TB’s Quote of the Day from Bloomberg: ” Morality, like art, means drawing a line someplace.” – Oscar Wilde. Come on Elliot…draw a line…somewhere…anywhere. TB
Today’s topics:
1. Credit Markets – it’s later than you think!
2. Stocks – the movers, or lack thereof
3. The risk premium - meaningless?
4. Inflation, commodities and the dollar -joined at the hip
…last night, the roaches were running all over the market. Not the Stephen Roach’s, who just a week ago warned us that we in danger of repeating Japan’s recent history when their stock and real estate bubbles imploded and have demographics that we are following. Roach is a very bright guy yet the guru’s of Wall Street have frequently challenged his thinking which is anything but challenged.
Credit Markets. We all know that there is never just one cockroaches and now they are multiplying by the day. Carlyle Capital (see below under overnight markets), and funded by the Carlyle Group, may make the Bushie’s the most reviled first family in history, having not one but two Presidents, the former in the group and the latter would most assuredly be in it if he weren’t President. TB has frequently commented on the Group’s investment prowess which is in defense and other businesses where their political contacts are most helpful while they have not done well in other private equity and now hedge fund forays. Now the world is sitting at attention as the dollar plunges to record lows against the Yen, Euro, and Sterling is almost to $2.04. The Canadian Dollar is still below parity but that is only because the government wishes it to be as we are mutual ‘best trading partners’ and it wouldn’t be prudent for it go remain above par for long.
How can those of us who have been trying to spread the word…as opposed to the gospel of a few repetitive talking heads, you know their names…get the point across to lovers of equities that we are in a major credit crisis and that is what the Fed is concerned about? Not one of the moves they have made to date has been to stimulate the economy…merely to prevent the unthinkable…and despite using every tool in their arsenal they have not been able to do anything more than apply strong pressure to the wound. Yet every time they try something the stock market rallies and that is totally deceiving: the market has been falling because conventional money managers and mutual funds are fully invested…you hear several of them every day on CNBC saying they like this or that stock or sector but when asked if they are buying the say they are fully invested…meanwhile due to the credit crisis, hedge funds are being forced to delever (no, not deliver as that is beyond belief at this point), so liquidity is evaporating just when we need it most. Every rally of late has been due to shortcovering as the effects of all of the monetary and fiscal stimulus are unknown and that is the biggest danger to a short. But each time the covering becomes sharper and faster and then quickly stops and the market fails…there is no buying support. This too is unthinkable because where will lasting support come from?
Stocks. Perhaps the strongest stock in the US market is IBM which had blowout earnings, yet is isn’t even back to the October highs while the four horsemen have been reduced to three, with Amazon in a rout and down 31% since 1/2/08…it’s high close aside from the spike to $101.08 on a gap up which was followed by a gap down the following day returning it to the $90 level of reality…they are an online bookseller…and some other things but they are retail nonetheless. Lately, TB has taken to listing besides the indexes the key movers and the names are generally the same, only the sign is different. But rather than being indicative of the market they have now become the outliers with most other stocks adding or subtracting in a minor fashion. Here are the key offenders: AAPL, RIMM, GOOG, QCOM, AXP, GE, XOM, CVX, COP, BA, MSFT, KLAC, SLB. Note that these issues are key components of the S&P 500, Nasdaq 100, NYSE Energy Index and to a lesser extent the Dow. IMO (Imperial Oil) and BTI (British American Tobacco) keep popping up as the only winners or losers on the AMEX. But note that with the exception of BTI the trend is down or at best sideways. This smacks of black box trading by hedge funds that are shorting and covering over and over but trust TB if you try to time this you will lose. They can move and make money on moves of a point or less due to the huge size of their trades but you will be eaten up by commissions. Even if you are trading at $13 per, that is 1/8 on a 100 share trade and a 1/4 round trip…subtract out the times when you are wrong and you will lose money.
The risk premium. Someone studied stock market history and saw a linkage between treasury yields and stock market p/e ratios. If you take the inverse of the p/e (i.e. a 20 p/e becomes 5%), and it is less than the yield on a 10 year treasury note then stocks are at most fairly valued and more likely undervalued. This is known as serial correlation where two unrelated events appear to be linked but are actually random. True, over most time periods this is true, but it is the outliers that are meaningful as those are the periods where money is made or lost…or at least capital is preserved. TB has always considered this metric apples and oranges. Why? What does a non-risk asset, Treasury’s, have to do with a risk asset, equities? Pretty obvious: in a low inflation environment, stocks look attractive, yet the best gains have come in periods of low but gradually rising inflation and in high inflation when yields are high stocks look expensive…yet aren’t stock supposed to be a hedge against inflation? Still, the inverse correlation will hold in most environments
But what about a period, say four years of rapidly rising earnings, each quarter higher than the last, and further distorted on a per share basis by record stock buybacks (most of which eventually filter their way back into the market since they are not retired just held in treasury)? We know one thing: broad market earnings do not flatten at the peak they decline and sharply. Even if you use forecast, not trailing p/e’s, the estimates will be too high due to interpolation and projection by optimistic analysts whose job is to promote stocks. Also, remember that if you are wrong on a stock or stock market call it is far worse to be a bear in a bull market due to the potential returns, then to be a bull in a bear market…the opposite applies to credit analysts (or did until we lost our senses on risk thanks to CDS derivatives). Thus there is a natural bias to stocks…despite the market of the last 10 years being driven by leverage and since it is far riskier to use leverage to short, again the bias is to be bullish as it is far easier to sell them than to cover a large short position.
Now consider the bond market, with the yield on 10 year treasury’s declining to a new low of 3.40% overnight (meanwhile mortgage yields are rapidly rising and above levels of a year ago), a p/e of less than 23 times would be a screaming buy in stocks…so the S&P 500 at 19.5x is attractive…huh? If there is an aversion to risk and stocks now why should we equate their value to 10 year treasury’s? Originally, it was felt that the duration (time to receive half of the expected returns) of the stock market is about equal to the 10 year treasury. But duration is function of yields and reinvestment rates over a period of time and that is fluid as rates rise and fall. The only sure thing on return on bonds is a zero coupon treasury…no risk and price calculated on reinvestment at the yield. That yield is now about 4% in 10 years to 4.50% in 30 years…for the first time in more than a decade the peak is not in 2020-2025. But when yields are high the risk (duration) is lower as reinvestment is at a higher interest rate so it can run to 6 years and currently it is at 8.4 years…the highest on record. But the point is that we are in a major flight to quality and that implies higher stock dividend yields and lower prices as well as p/e’s. So regardless of correlation over an extended time period it is meaningless in the current environment! Stocks are not cheap and even if they were, they will probably get cheaper.
Inflation and commodities. There are two types of inflation: demand pull and cost push. Cost push is due to rising input costs (commodities or labor), while demand pull implies too much availability of money. The latter is the type we had before Paul Volcker painfully nipped it…not in the bud though, in full bloom. The Fed is right to be concerned too about the former but our measurement of inflation is grossly understated. This happened under the Clinton Administration where he signed into law what a GOP Congress passed at the suggestion of his Treasury Secretary Rubin… a change to lower COLA adjustments by eliminating cost like homes from the calculation and replacing with ‘equivalent rent’ since retirees don’t buy homes. That has saved the government billions but in the process understated the true inflation rate…they also introduced hedonics where the cost of an item is decreased for measurement purposes by the added improvements (most notably when cars went from base with options to standard equipment), but it still costs you more than the measurement suggests. Still the worst is the elimination of food and energy (the former already included substitution like chicken for steak in a rising cost environment). But now it is rising energy…and now food prices that are sapping productivity and disposable income which is sorely lacking thanks to greedy senior management of many companies.
Over the past 6 months the CRB commodities index is up 32%…Wheat +76%, Corn +51%…that loaf of bread I talked about a month ago at $4.56 now costs $4.86 (+6.6%)…thanks to our Energy policy of subsidizing Ethanol. Crude is up 38%, Gasoline +35%…yet despite being told a few years ago by Alan Greenspan that $35 oil was a tax on consumption, at $110 it is only beginning to cause concern. Thanks to a plethora of plastic in the consumers pockets and equity in their homes, we have muddled through but no we are exhausting our means…or more accurately our creditors trust of our paying ability. Crisis.
None of this is fun to talk about but as our personal, corporate and government deficits swell we have reached a breaking point. True, corporate balance sheets, sans financials, look good, but what about that debt in the form of loans, bonds, or preferred stock that was used for stock buybacks that now look insane…but as Angelo Mozilo testified: they were the best use of the shareholders money…do you believe that?
Do Hillary a favor and send her packing…if for no other reason than so she can make money. Not only can she write another book but she can do what she does best…commodities futures. Of course it may be more difficult without an accommodating firm that let her trade without margin requirements and also split good and bad trades between her account and a sham account but what the heck…TB still likes Obama best but if he had a choice for another black candidate it would be Bill Cosby because he tells it like it is to his people not just give hope and promises that will disintegrate. McCain? More of the same as the cost of Iraq increases…perhaps past the $3 trillion mark?
TB had lunch with two friends who are economics and financial pros and both like he are appalled at the acumen of Treasury Secretary Paulson and from listening to him cannot fathom how he became CEO of Goldman Sachs…something is dreadfully wrong here and he has more of a clue than anyone other than Bernanke. Then he had dinner with a friend…a journalist from Iraq and discussed what is happening there. He says everyone hates the government there but agrees with TB and the two gentlemen from lunch that had we protected the Central Bank and the Museum of Antiquities…how could a civilized, capitalistic nation not do this?…and not banned the Baathist party, things would be much different…and we might be a trillion or more wealthier…money that could better be spent here for education, etc.
Indeed we do live in interesting times…but trying ones that will test our mettle.
TB
Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and in no way reflect the views of anyone other than himself. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. No fee…nothing to sell…merely observations of events in the marketplace offering a non-mainstream viewpoint…sometimes…usually? Hope you find it useful.
Copyright TBD Capital LLC March 13, 2008
