Diary Archives

December 15, 2008

Global Market Comments for December 15, 2008
Featured trades: (GM), (BAC), (WFC)

1) Yet another weekend of investors furiously paging through IRA's, 401k's, and brokerage statements, struggling to learn if they have been wiped out. The stunning revelations about Bernard L. Madhoff Security Investments, LLC's $50 billion Ponzi scheme, which decimated a good portion of the Jewish charities in New York, is triggering a rebirth of due diligence. It appears that the bulk of the losses were taken by European banks, where that extra bit of distance gave him the cover he needed. One Spanish fund alone, Grupo Santander, took a $3 billion hit.

2) The Madhoff affair highlights the need to spot red flags before making any investment. A short list includes, embellishments on resumes, secretive control systems, inaccessible back office staff, obscure affiliated auditors, subtle conflicts of interest, trades executed only through a captive brokerage subsidiary, mismarked portfolio prices, and too many close relatives in key decision making positions. Another warning is 'mandate creep' whereby managers abandon conservative strategies described in a prospectus in favor of higher risk positions reliant on derivatives. And investors should be alarmed when a track record is too perfect, to the point of statistical impossibility. Madhoff's track record showed only two down quarters out of 214! Madhoff violated all of these principals. Security expert Kroll Fraud Solutions says that investment fraud is up 22% YOY and is rising, and urges more frequent spot checks by regulators. The problem with out of the blue blow ups like this is that they are like cockroaches. There never is just one. They tend to come in waves. Expect more scandals like this as we approach the year end book closing. Twenty twenty hindsight is a wonderful thing.

3) New Mexico governor Bill Richardson has been appointed to the post of Secretary of Commerce. This should be the world's easiest job because there isn't any commerce anymore.

4) The Empire State Manufacturing Index for December came in at a stunning 25%, the lowest on record. But the Baltic Dry Index is rallying, as are secondary resale prices for steel in China. Most importantly, spreads are narrowing across the board in the debt markets, the best leading indicator of future risk taking there is. All good bottom of cycle stuff. This data is not consistent with the world ending. We are in a no man's land now, where the lagging indicators show us still descending into hell, but the leading ones show us at least making it back up to purgatory (I just read Dante's Divine Comedy).

5) Many analysts expect that commercial real estate will be the next shoe to fall. Any deals done in 2005-2007 are particularly suspect, especially those with a high retail exposure and junk financing. Valuations were made based on cap rates as low as 3%.?? Move that cap rate back up to 8%, the minimum needed to attract new investment now, and the underlying property drops in value by half. Most REIT's have the cash flows needed to get through this crisis. But if they need to roll over debt in 2009, Heaven help them. Vacancy rates are now 15.7% nationally, and will easily exceed 20% next year. Still, problem loans in this sector are only thought to reach $200 billion, change under the sofa cushion compared to the other disasters out there.

5) The cash tsunami is finally hitting the mortgage market, with 30 year rates hitting a four year low of 5.47%. Bank of America (BAC) is offering a 1-2-3 program where rates start at 3 5/8%, then graduate to 4 5/8% and 5 5/8% in the second and third years. Wells Fargo (WFC) offers borrowers a jumbo rate of 8.5%, but will cut it to 6.5% if you deposit $250,000 with them. These 'compensating balances' use to be illegal, and tell you a lot about the current state of the banking businesses. In the meantime we learn that 50% of the homeowners in Nevada are now underwater on their mortgages.

December 15, 2008/by DougD

December 15, 2008

Diary

Global Market Comments for December 15, 2008
Featured trades: (GM), (BAC), (WFC)

1) Yet another weekend of investors furiously paging through IRA's, 401k's, and brokerage statements, struggling to learn if they have been wiped out. The stunning revelations about Bernard L. Madhoff Security Investments, LLC's $50 billion Ponzi scheme, which decimated a good portion of the Jewish charities in New York, is triggering a rebirth of due diligence. It appears that the bulk of the losses were taken by European banks, where that extra bit of distance gave him the cover he needed. One Spanish fund alone, Grupo Santander, took a $3 billion hit.

2) The Madhoff affair highlights the need to spot red flags before making any investment. A short list includes, embellishments on resumes, secretive control systems, inaccessible back office staff, obscure affiliated auditors, subtle conflicts of interest, trades executed only through a captive brokerage subsidiary, mismarked portfolio prices, and too many close relatives in key decision making positions. Another warning is 'mandate creep' whereby managers abandon conservative strategies described in a prospectus in favor of higher risk positions reliant on derivatives. And investors should be alarmed when a track record is too perfect, to the point of statistical impossibility. Madhoff's track record showed only two down quarters out of 214! Madhoff violated all of these principals. Security expert Kroll Fraud Solutions says that investment fraud is up 22% YOY and is rising, and urges more frequent spot checks by regulators. The problem with out of the blue blow ups like this is that they are like cockroaches. There never is just one. They tend to come in waves. Expect more scandals like this as we approach the year end book closing. Twenty twenty hindsight is a wonderful thing.

3) New Mexico governor Bill Richardson has been appointed to the post of Secretary of Commerce. This should be the world's easiest job because there isn't any commerce anymore.

4) The Empire State Manufacturing Index for December came in at a stunning 25%, the lowest on record. But the Baltic Dry Index is rallying, as are secondary resale prices for steel in China. Most importantly, spreads are narrowing across the board in the debt markets, the best leading indicator of future risk taking there is. All good bottom of cycle stuff. This data is not consistent with the world ending. We are in a no man's land now, where the lagging indicators show us still descending into hell, but the leading ones show us at least making it back up to purgatory (I just read Dante's Divine Comedy).

5) Many analysts expect that commercial real estate will be the next shoe to fall. Any deals done in 2005-2007 are particularly suspect, especially those with a high retail exposure and junk financing. Valuations were made based on cap rates as low as 3%.?? Move that cap rate back up to 8%, the minimum needed to attract new investment now, and the underlying property drops in value by half. Most REIT's have the cash flows needed to get through this crisis. But if they need to roll over debt in 2009, Heaven help them. Vacancy rates are now 15.7% nationally, and will easily exceed 20% next year. Still, problem loans in this sector are only thought to reach $200 billion, change under the sofa cushion compared to the other disasters out there.

5) The cash tsunami is finally hitting the mortgage market, with 30 year rates hitting a four year low of 5.47%. Bank of America (BAC) is offering a 1-2-3 program where rates start at 3 5/8%, then graduate to 4 5/8% and 5 5/8% in the second and third years. Wells Fargo (WFC) offers borrowers a jumbo rate of 8.5%, but will cut it to 6.5% if you deposit $250,000 with them. These 'compensating balances' use to be illegal, and tell you a lot about the current state of the banking businesses. In the meantime we learn that 50% of the homeowners in Nevada are now underwater on their mortgages.

December 15, 2008/by DougD

December 12, 2008

Diary

Global Market Comments for December 12, 2008
Featured trades: ($RTSI), (GM), (F)

1) It looks like the Senate's unequivocal refusal to bail out the Big Three is forcing Paulson to redefine the TARP mission yet again. There are just too many parts suppliers in battle ground state Ohio to think otherwise, even though the bailout is diametrically opposed to administration ideology. It's worth $15 billion to punt the Issue to Obama, and assure the actual chapter 11 filings happen on his watch. The derivative effects of a bankruptcy are just too dire to contemplate. General Motors (GM) and Ford (F) equities and bonds were classic widow and orphan investments. If we learn nothing else from this, it's that unions make lousy co-investors.

2) Sharply lower energy prices drove the November PPI down 2.2%. Retail sales dropped?? by 1.8%, the fifth down month in a row. The good news is that gas at my local station is down to $1.69/gallon. The bad news is that I had to trade my car for a 50 pound sack of beans and a couple of cases of Spam in order to eat this winter.

3) There are some fascinating things going on in global capital markets which are crucial to everything you do. Guess what the best performing stock market in the world has been since the Lehman bankruptcy? Shanghai, which has actually gone up since September 15. Then when terrorists hit Mumbai two weeks ago, slaughtering hundreds, everyone expected a total meltdown of the Indian market. Instead, it was up 2%. Today we have the big three threatening bankruptcy, the Senate refusing a bail out, and the uncovering of a $50 billion mutual fund fraud, and the Dow is up. What all of this is saying is that global equity markets are sold out, that no one has any stock left to sell, and that things have stopped getting worse. Throw bad news on a market, and if it doesn't go down, it will go up. That suggests that this, right here, this nanosecond, is the 'V' bottom for the economy. The economic data won't show this for another six months, but global stock markets are sensing this now, and will start to rally once we are into the New Year.

4) The collapse of crude has had a double whammy effect on Russia, knocking the wind out of both the stock market and the ruble. The RTS Index may stabilize around here at the 600 level, but the ruble could drop another 25% next year. The country has used up $200 billion of its $500 billion of reserves in just five months supporting the Russian currency to stave off a surge in imported inflation. So far the Russian consumer, the bedrock of Putin's political support, has not been affected because they don't borrow (only 4% of Russians have mortgages), and don't own stocks (70% of RTS trading is by foreign hedge funds, the rest by a handful of oligarchs). The income tax is only a flat 13%. Putin is cleverly using the crisis to buy back natural resource monopolies from heavily leveraged oligarchs on the cheap.?? I think Russia will be a huge buy next year, along with the remaining BRIC's, which should be at the core of any long term portfolio.

5) This is truly the year from hell for big hedge funds, which will see assets fall 50% from $2 trillion to $1 trillion through a combination of market losses and redemptions. The mega hedge fund model is truly broken. Monster fees and hockey stick performance bonuses that ran up to 50% are headed for the scrap heap of history. Surviving funds are splitting into two parts. One will hold illiquid highly leveraged junk debt positions where redemptions have been frozen, and can only be unwound over a period of years, essentially becoming private equity funds. The remainder will go to smaller, nimble long/short trading strategies in large liquid markets like currencies, Treasuries, and large cap equities where the older funds sprang from. Dating back to the days when hedge funds were run out of garages, guest bedrooms, and attics, and $25 million was considered a lot of capital, I have to tell you that these developments are way, way overdue.

December 12, 2008/by DougD

December 12, 2008

Diary

Global Market Comments for December 12, 2008
Featured trades: ($RTSI), (GM), (F)

1) It looks like the Senate's unequivocal refusal to bail out the Big Three is forcing Paulson to redefine the TARP mission yet again. There are just too many parts suppliers in battle ground state Ohio to think otherwise, even though the bailout is diametrically opposed to administration ideology. It's worth $15 billion to punt the Issue to Obama, and assure the actual chapter 11 filings happen on his watch. The derivative effects of a bankruptcy are just too dire to contemplate. General Motors (GM) and Ford (F) equities and bonds were classic widow and orphan investments. If we learn nothing else from this, it's that unions make lousy co-investors.

2) Sharply lower energy prices drove the November PPI down 2.2%. Retail sales dropped?? by 1.8%, the fifth down month in a row. The good news is that gas at my local station is down to $1.69/gallon. The bad news is that I had to trade my car for a 50 pound sack of beans and a couple of cases of Spam in order to eat this winter.

3) There are some fascinating things going on in global capital markets which are crucial to everything you do. Guess what the best performing stock market in the world has been since the Lehman bankruptcy? Shanghai, which has actually gone up since September 15. Then when terrorists hit Mumbai two weeks ago, slaughtering hundreds, everyone expected a total meltdown of the Indian market. Instead, it was up 2%. Today we have the big three threatening bankruptcy, the Senate refusing a bail out, and the uncovering of a $50 billion mutual fund fraud, and the Dow is up. What all of this is saying is that global equity markets are sold out, that no one has any stock left to sell, and that things have stopped getting worse. Throw bad news on a market, and if it doesn't go down, it will go up. That suggests that this, right here, this nanosecond, is the 'V' bottom for the economy. The economic data won't show this for another six months, but global stock markets are sensing this now, and will start to rally once we are into the New Year.

4) The collapse of crude has had a double whammy effect on Russia, knocking the wind out of both the stock market and the ruble. The RTS Index may stabilize around here at the 600 level, but the ruble could drop another 25% next year. The country has used up $200 billion of its $500 billion of reserves in just five months supporting the Russian currency to stave off a surge in imported inflation. So far the Russian consumer, the bedrock of Putin's political support, has not been affected because they don't borrow (only 4% of Russians have mortgages), and don't own stocks (70% of RTS trading is by foreign hedge funds, the rest by a handful of oligarchs). The income tax is only a flat 13%. Putin is cleverly using the crisis to buy back natural resource monopolies from heavily leveraged oligarchs on the cheap.?? I think Russia will be a huge buy next year, along with the remaining BRIC's, which should be at the core of any long term portfolio.

5) This is truly the year from hell for big hedge funds, which will see assets fall 50% from $2 trillion to $1 trillion through a combination of market losses and redemptions. The mega hedge fund model is truly broken. Monster fees and hockey stick performance bonuses that ran up to 50% are headed for the scrap heap of history. Surviving funds are splitting into two parts. One will hold illiquid highly leveraged junk debt positions where redemptions have been frozen, and can only be unwound over a period of years, essentially becoming private equity funds. The remainder will go to smaller, nimble long/short trading strategies in large liquid markets like currencies, Treasuries, and large cap equities where the older funds sprang from. Dating back to the days when hedge funds were run out of garages, guest bedrooms, and attics, and $25 million was considered a lot of capital, I have to tell you that these developments are way, way overdue.

December 12, 2008/by DougD

December 11, 2008

Diary

Global Market Comments for December 11, 2008
Featured trades: (BA), ($WTIC), ($GOLD), ($XEU)

1) Weekly jobless claims soared by 58,000 to 573,000, a 26 year high. A lot of workers came back from their Thanksgiving turkey only to get fired. According to UCLA's Anderson report, unemployment in California will peak at 8.7% next year. This may be conservative.

2) The euro ($XEU) broke out to the upside, moving to $1.3280, a two month high. Gold ($GOLD) also moved up $20 to $827. If the dollar continues to weaken, it could jeopardize Treasury efforts to sell bonds to finance reflation, half of which are bought by foreigners. The weak dollar could also be the trigger for a long overdue trading rally in commodities. Crude ($WTIC) has already rocketed from $40.50 to $48.50 this week. I think commodities will be the big play next year, and some hedge funds are already starting to do some early toe dipping in the waters at these incredibly oversold levels.

3) Real Estate investor Sam Zell says that it took a 'tsunami' of?? unforecastable developments to drive the Chicago Tribune into a preemptive bankruptcy. The Chicago Cubs won't be affected by the proceedings. Zell bought the company a year ago when revenues were falling at an annualized 3%, at a price assuming a 6% annualized drop. Instead he got a 20% plunge in revenues, death for any leveraged deal. Complicating matters is an FBI interrogation of Zell related to the governor Blagojevich case.

4) The International Energy Agency predicts that total crude demand will fall this year for the first time in 25 years. This has created an unexpected?? window of opportunity to move to alternatives before the next up spike, which will probably start in 2010.

6) Boeing (BA) announced that it was delaying delivery of its fuel efficient 787 Dreamliner by another six months to Q1, 2010. Some airlines have decided that with fuel prices down 75% in five months, and with a deep recession staring them in the face, their rusty, worn out, gas guzzler aircraft don't look so bad after all. Some 2,444 planes, or 11.5% of the global fleet is now parked in mothballs, with the bulk coming from Europe.

7) Jamie Diamond, CEO of JP Morgan (JPM), believes that US home prices could drop another 20%. Oops.

8) Goldman Sachs (GS) put out an important report on China, predicting that its growth rate will drop from?? 9% in 2008, to 6% next year. It will then bounce back?? to a 9% rate in 2010. While I believe this is still optimistic, it is more evidence pointing towards the 'V' type recession scenario I have been expecting, rather than the 'U' type scenario anticipated by most.?? Last month, exports fell 2.2%, the sharpest drop in nine years. A big problem here is that modern China has never had a recession, just a growth rate that varied from hot, to red hot, so the country's companies have no experience in managing real downturns.

QUOTE OF THE DAY

' This recession will be so deep and so prolonged, that 0% interest rates will be reached even by the most anal retentive, gradualist central bank before the middle of 2009.' Willem Buiter, a former member of the Bank of England's monetary policy committee. Imagine, global zero interest rates.

December 11, 2008/by DougD