Traderbill’s Financial Markets Weblog

 

The above quote should make Americans hang their heads in collective shame…that it would take a German to proclaim it. Only the neo-cons of America feel that ‘unbridled’ capitalism is the right way and the only way for economic well-being…at what cost to our own people and to other citizens of the world?

 

A little regulation goes a long way towards guiding capitalism in the interests of the people, but a neglect of this responsibility is precisely what has put us and the entire world in the place we are today, and that is on the brink of financial ruin. Some of you will scoff at this and sadly, if so, you are wrong. It has often been said that the US is never more one generation from destruction…or one President when the checks and balances created by the Constitution and the Bill of Rights are trodden on. Perhaps that was the Constitution saying: “Don’t tread on me!”…a warning and a plea for the future of the noble experiment.  

 

TB has been moved by several pieces he has read along with voiced concerns of people like him with decades of investment experience…not voices of fear but voices of reason…fear will come later if we don’t do something first. What appalls TB is that the financial markets have turned into a crapshoot where only the biggest are winners. This is being perpetuated by CNBC with 90% of the stock mavens being trotted out daily always bullish and always using historical averages to support their hypothesis. This economic downturn is anything but average…it is unlike anything seen since 1929 since the economy did not put us in the crisis we are in…the financial markets did while the real economy was doing quite well thank you…by that TB means large business as individuals and small businesses were already beginning to feel it. By focusing on big business and thus the stock market we were and are unable to see the weakness in consumption…see yesterday’s commentary on the inventory/sales ratios of retailing, ex-groceries and thus on retail sales ex food and energy. How we can believe that the housing market implosion will not affect the economy via consumption defies explanation…Allan Sloan in the Fortune article referenced yesterday called it ‘Tinker Bell’ an obvious slam at ‘Goldilocks’…and it is broke. Not only did the housing boom fuel the economy, mortgage equity withdrawals (MEW’s) added more than 2% to economic growth every year over the past three years deluding us into believing things were better than they were concealing any problems (objects in the rear view mirror are larger than they appear). 

 

As TB has written on several occasions, without the growth of credit cards and financial derivatives which allowed for the financial placement of hitherto illiquid instruments …i.e. mortgages…we could not have achieved the growth we experienced, yet thru a total neglect of responsibility, dereliction of duty, even that growth would have been challenged yet we would still likely be on an upward track, albeit from a lower level…but that is good…isn’t it slow steady growth that produces the best results with the least danger? Not if you are on commission or receiving enormous bonuses relative to your added value. Was Exxon Mobil’s Lee Raymond responsible for the growth of earnings and revenues?…certainly not! A toad at the helm could have succeeded similarly given the unprecedented rise in the price of crude. IF Chuck Prince at Citi and Stan O’Neal at Merrill…not to mention guru’s Jimmy Cayne and Alan Schwartz at Bear Stearns…all of whom said they had no idea the risk was so high…when the engine of growth is as singular as it was aren’t you supposed to ask questions?…not just sit back and collect your bonus!

 

In a sister article to the Sloan piece, Shawn Tully, editor at large for Fortune, said ‘bankers’ (in the broad sense) “fell victim to their love of risk, leverage, and high pay.” If a little is good more must be better, and besides the commissions and bonuses are sooooooo nice! Here is the link: http://money.cnn.com/2008/03/31/news/companies/tully_wall_street.fortune/index.htm?section=money_topstories

 

He notes that from 2002 to 2006 the big five (Goldman, Merrill, Morgan Stanley, Lehman and Bear) tripled their earnings to more than $30 billion while achieving at the peak a 22% return on equity…and do remember: they don’t produce anything…not of value or if it was like CDO/CDS it is no longer. Their fees were traditionally fee-based such as M&A advisory, underwriting, and asset management. But from 2000-2006 trading jumped to 54% from 41% of revenues, rising to $70 billion a year for the big five.

 

Tully points out that they depend far too heavily on risk…such as their proprietary trading…which often stems from watching trading patterns of their top clients…there are no secrets on trading desks…what’s the percentage in that? When TB worked for L.F. Rothschild proprietary trading would make or break our year in an almost predictable pattern…yet salaries, let alone bonuses for traders are ridiculous given the level of risk they take. TB recently read where an average CDS trader earned $500,000 a year while a top trader could earn $5 million. But here is the problem: when they have losses, they don’t feel them other than see a decline in income to their base salary…they have already booked the prior profits.

 

As for leverage…nobody…nobody…including LTCM Founder John Merriwether learned from that debacle…unless you think Merriwether’s reincarnation into another hedge fund with 25 times leverage was an improvement on 100 times! In LTCM’s case it was repo on treasury bonds which morphed into all forms of global debt until the Asian and Russian crisis brought them to their knees. Wall Street was taken to the shed over that by William McDonough of the NY Fed who arranged a bailout at no cost to the taxpayers…instead forcing the big five to take the hit (which they ultimately made money on…when you are highly leveraged time is definitely not on your side due to those nagging margin calls). But prime brokerage being as profitable an engine as it was clouded the eyes and brains of Wall Street.

 

This leads us to the third reason cited by Tully: an incredible share of the profits go out the door in the form of commissions, bonuses…from salesmen to traders to the CEO. This has been another recurring theme with TB: the problems over the past two decades derived from investment firms going public. This began before that when Merrill Lynch went public and other firms gradually followed suit. Goldman Sachs was really the last powerhouse partnership, forced to go public by a limited partner, the Bishop Trust who wanted their money back but couldn’t take out any more than the income…as went for the partners…the same as it was for Salomon Brothers before and every other partnership.

 

That is the most important point: in a partnership, the salesforce and traders are paid bonuses not commissions…and since their capital is at risk, partners have a reason to care about hiring the best, not some hotshot who can produce quick returns that eventually cost the firm…and themselves…money!

 

But in a publicly held company you are playing with OPM - other peoples money and unlike a partnership even your own longevity is not guaranteed so make the most of it while you can. Again, at L.F. Rothschild, TB witnessed the transition to a publicly held company…by the way the stock symbol was ‘R’, which has covered several companies before and since…and the accompanying change in risk-taking which eventually bankrupted it or would have had it not been bought up by a savings and loan!

 

It is not just the individuals in a corporation that succumb to fear of losing their jobs and greed, it is the shareholders who no longer care about sustainable earnings but those for the last and next quarter, so don’t hold management totally accountable…they have been aided and abetted by investors.

 

So the first step back to financial health is to only allow a percentage of the bonus to be paid out each year, say 25% with the remainder into a pool which would earn at the firms return on equity…fair? Then, each year it be increased…except that losses would also be netted against gains…withdrawals could then be made on a rolling five year basis. Something also has to be done about other companies to eliminate management from getting obscene bonuses thru things other than the job they are doing…this cuts both ways as they would still receive something if, due to factors other than their own doing…such as the broad economy, not people they have appointed…they too would only receive a fraction of the payment in cash and the remainder in restricted stock.

 

The second step is a much more painful one…because it involves you! Instead of thinking of our own instant gratification we have to think of future generations…that means saving again…and not counting those illusive paper profits on homes and investments. It also involves teaching our children to save, something we haven’t done since the 70’s. Babyboomers are now at risk of being the first generation in history to not leave the next generation better off than they were…as the saying goes…it isn’t as if they are egocentric…they just believe the world revolves around them…a funny but sad commentary.  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

…turnabout is fair play…after all if it wasn’t as bad as it could have been on Friday, then the opposite should hold too, right? But look what happened: Sorting through the chaff of an Exxon Mobil which has created huge swings in opposing directions on a daily basis in the NYSE Energy Index, plus the four horsemen moving the Nasdaq 100 (yesterday 8 stocks contributed 22 of the 37 point gain), the same two stocks, BTI and IMO, were the only two movers in the AMEX Composite, with IMO adding 9 points and BTI subtracting 3 of a net 8.49 gain on an index of 627 stocks.

 

 

1. AIG and MBIA. TB’s concern is the reaction to the problem stocks. Consider: every time some financial stock gets an infusion of capital the stock rallies…even when they cut or eliminate the dividend. No concerns over dilution where the future earnings are going to come from but if someone else is buying they must know something, right? Now look at AIG with that big loss…and raised the dividend by 10% because they didn’t want to break a string of increases that goes back for years…is that a good reason for a board of directors to raise it at a time when they are looking for new capital? The board has proven they are not qualified to run this company and should be replaced. Robert Willumstad, 61, is Chairman and was brought in when ‘Hank’ Greenberg left. The only younger director is Virginia Rometti, 49, from IBM. But of the 13 board members 8 are 64 or older with 3 over 70. Age is not TB’s concern but the changing financial market is and none seem able to cope. Martin Feldstein, 67, is Chairman of the National Bureau of Economic Research…the organization that tells us if we are in recession…as an economist he should understand why they should not have raised the dividend. Business Week has a website where you can get all the data on boardmembers. Feldstein is on 129 boards with 5 directors and 3 are with AIG. Richard Holbrooke, 67, runs Perseus LLC, a private equity firm and is on 492 boards…surely he understands the importance of capital? Frank Zarb, 72, is with Hellman & Friedman, another private equity firm based in SF and is on 103 boards…how can he not understand it?

 

TB thinks that Holbrooke and Zarb illustrate a problem with American corporations…hedge fund and private equity managers do not look at the long term…still…how could they support raising the dividend when they should probably have moved to cut it? Besides, if they had cut it the stock might have rallied instead of tanking for two straight days for a total loss of 13% and bringing the decline over the past 12 months to 47%! In fact, over the past 5 years it is down 32%…28.9% if you reinvested the dividend, for annulized losses of 7.3% and 6.6% respectively. Did they blink?

 

The above are just opinions and a warm-up to MBIA Inc. (MBI). As you all know, MBIA is a monoline insurer that got into trouble by not sticking to what they knew…insuring municipal bonds which is about as risky as sniffing oxygen. The stock which is -86% over the past year reported a big loss but then camoflauged it by saying that you can’t measure the company in the standard way, so they provided a new metric…one that, not coincidentally made the losses look better. But get this…the rating agencies cut AIG’s rating, and their stand alone finance arm International Lease Finance, from AA to A, but maintained MBIA’s rating at AAA. This for a company that now has no credibility and no product to sell. TB would be much more likely to buy insurance from AIG than to insure a portfolio with MBIA!

 

Remember that analysts expected a $1.21 a share loss for MBIA, not the $3.01 they reported. Yet on Friday the stock declined 9% to $9.43, only to rebound by 4.5% yesterday…presumabley it could have been worse. Note also that the low close was set on 1/18/08 at $8.55…making the events even more puzzling. In what investment hell do people think this way? Certainly the worst is not behind them, not yet anyway.

 

But TB believes the fact that the same handful of stocks move the indices daily…and in opposite directions most of the time…and AIG and MBIA are connected…a thin market…we set a new low volume for the year yesterday…with huge range trade bets on stocks and then hedged with out of the money puts and calls. How else does one explain the blend of inside days, outside days, key reversals - occasionally even back to back? There is no momentum to this market but if they can continue that for the next six to nine months they might be able to generate a meaningful rally…doubtful that that is! 

    

2. Treasury refunding. A long-time friend with significant government securities experience pointed out to TB yesterday that the May refunding of 10 and 30 year bonds, which totalled just $21B replaces $74B maturing on Thursday, May 15. He asks where the extra $53B will be invested. Hard to say but depending on leverage, how many long term investors still hold the maturing issues, it could spark some buying of bonds…or not…simply be aware of it.   

 

3. Beranke and liquidity. Bernanke just gave a televised speech to the Atlanta Fed in which he cited problems for some institutions even borrowing in the repo market…and cited his concern over the relatively high LIBOR rates vs. Fed Funds…currently 40 basis points for one week rising to 5/8 for two months which is in turn driving up commercial paper and other short term rates. He cited the liquidity concerns which forced the Fed to take unprecedented actions to be the ‘lender’ by taking in collateral that no one else would…not mentioning that they have committed over half the Fed’s balance shee to this.

He said that when normalcy returns they will be able to eliminate these term lending facilities.

 

On LIBOR it is interesting since a top story on Bloomberg this morning says that for the first time since 1998 the British Bankers Association is considering changing the way it is set…this is because the reported rates which are used to set all types of commercial and mortgage loans are being understated so the 8 reporting banks, the two outliers are thrown out and the remaining six averaged, but the reported rates are lower than what is indicated in the marketplace. For instance on April 7, the BBA reported the one month LIBOR rate as 2.72%, yet that day the Fed reported a 2.82% for secured loans which traded at lower rates than LIBOR. So it is interesting that Bernanke said high LIBOR rates concerned him. On April 16, the BBA said that anyone reporting false rates would be banned causing an immediate increase of 18 basis points in the three month sector. This has implications for the US consumer but illustrates that banks do not trust one another and are afraid that anyone see they are being forced to pay more for money than other banks. No, it isn’t over yet!

 

Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC May 13, 2008

…given the bad news on AIG indicating the worst is not yet behind us…this morning MBIA (MBI)reported a loss of $3.01 a share vs estimates of a $1.21 loss…whether they survive is moot…they are out of the municipal insurance underwriting business. It is not over yet!

 

 

1. U.S. Stocks. TB did a lot of catch-up reading over the weekend and was not cheered up. That after a week where the Dow not only was down but had the lowest weekly close in four weeks…same for the S&P 500, Russell 2000, while both Nasdaq indices were just down on the week. Oddly, Transports which were down for the week but posted a new six month high on Tuesday and Energy (up on the week and a new record high) were bedfellows…hard to imagine with a weakening economy and rising fuel costs, no? The hapless Philly Semiconductor Index was down slightly on the week but at least well off the 3/19 lows. 

 

Year to date the Dow is -3.9%; S&P 500 -5.5%; Nasdaq Composite -7.8%; NDQ 100 -6%; and Russell 2000 -6%; Utilities -4.5% but -3.4% with dividends reinvested, while Energy is up 5.2%.

 

For 12 mos. the Dow is -4.5%; S&P 500 -7.6%; Nasdaq Composite -4.9%; NDQ 100 +3.8%; and  Russell  2000 -12.4%! Utilities –3.7% but -0.9% with dividends reinvested…Energy is +24.9%!

 

Now look at these interesting highlights:

 

*S&P 500, while down 7.6% for 12 months was down 5.8% if dividends were reinvested…and that with a puny 2.19% dividend…that is the power of dividends and compounding…what if div. had been 5%? That is why TB is focusing on dividend producing value stocks not growth stocks.

 

*Barron’s, earlier this year proudly introduced the Barron’s 400 index of the ‘best’ stocks. That index is -3.9% year to date…same as the Dow…and down 8.2% over the past 12 months or almost double the loss in the Dow. The point is there are no defensive stocks, stock prices are determined by fundamentals.

 

*Everyone is excited about transportation stocks…why not? …they are +13.6% year to date and only positive group. But over the past 12 months they are up just 1.5%! Why should Transports be doing well with a slowing economy and rising fuels prices…certainly not the shippers or truckers…airlines? You have to be kidding…leaving just rails as the low cost providers. As for shipping companies, they are volatile (cruise lines break even with ticket sales and make money off of purchases aboard ship and tours…some are adding fuel surcharges), with dry ships and tankers often diverging in performance. OSG is +11.6% 12 months and 9% year to date with dividends reinvested while Dryships (DRYS) is +130% and 19% ytd while some like Teekay have large losses in both periods. This is why Transports like Biotech and Pharma are not good ways to play ETF’s…too divergent returns.

 

*Utilities are not bonds. -4.5% ytd and -3.7% 12 months, or -3.4% and -0.9% with dividends reinvested, contrast to bonds as follows: 2yr treasury +2.3% and +8.1%; 5 yr +3.2% and +11.4%; 10 yr +3.3% and +11.1%; 30 yr +0.6% and +9.3%. The iShares TIPs ETF (TIP) meanwhile is up 7.3% over the past 12 months and +13.2% with dividends reinvested, +1.9%, +1.9%/4% respectively ytd. Yet we continue to be told that stocks are cheap and bonds expensive…that will hold till they aren’t!

 

2. International Stocks. TB believes in being diversified, especially globally. But when too many throw too much at anything it gets killed…witness the hapless European pension funds who threw money into the US stock market right after Y2k! The EAFE Index of global stocks, ex the Americas, is -5.1% ytd, -3.5% with reinvested dividends and down 4.7% and 1.6% respectively for the 12 months…about the same as the Dow 30. But how about the hot markets since the Nikkei is down 22.3% over the past 12 months and -10.2% year to date…what about China and India? Here is the breakdown for Asia:

 

Hang Seng +19.5% for 12 months but from the high on 12/7 it is -13% after falling 21% to 1/31 and then recovering. Mainland China is surprising: Shanghai…DOWN 10% over past 12 months after surging to 10/16 then falling 40% since then…including a recovery since 4/`8 of 17% while the Shenzhen is down 1.4% for the 12 months after falling 19% since the high on 1/15/08 including a 21% recovery since 4/22. So much for the easy money but then there is always India, right?

 

India is +15.2% over the past 12 months, but that is after falling 18% since January 10. Perhaps the US recession is becoming global and even emerging markets are not immune?

 

Korea is up 19.5% over the past 12 months and Mobius just came out very bullish on it. Since the 11/1 peak however is it down 11.6% including a 12% rebound since 3/19/08.

 

As for Europe the CAC 40 is down 17% over the past 12 months and 19% since the 6/1/07 high, and has only bounced 9% since the 3/15 low; UK FTSE is -4.9% (but just 1.1% with divs) and is -1.7% ytd, while the German DAX is -5.5% for 12 months but -12.7% since the 12/12 high even with a 14% bounce from the 3/17/08 lows.

 

Now for the reason TB did this research. A friend sent him a commentary (AIA “Advocate for Absolute Returns”), in which the authors said the future is in Africa and point to how the iShares South Aftrica ETF (EZA) is up nearly 80% since they recommended it in April 2005. Now TB started following this in 2004 but gave up after it got hammered. True, it is up 73% as of Friday, but was +104% at the high on 11/8 and has fallen 14% since then…so it appears South Africa is in the same world as the rest of us.

 

3. Commodities. There is a lot of conspiracy theorizing going on about how prices are all due to speculation…undoubtedly this is true to an extent, but TB’s favorite daily commentary writer, Joan McCullough laid the problem at the feet of the Fed and the dollar…TB would reverse the order but is otherwise in agreement. Wait…she really laid the blame on regulators for not raising margin requirements in securities…that reduces leverage and mitigates prices…especially when first announced. Why else do we see grains…including a global rice shortage…she cites Haiti which was encouraged to get rid of their rice crop due to low prices and now are suffering for that decision…with some rioting. We have a total failure at the regulatory level and the cure will be worse than the cause. Cox now wants to reduce leverage at brokers…and that means cutting back on prime broker accounts which are highly profitable to them…of course it is borrowing short and lending to some guys who think the more leverage the more you make…and why not when those that fail seem to have no problem getting new money…witness John Merriwether of LTCM fame but there are others. As for the Fed it is that it has committed more than half of its balance sheet to taking in collateral that is worthless or totally illiquid and may never again be liquid…and is of questionable value…that is not good for the dollar despite those who are enthralled by the recent rally. Looking at just two contracts TB checked the performance of the lead contract in Crude since the 11/19/01 low of $16.70 to Friday’s record high of $126.27…up 756%! …and rising! Gold has a low of $255 on 2/16/01 and hit $1,033.90 on 3/17/08 which is an increase of 405%. Note the start dates for both commodities…the peak in the Dollar Index was 7/16/01 at 121.02 and the low was 72.34 on 3/17/08, a decline of 40%…it is only slightly off that low! Read on.

 

4. Currencies. With the dollar down 40% against the basked since July 2001 let’s see how the other major currencies have fared. The Euro which was $1.19 at inception 1/1/98 fell to 82.30 on 10/26/00…again note the date…a decline of 31% and since rallied to a high of $1.60 on 4/22/08, a gain of 94.4%. The Yen bottomed at 102 on 4/4/00 and after a rally fell back to 135 on 1/31/02…since then it hit a high of 95.78 on 3/17/08 for a gain of 41%. Sterling was $1.3682 on 6/12/01 and peaked at $211.62 on 11/19/07, a gain of 36.8% but has since fallen back to $1.9588. Thus we are suffering far more from the rise in food and energy prices than anyone else in the world and that is not a good thing when you are the largest debtor nation. The trade balance improvement for April should not be view as sustainable…it was caused by a larger drop in imports than the increase in exports and due to the weaker dollar.      

 

To TB the above suggests further dollar weakness, or at least not a meaningful rally and while commodities prices could fall don’t expect them to be meaningful either…Houston we have a problem!  

 

Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC May 12, 2008

…one of TB’s favprite old standards and appropriate for how he and other technicians are feeling not that stops the motor mouths on CNBC every afternoon from sounding like they know exactly what you should do.

 

Take a look at the overnight markets section for all the news that is driving the stock markets south.

 

 

1. Bloomberg on credit. Bloomberg unleashed some new functions and to those of you who were impressed by the rally yesterday…which didn’t even qualify as a dead cat bounce as not even 50% of the loss was regained in any sector except gold/silver stocks. Even energy just retraced the prior day with a modest net gain, despite record highs in crude both days. Anyway, Bloomie set up some new functions that are quite useful in determining whether the worst is behind us yet…TB contends it is not or if so, we will suffer for much longer than expected.

 

The first function is WDCC which is worldwide write-downs and credit losses along with capital raised by quarter since 12/31/06. First, global write-downs and credit losses have totaled $318.5B of which $152B was by US financials. Meanwhile, globally financials raised $238B in new capital with $130B going to US entities. Here are the most important ones and their ranking in terms of losses:

1. Citigroup (C). $40.9B in write-downs; raised $44.1B, $12.9B so far in Q2.

2. UBS (UBS). $38.2B in write-downs raising $28B, $12.9B in Q2.

3. Merrill Lynch (MER). $31.7B in write-downs raising $16.1B, $2.6B in Q2…and did not cut or omit dividend…in other words raising capital to pay it out!

4. BofA (BAC). $14.8B in write-downs raising $17B, $4B in Q2.

19. Wachovia (WB) $7B in write-downs raising $10.5B, $7B in Q2…they just realized they understated the losses too so these are adjusted figures     

 

Isn’t it of concern that we are talking about the worst being behind us when the write-downs continue and both UBS and Wachovia keep raising the losses? All we are talking about is the subprime and related derivative losses, mainly by the brokers. Banks on the other hand are faced with rising delinquencies and foreclosures which require additions to the loan loss reserves and these are now morphing into credit card and auto loans. More of the same to come.

 

A broader function is WWCC which is ‘worldwide credit crunch’ and has a broad menu of functions. In another function Bloomberg reports that 650,000 jobs have been cut worldwide due to the credit crisis, and they are much better paying than those hospital and leisure jobs…a staggering number.

 

2. Financials deteriorating. Wednesday, Financial stocks declined by 2.8, followed by a 0.8% decline Thursday. While big banks were down 2.9% followed by -0.7% but the Keefe Bank Index of smaller regional banks was down 3% and 1.6%. Brokers however fell 3.4% and 1.6% for a total of 5% in two sessions…still sound like the worst is behind us? The brightest spot was Insurers which rose 0.6% Thursday after falling 2.4% Wednesday…but then AIG reported after the close and it wasn’t pretty. They took the stock down overnight and it will be a big drag tomorrow. Clearly insurers are dragging down Berkshire Hathaway too…perhaps we should be saying the best (worst) is yet to come?

 

3. AIG. Posted a Q1 loss of $3.09 a share due to write-downs but had had an adjusted loss of $1.41 vs. estimates of 34 cents a share. Also, they will raise $12.5B of which $7.5B will be equity linked. $5.92B of the loss was for AIGFP market to market losses, citing weak US housing market, credit market disruption and equity market volatility for the problem…poor baby’s. But then they had to increase the quarterly dividend by 10% to 22 cents a share…what is this, good faith? Now get this: they also said they are looking for a new CEO…duh! So what happened afterwards: S&P cut their rating to AA- from AA with all ratings on watch list - negative and stand alone subsidiary International Lease Finance to A+/A1 (the latter is their short term rating from AA-/A1+. Fitch also cut ratings. The stock sold off 7.7% to $40.75. TB thinks the entire board should resign for raising or even maintaining the dividend in a true sham…that is even worse than Merrill maintaining the dividend and paying out $341,220 as on AIG’s 2,180.48 million shares at 22 cents that is $479,705,600! What fools!

 

4. State Street and Wachovia. Here is a motley crew if there ever was one. State Street reserved $625 million for litigation over subprime derivatives they put in pension funds…but that is the low end. The high end is about $7.5B. Contrast this to Merrill during the Orange County bankruptcy which reserved the max and then later was able to bring the remainder back into income…if memory serves they reserved over $600 million (remember, that was 14 years ago), settled for $35 million plus legal costs. On this news State Street (STT) fell about 1.7% yesterday to $72.73…now get this: UBS after the news raised their target to $82…this goes a long way towards explaining UBS’s problems.

 

As for Wachovia after a near riot at their shareholder meeting a week ago Kennedy Thompson was deposed of Chairman but remains a director while Larry Smith, an outside director assumed the mantle. Smith however was critical of dissidents at the meeting saying they should have expected a dividend cut. Not a good sign and he omits that their problems was the purchase a couple of years ago of Golden West Financial with a big portfolio of option ARM’s.

 

5. Auction Rate Securities. The implosion of this market due to monoline insurer problems, as well as broker capital problems, is now costing the taxpayers. Citi was the biggest underwriter of these issues to the tune of $55B in a $166B market with UBS number two (they truly are number two) at $42B and Morgan Stanley at $22B. When the problems developed, rates of 10% or more were not uncommon, and in the case of the Port Authority of NY and NJ it reached 20%. On the other hand, those with index resets tied to LIBOR fell to unattractive rates of 1% and in some cases zero…really, but those were taxable issues. In the tax exempts, issuers entered into interest rate swaps with the issuers for healthy fees and we all know what happened to Jefferson County, Alabama (Birmingham), although that was largely stupidity and greed on the issuers part…but also officials were ‘entertained’ lavishly and induced to enter into agreements. Under the swaps they would issue bonds, convert them to auction rate securities and then pay the lower short term rate while receiving the fixed…it worked for years and in some cases decades…until it didn’t. Now they are hit with high penalties to exit the swaps so they can issue the long term debt to reduce exposure. Bloomberg did a great article on this and some of the data comes from it. For instance, Sacramento County had to pay Morgan Stanley $5 million to get out of a swap so they could refund $79.5M of bonds…that is 6.2% of the value; Redding California had to pay Citi $6.7M to refund $67.3M and Wisconsin Public Service had to pay $11M to refund $192M to Bear Stearns (now JPM) and to JPMChase directly…a dynamic duo. The problem continues although TB does see some relief in the rate area but two-thirds of the auctions are ‘failing’ every day…meaning you can’t get out of the bonds or there aren’t enough buyers to allow everyone who wants to redeem to get out.    

 

6. Regulation. Muriel Siebert, 75, and the first woman to hold a seat on the NYSE and later the first woman to found a member firm was interviewed by Maria B. on CNBC yesterday afternoon. This, soft spoken woman, Muriel not Maria, talked on market volatility and like TB laid it right in the lap of the SEC for eliminating the uptick rule. She has studied the moves since July 2 when the rule was eliminated and says that the volatility is worse due to piling on as stocks are declining since much of the shorting was done without an uptick or an even plus (same as last trade). She almost begged the SEC to examine this and replace the rule. This is the biggest blunder of Chairman Christopher Cox’s tenure, additionally he has not been firm enough on ‘naked shorts’ which take on even more significance without the rule.

 

Cox, the subject of WSJ’s Heard on the Street as he gets tough on dealers over there heavy reliance on short term funding for their leverage positions and wants them to raise their long term capital. The article questions their ability to do this in the current environment and to TB shows how Cox learned from his years in Congress to not fix something until it is totally broke then go overboard to correct a problem that happened on their watch. This goes for the Fed, FDIC, and every other regulatory body in this country except the CFTC which may also have to do something with commodities markets driving prices and expectations higher and higher. Goldman this week said Crude could reach $150-200 in the near future and overnight Nigeria problems drove it above $125 and raising havoc with global stock markets.

 

With commodities prices surging, some are pointing to retail sales not being all bad…but that is distorted by food and energy and that is becoming a bigger component of sales of stores like WalMart and Costco. Stands to reason and you can bet those rebate checks WalMart will cash will be used in those two areas as well as for over the counter drugs which they just reduced in price for a second time. Meanwhile the high end retailers like Coach and now seeing problems and relying more on their outlet stores to produce revenues to hold prices at retailers firmer. That solution is unlikely to last. We are in a recession and without the juice of home equity withdrawals, consumption will undoubtedly slow. The only two solutions are saving and higher wages and those are illusive and will take years to accomplish. 

 

Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC May 9, 2008

 

…how does the broad stock market have a nothing day on Friday despite a horrible payrolls report (oops, forgot it could have been worse), an inside day on Monday on the lowest volume of the year to date, a key reversal UP on Tuesday, and then a key reversal down on Wednesday…the latter two occurring on volumes of just 1.23B shares or about 230 million shares below an average day…even with the weak average since March 24 the volume is 120 million below average. As TB as frequently stated, inside days are a sign of indecision - nobody willing to commit funds, but outside days (higher high and lower low than the prior) and key reversal days (same as outside but with a close above or below the prior days range), are usually market altering events and come infrequently on some new information. What new information did we have on Tuesday or Wednesday? In fact the only real news we have had in this period was the jobs report and the Fed increasing the TAF auctions to $150B and allowing credit card obligations and student loans as collateral…a clear sign that the worst is not yet behind us? Yet the market is what it is…and right now it is a bear trap…or even a bull trap as the true believers dump more money into the market…yet as TB reported Tuesday a Deutsche Bank survey found almost a third of the largest hedge funds sitting on 5-10% cash reserves…record high levels! Do you get it? If they don’t know what to do…or are waiting for better opportunities…and they are penalized by holding cash since they are charging their investors 2% and thus losing money on each day they are in cash. Perhaps it was the announcement of this survey in Tuesday’s WSJ that caused the reversal as the hedgies tossed a bit of green into the market…selectively…to make it look like it was a lot more…and then reversed the entire game yesterday?

 

1. Stocks. TB monitors the ‘movers’ every day and reports them in the stock summary…a review of them shows little over time…up one day, down the next and due to the market weightings distorts the movements greatly. Exxon Mobil (XOM) has been the frequent flyer…like the four horsemen of last year (AAPL, AMZN, GOOG, and RIMM…but this year it has been reduced to just two consistently: AAPL/RIMM). Take a look at how XOM moved the NYSE Energy Index since 4/29/08…numbers are index points: -18; +35; 5/1-5/2 not a mover; +9;+14; -31. What possible news came out on XOM on all of these days? To TB this confirms his theory of major hedging in options so they can range trade key stocks and yet avoiding the big hits…this has pulled down volatility on both S&P 500 and NDQ 100 options to apparently safe levels when they are in fact not…but the reports show that the cost of options is rising sharply as more players enter and more traders get burned…in other words it is harder and harder to find value in an out of the money put or call…meanwhile the specs keep on playing…that is going to be the unseen culprit when we finally collapse as the costs keep on rising. Heck, we have destabilized the derivatives market already in OTC contracts why not in the real deal. Don’t just think stocks on this, we have all seen what is happening in commodities.  

 

2. Buffetted? Poor old Warren…has he lost it? Briefly he lost it in 2004 when he made that big bet against the dollar and it cost him dearly…yes him, as he is still principal investor in Berkshire Hathaway at 32.4% of the outstanding stock while his colleague Charlie Munger owns a mere 1.4%…on a $128,400 stock that is. So how mad can you get at a guy who took a third of the $15B hit? Think of it as a poor man’s hedge fund (the class B shares are just $4262: no 2% +20 fees! TB is revisiting Berkshire because they just held their annual outing in Omaha and CNBC’s Becky Quick has become enamored with Warren and he with her (get your minds out of the gutter…not that way!). In the week before the annual shindig the stock rallied off its near low for the year…since the 12/11/07 record high of $152,000, the ‘A’ shares are off 13.9%, but rallied 5.3% from 4/25 to 5/2…pretty typical before the meeting. Since then they have give back 3.9% of the gain putting them back near the lows.

 

The intriguing thing about Berkshire it people are always talking about it yet they don’t really understand it. It is the ultimate conglomerate with no dividends, no stock splits, and a license to invest in whatever Warren deems appropriate…witness the flawed currency ’strategy.’ But isn’t Berkshire a defensive stock? After all, look what happened after Y2k and how it didn’t even blink at 9/11…a true defensive stock…or is it? One reason that Berkshire performed well in 2000 was that it peaked at $84,000 on 6/22/98 then declined to $40,800 on 3/10/00…a 46.8% loss or 30.7% annualized…ouch! But from that low it rallied 219% to its high on 12/11/07, 15.5% annualized. Since then it has declined by 13.9%. So while it is a well-run company it should not be determined to be a defensive stock…and from the 6/22/98 high to the 12/11/07 peak the gain is reduced to 94.9% or 7.3% annualized…more than halving it. Would you have held on for that 46% loss? Doubtful.

 

The point is there are no defensive stocks over the long run…and when one believes they have found one they are usually disappointed. That is why technicals rather than fundamentals are more important, or should, be to investors. This is not to say that one shouldn’t base an investment decision on fundamentals but to really make money, buy and hold is simply not going to get you there…but having seen the ups and downs since 1998 you already knew that.

 

 

3. Commodities. TB has commented that most investors have no business investing in commodities, and that there is a distinct difference between a commodity and a commodity based stock. Most obvious of these are gold and silver stocks which are relatively thinly traded and thus very volatile with the biggest gains and losses coming just as a turnaround in the metals price occurs…then the small guy reads about it and invests and is ultimately disappointed, or worse. We are now seeing that in energy stocks and that is now migrating to ‘green’ stocks…again the early gains are always the best. Coal is on a tear and one of the big recipients of that is Arch Coal…but is it time to get in? Who knows, but one thing for sure, there is much more speculative interest in commodities than the underlying demand and it is feeding on itself.

The streetTRACKS Gold ETF (GLD) is an example of this: the trust buys gold as the fund grows and of course as the price of gold rises more gold has to be purchased a virtuous cycle but when the price drops and investors lose interest that causes more selling of the underlying commodity…a vicious cycle. Note also that since you are buying the actual commodity gains are ordinary, not capital!

 

Gold peaked on 3/17/08 at $1,038.60 ($1149 on the Dec ’12 longest dated contract since gold trades in contango)…a nice run from 8/16/07 when it was $669.70. But it is showing weakness having failed to support intraday at $850 and going down to $846.40 before recovering. The 50% retracement of the rally is $854.15 so another downdraft should be respected. Similar for Silver (SLV is the ETF) which also began the rally the same date at $11.55 and also peaked on March 17 at 21.50…then fell back to $16 and is last at $16.82. $16.53 is the 50% retrace so it too is at a critical juncture.

 

iShares has several commodities ETF’s that might be appropriate if you know what you are doing but you can’t just buy them willy-nilly. Since, other than gold and silver, they are linked to a commodity index they are eligible for capital gains…just be sure you look before you leap…could be expensive.

 

Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC May 8, 2008

 

 

 

 

 

 

 

 

…was going to title this ’vindication.’ Not only did yesterday’s stock market fail again…it did so after what would normally unequivocally be a breakout on Thursday. Then it failed to hold on and only after the buying late in the session Friday that can only be labeled ’short covering’ it managed to eke out a gain, albeit a meaningless one. As for yesterday, it doesn’t get much worse. Not only was it unable to hold on but the Dow declined by 89 points and on just 1.1B shares…the lowest volume of the year! and this at a time that markets are usually humming. The average daily volume since March 24 has been just 1.34B shares…the same period last year averaged 1.55B shares…about average…and the lowest volume was on April 5 at 1.25B shares and the highest was 1.94B shares. Since 3/24 we have had just 3 days with volume above 1.5B shares, the highest being 1.7B on April Fools’ Day, and we have had four days with volume less than 1.2 billion shares…that doesn’t even begin to pay the utility bills. This begs the question: what will the summer doldrums be like? Last year there really were no doldrums as the average daily volume never dipped below 1.5B shares. Last year there never really were no doldrums as the stock market was roaring to record highs but August averaged 1.37B shares…about the same as now!

 

An answer to the low volume might lie in today’s WSJ Heard on the Street column which states that according to a Deutsche Bank survey about a third of hedge funds are holding 5-10% cash! This is unprecedented as it should be…because if investors are paying you 2% to manage their money their return on cash is negative. This is either fear or as the survey suggests waiting for opportunities to buy distressed assets. Who would you believe: a hedge fund manager with his own money invested in the fund or some stock junkie on CNBC who says this is as cheap as stocks are going to get and you should be buying now? Don’t bother answering, it was a rhetorical question. So the next time someone tells you the S&P 500 is cheap at 22.6x earnings with a whopping 2.13% dividend yield…blow them off.

Of course they are quick to point out that the 22.6x includes financials and consumer stocks, many of which have low or negative returns, but it also includes AAPL at 38x, GOOG at 30x, AMZN at 41x and RIMM at 35x…all of these are estimated earnings so trailing is a lot higher…all well and good so long as the growth rate in excess of 25% continues to infinity. According to Merrill’s David Rosenberg that p/e is now 15% higher than it was in October at the market peak! The Dow, if you want quality, is at 74.5x earnings with a dividend yield of 2.42%…and remember both of the indices are well off the lows!

 

TB discussed several times that role options have in the current market. When we were going sideways so long and the bands were clear it was a lay-up for the big hedge funds. When a stock is at the low end of it’s ‘band,’ buy it and along with it an out of the money put as well as an out of the money call…very cheap protection against breaking the band…but then we went down again and the band on the big stocks was broken, and the puts exercised. Since this event the cost of options has risen dramatically (TB looked for the reference but wasn’t able to find it yet but it was a big number).

 

Rosenberg makes an interesting point that while the worst of the write-downs may be in that they will drag on as the banks continue to be forced to take them. For subprime mortgages taken out between the second half of 2005 and first half of 2007, 25-40% of the borrowers on average are more than 60 days delinquent…for 2005 it has ’stabilized’ at 30% for the last four months. This is supported by the Fed’s Senior Loan Officer Survey which was released yesterday and is prepared for the FOMC meetings. It deteriorated sharply with the main takeaways being banks are trying to rebuild their margins and are making fewer loans. It is clear they don’t trust one another so why would you trust them as an investment?…OK, if you are a short term trader but there are literally only a handful of regional banks that are still attractive and hopefully have no land mines. Rosie, like TB, thinks it is ridiculous to believe those stimulus checks will have any positive impact on the economy…where Goldman came up with 50% being used for consumption…other than gas and food, certainly not autos which are selling at levels not seen since 1993. TB could go on and on…one factoid he presents though is that according to the Inter-American Development Bank only half of the 18.9 million Latin immigrants now send money back to their families at home…down from 73% two years ago…he adds transfers to Mexico were down 2.3% year over year in the first quarter.  

 

This morning UBS announced another $10.9 billion in write-downs and plans to cut 5500 workers by mid-2009…half of these will be in investment banking (probably a lot by attrition after reading this…the best ones). They also sold $15 billion of subprime assets to BlackRock. Sound like the worst is over to you? Not to TB.

 

Yesterday, TB commented that the Fed will not release the eligible collateral to the public…well it turns out they did…sort of…this information only was disseminated from some dealers to clients but is still vague. The combination of repo, TAF, and other auctions after increasing the limit on TAF to $150 billion is now $450 billion…that is a huge chunk of the assets of the Fed! Furthermore, the TAF does not require daily repricing of collateral and on May 2 they announced they would accept student loans as collateral. As Joan McCullough points out…when asked by Sen. Dodd if they would accept them, Big Ben deflected it…of course Congress passed a law last year that made it less profitable to underwrite student loans so we lost a lot of issuers…anyway, now in a dramatic but quite reversal, they will now accept student loans as well