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
