Sunday, November 29, 2009

The Week Ahead

No surprise. After getting slaughtered Thursday night (their Friday) Asia is up strongly across the board. This also has not surprisingly put a bid into US futures. The market may indeed open up tomoorw but I really think any rally should be faded. Friday there was alot of technical damage done. The weekend holiday sales were pretty poor all things considering. Average purchase was down alot. Number of purchases were up but that just means more people got done with their Christmas shopping earlier. This week you have alot of economic news which I don't think will be that kind. The unemployment number may be pretty good due to seasonal factors but that could help the dollar and cause weakness in the stock market. This Dubai thing also hasn't been resolved and could have some ugliness hidden still. Like the rest of the world United Arab of Emirates is treating a solvency issue with liquidity maneuvers. This does nothing to help the actual problem but should help the local banks.

Gold is now down and by quite a bit (10 bucks). Europe was up on Friday so how they end up will tell you alot about the U.S. markets. In general I think the next few days is a bearish set up. Of course if our government figures out a way to ruin the value of the dollar a little more who knows. Even the dollar however may have some bullishness to it this week.

Friday, November 27, 2009

El-Arian Interview Concerning Dubai

El-Arian, CEO of Bond giant PIMCO, was on CNBC this morning. He basically agrees with what I was saying in my post last night. Dubai really isn't that big of a deal. I don't think he is putting enough weight on Dubai but in general I agree that Dubai is not enough to start the crises all over again. I do think it foreshadows what is to come.

CNBC El-Arian interview.

Now it looks like the U.S. markets is almost completely blowing off the news. The short day with lower volume is working in the markets direction. Of course if the government is trying to stabilize the markets, it would take alot less money to do it today than normal. The fact that Europe stabilized today really helped the U.S. markets also. Considering the markets sold off so hard overseas the last couple of days, Asia will probably be up Monday night and one could see green worldwide leading into a U.S. Monday open.

Citigroup is only down 2%. Ridiculous.

One Interesting Setup

Happy Thanksgiving all!! (A few minutes after Thanksgiving as I type this)

Tomorrow is going to be an interesting day!!

Steve pointed out in one of the comments that the credit markets foresaw the Dubai debt debacle. I would heartily agree with that. I have been watching the CDS on government debt slowly start inching up over the last month or so. It was not occurring in the corporate debt which was puzzling until you realize that most of the risk has been transferred to the government level. Which has me so angry because it means everything will be affected.

So, it is all over the market news but Asia has been slaughtered, Europe has really been slaughtered and right now the markets are indicating a 3% down open. Tomorrow is a short trading day, historically is bullish, and no volume. So it will be interesting how it plays out.

From an investing friend:

So we have a half day when people are panicking about Dubai where no one will probably want to be long going into the weekend when no one will be working tomorrow...could be quite the day

Yeah, any heavy desire to sell will be met with alot of people trying to get out of a very small hole. The London exchange was closed for several hours today and they don't even have a holiday.

Two interesting things. One, the Dubai thing, really isn't that big of a deal. It is an overall a small amount of debt but it may put some reality back into the market. Also, no one saw this coming. It may be why it has the market so nervous. Market hates things it doesn't know about. The market knew about Spain, about Greece, about Japan but no one was talking about Dubai. This is catching Europe especially off guard as several European banks have exposure to Dubai.

What may be most interesting of all is how this plays out over the longer term. Remember the markets had a severe down move in September of 2007. Rallied to November before finally rolling over. This was because of risk in the banking sector. Could we see something similar? Where the new risk is at the sovereign level. We get a huge sell off. Get a rally to make a double top over the next month or so and the risk that never went away starts the next big downturn? Or is the system so much weaker than once we start going down we won't look back? Because I would think Dubai is not that big of deal, I sort of doubt the market will just crumble without some sort of stabilization / rebound attempt. Who knows.

Will be very interesting. If this is the start, I fear what the world will look like twenty four months from now. Sigh, it could have been avoided.

Dollar is of course surging and British Pound and Euro are selling off hard. Commodities have been getting slaughtered except gold which has been holding up very well until the last hour. Now down $15.

Thursday, November 26, 2009

China and Its Harm to the Global Economy

Well Asia was down pretty hard and Europe is following. US futures are down 11 points or 1% which is pretty big. Of course it really doesn't mean anything this early considering it is not even Friday yet. The reason could be a bunch of things but a European business group warning is garnering alot of attention. The warning: China is building way to much capacity. Um. yeah. China is setting up for its own world economic plunge. This should be so obvious it isn't funny. Why you need a European business group to say this that causes it to hit news wires is beyond me.

Thanks to GK.

From Yahoo:

China's stimulus spending has fueled massive overexpansion in industrial capacity that could drive a surge in low-priced exports amid weak global demand, possibly igniting a protectionist backlash abroad, a European business group warned Thursday.

Industries including steel, cement and plastics are "still blindly expanding" despite the worst global slump since the 1930s, the European Union Chamber of Commerce in China said in a report.

All this is really old news but it is on all the front pages of most major market news sites. China has started to pull back. Way to little, way to late.

The government says that since September it has rejected 47 proposed industrial projects with a total price tag of 191 billion yuan ($28 billion) in industries including steel, glass and cement. It said 339 projects totaling 1.7 trillion yuan ($252 billion) in investment were approved.

Its pretty broad overcapacity. I would not be surprised to see Alcoa file for bankruptcy in the next three years because of this. Way overlevered and at some point the price of aluminum will plunge.

In steel, China's annual production capacity is 660 million tons and mills are adding another 58 million tons, even though they sold less than 500 million tons of steel last year, according to Charles-Edouard Bouee, Asia president for Roland Berger Strategy Consultants, which conducted the study.

China faces similar problems in aluminum, cement, plastics, refining and production of wind power equipment, the group said.

Yep yep and yep. At some point U.S. markets will stop ignoring all of this. At some point.

Wednesday, November 25, 2009

1 plus 1 = 3 ???

Another day that did not quite add up. Dollar got slaughtered today. Obliterated down over 1%. This has typically meant big up day in the stock market. Nope, only up slightly today. Financials were actually down and the Russell 2000 was flat. Oil was up but has gone sideways to down over the last few weeks.

The biggest loser today has to be Japan. The Yen was up 1.25%!! Talk about a Python grip. Japan is getting squeezed to death. Watch the Japanese markets tonight. You could have a big move down in Japan. At some point that spreads to the rest of the world.

Everything that is seemingly out of balance is getting more out of balance. Torquing is occurring.

Tuesday, November 24, 2009

Blind As A One Eyed Cataract Wart Hog

There are some days I just sit back and am baffled. Today was one of those days. You would think after days upon days, weeks upon weeks, and months upon months of this stuff, you would get used to it. No, not the case. Certain days I still just shake my head. Today GDP got revised down from 3.5% to 2.8% growth. That is a 20% reduction for the math whizzes. SUBSTANTIAL!!! Yet the market is well above where it was when that 3.5% print sent the market running higher. The market blinked but shoved off the news.

Than it became official that the FDIC, the agency that supposedly "insures" the deposits for the American population (insert trumpets here), is officially insolvent. They have a negative 8 billion dollar hole. Months ago this was inevitable and I would have thought the markets would have not liked that news at all. Well not only did it happen (when most people I was arguing with said it would not happen) but it was mostly ignored. Does the fact that the insurance system of the biggest most powerful country in the world is insolvent not say something with how sick our financial system is? Think about that previous sentence for a second! The FDIC is begging small town mom and pop banks for three year insurance fees in advance. Is there something wrong with this picture?

Now both of these news items didn't really come in as a surprise so it should have been priced into the market but that is the thing. The market isn't pricing in any of this it appears. It just continues to ignore and ignore and ignore.

Extend...pretend....extend...pretend. If it only it worked for everyday Americans when one loses a job, a bill that can't be paid becomes due, or one is kicked out of their house. Just close your eyes and extend...pretend...extend...pretend. Did it work?

Wall St. has taken the Dory approach from the movie Finding Nemo. Just keep swimming just keep swimming, swimming swimming, just keep swimming.

Japan Musings

What is going on in Japan. The currency keeps going up but the stock market keeps going down?? Something doesn't make sense there. For one, if the stock market is going down, that typically means money is flowing away from Japan. Well if that were occurring, shouldn't the Japanese currency be going down not up? Sell yen and buy currency x? That would be intuitive but that is not what is happening. A couple of thoughts. I have read that Japanese companies are repatriating there money back into Japan. Since alot of facilities of Japanese companies are overseas, they are making money overseas. Well they are bringing back money to Japan. This means they are selling currency x and buying yen which is currently overshadowing the exit of investors. Of course this puts more pressure on exports, the lifeblood of the Japanese economy.

There is an additional problem with the Japanese stock market going down. The banks in Japan own alot of equities. They also count it towards capital. This is one of the problems from Japan's bubble peak in 1989 that never got resolved. So the equity markets decline, is at the same time weakening the banking system.

It all feeds on each other though. U.S. dollar goes down, U.S. stock market goes up with the corollary that the Japanese Yen goes up with the Japan stock market going down. This cannot go on indefinitely but the torquing, the pressure continues to build.

Interestingly, last night China was down almost 4%. China topped out in August, had a big sell off and was getting close to its highs for the year. If it continues down you could start hearing alot of chatter about a double top.

Monday, November 23, 2009

Government Debt - Possible Trigger

In a follow up to my post from earlier about sovereign cds implying investors are more concerned, Ambrose Evans-Pritchard has an interesting write up on Greece.

From the UK Telegraph

Greece is disturbingly close to a debt compound spiral. It is the first developed country on either side of the Atlantic to push unfunded welfare largesse to the limits of market tolerance.


The interest spread between 10-year Greek bonds and German bunds has jumped to 178 basis points. Greek debt has decoupled from Italian debt. Athens can no longer hide behind others in EMU's soft South.

and Greece banks are playing their own carry trade.

Greece has long been skating on thin ice. The current account deficit hit 14.5pc of GDP in 2008. External debt has reached 144p (IMF). Eurozone creditors – German banks? – hold €200bn of Greek debt.

A warning from Bank of Greece that lenders must wean themselves off the ECB's emergency funding has brought matters to a head. Default insurance on Greek debt jumped 40 basis points last week.

Greek banks have borrowed €40bn from the ECB at 1pc, playing the "yield curve" by purchasing state bonds. This EU subsidy has made up for losses on property, shipping, and Balkan woes.

Sovereign debt issues may be the next catalyst. Not to be outdone however, the banks are still have massive issues as also reported by Pritchard at the UK Telegraph This really should be no surprise though the market continues to price in an immaculate recovery.

Standard & Poor's has given warning that nearly all of the world's big banks lack sufficient capital to cover trading and investment exposure, risking further downgrades over the next 18 months unless they move swiftly to beef up their defences.

This is amazing.

Every single bank in Japan, the US, Germany, Spain, and Italy included in S&P's list of 45 global lenders fails the 8pc safety level under the agency's risk-adjusted capital (RAC) ratio. Most fall woefully short.

The most vulnerable are Mizuho Financial (2.0), Citigroup (2.1), UBS (2.2), Sumitomo Mitsui (3.5), Mitsubishi (4.9), Allied Irish (5.0), DZ Deutsche Zentral (5.3), Danske Bank (5.4), BBVA (5.4), Bank of Ireland (6.2), Bank of America (5.8), Deutsche Bank (6.1), Caja de Ahorros Barcelona (6.2), and UniCredit (6.3).

Still Amiss

Things continue to be amiss in the capital market which seems bearish until proven otherwise. Very bullish open today that was slowly sold off. NYSE made a new high but the other indexes got left behind. In fact financials haven't gone anywhere in a couple of months. The market in general has been churning and has felt much more bullish than it actually is.

In general, I haven't seen much of interest to post on lately. It is the same ol same ol. No volume, technical driven rally. Fundamentally, for the time being, nothing seems to matter.

One thing of interest is CDS (credit default swap) of countries has slowly been inching higher (implying higher risk to government debt worldwide) over the last couple of months. I have been watching high yield corporate credit because it usually leads the market. It topped out well before the stock market did in 2007. Is it possible that this won't be the case this time? That it will manifest itself instead in the credit risk of sovereignty's. This could make sense because essentially the risk of the system has been transferred to the sovereign level. It could be the case. Worth watching anyway.

Japan continues its meltdown. There loss economically is others gain, for now. At some point it could be a net negative for the world economy.

Thursday, November 19, 2009

Something Amiss

Today was weird. Not going to speculate why, but alot of things just didn't add up. For one the market was down on light volume. Previous down moves of late are typically with heavier volume. No on believe the down move now and everyone has gotten burned selling and so there is no conviction anymore? May be a good thing if your a bear.

Despite the lack of volume, breadth was fairly negative. Widespread sell off. Financials especially got spanked.

Dollar was up today, commodities were down, EXCEPT Gold. Gold was up today. Interesting divergence.

The most amazing thing may have been in debt land. The three month U.S. Government t-bill yield went negative today!!! Meaning that people were essentially paying to lend money to the government. The last time this happened was right after the Lehman bankruptcy at the peak of the panic. The move down was fairly swift and dramatic. Yet, high yield debt and investment grade debt seemed to perform fairly well.

What is going on? Things just didn't add up.

I thought about posting something on Japan yesterday and wish I would have since it seemed like every blog talked about it today but the stock market in Japan has started vastly outperforming the rest of the world even while China is approaching year highs. Not sure what that is all about.

Things just seem amiss right now. Not sure that is bearish but at the same time it might be.

Tomorrow is options expiration day and than next week is a holiday short week which should be bullish. Interesting things.

Monday, November 16, 2009

Bernanke Clueless - No Surprise

This would be humerous if it wasn't so catclysmic for American future.

From Bloomberg

Federal Reserve Chairman Ben S. Bernanke said it’s “not obvious” that asset prices in the U.S. are out of line with underlying values after a 64 percent jump in the Standard & Poor’s 500 Index from its March low.

“It is inherently extraordinarily difficult to know whether an asset’s price is in line with its fundamental value,” he said today in response to audience questions after a speech in New York. “It’s not obvious to me in any case that there’s any large misalignments currently in the U.S. financial system.”

Of course its not. If you could not see the housing bubble, the most glaring bubble of all time, you are hopeless seeing asset price misalignment.

The truth is, he may just be lying through his teeth or just may not care. He would rather deal with the aftermath than focus on being unpopular in attempt to prevent the party.

“The best approach here if at all possible is to use supervisory and regulatory methods to restrain undue risk-taking and to make sure the system is resilient in case an asset-price bubble bursts in the future,” Bernanke said.

Merdedith Whitney on CNBC

Meredith Whitney Interview on CNBC.

Her comments attempted to cause the market to sell off but to no avail. The market skyrocketed on her comments in July. Basically ignored them this time around. No surprise. The market has ignored the bad at all costs for months building up the pressure.

Funny to watch Maria Bartiomo when Meredith starts talking about price and value. You see this glazed look of I don't understand.

Meredith says she doesn't know what is going on in the market right now because it makes no sense. She hasn't come to the realization that it is entirely a ponzi scheme. Hence it also probably makes her to bullish in regards to price.

From a CNBC article about the interview:

The US consumer was going through the biggest credit contraction ever—even bigger than that during the Great Depression. "That credit contraction is accelerating," she said. "There's nowhere to hide at this point."

The banking sector is not adequately capitalized and will need to raise more capital in the coming year.

The residential real estate market is likely to worsen and remains a much bigger threat than the commercial property market. The government's mortgage modification program won't result in any major improvement in homeowners' ability to stay above water, she added.

The Ponzis End

I am becoming more and more convinced that the ending of the ponzi scheme occurs when yields on government debt goes up. This is very backwards from typical market behavior. When yields moved higher (bonds were being sold) stocks were usually bought. (I am talking about Treasury yields, not the Fed Funds rate). This is because it showed signs of economic strength as the economy was heating up.

This time will be very different. It will be because trust will dissipate from government debt. Inflation expectations will rise demanding more return for the bonds. This is regardless of economic strength.

Since Ponzis rely on liquidity, if government debt yields were to really spike higher this would be a very big impediment.

Probably does not start in the U.S. but in Europe or Japan. That is why things in Europe are so important.

From Bloomberg:

Greek bonds dropped as the nation’s deteriorating finances deterred investors from owning the government’s debt.

The difference in yield, or spread, between 10-year Greek securities and benchmark German bunds widened to 156 basis points, the most since July 16. The yield on the bond climbed 11 basis points to 4.89 percent as of 4:45 p.m. in Athens. The yield has risen 22 basis points in the past three days.

This is not glaring yet. At some point, Greece, Spain, Japan, (or some government I am not watching as closely) could start the domino affect.

Ponzi Continued

Big move up in the market today. We broke through major resistance I would say the odds are for another 5 to 10% move at this point UNLESS we move back under resistance in a big reversal in the next day or two.

Why is the market up? Simple, the ponzi continues. Very bad economic data today means more juice for the market. So as our country continues to head towards failure, the market continues higher.

What was the economic news. Inventories down gain. Now down 13.4% year over year but the ratio to sales is still elevated. So still no mystical inventory rebuild that has literally been touted for 8 months as a reason to buy.

After showing alot of improvement the last few months the Empire State Manufacturing General Business Conditions Index plunged 11 points to 23.5. New orders fell from 30.8 to 16.7 shipments declined from 35.1 to 13. Very bearish for the economy but oh so bullish for the stock market. (The market was expecting a number around 30).

Retail sales were heralded to dumb Americans as good but Wall St. is not fooled. They know how bad the numbers are and so adds to the reason to buy. YOY sales were down 1.7%. When you consider how bad last October was, that seems like a very bad print.

Some of these numbers are not horrendous but it definitely points to a non V shaped recovery if you can even use the word recovery. Here is the dirty little secret though. Wall St. does not really want a recovery. That would mean the equity markets would go down.

Sunday, November 15, 2009

Bruce Greenwald and Structural Problems of the World Economy

Good interview with Bruce Greenwald. He is maybe the most famous value investing professor in the world. He teaches at Columbia and is involved (may even be in charge of) Columbia's MBA value investing program. He is also a person value investing gurus go to when they need advice and opinions.

Anyway he talks about the structural issues world wide and a possible solution (which I put at low odds of working. There just isn't a viable solution).

Here the interview.

Some excerpts:

To answer that, you must first understand why this situation has been so bad and so prolonged – and I think it’s going to be much more prolonged. The first evidence that you have to think about is that while this is the first occurrence of problems this severe in the US, these problems have been around in Asia, Argentina, Mexico, Russia – and Japan, of course, most obviously – for many years. This is not new.

You want to go back and think about what is going on. In a sense, you are seeing issues that are going to take a long time to fix and are similar to what happened in the Depression. Basically, in the Depression a huge sector of the economy that everyone had always regarded as central, died. And it dies for an almost virtuous reason.

That sector of course is agriculture.


The comparable thing that is going on today is that manufacturing is dying, and it is dying for exactly the same reason, which is productivity growth is 5% to 6% a year and demand growth is 2% to 3% a year.

a possible solution

So the actual way we could relieve the pressure is to have the IMF just print money and give it to Korea and the other countries so that they could buy Chinese and the other exporting countries’ goods without having to incur foreign debt. That is the Stiglitz plan and that’s the plan that the Chinese are talking about.

I think this is way optimistic

There is this huge structural problem taking place. The governments can offset it to some extent. I think what you are going to see in the US is what you saw in Japan for years, which is stagnant demand. We will grow a little bit, imports will flood in, purchasing power will go out of the US economy, and we will stop growing, and then the government will do something and the dollar will fall a little. All these things will happen sequentially, but ultimately you are going to have slow growth.

on unemployment

Imagine that you’ve got basically 1% or 0% GDP growth and productivity growth of 2% to 3% per year. Employment is going to be decreasing by 2% to 3% per year. That means unemployment is going from 10%, where it is now, to 12% to 14%. I don’t think there’s a natural stopping place for that much below 15%.

Friday, November 13, 2009

Ron Paul on CNBC

Must see Ron Paul video in a 10 minute interview on CNBC this morning. Ron Paul has made some questionable remarks over his lifetime. When he sticks to the Fed I basically agree. The only thing I disagree with in this video is to abolish FDIC insurance. I think that serves a valid purpose in our financial system.

Thursday, November 12, 2009

Laws of Finance

Below is an email response I wrote as part of a chain of emails. It may be interesting reading to some of you. In many ways I have gone to the darkside in thinking the whole system is going to collapse or have to be dramatically altered over the next decade. How it plays out is anyone's guess.


Now, why I have gone to the dark side. There are laws of finance just like there are laws of nature. Most of the laws of nature can be overcome through the right force, the right combination of other natural elements. Rocket boosters can overcome gravity. A natural force that cannot be overtaken is death. Similar to the concept of entropy. One can delay the process but one (so far) cannot reverse death. In finance, there are many laws also. Supply and demand, diminishing returns, etc. etc. For finance, that law that cannot be overcome is leverage. Centuries upon centuries of financial history is littered with economic failure because of to much debt. Not once has financial failure because of debt been reversed by adding more debt. To prevent an economic entity from leverage collapse, there is only one solution and only one solution. Deleverage!!

Let's look at the last twenty years of economic history in the U.S. Late 80s into the early 90s we had a commercial real estate and residential downturn. We had the culmination of the S&L crises and a general economic recession. We addressed it as a country head on, allowed a form of cleansing to take place and continued on. Economy got overheated and to much financial leverage got in the wrong hands and we had LTCM in 1998. What happened? We should have gone into a recession at that point. Instead the government bought the recession and it didn't occur and off to the races in a full blown equity bubble. We bought 3 years. At that point it got to overheated. We should have gone into a severe recession. The government bought the severe recession away and only entered a recession. We still not did not cleanse. We bought 3 more years (2004 to 2007). At that point we still did not cleanse and instead spread the bubble somewhere else. This time we should have gone into a depression. The government stepped in and purchased a severe recession. We still have not cleansed. In fact, despite all the money spent, we are more insolvent, more indebted, in an overall weaker state!! We are not using the only solution that works, deleveraging. Each step the economy was unbalanced and needed a natural capitalism rebalancing. Each step we did not allow a reblancing to occur and the next iteration was even a more imbalanced system. Imagine a see saw where it is off center and keeps getting more and more off center.

There is one fundamental difference between each iteration. Until the last twelve months, the risk was confined to the private sector. At this point, all risk has been transferred to the public sector. What this means is that mom and pop restaurant in po dunk Texas is bearing the risk of the of the entire financial system. The risk that was confined to Citigroup has been transferred to the government and hence transferred to mom and pop restaurant. Did they want to take this risk? No, the government decided to place this risk upon them.

Since all risk has been essentially been transferred to the public sector, the next downturn will probably cause the public sector to fail which will cause the meltdown of the entire private sector. This would cause the failure of those who have been conservative and did not take the risk that others driven by greed took.

Now the U.S. government has bought time. Possibly multiple years but the municipal crises, Europe, or Japan I think are the 3 most likely trigger mechanisms. (since we have not fixed anything, it really could come from anyway). The municipal crises I have already touched on. I have a report that details all of it if anyone is interested. Europe is ****show. I could write for hours on the problems in Spain, Greece, Italy, and Eastern Europe. Because of the way these countries are all tied together with the Euro, a collapse (think Iceland) in one or more of these countries (which I consider a very high probability event in the next five years) has at least a coin flip probability of causing the entire Euro structure to collapse. Is Germans going to suffer massive economic pain because the economy run by Spaniards collapsed? Japan may be the darkhorse. Kyle Bass has been all over this story buying up the cds (betting essentially they will default). Government debt to GDP is approaching 200%. In the next year the interest expense will be more than all government revenues. The yield on government debt has been extremely low. If the 10 year yield goes above 2%. Watch out. The shakeout globally from that occurring could be sharp and very very painful.

One other comment. China. What is going on there is unfathomable and is setting up for its own collapse regardless of everything else. They are spending $900 billion to prop up a 4.3 trillion economy!! That is unheard of by multiples of like 10. To make matters worse, 48% of GDP is going into fixed investment!!! What does that mean? That means they are building **** that has no use currently and is simply adding to capacity. This is great in the short term but considering the world already has to much capacity this is setting up for a collapse a few years down the road. Consider this. China consumer more cement than the rest of the world at 1.4 billion tons per year. Yet they have been adding to capacity at a break neck pace now having an estimated 340 million tons in excess capacity. To put that into perspective, that is more cement that the U.S. India, and Japan use combined. China's collapse would probably naturally occur years down the road. It will probably happen much quicker because of other things mentioned.

I slightly disagree with you when you said "we only come together in times of peace and optimism, not times of despair." That is normally true unless the despair is severe. It is usually then end of the process. United Nations after WWII. So you have a collapse of the system, massive human suffering, and at the end (5 years into it) a new system is introduced. A world currency may or may not come. I don't know. I just know that the odds are increasing because the world reserve currency (the U.S. dollar) won't be able to hold that status in the next two decades.

Monday, November 9, 2009

Back To Normal

Nothing much to talk about today. Seems like we are back to "normal." Mindless, low volume (close to no volume), dollar bashing, equity buying days controlled by your friendly Goldman Sachs traders and a few yapping computers. Low low volume today as more and more normal market participants throw up their hands and leave.

No real news today so you left looking at charts. The great big bear downtrend line on a S&P closing basis is 1093.07 today. We closed .01 above it. This line turned the markets lower at 1103 a few weeks ago.

On an intraday basis the downtrend line is 1103.76 tomorrow dropping about .9 points a day. These are obviously very important lines.

Saturday, November 7, 2009

Ponzi Finance

Last week more than anything displayed exactly what is going on in the stock market. The two prior weeks before this week economic data started to actually look really good. What happened? The stock market started falling. Why? Because it meant that liquidity may have to be taken out of the system by the Fed. This week, two things happened. On Wednesday the Fed did not make any aggressive moves on the language concerning interest rates and basically said, party on. On Friday, you had bad job loss number but it was about perfect for the stock market. How can over 260,000 job losses (if you count previous revisions) be good? Because, our finance system has become a ponzi system. In a ponzi scheme, fundamentals don't matter. What matters is liquidity. For Bernie Madoff, the fundamentals never mattered. What mattered was always having new money to be able to give to investors that withdraw money. When the stock market started crashing and too many people started withdrawing their money, the scheme collapsed all around him.

Same thing with the stock market. Real numbers do not matter UNLESS it interrupts the liquidity flow. Friday's job number was absolutely perfect from a stock markets viewpoint. Temp jobs (a leading indicator) was up while job losses where basically steady from previous months so it could be argued there was a slight improvement while at the same time the headline that went out to every news source was 10.2%. While 10.2% was what everyday people saw, what does Wall St see? Dollar signs. It tells them more stimulus will be coming from Washington, more liquidity from the Fed, and that interest rates will stay really low. It was a horrific number for bears. I was texting at 7:35 central time right after the number came out with bears who were all excited about how bad the number was. My text back was "the worse the number the more bullish bc fed stays easy." If the number would have come out and surprised everyone with a 30k job gain, my guess is the market would have dropped over 2%. In fact when the number came out, I groaned. Did not surprise me at all the stock market was up.

All of that screams ponzi and screams that macro liquidity issues is what matters. Where does that leave investors? I owned IMS health at the beginning of the week. It got bought at a close to a 30% premium on Thursday and I made a lot of money. Was I lucky or was that a great call by me? I am short Amazon which I have lost even more money on that trades north of 70x earnings. Am I unlucky or am I just stupid? Everyone is feeling smart or dumb right now depending what side of the trade your on but I think on many levels it is all just pixi dust. The trade is one way.

With all ponzis, they all end but there is basically no way to make money on it. The reason is because when they end, they end almost overnight. If your long the ponzi, you feel brilliant as your making money day after day, statement after statement. Until the day you wake up and it all implodes and you have lost close to everything. If your betting against the ponzi you will have one day when it pays off. You will lose money (possibly everything) as the ponzi continues and you try to bet against it. How rich were Bernie Madoff investors in 2007. Their financial statements said they were very rich. Where they? The Dow claims it is at 10,000 today. Is it?

So what are investors to do? The answer is simple. Avoid it. There were many investors who looked at Madoff's fund and said something is not right and didn't invest with Madoff. They went elsewhere. What if elsewhere does not exist? What if there is no other option? I present you the U.S. financial system. Even many bulls would not argue that the system is not solvent today. The bulls would argue that we will be able to earn our way out of it (Whitney Tilson who is not really a bull makes this argument with Wells Fargo). Whether you buy that argument or not, what that arguments implies is a basic form of ponzi. The system is insolvent, liquidity will enable to allow the firms to keep paying people who want out (to really understand that at a deep level you really need to understand the accounting framework of a liquidity transaction, maybe at some point I will do a post on it), and at some point out in the future earnings will make the system solvent again. Not a game I really want to be apart of. Why? Because maybe it works maybe it doesn't (it usually doesn't) but the U.S. government has taken over the entire system in this matter. That means that the mom and pop shop is going to be affected by this outcome. Why I get so discouraged is because it seems that studying the financial statements and business opportunities of company x on the NYSE does not really matter. Because it has gotten unwillingly trapped in the ponzi system (the government decided to place it in the ponzi system when it took the entire system in this direction) all that matters is the outcome of system. The failure of the system means failure of company x.

It is why I thought Mark Sellers nailed it in his last letter when he said: "A weak U.S. economy is required to continue the boom in the U.S. stock market. It’s nuts." The weaker we are, the more people without jobs means the more liquidity will be there to continue the ponzi game.

So the question I have been asking myself, which has been sort of depressing, is why am I playing this game? If company x was a ponzi I would avoid company x. I would look a company y or company p or company j. The fact is the government has made every company a ponzi inherently by being part of the system. My successful investment of IMS Health would have probably been a complete failure if the ponzi system would have unraveled three weeks ago. Goes back to the question again. Was that a good investment or was that luck and actually a bad investment that was putting money in part of the ponzi scheme that I happened to be able to collect on before the ponzi unraveled?

To make matters worse from an investors standpoint, there is a second aspect to this all. The deck is heavily rigged. Goldman Sachs lost money from its prop trading desk only three days in the last two quarters (this last quarter they only lost money 1 day). Statistically in the old system that would be almost impossible. Probably be like a 10 standard deviation event or something. In today's system, it is hardly a surprise. Big competition (like Lehman and Bear Stearns) has been destroyed leaving bascially only one major player on the street. They essentially have a monopoly on which way the market will go in the short day to day trading. Completely making up numbers but if they were 20% and they are now 60% they can now push the market on any given day in whichever direction they want. So in the short term, the question is not what will the fundamentals do. The question is what does Goldman want the market to do. It is asinine. I know traders who have thrown up their hands and quit in the last three months because the markets have not followed the patterns they have traded in for 20 years. Well those patterns only depend now on what side of the bed Goldman Sachs traders wake up on.

So I come full circle. Why am I participating? If the system is a ponzi I will lose money eventually when the ponzi finally pops if I am participating in it. If I am betting against it I will lose money until it pops in which case there is no telling if I will be able to be around to collect on that bet when it pops. If you could short Bernie Madoff you would have lost a fortune betting over 10 years that the ponzi would collapse. If you were enjoying the ride investing with Madoff, it was good until the day you woke up and found out your investment was a complete zero. If your shorting a stock that Goldman has a desire to see increase for some reason or another, you will lose your shirt as Goldman decides it will make sure it will not go down.

Ever since I was around 13 I loved looking at companies and getting to know what they do. I am finding it more and more a meaningless task because more and more I come to the conclusion it does not matter. As a result, more and more I question why I am participating in a rigged game. Life is short. The ending to all of this is likely to be horrific and even if I have nailed exactly what is going on, there is no guarantee I will ever collect on it. Just thoughts bouncing around in my brain.

I think the odds are growing that this market rally thing will end on a 10% down day or 25% down month type of event.

In the short term, because the job loss number was so bad, it probably means the stock market has a decent chance of making new highs. What is really freaking amazing is that the AAII weekly survey of US retail investors was the bearish it has been since February 19th 2009. This is usually a major contrary indicator. This number just collapsed after the stock market pulled back a mere 6%. What the great bear trendline from the November 2007 highs. If we break that, there will be a rocket ship higher. Correlations seemed to have started breaking down recently so it is possible we are not headed for new highs but those odds have been falling. If we don't, I think it will have to do with U.S. financials and/or Europe. Those two is what will eventually end the Ponzi game.

Wednesday, November 4, 2009

In Defense of Warren

Readers must make up their own mind. I still don't think the deal makes out that sense. Time will tell. A few emails.

Talked to ___ today and his friend who works for ____ claimed that the railroad industry will be a 25% roe industry, he had 30% of his net worth in BNI and thinks that Warrren stole it, and it’s worth 175-200. Didn’t get any details really, other than he just thought margins would rise substantially as we moved from trucking to rail.


Couple comments -

Part of the reason Buffett has invested in railroads is bc he has realized the economics and value proposition have for the industry has improved in the last 5 years.

As energy prices have increased, rail has become more competitive (my understanding). So if inflation comes, yes the energy costs will increase putting a headwind on Burlington margins/profits but doesn't that just make their value proposition more compelling? I think it could be viewed as this:

Prices double which is a good thing mainly bc several other big costs (like depr / PPE) is fixed so you'll see operating leverage but more importantly rail becomes more competitive which means volume spikes as people switch from truck to rail?


Interesting. I dont have all the answers either of course. I was
surprised he used Berk stock me all the evidence laying
around the scene points to him thinking BNI is worth a lot more than he
paid for it due to the price paid, his enormous enthusiasm, 40% stock
used of Berk which Berk itself may not be cheap but is not expensive
either, and again his enormous enthusiasm! The way he explained how
the deal unfolded makes me think he has been licking his chops on this
one for quite sometime, again though that is just my own biased

Whether he is right or not on doing the deal (it being "accretive over
time" sort of speak) is another matter.....but he is almost never
wrong. Especially on a deal of this size....he has been wrong in the
past but generally on smaller deals.....this one is a biggie.

We all know he thinks very long the short term reasons are
meaningless in my view (trying to jump out of dollars quickly,
etc......I find those to be additional factors but he bought it for one
reason...bc he thinks the after tax return on his capital will be
attractive in comparison to everything else he see's plus considering
the massive amount of capital he can put to work in this deal and the
control received). In the end, it is a bet on increasing prosperity in
America over time, just as he states. People can dig into and come up
with all kinds of theories as to why....and they will find the one's
that best suit their viewpoint of the world through their own bearish,
bullish, or neutral lenses.......but in the end the bet is that
royalties on transported goods will be a good business in the USA.

You miss the most important of all Berk stock deals in his post
though.....the big shoe acquisition (HH Brown, Dexter, etc.). That was
done with mostly stock as I recall and was a large
disaster.....probably the biggest mistake Buffett has ever made.

This is very interesting. The whole thing is fascinating. From Bloomberg:

Warren Buffett called Berkshire Hathaway Inc.’s deal to buy the part of Burlington Northern Santa Fe Corp. that it doesn’t already own an “all-in wager on the economic future of the United States.”

If so, it’s a survivalist bet. The railroad business is never going away, but it’s not going to lead the economy out of recession, either. Buffett has spent a lot of time in the last year burnishing his legacy by tackling Franklin Roosevelt’s role as the verbal antidepressant for this wretched economy. As I have said before, though, Buffett isn’t as bullish as he sounds.


On CNBC Whitney Tilson made a case why it was a good deal. I thought his argument on cost of capital was very weak and heavy on rationalization. He is accurate that the cost of capital is really low but Buffett has never been about doing marginal deals because of that reason. It was that case five years ago (probably even more so because so many competitors were not getting financed from the government).

Tuesday, November 3, 2009

Warren - What Are You Doing?

So the blockbuster news today is that Warren Buffett is buying Burlington Northern for $44 Billion. That is a huge move for Warren on multiple fronts. He is using debt to buy it, he never does that. He is splitting his B shares, he never does that. He is using stock to purchase the company, he very very rarely ever does that. What is going on?

All the headlines are quoting Warren that is he is going all in on the economy. On the future of America. That has to be the long term bet (railroads are the most economic senstive things you can buy) but is that what he is doing in the short term? Is there something more going on?

I honestly don't know what is going on but here are some thoughts.

He is using I think $8 billion in debt to buy the company. Why? Yields are really low and he is essentially betting it makes sense to finance through debt because later yields are going to blow out? Similar to a Julian Robertson play? Sounds good in theory but I think the debt is only a three year note so the duration is short and the overall debt level at $8 billion is small.

He is using stock!!! I can think off the top of my head him only using stock twice in his life to buy something and both times he said later he regretted it. The first tme I think was in the late 60s / 70s and he purchased a small company with stock. He did the math years later showing how much of a mistake it was. He also used stock to buy Gen Re 5 to 10 years ago. The first case, if I remember correctly, the company wouldn't do the deal without stock. The second case, he thought Berkshire was selling at a very rich price. So the question must be asked (the deal is 40% stock, that is big), does Buffett think Berkshire stock is trading at a very high premium? Does he think his stock is overvalued?

Why now? Is it possible all his economic strength mumbo jumbo is a front? This transaction is actually occurring because this is the quickest way to get out of dollars? Is he worried about large amounts of inflation down the road? It would be easy to argue yes but I am not totally sure. On the plus side, transportation typically takes a percentage of the value of the freight moved. If prices double and the railroads take the same percentage, the amount of money on the revenue side doubles. It is essentially like an inflation protected TIP. However, one of the biggest inputs is energy. If we had serious inflation, my guess is the volume would drop and profits would be squeezed from the big boost in energy costs. Also, railroads are very capital intensive businesses. In the 70s he wrote an article (I think it was Forbes) describing why you would rather not own heavy cap ex companies in periods of high inflation. It is better to own companies with alot of intangible value. So that from an inflation standpoint, it doesn't make sense.

These are all just thoughts off the cuff. I may have more later. The deal doesn't make sense to me. I put this one in the General Electric deal he did (though that one was small). The Goldman Sachs deal I thought was genius. The General Electric deal did not makes sense and to me, neither does this. (I have that posted in old blog posts from last October)

I love studying Buffett but to be honest he is not gotten this economic downturn right. This smacks of a USG 2006 purchase except a much bigger bet.

Here is a 30 minute interview with Buffett on CNBC this morning.

If you have thoughts, feel free to email them. I would be interested in others thoughts.

Monday, November 2, 2009

Absurdity of the Week

And people actually don't think America is in serious trouble? On Friday, the FDIC took over 9 banks which is the most banking institution to fail in one week since the crises began. Well one of these banks was Park national Bank of Chicago. A $4.7 billion asset bank in Chicago. What was going on the same day? This is ridiculous. From the Chicago Tribune:

The timing was awkward. The government shut down $4.7 billion-asset Park National on the same day that its community development arm, Park National Bank Initiatives, received $50 million from Treasury Secretary Timothy Geithner at a ceremony in Chicago. That money is intended to stimulate investment in low-income communities on such projects as charter schools, health clinics and stores.

Say what? Taxpayers were giving them $50 million even as taxpayers were going to take large losses because they could not manage their financial? This all happened the same day??? Good grief.

I am curious what happens to the $50 million. If the entire amount will still be earmarked for low income communities or if it goes in the asset pool and gets haircutted in loss assumptions.

Whirlwind Continues

Back from a jam packed weekend. I fly out of state tomorrow on business and won't be back until Sunday. I am hoping I will have decent Internet connection and time to post some things but not sure. This should bring an end to last three in half week whirlwind that I have been experiencing.

This week is going to be very tricky with Fed day on Wednesday and unemployment numbers on Friday. We are possibly entering a very screwy period in the markets where good data will send the market down because it could mean liquidity will leave the market as the Fed takes action. So with that the first tricky data point is the ISM numbers tomorrow. Chicago PMI was much better than expected so there may be high expectations for that number but other regional numbers that don't really get followed like the Richmond PMI and Milwaukee number was worse than last month. Either way, what will be more telling is how the market reacts to a good number or bad number.

This CIT thing is non news though it is getting talked about alot over the weekend with the CHP 11 filing.

Don't really have much. If we have had a top which it appears more and more likely that we have, I would expect the market not to make it easy for the bears. We shall see but would not be surprised at all that the markets rally during the week.