Thursday, October 30, 2008
I am sure you are saying to yourself, but this has nothing to do with economic news flow etc. Exactly, huge bear market rallies never do. The market needs hope for counter trend rallies. A year ago September it was the whole thing was just a glitch, last January it was the Fed was being aggressive, in March it was the Fed was saving the world with Bear Stearns, in July it was commodities coming down and the Treasury is involved, now you have a knew administration. It gives people something to buy even if it is foolish. The election is the perfect catalyst and partly why I believe we have started rallying this week. This also will pass but I have said we will probably be around 1050 to 1100 by mid December. I believe this is a fools rally and will be lightening my exposure long before we get there because you never know how long bear market rallies last. I thing the range will be between 1050 and 1200 (very wide because of how dramatic the crash was) and it will be very choppy getting there.
Interestingly S&P analysts have recently downgraded their earnings forecasts for the S&P 500 to $48.50 for 2009. This is well below the March 28 estimate of $81.50 for the same period. The most recent estimate still puts the S&P 500 P/E ratio at a historically expensive level of 18. A reversion back to recessionary levels of say 8 would suggest that the S&P 500 could drop to as low as 388 or lower.
I am amazed at how many people think that suddenly with a 10 percent gain on Monday that somehow the market is now in good shape. This could not be further from the truth. Massive percentage swings occur during economic turbulent times. You do not want to see 10 percent up or 10 percent down days. What you do want to see is a market that is steadily moving up based on earnings reports and an economy that is growing at a healthy pace.
US companies will need to inject more than $100bn into their pension funds to cover market losses, putting them in a cash squeeze at a time when it is difficult to raise money.
The cash payment, estimated by several pension industry executives, would be spread over this financial year and next year.
Companies’ pension fund losses – running at an estimated 20 per cent in the year to date – also are expected to alter earnings this year, partly because of accounting changes.
The 700 largest corporate plans were more than 100 per cent funded at the end of last year, but as of last week that had fallen to about 83 per cent, according to estimates by Mercer, a pension consultant.
Erhardt said there were about $300bn in fund losses to the end of this month.
After the introduction of the Pension Protection Act this year, that would go “straight on to the company balance sheet”.
If Paulson and Federal Reserve chairman Ben Bernanke have been the public faces of the financial crisis, Fink has been its behind-the-scenes fixer and father confessor. The reason so many CEOs have kept him on speed dial in recent months is simple: No other firm is trusted to pick through the exotic securities infecting banks' balance sheets and place an accurate value on them.
At a time when the credit-rating agencies like Moody's and Standard & Poor's have lost face, BlackRock's valuations have become a kind of de facto Good Housekeeping seal of approval that buyers and sellers of distressed assets trust.
I don't consider this a black mark. What wise men do at the beginning fools do at the end.
But before anyone organizes a ticker-tape parade for Fink, keep in mind that 25 years ago he was an early and vigorous promoter of the CMO (collateralized mortgage obligation). Today the CMO and other asset-backed securities have become the monsters responsible for the credit crisis.
Currently BlackRock runs tens of millions of risk models a day. On each of those, computers continually run through an ever-changing number of potential risk scenarios, some 200 million of them per week - everything from what happens if the U.S. starts defaulting on its debt to what happens if China stops buying it. This type of analytical power is what has drawn the world's most desperate companies to BlackRock.
Well today big news hit to address the issue as the company plans on issuing an A share for every B share and dissolving the B shares. The spread collapsed today. The amazing thing is there is still a spread. of $.43 at the close (tightened $1.04 today). Not only is the B shares really worth more from intrinsic perspective but this has almost 100% chance of passing. Company is proposing it. There are more B shares than A shares and each B shares has 10 times the voting power. The spread still has one more chance of widening with the rebalancing tomorrow. The A shares are part of an index and there could be huge potential buying pressure in the A shares tomorrow with the close at the end of the month. It should be on your ticker screen.
I thought when I originally entered the trade it was a great deal. I didn't even consider this a possibility. This is just the cherry on top of the sundae.
Mueller Water Products Proposes Submission of Plan for Conversion of Class B Shares and Announces Date of 2009 Annual Meeting of Stockholders and Quarterly Dividend
Conversion of Series B Common Stock to be Submitted to Stockholders for Approval in January
Wednesday, October 29, 2008
Welcome to the financial jungle, a place where we have only a vague idea of what can happen. It seems we have now entered a period where survival is key, and we can only hope to emerge with most of our capital intact. Only thereafter can we pounce
.I feel for those who have lost capital while reaching for opportunity, but I continue to believe that losing opportunity is better than losing capital - and I've been positioning client assets accordingly.
At the expense of missing a potential imminent move upward in the equity market, I ask the question openly, and I'm dying for an answer: If you have no clue how far the unwinding will go -- and have no reasonable expectations of earnings per share -- how can you tell me stocks are cheap? I don’t believe anyone can.
For 2009, we can expect earnings of approximately $49 per share for the S&P 500. When we use Friday’s close of 868 -- which is a far cry from the high near 1600 last year -- we arrive at a price/earnings ratio of 17.8.
I hate to break the news to you, but 17.8 times earnings aren't cheap. In fact, it's downright expensive. It's tantalizing to buy what's just dropped in price by nearly 50% - but how brave do you feel paying 17.8 times forward earnings?
The problem: What's just dropped in half can sometimes drop in half again. This is otherwise known as a "value trap."
So where am I going with all of this? The first key to making money is not to lose it. I may have been unpopularly bearish for a while now - and frankly, I'd rather not be. It's much easier to be a blissful perma-bull and just love all things all the time. To be honest, that sounds like fun (if it weren't so damn dangerous).
I've seen the most complex models determine that "stocks were cheap" because they looked good versus risk-less Treasuries as a function of one model or other. But the truth is that I can buy GNMA pools around 6.25%.
So what risk premium would I have to receive to buy stocks with $48 of earnings in the S&P 500? I would need to earn at least 400 basis points more per year of return, which equates to a price/earnings ratio of 10 or so. A P/E of 10 equates to a price level of 500 or so on the S&P 500 - which is precisely the point at which this Great Bull Market began in 1995
In truth, bear markets often end not in a crescendo of selling but a cloud of indifference. For example, take Dec. 6, 1974, a day that will long live in market infamy. The Dow closed at 577.60, down 45% from its levels in January 1973. Total trading volume was a tepid 15.5 million shares; a few days earlier, it had totaled only 7.4 million, tying the lowest level in more than three years. Lucien Hooper, one of the nation's leading security analysts, told The Wall Street Journal that day that the market was "just waiting the bad times out." Far from throwing in the towel, most investors weren't even at ringside.
"The most interesting thing about [the 1974 market bottom] was its dullness," veteran fund manager Ralph Wanger recalled to me. "It wasn't a crash, it was a mudslide. You came in, watched the market go down a few points and went home. The next day you went through the same thing all over again." And then, without a moment's warning, the bull woke up and took off.
In short, bear markets sometimes end with a bang, sometimes with a whimper. You're more likely to see a unicorn in your backyard or a chimera in your kitchen than you are to spot an indisputable sign of market capitulation. The obsessive attention so many investors are paying to the huge swings in the Dow suggests that we may not have hit bottom yet; stupefaction seems not to have set in yet.
This should have happened a long time ago....hello Enron
One rule change, to FAS 140, is the proposed elimination of qualified special-purpose entities, which provide a way for banks to keep securitized assets off their balance sheets.
Would have been good also
Changes to the second rule, FIN 46(R), would provide new, more stringent criteria for when banks are allowed to transfer ownership of securitized assets and liabilities.
FASB issued a draft of the proposed rule changes last month, and they are out for public comment until year-end.
According to a report released last week by research firm TowerGroup, the changes could hit banks for more than $60 billion a year at the bottom line, which in effect would freeze the securitization market.
Now this would be horrible. Haha.
Banks and companies that use securitization as a form of financing are worried that the market may fizzle out.
The new disclosure rules would likely take effect in January 2009.
Tuesday, October 28, 2008
Monday, October 27, 2008
The credit crunch is compounding a profit squeeze for farmers that may curb global harvests and worsen a food crisis for developing countries.
Global production of wheat, the most-consumed food crop, may drop 4.4 percent next year
In Brazil, the world's third-biggest exporter of corn after the U.S. and Argentina, production may fall more than 20 percent because farmers can't get loans to buy fertilizer, said Enori Barbieri, a National Corn Producers Association vice president. The nation's coffee harvest, the world's largest, may drop 25 percent for the same reason, said Lucio Araujo, commercial director at farmer cooperative Cooxupe, located in Guaxupe.
this while inventories are at rock bottom lows
Global inventories of corn, wheat and soybeans before the harvest in the Northern Hemisphere next year will be the second- lowest since 1974, enough for 67 days of consumption, compared with 144 days of supplies in 1986, U.S. data show.
``Stockpiles are going to be extremely tight,'' said AgResource's Basse. ``The world cannot afford any dislocation in production next year, or there will be a real shortage.''
Friday, October 24, 2008
Mikey brought this to my attention and my jaw dropped. I thought everyone should see it. Most of these heavy trucks were probably related to construction and mining. Extrapolate this to related companies that feed this industry and you can see why these companies are cliff dicing. I.e. Terex
Volvo said it received 115 order bookings for heavy trucks in Europe in the quarter, down from 41,970 trucks a year earlier.
``The downturn in demand in Europe has been more severe than previously expected,'' Chief Executive Officer Leif Johansson said in the statement. Customers have ``increasingly opted to cancel already placed orders.''
Volvo said the construction equipment division, the second- largest after trucks, posted a 44 percent decline in its order book in the third quarter and that ``there are increasing sings of demand weakening also in markets outside Europe and North America.''
- The longest recession ever was 16 months. He thinks best case we entered into a recession in November of 2007 or worst case January 2008. This would put us well into the later half of the cycle, which will be painful but short.
- We are setting the base for a 10 - 15 year bull run. The stock market has never performed worse in the last 10 years, yet corporate profit expansion has never been better.
- The market will not rally until bond yields come down on the long end. Right now you should be in munis of solid states that are yielding 7% - 8% risk free.
- TARP will make money. Historical yields on toilet quality mortgage packages are well above the prices people are contemplating buying them. Really smart vulture guys are buying at the 50% - 60% levels. He and Buffet are also buying at these levels.
- We will see a healthy level of deflation before we see inflation. He predicted $50/barrel oil. Demand has been slowing for a year. As long as money velocity turns to favorable, government can pull out the excess liquidity before it becomes inflationary.
- The dollar has turned the corner and will rally from here against the Euro.
- Governments will drive LIBOR down to force interbank lending. Europe is much worse off than the U.S. in terms of bank health.
- Cash on the balance sheets or corporates has never been higher. If they all bought back there stock their P/Es would be trading at a 50% discount to the historical market average.
- He and Buffet are buying U.S. equities for their personal accounts.
Wal-Mart Stores Inc's U.S. customers, increasingly worried about their own financial security, are waiting until they get their paychecks to buy even the most basic necessities, the retailer's U.S. division head said on Tuesday.
And, in a "disturbing" trend, Castro-Wright said Wal-Mart for the first time is seeing a paycheck-related spike in sales of baby formula, suggesting consumers are rushing to buy such necessities as soon as they have the cash.
On Tuesday he said that many consumers have "maxed out. Credit card limits don't allow them to use credit."
Right now futures are limit down which means the market is closed.
Thursday, October 23, 2008
If you have difficulty understanding the current world financial situation, the following should help...
Once upon a time in a village in India, a man announced to the villagers that he would buy monkeys for $10. The villagers seeing there were many monkeys around, went out to the forest and started catching them. The man bought thousands at $10, but, as the supply started to diminish, the villagers stopped their efforts. The man further announced that he would now buy at $20. This renewed the efforts of the villagers and they started catching monkeys again, Soon the supply diminished even further and people started going back to their farms. The offer rate increased to $25 and the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it! The man now announced that he would buy monkeys at $50! However, since he had to go to the city on some business, his assistant would now act as buyer, on his behalf. In the absence of the man, the assistant told the villagers: ' Look at all these monkeys in the big cage that the man has collected. I will sell them to you at $35 and when he returns from the city, you can sell them back to him for $50. 'The villagers squeezed together their savings and bought all the monkeys. Then they never saw the man or his assistant again, only monkeys everywhere!
*Welcome to WALL STREET*
Wednesday, October 22, 2008
Today sell off is rumored to be because of several things. Supposedly a large fund of funds was liquidating. Also supposedly a quant fund was blowing up. Basically once again forced selling by hedge funds that are out of the market. Also heard that alot of funds are working their way up the capital structure as corporate debt is stupid cheap while equity is just cheap.
Anyway I would love to see a blow off down to the 7000 to 7500 level. It still may not be the absolute bottom over the next three years but I think alot of bad news will be priced in and that things can be bought.
Tuesday, October 21, 2008
I said as far back as 1999, while suffering from selling too soon, that my next big mistake would be buying too soon. This probably sounded ridiculous for someone who was regarded as a perma bear, but I meant it. With 14 years of an overpriced S&P, one feels like a perma bear just as I felt like a perma bull at the end of 13 years of underpriced markets from 1973-86. But that was long ago. Well, surprisingly, here we are again. Finally! On October 10th we can say that, with the S&P at 900, stocks are cheap in the U.S. and cheaper still overseas. We will therefore be steady buyers at these prices. Not necessarily rapid buyers, in fact probably not, but steady buyers. But we have no illusions. Timing is difficult and is apparently not usually our skill set, although we got desperately and atypically lucky moving rapidly to underweight in emerging equities three months ago. That aside, we play the numbers. And we recognize the real possibilities of severe and typical overruns. We also recognize that the current crisis comes with possibly unique dangers of a global meltdown. We recognize, in short, that we are very probably buying too soon. Caveat emptor.
At under 1000 on the S&P 500, U.S. stocks are very reasonable buys for brave value managers willing to be early. The same applies to EAFE and emerging equities at October 10th prices, but even more so. History warns, though, that new lows are more likely than not. Fixed income has wide areas of very attractive, aberrant pricing. The dollar and the yen look okay for now, but the pound does not. Don’t worry at all about infl ation. We can all save up our worries there for a couple of years from now and then really worry! Commodities may have big rallies, but the fundamentals of the next 18 months should wear them down to new two-year lows.
I suggested last quarter that it was ridiculous to expect great financial and economic skills from the Chinese government, which is faced with the spectacularly complicated task of maintaining the highest economic growth rate in history. “Surely they will stumble,” I said. Well, the more I think about it, the more likely it seems that this is both the most likely and most dangerous disappointment (even shock) that awaits the current consensus.
Friday, October 17, 2008
Of course whether it actually marks a bottom depends on fundamentals. Morgan stopped the crash of 1907. 6 months later after the crash of 1929 the markets about regained everything before rolling over setting knew lows in 1932.
Buffett is right. Stocks are cheap. Not stupid cheap, but cheap. Debt is cheaper and my guess is stocks will get cheaper yet but who knows. I spoke with confidence that the market had not reached an absolute bottom when it was at 1150 in July. Down here I don't think it has reached the absolute bottom but am much less confident of that declaration and hence do not own any puts or have major short exposure. I also still think we are at a probable multi week to multi month interim bottom where the markets could easily go up another 10% or more.
Buffett is not buying the S&P 500. He is buying individual stocks and taking advantage of individual opportunities. I am not sitting on 100% cash anymore. There are cheap cheap things out there but that is very different than buying the S&P 500 and putting it in your 401k. In the editorial he talks about the bottoms of 1932, 1942, and 1982. Stocks were much cheaper at all three of those bottoms than they are now.
I sent this in an email this morning:
10 to 15 years from now stocks will be higher and in 5 it will be close. In the interim could we be 30 to 50% lower? Fairly easily I would say. I don't think any investor (including Buffett) has a model for what is going on. He is much later than the Leon and Whitman's of the world but I still think he is early. In a way he also has an annuity stream with his insurance and and free cash flow business giving him more money which is also why he has a better model and one that I want someday. If your Buffett I think you absolutely start buying now.
There is one other aspect of all this. If we get inflation you absolutely want to be in stocks and not government bonds which if you read the oped piece is what Buffett is selling to buy stocks.
Everything Buffett says in his piece is right on. How it applies to everyone individually is something different. I am also curious if he was asked to white this editorial by anyone in government?
THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.
So ... I’ve been buying American stocks
Thursday, October 16, 2008
While I haven't spoken to him lately, we had been communicating by email. I thought we were pretty much on the same page regarding the credit crisis, but it turns out that I was wrong. He informed me that in his opinion, there is not enough high-quality collateral around in the system to do the securitized lending that's part of the bailout facilities we've seen so far. He believes that the credit crisis is not even close to being solved, as I suggested yesterday. That's because the deleveraging under way is about to accelerate.
What would be needed, he said, is something on the order of an epic Treasury issuance, say $1 trillion, which would be monetized by the Fed, thereby allowing it to flood the system with collateral. Said differently, rather than buying decent collateral, he feels that to solve this, the Fed will have to supply cash for unsecured "trash," or high-quality liquid assets such as buildings.
WOW!!!! This echos John Burbank's comments at the Value Investing Congress last week. I had dinner with another investor last night and our discussion involved the inflation versus deflation debate. My point has been that if inflation comes, it will be the deadly inflation that sends the economy down (i.e Iceland) not the good kind that can help reinflate our way out.
Already billions in treasuries are being issued, sending yields higher, sending mortgage rates higher, which will cause housing prices to fall more, which will weaken our economy more, which will cause more problem in the financial area, which will send housing prices down more.
Of course there is the possibility, and hence the bifucation of the outcomes, that the dollar becomes toilet paper very very quickly with a massive issuance of treasuries sending hard assets skyrocketing but in a very bad way.
The bifurcation nature of this is nuts and the really smart money out there doesn't really know and can't really handicap it beyond a coin flip. Hence, the money sitting in cash.
Clarity will not come overnight. It will happen in weeks and months but when it does come, just to reemphasize, it could happen very very quickly.
Highland Capital Management LP will close its flagship Highland Crusader Fund and another hedge fund after losses on high-yield, high-risk loans and other types of debt, according to a person with knowledge of the decision.
Highland, whose total assets under management has shrunk to about $35 billion from $40 billion in March, will wind down the Crusader fund and the Highland Credit Strategies Fund over the next three years, said the person, who declined to be named because the decision isn't public. The hedge funds had combined assets of more than $1.5 billion.
Wednesday, October 15, 2008
I am surprised that we didn't rally more than we did, maybe still will but the fact of the matter is the trust has been broken and it is going to take time to heal that trust chasm. You don't have mindless rules on short selling, guarantees of a passage of a bailout bill and then failure to pass, and then forced dilution without ownership votes without huge damage to trust about the system. It is like a spouse committing adultery. The marriage may technically survive but the relationship will be sick for a long time.
A positive outcome at this point is a severe recession or a slight depression. A negative outcome is a severe depression or inflationary spiral similar to Iceland. The governments of the world are trying to desperately inflate but I think if they succeed that the spiral could be so violent and much faster than what government officials envisioned causing it to spiral out of control.
I have said it before, our system is a system of creation and destruction. Destruction was not allowed in 98 or 01. It makes this destruction cycle much worse when the problem gets to big to manipulate.
Bearish estimates on S&P earnings for 2009 is 65 (I still think could be slightly bullish). Assume 65. Put a 15x multiple on that and fair value is 975. The market is below fair value but does growth prospects from 2010 onward really justify a 15x multiple? Put a 10x multiple on that and you are looking at 650 on the S&P. Another 30% drop from here.
Tuesday, October 14, 2008
One more item for you--and believe me around here I am in the minority--MARK TO MARKET IS NOT NEW!!!!!!!! It's been around for 15 years.
The only "new" accounting standards are
1) FAS 157 which is a definition of fair value intended to beat people over the head because they were ignoring the literature and
2) FAS 159 which is an OPTION to fair value debt for companies not required to do so but who would like to. The option part is weak, I agree, but since they can elect it instrument by instrument I am sure all the newer instruments aren't being marked anyway...
And I still haven't heard what value are they proposing using. Historical cost would certainly aid investors...
It makes complete sense that an overleveraged market without alignment of incentives is the fault of the accountants. If we had just let them lie to their investors, the investors would still be too stupid to have figured it out and we'd all be just fine...poor logic and I am disappointed to see so many highly intelligent investors succumbing to it.
Of course, it's always good to question our own biases...
Some hedge-fund titans have yanked most of their money out of the stock market, a bearish sign amid Monday's euphoria and an indication of how the hedge-fund business is changing amid chaos.
In recent days, Steven Cohen, the hedge-fund manager who runs the $14 billion SAC Capital Advisors, moved about half his funds, or about $7 billion, into money-market and other short-term securities, eliminating much of his fund's exposure to the stock market, says a person close to the fund. Mr. Cohen plans on sitting on the sidelines for the rest of the year -- trading a small portfolio himself but keeping shuttered most of the stock portfolios of his other managers.
Israel Englander, who runs the $14 billion Millennium Partners fund, has shifted about $6 billion from the stock market into cash, a person close to the fund says.
Meanwhile, John Paulson, manager of $35 billion Paulson & Co. -- who made a spectacularly successful bet against the housing market last year -- has much of his fund in cash equivalents.
In the email, Mr. Fuld, summarizing the points from a dinner with Treasury Secretary Henry Paulson, said Mr. Paulson wants to "kill the bad HFnds + heavily regulate the rest."
Monday, October 13, 2008
Also a good video of famed short seller Jim Chanos. He is the least short in financials in four years and focusing alot of effort on companies that focus on the global infrastructure plays.
Sunday, October 12, 2008
I think the highest probabilistic outcome is for a multi week, multi month rally of 15% or more. The government seems to be doing what they have to do. Of course the U.S. is still the ones sucking their thumb behind England and the rest of Europe though Paulson is feverishly preparing for equity injections into the banking system (about time).
I don't think this is an absolute bottom and the usual people out there who have gotten slaughtered who have been saying every bottom is the bottom have worked themselves into a fervor preaching bottom. That in itself is discouraging. We need capitulation by most everyone that the market is going to be bad with minimal returns for years to come. You saw it several months ago in housing. Have not seen that in the equity markets.
Wise people know never to predict the end of the world because it only happens once. As a result, you will look like an idiot if you predict the end of the world. I am by no means predicting the end of the world but the unthinkable has a much higher probability than a year ago. If a creature, walks like a duck, looks like a duck, quacks like a duck, it is probably a duck. At this point we have had the worst housing collapse, banking crises, and now stock market crash since the Great Depression. You extrapolate. To be sure there are many things that could happen to catch us and we avoid a depression but how many times out of 10 with these dire of circumstances do we go into a depression? That number is the percentage you would put on a depression. For those of you who say zero then my question would be is what would it look like? What hasn't happened that has to happen to make it at least 1 out of 10?
What I am trying to do is force you to think about something that you have no mental model for. No one alive has a mental model of a depression and so we don't think about, don't talk about, and write it off as wacky and looney. Well we had several in the 1800s. One in 1900s and guess what, if not this time we will have one again at some point in the future. My number is 7 so at this point 70% chance of a depression in my mind. Maybe I am high, I hope I am high, but it is not zero and if you think it is drastically lower, contact me, we maybe be able to work out some kind of bet.
So the next question is what should you do if there is a depression. How does your life look and what can you do to prepare? That answer is personal for everyone. Friday I took several thousand in cash out of the bank. Saturday I started looking for gold (which is actually not a good depression investment) but that is almost impossible to buy now. Nothing overly dramatic but enough for now. A depression won't happen overnight. It will take a year or more to grind into.
So anyway, I don't think this is an absolute bottom but there are trades everywhere. I hate doing trades because I want to own for years not months but at times the probabilities can become high enough that I can play rent a stock to make a bet. Unfortunately, Monday is going to be a sloppy day for trading indicators. Banks are closed on Monday so credit widening and tightening could be misleading. Volume will not be as high as it would be. Indications London may not open on Monday or delay the opening. I wouldn't be shocked to see the U.S. canceling trade tomorrow if London never opens. Morgan Stanley and the rumors of the deal with Mitsubishi UFJ will be at center stage. Then you have options expiration on Friday and massive amounts of economic data coming out. The market promises to be very violent.
I think you have to use options to construct any type of safety. Let's take Wal Mart for example. With the volatility so high there are all kinds of thing you can do depending on what kind of risk you want to to take. Looking at all January options you can sell the 50 puts for $4.45. Use the proceeds to buy the 45 puts for 2.70 and buy the 60 calls for 1.65. Trade doesn't cost you anything (it even covers commissions) and the most you can lose is $5 which is about a 10% loss on the underlying security. Yet you have large upside. With potential for violent moves upwards in stocks that got puked out, this could be very profitable and a low risk trade if the markets decide what the government did does not matter and stocks start plummeting again. I am not pitching Wal Mart. Just randomly picked a name.
I went to bed Friday thinking through the probabilities of a complete collapse of our financial system and trying to figure out what to do. Looking at the government action I don't think that is a concern in the short term (though that could change). What has happened hopefully catches us for a little while though I do not think we are at an absolute bottom. Credit markets will be key.
Saturday, October 11, 2008
Do you think we will learn anything from all of this turmoil?
We will learn an enormous amount in a very short time, quite a bit in the medium term and absolutely nothing in the long term. That would be the historical precedent.
Do you have any closing thoughts about how we got into this financial state?
I ask myself, "Why is it that several dozen people saw this crisis coming for years?" I described it as being like watching a train wreck in very slow motion. It seemed so inevitable and so merciless, and yet the bosses of Merrill Lynch and Citi and even [U.S. Treasury Secretary] Hank Paulson and [Fed Chairman Ben] Bernanke -- none of them seemed to see it coming.
I have a theory that people who find themselves running major-league companies are real organization-management types who focus on what they are doing this quarter or this annual budget. They are somewhat impatient, and focused on the present. Seeing these things requires more people with a historical perspective who are more thoughtful and more right-brained -- but we end up with an army of left-brained immediate doers.
So it's more or less guaranteed that every time we get an outlying, obscure event that has never happened before in history, they are always going to miss it. And the three or four-dozen-odd characters screaming about it are always going to be ignored.
If you look at the people who have been screaming about impending doom, and you added all of those several dozen people together, I don't suppose that collectively they could run a single firm without dragging it into bankruptcy in two weeks. They are just a different kind of person.
So we kept putting organization people -- people who can influence and persuade and cajole -- into top jobs that once-in-a-blue-moon take great creativity and historical insight. But they don't have those skills.
Where do you see all of this going?
I want to emphasize how little I understand all of the intricate workings of the global financial system. I hope that someone else gets it, because I don't. And I have no idea, really, how this will work out. I certainly wish it hadn't happened. It is just so intricate that all I can conclude, by instinct and by reading the history books, is that it will be longer, harder and more complicated than we expect.
Sobering thoughts. Thanks, Jeremy.
Friday, October 10, 2008
1) Rating agencies who rated things AAA implying less than .5% chance of going default and saw these AAA things defaulting left and right
2) In Wall St executives who take huge bonuses on earnings that haven't been really earned and then walk away when things go sour.
3) Wall St executives who come out on CNBC promising everything is fine and then burn investors with billions in writedowns and equity raises a week later
4) Bernanke who over and over again said there was no problem in housing, then there was no problem in subprime, then the problem was contained being clueless at the real problems.
5) Pauslon in being just as clueless and proposing stupid stupid ideas
6) Counterparties because they may be gone tomorrow
7) Regulators who missed this entire thing not pushing restraint in the go go years
8) Regulators who changed the rules in the middle of the game when hedge funds have followed a playbook that had been in place over a hundred years.
9) Accounting that hid the problems
This is definitely not an all inclusive list. When talking about borrowed money, without trust you have nothing and multiple parties at every step has destroyed trust.
Thursday, October 9, 2008
First, and most importantly, the mark to market accounting has helped the U.S. make the situation much better than it otherwise would be. How? Because of mark to market accounting U.S. banks have been raising over 400 billion in equity over the last year. Grant it we need 4 to 5 times that but compare that to Europe whose accounting is much more opaque, not to market to market and they have been denying they have a problem at all. Besides UBS (who trade in the U.S. and thus follow GAAP) the European were in complete denial and did not raise equity even though I would argue strongly they are in worse shape than us. The European regulators as recent as a week ago Thursday were throwing insults at the U.S. and then over the weekend were forced to scramble and do the American two step bailing out four banks. The equity window is closed for banks and when the window was open only the U.S. banks took advantage of it though reluctantly. Europe didn't because they were able to fool themselves even more than we are able to fool ourselves, not an easy task.
Secondly, the banks are hardly valuing their assets at FV. That goes back to Bridgewaters contention that there are 500 billion in writedowns on the books of banks. That is why banks are trading at statistically cheap valuations. Everyone who actually knows what the marks on the books of banks are know they are BS. Banks also know they are BS which is why they aren't willing to lend to one another. Changing the accounting doesn't change the fundamental solvency issues at all. It just tries to put the man behind the curtain again. So what do you change by changing the accounting rules? I would argue you change almost nothing. Intrinsic value doesn't change so you are making the argument that banks are trading intrinsically below fair market value and I would argue regardless what the accounting rules are that across the board they are trading above intrinsic value. By changing the accounting, it creates more uncertainty, more obscurity, and focuses the attention once again on something that isn't the major problem which in itself is counterproductive. I would be more in favor of lowering the required capital ratios for a set period of time and actually forcing the assets to true market to get to the bottom of the problem versus doing what Japan did and continually try to obscure the problem.
Sure, some of the assets may be trading below fair market value (especially if the gov sets the market) but if a bank can't survive stress in the markets it tells you the problem is to much leverage. If I run a leveraged hedge fund, I can't send my analysis to my broker showing that I think the intrinsic value is X and it is trading at 30% below X and the market has it wrong. The broker is still going to declare a margin call. That is essentially what the market is doing to banks, saying there is a margin call, which is forcing down the leverage of the banks which is the problem in the first place.
I have much much more I could write about but I will save it if we talk about it at some point. Remember it was the banks who lobbied for mark to market accounting in the first place.
From two weeks ago:
"Blaming fair-value accounting for the credit crisis is a lot like going to a doctor for a diagnosis and then blaming him for telling you that you are sick." analyst Dane Mott, JPMorgan Chase & Co.,
It was crazy being in NYC as the markets continued to burn. I was on the Deutsche Bank trading floor located on Wall St for awhile. Just nuts. I sent out this email to several of you of thoughts from the Value Investing Congress. There are all kinds of articles and blogs that cover what everyone talked about.
Below is some thoughts that came from the Value Investing Congress. In general the first day was pretty negative but the second day was pretty positive. Most there (including myself) think in the next 36 months we are going to have a buying opportunity of a lifetime. Short selling wasn't mentioned at all except for the last 30 minutes of the conference. There was some talk of the horrendous policy decisions by the FED and the Treasury. Alot of hard core value investors run long only funds. Not surprising everyone there I ran into was getting killed. I have included the most macro presentation entitled An Overview of the Housing/Credit Crisis, Why There is More Pain to Come by Whitney Tilson and Glenn Tongue. This presentation was first given about 9 months and is updated. It is by far the most complete presentation I have seen on housing. They have pricing data on every single mbs transaction going back to 2004. Below is just some interesting macro comments from a few presentations. As a side note I think we are getting set up for a huge counter rally.
Whitney Tilson and Glenn Tongue of T2 Partners
* Mortgages used to be made on a 3 to 1 income ratio while putting down 20%. The peak went to 9 to 1 and on average putting 10% down. Only currently back down to 5 to 1 income ratio. Borrowing power has tumbled 39%
* Everyone was calling it a subprime crises but not really a subprime crises. Prime is a huge problem.
* To many homes created. Over 10% of homes built this decade stand vacant (slide 15)
* 42% of homes sold in August in California were in foreclosure. You had a 54% decline in regular sales in August as homeowners anchor to old prices just like investors. (slide 16)
* Home prices are halfway finished going down. (slides 18 to 23)
* The only data point contrary to this and pointing to the fact that homes prices may have bottomed is home prices compared to income (slide 23)
* Contrary to popular belief mortgages guaranteed by Fannie and Freddie are running much higher (more of them being made) helping the housing market.
What does the future hold *Getting passed the balloon of arm resets (slide 33)
* Much bigger and much more scary is the option arm resets. These will be much more painful for housing and the banks for many reasons. (slides 34 through 40). They spent alot of time talking about this. It is a 2009 story and something that really scares them.
* On Alt A's, It is estimated that 70% of Alt A mortgages were made with exaggerated income.
*In March the IMF was talking about 30 billion of losses in prime loans as part of their 1 trillion estimate. Whitney said months ago he thought WAMU alone would have 30 billion of losses in prime mortgages. (slide 69).
* I can't overemphasize the data they have on every loan securitization going back several years. Slides 46 though 68 walk through several securitizations and the resulting outcomes showing how the mortgage origination's standard fell off and then disappeared. Those red data point were loans never made in the history of man. There is no data to be able to predict at all how bad the non performing loans will be. Slide 68 walks through a full securitization with their estimated potential losses.
* Slide 78 on talk about 3 stock ideas they like. They like SATS, Fairfax Financial, and Berkshire Hathaway
John Burbank of Passport Capital
Another who focused on macro issues. Thinks biggest policy errors in the history of the United States are happening right now. Believes there was secret massive intervention to get the dollar up and oil down. The current policies demonstrate a remarkable lack of understanding of what is going on (what I have been saying) and foresight. Believes a huge withdrawal from the dollar is coming if policy decisions get on board with the actual problems. The only way out is massive inflation. According to him it is unthinkable that the Treasury hasn't printed 2 trillion to put directly into the banking system. If the government doesn't get on board quickly a depression is coming. We are on the precipice. His contention was that alot of hedge funds were positioned correctly for proper policy decisions but the government went down a route that was unthinkable. Currently he says the economy has had a cardiac arrest and the policy decisions by the government is prescribing vitamins and exercises to the cardiac arrest patient. Believes if they wait over a month for the TARP to work that the cardiac arrest will be terminal. Stock ideas. He likes the idea of longing Monsanto and Potash and shorting Vulcan. Likes longing EFG Hermes (the Goldman Sachs of the middle east)
Bill Ackman of Pershing Square
Bought a huge amount of Wachovia when the CITI deal was announced (I have to say that took guts). Walked through the analysis (incredible insight) of that trade. Has also bought AIG though small position because it is high risk high reward position.
Think Paulson should take the 750 billion and don't buy CDO's or other toxic paper derivatives etc. Instead buy any and all actual delinquent mortgages for say $.50 on the dollar. Just buy the actual mortgages. This will be far more effective because all the derivatives and cdos will gain in considerable value because the assumptions going into the recovery assumptions will change dramatically. Most of the losses in the financial system are in these derivatives and if the loss assumptions are adjusted in the models because all of a sudden the actual delinquent loans are getting back more than was expected it has a huge impact on all the derivatives of these mortgages and hence the financial system.
Carl Ichan (fill in speaker)
*Thought the real problems were are at the board level. The boards are not making these guys accountable.
*Created an environment where many years the most aggressive and reckless gobbled up the more conservative.
*Said we made tulip bulbs and in our case it was houses.
* Thinks the accounting should be loosened now but doesn't think it caused the problem or will help the problem much.
* Very cautious about the current market
* Loves the asset class of bank debt. 15% IRR now. This was echoed by several speakers and I agree and an area I have been talking about. I just don't have the tools needed to research bank debt.
*By far he was the biggest bull speaker (he was last year also)
* Climate chilly but not as bad as some assume
* 1957 was the year of reversals. Prior to 57 you got higher yield in stocks than bonds. Approaching this switch again. Bearish view is that growth opportunities are limited (like Japan), bullish view is the market is cheap.
*Cash acquisition activity suggest the market isn't overvalued
*Best news will be when stocks don't go down on earnings disappointments. Not seeing it yet.
* Eight things to be watching 1)credit markets 2) home prices 3) oil and commodity prices 4) The dollar 5) leading indicators of economy and employment 6) new fiscal stimulus package 7) financial stocks 8) individual stock prices response to disappointing earnings.
* Likes ATLS,ATN, APL, and AHD There were many more speakers but those above where the ones who had macro stuff. All the other ones talked exclusively about stock ideas.
Sunday, October 5, 2008
I would not be surprised to see a co rate cut tonight by the FED and the EU. If not tomorrow in the stock market could be ugly.
Saturday, October 4, 2008
Mark Sellers III's hedge-fund career peaked this summer about the time he turned 40. Then it cratered.
Mr. Sellers, who once managed close to $300 million, is shutting his Chicago-based firm and retiring, at least until his distaste for the pressures of managing other people's money subsides.
"What I've learned about the hedge-fund business is that I hate it," says Mr. Sellers, a former stock analyst with Morningstar. "I have enough money that I don't have to work, and why should I put myself under that much stress?"
The past year has been brutal for hedge funds, and September looks to be the worst month in a decade in the industry, according to Hennessee Group, which advises hedge-fund investors. Funds of all sizes have been battered, but the bigger players can often endure rough times.
The day of reckoning can arrive remarkably fast for managers with assets under the half-billion-dollar mark, like Mr. Sellers, who started July with performance up 50% on the year but by the end of last month was down 20%.
"There are real questions about who can stay in business," says Andrew Fishman, president of Schonfeld Group, a New York brokerage and trading firm whose hedge-fund clients range from about $200 million to $3 billion in assets. The most vulnerable are under $1 billion, he says. "There are guys who should not have been in business, and this will force them out, but guys don't want to give up easily."
There is no doubt the hedge fund blow up has started. The question is how far it has to go and what that means for stock prices. Below is a graph from a recent Bridgewater presentation showing how hedge funds have been deleverging (click for bigger picture). I don't really like the graph because you lose sense of scale. For example, back in 1997 you have maybe a 100 billion in assets managed by hedge funds. What was the leverage? 150 billion would be 50% leverage. Now you have 1,500 billion. That same leverage would be 2,250 of levered assets. Are we in line after the latest deleverging or is there still more to go? We may actually have less leverage than back in 1997. You can't tell from the graph because the scale is all out of whack. What you can tell is that starting in 2003 the amount of assets going into hedge funds broke from the trend line and started a much steeper trend line up. This has flattened and here is where I think the real danger is versus the deleverging. This is similar to what you saw in housing prices. Housing prices left their long term trend line around 2002 starting a much higher trajectory up before rolling over. You may for the first time ever see decreases (possibility dramatically) in hedge funds assets under management. Throw on the leverage issue and you are talking about billions if not a trillion leaving the market. Sure some of this will get recycled but most of it in the short term will seek out the same "safe havens" the rest of the cash has been seeking out. This process was greatly accelerated with the total idiotic actions of the SEC on short selling. This has greatly amplified the problem and quickened the unwind causing massive dislocations in the market and I fear maybe even worse dislocations in the coming weeks. The quickening of this process I believe will also have negative impacts on the actual fundamentals of the economy. The unintended consequences I fear could be more brutal than anything else the government has done so far. You cannot have such a big market player shrinking so quickly.
These dislocations do create opportunities though (assuming it doesn't take out the whole system). Below is a graph tracking Mueller Water Products A and B shares. This is a company I have followed for years. The A and B shares essentially have the same intrinsic worth. The absolute only fundamental difference is that the B shares actually have more voting power than the A shares and so would technically have slightly higher intrinsic worth. However, for technical reasons the A shares often times trade at a slight premium. The A shares are part of an index so ETF's and other index tracking funds buy the A shares. Also the B shares have historically had slightly less liquidity. Well starting a couple of weeks ago and peaking last Monday when the market crashed over 7%, the B shares just collapsed compared to the A shares creating a huge gap between the A shares and the B shares. On a percentage basis it was the biggest gap ever. The biggest gap on an absolute basis occurred when the A shares joined the index (I think the Russell 3000). It was obvious that a hedge fund who owned the B shares was liquidating their position and fast. So the trade becomes to short the A and long the B. I never talk about trades on this blog but I figured this would be an exception. I moved 15% of my portfolio into this trade with a spread between $2.40 and $2.00 (the spread is down to $1.54). Their are two risks that essentially are not risks. One is that the gap widens and two is that the gap remains wide for a long period of time driving down your IRR. Considering the other investing opportunities out there, I was more than willing to take both risks especially considering in the long term there was essentially no risk in taking an impairment to your capital investment. Even if the company goes bankrupt you make money. These are the opportunities that are starting to pop up. I have been saying for over a year that the contrarian bet was that things were going to get worse than what everyone expected. We are quickly closing that gap and the contrarian bet is becoming that things are not going to get as bad as what everyone expects. We are not there yet (especially with the freight train of hedge fund liquidations on top of us) but opportunities like this arbitrage trade are starting to come to light.
Friday, October 3, 2008
Wednesday, October 1, 2008
Buffett was on Charlie Rose tonight. When I get the links to the videos I will post them here. In general the excerpts I am reading are anything but bullish.
Billionaire Warren Buffett, the world's preeminent stock picker, said the U.S. economy is ``flat on the floor'' after a cardiac arrest as companies struggle to secure funding and unemployment increases.
``In my adult lifetime I don't think I've ever seen people as fearful, economically, as they are now,'' Buffett said today in an interview with Charlie Rose to be broadcast tonight on PBS. ``The economy is going to be getting worse for a while.''
He is definitely taking advantage of the current dislocations and receiving a pretty penny.
For both Goldman and GE, Buffett's endorsement comes with a cost. Both companies agreed to pay Berkshire a 10 percent dividend on his preferred shares, and each gave him warrants to buy their common stock at any point in the next five years at a price that's a discount to where it's currently trading.