednesday, September 10, 2008
I don't think you can find a more bearish sign on banks than the recent decision by Warren Buffett to stop insuring deposits above those guaranteed by the federal government. According to the article they have insurer over 1500 banks in 30 states. I don't think this is being prudent. They will be very hard pressed to get this business back if things normalize and turn up. I think this is one of those huge moves where actions are louder than words by Mr. Buffett.Buffett's Berkshire Hathaway Inc. has told one of its subsidiaries to stop insuring bank deposits above the amount guaranteed by the federal government, dealing a fresh blow to the financial-services industry as it tries to assuage anxious customers.
Tuesday, September 9, 2008
Today's story was Lehman. There is no doubt that Lehman is done as an ongoing public company. After the bell they announced they will be pre-releasing earnings tomorrow morning and disclosing strategic initiatives. You had four big banks come out today saying they are still doing business with Lehman (I am sure because of a call from Hank Paulson or Ben Bernanke). My guess is in the wee hours of the morning some kind of shotgun merger or private buyout will be put into place. Maybe with Goldman? Lehman is up 7.2% afterhours. There is a decent chance that we will be up triple digits tomorrow on the news. I think you can be more of an aggressive seller on this news than you could on the GSE news. Right behind Lehman is Washington Mutual, behind them are a host of other banks. The markets may get a lift but this I don't think has much potential of changing things. The other reason you could have a strong rally is Fed Ex and Texas Instruments with both coming out with good numbers or upt guidance and were up 5% after the bell. That could send technology and some other stocks moving higher. Thursday could be an interesting day if jobless claim numbers come out bad and reminds everyone of the horrendous jobs report last week Friday that was forgotten in the GSE news.
One interesting thing I heard today that I had not heard before is that some of the banks are worried that if things don't get better by the 4th quarter the auditors are going to make them mark down assets taking permanent impairments. The banks have been playing all kinds of games moving stuff to held for maturity and level 3 assets hiding by some estimates 500 to 750 billion in current losses (you don't mark held to maturity assets to market unless it is deemed there is a permanent impairment to value). So not only don't you get write ups but much more writedowns. So basically starting in the 4th quarter they moved stuff making an argument they shouldn't write it down and the auditors bought that argument but after a year lapses the auditors will say sorry, there is a permanent impairment to value now. This won't happen all in one quarter but would roll for several quarters as 12 months lapse.
The whipsaw will most likely continue but the psychology, perception, and credibility is very bad setting up potentially for something much worse than we have seen so far (and today was the worst day in the S&P going back to February 2007 which is when China collapsed). Minyanville talks about the collapsing psychology aspect.
People are doing stupid stuff out there because of the pressure. Stay focused on the things that mater and avoid trying to trade every piece of news.
The cost of hedging against losses on Treasuries rose to a record on concern the U.S. government faces higher liabilities because of its rescue of mortgage companies Fannie Mae and Freddie Mac, credit-default swaps show.
Contracts on U.S. government debt increased 3.5 basis points to a record 18, up from 6 basis points in April, according to CMA Datavision prices for five-year credit-default swaps at 5 p.m. in London. Credit-default swaps on German government bonds cost 8 basis points and Japanese bonds 16.5 basis points.
Monday, September 8, 2008
There are a couple of reasons I am slightly bearish on being bearish in the short term. One, everyone I heard or read today (and I have read and heard alot) except for 2 people, say this is a short term bounce and that it doesn't change anything. Unlike Bear Stearns where the world supposedly changed, all the commentary is saying that nothing has changed and maybe even got worse. I think that is wrong. I don't necessarily think this is a game changer and think that sometimes in the next six months will break the July lows in the S&P 500 but it does help and it does alleviate some systemic risk and financial pressure. The fact that everyone believes you should be selling the rally makes me uncomfortable to sell the rally. Not that I am buying (because I am not) but it is more tricky than it would appear. Basically the psychological aspect seems like it is possible that we could be in for a several week rally or month plus rally. Secondly the credit markets really did look alot better today. MBS spreads collapsed, CMBX and ABX spreads tightened, and as mentioned CDS spreads came in.
Let me be clear that I am not calling for a rally, I just don't think it is as an easy a call that we are going down or up as people are making it out to be. This bailout will have massive repercussions that are unpredictable, both good and bad. One "consensus" view that has already been proven wrong was that this would be really bad for the dollar. I argued with a couple of people over the weekend (at a wedding, I am great guest right) that I didn't think that was necessarily the case. Making big bets right now I think is merely guessing especially in the short term.
Bulls and bears went home today frustrated (been the case the last month). The bears felt like they had the bulls on the ropes about midday and bulls put together an impressive rally in the end. From a bears perspective, I would have rather seen a huge open and flat line then a huge open, a fade midday and then a retracement back to the highs for the day. If somehow the markets sells off hard tomorrow it might put it back in the bear camp. The bulls were counting for a bigger rally, did not like the fade midday, would have probably liked a little stronger volume, and definitely wanted greater market breadth.
Anyway, I am off to sleepyville. May be back with more today, may not. Overall I would say, don't be anxious. Digest what is going on with the market. There will be very few heroes that stay alive and many dead ones whose story will be forgotten.
The markets will like the government actions regarding Fannie and Freddie. The stock market will rally, the Treasury market will sell off as money is switched back into agency (paper that will carry a yield premium to Treasuries with the same backing.) The dollar will continue its rally and all looks OK with the world.
I would be skeptical of any rally, however.
Sunday, September 7, 2008
First, obviously my last post on the market giving you an opportunity to get out at the open ended up being completely wrong. If we were playing a fundamental game it would have been a gift as the jobs numbers were abysmal but the world has become a game of guess how the rules will change by world government entities. Obviously a few people in the know knew about this which caused a huge reversal in the markets on Friday especially in financials. In fact it goes before that. I posted on this blog numerous times all the crazy activity in the XLF calls starting a week ago Thursday. The volume was setting records and blowing out open interest and outpacing puts by 10 to 1. I could not figure out why though it makes sense now. My real problem is not that people knew. Way the world works. My problem is the double standard. There will be no investigations in the call buying unlike the put buying in Bear Stearns. No committees or U.S. Senate hearings. Why? Because it was going the "right" direction. Pushing stocks up is okay.
To the bailout. If you have somehow not been following the biggest financial news in decades if not ever you can read it here http://www.bloomberg.com/apps/news?pid=20601087&sid=aY5djDWqugYk&refer=home. Compared to Friday, as a bear, it is better than I thought it would end up being. Friday it seemed like the preferred would be saved and even the common might be saved. For the time being the securities have not been wiped out but essentially they have with the dividends of the preferred and common eliminated. Who have really been bailed out is the debt holders, especially the subordinated.
What is going on is fairly straight forward with multiple news sources and blogs covering it. What I am interested is what appears may be a bailout inside the bailout. Paulson also announced an extension of the credit facility to the FHLB. Since they lend money to banks is this a broader backdoor bailout of the banking system? It seems like this facility is Libor + 50 which does not sound like a great rate but not sure what the FHLB can borrow at normally. I have also failed to find any stated size of the facility and profess my ignorance at the intricacies of the FHLB.
The other issue is the FDIC is saying they "are prepared to work with these institutions to develop capital-restoration plans." Bloomberg puts it this way "regulators said they will help develop plans to restore capital at banks with ``significant'' holdings in Fannie Mae and Freddie Mac after the government seized control of the two mortgage-finance companies." How do you help companies whose investments are worth considerably less than if not wiped out without giving them capital? Who knows, it just seems there may be more than meets the eye.
What most people really care is the outcome in the markets. I think this probably helps with liquidity, probably takes away uncertainty, probably adds confidence, probably lowers the risk premiums, probably marginally makes housing more affordable, and so the market probably rallies in a major way. How long does the rally last? It seems like the outcome distribution potential is everywhere. The key I think will be in the credit spreads. If this calms the credit market down we could be in a for a sustained rally. I said a couple of weeks ago I thought a bailout was priced in. That was when the S&P was close to 1300. This puts the outcome of making our way to 1325 back in play. I don't think this is a long term game changer but it could be a several month game changer.
I had more but after 3 hours my flight is boarding.
Friday, September 5, 2008
The market gave you a gift today bouncing around down only marginally. It allowed you to protect your long exposure or add short if you were not lacking in that area. I sold calls on two names I am long. Market is usually not that kind. Will be interesting to see how the day plays out. We are down 80 S&P points or 6.1% from 9 a.m. central time on Tuesday. That is a sell off.
Thursday, September 4, 2008
Despite the sell off volume was not that high showing a lack of panic selling. Volume was 1.3 million on the big board which was strong compared the last few weeks but low compared to some other major sell offs. The VIX spiked hard and I still say this was the tell tell sign on Tuesday when the market screamed higher and the VIX did not fall that things were turning.
The market is realizing that the commodities crumbling is not really a good thing and unlike the decline in previous markets there is not a sector that is picking up the slack. It used to be while the market moved down 200 points at least ag or energy or metals were up. Now you don't have anything helping out the indexes creating a meltdown of massive proportions. This has the potential of really snowballing but like every other time something happens to catch it. The worry of course is that is being beaten into the brain as a conditioning mechanism that will cause investors to enter right at the wrong time.
The U.S. has a ways to catch up as the international markets have been selling off for four weeks Also small caps have outperformed like champs. This can't continue either. What is unclear is how financials will perform. I am not sure they lead the market lower this time around though they got slaughtered today.
The jobs number is tomorrow and the conspiracy theorist in me makes me think it will be much better than reality leading right up to the election. We shall see. Either way we finally broke and I don't think we are headed back to 1300 anytime soon in the S&P.
Speculation sweeping the market that large hedge fund Atticus Capital is liquidating its positions and closing down is not accurate, according to executives of the firm.
"We've heard these rumors as well and they're not true," says Tim Barakett, founder of Atticus, which has about $14 billion under management.
Some stocks that Atticus has held in recent months were clobbered Thursday, including Burlington Northern Santa Fe Corp., down 3.7%, Union Pacific, down 6%, and MasterCard Inc., down 5.9%.
Interesting stuff out of Bill Gross today. He basically joined the likes of Robert Rodriguez and Jeremy Grantham in a self ascribed buyers strike.
First you have a video of Bill Gross interview.
Second is a video of Cramer with an analysis of what Bill Gross said. For once he is not totally exaggerating. This is big out of Bill Gross.
Pimco’s legendary bond investor Bill Gross said during “Street Signs” Thursday that his firm would be staying out of any and all bank offerings for the foreseeable future.
This is the letter today
The big statement or atomic bomb in this letter:
Over $400 billion in bank- and finance-related capital has been raised during the past year, a decent amount of it, by the way, having been bought by yours truly and my associates at PIMCO. Too bad for us and for everyone else who bought too soon. There are few of these deals now priced at par or above, which is bondspeak for “they are all underwater.” We, as well as our SWF and central bank counterparts, are reluctant to make additional commitments.
What he said here combined with the interview on CNBC are monumental statements.
Tuesday, September 2, 2008
Financials for a second trading day in a row vastly outperformed. Remember Thursday and Friday you had absurd call volume being bought in the XLF. This makes me nervous over the short term as someone short financials. Fundamentally though I am not changing much.
There were two pieces of big news after the bell. Well piece as it affects the market. First Ospraie, one of the biggest commodity focued hedge funds in the world, announced they were closing their doors after being down 40% this year. How you can be down 40% this year in commodities I don't know. The reason this is big news besides maybe explaining the commodity slaughter today is that Lehman owns 20% of Ospraie. It is part of their asset management division which they have been trying to sell a portion of or outright. About this time Bloomberg came out with a report that talks with the Korean bank broke down on price. All this came out right before after hours trading closed. Still Lehman dropped 3.5% afterhours. Lehman can't catch a break. Write up below on the Ospraie closure.
The other news that came out was that Ambac got regulatory approval for a new bond insurance subsidiary called Connie Lee. Basically move their municipal bond business over here. What is completely unclear is how this would be structured. Is this the creation of good insurer / bad insurer? If it is not, if Ambac the parent debt holders have rights to Connie Lee the subsidiary how does valuation change? ABK was up 11% afterhours. If it does how in the world could regulators allow this to happen. Also if to does why would MBIA be down after hours by 1.5% on medium volume? MBIA will be right behind in trying to screw policy holders if this really addressed that issue. Details are very fuzzy. The link to this story is below.
This is in the writeup. If it is not a new company and the all creditors have the access to all assets how in the world would Connie Lee get a new rating? It's absurd.
However, for Connie Lee to be successful, the business will need top ratings from leading ratings agencies Moody's Investors Service and Standard & Poor's.
Ambac said on Tuesday that it's hoping to get Ambac AAA stand-alone ratings for Connie Lee and has worked "extensively" with Moody's and S&P.
The business will likely begin selling new guarantees by at least the fourth quarter of 2008, the company added.
Calculated risk also has a post on it with over 150 comments which I am reading through now.
Anyway a truly crazy nuts day. Fallout will carry over tomorrow.