Market Comments for March 18, 2008

1) The price action of Lehman Brothers these days is frighteningly similar to that of Bear Stearns just before it went bankrupt. In the last week Lehman's share price has dropped from $60 to $20. At the very least this has to be considered a near death experience. Today CEO Richard Fuld came out and said that there were no liquidity concerns at Lehman. Thanks to better than expected earnings announced today the stock is back up to $45. If they go under the way that Bear did they will get taken over the same way at a nominal price, say $1/ share, wiping out the equity holders but not actually going bankrupt. That effectively wipes out all of the shareholders but preserves the rights of bond holders, minimizing the impact on the financial community. Watch out for LEH!

2) The big news today was the Goldman Sachs earnings which came in at $3.23/ share vs. and expected $2.58/share. They disclosed that their leveraged loan book shrunk from $47 billion to $20 billion, a staggeringly rapid shrinkage of their balance sheet. This shows you how quickly the whole industry is downsizing.

3) The homebuilders most likely to go bust are those that have the highest reliance on revolving credit facilities. Those are WCI, and Hovnanian. The most liquid and financial strongest homebuilders are?? NVR Inc., MDC Holdings, KB Home, and Toll Brothers.

4) With the Fed rate cut from 3.0% to 2.25%, and the inflation rate now at 2.5% on its way to 3%, real interest rates are now officially negative.

5) Bear Stearns stock today traded up to $8, four times the bid from JP Morgan. This is not a cash deal but an exchange for JP Morgan stock which is up big today. There are also moves by Bear employees to sue to tie up the deal in court for a few years. In the meantime the sub prime market will recover and Bear will regain the $80/ share in book value the firm had a few months ago. Many shareholders also believe they will do better in a plain vanilla bankruptcy or that JPM will increase their bid. Another big payday for the lawyers.

Market Comments for March 17, 2008

1) Bear Stearns (BSC) was taken over by JP Morgan (JPM) at $2/share, about 5% of its breakup value of $7.7 billion. It is a virtual total wipe out for the BSC equity holders. JP Morgan stock jumped 10% on the windfall gain. They are getting about $20 billion of sub prime securities for free in the deal. The HQ building alone is worth $4 billion. Half of 14,000 employees will lose their jobs. Clients were pulling out money on Friday as fast as they could write the wire transfer orders. Some people knew this was coming. On Tuesday when the stock was still above $60, more than 90,000 $35 strike BSC puts were bought at 20 cents. They hit $33 today with an implied volatility of 700%, a gain of 165 times! The other big winners in the deal are Bear Stearns bond holders which now have a de facto JP Morgan guarantee. Next to be targeted by short sellers: Lehman Brothers, which has dropped 50% since Friday. It reports earnings on Tuesday which could spark a further sell off.

2) Crude dropped $7 on the Bear news for fear of margin calls on all other speculative products. All other commodities except gold also suffered big drops. Hedge funds are selling their good positions to meet margin calls on the bad.

3) The futures market is now discounting a high probability of a 100 basis point cut by the Fed tomorrow. Anything less than that and there could be another market sell off.

4) There has been a wholesale stampede into risk free assets. The 90 T-Bill rate got as low at 80 bp today, which is as low as it has been in Japan. The ten year bill hit 3.30%. After tomorrow the US dollar may become the new carry currency, replacing the yen. There are massive unwinds of short yen, long euro positions going on.

THOUGHT OF THE DAY

30 year Treasury bond futures hit 122 today, yielding 4.2%, the highest price since the big deflation scare of 2002. In the meantime the yield on Treasury Inflation Protected Securities (TIPS) are now trading at negative yields, indicating a strong resurgence of inflation by year end. This makes 30 year bond futures a screaming short, with my three year target at 85. Do this five times, a relatively low amount of leverage in the bond market, and you will get a three year return of 150%.

Market Comments for March 14, 2008

1) Put buying on Bear Stearns (BSC) increased tenfold yesterday and so did the stock volume. In every financial crisis it seems that one major institution has to be offered up to the market gods for sacrifice before it ends. Bear Stearns is the most likely candidate this time. Goldman Sachs (GS) and Morgan Stanley (MS) have already ceased dealing with Bear for fear of counter party risk. Alternating rumors of bailout and collapse caused an intraday range of 500 points in the Dow today. Look for something to happen over the weekend.

2) As a Latin scholar you will immediately recognize that tutefu valui means 'fair value'. That is what the tattoo says on 'Kristen's' stomach.

3) When the credit markets recover, one big play will be the publicly traded private equity firms. Fortress Investment Group has seen its share price drop from $32 to $11, while Blackstone has plummeted from $32 to $14. Collapse of the credit markets have shut these firms out of their most profitable business lines. To show you how desperate they are Fortress just arranged a $25 million private refinancing of Michael Jackson's Neverland property to head off foreclosure. Not exactly prime business.

4) The government's tax receipts are falling sharply indicating that the recession may be sharper than expected!

5) The consumer price index for February came in unchanged versus an expected rise of 0.2%. With inflation temporarily under control the Fed now has a green light to cut interest rate by 0.5% on March 18. Your cost of financing is about to drop further.

6) Cattle futures have collapsed as ranchers accelerate slaughters due to the high price of corn, which has doubled to $6.30/bushel in 9 months. This will lead to sharply higher beef prices and shortages by the beginning of next year.

7) Junk stocks are an area where you can run a small back book. Buy ten of these. If half go bankrupt and the survivors increase fivefold you get a return of?? 250%. These are firms that were taken private, loaded up with debt, and then refloated at the top of the market last year. A good example is Idearc (IAR), the yellow pages spin off of Verizon. The company kindly loaded up IAR with a bone crushing $9 billion in debt before the spin off. In the past year the stock has cratered from $34 to $3. The stock now has a PE multiple of 2 and a dividend yield of 25% (no typo here). But the company also has huge cash flow giving it an interest coverage ratio of 2:1. There are a dozen more of these out there.

TRADE IDEA

Google, last year's darling of the market, has nearly halved in four months. With a 70% market share in internet search, the company has basically become the toll taker for the internet. At $420 GOOG is now selling at a multiple under 20 times. The company is a cash machine almost as efficient as the US Treasury, and has almost as many reserves as Fort Knox. Even though economic conditions are dire, it is still increasing sales as advertisers accelerate their epochal shift away from traditional print and broadcast media to the Internet. Its only potential competitor is Microsoft (MSFT), which first ignored the Internet, then was hobbled by the Justice Department, then finally stumbled over its own big feet with a series of small and meaningless acquisitions. Its latest attempt to break the Google monopoly with a takeover of Yahoo (YHOO) came to naught. Although Google is excessively wasteful on things outside its core business, like space travel, it still offers a rare chance to get into a best of breed company on the cheap.

Market Comments for March 13, 2008

1) Carlyle Capital was the big story today with its default in Amsterdam. These bone heads had $23 billion in bond positions securited by only $650 million of capital, giving them a leverage of 35 times. Good riddance. Expect a lot more bodies like this to float to the surface. A lot of big milestones were hit today: Gold over $1,000, Yen at Y99, crude over $111. You know things are bad when they call the 'stock report' the 'damage report.'

2) Another thing eroding the muni bond market has been an upsurge in applications by homeowners to have real estate taxes cut because of falling home values. This could erode the revenue bases of municipalities in the hardest hit real estate markets in Florida and California and could snowball.

3) The association of Commercial Realtors predicted that transactions could drop 30-40% this year. The default rate on commercial CMO's will almost certainly increase from last year's low 0.6% rate. Goldman Sachs (GS) is said to be covering shorts in residential CMO's where they made a fortune last year and are putting the same trade on in the commercial area. But industry veterans believe that only recent high LTV deals are at risk, or anything connected with Florida condos.

4) Crude inventories rose by 6.2 million barrels last week, a build three times larger than expected. The price fell from $110 to $107, then shot right back up to $111. This shows you that the oil industry has completely lost control of oil prices and that they have nothing to do with actual supply and demand. It is now completely controlled by hedge funds and the price is going higher. Next stop $120. Bay area gasoline is going over $4 next week and will hit $5 in two months.

5) February retail sales came in at -0.2% versus expectations of +0.6%, indicating that the economy is far sicker than people realize.

THOUGHT OF THE DAY

Of the $1.8 trillion in hedge funds under management, possibly half is devoted to super leveraged bond strategies of many descriptions like those employed by Carlyle. There is going to be a flight by investors from these funds who will be looking for less leveraged strategies to invest in. That means it is a good time to launch a limited leveraged equity oriented hedge fund.

Market Comments for March 12, 2008

1) The Fed action yesterday is like a cortisone shot for a sick patient. It gives immediate relief, but doesn't cure the disease. Financial problems won't end until house prices stop going down and eroding bank capital. But the Fed has injected $1 trillion in liquidity since December and by next week will have lowered interest rates 3%. They are pouring a lot of gasoline around hoping that someone will eventually strike a match.

2) Call buying in Sallie Mae increased ten times yesterday. The stock has fallen from $60 to $16 and is now a screaming buy. Unlike Fannie Mae and Freddie Mac you cannot discharge student loan obligations through bankruptcy. They carry a call on your future earnings for your entire life until they are paid off.

3) The CEO of Freddie Mac said that we are in the worst housing crisis in 100 years. He said that we are only 1/3 of the way through the down move in house prices.

4) Commercial real estate transactions declined by 68% in January YOY. But this represents just a backing off of the record $470 billion in total transactions in 2007. The industry is in far better position to enter this recession than in past recessions. Occupancy rates are higher, the quality of properties is better, and lease terms are longer. There is less unused capacity, less overbuilding, far greater institutional participation, and plenty of vulture money from outside the industry waiting on the sidelines to swoop in and buy distressed properties (Warren Buffet, sovereign funds, hedge funds, etc.). One new and worrying problem is the record level of spreads of commercial mortgage backed securities over Treasuries, which will inevitably raise the cost of capital for investors, despite the Fed rate cuts.

5) The media is having a feeding frenzy over Spitzer. The tabloids are offering $1 million to 'Kristen' to come forward for an interview. Papers are scouring East coast model agencies looking for the 5'5' petite brunette. ??Who were 'Clients 1-8'? Were they republicans? It wasn?t me! Watching the coverage of?? Spitzer's motorcade to the resignation speech on TV was reminiscent of the OJ arrest. That's what happens when you live in a glass house and throw rocks. Couldn?t happen to a nicer guy.

THOUGHT OF THE DAY

My suggestion to short the 2-10 year Treasury spread at 260 points last week came in big time today. The spread collapsed to 220 basis points. The profit on the trade would have been 4% in 5 days, or $120,000 on $3 million in capital, which is huge for an almost riskless trade. Normally you have to wait six months to make this kind of profit on a spread trade.