The big news today is not the Countrywide merger with BAC. It isn't American Express or even Merrill's rumored write down of $15 billion. Oh no. The big news today in my opinion looking long term is what is going on in the trading pits at the Chicago Board of Trade. WOW.
The USDA released much anticipated agriculture report this morning. All that can be said again is WOW. Basically there isn't enough corn worldwide to meet world demands and even really domestic consumption. So corn has limited up today and there is chatter that it will limit up on Monday. Winter wheat acres projected planted is also very disappointing. Wheat is up. 6 month contracts and out on Soybeans has limited up also.
Why is this more important than Countrywide or American Express. INFLATION. If these food commodities move up another 50 to 100% the consequences for inflation are huge. The government will ignore them but they will make there way into other areas of the economy and be one more very large limiting factor on consumer spending.
Friday, January 11, 2008
Wednesday, January 9, 2008
Example of Money Velocity Deterioration
Countrywide made $6 million in subprime loans in December, down from $3.7 billion a year earlier .....................WOW!!!
Big Picture Overview
Unfortunately I can't add an attachment but I recently received a quarterly review from Hoisington Management (Thanks Nathan). I am not an economist and it focuses a little more on economics than I typically do but it touches on some big themes that I thought made it very interesting. If someone wants it, feel free to email me. Here are some highlights.
The beginning of what will surely be considered the greatest credit event since the 1930s emerged in 2007 with the discovery that derivatives multiply bad credit. The "seizing up" of credit markets resulted in a worldwide reduction of credit issuance from $2.5 trillion in the 2nd quarter to $1.3 trillion in the 4th quarter...... A supply shrinkage of over $1trillion is enough to shift the supply curve to the left, resulting in a bond price increase and lower yields in high quality fixed income securities. This more than offset an increase in inflationary expectations, and was most likely the proximate cause of the sharp reduction in Treasury interest rates in the latter half of 2007.
I have mentioned a couple of times that I am starting to think that because of the credit crises that the bond market is not telling the whole story. The story it is telling is tainted because of capital preservation concerns. The paragraph above said the same thing in an economist language, "a supply curve shift." They think this will continue, not because inflation concerns will go away or even slow but because their will be a decreasing supply of high quality options as demand increases.
In this environment, short-term interest rates will continue to move downward, reinforced by several reductions in the administered Federal funds rate. The long end of the Treasury market will benefit from two factors. First, investor desire for risk-free assets will increase at a time when default rates will be soaring on other fixed income securities. Second, the overall reduction in credit market instruments will mean fewer alternatives for those desiring a fixed rate of return. By the end of 2008 we would expect new record low yields in Treasuries for this cycle.
One very interesting point from this newsletter I have only partly thought of is the falling money velocity. The thing I found really interesting is that compared to historical standards, according to Hoisington, is it has much further to fall.
Under the right conditions, private sector activities can mitigate, and possibly overwhelm, actions taken by the Federal Reserve. Historically, swings in velocity have neutralized changes in the money stock many times, and currently appear to be having a profound affect on nominal GDP. During the past six quarters velocity has declined from 1.930 to an estimated 1.902 in the final quarter of 2007. At the same time, the annualized six quarter growth rate of M2 has accelerated to 5.9% from 4.3%. The interaction of these two forces has slowed the nominal growth rate to 4.9%, or 1.7% lower than the six quarter annualized growth rate prior to the peak in velocity a year and a half ago.
Velocity is functionally related to the rate of increase in financial innovation, rising when innovations are occurring rapidly. Due to innovations in mortgage finance that made mortgages available to households previously deemed not credit worthy, as well as the spread of collateralized debt obligations (CDOs) and structured investment vehicles (SIVs), velocity increased from 1.82 in 2003 to its peak of 1.92 in mid 2006. With these innovations dramatically reversed, velocity is likely to continue to fall significantly.
Over the very long run, the level of velocity tends to revert to its average. In spite of the recent modest declines in velocity, the latest level is far above the post 1959 average of 1.80. Even with further declines at a conceivable 2% annual rate, velocity would not return to its post 1959 average until the first quarter of 2010, providing a meaningful offset to money growth. Indeed, at a 4 ½% growth rate in M2, a rise of 2 ½% in nominal GDP could be expected—a pace that would not cover inflation. Real GDP would turn negative and cement recessionary conditions. The downturn in velocity and the persistent inverted yield curve suggest that the Fed remains behind the cumulating economic weakness.
I don't care what the numbers are or care whether something comes in at 4.2% or 4.5%. What you have above is a bunch of details or economic issues that alone are really not worth that much but the big picture it can give as you go look for individual ideas is huge. Focus on the themes. Value guys do not do this near enough in my opinion. I think the mispricing of bonds compared to equities will last alot longer than most people think because of what was touched on above. This also greatly bolsters my theory that there is really nothing different from the Tech Bubble in 2000 and the Financing Bubble in 2007. Both saw the initial cracking in the Feb March time frame (coincidence), 9 to 18 months after the initial cracking is when the biggest depreciation will occur in prices (we are currently in that period), both will take 3 years or so to work out with 18 months to 36 months entering into a buying opportunity of a lifetime. It will be different of course but it seems to be rhyming nicely. This bubble is scarier with fewer prices to hide though because of how it affects everything else. The tech bubble didn't really touch something like trash collection or toothpaste. The current unwinding bubble does because it makes capital more expensive for fringe borrowers (a trash company needing another trash processing facility) and because of the dramatic decrease in available credit and overall economic spending power by consumers and businesses alike.
The beginning of what will surely be considered the greatest credit event since the 1930s emerged in 2007 with the discovery that derivatives multiply bad credit. The "seizing up" of credit markets resulted in a worldwide reduction of credit issuance from $2.5 trillion in the 2nd quarter to $1.3 trillion in the 4th quarter...... A supply shrinkage of over $1trillion is enough to shift the supply curve to the left, resulting in a bond price increase and lower yields in high quality fixed income securities. This more than offset an increase in inflationary expectations, and was most likely the proximate cause of the sharp reduction in Treasury interest rates in the latter half of 2007.
I have mentioned a couple of times that I am starting to think that because of the credit crises that the bond market is not telling the whole story. The story it is telling is tainted because of capital preservation concerns. The paragraph above said the same thing in an economist language, "a supply curve shift." They think this will continue, not because inflation concerns will go away or even slow but because their will be a decreasing supply of high quality options as demand increases.
In this environment, short-term interest rates will continue to move downward, reinforced by several reductions in the administered Federal funds rate. The long end of the Treasury market will benefit from two factors. First, investor desire for risk-free assets will increase at a time when default rates will be soaring on other fixed income securities. Second, the overall reduction in credit market instruments will mean fewer alternatives for those desiring a fixed rate of return. By the end of 2008 we would expect new record low yields in Treasuries for this cycle.
One very interesting point from this newsletter I have only partly thought of is the falling money velocity. The thing I found really interesting is that compared to historical standards, according to Hoisington, is it has much further to fall.
Under the right conditions, private sector activities can mitigate, and possibly overwhelm, actions taken by the Federal Reserve. Historically, swings in velocity have neutralized changes in the money stock many times, and currently appear to be having a profound affect on nominal GDP. During the past six quarters velocity has declined from 1.930 to an estimated 1.902 in the final quarter of 2007. At the same time, the annualized six quarter growth rate of M2 has accelerated to 5.9% from 4.3%. The interaction of these two forces has slowed the nominal growth rate to 4.9%, or 1.7% lower than the six quarter annualized growth rate prior to the peak in velocity a year and a half ago.
Velocity is functionally related to the rate of increase in financial innovation, rising when innovations are occurring rapidly. Due to innovations in mortgage finance that made mortgages available to households previously deemed not credit worthy, as well as the spread of collateralized debt obligations (CDOs) and structured investment vehicles (SIVs), velocity increased from 1.82 in 2003 to its peak of 1.92 in mid 2006. With these innovations dramatically reversed, velocity is likely to continue to fall significantly.
Over the very long run, the level of velocity tends to revert to its average. In spite of the recent modest declines in velocity, the latest level is far above the post 1959 average of 1.80. Even with further declines at a conceivable 2% annual rate, velocity would not return to its post 1959 average until the first quarter of 2010, providing a meaningful offset to money growth. Indeed, at a 4 ½% growth rate in M2, a rise of 2 ½% in nominal GDP could be expected—a pace that would not cover inflation. Real GDP would turn negative and cement recessionary conditions. The downturn in velocity and the persistent inverted yield curve suggest that the Fed remains behind the cumulating economic weakness.
I don't care what the numbers are or care whether something comes in at 4.2% or 4.5%. What you have above is a bunch of details or economic issues that alone are really not worth that much but the big picture it can give as you go look for individual ideas is huge. Focus on the themes. Value guys do not do this near enough in my opinion. I think the mispricing of bonds compared to equities will last alot longer than most people think because of what was touched on above. This also greatly bolsters my theory that there is really nothing different from the Tech Bubble in 2000 and the Financing Bubble in 2007. Both saw the initial cracking in the Feb March time frame (coincidence), 9 to 18 months after the initial cracking is when the biggest depreciation will occur in prices (we are currently in that period), both will take 3 years or so to work out with 18 months to 36 months entering into a buying opportunity of a lifetime. It will be different of course but it seems to be rhyming nicely. This bubble is scarier with fewer prices to hide though because of how it affects everything else. The tech bubble didn't really touch something like trash collection or toothpaste. The current unwinding bubble does because it makes capital more expensive for fringe borrowers (a trash company needing another trash processing facility) and because of the dramatic decrease in available credit and overall economic spending power by consumers and businesses alike.
Tuesday, January 8, 2008
More on Inflation
http://business.timesonline.co.uk/tol/business/economics/article3156141.ece
I have been on this theme for almost six months now and I am finally starting to see it mentioned here an there in the press. China's next big export will be inflation. This is from an England publication but it applies to America. It is why I have held the thought that the stock market is telling the better story than the bond market. Time will tell.
From the article
Growing numbers of economists are sounding warnings that rising cost pressures and wages in China mean that it may be starting to export inflation. Analysts fear that the era when Britain and other big Western economies could depend on steadily falling prices for Chinese imports to keep a lid on inflation and allowing their economies to grow faster without sparking price pressures, is ending.
and
The threat of a new wave of China-fuelled inflationary pressures has been thrust on to the agenda by official US figures, not previously available, which show that after years of steep falls, the cost of Chinese exports to America began to rise very sharply last year.
and
The very steep gains in America’s Chinese import bill were fuelled as sharp falls in the dollar cut US buying power abroad. But City economists are now increasingly concerned over signs that the same price pressures from dearer Chinese imports are emerging on this side of the Atlantic.
These cycles, like commodity cycles tend to be very long 10 year plus cycles. We may have a temporary inflation slowdown due to US recession but the wave I think is coming big time.
I have been on this theme for almost six months now and I am finally starting to see it mentioned here an there in the press. China's next big export will be inflation. This is from an England publication but it applies to America. It is why I have held the thought that the stock market is telling the better story than the bond market. Time will tell.
From the article
Growing numbers of economists are sounding warnings that rising cost pressures and wages in China mean that it may be starting to export inflation. Analysts fear that the era when Britain and other big Western economies could depend on steadily falling prices for Chinese imports to keep a lid on inflation and allowing their economies to grow faster without sparking price pressures, is ending.
and
The threat of a new wave of China-fuelled inflationary pressures has been thrust on to the agenda by official US figures, not previously available, which show that after years of steep falls, the cost of Chinese exports to America began to rise very sharply last year.
and
The very steep gains in America’s Chinese import bill were fuelled as sharp falls in the dollar cut US buying power abroad. But City economists are now increasingly concerned over signs that the same price pressures from dearer Chinese imports are emerging on this side of the Atlantic.
These cycles, like commodity cycles tend to be very long 10 year plus cycles. We may have a temporary inflation slowdown due to US recession but the wave I think is coming big time.
Monday, January 7, 2008
Bargaining Stage
http://bigpicture.typepad.com/comments/2008/01/5-stages-of-mar.html
Many of you have probably seen this but I thought it was worth posting. I agree.
Many of you have probably seen this but I thought it was worth posting. I agree.
Sunday, January 6, 2008
An Argument Against Inflation
http://www.centman.com/2007update.html
This is a thought provoking presentation by Century Management. It is over 2 hours long (I only watched 2 hrs) (it is nice to work for yourself, don't think I could have done that at my previous job) but Wayne Angel gives his argument on why he thinks inflation is not a problem and we are entering a time period of ultra low inflation causing equities to be a screaming buy. Because that is very counter to my own thinking I wanted to hear what he had to say.
There is also interesting discussion about the consumer balance sheet which they argue is very strong and argued that we are in an oil bubble (which I disagree with).
Anyway Century Management has a very good long term track record and so it is worth listening to if you have the time.
Thanks goes to Pete for bringing this to my attention.
This is a thought provoking presentation by Century Management. It is over 2 hours long (I only watched 2 hrs) (it is nice to work for yourself, don't think I could have done that at my previous job) but Wayne Angel gives his argument on why he thinks inflation is not a problem and we are entering a time period of ultra low inflation causing equities to be a screaming buy. Because that is very counter to my own thinking I wanted to hear what he had to say.
There is also interesting discussion about the consumer balance sheet which they argue is very strong and argued that we are in an oil bubble (which I disagree with).
Anyway Century Management has a very good long term track record and so it is worth listening to if you have the time.
Thanks goes to Pete for bringing this to my attention.
Bond Yields Compared to Equity Yields
http://www.bloomberg.com/apps/news?pid=20601170&refer=home&sid=aS8Q29PCJq00
From the article.
Stocks fell to the lowest last month relative to bonds since the 1970s according to the so-called Fed model, which was cited by former Federal Reserve Chairman Alan Greenspan a decade ago. Equities yield 4.17 percentage points more in projected earnings than 10-year government bonds paid in interest at the end of 2007, according to an analysis of 29 countries by New York-based Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm by market value.
and
The gap is now the widest since September 1974, when adjusted for volatility, the data show. The last time the spread was wider, equities outperformed debt by 24 percentage points in the next 12 months, according to Lehman.
This is the biggest bullish argument I think right now. The spread between bonds and equities is what keeps me up at night. Along with inflation I have pondered that point more than any other point. I don't have a great answer. If I was a macro guy and was running a large asset allocation portfolio and could choose only between stocks and bonds I would be 100% stocks and 0% bonds. There is no question in my mind bonds will underperform stocks but will it happen through bonds going down more than equities going down or bonds go down and equities go up?
My guess is we will see something similar to the 24% point outperformance by equities. The key to this whole thing though is inflation. If I am right in my thinking that inflation picks up speed, equities won't be going up much and bonds will go down alot more shrinking the yield difference. Right now everyone sees recession, a fear in the banking market, and a corresponding flight to safety pushing down treasury yields. If people stop worrying about the banking system then all of a sudden you may see a reverse as people worry more about the eroding of the value of their money (through inflation) rather than losing all of it (through banking insolvency). Because of banking fears we may be at one of those rare points in history where equities are telling the better (or I should say more true) story rather than government bonds.
If the bond market is telling the better story than we are at the buying opportunity of a lifetime.
From the article.
Stocks fell to the lowest last month relative to bonds since the 1970s according to the so-called Fed model, which was cited by former Federal Reserve Chairman Alan Greenspan a decade ago. Equities yield 4.17 percentage points more in projected earnings than 10-year government bonds paid in interest at the end of 2007, according to an analysis of 29 countries by New York-based Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm by market value.
and
The gap is now the widest since September 1974, when adjusted for volatility, the data show. The last time the spread was wider, equities outperformed debt by 24 percentage points in the next 12 months, according to Lehman.
This is the biggest bullish argument I think right now. The spread between bonds and equities is what keeps me up at night. Along with inflation I have pondered that point more than any other point. I don't have a great answer. If I was a macro guy and was running a large asset allocation portfolio and could choose only between stocks and bonds I would be 100% stocks and 0% bonds. There is no question in my mind bonds will underperform stocks but will it happen through bonds going down more than equities going down or bonds go down and equities go up?
My guess is we will see something similar to the 24% point outperformance by equities. The key to this whole thing though is inflation. If I am right in my thinking that inflation picks up speed, equities won't be going up much and bonds will go down alot more shrinking the yield difference. Right now everyone sees recession, a fear in the banking market, and a corresponding flight to safety pushing down treasury yields. If people stop worrying about the banking system then all of a sudden you may see a reverse as people worry more about the eroding of the value of their money (through inflation) rather than losing all of it (through banking insolvency). Because of banking fears we may be at one of those rare points in history where equities are telling the better (or I should say more true) story rather than government bonds.
If the bond market is telling the better story than we are at the buying opportunity of a lifetime.
Friday, January 4, 2008
Shower Me with Agriculture
What went up today? Rice, corn, later dated contracts for soybeans, other soft commodities.
What went down? Everything else.
Agriculture is still the only asset class on an absolute basis that I am jumping up and down about. Yes there are individual companies I like but as an entire asset class agriculture is to me the only no brainer though we are due for a 10% correction as it has been nothing but up for two solid months. I recently bought rice and am planning to buy more. The dollar looks like it has resumed its downfall which will only add to the tailwind. Unfortunately buying companies geared towards agriculture is much more difficult. My fund continues to hold MOO which seems like a lazy way of doing but it is up nearly 20% in the last month and I think will go higher (probably considerably). I am looking at companies within the indexes to try and find a better one but this is one of those rare situations where I am bullish on the sector in general but because of individual stock prices it appears you are taking on to much individual business risk. So hold the sector and if Potash or Monsanto stumbles because of a company specific problems you are not hurt to bad. The sector should continue to vastly outperform.
What went down? Everything else.
Agriculture is still the only asset class on an absolute basis that I am jumping up and down about. Yes there are individual companies I like but as an entire asset class agriculture is to me the only no brainer though we are due for a 10% correction as it has been nothing but up for two solid months. I recently bought rice and am planning to buy more. The dollar looks like it has resumed its downfall which will only add to the tailwind. Unfortunately buying companies geared towards agriculture is much more difficult. My fund continues to hold MOO which seems like a lazy way of doing but it is up nearly 20% in the last month and I think will go higher (probably considerably). I am looking at companies within the indexes to try and find a better one but this is one of those rare situations where I am bullish on the sector in general but because of individual stock prices it appears you are taking on to much individual business risk. So hold the sector and if Potash or Monsanto stumbles because of a company specific problems you are not hurt to bad. The sector should continue to vastly outperform.
Thursday, January 3, 2008
Darwin Awards
http://darwinawards.com/darwin/darwin2007.html
This has nothing to do with finance but I always enjoy them.
There needs to be a Finance Darwin Awards. Seriously. You know how many stupid things people do with money or how many stupid comments are made in any given year.
Chuck Prince's comment about how they were still dancing would qualify. Seems he got left in the danc hall after everyone had cleaned up and lock the door. I think that story would definitely qualify for a Finance Darwin award.
This has nothing to do with finance but I always enjoy them.
There needs to be a Finance Darwin Awards. Seriously. You know how many stupid things people do with money or how many stupid comments are made in any given year.
Chuck Prince's comment about how they were still dancing would qualify. Seems he got left in the danc hall after everyone had cleaned up and lock the door. I think that story would definitely qualify for a Finance Darwin award.
Trillion Dollar Survey
Happy New Year everyone. Well not for the stock market though you wouldn't know it from the "trillion dollar survey." A survey of various powerful money managers. A recap was given here.
http://www.cnbc.com/id/15840232?video=618866675&play=1
Good grief. In the survey 89% think the S&P will finish up for the year. 60% think it will finish up 8% or more. Only 2% think there is a greater than 50% chance for a recession!!!! 30% think the U.S. will be the number one performing market in the world!!! That is ahead of China which is 21%.
A couple of comments. There is no way the market can have a strong 20 to 25% run if that is the true level of pessimism (there is none). I coulnd't believe it. I can't believe I am saying this (again) but Cramer made a couple of comments (which I agreed with) on this and said he threw up his hands when he heard it.
Well so much for 2008....maybe 2009 will be better. (I am joking.....sort of)
http://www.cnbc.com/id/15840232?video=618866675&play=1
Good grief. In the survey 89% think the S&P will finish up for the year. 60% think it will finish up 8% or more. Only 2% think there is a greater than 50% chance for a recession!!!! 30% think the U.S. will be the number one performing market in the world!!! That is ahead of China which is 21%.
A couple of comments. There is no way the market can have a strong 20 to 25% run if that is the true level of pessimism (there is none). I coulnd't believe it. I can't believe I am saying this (again) but Cramer made a couple of comments (which I agreed with) on this and said he threw up his hands when he heard it.
Well so much for 2008....maybe 2009 will be better. (I am joking.....sort of)
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