Stocks are racing for year-end as investors would like to lock in 2009 profits. Earning season is over and Christmas Season is just beginning. It looks like shoppers came out in droves for Black Friday but most customers were focused on bargains and buying necessities. It also looked like online shoppers spent 35% more this year than last on Friday according to web analytics firm Coremetrics. It appears the Internet buying was very focused and pre-planned as shoppers spent less time on-line than last year even though purchase volume increased.
Even with some positive early signs, we still expect Christmas won't be a great season for retail sales. Perhaps revenues will rise but gross margins will be squeezed. Retailers will be primarily relying on overhead cost cuts and limited inventory. This holiday season will likely bring cheer to the most price focused retailers like Amazon and Walmart while bringing frowns to many others.
When 2009 comes to a close, the consumer will still be focused on saving and deleveraging. The stimulus plan will still be the driving force for economic growth;but limited bank lending, a weak job market, soft housing sales and the many other problems emanating from the financial crisis will still be overhanging the markets for 2010.
Although we have been cautious in the markets as we expect the economy to limp along, we are most concerned with what we don't know. We believe there are many unknown obstacles ahead which could be devastating for stocks and in turn become a shock to the financial system. What are the implications for the Dubai Debt Crisis? How about the Russian Terrorist Attack? Iran announced a build up of their Nuclear Sites. Will this lead to Israel attacking Iran in 2010? Any one of these events could be the impetus to some unknown chain reaction that could cripple the global economy and lead to new financial stresses.
China has been the driver of the global economy as it buys commodities around the world and builds its own domestic infrastructure and industrial base. Chinese banks may be overextended and its industrial capacity may be overbuilt. If China's growth slows or its banks face defaults from its aggressive lending, what will happen to the world economy? Will China be a seller of U.S. Treasuries and where will interest rates go?
Oil is much higher than it was a year ago but an Israeli conflict in the Middle East could send it much higher. Higher energy prices will certainly send the economy back into recession and perhaps create another financial meltdown. We are not predicting any of these scenarios for 2010 but we do believe the risks are high for some uncertain event to occur. Investors want to be bullish,as do we,but maintaining ample liquidity and hedging for unforeseen events is the prudent way to invest in this volatile economic environment.
Sunday, November 29, 2009
Monday, November 23, 2009
The Bernanke Bubble
The stock market continues to rise, albeit with some volatility. We have been cautious for months and have raised cash while also keeping exposure to stocks. It appears to us that most investors have the same information about the economy but some are bullish and some are bearish. When one looks at the data everyone seems to be right but it is all about timing.
The third quarter seems to be the turning point of the recession. Government stimulus drove auto sales and new home purchases. The Federal Reserve has orchestrated low interest rates and the capital markets have opened to large companies. Banks have increased their capital and their liquidity but have not dramatically expanded their loan portfolios. In the depths of the Great Recession, the consumer stopped shopping and businesses slashed staff while production halted. When panic subsided as the markets were rising, consumer confidence rose a little and businesses began to replenish inventories. All this contributed to the 3rd Quarter GDP growth.
With low interest rates, the dollar has been sinking. This has lead to a rising stock market but it is definitely climbing a Wall of Worry, as it should. Commodity prices, oil, and gold keep climbing and a weak dollar will exacerbate that trend. Unfortunately, government debt continues to bloom. Debt is everywhere from the consumer, to business, to real estate, to all governments globally. As long as rates stay low, investors are predicting economic activity will improve and the U.S. government can finance their needs cheaply.
So far, all investors agree with the above scenario, whether one is a bull or a bear. The other key factor driving some growth is China. China holds the cards to not only global growth but low interest rates in the U.S. Now we must highlight where the two camps may differ.
China is still growing at high single digit rates but the U.S. was a driving force to their exports. Bears are concerned that China is spending tons of capital to build domestic infrastructure which may be creating its own bubble if their standard of living doesn't improve. They have also been driving commodity prices through large purchases in order to fill their domestic manufacturing needs. Those purchases have been kick starting the growth of many natural resource economies. What happens if China can't maintain this growth?
China holds many of the cards. If their growth slows, so does most of the world's. The U.S. would likely suffer immensely. What is more troubling is the amount of U.S. debt China holds. China has been a big buyer of U.S. treasuries for many years. If they suddenly decide to stop buying or worse they become sellers, the interest rates in the United States will begin to rise. Our fear is that those rates may reach levels that will be extremely damaging to our economy.
Furthermore, the towering government debt will grow significantly when we add in healthcare, medicare, and social security funding. How can the United States pay all this debt off? We are seeing the beginning trend in the dollar as the answer to that question. We believe the dollar weakness is due to the Federal Reserve keeping rates low and concerns with the growing debt balances in the U.S.
Given these concerns, how can stocks keep rising? Low interest rates may persist for a while longer as the Federal Reserve floods the markets with liquidity. Inflation has been tame because the velocity of those additional dollars is low. This velocity may not accelerate if employment stays high and lending is curtailed. If the economy actually kicks into high gear, the Fed will have a new juggling act to perform to keep rates low. This scenario will lead to rising inflation. Bullish investors expect rates to stay low, dollar weakness to be positive in the short-term, the economy to be strong in 2010, and unemployment to improve next year.
Our concern is that the Government Stimulus has been a big driver of recent growth and low rates created by the Federal reserve is a catalyst for the weak dollar and improved capital markets. Eventually, markets will need to act on their own and the results may not be pretty. The Federal debt is high and getting higher. State and Local Governments are bleeding huge deficits. The answer in many cases is to raise taxes. Can the consumer or business afford more taxes? The bottom line is that bubbles are being built in stocks and bonds and as long as rates are low, maybe that trend will persist. We remain cautious because we know there will be a day of RECKONING. It is not If, it is When. We are just trying to figure out how to protect our assets. Gold will clearly be a beneficiary but U.S. assets will have to be devalued and interest rates will likely skyrocket in order for the United States to fund its enormous debt.
The third quarter seems to be the turning point of the recession. Government stimulus drove auto sales and new home purchases. The Federal Reserve has orchestrated low interest rates and the capital markets have opened to large companies. Banks have increased their capital and their liquidity but have not dramatically expanded their loan portfolios. In the depths of the Great Recession, the consumer stopped shopping and businesses slashed staff while production halted. When panic subsided as the markets were rising, consumer confidence rose a little and businesses began to replenish inventories. All this contributed to the 3rd Quarter GDP growth.
With low interest rates, the dollar has been sinking. This has lead to a rising stock market but it is definitely climbing a Wall of Worry, as it should. Commodity prices, oil, and gold keep climbing and a weak dollar will exacerbate that trend. Unfortunately, government debt continues to bloom. Debt is everywhere from the consumer, to business, to real estate, to all governments globally. As long as rates stay low, investors are predicting economic activity will improve and the U.S. government can finance their needs cheaply.
So far, all investors agree with the above scenario, whether one is a bull or a bear. The other key factor driving some growth is China. China holds the cards to not only global growth but low interest rates in the U.S. Now we must highlight where the two camps may differ.
China is still growing at high single digit rates but the U.S. was a driving force to their exports. Bears are concerned that China is spending tons of capital to build domestic infrastructure which may be creating its own bubble if their standard of living doesn't improve. They have also been driving commodity prices through large purchases in order to fill their domestic manufacturing needs. Those purchases have been kick starting the growth of many natural resource economies. What happens if China can't maintain this growth?
China holds many of the cards. If their growth slows, so does most of the world's. The U.S. would likely suffer immensely. What is more troubling is the amount of U.S. debt China holds. China has been a big buyer of U.S. treasuries for many years. If they suddenly decide to stop buying or worse they become sellers, the interest rates in the United States will begin to rise. Our fear is that those rates may reach levels that will be extremely damaging to our economy.
Furthermore, the towering government debt will grow significantly when we add in healthcare, medicare, and social security funding. How can the United States pay all this debt off? We are seeing the beginning trend in the dollar as the answer to that question. We believe the dollar weakness is due to the Federal Reserve keeping rates low and concerns with the growing debt balances in the U.S.
Given these concerns, how can stocks keep rising? Low interest rates may persist for a while longer as the Federal Reserve floods the markets with liquidity. Inflation has been tame because the velocity of those additional dollars is low. This velocity may not accelerate if employment stays high and lending is curtailed. If the economy actually kicks into high gear, the Fed will have a new juggling act to perform to keep rates low. This scenario will lead to rising inflation. Bullish investors expect rates to stay low, dollar weakness to be positive in the short-term, the economy to be strong in 2010, and unemployment to improve next year.
Our concern is that the Government Stimulus has been a big driver of recent growth and low rates created by the Federal reserve is a catalyst for the weak dollar and improved capital markets. Eventually, markets will need to act on their own and the results may not be pretty. The Federal debt is high and getting higher. State and Local Governments are bleeding huge deficits. The answer in many cases is to raise taxes. Can the consumer or business afford more taxes? The bottom line is that bubbles are being built in stocks and bonds and as long as rates are low, maybe that trend will persist. We remain cautious because we know there will be a day of RECKONING. It is not If, it is When. We are just trying to figure out how to protect our assets. Gold will clearly be a beneficiary but U.S. assets will have to be devalued and interest rates will likely skyrocket in order for the United States to fund its enormous debt.
Thursday, November 5, 2009
Does Cisco Have It Right?
John Chambers, CEO of Cisco, is one of the most forthright executives in the business world. He tells it as it is and he believe the economy has bottomed and demand is picking up. Most people would agree the recession looks like it has seen the worst days and there is some positive momentum. The key is how strong of a recovery will we get. Mr. Chambers was clearly cautious about being too bold on the growth prospects other than to say the outlook is better but growth is likely to be slow. The stock market appears to believe the economy may have good growth in 2010.
Look at the productivity numbers. 9% improvement is unheard of but labor costs are dropping fast. A little bit of revenue growth is likely to produce strong earnings. There are still many caution flags to watch out for such as the weakened consumer, the limited small business lending, the dismal prospects for commercial real estate, and let's not forgot the unemployment picture.
Investors were happy to see stronger unemployment results but how happy can we be when 500,000 plus jobs are still being lost every week. We historically focused on continuing claims as the key indicator for the employment picture but as unemployment benefits are running out for many people, a drop in this number may not really be a good sign.
Tomorrow is likely the day when unemployment will hit 10%. If that happens and the markets continue to roar ahead, then perhaps we can rally to year end. We would remain very cautious as volatility is back and fear is rising. The stimulus package has propelled a big part of the GDP growth and the government is reinstating the new homes credit to keep that train chugging.
The White House boasts about the hundreds of thousands of jobs they created or saved with stimulus money, but is the cost to this country's future worth it? We may be too concerned about the dangers ahead and stocks may continue their rise but there will be a day of reckoning as the bloated balance sheet of the United States will need to be addressed. It is just another bubble waiting to pop. Enjoy the ride in the short-term but make sure you have some hedges along the way.
Look at the productivity numbers. 9% improvement is unheard of but labor costs are dropping fast. A little bit of revenue growth is likely to produce strong earnings. There are still many caution flags to watch out for such as the weakened consumer, the limited small business lending, the dismal prospects for commercial real estate, and let's not forgot the unemployment picture.
Investors were happy to see stronger unemployment results but how happy can we be when 500,000 plus jobs are still being lost every week. We historically focused on continuing claims as the key indicator for the employment picture but as unemployment benefits are running out for many people, a drop in this number may not really be a good sign.
Tomorrow is likely the day when unemployment will hit 10%. If that happens and the markets continue to roar ahead, then perhaps we can rally to year end. We would remain very cautious as volatility is back and fear is rising. The stimulus package has propelled a big part of the GDP growth and the government is reinstating the new homes credit to keep that train chugging.
The White House boasts about the hundreds of thousands of jobs they created or saved with stimulus money, but is the cost to this country's future worth it? We may be too concerned about the dangers ahead and stocks may continue their rise but there will be a day of reckoning as the bloated balance sheet of the United States will need to be addressed. It is just another bubble waiting to pop. Enjoy the ride in the short-term but make sure you have some hedges along the way.
Tuesday, October 27, 2009
What Do Apple, Google, Walmart, and Amazon Have In Common?
The consumer is a dominant factor in GDP growth. The U.S. economy has avoided the Great Depression II and seems to be ending the Great Recession. However, we aren't convinced good times are coming. The consumer is saving and not spending. Small businesses are cautious with their hiring and can't get credit to grow. Bankruptcies continue to rise and the commercial real estate collapse is in progress. Of course, the Stimulus plan has helped create short-term spurts in housing and autos while piling more debt onto the United States balance sheet. Does this sound like good times are coming?
There are some bright spots as the stock market's huge leap from the March lows has given most people a feeling that better times may be ahead. That may be true but unemployment continues to grow and high leverage still remains with consumers, businesses, and the government. We are now in an economy where spending is picking up a little but only for bargains. Of course, consumers will also pick up the hottest new item if there is value to be had.
Apple, Google, Walmart, and Amazon have all announced good earnings and growth. Why is that? In an environment where consumers use caution, they will buy what they need at the lowest price. If there are any discretionary funds, they will buy the products which have the best value. Apple has the hottest products with great value; Walmart and Amazon are large supermarkets of goods sold at the most competitive prices; and Google is the vehicle to search for the best value at the cheapest price. Until we have an economic environment where the future becomes more certain, the consumer will continue to migrate to those companies that lead in value.
There are some bright spots as the stock market's huge leap from the March lows has given most people a feeling that better times may be ahead. That may be true but unemployment continues to grow and high leverage still remains with consumers, businesses, and the government. We are now in an economy where spending is picking up a little but only for bargains. Of course, consumers will also pick up the hottest new item if there is value to be had.
Apple, Google, Walmart, and Amazon have all announced good earnings and growth. Why is that? In an environment where consumers use caution, they will buy what they need at the lowest price. If there are any discretionary funds, they will buy the products which have the best value. Apple has the hottest products with great value; Walmart and Amazon are large supermarkets of goods sold at the most competitive prices; and Google is the vehicle to search for the best value at the cheapest price. Until we have an economic environment where the future becomes more certain, the consumer will continue to migrate to those companies that lead in value.
Monday, October 19, 2009
Earnings and Liquidity Drive the Market Higher
A majority of companies reporting third quarter earnings have beaten expectations. Apple once again crushed their numbers today and the stock soared. Technology remains a good sector to focus on as Google and Intel proved last week. Not all earnings reports will be good but many will be. During the past year, most companies drastically cut costs and when revenues pick up a little bit, earnings can soar.
We haven't turned bullish but continue to have investments in the market because the negativeness by investors and the plethora of cash on the sidelines keeps driving the markets higher. We believe there will be a day of reckoning and we will cautiously invest accordingly. With the U.S. deficit reaching 10% of GDP and the government debt growing by the trillions, we need to be concerned. The recession may be over but many problems still loom.
Perhaps we will be wrong and the global economy will pull the U.S. into a growth mode but a falling dollar, rising oil prices, a looming commercial real estate problem, and rising unemployment makes it hard for seasoned investors to think we are back to normal. Companies are acting responsibly by slashing costs and minimizing inventories while reducing employment. The result has been better than expected earnings. However, the economy got a big boost from the stimulus plan when it comes to auto sales and housing. The government grew its debt for the sake of moving home and car inventories but that stimulus is over. Manufacturers are rebuilding inventory but the consumer is still constrained and may not be there to buy again.
The consumer must pay back its debts and that is why savings rates are rising. Companies must pay back their debts and that is why we are seeing many refinancings, exchange offers, and bankruptcies. This trend will continue well into 2010. Finally, the government must pay back its debts and that is why we expect interest rates to eventually rise significantly. This coupled with a continual drop in the value of the dollar should lead to rampant inflation. This scenario will put a crimp in stock prices at some point but for now liquidity and earnings may drive the equity markets higher. Be cautious and careful and buy large, liquid stocks with strong growth characteristics. Alternatively, buy distressed securities or real estate.
We haven't turned bullish but continue to have investments in the market because the negativeness by investors and the plethora of cash on the sidelines keeps driving the markets higher. We believe there will be a day of reckoning and we will cautiously invest accordingly. With the U.S. deficit reaching 10% of GDP and the government debt growing by the trillions, we need to be concerned. The recession may be over but many problems still loom.
Perhaps we will be wrong and the global economy will pull the U.S. into a growth mode but a falling dollar, rising oil prices, a looming commercial real estate problem, and rising unemployment makes it hard for seasoned investors to think we are back to normal. Companies are acting responsibly by slashing costs and minimizing inventories while reducing employment. The result has been better than expected earnings. However, the economy got a big boost from the stimulus plan when it comes to auto sales and housing. The government grew its debt for the sake of moving home and car inventories but that stimulus is over. Manufacturers are rebuilding inventory but the consumer is still constrained and may not be there to buy again.
The consumer must pay back its debts and that is why savings rates are rising. Companies must pay back their debts and that is why we are seeing many refinancings, exchange offers, and bankruptcies. This trend will continue well into 2010. Finally, the government must pay back its debts and that is why we expect interest rates to eventually rise significantly. This coupled with a continual drop in the value of the dollar should lead to rampant inflation. This scenario will put a crimp in stock prices at some point but for now liquidity and earnings may drive the equity markets higher. Be cautious and careful and buy large, liquid stocks with strong growth characteristics. Alternatively, buy distressed securities or real estate.
Monday, October 5, 2009
The Economic Clunkers of Autumn
Back-to School sales weren't so good. Factory Orders were weak. Auto sales plummeted. Non-Farm Payrolls were much worse than expected. We have been concerned for months that investors were too bullish with the signs of green shoots. The economy almost fell off a cliff a year ago and stocks were plunging in the spring so it was not a huge surprise to see the stock market rally when the economy showed some signs of a slowdown in the economic decline. The rally persisted as business seemed to not be getting worse but stocks may have over shot on the upside as they did on the downside.
It is only in the last two weeks where stocks have taken a little breather as the green shoots are starting to look like weeds. It is not really a surprise to see auto sales fall last month as the cash for clunker program ended. The stimulus plan gave a shot in the arm to the auto industry by creating bargains for consumers to trade in their old cars. With those bargains gone, there aren't many buyers of new cars. The same result is likely to happen to housing next month as the governments subsidies for first time buyers go away. Anyone looking to buy a house surely took advantage of the stimulus plan but once that ends so will aggressive buying of new homes. We expect the government to extend the housing stimulus or creat another boost for housing. However, a continuation of the plan will unlikely produce the same jolt to housing sales as anyone who wanted to take advantage of a subsidy likely did already.
The consumer is still weak and appears to only be looking for bargains. Debt remains high in all sectors of the economy with the commercial real estate troubles just getting started. Financial institutions still are not lending to small businesses, a primary source of economic growth and new job creation. The recession may be over but economic prosperity is a long way away. As such, stocks will likely begin to recognize this reality.
It is only in the last two weeks where stocks have taken a little breather as the green shoots are starting to look like weeds. It is not really a surprise to see auto sales fall last month as the cash for clunker program ended. The stimulus plan gave a shot in the arm to the auto industry by creating bargains for consumers to trade in their old cars. With those bargains gone, there aren't many buyers of new cars. The same result is likely to happen to housing next month as the governments subsidies for first time buyers go away. Anyone looking to buy a house surely took advantage of the stimulus plan but once that ends so will aggressive buying of new homes. We expect the government to extend the housing stimulus or creat another boost for housing. However, a continuation of the plan will unlikely produce the same jolt to housing sales as anyone who wanted to take advantage of a subsidy likely did already.
The consumer is still weak and appears to only be looking for bargains. Debt remains high in all sectors of the economy with the commercial real estate troubles just getting started. Financial institutions still are not lending to small businesses, a primary source of economic growth and new job creation. The recession may be over but economic prosperity is a long way away. As such, stocks will likely begin to recognize this reality.
Tuesday, September 22, 2009
Time To Look At The Glass Half Full
We continue to be concerned with the many obstacles to a strong recovery. Stocks have been rising to new highs for six months now and the bulls and bears continue to battle. We believe the economy has bottomed but remain skeptical that the stock rally can maintain its surge without bumps in the road. Although we have participated in the rally, we also hold plenty of cash and keep some stock market hedges in place.
We have taken a cautious approach to stocks but investors need to search for opportunities within the boundaries of their macro views of the economy. We expect the financial services industry to undergo many changes in the next few years. A year ago the financial system faced Armageddon and many financial companies have been saved with government help; while others have either gone bust or were taken over by stronger enterprises. We can expect the strong to get stronger while many others will need capital infusions, will be taken over by the FDIC, or will be forced to sell themselves. We think the opportunities in financial services will produce some of the best returns to those who have the knowledge and research to find the winners. Many funds have raised capital to buy distressed banks and build platforms to lead turnarounds for the financial institutions of the future. As such, we are buying the Paulson Recovery Fund. Although this is a high risk illiquid fund, we believe John Paulson has a unique knowledge of the financial industry. His firm is best known for identifying the imminent collapse of the housing market and the mortgage securities that came tumbling down. He also parlayed that insight into shorting many financial institution stocks. We believe his firm has extensive research on the banking universe and will now be able to pick the winners in the recovery phase. A select group of investors will also be shown opportunities to invest in or buy distressed banks and Paulson should have the access to what in our opinion will be some of the greatest investment opportunities of our life time.
For months we have discussed our concerns with the rising bankruptcy rates we expect in the corporate world. Many companies have filed Chapter 11 and many more will follow suit in the next couple of years. Leverage was a killer in the housing market, it will create record corporate bankruptcies, and it will severely damage the commercial real estate market. Companies borrowed to fuel the leverage buyout boom which helped to propel the stock market higher. Financial markets collapsed and bank financing dried up. These events coupled with a severe recession has put many companies into default while many more are heading in that direction. We try to invest where opportunities present themselves. We have plenty of knowledge and experience with bankruptcy investing and believe the next few years will produce significant returns for vulture funds who take over distressed companies by acquiring the debt of the target company. It is hard for individuals to participate in these opportunities on their own as large pools of capital are needed to be successful as well as extensive research capabilities. We have decided to pursue these opportunities through Oaktree Capital Management who is raising their fifth domestic fund focused on buying companies through the debt. Their track record is very good through many cycles and we believe the timing couldn't be better than now. A good investor should produce great returns when the timing is perfect.
Finally, we have been talking about the collapse of the real estate market for a year. Housing prices have plummeted around the country and commercial real estate is next in line. Housing has shown some positive signs in the last few months but we remain somewhat skeptical as much of the momentum is driven by government incentives to first time buyers. On the other hand, this may be the greatest opportunity in our lifetimes to take advantage of weak real estate markets. As such, we are focused on buying multi-family housing that produces positive cash flows. It may be a year or two too early to invest in commercial real estate so we are currently focused on housing. If our thesis on future inflation is inevitable, holding real estate should better protect our assets from a weaker dollar.
We remain concerned with the stock market and the many land mines left throughout the economy but it is important to take advantage of the opportunities created from the past year's financial calamity.
We have taken a cautious approach to stocks but investors need to search for opportunities within the boundaries of their macro views of the economy. We expect the financial services industry to undergo many changes in the next few years. A year ago the financial system faced Armageddon and many financial companies have been saved with government help; while others have either gone bust or were taken over by stronger enterprises. We can expect the strong to get stronger while many others will need capital infusions, will be taken over by the FDIC, or will be forced to sell themselves. We think the opportunities in financial services will produce some of the best returns to those who have the knowledge and research to find the winners. Many funds have raised capital to buy distressed banks and build platforms to lead turnarounds for the financial institutions of the future. As such, we are buying the Paulson Recovery Fund. Although this is a high risk illiquid fund, we believe John Paulson has a unique knowledge of the financial industry. His firm is best known for identifying the imminent collapse of the housing market and the mortgage securities that came tumbling down. He also parlayed that insight into shorting many financial institution stocks. We believe his firm has extensive research on the banking universe and will now be able to pick the winners in the recovery phase. A select group of investors will also be shown opportunities to invest in or buy distressed banks and Paulson should have the access to what in our opinion will be some of the greatest investment opportunities of our life time.
For months we have discussed our concerns with the rising bankruptcy rates we expect in the corporate world. Many companies have filed Chapter 11 and many more will follow suit in the next couple of years. Leverage was a killer in the housing market, it will create record corporate bankruptcies, and it will severely damage the commercial real estate market. Companies borrowed to fuel the leverage buyout boom which helped to propel the stock market higher. Financial markets collapsed and bank financing dried up. These events coupled with a severe recession has put many companies into default while many more are heading in that direction. We try to invest where opportunities present themselves. We have plenty of knowledge and experience with bankruptcy investing and believe the next few years will produce significant returns for vulture funds who take over distressed companies by acquiring the debt of the target company. It is hard for individuals to participate in these opportunities on their own as large pools of capital are needed to be successful as well as extensive research capabilities. We have decided to pursue these opportunities through Oaktree Capital Management who is raising their fifth domestic fund focused on buying companies through the debt. Their track record is very good through many cycles and we believe the timing couldn't be better than now. A good investor should produce great returns when the timing is perfect.
Finally, we have been talking about the collapse of the real estate market for a year. Housing prices have plummeted around the country and commercial real estate is next in line. Housing has shown some positive signs in the last few months but we remain somewhat skeptical as much of the momentum is driven by government incentives to first time buyers. On the other hand, this may be the greatest opportunity in our lifetimes to take advantage of weak real estate markets. As such, we are focused on buying multi-family housing that produces positive cash flows. It may be a year or two too early to invest in commercial real estate so we are currently focused on housing. If our thesis on future inflation is inevitable, holding real estate should better protect our assets from a weaker dollar.
We remain concerned with the stock market and the many land mines left throughout the economy but it is important to take advantage of the opportunities created from the past year's financial calamity.
Monday, September 14, 2009
A Year After the Lehman Collapse
A year ago, the financial system was on the verge of imploding. The Lehman collapse set off a trying few weeks where many other financial companies such as AIG, Fannie Mae, Freddie Mac, Goldman Sachs, and Morgan Stanley were also on the verge of imploding. The Federal Reserve and the Treasury department flooded the financial system with liquidity and shored up the banking system with loans resulting in improved protection from failure. Today the banking system appears to be healing and the economy has stabilized but many risks still exist.
We have been writing about excessive leverage and our concerns with its likely drag on the economy. This morning Nouriel Roubini spoke on CNBC about his concerns with consumer leverage, corporate leverage, real estate leverage, and finally, the excessive amount of debt created by the U.S. government. His thoughts are very much in line with our concerns for the future. Economic activity can not be robust until debt levels decline precipitously and this can only happen with time.
Another topic we have focused on is banks too big to fail are too big to exist. The Bank of International Settlement has concluded, as discussed in the WSJ, that "big banks' risks to the system increase more than proportionately with their size". We agree and have suggested that capital requirements should rise with the size of a bank. This method will allow banks to self judge wether they can garner sufficient returns on capital as their size grows. The BIS seems to have come to a similar conclusion as they suggest bigger banks pay higher taxes. If such tax is in the form of higher capital requirements then sytematic risk won't be avoided but managed more prudently.
We have been writing about excessive leverage and our concerns with its likely drag on the economy. This morning Nouriel Roubini spoke on CNBC about his concerns with consumer leverage, corporate leverage, real estate leverage, and finally, the excessive amount of debt created by the U.S. government. His thoughts are very much in line with our concerns for the future. Economic activity can not be robust until debt levels decline precipitously and this can only happen with time.
Another topic we have focused on is banks too big to fail are too big to exist. The Bank of International Settlement has concluded, as discussed in the WSJ, that "big banks' risks to the system increase more than proportionately with their size". We agree and have suggested that capital requirements should rise with the size of a bank. This method will allow banks to self judge wether they can garner sufficient returns on capital as their size grows. The BIS seems to have come to a similar conclusion as they suggest bigger banks pay higher taxes. If such tax is in the form of higher capital requirements then sytematic risk won't be avoided but managed more prudently.
Wednesday, September 9, 2009
Gold, Inflation, and the Markets
The market keeps rising but the fear of inflation is still embedded in investor's minds. The weakness of the dollar has oil, gold, and other commodities rising again. The federal Reserve and its brethren around the world are focused on curbing future inflation but the fight will be arduous if not impossible over time. Governments continue to spend on stimulus plans while also printing plenty of money to jump start the global economy. We find it hard to believe that in two years, inflation won't start to inch up or even climb higher.
The good news these days is the increase in merger activity. Companies can't seem to grow revenues in this environment so it is a good time to acquire revenues through acquisitions. Valuations are still low if one has a long term horizon and most CEO's make strategic acquisitions with an eye on short term synergies and long term strategic value. We expect Wall street to garner a bigger stream of revenues as well capitalized companies pursue growth through M&A.
Stock prices could benefit with merger activity as the supply of stock is reduced when the acquired company is no longer trading. Incrementally this is a positive for the markets but we still believe a weak economy, high leverage, rising unemployment, and a weakened consumer will make this economic recession last longer than most expect. If we are wrong, the government debt, the corporate debt, the consumer debt, and the real estate debt will create roadblocks to a sustained recovery. We will need to see many more bankruptcies and defaults in order to equitize the system and allow businesses to grow again.
The good news these days is the increase in merger activity. Companies can't seem to grow revenues in this environment so it is a good time to acquire revenues through acquisitions. Valuations are still low if one has a long term horizon and most CEO's make strategic acquisitions with an eye on short term synergies and long term strategic value. We expect Wall street to garner a bigger stream of revenues as well capitalized companies pursue growth through M&A.
Stock prices could benefit with merger activity as the supply of stock is reduced when the acquired company is no longer trading. Incrementally this is a positive for the markets but we still believe a weak economy, high leverage, rising unemployment, and a weakened consumer will make this economic recession last longer than most expect. If we are wrong, the government debt, the corporate debt, the consumer debt, and the real estate debt will create roadblocks to a sustained recovery. We will need to see many more bankruptcies and defaults in order to equitize the system and allow businesses to grow again.
Monday, August 31, 2009
What Will September Bring?
We were pleased to see Intel and Dell have positive outlooks for the rest of the year. At the beginning of 2009 our model portfolio had plenty of technology stocks. Companies and consumers defer such purchases first when economic conditions look bleak; however, if an enterprise wants to improve productivity and remain competitive, technology spending can't remain dormant for too long. As such, we don't find it too surprising that the technology sector has some positive teas leaves at this time in the economic cycle.
This doesn't change our stance of the last few months as we continue to proceed with caution. Investors are becoming a little more suspect of China's growth. China seems to be in better shape than the U.S. and most parts of the world but we have speculated that some of their commodity buying was a result of low prices and not current demand. Why not store cheap raw materials today and use them when manufacturing starts to surge again?
As we have been saying, the economic tsunami has passed and economic activity has improved. Most companies will say business is not getting worse any more but few see much revenue growth ahead. Stocks tend to reflect future earnings but sometimes other factors can affect reality. We believe the rally was justified to a degree as signs of an Apocalypse dissipated. Stocks were probably way oversold but because there was so much cash on the sidelines, investors jumped in to the market for fear of missing the next leg of the rally. Risk taking may be back but risk management is still more important. At some point there will be a stream of negative news which may reverse the upward trend of stocks. The consumer is still weak, debt levels everywhere are high, the auto stimulus is gone, and foreclosures continue to rise. Stocks can't go up in a straight line until leverage is much lower, credit is flowing to small businesses again, and the consumer is comfortable spending again.
This doesn't change our stance of the last few months as we continue to proceed with caution. Investors are becoming a little more suspect of China's growth. China seems to be in better shape than the U.S. and most parts of the world but we have speculated that some of their commodity buying was a result of low prices and not current demand. Why not store cheap raw materials today and use them when manufacturing starts to surge again?
As we have been saying, the economic tsunami has passed and economic activity has improved. Most companies will say business is not getting worse any more but few see much revenue growth ahead. Stocks tend to reflect future earnings but sometimes other factors can affect reality. We believe the rally was justified to a degree as signs of an Apocalypse dissipated. Stocks were probably way oversold but because there was so much cash on the sidelines, investors jumped in to the market for fear of missing the next leg of the rally. Risk taking may be back but risk management is still more important. At some point there will be a stream of negative news which may reverse the upward trend of stocks. The consumer is still weak, debt levels everywhere are high, the auto stimulus is gone, and foreclosures continue to rise. Stocks can't go up in a straight line until leverage is much lower, credit is flowing to small businesses again, and the consumer is comfortable spending again.
Monday, August 24, 2009
Of Course Housing and Auto Sales Are Up
The markets reacted well to strong existing home sales last week as they did when domestic auto sales jumped in July. It should be no surprise to anybody that those have been two extremely damaged areas in this recession. The Obama administration may have a trillion dollar Stimulus Plan but it is likely that only their assistance in buying homes and cars may be the only two line items that will directly grow sales and add to employment. It is working albeit at a big cost to Americans.
It is also unlikely that such programs will have lasting affects. Consumers always like a bargain and that is why they are gravitating to Walmart, TJ Max, McDonald's, and other discount retailers. So when the government handed out free money to buy cars and homes, consumers jumped for another bargain. Unfortunately, those programs won't last forever and this economy needs some other sources of demand to jump start growth.
99% of employment growth comes from small-businesses but 99% of news headlines comes from large corporations. The National federation of Independent Business announced the results of their July survey of small-businesses. The results are bleak. Small-business owners aren't convinced the recession is ending and their outlooks darkened in July. The recorded index declined for the second month in a row and the biggest reason for the drop was that small-business owners don't expect the economy to improve in the next six months.
This shouldn't be much of a surprise as financial institutions still haven't opened the lending spigots, sales remain weak, taxes may be rising, and the cost of health care is uncertain. The consumer is still weakened and their inclination to increase savings will keep the small-business owner concerned.
We continue to wonder why stocks keep rising but it seems pretty simple. Stocks were in free fall when the prospects of the Second Great Depression was looming. Investors ran for cover and focused on capital preservation with minimal risk. Now it appears that the recession has come to an end and the trillions of excess liquidity is looking for a place with higher risk and improved returns. Companies are reporting better earnings and investors seem to overlook the negative news and focus on the green shoots.
Stock prices must reflect the realities of corporate growth and the discounted cash flows of earnings. Bull markets climb walls of worry and we remain worried. We see improvement in the economy but we also see the plethora of risks ahead. The financial industry calamity we had can be attributed to poor risk management. Housing prices were expected to rise forever and leveraged financial instruments were viewed as gold. Consumers, businesses, and financial institutions yearned for more and more so they piled on debt. It was just a game of musical chairs until the music stopped.
We may be in a similar game of musical chairs. The logic is that the recession is over and investors need higher returns. They step back into the stock market and feel much better as stocks have risen. Others missed the rally but need to get on the train so they take their over abundance of cash and enter the market which in turn pushes stock prices even higher. Housing sales and auto sales confirm an improving economy and more investors become comfortable taking the ride on the stock market express. Is this a ride to riches or are we at the top of the roller coaster?
We wish we knew the answer. We believe stock prices have risen too far, too fast. Business is improving but true growth is small. Until the consumer is back and small-business confidence improves, we will remain concerned. We still own stocks but writing covered calls and adding stop limit orders seems to be the best way to minimize risk. We may be giving up the upside if stocks continue on the current trajectory but investors need to focus on risk management.
It is also unlikely that such programs will have lasting affects. Consumers always like a bargain and that is why they are gravitating to Walmart, TJ Max, McDonald's, and other discount retailers. So when the government handed out free money to buy cars and homes, consumers jumped for another bargain. Unfortunately, those programs won't last forever and this economy needs some other sources of demand to jump start growth.
99% of employment growth comes from small-businesses but 99% of news headlines comes from large corporations. The National federation of Independent Business announced the results of their July survey of small-businesses. The results are bleak. Small-business owners aren't convinced the recession is ending and their outlooks darkened in July. The recorded index declined for the second month in a row and the biggest reason for the drop was that small-business owners don't expect the economy to improve in the next six months.
This shouldn't be much of a surprise as financial institutions still haven't opened the lending spigots, sales remain weak, taxes may be rising, and the cost of health care is uncertain. The consumer is still weakened and their inclination to increase savings will keep the small-business owner concerned.
We continue to wonder why stocks keep rising but it seems pretty simple. Stocks were in free fall when the prospects of the Second Great Depression was looming. Investors ran for cover and focused on capital preservation with minimal risk. Now it appears that the recession has come to an end and the trillions of excess liquidity is looking for a place with higher risk and improved returns. Companies are reporting better earnings and investors seem to overlook the negative news and focus on the green shoots.
Stock prices must reflect the realities of corporate growth and the discounted cash flows of earnings. Bull markets climb walls of worry and we remain worried. We see improvement in the economy but we also see the plethora of risks ahead. The financial industry calamity we had can be attributed to poor risk management. Housing prices were expected to rise forever and leveraged financial instruments were viewed as gold. Consumers, businesses, and financial institutions yearned for more and more so they piled on debt. It was just a game of musical chairs until the music stopped.
We may be in a similar game of musical chairs. The logic is that the recession is over and investors need higher returns. They step back into the stock market and feel much better as stocks have risen. Others missed the rally but need to get on the train so they take their over abundance of cash and enter the market which in turn pushes stock prices even higher. Housing sales and auto sales confirm an improving economy and more investors become comfortable taking the ride on the stock market express. Is this a ride to riches or are we at the top of the roller coaster?
We wish we knew the answer. We believe stock prices have risen too far, too fast. Business is improving but true growth is small. Until the consumer is back and small-business confidence improves, we will remain concerned. We still own stocks but writing covered calls and adding stop limit orders seems to be the best way to minimize risk. We may be giving up the upside if stocks continue on the current trajectory but investors need to focus on risk management.
Thursday, August 13, 2009
August 13 Is Bullish Day
It was twenty-seven years ago when we entered life on Wall Street. August 12th was the bottom of the market following the recession of the late seventies and early eighties where interest rates soared, inflation spiraled out of control, and unemployment pierced the 10% level. Stocks started to soar on high volume and the bull was off and running. Inflation was being tamed, interest rates were about to drop, and the economy was on its way to recovery. We can remember many professional traders loading up on call options as rising stocks generated more zeal every day. The bull was here to stay.
A score and seven years later investors ponder whether the current bull run is for real. The recession appears to be over but the economy is still weak. Retail sales numbers for July appear to be soft and the employment picture is not truly getting better. Of course, investors have driven prices higher with every earnings report that has shown improvement. As we have said in the past, earnings growth has been driven by cost cutting but sustainable growth will only be generated when corporate revenues improve.
Today's market participants can not expect interest rate to decline or inflation to be tamed or unemployment to abate. Those were the 1982 bull market drivers so what will drive the 2009 market higher? We are not sure. Perhaps China and India will continue to grow quickly and pull the U.S. out of its economic slump. This country certainly needs help from the global economy. The U.S. usually leads global growth but if stock investors are discounting better times ahead, the U.S. will definitely need help from abroad to drive exports and spur revenue growth.
We are in a cash driven market. The fear created in the markets by the financial collapse left trillions of dollars on the sidelines. It is hard for investors to watch stocks rise while they sit with a plethora of cash. Each surge in stocks draws in more money from those who don't want to miss the next bull run. We may want to believe the economy is improving but it has only really stabilized. Growth is a long way away and when back-to-school sales are weak the markets will suddenly become concerned about Christmas sales.
Cash for clunkers has created a surge in demand for new cars. This program has certainly provided stimulus in the same way the subsidies for first-time home buyers has rekindled the housing market. Unfortunately, these subsidized sales may be stealing from future demand. If consumer incomes don't improve and the inclination to save is rising, this economy cannot depend on the consumer for future growth. With no consumer, it is either up to big business or the government to drive growth.
Businesses take their cues from the economic outlook. If final sales are driven by the consumer and unemployment continues to be weak, it will be hard for businesses to invest in the future. Perhaps technology companies will be the beneficiaries of the economic weakness as companies will need to improve productivity if revenue growth will be dismal.
That leads us to the government to create growth. The stimulus plan has many wasted programs but the auto and housing industries have generated some positive results. The banks have been bailed out by Federal help also and perhaps the commercial real estate industry will also get a helping hand. Most of the fixes are short term and have contributed to the stabilization of the economy and the end of the recession.
Where does this leave us? We may have borrowed some future sales to jump start the weakened economy. All of these programs have added trillions to the government debt burden. The government is no different than a consumer or a business when it comes to debt. If a consumer's earnings decline and his expenses stay steady or rise, he his likely to accumulate a debt burden. Should this trend continue or one lose his job or his expenses rise (i.e. gasoline and heating bills) that debt burden will result in a default on a mortgage or personal bankruptcy. The same process is true for companies. Too much debt is leading to a huge wave of corporate restructurings and bankruptcies.
As for the government, the debt burden being created may help in the short run and the bull market may continue for awhile. However, at some point in the future the fat lady will sing. The United States will need to pay back its debts. Unless the economy starts growing exceptionally fast, which is highly unlikely, the government will need to aggressively raise taxes, as they are contemplating for the rich. Higher taxes will likely crimp economic growth and make the debt burden even worse. The only other logical solution is to devalue the dollar while printing more money. (We are assuming the government won't default on its debts.) This is a situation that seems likely to happen and the ownership of gold or other hard assets in the future may be the only safe place to hide.
August 13th is a good day to contemplate where we are in the next bull market. We remain concerned that growth will be slow in 2010 and that stocks are being driven by technicals. The recession may be over but the lack of revenue growth from companies, a weakened consumer, and the debt burdens of this country will ultimately come to roost.
A score and seven years later investors ponder whether the current bull run is for real. The recession appears to be over but the economy is still weak. Retail sales numbers for July appear to be soft and the employment picture is not truly getting better. Of course, investors have driven prices higher with every earnings report that has shown improvement. As we have said in the past, earnings growth has been driven by cost cutting but sustainable growth will only be generated when corporate revenues improve.
Today's market participants can not expect interest rate to decline or inflation to be tamed or unemployment to abate. Those were the 1982 bull market drivers so what will drive the 2009 market higher? We are not sure. Perhaps China and India will continue to grow quickly and pull the U.S. out of its economic slump. This country certainly needs help from the global economy. The U.S. usually leads global growth but if stock investors are discounting better times ahead, the U.S. will definitely need help from abroad to drive exports and spur revenue growth.
We are in a cash driven market. The fear created in the markets by the financial collapse left trillions of dollars on the sidelines. It is hard for investors to watch stocks rise while they sit with a plethora of cash. Each surge in stocks draws in more money from those who don't want to miss the next bull run. We may want to believe the economy is improving but it has only really stabilized. Growth is a long way away and when back-to-school sales are weak the markets will suddenly become concerned about Christmas sales.
Cash for clunkers has created a surge in demand for new cars. This program has certainly provided stimulus in the same way the subsidies for first-time home buyers has rekindled the housing market. Unfortunately, these subsidized sales may be stealing from future demand. If consumer incomes don't improve and the inclination to save is rising, this economy cannot depend on the consumer for future growth. With no consumer, it is either up to big business or the government to drive growth.
Businesses take their cues from the economic outlook. If final sales are driven by the consumer and unemployment continues to be weak, it will be hard for businesses to invest in the future. Perhaps technology companies will be the beneficiaries of the economic weakness as companies will need to improve productivity if revenue growth will be dismal.
That leads us to the government to create growth. The stimulus plan has many wasted programs but the auto and housing industries have generated some positive results. The banks have been bailed out by Federal help also and perhaps the commercial real estate industry will also get a helping hand. Most of the fixes are short term and have contributed to the stabilization of the economy and the end of the recession.
Where does this leave us? We may have borrowed some future sales to jump start the weakened economy. All of these programs have added trillions to the government debt burden. The government is no different than a consumer or a business when it comes to debt. If a consumer's earnings decline and his expenses stay steady or rise, he his likely to accumulate a debt burden. Should this trend continue or one lose his job or his expenses rise (i.e. gasoline and heating bills) that debt burden will result in a default on a mortgage or personal bankruptcy. The same process is true for companies. Too much debt is leading to a huge wave of corporate restructurings and bankruptcies.
As for the government, the debt burden being created may help in the short run and the bull market may continue for awhile. However, at some point in the future the fat lady will sing. The United States will need to pay back its debts. Unless the economy starts growing exceptionally fast, which is highly unlikely, the government will need to aggressively raise taxes, as they are contemplating for the rich. Higher taxes will likely crimp economic growth and make the debt burden even worse. The only other logical solution is to devalue the dollar while printing more money. (We are assuming the government won't default on its debts.) This is a situation that seems likely to happen and the ownership of gold or other hard assets in the future may be the only safe place to hide.
August 13th is a good day to contemplate where we are in the next bull market. We remain concerned that growth will be slow in 2010 and that stocks are being driven by technicals. The recession may be over but the lack of revenue growth from companies, a weakened consumer, and the debt burdens of this country will ultimately come to roost.
Friday, August 7, 2009
Unemployment Drives the Market Higher
The unemployment rate actually dropped to 9.4% and only 247,000 jobs were lost in July. It seems like many people were fired last month but it is a big improvement for all of 2009. Stock futures have leaped and investors are euphoric. There is plenty of cash sitting on the sidelines and everybody has been keenly focused on this employment number. This could be the tipping point to send the markets running as more shorts cover positions, bears turn to bulls, and the fear of missing the next rally drives cash into the stock market.
The economy is still weak and economic growth is still not in sight. Company costs have been trimmed but top line growth is tepid. The consumer is saving and not spending; banks are still not aggressively lending; and leverage remains high at the consumer level, corporate level, and in all areas of government. The stock market may be separating itself from reality.
It is obvious that the patient has stabilized but he is not ready to run a marathon. Investors feel better about earnings as we all do but as we have said for awhile, stocks need to discount future earnings. Earnings and growth could improve in 2010 but current prices of stocks assume much faster growth than we think likely. If top line growth miraculously improves in the range of 3-5%, then earnings will skyrocket and stocks are trading in the right range. We just aren't that bullish.
The economy is still weak and economic growth is still not in sight. Company costs have been trimmed but top line growth is tepid. The consumer is saving and not spending; banks are still not aggressively lending; and leverage remains high at the consumer level, corporate level, and in all areas of government. The stock market may be separating itself from reality.
It is obvious that the patient has stabilized but he is not ready to run a marathon. Investors feel better about earnings as we all do but as we have said for awhile, stocks need to discount future earnings. Earnings and growth could improve in 2010 but current prices of stocks assume much faster growth than we think likely. If top line growth miraculously improves in the range of 3-5%, then earnings will skyrocket and stocks are trading in the right range. We just aren't that bullish.
Monday, August 3, 2009
The Bull Charges Ahead
Stocks only seem to want to go higher. Can you blame investors for getting so excited? Housing sales, the focus of the recession seems to be improving; Ford is about to announce a sales increase; 3/4 of all companies are beating earnings estimates; commodities are rising; the employment picture isn't quite so bad; and stock analysts are raising estimates and outlooks for companies. The bull market must be back.
Perhaps the above picture describes the beginning of the next bull market. The economy has clearly seen the worst and we have bounced off the bottom or at least nudged above it. The question investors need to ask themselves is where should stocks be if economic growth will only be 1-2% in the next 2 years and credit is not expanding?
Loews Corp. Chairman Jim Tisch is a savvy investor and has enough assets in his portfolio to be a true gage of reality. The Tisch's are very conservative and always have their eyes open for undervalued assets. Mr. Tisch believes the massive debt held by banks, corporations, and individuals led the economy into the tank. Normally, when a a recession ends, the economy expands 4-6% over the next 2 years. However, this time the credit crisis is not going to go away quickly. New credit will not expand at a normal pace as banks must still focus on liquidating many toxic assets. If credit isn't readily available, then businesses can't expand. If businesses can't grow, employment can't improve quickly.
We now have our eyes wide open and the picture is still a little blurry. Any recovery will be quite tepid and many future problems still exist especially when we focus on commercial real estate, bank balance sheets, and consumer spending. Stocks prices reflect the present value of future earnings and we still remain concerned that revenue growth and in turn earnings will be slower than many investors expect. We maintain our portfolio of stocks but keep cash high and the market hedge in place. Although we won't catch all the upside, it is better to be safe than sorry.
Perhaps the above picture describes the beginning of the next bull market. The economy has clearly seen the worst and we have bounced off the bottom or at least nudged above it. The question investors need to ask themselves is where should stocks be if economic growth will only be 1-2% in the next 2 years and credit is not expanding?
Loews Corp. Chairman Jim Tisch is a savvy investor and has enough assets in his portfolio to be a true gage of reality. The Tisch's are very conservative and always have their eyes open for undervalued assets. Mr. Tisch believes the massive debt held by banks, corporations, and individuals led the economy into the tank. Normally, when a a recession ends, the economy expands 4-6% over the next 2 years. However, this time the credit crisis is not going to go away quickly. New credit will not expand at a normal pace as banks must still focus on liquidating many toxic assets. If credit isn't readily available, then businesses can't expand. If businesses can't grow, employment can't improve quickly.
We now have our eyes wide open and the picture is still a little blurry. Any recovery will be quite tepid and many future problems still exist especially when we focus on commercial real estate, bank balance sheets, and consumer spending. Stocks prices reflect the present value of future earnings and we still remain concerned that revenue growth and in turn earnings will be slower than many investors expect. We maintain our portfolio of stocks but keep cash high and the market hedge in place. Although we won't catch all the upside, it is better to be safe than sorry.
Wednesday, July 29, 2009
Are The Shoots Green or Beige?
Over the last few weeks investors have been pretty excited about strong earnings reports and some positive economic news. Each time good news comes out we try to express some caution as we view the economy stabilizing but with many risks still present.
Today we had some weak statistics reported where durable goods declined and mortgage applications fell. We aren't that concerned with the durable goods number as it can fluctuate on a monthly basis but we still believe it will be a long time before durable goods orders have a steady positive trend. The other day consumer confidence numbers also showed a decline. These are only a few areas where investors might realize that everything isn't so rosy.
Today the Federal Reserve released its Beige Book which indicates economic conditions in the twelve districts around the country. While the recession seems to be moderating, there are clear signs of weakness everywhere. Banks continue to tighten credit,the job market is soft, retail activity is sluggish, residential real estate is soft, commercial real estate is weakening further, and wages are steady or falling.
Although the Beige Book covers the three month period ending in May, it is unlikely that economic activity has improved dramatically in two months. There is enough weakness in these numbers for investors to question whether stocks have been anticipating a return to sales growth sooner than is likely possible.
Today we had some weak statistics reported where durable goods declined and mortgage applications fell. We aren't that concerned with the durable goods number as it can fluctuate on a monthly basis but we still believe it will be a long time before durable goods orders have a steady positive trend. The other day consumer confidence numbers also showed a decline. These are only a few areas where investors might realize that everything isn't so rosy.
Today the Federal Reserve released its Beige Book which indicates economic conditions in the twelve districts around the country. While the recession seems to be moderating, there are clear signs of weakness everywhere. Banks continue to tighten credit,the job market is soft, retail activity is sluggish, residential real estate is soft, commercial real estate is weakening further, and wages are steady or falling.
Although the Beige Book covers the three month period ending in May, it is unlikely that economic activity has improved dramatically in two months. There is enough weakness in these numbers for investors to question whether stocks have been anticipating a return to sales growth sooner than is likely possible.
Tuesday, July 28, 2009
Mixed Signals Create Uncertainty
We continue to see mixed results from earnings reports. Many companies have beat analyst expectations and as we have said before, cost cutting has been the leading factor in those positive earnings reports. However, most industrial companies don't see light at the end of the tunnel yet. 2010 may show improved growth prospects but have stocks run to far too fast? Unemployment will continue to rise as we see Verizon cutting 8000 jobs and B of A cutting 6000 jobs. These trends are countered by improved home sales but it appears that pricing is still weak but clearly improving (Case/Shiller) and the injured consumer is not enthusiastic about aggressively buying a new home.
The markets have run fast and there seems to be a little consolidation in them the last couple of days. Until we see some great economic news or a very positive outlook from an industrial company, the mixed signals will prevent stocks from moving much higher. We are more concerned about the W market than the V market. Time will tell who is right.
The markets have run fast and there seems to be a little consolidation in them the last couple of days. Until we see some great economic news or a very positive outlook from an industrial company, the mixed signals will prevent stocks from moving much higher. We are more concerned about the W market than the V market. Time will tell who is right.
Friday, July 24, 2009
It's Hard To Fight the Tape
Microsoft and Amazon disappointed and we had all the makings of an ugly day but investors seem to be indifferent. As they say, "the tend is your friend". Unfortunately, very few companies have top line growth but aggressive cost cutting has produced much better earnings than forecast. Investor euphoria is back and as long as earnings continue to improve so will stocks.
If the market is right and stocks continue to rise, why are we still concerned? Companies can only cut costs so much before they hurt productivity. As such, investors must be assuming revenues will begin to grow in the not too distant future. Stock prices discount future results and if growth occurs in the first quarter of 2010, then perhaps the bulls are correct.
We still remain concerned that unemployment and a new propensity for consumers to save, will curtail spending and lead to minimal growth, if any. When we focus on the debt piled up by local governments, states, and of course the federal government, we wonder what effect this will have on the economy. Let's not forget the toxic assets on the books of financial institutions will also likely limit the lending engine. If small and middle market companies can't borrow, the heart of this economy is in trouble.
Perhaps China and India will spend enough to pull the United States out of its economic mess but that is a big bet to make. We remain quite cautious as earnings season continues. Disaster seems to have been avoided. Stocks rallied hard to reflect the reduction of fear in the markets but for the rally to continue we need to see corporate revenues show some growth.
If the market is right and stocks continue to rise, why are we still concerned? Companies can only cut costs so much before they hurt productivity. As such, investors must be assuming revenues will begin to grow in the not too distant future. Stock prices discount future results and if growth occurs in the first quarter of 2010, then perhaps the bulls are correct.
We still remain concerned that unemployment and a new propensity for consumers to save, will curtail spending and lead to minimal growth, if any. When we focus on the debt piled up by local governments, states, and of course the federal government, we wonder what effect this will have on the economy. Let's not forget the toxic assets on the books of financial institutions will also likely limit the lending engine. If small and middle market companies can't borrow, the heart of this economy is in trouble.
Perhaps China and India will spend enough to pull the United States out of its economic mess but that is a big bet to make. We remain quite cautious as earnings season continues. Disaster seems to have been avoided. Stocks rallied hard to reflect the reduction of fear in the markets but for the rally to continue we need to see corporate revenues show some growth.
Tuesday, July 21, 2009
It's All About Earnings
For the past week we have been getting strong economic numbers from all the government reports. This is very positive for future growth as the economy surely looks like the worst may be over. However, the financial crisis still has risks with commercial real estate being the most obvious future problem. Perhaps there are some real green shoots out there but don't forget unemployment continues to rise and we expect it to move into solid double digit numbers.
Most companies that have reported second quarter numbers have beat Wall Street earnings expectations. It is easy to see why the banks have done very well as their cost of funds are negligible. If you can't reach profitability when your cost is zero, the future should be pretty cloudy for banks. Certainly Citigroup remains a disappointment and other banks will also not do well. The strong will get stronger and Goldman and J.P. Morgan will lead the way.
The markets are soaring as earnings are strong but we still raise the red flag as most companies continue to report weak revenues. Ultimately, sales need to drive profits and cost cutting can only go so far. Investors appear to only care about the bottom line so far as aggressive cost cutting seems to be enough for now. Productivity is likely soaring which is good for future growth and stability. We also expect consumer confidence to rise with stock prices and the stabilization in the economy is also removing the fear in the markets.
Global growth, especially from the China stimulus plan, may be boosting the order flow for many companies but as we have stated in the past, some of the Chinese commodity buying is for storage and not for current production. The bottom line is that even with great earnings most companies find revenue growth to be tepid and business may not be declining but it certainly is not improving much. The bottom was reached in March but happy days may not be here yet. We may have missed last week's stock market run but the downside concerns are still real. We view our hedged stock positions as a way to be safe rather than sorry. We may not have the same upside but if the growing government debt, the real estate defaults, corporate bankruptcies, and the weakened consumer become the focus of investor attention, then stocks could still see a sharp reversal.
Markets usually foreshadow the future but it is not always accurate for short term moves. Investors seem to be willing to expand P/E ratios as cost cutting boosts earnings but if order rates don't begin to improve and revenues don't begin to grow, then stock multiples may contract and the bullish euphoria may disappear. There are many more companies that need to report earnings and we will focus on industrial enterprises to get a true feel for the economy. Financials should do well this quarter, and large technology companies are well positioned to weather the downturn but leverage remains high in our financial system and all risks have not abated.
Most companies that have reported second quarter numbers have beat Wall Street earnings expectations. It is easy to see why the banks have done very well as their cost of funds are negligible. If you can't reach profitability when your cost is zero, the future should be pretty cloudy for banks. Certainly Citigroup remains a disappointment and other banks will also not do well. The strong will get stronger and Goldman and J.P. Morgan will lead the way.
The markets are soaring as earnings are strong but we still raise the red flag as most companies continue to report weak revenues. Ultimately, sales need to drive profits and cost cutting can only go so far. Investors appear to only care about the bottom line so far as aggressive cost cutting seems to be enough for now. Productivity is likely soaring which is good for future growth and stability. We also expect consumer confidence to rise with stock prices and the stabilization in the economy is also removing the fear in the markets.
Global growth, especially from the China stimulus plan, may be boosting the order flow for many companies but as we have stated in the past, some of the Chinese commodity buying is for storage and not for current production. The bottom line is that even with great earnings most companies find revenue growth to be tepid and business may not be declining but it certainly is not improving much. The bottom was reached in March but happy days may not be here yet. We may have missed last week's stock market run but the downside concerns are still real. We view our hedged stock positions as a way to be safe rather than sorry. We may not have the same upside but if the growing government debt, the real estate defaults, corporate bankruptcies, and the weakened consumer become the focus of investor attention, then stocks could still see a sharp reversal.
Markets usually foreshadow the future but it is not always accurate for short term moves. Investors seem to be willing to expand P/E ratios as cost cutting boosts earnings but if order rates don't begin to improve and revenues don't begin to grow, then stock multiples may contract and the bullish euphoria may disappear. There are many more companies that need to report earnings and we will focus on industrial enterprises to get a true feel for the economy. Financials should do well this quarter, and large technology companies are well positioned to weather the downturn but leverage remains high in our financial system and all risks have not abated.
Sunday, July 12, 2009
Earnings Season Will Hit Full Stride
This week will be the true beginning of earnings season as many companies shall report their second quarter results. The economy certainly doesn't look great as oil has moved below $60 and consumer confidence continues to drop. Only a month or so ago investors were bullish on the economy and the stock market. The green shoots seemed to be sprouting up everywhere but they only seemed like weeds to us. Now retail sales remain ugly, housing is still drifting, unemployment is rising, and the consumer is not happy.
Business seems to have stabilized but unless companies report that order rates are improving and the outlook is bright, investors are likely to sell stocks. We haven't been in the optimist's camp and the tidbits from the Allen & Co. conference leave us to believe that earnings season will not bring summer cheer. Let's hope for the best but cash will remain king.
Business seems to have stabilized but unless companies report that order rates are improving and the outlook is bright, investors are likely to sell stocks. We haven't been in the optimist's camp and the tidbits from the Allen & Co. conference leave us to believe that earnings season will not bring summer cheer. Let's hope for the best but cash will remain king.
Thursday, July 9, 2009
The Economy Chugs Dowwwn
Jobless claims may have moved down 52,000 to 565,000 but the unemployed still can't find jobs as the continuing claims hit a new high not seen since 1967. The weak employment picture and the decreased appetite for spending by the consumer resulted in very soft retail sales in June, Weather was also likely a big factor but our concern for earnings should be highlighted. Retailers have been aggressively marking down prices which should create a dismal earnings picture.
Alcoa may have beat expectation but the numbers are still ugly. Perhaps lower oil prices and declining interest rates will give the consumer a new lift as gasoline prices should begin to decline and mortgage rates are coming down again. An improved affordability index could lift consumer confidence but unless businesses think they can generate stronger earnings in the second half of 2009, stocks will only make investors miserable.
We remain cautious and anxiously await comments from corporate chiefs' outlooks for the rest of the year.
Alcoa may have beat expectation but the numbers are still ugly. Perhaps lower oil prices and declining interest rates will give the consumer a new lift as gasoline prices should begin to decline and mortgage rates are coming down again. An improved affordability index could lift consumer confidence but unless businesses think they can generate stronger earnings in the second half of 2009, stocks will only make investors miserable.
We remain cautious and anxiously await comments from corporate chiefs' outlooks for the rest of the year.
Tuesday, July 7, 2009
Will Earnings Season Bring Surprises?
The economic news, especially employment numbers, have disappointed investors lately. Stocks have been dropping fast and it might take a big decline or an unexpected catalyst to reverse the downward trend. The next few weeks should tell the true story of the economy. Alcoa will report its earnings tomorrow followed by most other companies. We have low expectations for many positive surprises but hope we are wrong. However, until the green weeds start to look like real green shoots, we will sit on our cash and maintain the puts on the S&P. Be cautious and wait for the tea leaves that say business is improving, housing has bottomed, the consumer is ready to spend, the financial system is once again functioning normally, and lending is on the rise.
Sunday, July 5, 2009
"Rising Job Losses Damp Hopes of Recovery"
The title of today's post was the leading article in this weekend's Wall Street Journal. At the beginning of last week, we scripted an article which referred to last Saturday's New York Times' story titled "U.K.'s Recovery Slows Amid Sluggish Spending". We highlighted the fact that the United Kingdom was foreshadowing what was inevitably going to happen in the U.S. It didn't take a week for the weak economic news to hit and for investors to flee stocks as fast as they could.
Thursday's markets dropped 2.6%, oil cratered 3.7% and the unemployment picture was bleak. It shouldn't be much of a surprise to our readers that the green shoots are more likely weeds. Euphoria has struck the markets as the fear to miss the chance to recoup losses hit individual investors as it did many professionals. Stocks had an amazing ride in the great bear rally of spring 2009 but what will the latter half of 2009 look like?
This week 2nd quarter earnings will start to be reported and unless we are completely surprised, companies are likely to report that they continue to cut costs and jobs to help their earnings but the economy remains bleak and sales will not be growing for the rest of the year. Many economists and investors have been banking on an economic recovery in the second half of 2009 but we just don't know from where it will be coming. The stimulus plan will add some positive momentum but it won't be enough to counteract weak consumer spending, a hampered commercial real estate market, and rising consumer defaults.
In a few months it will be apparent to most investors that China was driving demand for commodities as they took the opportunity to hoard raw materials at low prices. China has put in place their own stimulus plan but its true growth has also tempered. China will remain a big driver of industrial demand in years to come and their consumption for copper, steel and other commodities will be strong but not in this global recession. As prices of these commodities rise, China's buying will be curtailed and speculators of such commodities will be in for a big negative shock.
Unemployment will continue to rise, manufacturing will be tame and when back-to-school sales are disappointing the markets will start to focus on the impending disaster for Christmas sales. If investor psychology hasn't turned completely negative in the next few weeks, reality will set in once school is back in session and retailers brace for the weakest sales they have seen in three decades.
We look forward to earnings season and hope our concerns are proven wrong but until then, we will continue to raise cash and hedge our long positions with S&P puts and selling covered calls.
Thursday's markets dropped 2.6%, oil cratered 3.7% and the unemployment picture was bleak. It shouldn't be much of a surprise to our readers that the green shoots are more likely weeds. Euphoria has struck the markets as the fear to miss the chance to recoup losses hit individual investors as it did many professionals. Stocks had an amazing ride in the great bear rally of spring 2009 but what will the latter half of 2009 look like?
This week 2nd quarter earnings will start to be reported and unless we are completely surprised, companies are likely to report that they continue to cut costs and jobs to help their earnings but the economy remains bleak and sales will not be growing for the rest of the year. Many economists and investors have been banking on an economic recovery in the second half of 2009 but we just don't know from where it will be coming. The stimulus plan will add some positive momentum but it won't be enough to counteract weak consumer spending, a hampered commercial real estate market, and rising consumer defaults.
In a few months it will be apparent to most investors that China was driving demand for commodities as they took the opportunity to hoard raw materials at low prices. China has put in place their own stimulus plan but its true growth has also tempered. China will remain a big driver of industrial demand in years to come and their consumption for copper, steel and other commodities will be strong but not in this global recession. As prices of these commodities rise, China's buying will be curtailed and speculators of such commodities will be in for a big negative shock.
Unemployment will continue to rise, manufacturing will be tame and when back-to-school sales are disappointing the markets will start to focus on the impending disaster for Christmas sales. If investor psychology hasn't turned completely negative in the next few weeks, reality will set in once school is back in session and retailers brace for the weakest sales they have seen in three decades.
We look forward to earnings season and hope our concerns are proven wrong but until then, we will continue to raise cash and hedge our long positions with S&P puts and selling covered calls.
Thursday, July 2, 2009
Bad Economics, Bad Markets
Our concerns for the past few weeks are starting to play out. June jobs lost equaled 467,000, a number much worse than expected by the wizard economists. Unemployment rose to 9.5% from 9.4%. Finally, weekly unemployment claims were 614,000. The markets didn't like what they saw and stocks proceeded to drop over 2.5% Thankfully the holiday weekend is here for investors to ponder what economic weakness may lie ahead.
Since March ninth, stocks looked like they were leaping into the next bull market but as we have been saying, it may only be a major bear rally. Unless second quarter earnings reports reflect growth in revenues and sustained earnings, expect stocks to wither on the "green weeds".
Since March ninth, stocks looked like they were leaping into the next bull market but as we have been saying, it may only be a major bear rally. Unless second quarter earnings reports reflect growth in revenues and sustained earnings, expect stocks to wither on the "green weeds".
Wednesday, July 1, 2009
Are The Green Shoots Actually Weeds?
We have been concerned for months that the pick-up in economic activity is a blip in a weak economy. Low oil prices, low inventories, and a rising stock market brought some euphoria to investors as consumer confidence rose and businesses began to spend more. Earnings reports were better than expected but they weren't from growth but aggressive cost cutting. Stocks took each queue as a sign of the economy improving and baked in an expectation of higher GDP in the second half of 2009.
Yesterday, consumer confidence was announced and it was weaker than the previous month. The markets viewed that as a big concern but it doesn't appear to be a huge surprise. The world is not falling off a cliff and the banking system has not collapsed, yet. Business has stabilized and consumers are feeling better. The economy is in no man's land as business is not contracting but it is not growing either. The future trends for consumer spending is definitely a problem as the loss of net worth, higher oil prices, and rising mortgage rates will lead individuals to save more and replenish their net worth. Decreased consumption means weaker GDP growth in the future.
Today the ADP employment report showed that 473,000 jobs were cut in June when most economists expected 393,000. It doesn't look like a green shoot to us and neither does the consumer confidence numbers. It will be interesting to see today's reports on the June Manufacturing Index and the May Pending Home Sales. Will those green shoots also look like weeds?
Yesterday, consumer confidence was announced and it was weaker than the previous month. The markets viewed that as a big concern but it doesn't appear to be a huge surprise. The world is not falling off a cliff and the banking system has not collapsed, yet. Business has stabilized and consumers are feeling better. The economy is in no man's land as business is not contracting but it is not growing either. The future trends for consumer spending is definitely a problem as the loss of net worth, higher oil prices, and rising mortgage rates will lead individuals to save more and replenish their net worth. Decreased consumption means weaker GDP growth in the future.
Today the ADP employment report showed that 473,000 jobs were cut in June when most economists expected 393,000. It doesn't look like a green shoot to us and neither does the consumer confidence numbers. It will be interesting to see today's reports on the June Manufacturing Index and the May Pending Home Sales. Will those green shoots also look like weeds?
Tuesday, June 30, 2009
The U.K. Could Foreshadow the U.S.
Saturday's Wall Street Journal had a headline which said: "U.K.'s Recovery Slows Amid Sluggish Spending". The article discussed how the United Kingdom's speedy recovery was fizzling as banks still aren't helping businesses invest and consumers still aren't spending enough to spur faster growth. It appears that the U.K. has been moving in sync with the United States as rallies in stocks, bonds , and sterling were driven by positive data for retail sales, home prices, and manufacturing orders. "Optimism about an economic turnaround had surged in recent weeks. But in retrospect, many of those indicators may have been based on temporary factors such as warm weather that lured consumers to shops during Easter, boosting April sales". Manufacturing increases also generated enthusiasm for a recovery but when speaking to business executives, it appears that "businesses are restocking after running down their inventories during the last lean year.
Credit conditions in England remain tight and a "potential significant obstacle to recovery prospects." "If there are green shoots, the banks are cutting them down." "Creditless recoveries are possible but past recessions show such rebounds are typically weak. The biggest factor in past turnarounds globally has been an increase in consumption" but suggest demand is missing in the U.K. and globally. The United Kingdom, like the U.S., had a decade of debt-fueled shopping. The weakened consumer is more focused on reducing debt and saving than he is in spending. This will obviously lead to a tempered recovery.
The United Kingdom's story seems to us to be a mirror image of the economic situation in the United States. It is only a matter of time until we see headlines in the U.S. which will be saying the "U.S. recovery Slows Amid Sluggish Spending."
Credit conditions in England remain tight and a "potential significant obstacle to recovery prospects." "If there are green shoots, the banks are cutting them down." "Creditless recoveries are possible but past recessions show such rebounds are typically weak. The biggest factor in past turnarounds globally has been an increase in consumption" but suggest demand is missing in the U.K. and globally. The United Kingdom, like the U.S., had a decade of debt-fueled shopping. The weakened consumer is more focused on reducing debt and saving than he is in spending. This will obviously lead to a tempered recovery.
The United Kingdom's story seems to us to be a mirror image of the economic situation in the United States. It is only a matter of time until we see headlines in the U.S. which will be saying the "U.S. recovery Slows Amid Sluggish Spending."
Thursday, June 25, 2009
Enough With The Green Shoots
When we first started this blog we used the term Tea Leaves to imply signs of economic strength. However, most columnists and reporters have been spouting about green shoots. The economy is still in bad shape but optimism has risen with every green shoot that appears. All investors are searching for the turn of the economy to positive trends but the green shoot zeal may cost investors money if growth doesn't reappear in the next six months.
We remain in the camp that disaster has been avoided (so far) in the financial system but economic growth is not in site for 2009. Stocks were dragged down in early March to levels where disaster was priced in. Stocks then rose dramatically to reflect the sigh of relief. Suddenly, we have begun to see more volatility in the markets as investors may be questioning their optimism. Today, Jobless Claims for the week of June 20th were released and they ticked up to 627,000 people. Obviously, the bull is not around the corner but the bear market rally may have peaked. Only time will tell but we remain cautious and for every green shoot, we still see a weed.
We remain in the camp that disaster has been avoided (so far) in the financial system but economic growth is not in site for 2009. Stocks were dragged down in early March to levels where disaster was priced in. Stocks then rose dramatically to reflect the sigh of relief. Suddenly, we have begun to see more volatility in the markets as investors may be questioning their optimism. Today, Jobless Claims for the week of June 20th were released and they ticked up to 627,000 people. Obviously, the bull is not around the corner but the bear market rally may have peaked. Only time will tell but we remain cautious and for every green shoot, we still see a weed.
Monday, June 22, 2009
Does The World Bank Have It Right
We have been bearish on the economy for awhile. As the market rallied strongly from the March 9th low, many market pundits have been spotting "green shoots" everywhere. Sure signs of life have arisen and the financial meltdown seemed to have abated. However, a little optimism and higher stock prices led to increased consumer confidence but we have been concerned that the economy will not grow at all in 2009. Perhaps 2010 will bring better days but rising corporate defaults, increasing consumer credit defaults, and higher unemployment trends have left us a little perplexed at the forecasts for growth in the latter half of 2009.
Today the World Bank lowered its expectations for economic growth and it sees the United States GDP contracting 2.9% for all of 2009 and worse for most of the rest of the world. Perhaps others will start to see the reality ahead as the stock market took a dive today. Stocks bounced off the lows as the markets overshot on the downside but they certainly ran too fast and too high on the upside. The banks may be better capitalized but only time will tell as to whether they are truly capitalized with enough equity. The risk in the markets and the financial system are still high and a downdraft in stocks will only reflect the discounting of economic reality.
Today the World Bank lowered its expectations for economic growth and it sees the United States GDP contracting 2.9% for all of 2009 and worse for most of the rest of the world. Perhaps others will start to see the reality ahead as the stock market took a dive today. Stocks bounced off the lows as the markets overshot on the downside but they certainly ran too fast and too high on the upside. The banks may be better capitalized but only time will tell as to whether they are truly capitalized with enough equity. The risk in the markets and the financial system are still high and a downdraft in stocks will only reflect the discounting of economic reality.
Thursday, June 18, 2009
Time To Straighten Out The Financial System
President Obama has set in motion sweeping changes to our financial regulatory system with the goal of minimizing risks to the global financial system and protecting the consumer. During euphoric economic times money is plentiful and the desire to take risks seems to always increase. Investors search for ever enlarged returns and Wall Street is always there to fill those pursuits. The result seems to be that leverage rises, bubbles appear, investment returns improve but inevitably risk has skyrocketed. These cheerful times may continue for long periods but inevitably the party end when some unforeseen event occurs and the bubble is burst.
Risk managers focus on protecting financial firms from significant losses when markets move in the wrong direction. Unfortunately, the models used for downside protection typically assume unexpected events which may be two deviations from the norm and disaster occurs when a five standard deviation event appears. There are plenty of example in history that have resulted in disaster when those financial models never considered the black swan event and leverage became the nemesis of failure. This was true for Long-Term Capital, Amaranth, Bear Stearns, AIG, Fannie Mae, Countywide, etc.
Consumers typically get hurt in a financial wipe out but in the current crisis the damage has been ubiquitous. The housing crisis has crippled many families who have or will go through foreclosure. Those who survived the housing crisis still have seen the value of their home decline dramatically as has their net worth. Declining stocks also put a dent in the consumer's net worth as did Madoff and other financial advisers who stole from their clients.
We are generally not in favor of more regulation but President Obama is probably moving in the right direction. We need new controls and guidelines for financial institutions and we need to protect the consumer. Unfortunately the devil will be in the details and Congress may not be able to adequately create legislation that focuses on the consumer without being political.
Simple mortgages and easy to understand consumer loans should be in the best interests of everybody except the financial institutions who want to garner excessive profits. Therefore, we are in favor of instituting policies that protect the consumer. Nobody benefits from a failed financial institution. Rogue money managers, banks, and other financial institutions can create financial chaos to many innocent consumers, companies, financial institutions, and governments. We need to minimize catastrophic events so if the oversight of all financial institutions is increased and effective guidelines protect the global economy from future shocks, we support it.
We have written about banks that are too big to fail. We suggested controlling their size by increasing their capital requirements. It seems like the Obama administration is also moving in that direction. If a financial institution is too big to fail, it is too big to exist. Therefore, such entity must have an adequate equity capital cushion to prevent failure or sell off pieces to become smaller. Well structured guidelines can achieve such results.
The Obama financial restructuring is aimed at protecting the global financial system and the affected consumers. This legislation will likely define President Obama's legacy. There are many aspects to this legislation and the plan needs to be debated not only by Congress but by Wall Street, Corporate Executives, and consumers. If the goal is to create a plan that makes the financial system stronger while protecting the consumer, then we look forward to new financial reform. However, if the final legislation results in feeding many political agendas, then the future consequences of poor reform will likely result in a replay of our current financial crisis.
Risk managers focus on protecting financial firms from significant losses when markets move in the wrong direction. Unfortunately, the models used for downside protection typically assume unexpected events which may be two deviations from the norm and disaster occurs when a five standard deviation event appears. There are plenty of example in history that have resulted in disaster when those financial models never considered the black swan event and leverage became the nemesis of failure. This was true for Long-Term Capital, Amaranth, Bear Stearns, AIG, Fannie Mae, Countywide, etc.
Consumers typically get hurt in a financial wipe out but in the current crisis the damage has been ubiquitous. The housing crisis has crippled many families who have or will go through foreclosure. Those who survived the housing crisis still have seen the value of their home decline dramatically as has their net worth. Declining stocks also put a dent in the consumer's net worth as did Madoff and other financial advisers who stole from their clients.
We are generally not in favor of more regulation but President Obama is probably moving in the right direction. We need new controls and guidelines for financial institutions and we need to protect the consumer. Unfortunately the devil will be in the details and Congress may not be able to adequately create legislation that focuses on the consumer without being political.
Simple mortgages and easy to understand consumer loans should be in the best interests of everybody except the financial institutions who want to garner excessive profits. Therefore, we are in favor of instituting policies that protect the consumer. Nobody benefits from a failed financial institution. Rogue money managers, banks, and other financial institutions can create financial chaos to many innocent consumers, companies, financial institutions, and governments. We need to minimize catastrophic events so if the oversight of all financial institutions is increased and effective guidelines protect the global economy from future shocks, we support it.
We have written about banks that are too big to fail. We suggested controlling their size by increasing their capital requirements. It seems like the Obama administration is also moving in that direction. If a financial institution is too big to fail, it is too big to exist. Therefore, such entity must have an adequate equity capital cushion to prevent failure or sell off pieces to become smaller. Well structured guidelines can achieve such results.
The Obama financial restructuring is aimed at protecting the global financial system and the affected consumers. This legislation will likely define President Obama's legacy. There are many aspects to this legislation and the plan needs to be debated not only by Congress but by Wall Street, Corporate Executives, and consumers. If the goal is to create a plan that makes the financial system stronger while protecting the consumer, then we look forward to new financial reform. However, if the final legislation results in feeding many political agendas, then the future consequences of poor reform will likely result in a replay of our current financial crisis.
Thursday, June 11, 2009
Is The Economy Improving?
U.S. retail sales rose .5% in May from April but were actually down 11% from last year. In fact, rising gas prices accounted for a large part of the monthly increase. The other good news is that only 601,000 workers filed for unemployment claims last week. This was a drop of 24,000 claims. It hardly brings joy to us to see so many workers without jobs but the economists will probably like the numbers.
As long as gas prices keep rising and interest rates move up, the consumer will be weakened and the recession will drag on. Retailers will be compelled to keep prices low in order to drive sales but don't expect profits to be healthy. The stock market will keep evaluating the economic tea leaves and ultimately recognize investors hope for the v-shaped recovery was too optimistic.
As long as gas prices keep rising and interest rates move up, the consumer will be weakened and the recession will drag on. Retailers will be compelled to keep prices low in order to drive sales but don't expect profits to be healthy. The stock market will keep evaluating the economic tea leaves and ultimately recognize investors hope for the v-shaped recovery was too optimistic.
Wednesday, June 10, 2009
Commodities Keep Moving
The markets globally are taking their cue from Asia and a weak dollar. China continues to buy commodities and prices have been moving up. The weakness of the dollar, especially with negative comments coming from Russia, is also leading to higher prices for oil, copper, and gold. Commodities tend to be purchased in dollars and as the dollar declines, the commodity prices soar.
The economy doesn't seem to be getting much better and corporate earnings are being driven by cost cutting. As such the markets seem to be driven by higher commodity prices and the hope that the recession is ending. The financial crisis is abating but the risks are still high. However, rising stock prices have been bringing in some of the cash sitting on the sidelines which in turn keeps the bear rally going. Energy shares could lead the stock market higher but until revenues start to grow, we remain cautious.
How will the consumer feel in a few months when gas prices again could approach $4 and mortgage rates are solidly above 5% or even 6%? Unemployment will continue to rise well into 2010 and for those working, income might be declining. Non of these trends bodes well for the consumer and without a strong consumer, how can the economic engine be revived?
The economy doesn't seem to be getting much better and corporate earnings are being driven by cost cutting. As such the markets seem to be driven by higher commodity prices and the hope that the recession is ending. The financial crisis is abating but the risks are still high. However, rising stock prices have been bringing in some of the cash sitting on the sidelines which in turn keeps the bear rally going. Energy shares could lead the stock market higher but until revenues start to grow, we remain cautious.
How will the consumer feel in a few months when gas prices again could approach $4 and mortgage rates are solidly above 5% or even 6%? Unemployment will continue to rise well into 2010 and for those working, income might be declining. Non of these trends bodes well for the consumer and without a strong consumer, how can the economic engine be revived?
Tuesday, June 9, 2009
Banks Start To Give Back TARP
Ten banks are going to be able to give back TARP. These financial institutions will be announced today and their freedom will be given back. We believe in a free market system with minimal government control. Obviously, the financial industry needs tight regulatory control but they also need a free hand in running their businesses. These ten institutions will have a competitive advantage over the remaining TARP banks. Expect a free flow of human capital from TARP banks to non-TARP banks as employees don't want their compensation determined by the government. The same employee exodus has occurred in the past few months as TARP banks lost key personnel to boutiques.
Unless the government recognizes that compensation must be determined by the free market system, the weak TARP banks will only become weaker. The result will be more failed institutions and the loss of taxpayer money.
Unless the government recognizes that compensation must be determined by the free market system, the weak TARP banks will only become weaker. The result will be more failed institutions and the loss of taxpayer money.
Too Big To Exist
The big debate these days is if banks are too big to fail are they too big to exist? The financial crisis occurred because the economy was growing fast, it was extremely cheap to borrow money, and borrowers assumed asset values would continue to rise. Leverage in the housing, corporate, consumer, and commercial real estate sectors skyrocketed as banks and other financial institutions freely lent money to any willing borrower. Risk managers used obsolete models to value assets and determine the reserves needed to protect their institutions from volatile markets.
Long Term Capital, Amareth, Lehman Brothers (in 1998), and most financial blow-ups were caused by a simple analytical flaw. It is easy to forecast excessive returns when the growth of asset values exceeds the cost of capital. In such a scenario leverage is piled high and either the borrower will amortize the debt over time or refinance it when needed. Strong economic environments lead to healthy corporate profits and free flowing credit from the banking system and Wall Street. Risk managers assume a normal bell curve of economic and financial results to protect the downside. Unfortunately, most financial calamities occur when movements in financial markets or corporate profits gyrate to the extremes. For example, the models might assume a 2-standard deviation rise in the price of all when it actually moves 5-standard deviations or in the case of housing, home prices never go down on a national basis when suddenly they plummet.
Here we are today trying to clean up the mess of financial institutions who assumed the unthinkable would never occur as opposed to assuming the black swan is around the corner and having a contingency plan. The government and the Federal Reserve have helped to stabilize the financial industry by adding massive liquidity to the markets and infusing cash into many banks and other financial institutions. The banking system will need to maintain higher capital ratios to remain independent and relieve themselves of TARP funds and the restrictions that go along with them.
We believe in the short run, some of the larger banks will have enough excess liquidity to absorb some of the impending loan problems in the commercial real estate and consumer loan markets. As time goes on, complacency is likely to set in again. Large financial institutions will continue to grow globally through acquisition as well as organically. Risk managers may adjust their models to take into account for extreme financial occurrences but eventually new problems are likely to creep into the system. Incorrect assumptions will be made and excessive leverage will once again cause an unexpected financial disaster.
We are in the camp that says if you are too big to fail then you are too big to exist. The government has the choice to force these financial institutions to sell off assets and limit growth or to monitor their operations more closely. We don't believe regulators are capable of protecting the financial markets when a black swan pops up unexpectedly. Therefore we suggest new reserve requirements be put in place based on the size of a financial institution. If the failure of a bank can cause shock to the system, then it is too big. At the point a financial institution becomes too big then it must raise its reserves to reduce the risk of market shocks. Under this scenario, corporations can determine if the return on capital is sufficient to warrant its growth as its reserves increase with its size.
The result of this new reserve requirement system will be a self policing method. For example, if J.P. Morgan wants to make another large acquisition, their reserves may have to increase an extra 2 percentage pints. Jamie Dimon would have to determine whether such an acquisition will be accretive enough to improve or not hurt the firm's return on capital. If not, they might pass on the acquisition or sell off other assets to right size the bank. In fact, if the Federal Reserve determines J.P. Morgan is too big to fail today, and it is, then the new reserve requirements might implore the bank to sell assets today or raise additional capital.
This scaled reserve requirement concept will not be embraced by the CEO's of financial institutions but it is the government's responsibility to protect the integrity of the financial markets and stringent guidelines might be one way to do that. We are not in favor of the government dictating compensation or participating in operational decisions. However, the Federal Reserve and the government must act as chief risk manager. Set the financial parameters to protect the markets and let the corporate managers run their companies within the set guidelines.
Long Term Capital, Amareth, Lehman Brothers (in 1998), and most financial blow-ups were caused by a simple analytical flaw. It is easy to forecast excessive returns when the growth of asset values exceeds the cost of capital. In such a scenario leverage is piled high and either the borrower will amortize the debt over time or refinance it when needed. Strong economic environments lead to healthy corporate profits and free flowing credit from the banking system and Wall Street. Risk managers assume a normal bell curve of economic and financial results to protect the downside. Unfortunately, most financial calamities occur when movements in financial markets or corporate profits gyrate to the extremes. For example, the models might assume a 2-standard deviation rise in the price of all when it actually moves 5-standard deviations or in the case of housing, home prices never go down on a national basis when suddenly they plummet.
Here we are today trying to clean up the mess of financial institutions who assumed the unthinkable would never occur as opposed to assuming the black swan is around the corner and having a contingency plan. The government and the Federal Reserve have helped to stabilize the financial industry by adding massive liquidity to the markets and infusing cash into many banks and other financial institutions. The banking system will need to maintain higher capital ratios to remain independent and relieve themselves of TARP funds and the restrictions that go along with them.
We believe in the short run, some of the larger banks will have enough excess liquidity to absorb some of the impending loan problems in the commercial real estate and consumer loan markets. As time goes on, complacency is likely to set in again. Large financial institutions will continue to grow globally through acquisition as well as organically. Risk managers may adjust their models to take into account for extreme financial occurrences but eventually new problems are likely to creep into the system. Incorrect assumptions will be made and excessive leverage will once again cause an unexpected financial disaster.
We are in the camp that says if you are too big to fail then you are too big to exist. The government has the choice to force these financial institutions to sell off assets and limit growth or to monitor their operations more closely. We don't believe regulators are capable of protecting the financial markets when a black swan pops up unexpectedly. Therefore we suggest new reserve requirements be put in place based on the size of a financial institution. If the failure of a bank can cause shock to the system, then it is too big. At the point a financial institution becomes too big then it must raise its reserves to reduce the risk of market shocks. Under this scenario, corporations can determine if the return on capital is sufficient to warrant its growth as its reserves increase with its size.
The result of this new reserve requirement system will be a self policing method. For example, if J.P. Morgan wants to make another large acquisition, their reserves may have to increase an extra 2 percentage pints. Jamie Dimon would have to determine whether such an acquisition will be accretive enough to improve or not hurt the firm's return on capital. If not, they might pass on the acquisition or sell off other assets to right size the bank. In fact, if the Federal Reserve determines J.P. Morgan is too big to fail today, and it is, then the new reserve requirements might implore the bank to sell assets today or raise additional capital.
This scaled reserve requirement concept will not be embraced by the CEO's of financial institutions but it is the government's responsibility to protect the integrity of the financial markets and stringent guidelines might be one way to do that. We are not in favor of the government dictating compensation or participating in operational decisions. However, the Federal Reserve and the government must act as chief risk manager. Set the financial parameters to protect the markets and let the corporate managers run their companies within the set guidelines.
Sunday, June 7, 2009
The Employment Picture Shows Signs of Life II
Our concern with the appearance of a great employment report was going to be the details. As we highlighted last week, the government adjusts the numbers based on a prediction of how many new businesses were started and the resulting new jobs created. The additional jobs for may from new business formations was 220,000., a number that is 27% greater than last year. The reported loss of jobs was 345,000 for this May which was well shy of the 500,000 most economists were expecting. Does it seem likely that the business environment this year created 47,000 more jobs from new businesses than last year? Maybe but we remain sceptical that a total of 220,000 new jobs were created in May from new ventures. If we are correct, the employment picture isn't getting much better and the facts will become apparent in the not too distant future.
Friday, June 5, 2009
The Employment Picture Shows Signs of Life
Non-farm payrolls declined by 345,000 workers. It doesn't sound great but it is much better than the 500,000 job losses investors were expecting. Perhaps this is an indication that the economy isn't getting much worse. One month is never a trend but it is another sign that should draw additional cash into stocks.
The market has soared since March 9th and the economy has shown some signs of improvement to drive investment decisions. Oil prices have been rising and the yield curve is very steep. Both of those factors point to better times ahead. The employment numbers may drive stocks further but the world is far from rosy. It will be interesting to see how many jobs were accounted for by the government's guess of new business development. This adjustment can sometimes skew employment as fewer businesses may have been started which would also reduce the amount of jobs created. Perhaps the employment picture is improving, although still ugly, and the economy will bottom out in the next six months.
We remain skeptical as the consumer is still weakened; businesses have not seen growth; defaults on consumer loans are rising; corporate bankruptcies haven't peaked yet; commercial real estate problems are just beginning; and the housing market is still relatively lackluster. Stocks will continue to evaluate all these factors but we find it hard to believe that prices can go up at the same pace. There are too many economic challenges ahead to believe the bull market has started.
The market has soared since March 9th and the economy has shown some signs of improvement to drive investment decisions. Oil prices have been rising and the yield curve is very steep. Both of those factors point to better times ahead. The employment numbers may drive stocks further but the world is far from rosy. It will be interesting to see how many jobs were accounted for by the government's guess of new business development. This adjustment can sometimes skew employment as fewer businesses may have been started which would also reduce the amount of jobs created. Perhaps the employment picture is improving, although still ugly, and the economy will bottom out in the next six months.
We remain skeptical as the consumer is still weakened; businesses have not seen growth; defaults on consumer loans are rising; corporate bankruptcies haven't peaked yet; commercial real estate problems are just beginning; and the housing market is still relatively lackluster. Stocks will continue to evaluate all these factors but we find it hard to believe that prices can go up at the same pace. There are too many economic challenges ahead to believe the bull market has started.
Thursday, June 4, 2009
Bernanke Speak
Yesterday, our beloved Fed Chairman, Ben Bernanke spoke to Congress about the state of the economy, interest rates, inflation, and the financial system. Most investors agree with him that the banking system is not headed for collapse due to the bailouts by the government and the Federal Reserve. Fear was very high in the fall after Lehman Brothers went bankrupt and AIG, Fannie Mae, Freddie Mac, Merrill Lynch, Goldman, and Morgan Stanley were all potentially headed for collapse without government intervention. We would argue that risks to the financial system have not disappeared but the equity capital raises by many banks have reduced the probability of future failures.
Mr Bernanke addressed the concerns of controlling inflation down the road but he seemed far less convincing to us. The party line is that the government will be able to withdraw some of the excess liquidity at the right moment to minimize the chance of unleashing inflation when the growth of the economy resumes and the velocity of the monetary base accelerates. If one listened closely yesterday, they would have heard the Fed Chairman's voice cracking from being a tad nervous. It is hard to keep a straight face and explain away inflation when one truly knows it will take a miracle to perform such a magic trick flawlessly. Ben has been a magician so far and his bag of tricks have saved us from crisis but controlling the dollar, interest rates, inflation, and the stock market for long periods of time may not be so easy.
All markets today are much more global than in past recessions. In addition, information flow tends to be instantaneous with the internet and broadcast TV. As such, the interdependence of economies globally effect trade, currencies, commodity prices, and stock prices. The Fed and the U.S. government did a yeoman's job to provide enough liquidity to our financial system and saved the country from a depression. However, the unwinding of those programs may not be in its control. China cares most about China and they will do what is best for their country's health and prosperity. That sentiment can be said for every country in the world. The result may not be in the best interest of the United States and could be a major factor in the level of our interest rates and the value of the dollar.
Mr. Bernanke seemed to be pleading with Congress to focus on spending cuts and reducing the massive deficits. It is time to throw out politics and do what is best for the country. He is right but plenty of money has been printed and more will be spent by the government. Ben is a student of the past and he knows that he needs to juggle many balls at once. Unfortunately, hope won't help him but he is hoping to get lucky.
Mr Bernanke addressed the concerns of controlling inflation down the road but he seemed far less convincing to us. The party line is that the government will be able to withdraw some of the excess liquidity at the right moment to minimize the chance of unleashing inflation when the growth of the economy resumes and the velocity of the monetary base accelerates. If one listened closely yesterday, they would have heard the Fed Chairman's voice cracking from being a tad nervous. It is hard to keep a straight face and explain away inflation when one truly knows it will take a miracle to perform such a magic trick flawlessly. Ben has been a magician so far and his bag of tricks have saved us from crisis but controlling the dollar, interest rates, inflation, and the stock market for long periods of time may not be so easy.
All markets today are much more global than in past recessions. In addition, information flow tends to be instantaneous with the internet and broadcast TV. As such, the interdependence of economies globally effect trade, currencies, commodity prices, and stock prices. The Fed and the U.S. government did a yeoman's job to provide enough liquidity to our financial system and saved the country from a depression. However, the unwinding of those programs may not be in its control. China cares most about China and they will do what is best for their country's health and prosperity. That sentiment can be said for every country in the world. The result may not be in the best interest of the United States and could be a major factor in the level of our interest rates and the value of the dollar.
Mr. Bernanke seemed to be pleading with Congress to focus on spending cuts and reducing the massive deficits. It is time to throw out politics and do what is best for the country. He is right but plenty of money has been printed and more will be spent by the government. Ben is a student of the past and he knows that he needs to juggle many balls at once. Unfortunately, hope won't help him but he is hoping to get lucky.
Tuesday, June 2, 2009
The Bulls Are Winning
General Motors files for bankruptcy and investors rushed to buy stocks. Perhaps as each chapter of bad news unfolds, it is a sign that we are closer to a recovery. The GM news was followed by an improvement in the manufacturing sector. This is clearly another tea leaf the bulls have been looking for.
The problem we have is that we understand why the massive cash sitting on the sideline is quickly moving into stocks. The dire economic times of September seem to be gone. A depression seems unlikely and tidbits of an economic recovery have been appearing weekly. Many financial institutions are still troubled but companies like JP Morgan, Morgan Stanley, and American Express are rushing to the equity markets to raise capital to repay TARP.
However, are stocks ignoring the many problems that still exist? In March, the world seemed to be coming to an end for most investors and today every stock seems cheap. The truth is probably somewhere in between. Not too long ago oil was at 40 and heading to 20 and now it is at 60 and going to 70 or 80. The rise in oil seems odd as demand has not suddenly spiked and supply has not disappeared. Perhaps it is just trend trading or the equilibrium price should be around 60.
China seems to have been an aggressive buyer of commodities globally. Is the stimulus plan in China driving global demand for oil, gold, silver, iron ore, etc? Maybe but more likely China knows they have huge future needs of many commodities and it is using this environment of depressed prices as a time to stockpile commodities. Its aggressive buying has pushed prices higher and created some of the impetus for rising stock prices. We are concerned that when China finishes its buying, global demand may not be strong enough to continue to propel economic demand. As such, a reduction of demand as well as some negative economic surprises could put a crimp in this bull.
We continue to ride the bull with caution as it is hard to know when to get off the train. Our liquidity remains high as should yours. As stocks rise, so will our cash. We may not garner every last profit in stocks but hopefully we don't take a swan dive either if the economic mood changes.
The problem we have is that we understand why the massive cash sitting on the sideline is quickly moving into stocks. The dire economic times of September seem to be gone. A depression seems unlikely and tidbits of an economic recovery have been appearing weekly. Many financial institutions are still troubled but companies like JP Morgan, Morgan Stanley, and American Express are rushing to the equity markets to raise capital to repay TARP.
However, are stocks ignoring the many problems that still exist? In March, the world seemed to be coming to an end for most investors and today every stock seems cheap. The truth is probably somewhere in between. Not too long ago oil was at 40 and heading to 20 and now it is at 60 and going to 70 or 80. The rise in oil seems odd as demand has not suddenly spiked and supply has not disappeared. Perhaps it is just trend trading or the equilibrium price should be around 60.
China seems to have been an aggressive buyer of commodities globally. Is the stimulus plan in China driving global demand for oil, gold, silver, iron ore, etc? Maybe but more likely China knows they have huge future needs of many commodities and it is using this environment of depressed prices as a time to stockpile commodities. Its aggressive buying has pushed prices higher and created some of the impetus for rising stock prices. We are concerned that when China finishes its buying, global demand may not be strong enough to continue to propel economic demand. As such, a reduction of demand as well as some negative economic surprises could put a crimp in this bull.
We continue to ride the bull with caution as it is hard to know when to get off the train. Our liquidity remains high as should yours. As stocks rise, so will our cash. We may not garner every last profit in stocks but hopefully we don't take a swan dive either if the economic mood changes.
Monday, June 1, 2009
GM Is Finally In Bankruptcy
Twenty months ago Rescap, a subsidiary of GMAC, was struggling as the housing market had begun its downturn. For years,Rescap was the crown jewel of GM's financial subsidiary and a steady source of cash when Cerberus bought 51% of GMAC from GM. While Rescap's financials started to deteriorate Chrysler was also starting to crumble under its massive levergage. At the time, most debt investors were concerned about Chrysler as their loans started to trade in the $70's but bankruptcy was not on the radar screen at that point. Rescap bonds also started to trade at big discounts but it was believed that Cerberus would solve the problems. General Motors was clearly affected by these events but the stock was trading in the low to mid 20's and nobody gave much thought to what this meant for GM.
During this period, we ran into a senior person at Cerberus and discussed the unthinkable scenario of a General Motors bankruptcy. The logic went like this. If the housing sector continues to deteriorate, could Rescap go into bankruptcy? If Rescap is bankrupt, does that drag down GMAC? If GMAC falls off a cliff and Chrysler is in a tailspin, could GM go bankrupt? The answer was yes but the chain of events seemed far fetched to most investors in 2007.
Here we are today and the unthinkable has occurred. GM is in Chapter 11 and the government has put forth billions of taxpayer dollars to restructure the company in bankruptcy. It is never a good situation when the government is involved and its majority ownership will likely lead to bad economic decisions. We can see from the new union agreement that the government, although it pushed all stakeholders to take some pain, clearly didn't go far enough. New hires will be paid on par with competitors but does anyone expect GM to bring on new employees anytime soon? Current workers held onto their escalated pay of about $100 per hour. Taxpayers should be outraged as our money has been used to save the company from liquidation and operationally GM's wages are still way too high. This was the time to put the auto industry on an even playing field with its foreign competitors and the government didn't do it. Now it is our problem.
Shareholders have been virtually wiped out, bondholders are equity holders, the unions have a board seat and a large ownership in the company, and the government now controls the future of GM. This is the largest industrial bankruptcy of all time but at least it was done in a controlled process.
During this period, we ran into a senior person at Cerberus and discussed the unthinkable scenario of a General Motors bankruptcy. The logic went like this. If the housing sector continues to deteriorate, could Rescap go into bankruptcy? If Rescap is bankrupt, does that drag down GMAC? If GMAC falls off a cliff and Chrysler is in a tailspin, could GM go bankrupt? The answer was yes but the chain of events seemed far fetched to most investors in 2007.
Here we are today and the unthinkable has occurred. GM is in Chapter 11 and the government has put forth billions of taxpayer dollars to restructure the company in bankruptcy. It is never a good situation when the government is involved and its majority ownership will likely lead to bad economic decisions. We can see from the new union agreement that the government, although it pushed all stakeholders to take some pain, clearly didn't go far enough. New hires will be paid on par with competitors but does anyone expect GM to bring on new employees anytime soon? Current workers held onto their escalated pay of about $100 per hour. Taxpayers should be outraged as our money has been used to save the company from liquidation and operationally GM's wages are still way too high. This was the time to put the auto industry on an even playing field with its foreign competitors and the government didn't do it. Now it is our problem.
Shareholders have been virtually wiped out, bondholders are equity holders, the unions have a board seat and a large ownership in the company, and the government now controls the future of GM. This is the largest industrial bankruptcy of all time but at least it was done in a controlled process.
Friday, May 29, 2009
Stock Volatility Continues
Yesterday was another day where investors were bullish and today's futures point to another higher opening. The consumer confidence number has brought some new life into the market. Rising rates, higher commodity prices, and elevated gold prices doesn't seem to bother stock buyers.
We are pleased to see stocks go higher even though we remain very cautious. The bulls say rates are rising because the economy is getting stronger and higher commodity prices are a result of expected improving industrial activity.
We believe that interest rates are up because the government needs to raise trillions of dollars in the treasury market to fund the stimulus plan and all the programs implemented to avert a financial crisis. The Fed is printing money, the monetary base is growing, and the fear of inflation has been driving gold prices higher.
We like commodities for two reasons. Precious metals are appealing if one believes inflation is around the corner and some commodities like silver also would benefit with an improved economy. Farming related commodities could rise as farmers struggle to get enough bank credit to plant their crops. A lack of loans to the farming industry is likely to restrict crop production and thus cause prices to rise as the supply demand imbalance ensues.
As treasury prices decline, concern could grow with the U.S. dollar. A weak dollar is likely to push oil prices higher while also driving gold up. Rising energy prices could choke off the mild economic improvement we are seeing and then stock prices will reverse direction, quickly. A declining stock market is also likely to reverse consumer confidence.
We believe there was a chain reaction that has added to the bullish sentiment in the markets. Stocks took a dive through the beginning of March. The oversold condition led to a huge rally. Higher stock prices resulted in higher consumer confidence and higher consumer confidence led to even higher stock prices.
We are not convinced that this chain event will continue. Rising unemployment, weak corporate earnings, lower housing prices, and higher gas prices could lead to lower consumer confidence. Lower consumer confidence leads to reduced spending, minimal inventory replacement, declining corporate profits, and lower stock prices. If we add higher interest rates to the mix, misery will be ubiquitous and holding cash and gold will be the best investment strategy.
We are pleased to see stocks go higher even though we remain very cautious. The bulls say rates are rising because the economy is getting stronger and higher commodity prices are a result of expected improving industrial activity.
We believe that interest rates are up because the government needs to raise trillions of dollars in the treasury market to fund the stimulus plan and all the programs implemented to avert a financial crisis. The Fed is printing money, the monetary base is growing, and the fear of inflation has been driving gold prices higher.
We like commodities for two reasons. Precious metals are appealing if one believes inflation is around the corner and some commodities like silver also would benefit with an improved economy. Farming related commodities could rise as farmers struggle to get enough bank credit to plant their crops. A lack of loans to the farming industry is likely to restrict crop production and thus cause prices to rise as the supply demand imbalance ensues.
As treasury prices decline, concern could grow with the U.S. dollar. A weak dollar is likely to push oil prices higher while also driving gold up. Rising energy prices could choke off the mild economic improvement we are seeing and then stock prices will reverse direction, quickly. A declining stock market is also likely to reverse consumer confidence.
We believe there was a chain reaction that has added to the bullish sentiment in the markets. Stocks took a dive through the beginning of March. The oversold condition led to a huge rally. Higher stock prices resulted in higher consumer confidence and higher consumer confidence led to even higher stock prices.
We are not convinced that this chain event will continue. Rising unemployment, weak corporate earnings, lower housing prices, and higher gas prices could lead to lower consumer confidence. Lower consumer confidence leads to reduced spending, minimal inventory replacement, declining corporate profits, and lower stock prices. If we add higher interest rates to the mix, misery will be ubiquitous and holding cash and gold will be the best investment strategy.
Should The Government Bailout The Auto Companies II?
On November 6, 2008 we wrote how the government should not give the auto companies a loan until they forced them into a prepackaged bankruptcy. It took over six months and some wasted taxpayer money but the government finally got it. The auto industry is about to be deleveraged and the legacy operational cost structures and benefit plans improved to give the United States car companies a fighting chance to compete.
We applaud the GM process as being fairer to creditors than the Chrysler case. Perhaps the government realized that strong arming creditors isn't the best way to approach debt investors as they did with Chrysler. We are not opining on whether everybody got their fair share in the proposed new GM but at least it is not totally unjust. The completion of the bankruptcy process for GM will take at least 2 to 3 months but hopefully when the company is restructured, it won't need anymore government financial assistance.
We applaud the GM process as being fairer to creditors than the Chrysler case. Perhaps the government realized that strong arming creditors isn't the best way to approach debt investors as they did with Chrysler. We are not opining on whether everybody got their fair share in the proposed new GM but at least it is not totally unjust. The completion of the bankruptcy process for GM will take at least 2 to 3 months but hopefully when the company is restructured, it won't need anymore government financial assistance.
Wednesday, May 27, 2009
Nothing Like a Little Confidence
Consumer Confidence soared and so did the markets. Investors have been hoping for a turn in the economy and the glee from consumers is one data point moving in that direction. There are trillions of dollars waiting on the sidelines and whenever good news is announced hoards of cash seem to move into stocks. All markets were up more than 2.6% and everybody cheered for a day.
The global economy is still struggling and the financial industry is still fragile but we all hope the worst is behind us. Many problems are still ahead and the debt burden of the U.S. government will tax consumers for generations in the future. We still maintain caution as we ride the current wave.
The global economy is still struggling and the financial industry is still fragile but we all hope the worst is behind us. Many problems are still ahead and the debt burden of the U.S. government will tax consumers for generations in the future. We still maintain caution as we ride the current wave.
Tuesday, May 26, 2009
How Will May End?
We continue to be worried about a big pull back in the markets. The rally has been pushed higher as the cash on the sidelines gets antsy and feels compelled to participate in the rising stock market. For every positive tea leaf, we still see negative news.
This weekend North Korea stirred the pot with the launch of a nuclear missile test. OPEC ministers are gathering to determine the fate of oil supplies this week. Finally, GM is likely to file for bankruptcy. None of these events will ease investor concerns. Furthermore, we remain concerned with the weak consumer and the pending collapse of commercial real estate. Stocks fell off a cliff in the beginning of March but now they have risen too far, too fast. If the upcoming economic news turns slightly negative, investors are likely to become scared and begin to sell stocks again. If a black swan in the form of political uncertainty in Venezuela, Russia, or North Korea arises, look out.
We are still in fragile times. The financial industry is desperately trying to heal itself by equitizing their balance sheets but the toxic assets still exist. Citigroup is not out of the woods and BankAmerica is not minting money. The global financial industry will take years to undue the sins of the past and many surprises will pop up. We believe it will be years until the world is normal again and until that light at the end of the tunnel shines, investing will remain difficult. It is easy to become bullish as stocks gallop higher but we believe economic times will remain difficult and corporate growth stagnant. Stocks discount future earningsbut the short term earnings boost is due to aggressive management cost cutting. Long term earnings growth depends upon the growth in sales. Unless the Asian export machine picks up and corporate lending is reinvigorated, we don't expect corporations to resume their growth.
We continue to raise cash and buy S&P puts but until enough tea leaves convince us that the economic turn is here to stay, we will be cautious investors in this volatile and risky environment.
This weekend North Korea stirred the pot with the launch of a nuclear missile test. OPEC ministers are gathering to determine the fate of oil supplies this week. Finally, GM is likely to file for bankruptcy. None of these events will ease investor concerns. Furthermore, we remain concerned with the weak consumer and the pending collapse of commercial real estate. Stocks fell off a cliff in the beginning of March but now they have risen too far, too fast. If the upcoming economic news turns slightly negative, investors are likely to become scared and begin to sell stocks again. If a black swan in the form of political uncertainty in Venezuela, Russia, or North Korea arises, look out.
We are still in fragile times. The financial industry is desperately trying to heal itself by equitizing their balance sheets but the toxic assets still exist. Citigroup is not out of the woods and BankAmerica is not minting money. The global financial industry will take years to undue the sins of the past and many surprises will pop up. We believe it will be years until the world is normal again and until that light at the end of the tunnel shines, investing will remain difficult. It is easy to become bullish as stocks gallop higher but we believe economic times will remain difficult and corporate growth stagnant. Stocks discount future earningsbut the short term earnings boost is due to aggressive management cost cutting. Long term earnings growth depends upon the growth in sales. Unless the Asian export machine picks up and corporate lending is reinvigorated, we don't expect corporations to resume their growth.
We continue to raise cash and buy S&P puts but until enough tea leaves convince us that the economic turn is here to stay, we will be cautious investors in this volatile and risky environment.
Wednesday, May 20, 2009
What Are We Missing?
For the last few weeks we have been wondering why the market keeps rising in the face of a weakening economy. Investors have been assuming the economy is going to turn around in the second half of 2009 or at least by the beginning of 2010. We have our doubts.
Home Depot and Hewlett Packard don't see any improvement in the business environment. Our trading partners' economies are falling off a cliff. Mexico's GDP was down 21.5%, Germany's was down 14.4%, and Japan's dropped 15.2%. It will be hard to grow exports when the buyers of our goods are in dire economic shape.
Today the Fed released its April minutes and they expect a steeper recession and a slower recovery than their previous pronostications. With all this good news, what are we missing? The stock market has sucked in some of the cash burning a hole in investor's pockets. The short covering rally got us going and the mad dash to not miss the rally by investors with a plethora of cash kept it going. The rising market brought us rosy colored glasses about the economic prospects and stocks moved higher. When the disappointing news about the economy continues to flow in for the next few months stocks could retest the old lows. Buyer beware.
Home Depot and Hewlett Packard don't see any improvement in the business environment. Our trading partners' economies are falling off a cliff. Mexico's GDP was down 21.5%, Germany's was down 14.4%, and Japan's dropped 15.2%. It will be hard to grow exports when the buyers of our goods are in dire economic shape.
Today the Fed released its April minutes and they expect a steeper recession and a slower recovery than their previous pronostications. With all this good news, what are we missing? The stock market has sucked in some of the cash burning a hole in investor's pockets. The short covering rally got us going and the mad dash to not miss the rally by investors with a plethora of cash kept it going. The rising market brought us rosy colored glasses about the economic prospects and stocks moved higher. When the disappointing news about the economy continues to flow in for the next few months stocks could retest the old lows. Buyer beware.
Monday, May 18, 2009
"Obama's Auto Plan Is Capitalism At Work" or Not
The WSJ.com has an article written by Scott Sperling titled "Obama's Auto Plan Is Capitalism at Work". We have been saying since November 6, 2008 that the government needs to force a prepackaged bankruptcy at the auto companies to improve the cost structures and to reduce the leverage before tossing away precious taxpayer money. The Obama administration did just that as Mr. Sperling articulated. We agree with most of his article except for how the banks were treated in the Chrysler situation. The strong arming of banks, especially those with TARP money, and the public lambasting of the money managers who were trying to get their fair share was not capitalism as we know it. Nobody would benefit in liquidation. Perhaps the banks would have received less than 29 cents on the dollar but the unions and their pension plan and health plans would have wound up with nothing. The government was right to force a restructuring where everyone took some pain but the unions who had subordinated claims to the banks didn't deserve a bigger piece of the pie than the banks. The conclusion can only mean Socialism defeated Capitalism.
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