Archive for May, 2008

5/30/08…marking time?

May 30, 2008 at 5:27 am · Filed under economy, financial, markets ·Tagged , , , , , , , , ,

Today’s topics: a review of the financial markets over the past week.
 
…what a day yesterday was…a real head scratcher…Q1 GDP revised up but in line with expectations but that didn’t stop the talking heads from treating it like the second coming…you fill in of whom. After opening with a nervous tone the stock market ground it’s way higher till at one point it was up 130 points but then whittled the gains back down and steeled for 52 at the close. Volume was better at 1.22B shares starting out the well then fading later on but while the highest of the past five sessions the average has been just 1.17 days, well below the fairly typical 1.5B average of the past six months and even the puny 1.29B since March 24 that TB keeps harping on…bring on the doldrums…they are already here!
 
Bonds have been in freefall…even as the dollar rallies! The economic data has been mixed lately but if you sift through the numbers there is nothing to suggest a reason…other than the removal of ‘fear’ from the markets which TB contends has been replaced once again by complacency! The 1 month T-Bill which got down to well below 1% briefly is now at 2.02%, slightly above the Fed Funds target and even above the 3 month T-Bill (1.89%). We have had a terrible rout in bonds over the past four sessions, and if inflation is truly a concern, why have TIPS been the worst performer…sure they were over priced but at a 2.1% real rate of return they looks pretty good again…but never stand in front of a moving train. Over the past week the yield curve from 3 months out to 5 years has steepened and then while still rising has flattened out to 10’s and 30’s. The 2 year note at 2.65% is cheaper by 22bp’s; 5 yr, 3.40% cheaper by 26; 10 yr 3.40% cheaper by 21; 30 yr 4.73% cheaper by 17bp’s; 30 yr TIP 2.08%, cheaper by 23…all this in just three trading days. That is a loss of 1-5/8 on the 10 year; 2-1/8 on the 30 year; and 5-3/4 points on the 30 yr TIP!!! Surely, a correction will come soon…but having taken out the supports although on five occasions since late February we have mounted significant rallies.
 
The main focus is or should be on the dollar…it is bouncing and for the first time since the selloff from Mid May is back above the 40 day moving average…73.05 vs 72.54…considering the record low of 70.70 on 3/17/08 that is little consolation but merits close watching. What is happening? Is it merely a result of the yen carry trade?…borrowing cheaply in yen, selling the yen and buying the dollar…looks to be the case as it is the Yen that is suffering the most of the major currencies…although you wouldn’t know that by their stock market, the Nikkei which has been the strongest over the past few sessions, and in fact up 22.6% since the March 14 low…cheaper Japanese goods? S&P 500 in contrast, is up just half that from the March 17 low.   
 
As for commodities, there has indeed been speculation…but also investing in the form of ETF’s and commodity index funds which have seen enormous growth, mainly from pension funds…so let’s not blame the entire mess on hedge funds…or oil companies…or even OPEC. ETF’s and index funds have the result of amplifying both up and down moves in the market as they result in ‘piling on’: on the upside more money comes into them and has to be used to by commodities or commodities derivatives, but the converse is also true and even more significant. Yet in the April selloff Gold was able to support at $850…$857.80 is now the 200 day moving average, so both levels should be respected…go with the flow. As for Crude, which closed at $126.62…$120 is the 40 day, but it could fall to $111 and still be in the long term uptrend. There are your markers.  
 
Stocks have had the easy gains…if you want to call them that…would you want to go long on the last day of the month after a bounce like we have just witnessed? Furthermore, some of the biggest gains have been in sectors that have been hammered severely. Note the tech rally yesterday…sans Semi’s!
 
Auction rate securities update: If you are in awe of PIMCO and Bill Gross, you obviously do not own the auction rate preferred’s issued by their various closed end bond funds. Whereas Nuveen and some others have attempted to mitigate the problem of the two classes of investors one (bond funds) interested in higher returns accomplished thru leverage, and the other just wanting the liquidity they were promised. Now they are demanding it. According to Bloomberg, David Chandler, a retired commodities trader and lawyer…a perfect combination these days, no?…add in a quant and we would have a trifecta…a triple crown…like Big Brown has the chance of achieving next week…horse was even brought to the NYSE yesterday! Wait…where were we…oh yeah, PIMCO. Chandler, who bought several hundred thousand of PIMCO preferred’s has gotten tired of contacting the company who is, by the way, the only one of the five major issuers who hasn’t initiated a buyback. While TB is disgusted at PIMCO’s lack of action, he is more so with the SEC who could have taken everyone off the hook by demanding that they buyback the securities…harm to bond fund holders?…pullease…they have reaped enormous returns thru leverage and all they would be doing is leveling the playing field…so now PIMCO, along with major dealers of ARS is facing a lawsuit…unless justice is truly blind the answer is obvious…but the law being the law,  how it turns out is debatable.
 
Other fallout from ARS is money market funds. The only form of ARS that is money fund eligible is VRDO which has a hard put to a third party. With more institutional investors flocking to this form due to a lack of liquidity in the others, rates on these are less than 2% and in some cases less than 1%. Yesterday, TB was looking at Schwab money market funds. Taxable is yielding 2.20-2.40% while tax exempt is yielding 2.20-2.75%…TAXABLE EQUIVALENT! In other words, you may as well invest int the taxable which has sweep attached and daily liquidity! Tax exempt bond yields have loosened up a bit in the front end with about 2.70% in 2011-12…but the supply is still far exceeded by demand. That is why TB is more than happy to forego liquidity for yields of 3.5-4.5% on 7 and 35 day auction resets backed by municipal bonds…these are gradually be refunded or restructured so that by the end of the summer they will likely be a relic…by the way, about 1 in 3 are not ‘failed auctions’ meaning that they have some form of liquidity at least. The question will be what to do when that game is over? 
 
TB was a contributing author to Frank Fabozzi’s The Handbook of Municipal Bonds, a 1332 page tome. TB was referred by a friend and was flattered to be included with authors who are well-known in the industry, some legends from his early days in investment. He mentions this not to boast, but to make a comment. Last summer, when the book was being compiled, there were no problems foreseen on  auction rate securities or municipal bond insurers…none! TB read all the pertinent chapters and could find no indications of cracks in the system…amazing how two instruments that have been in use for decades can suddenly turn from gold to dross…but then, we are in a fast moving financial community. A Bloomberg story today is on Joseph Fichera who was the first to publicly see problems in ARS…but he was more than 20 years too early…had TB heeded that advice he would have given up a lot of returns! Article is by Mike Quint and a good read.
 
It seems to TB that we are at a significant crisis in the financial system that far too little has been written about it: the US has had a Uniiform Commercial Code for decades, that has mitigated the differences between varying laws in the states…but now mortgage law, including the ramifications on tax law, securities law, and other forms of contracts are being tested…and hopefully the stupidity of not having a usury law…imagine charging 25% interest when borrowing costs to lenders are so law…and they wonder why they are seeing rising defaults…even as their ‘best customers’ get zero interest for a year! Auto leasing and lending might even come under review…the only thing harder to do than get an auto lease these days is to get out of one! Due to all those big SUV’s and zero interest loans, half or more of all auto loans are upside down…and how about if your car is stolen…or totaled…now you not only have to pay more than insurance will reimburse you but you have no vehicle! So people are foregoing making home loans first…takes 9 months or so do get you…auto loans second…do they really want to repossess that worthless hunk of steel?…and finally credit cards…after they have maxxed out buying gas and food for their families. Sure glad this isn’t a depression…or even a recession…it’s just depressing!   
 
TB would urge you all to consider that above circumstances and realize that in thin markets, fundamentals or even technicals can be deceiving and costly.
TB doesn’t expect much action today but one never knows…he didn’t expect much yesterday either and is still scratching his head. IF he was to make a bet, despite the weak technicals, he would be inclined to favor bonds over stocks and commodities.
 
Hope you have a fun weekend…are we having fun yet?
 
TB

 

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 30, 2008

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5/29/08…the naked city

May 29, 2008 at 5:19 am · Filed under economy, financial, markets ·Tagged , ,

…in the ’60’s, there was a great series, The Naked City. It began each night with: “There are eight million stories in the naked city…this is one of them.” Actually, the series came from a 1948 Oscar-winning documentary of the same name. To TB it seems that there were almost that many stories overnight as a look at Bloomberg top stories will tell you. So today we will look at those stories and how the overnight markets have been impacted…it is all very puzzling and TB urges you to be very cautious in the markets. This could be an inflection point.
 
*Morgan Stanley, Deutsche, Citi investment bankers leaving as LBO market slows…so much for value.
*Sears reported an unexpected loss as clothing spending slowed while Costco beat expectations on higher groceries and clothing. TB also noted the other day the longest lines ever at Costco gas…the low cost provider…so long that he passed and went to the discount station next door. Also, shopping carts were mostly half full or less…usually most are full to the brim. Costco selling off after the release!
*UK home prices plunged in May, the biggest decline since 1991. Does this impact consumption?
*German unemployment unexpectedly rose in May for the first time in 28 months.
*Bankers are seeking a LIBOR alternative due to manipulation of the rate…you remember, they reported lower rates so other banks wouldn’t know they were paying a penalty rate. This index is the basis for most loans…even consumer adjustables now. The alternative suggested is the volume weighted overnight Fed Funds rate which is used for indexed swaps and cannot be manipulated…also it becomes a pure rate as opposed to using the averages of 8 banks and throwing out the two outliers…liars is the operative word here. Banks don’t trust one another or their customers…why should customers trust them?
*Dow Chemical price hikes may pave the way for Hershey, Monsanto, and General Mills. TB gave symbol for Dow yesterday as DD, should have been DOW. To recap, Dow was raising prices by 20% due to a 42% increase in their cost of materials…stock initially fell then rallied.
*OECD says that wheat and corn prices will rise 25% over 2007…you know what that means.
*US Q1 GDP may rise…due to increase in exports…but without inventory increases which must be viewed as involuntary…right?…it would be down. Economist, Mark Zandi said yesterday we are worse off than a year ago and that we are definitely in recession…breaking ranks! GDP did increase to 0.9% due to increased imports and a lowering of inventories from the advance…spending was little changed.
*Pakistan stock market is worst performer in the world and is at a 9 month low, -23% so far this year. TB commented on India and China yesterday. The only growth areas left are the America’s…Latin and South, not North, and Russia. Look below at Japan and Korea, the only winners overnight: +3% and 2% respectively! India fell another 1.3% and while Hang Seng was off slightly, Mainland fell 2.5%! 
*Royal Bank of Canada Q2 earnings drop on a 27% increase in subprime write-downs. Is it over?
 
Lastly, Bloomberg writer, Mark Gilbert wrote a piece today on inflation and how Merrill’s David Rosenberg says it may hit 4.5% due to oil…if so it would cut his forecast for 2008 GDP in half to 0.6% and to 0.3% from 0.6% for next year. Orignially, Rosenberg used a price of $100 a barrel for crude this year and $90 for next year. Let’s see what happens to the price declines we are now seeing, and just how far they drop…TB’s guess is well above $90 or even $100 a barrel.  
 
TB will let you dear reader ponder the significance of these stories but he is concerned about a decline in the Yen due to increased borrowing on the Yen carry trade and that that is the one and only reason for the albeit small improvement in the dollar. Also that gold and crude have ‘peaked’…or have they?…will we see just another seesaw as we saw in April? Are the potential ‘head and shoulders’ formations in Energy and the AMEX Composite signs of trouble ahead? What about rising unemployment?
TB read the other day that the State of California has over 1,000 employees making more than $200,000 a year. It seems our Governator and the legislature could take a look and see how many of those jobs could be cut. Jeff Tedford the head coach of the Cal football team makes $238,000 and that does not include all the other ‘benefits’ bestowed on him by the alums. This caused TB to do a Google search and on a blog (Carpe Diem by Mark J. Perry, an economics professor) he found that the average salary (again not including benefits) of a college football coach is $1,000,000! 66 of 120 studied make $1MM or more…kind of like CEO’s, no? In 2007, four of them earned $3 million or more vs. none in 2006; 50 earned $1MM up from 43; and 12 earned $1MM up from 9. Now, what does the average professor make? $94,000. Have we misplaced our priorities? It’s college, not IBM or the NFL!
 
Another story with unanswered questions is former Bush press secretary Scott McClellan’s new tell-all book…perhaps this kicked off the overnight activity as it presents a very unflattering view of the Bush Administration…especially Karl Rove. While it ties in with Recount, we need to know why Scotty wrote the book? Money? Fame?…certainly not revenge as Bush really liked him and we know his loyalty to those who follow instructions to a tee. Was it the Valerie Plame, Scooter Libby scandal that sent McClellan off on this crusade…time will tell…perhaps the book will too…it’s a big mystery. One thing of interest is the White House response…shocked…shocked that one of theirs would do this. Karl Rove: this is not the Scott that we all knew…does this mean the devil took control of him? Note there was no anger in the responses…same as with the Paul O’Neill book, and Scott Ritter…this is the way the ‘white shoes’ do it…destroy your credibility with kindness, never anger.
 
There are eight million stories in the naked city…these have been some of them. 
 
TB

 

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 29, 2008

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5/28/08…who killed J.R.?

May 28, 2008 at 4:59 am · Filed under economy, financial, markets ·Tagged , , , , , , , , , , , , , ,

…nope, not reminiscing about Dallas, J.R. Simplot has died at the ripe old age of 99. If you have ever had a MacDonald’s french fry you are connected with JR! Simplot was an eighth grade dropout, owned a successful ‘dirt farmer’ company that provided agricultural consulting and products and was 89th on the Forbes wealthiest list. TB used to travel to Boise when he was in banking in the ’70’s and his home on the hills was highly visible…due to a monstrous flagpole…causing it to be known as Fort Simplot. The flag must be at half mast now.
 
Today’s Topics:
1. Global stocks and the BRIC countries
2. Commodities
3. Currencies…the Yen carry trade is back…follow the money
4. Trade Wars?
5. Inflation, margins, and sales.
 
1. Global stocks. Want half a BRIC? The ‘BRIC’ countries, Brazil, Russia, India, and China have seemed impervious but looks can be deceiving. India and China are seeing slowing growth, and as one observer noted yesterday, they too are vulnerable to a slowdown in demand by the U.S. consumer. India has already been slowing leaving Brazil (and Mexico) and Russia. Here are the changes from the lows…all have settled back from the recent highs…in the case of China they have given back about 50% of the bounce from the lows. Data as of last close:
Losers:
Hang Seng:           12/7/07, -19%
  Shanghai:            1/14/08, -37.4%
  Shenzhen:           1/15/08, -33.3%
India Sensex:        1/10/08, -22.1%
Winners:
Brazil Bovespa:     1/23/08, +33.9%!
Mexican Bolsa:     1/21/08, +24.3%!
Russia All Traded: 1/22/08, +37.7%! 
 
Of course a contrarian might say that the losers are oversold and winners overbought. TB won’t enter that argument but is only illustrating the changes of fortune. Here are a couple of caveats though:
1. Mainland China exchanges (Shanghai/Shenshen) are unregulated so be careful.
2. India is seeing signs of a slowing economy due to rising food and fuel costs
3. Brazil has a lot going for it such as biofuels, and oil but could be vulnerable to price drop in crude
4. Mexico is not only aligned with the U.S. in trade, but with a loose peg to the dollar
5. Russia…ah the darlings, yet 20 years ago they were in crisis along with Asia. Bloomberg reports today that hedge funds own much of the corporate debt that was issued 15 years ago and is coming due and that is creating a credit crunch there (no man or country is an island). Some companies are facing costs of 16% to roll debt so those gains this year might prove elusive. Bloomberg story says that Moscow office rents have almost doubled, replacing Mumbai as Number Two…behind London.
 
2. Commodities. Another Bloomberg article talks about the price of crude hitting a one week low on concern prices are hurting fuel demand…isn’t this basic economics? But what about this: India is pulling out of OPEC as oil imports exceed exports! They are eating their own! Of course, neither of these means a high is in but is indicative of cracks in the system and with so much speculative money involved (whether or not you subscribe to the conspiracy theory), a rush for the doors could become a stampede as those exit doors are not wide enough. Also, with rice, just as panic set in, prices peaked, largely due to export curbs put on by countries to insure there was enough food for their people. There is a lot of money chasing commodities: hedge funds and commodity index funds fueled by pension funds seeking returns in an otherwise lackluster market…that 8% nut is hard to crack! Yesterday, TB covered the futures market in oil and how delivery was being taken…also how Iran is paying $14,000 a day to store crude per tankers, in anticipation of higher prices…of course if they fall there will be a stampede to dump it. How low could it go in that case? Your guess is as good as TB’s but the NYSE Energy Index looks to be forming a head and shoulders formation…a very clear one so far…and if so a lot of those stellar gains are going to be given back. 
 
3. Currencies. With a lackluster economy in Japan and 10 year Japanese governments trading at 1.72%, speculators are back borrowing in Yen and then selling yen to buy other currencies…follow the money…the dollar is just off it’s lows while the yen is back to its 40 day moving averages while both Sterling and Euro are supporting at their 40 day m/a’s. Nothing clear yet but keep an eye on all three to see where the flows are going as that means the money will be invested there…are loans Japan’s biggest export? What happens here is important for stocks, bonds, and commodities. TB wonders if they might mount a charge on stocks taking advantage of the thin summer doldrums (remarkably it appears they began on 3/24) trading, or not!
 
4. Trade Wars. The best indicator of a global slowdown is the emergence of protectionist policies. Above we have discussed crude and rice and there is no reason to believe that it will end there. In the past, wars have been started over these…undoubtedly Hitler came to power as a result of the global depression and unrest partially due to a widening wealth gap…don’t we have that now? The U.S. is planning to file a complaint with the WTO against the EU on electronics…be careful what you wish for.
 
5. Inflation, margins, and sales. Here is a story just out on Bloomberg: Dow Chemical said it will raise prices on all of its products by as much as 20% on June 1 because of rising costs for energy, raw materials and transportation. Dow says this is due to a 42% jump in 1st quarter raw materials and energy. Watch the stock today (DD) and see if they believe they can make this happen. In a slowing economy you cannot pass on all your costs, note the increases are less than half the rise in input costs, and that goes up the entire food chain (no pun intended). Not only that, small businesses are suffering…TB reported about a winery who has seen costs of sulfur and fertilizers increase tenfold this year. Restaurants respond by raising menu prices or more likely cutting portions or both, but no matter business will slow. The winemaker, restraunteur, or other small business has less business and narrower margins and that means lower take home and don’t forget their own costs of food and energy are rising…while their assets are declining in value. Another example of how the virtuous cycle becomes a vicious circle.
 
One reason transportation stocks, ex-airlines, is that they have fuel surcharges…all but the smaller and independent drivers. Also, the big truckers load them on trains for long hauls speeding up delivery times at lower costs. If fuel costs decline, don’t expect airlines to be outperformers…except perhaps from deeply oversold (whatever that means as TB wouldn’t touch them with a ten foot pole), the same as financials have done.
 
We keep hearing the worst is behind us but somehow TB doubts this is true…the markets still seem far too complacent…except bonds which are showing some weakness…especially TIPS…but if they get back to 2% could be a buy again. As for stocks, for the reasons listed above they should see lower revenues, shrinking margins, and thus increasing p/e ratios. Rather than the worst being behind us, the worst of the news may be behind us, but we still haven’t filtered and digested it. Take Wall Street, despite lowered earnings estimates and record write-downs, layoffs are not even at the pace of 2001, so there is another shoe to drop there. The most positive thing TB can see is that the flight to quality if off as the 3 month Bill is at 1.90%…almost to the 2% Fed Funds rate while the 1 mo bill which got to well below 1% is now at 1.98%!…or is that positive if indeed investors are too complacent. Watch the results of the 2 year treasury note auction today and the 5 year tomorrow for a clue. 
TB watched a movie last night, Recount, about the 2000 elections. It was well-done as a semi-documentary…would never guess that Warren Christopher was played by John Hurt…and two things came to mind: first, that it was really all about winning, not right or wrong…or even making every vote count…only the ones for their candidate…and the actions at all levels, especially Katherine Harris, were comical in a sick sort of way; secondly, one has to wonder what would have happened had Gore been elected…we would still have had 9/11…but what would the response have been? TB feels certain we would have gone into Afghanistan…but no way we would have gone to Iraq…no way! TB voted for McCain in the 2000 primary…write-in in California…and eventually succumbed to Bush…if only we knew what would have happened, he would know just how badly he erred in doing so.
 
Have a terrific day!
 
TB

 

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 28, 2008

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5/27/08…when is a commodity not a commodity?

May 27, 2008 at 6:07 am · Filed under economy, financial, markets ·Tagged , , , ,

…when it’s an ETF…or an Index Fund. Think about it there are commodities: gold, oil, corn, wheat, cattle, etc. Through the CTFC they are made available as futures with two classes of investors: commercials, those with a vested interest in the commodity such as producers who hedge their inventories with futures contracts, and speculators who easily move from one pit to another and could care less about the physical commodity…they never take delivery. Does anyone remember the I Love Lucy episode where she decided to speculate in commodities and got a ton of corn dumped on her front lawn? Well, that doesn’t happen…can you name any instance in which that has really happened? If you have a profit or loss you take it and close out the position. This is not to say that commodities trading is simple and over 80% of newbies get wiped out…about the same as options. Furthermore, you have to understand everything about the commodity you buy, such as weather, cycles, inventories, and more.
 
Many of you will remember Paul Erdman’s venture into commodities when he was CEO of a Basel based Swiss bank that a bank TB used to work for UCB (United California Bank), whose moniker was later changed to Uniformed Chocolate Buyers. That is because they had the misfortune of buying the bank, after an audit by the Swiss banking authorities by they way, and finding that the bank had a huge position in cocoa futures (think about that the next time you read TB’s commodities summary and see how any commodity can be significant). Earlier they had taken huge positions in an obscure currency and in silver (providing the title for Erdman’s book, The Silver Bears…fiction of course). See, Erdman is a very smart man…too smart in many ways…the bank had researched cocoa and found that there is a disease that hits the plants every hundred years…so they bought cocoa futures intending to reap huge profits…of course Hershey’s and Nestle knew a bit about chocolate too and so the bank lost…big time.
 
Until the last runup in gold, crude and then other commodities in the basket (we will get back to that later), how many of you cared about commodities?…or care now? TB follows them but has no interest in playing in them, while investment ‘biker’ Jimmy Rogers, who was a big factor in George Soros success, loves them…in fact has been a perma-bull in them. As in stocks, you can be a perma bull or bear in commodities and eventually be right because when they move they move big as we have just seen. When that happens people forget you have been wrong for the past ten years and flock to you for advice. That is because when it happens investing is in a crisis…not simply a bull or bear market. Then in another five, or ten years or whatever you are right again. Any ‘perma’ label is hard to shake.
 
There is currently more speculation about the causes of speculation then there are speculators themselves, figuratively speaking. It is being blamed on everyone from oil companies, producers, speculators, hedge funds…and now to ETF’s and commodities index funds. There are compelling cases for each of these…or at least on the surface.
 
Rick Santelli, CNBC’s man in the futures pits…and a veteran of commodities in trading was just screaming, trying to get his point across to the rest of the crew…who doesn’t get it…that on the last day of trading on a contract (expiry), the only buyers of that contract, besides those covering shorts, are those who need physical delivery. They didn’t get it…in fact all of them were trying to convince him that he is wrong…that is the beauty of CNBC…everyone can be an expert…TB has already pointed out that he is not an expert so don’t toss him into this. As far as commodities are concerned, TB is merely an interested observer. But here is what he has learned about futures and it supports, Santelli’s case: if you watch the ‘lead’ contract…readers have seen reference to this in TB’s columns you know that as expiry approaches in say the June contract (with oil that happens in May), and the volume and open interest increases in July while June falls…this is very visible…note TB’s comments that the next contract has 1/2…then 1 times…then 2 times, etc. the open interest of the lead contract. Strictly a function of the speculators rolling out the curve so that they don’t have to take delivery. In crude, at the close of the final day, if nobody wanted delivery, the open interest would fall to zero on the last day…instead there are usually less than 2,000 contracts…contrast to about 300,000 for the next month. First delivery of crude is roughly 45 days after expiry…which more or less coincides with ‘liftings’, the time between it comes out of the ground and is ultimately received. A crude contract is for 1,000 barrels. As TB has been reporting, recently the crude market has moved into contango…where the further out the contract curve the higher the price…you expect this with gold since storage costs, etc. impact the ‘profit’, but crude usually trades in ‘backwardation’ where the further out the curve you go, the less it costs and that curve is usually steepest when prices are rising…as they are then expected to fall. But over the last couple of weeks the long contracts, the longest is Dec ‘16 but the longest active contract is Dec. 15, surged…in fact Dec’ 15 rose over $10 in two sessions. What caused this? If we go back to 3/19, the last trade for April Crude, open interest was 56 contracts at the close…56,000 barrels which is typical, on 4/22 last trade for May, open interest was 6,222 barrels or 6,222,000 barrels (remember the closing price has to be multiplied by 1,000 to get the contract value), and on May 19, it was 4,345 contracts or 4,345,000 barrels! Someone needed delivery…but who? Not speculators as we have seen they trade the front contracts where volume is 100,000 contracts a day and open interest in the lead contract is nearing 400,000 contracts…there is just not enough liquidity after six months. Despite all of this, the smart guys on CNBC kept trying to tell Santelli he didn’t know what he was talking about…that you simply trade after expiry…sorry folks, can’t do that…but it didn’t stop one wiseguy from continuing to shake his head at Santelli…who has forgotten more about commodities than this guy will ever know!
 
To get a better picture lets look at prices on the expiring contract and Dec. 15 on expiry:
 
3/19 (April Contract): April $107.90; Dec ‘15 $98.81 - backwardation Dec ‘15 open int 12,461
4/22 (May Contract): May $119.37; Dec ‘15 $198.18 - backwardation Dec ‘15 OI 15,185
5/19 (June Contrct): June $127.05; Dec ‘15 $129.93 – CONTANGO Dec ‘15 OI 19,931
 
There you have it…there is a shortage of supply in the front end and that simply is not the case. Why? We now know that the Iranians are leasing tankers at about $140,000 a week to store crude, their crude is inferior and can only be properly refined in U.S. (which doesn’t buy it), China, and India. Would they do this if they thought oil prices would decline? By the way the U.S. does buy Iranian crude the same way we bought Russian crude during the cold war…it goes to Rotterdam or another harbor goes to another tanker and voila! …it is no longer Russian or Iranian…just a crude commodity.
 
Still doesn’t answer the question of why? To get at least a partial answer go back to when the first gold ETF began trading in London…immediately the price of gold moved up…why? Because they had to physically buy gold and put it in a vault each day…further driving up the price. Then StreetTracks got approval for their ETF (GLD) in the US, later followed by iShares (IAU). Together these contracts, which made gold easy to buy for individuals (keep in mind since you are buying the underlying commodity there are only ordinary gains or losses), and again gold surged. So long as it continues to move up more buyers will come in…but when it declines…it drops like a rock as sellers of the ETF’s now fuel the fire on the downside…that is what was so critical about $853 an ounce, the 38.2% retracement of the entire rally from the peak on 3/17 ($1,033.60). If you recall, it dipped below it on May 1-2 briefly but closed above $80 and then rose sharply again. But that is gold…what about crude?
 
With the commodity index ETF’s and index funds (which do have capital gains since they do not own the underlying commodities), they buy the front end and the big funds (like PIMCO) are huge and also short the long end of the curve. By doing this they are effectively hoarding and making supplies scarcer…of the futures, not the underlying commodity. A few years back PIMCO was criticized for buying bonds then buying puts on them or calls, or futures, but by not selling the physical bonds they were able to corner…some said manipulate the market as the cheapest to deliver price kept rising. This is what the indexers are being accused of doing…and due to all they interest in commodities, billions are piling into these funds further driving up the price of the underlying commodities…in other words it has nothing, or little to do with consumption demand. If so, once it is deemed that they have been milked to the fullest, or some exogenous event impacts them, prices will plummet…as gold did from the March peak to May.
For the entire article, see John Mauldin’s website: http://www.frontlinethoughts.com/printarticle.asp?id=mwo052308, then you decide as both cases are presented.
 
Interest is about to shift to food again…specifically beef as physical supplies are dwindling and young cattle…and hogs…have been slaughtered early since the cost of feeding them exceeded the value. Now watch for a huge increase in beef prices which will further impact restaurants and of course consumers.
 
TB was in COSTCO on Saturday and noted that no longer are all the shopping carts full to the brim…in fact maybe 10% were…most were half full or less…a lot of shoppers but less buying…and mostly foodstuffs and supplies. Meanwhile at the gas pumps the lines were the longest he has seen…and usually if it is crowded when he goes in, he gets gas after shopping…this time the line was even longer after! He didn’t buy gas there…instead opted to pay more and not wait in line…think about it.
 
TB hopes you found today’s piece interesting…albeit long…but it is a complex subject and further proof, at least to TB, that stocks are in trouble…at least for another downleg, meaning we just had a countertrend rally…not a new bull market and we are now entering the summer doldrums! CAUTION! 

 
TB

 

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 27, 2008

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5/23/08..clearing the decks

May 23, 2008 at 6:14 am · Filed under economy, financial, markets

“Volume was expanding on the way down and it’s contracting on the way up,” - Dan Wantrobski, senior technical analyst. TB is not one to say “I told you so,” but he told you so!
 
Today’s Topics:
1. Stock Market volatility redux
2. It isn’t all over…a tale of three banks
3. Sovereign Wealth Funds…or giving until it hurts…a redistribution of wealth…to the U.S.!
 
…that’s what they did yesterday. Wouldn’t you if you were a big trader with big positions ahead of the Memorial Day weekend in the U.S.? You would if you had any sanity left in you. Consider the hot spots in Iraq, Nigeria, South Africa, and gold surging, the dollar weak, the Asian Contagion possibly becoming a virus as India, China, and Korea are all weakening. We have had two major disasters in Burma (TB refuses to acknowledge a junta that takes advantage of it’s people and rejects aid from the U.S. Navy that could provide food, equipment, medical supplies, and millions of gallons of water. If you saw the Admiral on TV, sitting on his thumbs and seething inside but trying to be politically correct, you know how bad it is. Admirals are not used to being ‘dissed’, and he knew he could destroy the entire  revolutionary government in an hour if given the go-ahead…where is the UN when you need them?), and China. Anything could happen on a long weekend…perhaps U.S. citizens even stopping to think it is Memorial Day…oh yeah, we have the Indy 500…but we now have it on the last Friday of the month instead of the 31st further blurring it from ‘memory’…now they could have chosen a Friday or a Monday but TB would bet it was due to the Indy 500…because when it gets rained out…they can still run it on Monday with more than just a few diehards watching…think advertising, will you?
 
1. Stocks. To hear it on CNBC, yesterdays rally was amazing…all atwitter…on a day the Dow rallied 24 points after declining by 200 on two straight sessions and creating serious technical damage. TB chose the quote today from a Bloomberg story that affirmed his comments on the volume since 3/24 being well below average as well as the fact that since the selloff that began on his birthday (12/26), rallies have been on low volume and only the down days have anywhere near average volume. TB is a closet technician although readers might think he is an avid one. He does not invest based on technicals as his horizon is much longer term…but he does time his entry and exit points on technicals. That has become key in a market where fundamentals have little or no value and who can even guess what the average holding period of a stock is these days…last he saw it was 11 months, down from 5 years, but that is stale data from three years ago or more…if anyone knows the answer please let him know. He suspects they don’t want you to know or you would be going to Las Vegas rather than playing stocks.
 
But even technicals…or as some call it with stocks…momentum…you can’t do it accurately without all the details…transparency…there’s that word again that is nearly totally lacking in this environment, replaced by opacity. Ralph Acompara, one of the most highly respected technicians on stocks said in the Bloomberg piece, “Technicians should be losing sleep on this. I can’t be as trusting of my indicators because I don’t have all the data.” The missing piece he talks of is the same one that has appeared over the past week in the stock market summary in this column: you can’t rely on technicals if there is no volume to support them. We all know the expression: never short a thin market. The opposite holds true to a lesser extent. Going long on low volume when there are players out there who can move stocks at will is dangerous to your financial well-being. The article states that trading on the NYSE this quarter is down 26% to the lowest since 2001…1.27B shares vs. 1.57B in the comparable period in 2007…but thne readers knew this already since TB has been harping on it for the past month and a half! But here is what is interesting: volume is not the only answer because electronic trading is replacing the NYSE and with it goes transparency! In 1990, NYSE volume was 70% of total but today electronic trading has lowered that to 59%…pretty much explains the decline. But it also means that when a hedge fund or other big spec account wants to do a trade and be seen they can do it on the NYSE while adding to, or possibly reversing it on the electronic trading platforms.
 
Here are some key areas of concern in stocks. First, of course is financials. They rose in the rally but have returned to their weakened state…sure they bounced yesterday but only by 0.8% following a 2.3% loss. Large Banks and Insurers gained twice as much as they lost Wednesday, but Brokers declined another 0.1% yesterday following a 3% hit…and rightly so. While the banks sound better remember that is large banks…looking at the KBW Bank Stock Index they were up 1% yesterday following a 2.1% hit.
 
Housing is bizarre…TB thinks since the first decline last year that on no less than six occasions have they tried to rally it…each failing…and despite the fact that the sector keeps getting more and more dismal, they did it again leaving TB scratching his head…until Wednesday when the sector dove 4.3% followed by another 0.9% drop yesterday.
 
Tech, especially semiconductors (SOX) was coming back from hell but then reversed again and looks to be headed back down. Healthcare can’t get off the dime.  
 
What is happening here…well ‘what it is ain’t exactly clear’ to paraphrase Buffalo Springfield…but TB believes…after having had conversations with friend who study stock market history, is that investors are trying to put their money in sectors that rally at this point in the cycle. The trouble is this, while the antithesis of the 1990’s, is not a predictable cycle. The ’90’s boom was extended by tech, dotcom, and globalization, while this recession is unlike any other since the depression…if then. We have had 25 years or more of living off future earnings, thanks to credit…the stock market bubble…and then replacing that when it busted with the real estate bubble…and more credit as homeowners extracted equity from their homes taking trips, buying SUV’s and luxury cars, paying for education, etc. So to a large extent we are bankrupt: we have blown our savings…many do not know what the word means since we were first told our stocks were our savings and then that are homes were…despite a lack of wage increases for the general population. The home equity loans were the driver of the economy for four years and now they are gone as we become mired in a sea of debt. Hopefully we have learned that their is little satisfaction in immediate gratification rather the dream of owning something…TB would bet that those billionaires with their toys aren’t really happy…they are just happier than the rest of us! The cure for this will be painful, since we are a consumer economy…we don’t make much…we even replaced a lot of agricultural land with homes, especially in California…and what we grow we are converting to fuel instead of food (a gross generalization but it makes a point).
 
So how can you predict which sectors you should be buying if you don’t know where you are in the cycle? Sure we are in recession, but not all sectors…yet…but buying retail or homebuilders is not right. Some think that Tiffany can withstand this…or Walmart…but can they? How do you explain them being near highs other than expectations that they will continue to outperform? Tiffany sells at 20.3x trailing earnings or 17x forecast. While Walmart is about 16x vs its nearest competitors Target (15x) and Costco which is trading at 24x…both are back in the trading ranges of the past five months. If everyone is thinking the same way that is what you get…but then nobody ever got rich following the herd. for long.
 
2. Banking. The industry that TB has been involved in since 1972, yet knows nothing about today. What he sees out there makes no sense to him…zero rate loans for a year for those who can afford to pay and 25% credit cards for those who can’t. Before we let the government regulate us out of this remember that the repeal of Glass-Steagall in 1999…with Clinton as President…although TB believes this was the brainchild of the GOP as was revising the Bankruptcy Act to protect us just before Katrina in 2005. Robert Rubin was Treasury Secretary and was in favor of it…he then became Vice Chairman of Citigroup which got the most from it and now is suffering the most damage. Sandy Weill, bless him, said today that he screwed up in 2003 due to his succession plan…please! You screwed up when you tried to change basic banking! The buck stops with him and the only cure is to revive Glass-Steagall so we can once again trust our banks. Investment banks can do their thing…so spin them off or do whatever they have to do but get back to the business of banking…instead we have a Federal Reserve who, if you trust Alan Greenspan, had its hands tied…if he had any cajones he would have just done it…regulated anyway as Volcker did…not let us fall into the mess we are in today.
 
When TB was a banker two regional banks he remembers…of course he also remembers Continental Illinois and First Pennsylvania Corp…were Fifth Third Bank and National City Bank, Cleveland. They were well respected…who would expect them to become problem children? Well, they have. Fifth Third along with…drumroll please…Wachovia on their BOLI’s (Bank Owned Life Insurance) producing lawsuits and write-downs, and National City is so bad off they are trying to split the assets into a ‘good bank and bad bank.’ Meanwhile in Texas, Lewis Ranieri former Salomon Brothers mortgage guru first founded a bank and sold it out…then another Franklin Bank (FBTX), which is down over 90% while on his watch they made 1/3 of loans to homebuilders and 40% of mortgages were in California and Florida. TB recalls that Ranieri was a stickler for diversification so how could he have done this? Not only that but he was preaching over the past 2-3 years that the housing market was a bubble? On his watch??? Oh, and guess what? Taking a page out of his former colleague John Merriwether of LTCM fame playbook, who resurrected himself with a hedge fund (having learned from his mistakes at LTCM though he used 25x leverage rather than 100x), is starting a $1 billion fund to buy mortgages! You can’t make this up! Now do you see what TB means about a lack of credibility in the banking system. He still likes two: USBancorp (USB) which he owns, and PNC Corp (PNC)…but could something go wrong there too? In this market anything can happen…by the way he bought Provident Bancorp (PBKS) and lost about 1/3 of his investment when they screwed up on REIT investments and cut dividend by 60%…after raising it 0.5 cents a share per quarter for year but the stock rallied on the news…short covering…back to the lows now. Just what is a bank anymore? …and how about an online bank which are all the rage?
 
3. Sovereign Wealth Funds…the term envisions the Saudi’s or Chinese…but the second largest in the world is Norway which lost $22B (5.6%) in the first quarter for its second biggest loss since inception in 1998! You remember the small Norwegian town that was wiped out in mortgage derivatives, don’t you? The money comes from royalties on oil and gas reserves. They didn’t even do well on their fixed income investments which only earned 0.9% in the quarter. So should we let sovereign funds buy our financial institutions? Heck yes…let them suffer with the rest of us…kind of like TB’s view on gay marriage: why shouldn’t they be able to pay alimony like the rest of us?
 
Enjoy the long weekend…and the Indy 500 but please remember why we are getting the holiday…too many sacrificed so much so we can squander it all as we have over the past 25 years…they would be disappointed at what we have done with the opportunity they presented us with. A shame.
 
TB

 

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 23, 2008

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5/21/08…disconnect

May 22, 2008 at 5:19 am · Filed under economy, financial, markets ·Tagged , , ,

Bloomberg Quote of the Day: “Everyone rises to their level of incompetence.” Laurence J. Peter. That includes politicians, economists, financial analysts, and bankers. You fill in the names? TB.
 
…TB believes there is a massive disconnect between perception and reality in the marketplace. The dollar is in a crisis yet the bulls are hyping the stock market daily, despite two consecutive 200 point declines and neither with even an attempt to rally, and these followed Monday’s failed attempt at one.
 
We are faced with an incredible amount of information to digest and as TB has commented numerous times, we only have an ability to focus on one event at a time…be it Katrina, commodities prices, or the national elections which are a disgrace. A disgrace that the most powerful nation in the world has such an ego and obsession with its leaders that they campaign for office for more than a year…and almost all were U.S. Senators who are thus detracted from their elected responsibilities. The only positive TB can think of here is the hundreds of millions of dollars in contributions raised which have helped the economy, but at what cost? If one is honest, it is doubtful that your perceptions of the candidates has changed much if at all. Just how much more do you know about what they would do as President? Instead, we have learned of how they bash their opposition for saying more or less the same thing in a high stakes game of “he said, she said.” This will be the costliest election in the history of the world…and what have we to show for it? Besides, it is doubtful much will change in Washington, since the favorite pastime is “greasing the palm,” followed by getting reelected. What a waste of the taxpayers money. Just heard that the $289 billion Farm Bill has to be sent back due to a printing error. It is as if a printer with a mind of its own, or a computer, changed the words…no one is responsible…an appropriate motto for D.C.
 
But we are also faced with Black Swans…seemingly uncorrelated events which are impacting the global financial system and thus the economy. Here is a recap of some of the things that aren’t supposed to be:
 
*Subrpime Mortgages are only about 6% of the total mortgage market. True, but they were about 40% of the loans written in California and more than 25% nationally over the past year…and that does not include Alt-A, stated income mortgages. Furthermore, these were 100% variable rate.
 
*While foreclosures are rising they are less than 1% of total mortgages. True, but they are increasing at a rapidly rising rate…up 60% in California last month…and we already had an excess supply along with new homes still under construction.  Now add in reduced credit availability and it is not good.
 
*You know the bottom is in when bad news on financials come out and they rally. This is patently absurd…but not as absurd as stocks rallying after they get an infusion of capital other than shorts being forced to cover since the broker/bank/insurer isn’t going belly up! We are totally ignoring the fact that the most profitable areas are now history…kaput! Not to mention dilution effects of the added capital, and how higher capital lowers the return on equity…and that means eliminating businesses that were marginally profitable to increase the return on equity…and more one time charges…but who cares?
 
*We are in a global economy so it doesn’t matter if the U.S. slows, the others will carry us. Well, guess what? They aren’t! They are sinking too. Why is this so hard to understand? We exported our housing problems to them…although UK, and Australia were already there…in Spain they are razing condos to stabilize prices…Spain also has a water shortage by the way…and not bottled water! Our claim to fame is not our manufacturing…it is our consumption…we can outconsume any country in the world on a per capita basis…bring it on…it’s what we do! So who are they supposed to sell to?…besides China and India and by the way India’s economy is slowing to perhaps 3-4% according to Andy Mukerjee a Bloomberg reporter based there. China is consuming too and shipping to us at rising costs and yet we want them to revalue the renmimbi higher…be careful what you wish for.  Stocks in India and China are tumbling again…India’s SENSEX fell 2% overnight while China is down 4% over the past three sessions. They face the same problems we do…exploding prices on imported commodities, but unlike us they can still make things…albeit much of it is for U.S. companies who get the credit but that is changing.
 
*Stocks will rally when the Fed stops easing. This is because the stock market is nine months ahead of the economy…usually. But this time we are in a RECESSION that is unlike any other in our history. In most cases, an economic slowdown creates a credit crunch…in this case a credit crisis, caused by financial institutions being too flush with CHEAP money due to an irresponsible Fed Chairman caused them to make bad investments and loans…and at the same time to dramatically increase leverage. Thus, the best scenario is for a ‘muddle-thru’ economy (see later for comments on John Mauldin who coined this expression), the worst case is for…well, you know. Yet, stocks are still rallying on earnings and those cheap p/e ratios…cheap if you use trailing 12 mos earnings…a bit higher if based on forecast, yet not cheap if you use five years trailing earnings and that might be optimistic given the record stock buybacks over that period…money that has simply vaporized…or worse.
 
If the above statement is true, then how come the stock market tanked on the release of the minutes of the FOMC meeting yesterday…among other reasons such as oil…which is tossed in whenever they need a scapegoat, yet we have rallied on occasion when it is up or down…ditto for gold and the dollar. We have rallied on Walmart’s earnings for Pete’s sake! We are in a low volume market and entering the summer doldrums yet we have low volatility and bulls abound…why? But look at similar companies: Walmart and Target, Chesapeake and Devon, Exxon Mobil and any of the other contenders, and you would think they are in different industries…meanwhile, Apple, Amazon, Research in Motion, Google, Microsoft and RIMM, drive the market along with a few others so that we have little indication where the real market is. Consider yesterday when new 52 week highs rose (they have been above new lows since May 13), but how, on a day when the market was weak all day? New lows rose too! Meanwhile, advance/declines and breadth have gotten weaker by the day since Monday. then there is the fact that volume, although weak rose in the last two down 200 day sessions…explain that?
 
These are just a few of TB’s favorite things…or more accurately gripes!  Now for real concerns:
 
Who do you trust? If banks don’t trust one another why should they trust you…or you them? Isn’t a sound financial system a prerequisite for capitalism? …and isn’t that a function of transparency? Yet we have had monoline insurers drift from insuring municipal bonds destroying their credibility, rating agencies totally screw up ratings – Moody’s is now under investigation; AIG with big write-offs and Hank Greenberg is now being investigated by the SEC; Jefferson County, Alabama on the brink of bankruptcy…TB thought they already had done so…paying enormous fees and get this …the most to their advisor JPMorganChase…the darling just handed the gift of Bear Stearns by the Fed! Oh, that’s another one…the Fed…who has committed more than half it’s balance sheet to financing weak or valueless paper for the brokers so we don’t suffer another Bear Stearns. Now let’s look deeper.
 
The worst is behind us…we said that last August when they first announced the subprime problems…how come it morphed to Alt-A mortgages…and now is moving to prime where owners can’t sell their homes…we are told if you owned your home for five years you are still OK…not if you took out the equity along the way as a large number did. Now we are told the worst is behind us yet again. Are we so blind to believe this as the morphing continues now to credit card loans…and there has been a huge explosion in small business failures…and guess what folks…those are financed with credit cards! 
 
TB’s resource on autos is an experienced BMW salesman at his gym. He said yesterday that there is no market for large SUV’s…that he gets several calls a day from customers begging him to get them out of their leases…that not only are sales way down, but many of the sales are rejected on credit…and now commissions are being paid after the lease closes escrow…escrow on a lease? BMW is cutting way back and Daimler is up to its eyeballs in leases that could blow…not to mention Lexus.
 
In 2004, when TB started his business, AMEX gave him a credit card with a $20,000 line…despite the fact that he had no revenues. In a string of transfers he has moved the line three times and paid ZERO interest…he didn’t look to do it…the credit card companies and banks begged him to…so the loan is being paid down nicely…principal only! But here is the best one…Citi (who he just moved the business loan from), sent him a letter that he is preapproved for a total transfer of his home equity balance! OH, and it has to be a minimum of $50,000! The rate is prime less 101 basis point! Currently, he is paying prime less 76 bp’s. Should he take it? Why, when mortgages are going bad, and home equity loans present yet another problem as they are seconds, do they want to do this…and why him?
 
It must be that banks are desperate for revenues and yet want to improve loan quality so they are looking at people with solid FICO scores…not an indicator of future performance as it indicates a past of making payments but tells you nothing of their future condition, and homes with values well above the total amount lent…whatever that means in this market. By the way, TB has been pulled aside at the gym by several members with stories of canceled home equity lines, reduced limits, and even higher rates if they wish to draw down more money…this from a friend starting a remodel…these are all his bank! Nope not going to tell you the name but it has been in the press a lot.
 
Due to the lack of transparency, small banks are suffering more than large banks, with a few exceptions, and those are priced off the charts, while the good banks, mainly large sound regionals who did not engage in the same deadly activities are suffering with the bad. Seems like we have a long way to go!
Readers know how TB likes to read John Mauldin and loathes Larry Kudlow. The latter is due to his blending politics with ‘economics’ making him a bad choice to follow. Last night, he has Mauldin as a ‘guest’. It must be ego to go on there as whenever he asks a question he prefaces it with a statement, a biased one. For instance, “John, have you noticed how every time Obama wins a primary stocks go down? So don’t you think that is the reason for today’s selloff, not oil prices, which are not caused by speculation (or greedy oil companies)?” Mauldin replied no, it is due to oil prices and was cut off. Now, John is a good writer, but like TB not so good a speaker, so he was railroaded. Eventually he was able to get a few word on his point: rising gasoline prices are causing reduced consumption of other goods and that is going to significantly reduce GDP…Kudlow derailed him again, replacing him with a woman and another of his guests who railed that the Democrats are the entire cause of the oil crisis, ignoring the fact that it was Bush that was the first to go on record…in a State of the Union address favoring ethanol.
Robert Reich was on next and why for the life of me Kudlow isn’t on FOX is strange. If you have watched Hannity and Combes, you will note that Combes is the token liberal of the entire station…he is the whipping boy…making TB wonder if he is in fact liberal or just acting so Hannity can make a point.
Reich seems to truly like Kudlow even though he teams up against him…and frankly Reich is the more credible…yet gets sandbagged every time Not that he would be invited on, but if he were TB would decline…even his ego isn’t THAT big!
 
Have a terrific day…just be careful!  
 
TB

 

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 22, 2008

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5/21/08…trimming hedges

May 21, 2008 at 4:35 am · Filed under economy, financial, markets

“A hedge is a hedge…until it isn’t!” TB
 
…back when TB was a teen there was a book titled “A House is not a Home,” written by a famous madam. He and his friends thought it was interesting…this book about something that was mysterious. Today, there is also something mysterious: hedges! So mysterious that those who are engaged in them do not know what they are or precisely how they work…or more accurately interact with the underlying security one is trying to hedge in the first place.
 
The reason for bringing up the brothel issue is that seemingly like, or correlated, things may be enough of the time that you believe they always will be, and as the above quote says…until they aren’t. They won’t be at the precise time one wants or needs them to be, so today we will study a few examples.
 
First, is housing. If you sell a house and buy another house, on the surface that sounds like you have not assumed more or less risk, but there are many variables to this. Suppose you had to move, or your job location moved so you decided to reduce your commute. Let’s say you moved from New York City to Cleveland. We all know that the Cleveland market has collapsed while NYC’s is strong (definitely on a relative basis although it too is showing signs of weakness now as are other areas where the supply of qualified buyers is dwindling), the same holds for microregions in most parts of the country.
 
But let’s say you own your home and sell a second home, carrying back the ‘paper’ on it. Most certainly you are not hedged because you might just get that other home back when you least want it but hopefully you got a sizable downpayment on it…unlikely these days, but hopefully. Worse yet, for the above commute reasons say you sold your home and bought a condo at the peak of the market. Most likely, while that appeared to be hedged, it wasn’t…especially if you paid up for that dream condo.
 
The point of these is that you did something to hopefully improve your lifestyle or financial situation and thus were hedged of sorts, but found out that instead of being better off, you were worse off…don’t forget all those fees and taxes you may have had to pay to accomplish this (financial models always ignore trivial things like this as non-meaningful as they clutter up the model, which is fine if you are an academician teaching a room of eager entrepreneurs who foolishly take what you teach them to heart.
 
Second, let’s assume you buy a Prius and sell a Suburban…looks like a good trade, but you paid $40,000 for the Suburban two years ago and took whatever you could get and bought the Toyota. You took an enormous hit on the Suburban and now are paying a premium for the Prius due to a lack of supply…but think of the gas money you are saving. 
 
As good a car as the Prius is, it is rapidly becoming obsolete to the next wave of hybrid vehicles. Fine, you say, you will just keep it and save all that money on gas. But depending on your driving distance, that may not be as much as it sounds except over a long time period and you are now losing value on the Prius while the Suburban has probably bottomed out…especially IF gas prices suddenly decline again, not that they will but then at $16 a barrel in 2003 who would have thought…
 
There is also the issue of seemingly different priced assets moving differently…or as they say in bonds ’spread widening’. Condos are the last to appreciate and the first to decline in value in any cycle…of course subprime lending leveled the playing field in this selloff.
 
Third, is bonds…and this is where TB first learned about imperfect hedges. In the 1970’s, before financial futures, agencies like Fannie Mae, and Federal Home Loan Banks would issue large bond issues that dealers would ‘take down’ and hedge them by shorting a comparable treasury security. There was enough profit in the issues to overcome imperfections in the hedge…normally…but then when the economy began to weaken the spreads of agencies to treasury’s widened and the hedge failed to protect and in many instances traders lost money…they tried to overcome this by overhedging…buying more treasures than they needed for a 1:1 hedge…but then the spread narrowed and they lost again…at the same time adding volatility to the market. We still see this attempted in stocks today by selling stocks and buying treasury’s which sometimes works and sometimes doesn’t.
 
The advent of derivatives for financial instruments started in the late 1970’s with T-Bill futures and 30 yr bond futures, and later expanded to everything under the sun, so traders tended to become complacent until they discovered imperfect hedges. This is a result of basis risk where the contract doesn’t correlate to the underlying asset one is trying to hedge. The best example TB has ever seen is the current crisis. IF you were long the asset and short the derivative, such as a CMO or CLO, you lost your shirt, and points south, on the hedge as the contract did not decline as fast as the underlying asset (think homes and condo’s again). In today’s Heard on the Street, we see that as the market reemerges, the derivatives are outperforming the underlying securities. If you think about it, both of these make sense since the derivatives are leveraged, so if one wants to stick a toe back into the boiling water, that is the safest way to play it. Furthermore, as in the bond case above, a lot of people have overhedged due to the undeperformance of the hedge, so as the market comes back they are forced to lift the excess hedges. Ultimately…hopefully?…they will become correlated again.
 
The reason Goldman was able to emerge relatively unscathed is that being bearish on the market, they shorted the underlying subprime pools and hedged with the derivatives…if the market had continued to run, they would have been the goat…but on the upside they would still have lost far less as the two were correlated in that event.
 
A major problem in getting mortgages restructured is that nobody knows who owns the loans. To speed up loan processing a system called MERS was instituted allowing property to be registered in a nominee name…that is the only holder who has standing…yet they cannot be contacted since the holders are unknown. The bank that issued the mortgage is most likely still the servicer and is paid a fee for this, but the loans were sold to a dealer like Merrill, who packaged the loans into CLO’s and CDO’s and then sold them to investors. Months ago TB told how a friend, a lawyer in the Hampton’s, told him about MERS, and how she was getting several calls a day on mortgages in foreclosure, presumably by the holders but since they weren’t of record she could only refer them to the loan servicer…who in turn would have referred them to the dealer who packaged them…if one could even get an answer. The worst part of this is that now that the mortgages are securitized you have to get a majority of the holders to approve any restructuring. But with several tranches of these loans now worthless, those holders have no incentive in spending their time on a restructuring…or might use that as leverage to get something out of the deal. For instance, all those Aaa tranches that Merrill owns: it would clearly be in their interest to restructure so they can get some money back, but the holders of the tranches they sold might not even care if they were wiped out…once again a virtuous cycle has become a vicious circle…very vicious!
 
Similar to hedging and frequently seen in economic downturns is manufacturers selling their product to clients and carrying back the paper…presumably there is enough profit to offset typical losses. Watch closely for receivables changes along with sales, as that is a sign of trouble ahead. Levitz Furniture did that when they were a high flying stock in the ’70’s and it about ruined them…now think of all those electronics and furniture ads with no down and no payments until this year…and they are now offering those deals with no payments until 2009…so just because electronics sales remain strong…ask why! If you own the manufacturers, besides checking whether they were financing their sales, doesn’t this make the quality of their forecasts more suspect? It most certainly does! All is not as simple as it appears.

The economy is in a mess. You can believe the worst is over…TB believes it is going to be just one event after another until the excess of the past 25 years are sopped up.
 
Have a good day!
 
TB

 

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 21, 2008

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5/20/08…the old switcheroo

May 20, 2008 at 4:56 am · Filed under economy, financial, markets ·Tagged , , , , , , , ,

Bloomberg Quote of the Day: “If you can find something everyone agrees on. it’s wrong.” Former Senator Mo Udall…what, if on one hand, half believe the economy is coming out of recession (economists), and on the other hand, the people believe we are mired in it…are they both wrong?
 
…that’s what we had yesterday as they rallied the Dow almost 150 points then settled for a 41 point gain. So what? You say: a gains a gain…well that is patently wrong after Friday’s disappointment then ended with modest losses. But as TB pointed out yesterday it was the financial sector and banks that were key, and that theme continued as we trashed them again. The swing both days produced a head fake in new 52 week highs which on Friday totaled 292 and 316 yesterday, the two highest of the year while new lows languished just above the century mark. The problem with looking at this indicator without considering the market move is you can get headfaked and that is what created the bear trap of the past two sessions…and TB believes it will be one! On both days, advance/declines and breadth were very disappointing suggesting more was at play than just a minor selloff in the afternoon session. TB was puzzled on volatility on Friday and then yesterday we had a reversal where it declined in the morning then shot back up in the afternoon for a 9.2% swing on the day on VXN and 4.6% on VIX. This morning Bloomberg has a top news story on the five year low in volatility on VIX set yesterday (before the reversal) and an incredibly sharp decline from the March 17 highs. VIX opened at the session high 16.55, then plunged to 15.82 around 1:30 EDT and then back up to 17.01 for the close…now that is a reversal. Pro’s know that a decline from the high of 35.60 to 15.82 in less than two months is far too fast and show complacency. Furthermore, they see it due to a shift from short term to longer term hedging strategies. But punctuating this with a reversal should draw attention of spec traders…or did they cause it? This makes TB’s column yesterday on ’sell in May and go away’ all the more timely. It’s going to be a long hot summer which will likely leave investors cold.
 
TB spent a lot of time on top stories yesterday and they are back in force today. Yesterday, he reported virtually every one of them as they were all on the same theme. Today, there are fewer relevant ones but they are compelling:
 
German Investor Confidence Unexpectedly Falls on Economic Growth Concerns. So much for globalization being a stabilizing force…if I sell to you and you buy from me and one of us is hurting, we have a problem. For the US we don’t make anything here anymore…sure the companies are headquartered here but most of what they produce is abroad. Europe is hit the worst as they are in the same boat with us whether they like it or not…especially with the dollar so weak…and we are all energy importers. Asia is mixed between the China’s, Asia’s, etc., that import commodities but turn out products for export and are the low cost producers…rising energy costs are hitting them as well as food but at least somewhat offset by their industrial exports. The losers are the emerging markets (as they always are) that import food and energy but export nontechnical products. Note the declines globally in all equity markets, led by China…and then India. This impact is cited in another story Stocks Decline in Europe and Asia; U.S. Index Futures retreat. That about sums it up!
 
TED Spread Falls to Nine-Month Low, Signaling Global Credit Crisis Easing. There is a difference between improving and easing…there is no doubt that banks are going to have continued charge-offs, and already we are in the next leg: credit card losses…be careful of JPMorganChase who escaped much of the subprime debacle. Are we so stupid…OK, naive, to believe that sending out millions of unsolicited credit cards won’t be used to buy necessities when the economy goes slack, or worse? TB reported about how homeowners were doing the unthinkable…missing mortgage payments to make their credit card payments…miss a couple of credit card payments and they take away your credit…on a home you might have nine months or longer before they foreclose…of course somewhere along the way the credit reporting agencies are going to find out and there goes your FICO score out the window.
 
The TED Spread is the spread of Eurodollar deposits (LIBOR) over Treasury Bills…and since T-Bills have no credit risk (or so we are told, right?), more risks widens the spread to LIBOR. Overnight, the spread fell below 78 basis points for the first time since last August. Now let’s get something straight: even IF the credit crisis is behind us…or even the worst of it, which does not seem plausible given the leverage and derivatives still out there…why won’t anyone ask the obvious question: where will the replacement revenues come from now that the most profitable ones, mortgages and credit based derivatives are off the table?…follow-up question: even if there are replacement revenues how will the highly leveraged financial institutions some as much as 40 times capital overcome the dilution effect of all the capital they have raised at firesale prices…to the investor not the company who is paying a huge premium? TB believes we have sunk even below the financial analysis standards of the dotcom boom, which is hard to believe, but at least those were being written in a bubble…today’s analysts seem to have no idea of what a balance sheet even means after a decade of just projecting earnings.
 
Hedge Funds in Swaps Facing Peril with Fourfold Rise in Junk Bond Defaults…still people keep asking TB if this is the time to buy junk bonds which are rallying along with investment grade corporates, far too early in this environment. This is the counterparty risk that was the reason the Fed bailed out Bear Stearns…gee…thought that supposed to be behind us now? It is the piling up of “hedged” credit default swaps that is the biggest risk…in a $44 trillion market…of course their trade association says that is not the risk, it is only 2% of that … oh good…just $880B…but never trust a trade association…remember National Association of Realtors, David Lereah? But that is the loss IF they weren’t correlated…so if one counterparty fails and then causes another to not be able to fulfill their obligation on the hedge pairoff, you have a domino effect…bear in mind that JPMorganChase is the largest holder of CDS paper. In almost a flashback, the article says that Bear Stearns shares have plunged almost 50% today…TODAY, didn’t the Fed and JPM fix it?…nope, deal hasn’t closed yet…and the Fed is the one on the hook! Still think the crisis is over…if so, you better take another look…wishing does not make it so!
 
Now a roundup of company related stories: Home Depot posted an earnings decline on the housing slump yet profit beat estimates…this follows competitor Lowe’s whose profit fell 18% yesterday; Northern Rocks says 5% drop in U.K. home prices would hurt recovery plans…another one we thought was ‘fixed’; U.S. house prices may drop 30-%. Capital Economics, London, says; Wachovia, Fifth Third Bank face employee insurance losses tied to hedge funds. Wachovia and this time over BOLI, bank owned life insurance programs. Wachovia just can’t keep its name out of the press…TB says again, IF a major US bank fails…not saying one will…but IF it does, his money is on Wachovia; AIG says their capital raising will be to the tune of $20 billion…stock continues to skid along the bottom.
 
The last story is another investment titan like LTCM’s John Merriwether was…or a guru? Lewis Ranieri, who was a pioneer in developing the collateralized mortgage obligation while at Salomon Brothers, at the same time as Merriwether was, is running a Houston bank, his second having sold the first and starting with a new one, Franklin Bank (why does that name keep coming back and every time it does it seems to lead to failure?), which is now being investigated by the SEC on failure to increase loan loss reserves among other things while the stock price dove 90% last year. While Merriwether had absurd leverage and should have known better, Ranieri…a pro who know all about diversification and it’s place in the mortgage business…heck, he wrote the bible on it…had one-third of the banks loans to homebuilders, and 40% of the loan portfolio was in Florida and California! This is unconscionable and stupid!
 
BUT, the good news is the worst is behind us…when have you ever seen the worst behind us when a NEW story…or more…develops daily? It is NOT over…not by a damnsight!   
TB had a two hour lunch…not to be confused with a two martini lunch yesterday with two knowledgeable friends, and economist and former banker with vast investment expertise…the topics were varied but the concerns were uniform…from politics, to investing, to housing, it isn’t pretty.

Have a wonderful day!

TB

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 20, 2008

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5/19/08…sell in May revisited

May 19, 2008 at 5:49 am · Filed under economy, financial, markets ·Tagged , , , , , , , , , , , , , ,

Bloomberg Quote of the Day: “I hope life isn’t a big joke, because I don’t get it.” – Jack Handey, must be someone who has just been told he is entering the ‘golden years’…a very bad joke!
 
…it’s funny but due to the low volume since March 24, the old “sell in May and go away” has kept popping into TB’s head even as the pros say stocks are in rally mode. On Friday, TB was talking with a former colleague who also brought up the expression. Then on Saturday, John Mauldin devoted a section of his weekly column to it, http://www.frontlinethoughts.com/printarticle.asp?id=mwo051608. The data is compelling that if you bought in October each year and sold in May, each year, you would have been far better off…and probably slept a lot better too. This year with not only volume but volatility on both the VIX (S&P 500) and VXN (NDQ 100) at very low levels, normally indicative of complacency, the risks favor a selloff more than a continuation of the rally. This is because a majority of the guests on CNBC are bullish and Bloomberg reports this morning that more than 60 economists surveyed by the NABE predict that businesses and consumers will find it easier to borrow in the second half of this year, and the consensus (the elephant was designed by a consensus) is for 2.1% GDP growth in the second half. TB doesn’t know about you but he has never made money by following a herd. Before we go into the details of why May-Oct is not a good time to be in the market look at the following top stories from Bloomberg this morning:
 
TIPS Show Bonds See Bubble burst for Commodities Prices. Consumers expect prices to rise 5.2% over the next 12 months according to the UMich survey, the most pessimistic since 1982 while traders expect about 2.9% by January 2009, slightly below the 3.1% average of the past 20 years. This gap is the widest ever so the conclusion is that individuals are too pessimistic from looking at pump and store prices. According to TIPS pricing the bubble is about to burst and if prices then decline that will cause TIP prices to fall. But as TB sees it, timing it when the dollar remains weak may be problematic. Also, Congress is back on the warpath to get China to revalue the renmimbi which would be very inflationary. 
While long TIPS yield 1.90% which is still very rich, the 5 yr tips is 0.71% above the inflation rate, a sign of strong fears of inflation and only rises to 1.35% in the 10 year TIP.
 
Saudi Increase (production) Will Not Lower Oil Price, Iraq Says. As Bush returns from the Middle East having sent a mixed message to Iran implying Iraq should talk to Iran while his Secretary of State and Defense Secretary think we should talk to them…what, you aren’t surprised?…oil surged yet again overnight, after all the last time he talked to the Saudi’s they thumbed their nose at us. As the Friday summary shows oil prices are almost totally out of backwardation as the long end of the contract curve is almost as high as the lead contracts…well less than one dollar, after Dec ‘15 surged over $5 Friday. Speculators do not play in the long end of the curve…that should be disconcerting.
 
Banks Hide $35 Billion in Writedowns From Income Statements, Filings Show. That is nearly 10% of all write-downs so far and is shown in quarterly reports to the SEC yet not disclosed…if that isn’t regulation run amok TB has no idea what is. Citi alone wrote down $2B on declining home loans on May 2, but did not disclose it in the earning statement or conference call. ING did similar with $3.6B euros ($5.6B), while only disclosing 80 million euros of write-downs. Is it any wonder that banks don’t trust one another, so why should you trust them? Once again, transparency rears its ugly head. TB has been arguing that there were more losses to come…and the worst thing that can happen is repeatedly convincing yourself that they are all out there only to be disappointed again. On Tuesday, TB posed whether another financial sector selloff was starting only to see them improve…until Friday when Banks declined by 1.5% and Insurers by 1% while Wall Street somehow escaped with just 1.2% in losses…watch closely.
 
Post-Subprime Economy Means Subpar Growth as New Normal in U.S. Even if we aren’t in recession, which a majority of economists finally believe we are, and even if we recover from it quickly as they expect…some say September which TB believes is far too early…growth will be much slower than we are used to it being. Understandable, as we no longer have an equity bubble or a housing bubble with those accompanying huge mortgage equity withdrawals which added about 2% to economic growth since 2002. Some see long term U.S. growth dropping from the 3% average of the past 154 year to 2-2.5%…and this bodes poorly for high single or double digit stock price growth we have become accustomed to. Along with this banks are raising credit standards and raising spreads charged to corporate lenders…and as in the prior story, David Rubenstein, chairman of the Carlyle Group (the ex-Presidents club) says there are even more losses to come…”enormous losses.”
 
Auction-Rate Losses Cost Google UPS Shareholders $1.8B…yes…Google! and UPS not to be confused with UBS. Google took a $10.8 million write-down on $259.6 million invested, while UPS wrote down $383 million of investments by $33 million. The other shoe hear is that they will have to reclassify them as long term investments which in some cases could trigger problems with creditors. Yet there has not been a single default in auction rate securities…strictly a liquidity problem brought about by stupid highly leveraged actions by Wall Street firms…this story is still continuing!
 
UBS $100 Billion Mortgage Wager Prompted $24 Billion loss over Nine Months. UBS, not to be confused with UPS…or USB (US Bancorporation), a year ago was bragging about record profits.  
 
Of course knowing how our stock market functions, it might even rally on this news…go figure! OK, now that you are all ready to just run out there and buy stocks, here are the reasons to sell in May. Mauldin cites the data from the respected Ned Davis (NDR) database:
 
Starting in 1950, $10,000 invested in the S&P 500 every May 1st and liquidated every October 31st would only be worth $10,026…and that is before inflation! Out of those 57 periods 21 were negative and 36% of the time…a period when the stock market rose about 75% of the time and we had those long boom periods. But had you invested on November 1st and then sold all of your stocks on May 31, the $10,000 would now be worth $372, 890 as of April 30th. Out of the 58 periods you would have had positive results in 45 and negative in just 13. 
 
This does not mean you should all go out and liquidate your holdings…particularly in taxable accounts but it means it is a good time to evaluate your holdings and cut anything you are not comfortable with. Much has been made of the billions in money market funds that is seen as poised to jump into stocks. Likewise, professional money managers are holding huge sums of cash…many 25% of assets and some as high as 40%…this is a rare occurrence…even rarer is the 30% or more of hedge funds sitting on 5-10% cash positions. Bulls claim that that money will come back in the market and fuel a huge rally, while bears, like TB, can say that it is a sign of fear and indecision about the economy and will thus stay there until and unless the market takes another plunge…so with sell in May that could become a self-fulfilling prophecy.
 
TB has for some time been advising clients to invest for income…not capital gains…a blend of income producing securities of various types and that theory is catching on…true, TB did not invent it but on his own he concluded this and has been steering his clients in this direction. Ideally gains will offset losses and maybe even some capital gains exceeding the declines while the income grows and is reinvested at an average rate of about 6% or more. Just something for you to think about.
 
Beware of low volume rallies…and in fact low volume markets…but in the summer doldrums a selloff is much more likely on bad news than a sustainable rally on good news: a lot more sellers than buyers on bad news is a stronger likelihood than a lot more buyers than sellers on good news…usually! 

This weekend was unique for TB. First, on Saturday he attended the graduation of an Iraqi friend from the UC Berkeley Graduate School of Journalism. On the way there we drove past the Law School where the protests against John Yoo, the UC law professor who wrote the Bybee memo on torture, that has turned the U.S. into barbarians and put our own troops and citizens abroad in grave danger by ignoring the Geneva Convention. The friend, Omar Feikeki, worked for the Washington Post in Baghdad when the occupation (yes, it has turned into an occupation), began. Omar was selected to be the speaker for the class. After delivering a speech on how correspondents should respect and consider the risks that local reporters take, he introduced his girlfriend, Bahn, and proposed to her right there. It was touching and was the highlight of the day. Then, our mutual friend, Rajiv Chandrasekaran, who wrote the wonderful expose on the U.S. in Baghdad, Imperial Life in the Emerald City, delivered a speech on what journalists must do to get the information so that the true story can be told. Memo to files: never upstage your friend and mentor just before they are about to deliver a speech, LOL.

TB hopes you all saw the 60 Minutes piece on Kirk Johnson, who set up The List, to speed up the painfully slow process of bringing Iraqi’s who aided the US as interpreters etc. and whose lives are now in jeopardy. Omar wants to return home to start a newspaper and would even though he is at risk but his family has told him that now returning would place his entire family at risk. Far too many Iraqi’s who helped us have been abandoned by this Administration who cannot walk the walk…it is shameful what we have done and unprecedented…we brought home 100,000 Vietnamese who helped us yet have only brought 5,000 Iraqi’s over…well educated, American loving Iraqi’s…allegedly on fears of terrorism, but more likely as Johnson says…to avoid the embarrassment of our failure to set up a working government. We want democracy around the world but on our terms and don’t reward those who help us…very sad.

Then on Sunday, TB and a friend drove up to the wine country to visit two wineries we love in the Dry Creek Valley, A.Rafanelli, and Montemaggiore…the first a cult wine for their zinfandel and the second an up and coming small producer producing mainly syrahs. We learned how the rising cost of fertilizers and sulphites have risen by as much as ten times over the past year…add to this energy costs and their own cost of living and you see another industry that is under increasing pressure with only the high end and those who sell in Asia able to pass on the cost increases. Remember, winemaking is glorified farming, something every vineyard owner knows…you do your best but you are the mercy of external forces.

Hava a terrific day!

TB

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 19, 2008

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5/16/08…it’s broke…now how can we fix it

May 16, 2008 at 5:09 am · Filed under economy, financial, markets ·Tagged , , , , , , ,

Things you’ll never hear Kudlow say: “Capitalism only has a future if it rises up to its responsibility toward the weak. It is about practicing responsibility and solidarity without at the same time switching off market and price mechanisms.” – Hans Kohler, German President
 
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.  

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