Friday, June 26, 2009
"However, this strong economic growth was not to last. As the 1980s came to an end, the US economy slowed dramatically, and by the early 1990s tipped into recession. To make matters worse, the banking system was in turmoil, with hundreds of small and medium-sized banks failing and giants like Citibank and Chase Manhatten in distress. Meanwhile, the real estate boom had collapsed, causing even more pain."
"The inevitable collapse of the real estate boom really shook the banks. Uncertainty about the value of the real estate collateral securing their loans made bankers unsure how much capital they actually had—leaving many of them paralyzed, frightened, and reluctant to lend further. Big businesses were able to tap other sources of funds, such as innovative debt markets that had sprung up on Wall Street—(note: this is likely to be securitization and shawdow banking)a phenomenon that helped keep the 1990 recession shallow. But small and midsize manufacturers and mer-chants all over America were finding it hard to get even routine business loans approved. And that, in turn, made the recession unusually difficult to snap out of. "
"Nothing we did at the Fed seemed to work. We'd begun easing interest rates well before the recession hit, but the economy had stopped responding. Even though we lowered the fed funds rate no fewer than 23 times in the three-year period between July 1989 and July 1992, the recovery was one of the most sluggish on record. I would see President George Bush every six or seven weeks, usually in the context of a meeting with others but sometimes one-on-one. Before long, the administration began blaming its troubles on the Fed. Supposedly we were choking the economy by keeping the money supply too tight."
"When the recession hit that fall, the friction only got worse. 'There has been too much pessimism,' President Bush declared in his 1991 State of the Union address. 'Sound banks should be making sound loans now, and interest rates should be lower, now.'"
So the last credit crunch the US has had was saved by a new high in the US credit bubble made through securitization and shadow banking. This time the game is up, the Fed Senion Loan Officer survey still shows bank loan standards are being tightned across the board a weak jobless recovery looks like a likely outcome. The unemployment rate went up almost 1% after the last 2 recessions were declared over. It looks likely the current one will see unemployment reach 11%
Monday, June 22, 2009
I'm as bearish as a number of other people in the US stock market however one of all the arguments for 'this is a bear market rally' I'm not sure the 'low volume in the rally' is a good one, the market just came from a period where everybody thought things were going to $0, the market was trading in a economic depression type enviroment so it was expected that volume would shoot at absurd levels. As the depression is priced off the market is natural that volume would decrease, there's nothing unhealthy about this, its only unhealhy if you are looking at volume moving averages that are still capturing the Lehman crisis Sep08-Mar09 volume levels
Its almost impossible to beat that kind of volume without another massive failure so some bears are creating an strawman in order to support their cases. The current volume levels is still right in line with the pre-lehman 2008 levels so it could be a more neutralish technical point than some realize
Thursday, June 18, 2009
Friday, June 12, 2009
We hear a lot about helicopters dropping money from the sky in order to beat deflation, that kind of plan is not likely to be ever adopted since it would be unfair to all citizens not in the cities that is getting the cash rain, further more no government body(to my knowledge) has the authority to take such action. However the IRS has a paper check mailing authority that can and is likely to be used in the case deflation in the core CPI becomes a reality and is persistent.
Here's how it would work, the administration working with congress would receive a advice from the Fed chairman to go ahead and issue a tax cut to virtually all citizens for an gigantic amount(Say 50% of US consumer spending, $5T), the fed would stand behind the bond auctions and monetize to make sure the government would have no problem financing it. The US consumer would suffer an gitantic 'wealth effect' of receiving such windfall gains in networth and its very likely to spend a significant fraction of the tax cut(as the history of the wealth effect shows, people spend when they get big jumps in networth)
Immediately as those paper checks were deposited, the money supply would soar(checking accounts are a component of M1), total M1 as 04/2009 is $1.5T, that would jump to $6.5T(Which would be the largest jump in M1 in the history of the United States). Now keep in mind that no banking credit expansion would be necessary for this. To the extend that people spent some of that money(and there is no reason to expect that cash to have 0 velocity due the wealth effect and the fact that people spend some % of tax cuts) that would put A LOT of upward pressure on prices, we are talking an overnight huge jump in the money supply AND velocity, even if that didnt happen nothing prevents them from keep increasing the amount of money printed. They could print 1 quadrillion dollars if necessary, talk about wealth effect
In the meantime the banking system can be frozen and yet inflation on the moon. If you read the american central bank literature of the last decade there is simply no reason to expect Bernanke and Co to not go for these extreme plans in order to beat deflation, they already said they will if necessary.
Actually just the announcement of such intentions by the Fed chairmain is likely to send the dollar index plunging and everyone scared of inflation(therefore money velocity would rise), its possible that not a single check needs to be mailed
As of right now, there is no reason for the fed to take such action as the core inflation rate is in their comfort zone, inflation expectations are well anchored and the economy is showing signs of stabilization. But make no mistake, if those improvements reverse one of the easiest money fed chairman since Arthur Burns + politicians desire to spend without raising taxes(It shouldn't be too hard to convience congress and Obama that more stimulus is needed, specially with unemployment about 10%) and the IRS mailman drop of money(or direct deposits to bank accounts) virtually guarantees US deflation wont be here to stay(Or it would be cured naturally as the economy bottoms out)
That might not be the case in europe where deflation could be persistent as the ECB is not as extreme(plus they don't have a centralized mailman to send checks, they would have to pick a government and all sorts of problems could occur) they also have the German hyperinflation history which further creates political problems and criticism and certainly is not the case with the BOJ, which is run by incompetents who never tried extreme measures to reverse deflation and raise the money supply without depending on the banking system
Monday, June 8, 2009
Well, according to the stock market more than $4T dollars. Market cap of the Whilshire 5000 in the march lows day $9.38T, market cap today $13.4T. Given the total US corporate profits(including non-publicly traded corporations) was $1.2T in 2008
, the market decided that when economic data stops accelerating the rate of contraction that is worth putting a additional 4x profit multiple over it. It was a about an 43% rally, did the green shoot story overshoot?It looks like so since a 2nd derivative doesnt tell you anything about WHEN a bottom is coming, it just tells you that there is one. The green shooters have a $4T gamble going on, time will tell whether they paid the right price for their optimism
Wednesday, June 3, 2009
Krugman seems to be in the camp that deflation is inevitable, there is nothing that can be done and people shouldn't be worried about inflation.
Here's how the fed can create tons of inflation. Working with the treasury they announce a broad tax cut of $20T for all US citizens, it would financed by creation of new money by the Federal Reserve, this would bypass the banking system need to expand credit.
If people save 80% of that, they would still spend $4T. US consumer spending would rise by about 40% very quickly and tons of new money would flood the economy. This wouldn't create just inflation, hyperinflation would likely to be the result. The fed is not going there just yet(and they shouldn't) since the core CPI and inflation expectations are still within the Fed's range but if things fell out of bed you can count on the fed to make everybody to pay more for goods and services.
And to the extend that markets are forward looking people SHOULD be worried about inflation at some point over the next years as the fed suffers from an asymmetrical dilemma, where inflation is bad but deflation much worse therefore they will like to err in the side of the former
To argue otherwise is to ignore most of the american central bank literature of the last few decades where they make it clear they wont tolerate deflation and a frozen financial system wont prevent them from meeting their objectives.
Friday, May 29, 2009
Til Schuermann a member of the Federal Reserve Bank of New York testified before congress and he made some scary remarks. It's a highly recommended reading
"When one adds credit provision though corporate bonds and commercial paper, one realizes that commercial banks have provided only about 20% of total U.S. lending, since the early 90s. The four decades prior had banks’ share closer to 40%. The rise of market-based instead of bank-based credit provision in the last twenty years has been substantial and important."
Bernanke was using misleading numbers about a 50% share a few months ago, I assumed his figure was correct. I first saw the 20% in the Economist a few weeks back, the FRBNY now is backing this. With the shadow banking system now in its grave(the commercial banks still zombified) plus market lending still weak(although enjoy a nice temporary rebound) this spells big trouble for future credit growth and US potential GDP. The stock market is almost surely being delusional if they expect the type of corporate profit margins the US had in 2007 to return, if anything they will continue to shrink. 2010 GDP which is forecast to be around 2-3% is also almost surely too optimistic with the current levels of credit growth and household stress
Monday, May 25, 2009
Friday, May 22, 2009
"Recession Turns Malls Into Ghost Towns" - WSJ
Gap Profit Falls as Consumers Trim Clothing Purchases
This week ICSC-Goldman Store Sales posted a 1.2% decline W-W
Redbook reported -0.2% in store sales from Apr to May
Wednesday, May 20, 2009
What are the odds that the worst GDP report ever is followed by a V type recovery as it seems to be currently embedded in Japanese equity values?(Or at least expectations that another L wont occur)
Here's some analyst comments from the worst report ever
"We’ve turned the corner. The economy is no longer in free fall"
“The worst is over,” said Hiromichi Shirakawa, chief economist at Credit Suisse Group AG in Tokyo. “We’re going to see positive growth -- not significant growth, but growth --from the second quarter onward.”
They usually justify the optimism by hand picking data that is bouncing around
It just seems that the odds that people are engaging in wishful thinking is much greater than the odds of a actual V recovery after collapses of this magnitude(specially when needed reforms are still lacking), maybe wishful thinking is as much as 8-1 favorite to be taking place than the theory that an actual V type recovery is happening
I've been hearing a lot of 'inventory' recovery in the 2nd half following inventory drawdowns in the US and countries. That is totally wrong, inventories are down but SALES are down even more
As sales reset to a new level so does inventories, who is going to rebuild invetories when you can't sell anything?
Monday, May 18, 2009
John Hussman Watch
Hussman lastest article looks mostly correct with the exception of when he addresses the idea of pundits referring to consumers increasing their savings as being bad to the economy
"At present, it is not valid to say that the economy is weak because people are saving too much, because if gross savings were up, gross investment would also be up."
Well the problem is that when pundits say 'people' are saving too much they refer to US consumers and to some extend to the corporate sector not to "gross domestic savings"(that is, total saving including consumer, corporate and government entities) that Hussman is addressing, in fact one of the arguments of the pro-stimulus people is that since consumers are saving more its up to the government to borrow and spend so to keep gross domestic saving from collapsing national income(Like in the example he outlined)
So yes he is right that gross domestic savings is not rising(Mainly due the government deficit) but its not rising because left to its own devices it would have risen and the government decided to try to cushion its impact by increasing government investment(thus lowering government saving) by running deficits and through the stimulus plan, so the pundits are wrong from a nit picky English perspective but their main point still stands, a rise in consumer saving in a macro level while desirable in the long-run is not its good for the economy at all when it happens in a major way very quickly, if uncontrolled it would lead the US into a deep depression, yes savings equals investment but only because 'investment' includes inventories, so if everybody stopped buying from wall-mart tomorrow the rise in WMT inventories would show up as 'investment' even though WMT had no intention on increasing investment, in fact its just the opposite they will cut jobs, stop expanding till they see a pickup in sales(Hussman acknowledges this by saying "Output that is not consumed represents 'investment' even if it is unintentional 'inventory investment.' ")
This article from Wikipedia nails it
"Note that this is an "identity", meaning it is true by definition. This identity only holds true because investment here is defined as including inventories. Thus, should consumers decide to save more, and spend less, the fall in demand would lead to an increase in business inventories. The change in inventories brings savings and investment into balance without any intention by business to increase investment.
Note, that as such, this does not imply that an increase in savings must lead directly to an increase in investment. Indeed, business may respond to increased inventories by decreasing both output and intended investment. Likewise, this reduction in output by business will reduce incomes, forcing an unintended reduction in savings. Even if the end result of this process is ultimately a lower level of investment, it will nonetheless remain true at any given point in time that the S=I identity holds"
Therefore Hussman setup a bit of a straw man and is nit picking pundits and analysts because when they say a 'this rise in savings is hurting the economy' they do not mean 'gross domestic saving'(Which is affected by government deficits and investment) but they refer to consumer and business saving(that is gross domestic private saving), which a major quick rise in a macro level would result in a economy much weaker than otherwise(The so called Paradox of Thrift)
Friday, May 15, 2009
Credit Markets are healing and opening up for business. Credit Research indices of credit spreads are improving across the board
Could the market be engaging in wishful thinking and be ready for another blow out of spreads?Sure but this healing creates a self-fufilling propechy(What George Soros calls 'reflexivity'), the improvement in risk taking increases the amount of credit avaliable to economic agents which raises the chances they will make it without going through bankruptcy, it also lowers their cost of credit increasing their profitability which also raises their odds of survival. As Bill Ackman put it if everybody was a pessimist like Roubini the economy would die of a horrible death. If instead everyone just turned into a Pollyana the economy would perform much better than otherwise, thats why badly designed stimulus packages are not such a bad idea, quasi placebos can be a powerful thing
Thursday, May 14, 2009
Since my current macro thesis calls for lower equity prices(particularly in financials, reits and other leveraged garbage companies) I thought about making some counter arguments against a bearish view in stocks and the US economy
1 - The Yield Curve is suggesting recovery. People who ignore the Yield Curve are usually wrong
2- Housing Affordability is reaching generational levels
Some housing experts believe that a particular level of home prices is not what drives demand but actually housing cost against income, with mortgage rates so low AND prices dropping affordability is rising. Perhaps Case Shiller will surprise everyone by bottoming earlier
3 - IMF Research on Financial Crisis suggest financial crisis recessions last 5.5 quarters on average and syncronized recessions last 4.5 quarters on average. So far this US recession has lasted a little more than 5 quarters so a bottom could be around the corner
4- Private Banks might not be lending a lot but the US government is taking over the role of a lender(The so called Minsky Solution). TALF, fed facilities(like the Commercial Paper facility) are substituting the private sector and helping support credit. Those programs can surprise on the upside by getting more traction, in fact TALF for CMBS could start a big bailout of REITs and prevent GGP type failures
5 - US stocks already went down by 60% or so from peak to through its silly to keep pounding on the same bearish thesis as the risk reward is getting terrible and risk premiums and projected returns are rising. Experienced short sellers such as Jim Chanos follow this disciplined approach, he is out of short selling financials and beaten down sectors due a 'asymetrical risk reward relationship' he says he will let 'others pick up the last $10 a share'. There is a lot of wisdom behind this theory, in fact its pounding on the same thesis what destroyed Citigroup, Bear Sterns, Boone Pickens, Dwight Anderson, Tech Stock investors, others. In fact when you have markets going one way or the other in a straight line at turning points a lot of people will go broke because its natural to look at the 'fundamentals' in a very biased way when you have huge profits. People will make up excuses to stay in the trade
Tuesday, May 12, 2009
The Stress Test seems to be using a slighly worse forecast than 'the blue chip' consensus. A few points
-If the Blue Chips forecast for 91-day T-Bill rates plays out, that implies a federal funds rate at 2.5-3% by 2011, this would hurt bank margins and earnings. It's very likely this fact wasn't factored in the stress test as the Treasury seems to think all banks problems will be magically over by december 2010
-Its May and the unemployment rate already matched the blue chip forecast for the entire 2009
-They all expect 10 Year US Treasuries to be around 5% from 2013 to 2019, this seems like a joke, its very likely its going to be one extreme or the other, either the US becames japan and the ten year trades around 2% for a long time or it gets out of this problem with inflation and fiscal issues(including the severe entitlement problem) and rates soar
The stock market own forecast is probably a mix of those above, it clearly doesn't expect the stress test 'more adverse' scenario to occur otherwise banks would have no earnings(They would post a more than $200b net loss) and the XLF would nosedive. Consensus is usually too bullish, especially when massive bubbles burst, when the market realizes that the more adverse scenario is actually the baseline things will get ugly
Friday, May 8, 2009
The stress test result is out showing that is expected that banks will lose $600b against $362.9b in pre-tax pre-provision income(What the feds call pre-provision net revenue, PPNR), this is a $237.1B in net losses for the US 19 largest banks
Of all the banks tests only three show they will have a net gain over the next two years, Goldman with a whopping $0.7B gain($17.8B losses against $18.5B in PPNR), Bank of New York Mellon with a gain of $1.3B, Amex with a gain of $0.7B
Now keep in mind that the PPNR uses the management estimates of what they will likely earn, this is almost certainly too optimistic as anything that depends on a CEO judgement usually is. It also uses the Treasury economic forecast that will likely prove too optimistic as well(Unemployment is likely to top at 11%). But even then, forget Meredith Whitney, the fed just launched their own earnings forecast for Bank Stocks
over the next 2 years, virtually all of them will show a netloss, some of them will need additional capital and dillute shareholders as their rosy scenarios dont playout. If you look at anlysts earnings estimates they painting a much more optimistic forecast and the stock market is putting something like a 10 multiple on those rosy forecasts, what happens when the market realizes the economy wont grow at 2% rate in 2010 and there will be no earnings and more dillution coming?
What we are seeing in banks stocks is one of the biggest suckers rally ever
Wednesday, May 6, 2009
"We continue to expect economic activity to bottom out, then to turn up later this year....An important caveat is that our forecast assumes continuing gradual repair of the financial system; a relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall"
"Investors seemed to adopt a more positive outlook on the condition of financial institutions after several large banks reported profits in the first quarter, but readings from the credit default swap market and other indicators show that substantial concerns about the banking industry remain."
Bernanke's concern arises from his own research published in a paper and his book about the great depression. He found significant statistical correlation between banking panics in the 1930's and collapses in industrial production and economic activity
Most of the Q1 earnings were either one-time items(like mortgage refis or capital gains from holding GSE debt), volatile hedge fund type profits('trading' revenues), gains from declines in the bank own debt or write-ups from bad assets using rosy assumptions. It doesnt take a genius to realize that a quarter where GDP went down 6% and unemployment jumped shouldn't bring out profits to businesses that are simply levered bets in the US economy
With home prices still in decline and unemployment headed higher its very likely bank earnings will dissapoint the now optimistic forecasts, beating Q2 estimates will be much more difficult because everyone is now passing the green shoot bong and optimistic expectations are setting their own downfall
Looks like BAC needs $30b+ in capital, C $10b and 8 other banks also need money. Keep in mind that this is using the government rosy assumptions about unemployment and accepting bank management rosy assumptions about pre-tax pre-provision earnings, plug-in more realistic numbers and the capital needs would certaintly soar. This suggests Bernanke's fears might became reality as the market will grow its concerns about bank capital and earnings in the coming months. The XLF has lead this market all the way down, unless housing and the labor market turns around its quite likely this will happen again
Monday, May 4, 2009
Apparently Buffett believes in Madoff banking, he wants the government allowing banks to 'earn' their way out of the problem even if they are insolvent. He said sometime ago he feared the 'government forcing banks to issue stock at very low prices, they can earn their way out of this mess', he is the US zombie banking commander in-chief. For him its not a big deal for the banks to be be critically undercapitalized in a tangible common equity basis(like Wells Fargo) as a long bankers get a chance of to hit again after one of the biggest strike threes in the century. Although its an extreme comparison it resembles the idea of allowing Madoff to keep his company as a going concern and hand him taxpayer subsidies so he can try to 'earn his way' out his hole playing futures
Whats the problem with this approach? Banks wont lend, the latest Fed report on banking lending shows that net credit is down again, the truth is that banks need to be massively overcapitalized(preferably through preferred stock/unsecured debt to equity swaps while respecting property rights)right now so they can feel safe lending again and they can stop using the FDIC deposit and bond guarantees for funding. Banks uncertain about capital will fear their regulators and hurt the lending markets
Buffett claims WFC is a fabulous bank and he would put his entire net worth there I disagree the plain fact is that lots of wells advantages comes from federal subsidies. First the bank is too big to fail, most of the banks with more than $10b in assets pay less in interest for their deposits even though their banking portfolios are worse than smaller banks(Source: FDIC quarterly banking profile). This is the US depositor betting the bigger banks will be saved. Secondly the federal funds rate is at 0% while lending rates are high, this federal subsidy is not sustainable it will reverse eventually, the 'margins' that buffett mentions as one of the great banking assets will decrease at some point. This is a transfer of wealth from savers to banking shareholders, when the economy recovers and banks puts their balance sheet issues behind them they will face as earning issues as the fed raises the rate and banks face massive regulations(along with lower lending rates). Plus there are the FDIC guarantee programs that almost certainly charge a price that misprices its risks(given that they need a bailout themselves), so its a subsidy
Thidly, Obama needled Buffett when the oracle suggested banks shouldn't be forced to issue stock to raise capital 'at very low prices', he said something like 'Buffett is a large player in the financial markets, he is a big shareholder of wells' suggesting he will do the right thing and make banks issue stock and de-zombify them
And finally, there is very little hope banking stocks are something to get excited for the next 10 years
Greater regulation, higher capital ratios(Alan Greenspan is suggesting 15% capital) and a less levered weak growth economy will almost surely hit US banks ROE and therefore stock returns going forward. So perhaps Wells will beat its bank index benchmarks because its a bank that seems to exploit the tendency to get subsidies from the government better than its competition but that doesn’t mean its something to get excited about, it certainly means you wont put a significant part of your networth there due uncertainties, specially with nationalization risk on the table(Maybe Wells Fargo, the company, survives but its possible WFC, the stock, gets destroyed in the process) this is a particulay worry in a undercapitalized bank like wells facing the fat tail risk of 12-14% unemployment
Of course Buffett would object to this saying you cant predict macro/regulatory/economic events, nonsense. Its amazing how someone who makes fun of the efficient market hypothesis turns into a EMH himself when confronted with examples of people predicting macro events for a long time
Friday, May 1, 2009
Banks are believed to be holding 600K of REO in their books. This is probably a combination of needed repairs in some homes(Since vandalism against foreclosured properties seem to be running high), and efforts to try to stablelize the market and prevent collapses
This should work an effective ceilling on US Real Estate as banks will use upticks and increases in activity(What delusional sellers refer as 'waiting for better market conditions') to dump their properties thefore keeping home prices and markets depressed
This also makes the 'months of supply' data less relevant since it doesnt count shadow inventory
Wednesday, April 29, 2009
"The real change in private inventories subtracted 2.79 percentage points from the first-quarter"
"Real nonresidential fixed investment decreased 37.9 percent in the first quarter, compared with a
decrease of 21.7 percent in the fourth"
Business spending and inventories are tanking, it seems that the corporate sector is skeptical of any increase in demand so they are resetting to a new 'lower' level of activity and inventories. The market seems excited about consumer spending being up, this was lead by 'Personal Taxes' being down increasing disposable income, likely as a result of the stimulus package. The savings rate still rose even though spending was up(outlays rose less than the income increase), which shows cautious consumers as well. All categories of investment fell, animal spirits haven't been fixed yet the green shooters seem to think so
Tuesday, April 28, 2009
So far the government has managed to make a few mistakes that are probably raising uncertainty in the marketplace and raising risk premiums just in the middle of a credit crisis where premiums are already high. Here's some of them
-US Congress trying to disrupt US contract law by going after bonuses after the fact
-Bernanke and Paulson lied after Lehman's bankruptcy by saying it was intentional and they had things under control. Bernanke went as far as saying LEH CDS had already priced in that possibility. Meanwhile the Friday before the bankruptcy weekend the CDS stood at 700bps, it was just the opposite, the only reason the CDS wasn’t at Icelandic levels was because the market thought they were too big to fail, Citi CDS is close to that level, I dont think Bernanke would accept that the market is pricing in Citi's failure. Paulson said at no moment he thought of putting tax payer money to save LEH, turns out that was a lie
Later on Bernanke reveled that they wanted to bail them out but they could not because by a lack of Fed authority(no good collateral) and Paulson almost certainly must have considered using the currency stabilization fund but may have decided against due fear of a political problem(This was before the presidential election), just a few days later he did use that authority which shows it was always in his radar
-Treasury bails out Citigroup by giving preferential treatment to private preferred stock holders, which include foreign government bodies, to the expense of Citi public preferred holders
-Government favors unions in debt to equity swap negotiations in the Chrysler and GM bailout. The bondholders and the union are on the same legal level as unsecured creditors but the administration tried to hand more of the new auto companies to the unions. This will be deeply worrying if political pressure is extended to the bankruptcy court that will deal with the likely bankruptcy of the autos
-Government has a clause in TARP legislation that enables them to change that contract at any time for any reason. They already used this for compensation reform and other changes. TARP Bank shareholders and creditors are probably depressing the value of their holdings but more than usual because of that
-Treasury might be trying to mislead the markets by understating the level of capital needs of US banks. This could come back to haunt them as their credibility will be depressed even further
-Paulson might have encouraged a CEO to hide material information from bank shareholders
This is a credit crisis, now creditors and capitalists need to consider more factors when they are doing their investment decisions, the fact that the government can change rules, lie about systemic events, favor certain political groups(maybe even in bankruptcy), make unconstitutional moves, etc
Since the US is going to a new world where the government will play a bigger role in the private sector(because of bailouts, nationalizations, regulation etc) the fact that they are not behaving in a way that is consistent stable markets is troubling
The Fed seems to be trying its best to lower interest rates but other arms of the government are trying to hike it even if they are not aware of it
Friday, April 24, 2009
Hank Paulson took a lot of heat for 'allowing Lehman to fail', George Soros went as so far as to saying "The claim that they lacked the necessary legal powers is a lame excuse. In an emergency they could and should have done whatever was necessary to prevent the system from collapsing.", Paulson was the treasury secretary, the only way he could have bailed out Lehman at the time was using the US Exchange Stabilization Fund(there was no TARP money), those funds(about $50b) are supposed to be used to in foreign exchange intervention, so the only way he could have saved Lehman was to lie to the American public that Lehman threatened the US dollar in some way.
Essentially Soros wanted Paulson to mislead people in order to save the financial system. Well it turns out that Paulson might have encouraged Ken Lewis to commit securities fraud and withhold material information from his shareholders to assure that the MER merger would not fall out of bed. Now just where are Soros congratulations letter to Paulson for putting the financial system above his integrity?
I bet we wont be hearing from him that 'Paulson did the right thing' yet that’s what he suggested in a FT.com article I quoted the line above.
The same thing applies to Bernanke, the only way he could bailed out Lehman was to lend against the commercial real estate garbage that Lehman has on its books and lie that 'We think this collateral is appropriate' and its possible that Bernanke encouraged securities fraud as well, just where are the flowers from Soros and an invitation for a tennis match?
Wednesday, April 22, 2009
This great rally of 2009 has been lead by the worse most levered companies in the stock market, Bloomberg reports "The 130 companies in the S&P 500 and Europe's Dow Jones Stoxx 600 Index with debt-to-equity ratios above 50 percent and a return on assets of less than zero... rose an average of 82 percent from March 9 through April 17."
What seems to have trigged it was a expectation that banks are out of the woods with chances of lending again with now positive earnings and the economy is reaching bottom as the 'second derivative' improves.
As far as bank lending is concerned, its simply not happening
Fed H8 Bank Credit Report. This fed report shows that bank credit has gone down every month in 2009, meanwhile cash assets in banks balance sheets continues to soar
Deposits in banks are down more than $100b in Apr, that is the side effect of a rising stock market and improved confidence, banks get less funding(therefore can lend less) as people take risks and stop hiding behind FDIC guaranteed deposits and deposit taking too big to fail institutions.
As far as bank capital is concerned Geithner just said 'everything is ok, most don’t need any money', which means there is trouble coming down the pipe. The treasury doesn’t have the money to plug in the holes so its natural they would say more money is not needed, the last thing they would do is to say "Guys there is a $500b hole in the largest banks and we don’t have the cash!!", I mean what are the chances that the additional capital needed somehow will be conveniently less than the $130b in TARP money left when they report results in May 4? I'd say the odds are pretty high, the odds are also high that we are being mislead. If it looks too much like a made-up coincidence it probably is
As far as bank earnings are concerned we had a few groups those who became hedge funds ‘earning’ their money from trading and other highly volatile revenue streams(JPM, GS) those revenue streams can easily lose them money as it happened in the Q4, those who mislead equity investors about their reserves(WFC) and those who have more rare non-recurring one time items than an art gallery(C, BAC).
Since housing is still collapsing at a fast pace with CA stuck in a looming foreclosure crisis, with notices-of-default soaring nationally, credit card lines getting cut hurting the consumer and unemployment still jumping there is little or no hope for bank earnings recovery in 2009
This suggests that this great garbage rally is unfounded, these levered companies cannot refinance their debts, they cant pay it all off, they need either raise equity or go bankrupt there is no way around it. GGP will be just one of a bunch, there will be a heck of a lot more companies going bankrupt because of maturing debt obligations. Reits, airlines, utilities and other levered sectors are in for a new downleg when the market finds out there is still little credit or liquidity coming into the markets
Friday, April 17, 2009
Credit markets are beginning to show signs of improvement. The CDS counter-party index plunged 5% yesterday, LQD and JNK are both rising, so the stock market isnt the only one pricing in better outcomes this year this suggests that maybe its incorrect to be bearish and perhaps I need to cover short positions in banks/brokers, REITs, airlines, life insurers, levered utilities,etc
There is however one problem that the market simply doesnt know. CA is 35% of the foreclosure count and 45% of the dollar foreclosure figures(this data might have changed since 2008) nationwide. The Notices of Default(NOD) are simply soaring according ForeclosureRadar(reached a new record last month). NOD are a leading indicator for foreclosures down the road(they are the first step in that process), they were depressed for months as the government demanded moratoriums and other silly tools to 'fix' the problem. So we pretty much know that CA will be hit with a big supply jam down the road and Case-Shiller will keep nosediving(It collapsed at a 33% annualized rate in Jan, I would not be surprised if other US bubble markets were having high NODs as well). Unless decades of econometric evidence all the sudden break down there is simply little reason to expect the economy to 'pickup' in the 2nd half as asset markets lead by housing(and soon to follow stock and credit markets) keep diving
More home price declines will lead to the wealth effect on consumer spending, the capex effect on the corporate sector and the balance sheet effect of the banking sector and that simply wont sustain economic recovery in the 2nd half. Risk markets seem to be pricing in some kind of recovery in the 2nd half(consensus of economists is that the recession will end in September), however this looming CA foreclosure crisis should hit the banks hard and drive asset prices lower
Why I assume this data is not currently priced in by the securities markets? Because of the crazy reactions markets have on the slightest upticks in housing data, furthermore data disseminated by foreclosure radar doesnt seem to be widely followed, when dozens of Goldman traders glued to bloomberg terminals start to jam or crash ES futures or the CDS counterparty risk index swaps based on CA NODs then I might be inclined to listen to market signals more closely. You almost cant find anyone who follow these numbers, yet they love to pay attention to existing home sales upticks when those upticks tend to be generated by higher foreclosure sales
At this point however I'm inclined to agree that the post Lehman depression seems to be over and thats as bullish I'm willing to go
Mr. Mortgage new secret(not public yet) blog about the looming CA crisis
CA Foreclosures about to Soar
Monday, April 13, 2009
Lots of folks scorn the idea of inflation coming down the road, the argument goes as follows “money printing wont work, banks are hoarding liquidity, savings rates are rising, credit is being paid back, the output gap and unemployment will make deflation stay with us”. While I believe this argument is right for the next year or two it isn’t right for period after that, why?
Because in that scenario that world would end and since the world won’t end that means we will have high inflation. Its a bit of a exaggeration to say that world would end but that scenario implies downright dangerous deflation rates, the US simply cant survive with a 3-5%+ deflation rate, standards of livings would be smashed, debt and deflation is a deadly poison, the minimum wage would go up every year under deflation, debt burdens would go up, foreclosures, defaults all would soar and borrowers suffer the ‘pay option ARM’ effect of their real debt burdens going up every year and being more insolvent as the day goes by.
If sustained that kind of deflation would lead to something worse than the great depression since leverage is higher and global trade/flows are getting hit harder, thats what I mean by the world would end. Bernanke's paranoia is justified
The US central bank will simply not tolerate any kind of sustained deflation and those who think the fed is 'all-in' because of 0% central bank rates and money printing are mistaken. Bernanke is printing money like mad yet he continues to make apologies for it, he keeps assuring the markets they have a 'exit strategy' and it 'wont be inflationary in the end', he does this to prevent the 10y and 30y treasuries from tanking and also because inflationary expectations are still reasonably anchored as show by the TIPS market.
So in the US currently deflation is still not an issue, the core CPI and core PCE are still well into the fed's comfort zone, if they do take a nosedive and TIPS tumble its very likely the fed will change their tone, they wont just print huge money they will also try to convince people that their dollars are garbage. If people get convinced their money will lose purchasing power tomorrow they will spend it today creating a self-fulfilling prophecy of inflation. The fed have just began this process by creating a long-term inflation target of 2% but they are still waiting for the core indexes to go down
Japan had 1% deflation rates even though their central bank is headed by incompetents, had they pursued better policies instead of being paranoid about losing face they quite likely would have had positive inflation and better growth
What about the output gap and unemployment?
In 1933 when FDR devalued the dollar against gold, took the US off the gold standarad and allowed the fed to print its way out of the problem(the 30's version of quantitative easing), the unemployment rate was at 25% and GDP way bellow its potential having dropped 27% from its 1929 peak every single year, talk about output gap and deflationary forces. Yet the Producer Price Index jumped 25% y-o-y a little after the devaluation then averaged 7% up to 1938, the CPI jumped 6-7% then avg around 2.5% up to 1938. GDP then grew 30% from 33 to 38, the unemployment rate dropped from 25% to 15%. M1 grew something like 40% from 1933 to 1936
Yes, monetary policy works, when FDR screwed dollar holders overnight through devaluation that induced people to be worried their dollars were going to be worth less tomorrow and people spent today as a result(higher velocity of money), that shows in the private consumption data(83% of GDP) that jumped 25% during that period and private investment(2.7% of GDP) that jumped 80%, government spending(20% of GDP) jumped 20%, so it wasn’t FDR public spending that bottomed out the economy, it was his monetary policy inducing personal consumption(although effects on consumer sentiment from his programs probably account for some of the improvement, an additional positive factor was stabilization of banks)
The higher velocity coupled with money printing(higher supply) lead to a rise in prices stopping the debt deflation collapse and that showed up in the improvement in GDP and employment, prices rose even though the unemployment rates was still well above the Non-Accelerating Inflation Rate of Unemployment(NAIRU, in this case being above the NAIRU should create deflation). Why didn’t I considered the data from 1938 and on? Because in 38 the US suffered a government induced recession lead by higher taxes, higher reserve requirements for banks and cut back on public spending, its unlikely that mistake will be made again
Bottom line is the fed will not tolerate deflation, and to think that prices are outside the fed's control is to think that what the central bank says won’t have an impact, Bernanke has crashed the dollar twice with QE announcements, those were huge moves much bigger then what the Geithner comments on SDR ever made. That is because Bernanke not Geithner sets US dollar policy and gigantic levels of deficit monetization coupled with manipulating people into thinking the Fed doesn’t care about inflation is quite likely to make US inflation rates to be quite high after the recession/depression is over.
If by some oddity money printing stops working the fed will literally pay the entire national debt and finance the federal government forever, of course in equilibrium that is not possible because inflation would soar and this should end up being the Bernanke plan just in a smaller more cautious scale
I can only imagine what the gold market will behave like when Bernanke tries to fool people into thinking they will print money and 'drive the dollar down', that wont be true of course, the fed will pullback when inflation goes up alot but the gold conspiracy theorists will be puzzled when one of the bigger verbal supporters of higher gold becames Ben Bernanke
sources: The Recovery from the Depression of the 1930s
Inflation figures are from economagic
Thursday, April 9, 2009
Some people like the folks are pimco are speculating massive jumps on unemployment are not lagging indicators but rather leading ones because they affect sentiment and keep animal spirits depressed.
This argument makes sense even though you statistically employment lags as the evidence shows over the last decades. That evidence is not important because you cant find much evidence of a stock market collapse of this magnitude over the last decades either or a number of other plunges in economic data, so in these unprecendeted times it could very well make sense to throw some of these backward looking models out of the window. In the end it comes down to 'do you believe your crazy old theories or your lying eyes?', I dont think these eyes are lying, by observation you can tell these massive jumps have to affect sentiment, otherwise you are arguing massive reported economic destruction doesnt affect human behavior which simply not likely. So it looks like a good percentage bet to believe employment might have turned to leading indicator in this credit crisis
This suggests people(like stock bulls) ignoring employment because it lags are in for a big surprise when the very indicators that are slightly better now and which they are now cheerleading might turn back down or stay depressed killing off the 2nd half recovery they are antecipating
Monday, April 6, 2009
Switzerland is on the headlines as one of the first countries to reach deflation. Since the BOJ has been headed by morons for so long it could be the swiss central bankers who might show the world how to create reflation/inflation, avoiding nominal price declines and the downward spirals it creates
It might very well be the swiss price indexes one of the most important indicators of 2009/2010, success or failure there would signal whats to come for US, UK and EU
Tuesday, March 31, 2009
It seems that a lot of people are saying that private investors will overpay for bank assets because of the non-recourse loans. What they forget is that Lone Star purchased Merryl Lynch 'super senior' AAA CDOs last year for $6.7b, the notional amount of the CDO was $30.6B, it was carried on the books of merryl at $11.1b, Lone only paid a little over half of carrying value and they only put $1.675b down and the rest $5b was financed with a non-recourse loan.
Yet Lone Star got a heck of a deal(their risk aversion demanded good terms) as their down side is $1.675b and the upside is in theory $30.6B, the only recourse Merryl has is the asset itself. I understand some folks will say its the FDIC/Fed who will foot the bill instead of the bank like in the MER transaction but from a buyers(bid setters) perspective who foots the bill almost doesnt matter as a long its not them.
The private sector is very risk averse right now and they want bargains or they wont buy it, no cheap put will turn scared investors into gamblers. That Lone Star deal was done before Lehman went bankrupt, the Geithner bad asset plan will kill the banks, if they hit thoses bids they will be left far less profitable and less solvent. Private common equity offerings wont popup all over the place like Geithner hopes, he will have to provide the equity capital or nationalize the banks and wipeout the debt to 'create' capital
Monday, March 30, 2009
The CPB of Netherlands is out with a report on world trade that is downright frightening
CPB World Trade Report
World Trade Volume has collapsed at a 40% annual rate in the last 3 months. Now mind you that the total collapse of trade during the 30's was 66% peak to through(source: US Dept of State, I do not know if this data is for volume or is the dollar figure, is likely to be an amount not adjusted for the deflation of the time, that is the dollar volume), the current dollar volume collapse in world trade is at 20%(the collapse is running at roughly 41% annual rate), so in just a few months world trade has collapsed almost a third of what it took 29-34 to build it. We do not have Smoot-Hawley but we do have Citibank, credit is more important to the functioning of world trade these days therefore its having a similar impact, whether goods and services don’t cross borders because of politicians or troubled banks the economic effects will be the same, lower living standards and economic depressions.
That said protectionism is going on without much trouble as the world bank is reporting most of the G-20 countries had no trouble signing more tariffs and barriers after claiming free trade was good, and this is a on going politician reaction that will not stop anytime soon
Back in January I suggested world trade was in for a hard landing because human nature had not changed and the temptations didnt either, so far they way its going it will end up as a total crash with no survivors.
However at some point some kind of stabilization is likely to occur as the 'low hanging fruit' is shutout of trade but the main important products are not likely to be going nowhere(oil-energy products, food products as no politician wants riots, some medicines)so that annual rate will almost certainly slow down and further declines will be harder to generate.
The credit component however is still worrisome. If the US has policymakers who are slightly more knowledgeable than others in dodging depressions and STILL were not able to stabilize their banks and credit what does that say about dozens of other leaders around the world being able to create their soft landings? It says my statement that the "world fate is in the hand of morons" is likely to play out and things are in for a rough time, governments are not likely to prevent it as they don’t seem competent enough
My government skepticism has led me to keep a Short Assets bias through 2009, even though I kept hearing market savvy folks like the ones from Pimco assuring that the government was going to save the day(While at the same time refusing to take risks). Its likely that they wont, these problems are big and difficult to solve and efforts like 0% rates, credit facilities, stimulus plans, etc can HELP but they don’t seem enough, furthermore those efforts need to be applied in a global scale and when you see the protectionism getting out of hand and the slow response/success in stabilizing banks you know what they take out the benefits of some policies they are creating, so it could be a wash in the end
I’m not suggesting a Great Depression is likely, there is simply no deflationary gold standard to lock central banks into watching deflation to take hold. CBs are globally printing money(this intervention they are getting it right as it doesnt take a genius to fire up a printing press), even Trichet has complained his way into almost 0% rates but I do suggest depressions could became more widespread. It wont hit just Iceland and a few other names, it could hit a good chunk of the developed world and this is all very frightening
Thursday, March 26, 2009
I just finished writing a research report I made for a firm. I was able to make it avaliable for free(The report is free for distribution of any kind for the next 30 days)
Geithner and US Bank Stocks
Update: One thing I forgot to add to the report, total assets of the largest banks(more than $10b in assets) is $10,800b their 'surplus' over danger TCE is $226b. This is 50-1 leverage, a 2% change in assets trigger a widespread fear that the world's largest banks are becoming insolvent. Not a healthy system
Update 2: Total losses taken number is incorrect. Its actually near $800b according to Ft.com data, however my numbers of losses 'left to go' already uses the right data so no harm there. The 'rough estimate' on big banks TCEs is rough but VERY likely to be correct.
Tuesday, March 24, 2009
Bill Gross from Pimco is saying he expects to make 'double digit' gains from the bad asset program. Pimco, Blackrock and others will the first in line for losses from this program along with the treasury. If they are 'gaining' somebody else must be losing and it cant be the FDIC/Fed because the private investors/treasury will be the first in line for losses. This leaves only one group left to lose: The Banks
Bernanke back in Sep/Oct was mentioning the hold-to-maturity value and the market value of the assets. He was essentially saying the run-off value of a bad asset was X and the market bid was X - Y, the disconnection happened because no one could leverup to buy these assets and there was some uncertainty to extreme losses in those assets.
Then Geithner came up with this plan in order to 'connect' these two values again. In my view, the connection will not totally occur.
Think about it, the hold-to-maturity value of a bank asset is something you cant know before the fact, as a result private investors will try to GUESS what this value is, due the risk aversion currently present, plus investment grade corporate bonds yielding 7.5% and junk bonds yielding 17% is likely investors will demand a DISCOUNT to their GUESS of what the hold-to-maturity value is, that is they will demand a risk premium, they will demand compensation for political risk(like not being able to walk way from a large non-recourse loan), liquidity risk, credit risk, congress risk(I understand there is a cheap put and cheap funding but in the risk averse market right now that is not enough to offset the risks). Now, if they get this risk premium and make 'double digit' returns then the banks necessarily need to lose. So if this plan succeeds, the banks by definition must have lost money/future earnings. There is no such thing as a free lunch
To put it more simply, if the banks were allowed to run off their books without suffering a run they would return X from their bad assets, by selling to the bad asset program they will get X - Y, Y being the money that will endup in Blackrock bonus packages
This means for every bad loan(which is not marked to market) a bank sells to the bad assets program the Net Present Value(the long-run value of an institution) will go down, all else being equal, they also will have to raise shares, hurting the stock. When it comes securities(which are marked to market) its a bit more tricky because it might be a good idea to take the loss since holding the security could force you to mark the asset to irrational ABX numbers. But still it will decrease the value of that bank long-run asset side value putting the bank is a bigger hole
Another simple example is, suppose you had a corporate bond fund in Jan 2008 with a bunch of junk bonds in it. Its March 2009 and you have liquidity issues. You are forced to sell securities at a market clearing price, its quite likely buyers of of a diversified set of junk bonds will likely make money right now even if a few of them default, that is because the yield on junk bonds are very high compared to the likely default rate(that would have to reach Great Depression scenarios to make the buyers lose money), so the 'earnings' that buyers got come out of your pocket, the long-term value of your bond fund went down.
This happens because the market right now is depressing the value of all types of assets, that is risk premiums(the compensation the buyer gets) are very high, this means being a seller of assets is a bad deal these days. This is a buyers market where you dont want to be a seller at the market clearing levels
So ignore the critics that say this is a hidden way to give capital to banks, its not. It does just the opposite, its puts banks in bigger balance sheet holes
Therefore the Geithner plan is a hope private common stock capital will save the day once the banks are a bit cleaner in their balance sheets, it does this at the cost of making banks sell assets below their run-off values and decreasing their long-term capital(they get more insolvent). The hope is that if private common stock capital comes in, recaps the banks making them very solvent then banks will lend again and as an GROUP the US Banking system will increase its Net Present Value as the economy will grow again. Its a bold plan(particulary given that Congress does not want to give more funds for banks) but at this point I'm not quite sure if it will work
Wednesday, March 18, 2009
This is a question investors ask themselves everyday and they seem to be inundated by an avalanche of opinions and 'news' items as a result they act like manic depressive patients with chronic zinc deficiency. I'm going to present a very simply method that can save you HUGE amounts of money when there is a nasty bear market(like this one) and guaranteed you that you will NEVER miss a bull market in any financial asset. Its called the 200 day moving average, you sell everytime a long-term chart of the asset falls bellow that and buy everytime it goes above it
And this is not some technical analysis mumjo jumbo, its empirically tested. I highly recommend the following research report(they use the 300 day on the paper but results should be similar)
The paper shows that the 300 moving average system reaches the same kind of returns buy and hold does with less volatility. Furthermore it works in non-US stock markets and other asset classes as well.
This simple method can easly save investors huge amounts yet people rather pay attention to an neverending stream of news and opinions.
Right now I'm mostly short a number of stocks(JPM,GS,CAL,C, others) own puts in others(have a large put position in a company which I can't name), cautiously long a few names and I considering increasing my corporate bond exposure, I will however not take any meaninful risk while doing that, why? LQD/JNK(corporate/junk bond ETFs) are both bellow their 200/300 day MA. So I'm sticking to the safest credits I can find(Citigroup bonds, too big to fail and I'm hedged through the stock short, International Lease Finance Corp, profitable company that can be bailed by AIG if it runs into trouble, plus it got $43b in airplane assets against $30b in debt so its quite solvent in a bankruptcy) and I will remain in a defensive stance till they break their MAs.
I will surely miss the bottom(so what everybody does) but I will also dodge a complete collapse in financial markets/global economy in a protectionist hell which IS possible at this point
Monday, March 9, 2009
John Hussman is out with a flawed article on why the government ought to give haircuts to bank bondholders
Its amazing that someone from his caliber would write such absurd set of arguments and then try to claim "Oh Btw, there is no way I'm wrong"
"The course of defending the bondholders of insolvent institutions is not sustainable. Do the math. The collateral behind private market debt is being marked down by easily 20-30%. That debt represents about 3.5 times GDP. That implies collateral losses on the order of 70-100% of GDP, which itself is $14 trillion. Unless Congress is actually willing to commit that amount of public funds to defend the bondholders of mismanaged financials so they can avoid any loss, this crisis simply cannot be addressed through bailouts. Bondholders have to take losses. Debt has to be restructured. There is no other option – but the markets are going to suffer interminably until our leaders figure that out."
Its absurd to look at collateral losses then claim that somehow creates a hole in the banking system that congress would have to fill. Why?Because it assumes every mortgage defaults(that assumption doesnt go into his 10y stock market return forecast interestingly enough). One of the most bearish projections in total losses is from the Roubini Team at RGE, they project $1.8 trillion in losses for US banks and broker dealers, which the government can easly handle since demand for treasuries is still high, and IMF/Goldman figures are lower than this. It makes no sense to induce stress in this already weakned financial system by adding more losses to the system through the banking corporate bond channel.(Which would set a cascade of counterparty fears all over again)and remove all the going concern value that exists in some banks
Plus there is one more bottleneck which Bernanke has stressed, the US government does not have the legal authority to take over banks and 'haircut' bondholders(or even common or preferred holders for that matter). Citigroup has about 11% in Tier 1 capital, they have had 'adequate' capital for a while now and their regulators have approved that(other wise Citi would be in the troubled list or they would have been pressured to write some assets down and their Tier 1 would have tanked). Without a bank dropping below adequate capital levels or running into liquidity problems(Like Indymac like so many use as an example) they just cant seize private property like that, the FDIC friday banks we see being taken over every week usually have high texas ratios, illiquidity, etc
The bank itself can refuse a take over and they setup a massive lawsuit. The regulators cant stamp an approval on the Tier 1 ratio in one hand and nationalize in the other.
So while its fun(and probably correct) to call for nationalization its impratical in the real world
This means the current bailout policy of quasi nationalization(with regulators 'working' with bankers) and more injections look like the mostly likely path going forward. Geithner will own XLF by the time he is done
Thursday, February 26, 2009
Jeremy Siegel wrote an op-ed on the WSJ saying the current earnings methodology is incorrect. He is right in some scenarios yet all the Roubini minions who feel they need to be bearish to be right are attacking him. They would be right in normal circustances but Siegel is correct when you are talking about massive negative earnings, negative networth and stocks close to $0(low weighting in the index)
Lets say all the financials go down to $0.01c a share and they continue to lose billions matter of fact they lose so much, the SP500 earnings are negative according to the current SP methology
the PE of the SP500 is infinite, their earnings never recover and they keep losing forever
If you buy the SP500, you are essentially getting financials for free, yes they lose money but so what, you get all the other sectors who are making money and paying dividends for your income. You donot lose on the aggregate because common stocks under deeply negative networth, bankruptcy dont create a liability for you
Another example, lets say all stocks go to $0.01c a share except for XOM, they are all losing huge amounts but for some reason XOM keeps printing money, if you buy the SPY you are getting the sp499 for free and an nicely profitable XOM who will make you money and pay dividends. Yet according to the Siegel critics its a bad buy because the index has negative earnings and an infinite PE forever, yet what are you doing is essentially buying XOM and getting free options on the rest, since common stocks dont create liabilities even if they have negative networth or go bust
So the total earnings of the SP500 donot matter in those scenarios, what matters is what you get when you buy it and what price you paid for it. Thats because common stocks offers unlimited upside with limited downside
Bespoke wrote this
"Imagine you have two investments. The first is worth $1,000, and over the last year it generated $100 in ncome. The second investment is only worth $100, but over the last year, it had a loss of $100. Most people would probably think of their investments in the way S&P calculates the earnings for the S&P 500. You would have total investments of $1,100 ($1,000+$100) and earnings of zero ($100 profit on $1,000 investment plus $100 loss on $100 investment). "
Their mistake is not carrying that logic further, lets say the $100 investment(Inv1) on the second year loses $50,000(not a typo), and the $1000 investment(Inv2) earns $200. The Inv1 is a writeoff to you by then(its market value will be close to $0 as well), you probably dont expect anything from that ever again, you will mark down that investment to $0, so what that Inv1 earns is 100% irrelevant because common stocks dont create a liability to you. You will 100% care about Inv2 as it will became your index with 100% mental weighting, yet according to the current methodology as a long that 'dog' is in the index, it will produce massive negative earnings for that index and an infinite PE ratio
Bottom line is that financials are distorting the PE ratio of the SP500 and Siegel is right that stocks are cheaper than they appear(Even though I'm not long yet)
Tuesday, February 17, 2009
Here’s some beliefs that I have that are guiding through this crisis
-Soft landings are rare
-Government is inherently inefficient and unlikely to implement correct policies fast enough or at all
-The rear-view mirror is a misleading guide to the future
The market and the media are constantly looking the politicians and policymakers for ‘solutions’ for the crisis and ‘how to get out’ by implementing XYZ policy.
What they don’t seem to get it that is possible that there is no solution, in an ideal world where government is efficient and intelligent US banks would have all been recapitalized and the US consumer would have been brought to solvency again through debt relief. We do not live in such world, the stimulus package is a great example, it’s a huge piece of legislation which virtually nobody who supported has read and has any idea if the things inside are necessary or are results of lobbyists, so beside a short-term positive impact on Velocity of Money the long-term returns from this 'investment' are likely to be small.
The truth is governments don’t tend to attract smart folks simply because its pays too little for the kind of work and exposure you get, you get what you pay for, people from Pimco recommend policies all day long, they would probably work if implemented, yet how come they don’t give up their millions of dollars in pay to work as a bank regulator? The truth is that governments are under human capitalized, I would be surprised if the average IQ of the US Congress is not lower than the average IQ of the SP500 board of directors
The fed as recently as one day after lehman’s failure was voting no change in the fed funds rate citing concerns about inflation, the fdic and the gses continues to keep trying mortgage modifications that fail more than half the time, trichet is complaining lowering rates more in the fact of massive deflation and banking meltdowns. The current financial system is more complex and globalized than most realize, there are numerous interrelationships that we are not aware of, this makes the world economy in this crisis a passenger in a sinking ship. There is little hope that the unintelligent captain with political motivations who helped and cheer leaded the problem can get us of of it.
I do however accept that the downturn could be smaller than otherwise because SLIGHTLY better public policy that in the 1930’s(at least in the US, a good example is the fed commercial paper facility, aggressive easing or slightly higher tendency against protectionism) in the other hand the financial system is more complex and globalized plus some of fiscal holes that a few countries are in could be enormous, that is out global leverage is, if not bigger, far more dangerous due interrelationships(think of all the trillion in losses that are and will be taken worldwide, what if they keep happening in banks of countries with a higher tendency toward protectionism and a few wrong moves set off a round of tariff wars?) which could negate the slightly better (US, European)public policy factor. There is an worldwide asset, credit, economic implosion and the losses just keep mounting, we went from one of the strongest global growth periods in decades to one of the worst in decades in about a year, so extremes are clearly to be expected from this financial system
Wednesday, February 4, 2009
The news flow regarding world trade is going from bad to downright frightening, we all know trade credit is collapsing but that is just icing on the cake, the real ‘hammer’ will be laid by politicians. The ‘Buy American’ provision looks like to be on its way, while that provision says it can be removed if it violates language in existing trade agreements that is not the point, the point is that human nature has not changed, the temptations for politicians are still there and for now they seem to be respecting pre-credit bubble burst agreements however its just doesn’t look likely they will contain their visible hand from messing world trade.
There is little reason to believe US and world politicians are more disciplined today than they were in the past, spending as a percentage of GDP has been ballooning for decades and it only looks like it will continue. Hypocrisy is still widespread as tax fraudsters are running for office by the leaps and bounds. Free trade has been a consensus among economists for a really long time, Hoover got a letter signed by 1028 economists begging him to not go forward with Smooth Hawley, its likely he knew his measures would be damaging, however the temptations of politicians of trying to buy votes to stay in power were too great and he started a world trade war. We probably have the greatest risk of a world trade war now than we ever did since the depression, the risks are clearly on the downside as the future is depending on politicians who usually don’t posses a pristine track record. The G7 said no protectionism, then the individual countries proceeded to pass a number of tariffs and barriers to trade
It will be absolutely crucial to see how this ‘Buy American’ provision moves forward, could congress and the administration move in with this and simply ignore language from NAFTA and therefore give ‘reasons’ for Mexico and Canada to strike back? The consequences of such event could be apocalyptic as it would send a message to the entire world that the leader in worldwide trade thinks ballot boxes and special interests are more important than keeping their word, at that point all you can do is to sell everything, short the stock market, buy DEEP out of the money puts in the stock market as the consequences of such events tend to be underpriced by the market
The Chinese and Europe are also two to watch. The Chinese have been called currency manipulators and they were not pleased, verbal trade war has already began. We are not in what it seems to be a mining field where politicians will use each other mistakes and actions to justify their own lunacies. The Austrian Economist portfolio will not be in play in the case of protectionist hell, the Great Depression Portfolio(long gold, short stocks, long SPY puts, long treasuries, long select commodities, short select commodities) will be the name of the game.
At this point the outlook for world trade is not entirely clear but the news flow points that the same process is happening, in the beginning it’s the denial that protectionism is even taking place. Joe Biden downplayed the ‘Buy American’ provision, they want to tell us everything is fine and they are not that crazy. Except they are.
Even if the US is ‘different’ because their leaders are more aware of the consequences of trade wars(an not entirely resonable assumption), we are talking about dozens of countries, some led by nutcases, if you are an optimist, are you really that confident that the worst recession since WW2 wont lead dozens of leaders to do their usual lunacies because this time is different? The last time I checked Adam Smith was being ripped left and right in discussions
Tuesday, January 27, 2009
I’m going to address an issue here that I think its crucial for the US macro picture going forward
If you look the last FOMC statement and minutes the Fed is not yet on full blown panic mode yet, they still say stuff like "the Committee expects inflation to moderate further in coming quarters" "disinflationary effects" "further moderate reductions in inflation expectations caused the staff to reduce its forecast for both core and overall PCE inflation" "Several participants observed that monitoring measures of inflation expectations for signs of disinflationary dynamics would be especially important going forward."
This indicates that the D word(deflation) is still feared, the fed still got hopes the market itself wont jump(or at least that they could exacerbate) in deflationary expectations because of the careful fed language. The fed is somewhat still in some kind of denial phase with regards to deflation
The reason I say the fed is not all in is because they still haven’t gone "Bernanke 2002", if you read the "Deflation, making sure it doesn’t happen here" speech just by noticing the language(starting by the no apologies D word title) and things like "U.S. dollars have value only to the extent that they are strictly limited in supply" "By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services" "We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."
This "US dollar can became garbage at our will" attitude we still haven’t seen from the current Federal Reserve.
In Bernanke’s book "Essays on the Great Depression" he points out an interesting fact which I think its relevant for monetary policy today, countries that went OFF the gold standard(thus removing limitations to print more money) in the 30’s didn’t necessarily saw an increase in their money supplies right away(it only happened later), in fact in the first 2 years the countries on gold and off gold showed little difference in the collapse of their M1s, yet the amount of deflation was smaller in the countries that were OFF the gold standard.
Bernanke theorizes that the reason for that was going off the gold standard(through a devaluation, ending convertibility of paper money) initiated inflationary expectations in the economy, as people get worried the government is about to print or devalue more, which lead people to spend early and spend often.
I believe the same dynamic will be necessary to get the US out of this deflation trap, the fed has hinted sometimes they are printing money with statements like "we will fund our purchases with creation of bank reserves" but Bernanke as recently as Jan 13 lse speech went out of his way in a speech in London to explain why lots of the fed moves are not inflationary and how the people who accuse the fed of money printing are wrong, he explained how they would unwound all the facilities and cut down the monetary base. He still being a apologetic money creator
That’s not how a guy whos all in sounds like. We need to remember the fed is a bureaucracy, they where a bit slow to get in the massive easing, they are also being a bit slow to tell the world "US dollars are garbage, we’ve got printing presses and we will not be afraid of using them", they only have began thinking about an inflation target as a way to make people worried about money printing, ultimately I think they will go there(there meaning, managing expectations) big time because deflationary mindsets will keep sweeping the nation as gas drops to $1 and the output gap stays large and the huge credit bubble gets unwound, so even if some ultra deflation bears are right that banks wont lend and the money printing wont be multiplied through the financial system, all it takes for deflation to stop is for people to get worried dollars will be printed out of existence, money velocity will go up and inflation will come back, the austrian economist portfolio would benefit from this
The next FOMC statement should be interesting because I think they will more and more start hinting they want people worried about inflation but I think the key indicator is the Core CPI(the core PCE as well), when Ben made his speech in 2002, the yoy core CPI had tanked for more than 12 months by then, there was a War hurting comsumer spending, fiscal packages had failed, there was no hope the fed could try lean on, they had already agreed there was a train coming and had to do something, today the core cpi is only starting to tank and is still quite positive y-o-y, there still some hopes attached to the large fiscal package, once they get the final confirmation by a collapsing core CPI we will see the fed mouthpieces(like Bernanke was in 2002) go out and make ‘speeches’ on how dollars will be printed and if inflation comes ‘so be it’, they will try to get a false image the fed doesn’t care about inflation to get Joe and Jane to buy goods and services and I think the fed will succeed. As for right now the fed is still too hopeful deflation will be quick or that the stimulus will work or the commodity parabolic move is still fresh in their memories(what they refer as 'significant uncertainty remains'), reality will change their minds
- ▼ June (6)
- ► May (12)
- ► April (8)
- ► March (6)