The Cruel Unnoticed Tax

Interesting insight over at bigpicture. All below from big picture.

http://bigpicture.typepad.com/comments/2007/10/dumb-headline-o.html

Next, we look at the real world consequences of this artificial self-destructive focus of inflation ex-inflation:

Social Security Checks to Rise 2.3%

Cost-of-Living Adjustment Is Smallest Since '03
Payments to Social Security recipients and most federal retirees will increase 2.3 percent in January. It is the smallest cost-of-living adjustment since 2003, reflecting a lower rate of inflation.The adjustment will increase the average monthly Social Security retirement benefit by $24, to $1,079. It is based on the rise in the consumer price index in the third quarter, a figure the Labor Department released yesterday.The increase directly affects the finances of about 50 million people, including more than 31 million Social Security retirees and 11 million people who receive disability or other supplemental income from the Social Security Administration. It is also a significant number to the more than 4 million federal government and military retirees, about 500,000 of whom live in the Washington region.

So despite the enormous rise in energy, food costs, housing expenses, insurance, medical coverage, we see that Social Security is barely budging.

When we said that "Inflation is the cruelest tax," now you know what we mean.

Y'all keep focusing on the core . . .

Hurculean Effort and the Dollar

The Dow and the S&P 500 failed ultimately in their Herculean effort to come back today. The NASDAQ succeeded. When I woke up this morning Dow futures were down close to 100 points. In true market fashion (after all right now it is the hip thing to do isn't) the markets for the most part shrugged off everything I highlighted this morning and more. Financials got clobbered again, surprise surprise. For some reason I had one of the best days I have had in months powered surprisingly by my longs. Funny how those things work.

Everyone is acting like this weak dollar is great for the the American economy. It is to a certain extent and it if it would have happened several years ago the impact we would feel would be alot less but a plunging currency and a rising stock market does not mean all is well if you look with a longer time horizon. In 1921 the German mark was plunging and the German stock market surging. The WSJ on September 9th 1921 said

Early in July paper marks began to show such a tendency toward depreciation that the investing classes in Germany took alarm and there was a mad rush to invest their paper in industrial and other securities before currency dropped further.

Of course the party did not last long. Germany along with Russia, Poland, Austria and Hungry where no longer on the gold standard and pursuing inflationary policies to try and stimulate a struggling economy compared to France and England which had about 25% deflation and the U.S. which saw 11% drop in prices. Eventually this monetary policy caught up with them which led to an almost complete loss of capital in these markets and an almost non existent economy.

Of course the U.S. is nowhere near a post WWI Germany but my point is though a weak dollar can have some short term benefits it is no where near a good long term policy. A plunging currency means there is something wrong in that country as viewed by the rest of world. Time will tell how much unwinding needs to occur and the ramifications for American dominance both economically and militarily.

Panic is Back

Panic is back in the markets today. Look at the 1 month treasury, also the 10 yr. We have a full fledged flight to quality again similar to what we had back in August. Dollar hit a new all 40 year low. The Japanese finance minister talk about a full fledged dollar route next year all this while the chance of a fed fund cut for October went from 25% two days ago to 75%. (boy that helps the dollar) Jobless claims moved higher above street expectations.

I have been shaking my head not participating in this rally. Nothing seems to have changed since August and it appears the market is waking up to that fact once again.

Wow

I think E*Trade just must be being more honest than everyone else.

http://www.marketwatch.com/news/story/mortgage-meltdown-leads-e-trade-58/story.aspx?guid=%7BC23443AE%2D5625%2D4252%2D8B8A%2D99F20931A2B0%7D

"A lot of people think that sub-prime loans is where the problems center," [Jarrett Lilien, E-Trade's president] said. "But that's not our problem. Our issue is that the value of high quality loans is underperforming."

From their conference call
“ As a part of our guidance release last month, with respect to securities impairments, we forecasted we could see up to $100 million in the second half of 2007 and an additional 50 to 100 million in 2008 for a total of up to $200 million over six quarters. These impairments were primarily related to two categories within our asset backed securities portfolio which we identified to have the highest risk. Specifically, these were collateralized debt obligations or CDOs, and securities collateralized by second lien mortgages. Since the September guidance release, upon evaluation and refinement of our forecast, we determine that had certain writedowns needed to be taken in the third quarter. Additionally, we decided to accelerate the sale of the highest risk portions of these portfolios, writing down securities rated lower than double A by more than an average of $0.50 on the dollar. By changing the intent and designation to no longer hold these securities to recovery. The combined effect is that we recorded an impairment charge of approximately $197 million in the third quarter”

China's Biggest Export...Inflation

http://www.time.com/time/magazine/article/0,9171,1670255,00.html

I have touched on this several times in previous posts. In my opinion, this is going to be a big story over the next five to ten years. It will impact every aspect of the monetary system and economic fundamentals. Inflation runs in mega cycles. This is one is in the pre game warm-up.

After all, it was China's cheap laborers who turned the country into the world's factory. By one estimate, China's manufacturing unit labor cost was just 4% of that of the U.S. in 2005. Now, as the mainland economy powers ahead — GDP growth jumped by 11.9% in the second quarter — real wages of urban workers have been soaring at double-digit rates, rising 18% in the first half of this year alone, according to the government.

Other big trends I have been playing.

For now, Chinese officials seem to recognize that high economic growth almost always leads to higher inflation rates — and that they can live with that as long as people don't revolt. At the end of September, China's central bank predicted consumer price rises would accelerate from an average 4.6% rate this year to 5% in 2008. Higher food costs continue to be a worry. As Chinese grow richer, they are eating more meat, which pushes up demand for grains such as soy and corn, says Jing Ulrich, head of China equities at JP Morgan in Hong Kong. Although Ulrich expects food prices to stabilize by year's end as the pork supply recovers, she says inflationary pressures resulting from rising meat consumption, the country's shrinking farmland and water shortages will persist.

and the evidence is already starting to show.

In May, the price of Chinese products imported by the U.S. registered a 0.1% year-on-year increase, the first such gain since the U.S. Department of Labor began tracking Chinese import prices in 2005. Prices have climbed by at least 0.3% each month since then.

My New Favorite Sell Side Analyst

My new favorite sell side research analyst. Unless you know the game of Wall Street you do not know how rare this is where an analyst will challenge a company much less a CEO. Often times this is because any one who is negative on a call well get screened for next quarterly call. Go Mike!!

Operator
Your next question comes from Mike Mayo - Deutsche Bank.

Mike Mayo - Deutsche Bank
Chuck said this was the year of no excuses. You guys say the results are disappointing. So what are the repercussions at the level of the Office of the Chairman? When I look at results, and feel free to educate me, but the business line mishaps are not just investment banking. There are some other areas. There are some risk management issues. Expense management, no matter how you look at it, year-over-year, year-to-date, linked-quarter, you add back the charges, reducing some for comp, you still have negative operating leverage.

Then management. It was a year ago when Tom Maheras, Michael Klein were moved to head the Investment Bank and now that has kind of changed a little bit. Also, Dave Bushnell, Head of Risk Management, was promoted three weeks before the preannouncement. I was not sure what was going on with that.

But the bottom line here is almost all the investors that I talk with feel like there needs to be more significant changes in terms of management. So that is the data I am looking at. What are you looking at, or what is the board looking at that they feel more comfortable?

Charles Prince
I think I would repeat a large part of what I said to Ron. It sounds to me like a very similar question. If you look at our results this quarter, no one can be happy with the results in our fixed income business or with the results that relate to that. But I think if you are able to look at the other parts of our business, if you look at the strategic plan that we are executing on, I think any fair-minded person would say that strategic plan is working. The benefits that we saw in the fourth quarter and then more in the first quarter and then more in the second quarter are showing through in the third quarter in the businesses that haven't been impacted severely by the fixed income dislocations.

So if you look at parts of securities and banking, and we called those out; if you look at our international business; if you look at our GTS business; if you look at our wealth management business; if you look at our various businesses, the trend line of growth that we have sustained now for several orders is continuing. It is clear that the fixed income dislocation hurt us, and hurt us in a very significant way in those businesses. But I think I certainly have confidence in our strategic plan. I think that it is showing through. I personally expect that it will continue to show through in the future. I think those are the factors that people are looking at.

Mike Mayo - Deutsche Bank
Well, one of your main targets for this year was to grow revenues faster than expenses and that is not going to pan out. This could be the third year in a row where that doesn't pan out. That was clearly a very important factor. Also at the corporate level, the risk management you said it was on the extreme areas of where you thought it should be. How do you think about that?

Charles Prince
Well, you ask two questions there. Obviously, we want revenues to grow faster than expenses. It is true in many of our businesses. As I said, we had a very severe dislocation in revenues in our Markets & Banking business, one that I am not sure any fair-minded person would see a way to lower expenses rapidly enough to offset that in a five-week period. In the rest of our business, I think we are actually making very considerable progress in that.
In terms of risk management, obviously, we wish that our risk management models had predicted what had happened here. In fairness, they included it, but only at the wide margins of what we thought was possible. I am not sure we were alone in that difficulty. But the facts are the facts. Our job is to sustain our strategic plan is we go forward, and that is what we're going to do.

Mike Mayo - Deutsche Bank
As it relates to risk management, the promotion, or maybe it's not a promotion. I am not sure what it was. The addition to responsibilities of the risk management head three weeks before the preannouncement?

Charles Prince
I am not sure of your question, Mike, but it was a promotion for David. David has taken on a broader set of responsibilities. Again, I don't see risk management as a guarantor of results in the kind of market dislocations that we have had this quarter, so I don't see that as a connection at all.

Mike Mayo - Deutsche Bank
I mean, reasonable people can disagree. If you don't like the Office of the Chairman or the way it is being run, you just sell your stock. But my question is, I saw Robert Rubin quoted in the press saying that your job should be safe for four years from now. Did the board kind of reaffirm your CEO status for the next several years? To what degree was your job title reinforced?

Charles Prince
I don't think it would be appropriate for me to comment on what Bob said or about what the board might be thinking in that regard.

Mike Mayo - Deutsche Bank
But you did say the board feels comfortable with the levels of changes that have been made. So should we assume that the changes are done?

Charles Prince
Again, Mike, I think it just wouldn't be appropriate for me to comment further on that subject.

Junk Mortgages 101

http://money.cnn.com/2007/10/15/markets/junk_mortgages.fortune/index.htm?postversion=2007101609 (Thanks Ron)

In March, less than a year after the issue was sold, GSAMP began defaulting on its obligations. By the end of September, 18% of the loans had defaulted, according to Deutsche Bank.

As a result, the X tranche, both B tranches, and the four bottom M tranches have been wiped out, and M-3 is being chewed up like a frame house with termites. At this point, there's no way to know whether any of the A tranches will ultimately be impaired.

When you start getting up into the A tranches you have quite a few mortgage insurers who will be in alot of pain. i.e. MBI

What is there to take away from our course in Junk Mortgages 101? Two things. First, you have to pay at least some attention to all those "risk factors" that issuers forever warn you about - especially when you're dealing with a whole new thing like junk mortgages issued en masse instead of by specialists.

Second, when you rely on the underwriter and the rating agencies to do all your homework for you, you don't have safety. You have only the illusion of safety.

This goes for equity investments obviously as well. It is one reason I don't like reading sell side research. Besides all of the psychology issues of anchoring on projections it tends to make you lazy even subconsciously.

Buffett Likes the Loonie

http://www.thestar.com/columnists/article/266412

At an invitation-only Toronto dinner Thursday for about 140 prominent investors, billionaire investor Warren Buffett said he expects the Canadian dollar to continue rising beyond the parity it recently reached with the U.S. dollar.

and

Buffett, who has made substantial resource investments this decade, after a history of avoiding them, is now interested in the Alberta oil sands.

and

Buffett said it was "very unsettling" that Brazil now is helping prop up the U.S. dollar with its purchases of U.S. government securities. "Brazil is a country whose own currency has gone to nil five times in the past century," he noted.

Investing Cheat Sheet

From a memo passed around on Wall Street. Made me laugh because it seems to have been what the market has been acting on. From Sep 10th to Oct 10th the NASDAQ created an 11% rally. That is moving.

Weak data = Fed ease, stocks rally

Consensus data = lower volatility, stocks rally

Strong data = economy strengthening, stocks rally

Bank loses $4 billion = bad news out of the way, stocks rally

Oil spikes = great for energy companies, stocks rally

Oil drops = great for consumers, stocks rally

Dollar plunges = great for multinational companies, stocks rally

Dollar spikes = lower inflation, stocks rally

Inflation drops = improves earnings quality, stocks rally

Inflation spikes = improves earnings quality, stocks rally

RJ's Research Note

I enjoyed the research note by Jeffrey Saut today. It starts with an excerpt by Adam Smith below.

http://www.raymondjames.com/inv_strat.htm


“Poor Grenville runs a fund, one of a group of funds, and he is in charge of $100 million or so.

. . . I asked Charley why Grenville was suddenly Poor Grenville.

‘Poor Grenville,’ said Charley, ‘has gotten caught with twenty-five million in cash. It’s a disaster. How would you like to have twenty-five million in cash with the Buy Signals you’ve just seen? Come to lunch. Poor Grenville has to lose his cash, right away.’

I know it sounds little funny that having $25 million in cash is a disaster. It sounds just as funny to me as the phrase ‘lose cash.’ When it isn’t your cash in the first place and all you are doing is taking the cash – somebody else’s – and buying stocks with it. But professional money managers love to say, ‘We lost five million in cash this afternoon,’ meaning they bought stocks with it. I guess it sounds professional.

. . . As to why Poor Grenville’s $25 million in cash was a major disaster that is more comprehensible. Grenville should have all $100 million fully invested if the market is coming off the floor; his fund is ‘performance-oriented,’ trying for big capital gains. If Poor Grenville has $25 million in cash he guessed dead wrong at the bottom of the market, and in one career you don’t get too many chances like that. Poor Grenville had gotten himself all ready for a big drop in October and now in January the market turned around and ran away without him. He has to make it up in a hurry.”

– The Money Game, by Adam Smith