It may not officially be nationalization but if it looks like a duck, walks like a duck, and sounds like a duck, it must be a duck. The U.S. government is converting some of its preferred stock to common equity and the same opportunity is open to other preferred share holders. The U.S. could wind up owning as much as 36% of Citigroup. We would expect the common stock and preferred shares of other large banks to drop today in sympathy. We believe the new deal will also halt preferred dividends.
The markets won't like this news as it portends more difficult times ahead for the financial industry. The markets have been very volatile in the last few weeks and has been headed down. New lows are being hit on all the indices and the bottom doesn't seem to be in sight. We still haven't had panic in the markets but it should be just around the corner. Liquidity will be king and caution remains key. The economy is weak and getting weaker and the markets are following along. Buckle up because the ride will remain bumpy.
Friday, February 27, 2009
Wednesday, February 25, 2009
The Oracle From Chicago Has Spoken
After a month of creating fear about the economy, financial system, and the stock market, President Obama finally gave the American People a pep talk last night in his State of the Union Address. While he was direct and honest about our turbulent times, he laced his speech with hope and encouragement for the future of the United States and its people.
Tough measures will be needed to stimulate this economy and fix the banking system but the cost of such measures will be painful for many years to come. This administration is prepared to spend as much money as it takes to revive the patient but it will also extract a lot of pain from the floundering industries. The auto companies will get financial help but it may only happen in bankruptcy. Banks will get more capital but the structure of those investments and potential future returns will be beneficial to the American Taxpayer. We may not get full Nationalization but the government's stake in banks will surely rise.
Yesterday's markets surged as the S&P was up 4% and the DOW rose 3.3%. The excitement by investors was bolstered by the testimony of Ben Bernanke to the Senate. Recent concerns dragging down stocks were related to the uncertainty of the Nationalization of banks. The Fed chief seemed to ease those concerns by indicating Nationalization wasn't necessary. He also gave some hope that the economy could see some improvement in 2010. There is enough cash on the sidelines coupled with short positions to quickly boost the markets and that is what we witnessed yesterday. Perhaps we get another day of that rally but in the end it is still "All About the Economy" and as Mr Bernanke and The President both bluntly indicated, the economy is extremely weak and getting weaker.
We remain cautious and liquid while searching for the tea leaves to become more encouraged about the housing market, auto industry, retail, and the financial system. The economy will bottom and the financial system will be fixed but it takes time. Investors have been too optimistic for too long and they will be too pessimistic for too long also. The key will be to recognize when stocks drop too much and when there is a light at the end of the economic tunnel.
Tough measures will be needed to stimulate this economy and fix the banking system but the cost of such measures will be painful for many years to come. This administration is prepared to spend as much money as it takes to revive the patient but it will also extract a lot of pain from the floundering industries. The auto companies will get financial help but it may only happen in bankruptcy. Banks will get more capital but the structure of those investments and potential future returns will be beneficial to the American Taxpayer. We may not get full Nationalization but the government's stake in banks will surely rise.
Yesterday's markets surged as the S&P was up 4% and the DOW rose 3.3%. The excitement by investors was bolstered by the testimony of Ben Bernanke to the Senate. Recent concerns dragging down stocks were related to the uncertainty of the Nationalization of banks. The Fed chief seemed to ease those concerns by indicating Nationalization wasn't necessary. He also gave some hope that the economy could see some improvement in 2010. There is enough cash on the sidelines coupled with short positions to quickly boost the markets and that is what we witnessed yesterday. Perhaps we get another day of that rally but in the end it is still "All About the Economy" and as Mr Bernanke and The President both bluntly indicated, the economy is extremely weak and getting weaker.
We remain cautious and liquid while searching for the tea leaves to become more encouraged about the housing market, auto industry, retail, and the financial system. The economy will bottom and the financial system will be fixed but it takes time. Investors have been too optimistic for too long and they will be too pessimistic for too long also. The key will be to recognize when stocks drop too much and when there is a light at the end of the economic tunnel.
Monday, February 23, 2009
Just Another Down Day
It is amazing anybody is surprised that the markets were down another 3.4% today. The driving concerns were a deepening recession and the stability of the banking system. It seems like old news but until there is an indication that the bottom is in sight, the markets will continue to drift down. We may get some short-term rallies but when staples such as Campbell's Soup have weak earnings, it is hard for investors to get too excited. Everybody is waiting for the Obama administration to pull a rabbit out of the hat but that trick may take a while to be learned. For now, fear will remain high and the markets will be driven by the economy and the shaky financial system.
Sunday, February 22, 2009
The Obama Honeymoon Is Clearly Over
Last week the Dow was down 6.2% and the S&P dove 6.9% as investors became more impatient with the stimulus plan and the lack of details from the Geithner bailout. Companies such as J.C. Penny and Lowe's posted weak profits while the New York Times cut its dividend. Earning this quarter have been horrible and we can expect that trend to continue for the rest of the year and into 2010. By now, it is apparent to anyone who lives on this planet that the economy is weak and getting weaker. Unemployment is on the rise and double digits are likely by next year. There does not seem to be any glimmer of hope anywhere as housing remains weak, manufacturing has stopped, and HP's negative earnings surprise doesn't bode well for the technology sector.
The commercial real estate sector is soft but the true pain is coming. Rents are coming down and vacancies are rising. The next year or two should see a huge downdraft in this market. We have been saying for a long time that the corporate default rate will rise to 15 to 20% and it seems like the bankruptcy pace is picking up steam as Trump Casino came crashing down last week. Many more chapter 11's are in the cards as this year progresses. Sirius Satellite was saved from a bankruptcy by Liberty Media infusing expensive capital while also taking a 40% ownership in the company. These are the opportunities for companies or funds with large stashes of cash. Warren Buffett may have been profiled for his similar investments in GE, Goldman, USG, and Harley Davidson but companies or funds with cash will be looking to structure similar transactions throughout 2009. In fact, we believe this strategy is one of the prime opportunities available to cash rich investors.
The biggest driver of falling stocks last week was once again financials. The financial crisis isn't going away easily no matter what the government says or does. Many banks need to clear out the toxic assets which will result in a need to be recapitalized. The government may have injected capital into financial institutions but more will be needed. The biggest fear last week was Nationalization of the banking system. The definition of Nationalize is to transfer ownership or control to the government. We don't know what is going to happen but we can interpret what has already happened. With each injection of capital into the banks, the government has taken an equity stake along with a preferred stock investment. In most, if not all of these banks, the market capitalization has gone down significantly after such investment. Any new investment should result in a much larger equity stake for each dollar invested by the government. Hence, we can argue for or against Nationalization but the facts show that our government is steadily increasing its ownership and control of the banking system.
It is time for Treasury Secretary Geithner to confidently address the issues and win some investor support. We need facts on his plan to buy assets with the private sector. Perhaps in addition to pooling the governments money with private equity funds and hedge funds, the government should create a new fund for any accredited taxpayer who would like to participate in the bailout. There are many wealthy investors (perhaps less wealthy than they were 18 months ago) who might want to invest alongside the "smart money" and take advantage of a once in a life time distressed opportunity. This fund could potentially add billions to the governments efforts to find private money to help clean up the distressed assets on banks' books.
This week could potentially be just as frightening to investors as last as the S&P is only 18 points from hitting its November 20th low. The DOW already is in new territory and many investors are hoping for a bounce. Ironically, panic didn't seem to be anywhere and we would think it may show up again before the absolute bottom actually is hit. Many months ago we thought Apple needed to have a big negative earnings surprise before the market could bottom and perhaps the company will meet those expectations in their second quarter. Until then, we expect choppy waters ahead. Two weeks ago we wrote that we became very negative on the economy and the market after going to the J.P. Morgan Credit Conference. Unfortunately, our intuition has been right in the last couple of weeks and unless a miracle occurs, the economy will continue to deteriorate and the markets will hit a new low before resuming a sustained upward trend. Of course, President Obama could bring some good short term news to create another bear market rally and one that most investors would like to see.
The commercial real estate sector is soft but the true pain is coming. Rents are coming down and vacancies are rising. The next year or two should see a huge downdraft in this market. We have been saying for a long time that the corporate default rate will rise to 15 to 20% and it seems like the bankruptcy pace is picking up steam as Trump Casino came crashing down last week. Many more chapter 11's are in the cards as this year progresses. Sirius Satellite was saved from a bankruptcy by Liberty Media infusing expensive capital while also taking a 40% ownership in the company. These are the opportunities for companies or funds with large stashes of cash. Warren Buffett may have been profiled for his similar investments in GE, Goldman, USG, and Harley Davidson but companies or funds with cash will be looking to structure similar transactions throughout 2009. In fact, we believe this strategy is one of the prime opportunities available to cash rich investors.
The biggest driver of falling stocks last week was once again financials. The financial crisis isn't going away easily no matter what the government says or does. Many banks need to clear out the toxic assets which will result in a need to be recapitalized. The government may have injected capital into financial institutions but more will be needed. The biggest fear last week was Nationalization of the banking system. The definition of Nationalize is to transfer ownership or control to the government. We don't know what is going to happen but we can interpret what has already happened. With each injection of capital into the banks, the government has taken an equity stake along with a preferred stock investment. In most, if not all of these banks, the market capitalization has gone down significantly after such investment. Any new investment should result in a much larger equity stake for each dollar invested by the government. Hence, we can argue for or against Nationalization but the facts show that our government is steadily increasing its ownership and control of the banking system.
It is time for Treasury Secretary Geithner to confidently address the issues and win some investor support. We need facts on his plan to buy assets with the private sector. Perhaps in addition to pooling the governments money with private equity funds and hedge funds, the government should create a new fund for any accredited taxpayer who would like to participate in the bailout. There are many wealthy investors (perhaps less wealthy than they were 18 months ago) who might want to invest alongside the "smart money" and take advantage of a once in a life time distressed opportunity. This fund could potentially add billions to the governments efforts to find private money to help clean up the distressed assets on banks' books.
This week could potentially be just as frightening to investors as last as the S&P is only 18 points from hitting its November 20th low. The DOW already is in new territory and many investors are hoping for a bounce. Ironically, panic didn't seem to be anywhere and we would think it may show up again before the absolute bottom actually is hit. Many months ago we thought Apple needed to have a big negative earnings surprise before the market could bottom and perhaps the company will meet those expectations in their second quarter. Until then, we expect choppy waters ahead. Two weeks ago we wrote that we became very negative on the economy and the market after going to the J.P. Morgan Credit Conference. Unfortunately, our intuition has been right in the last couple of weeks and unless a miracle occurs, the economy will continue to deteriorate and the markets will hit a new low before resuming a sustained upward trend. Of course, President Obama could bring some good short term news to create another bear market rally and one that most investors would like to see.
Friday, February 13, 2009
Volatility, Volatility, Volitility
We promised more volatility and we got it. The markets were down over 2% yesterday afternoon until a news report about the Obama plan to help homeowners keep their homes through a mortgage subsidy program. Details are not out yet but it appeared to be good news so the market rallied to end up 1%. It only seems fair that some negative news should come out this morning to send it down again.
The next few months will keep the market on a yo-yo string until there is some clarity to the Obama/Geithner plan. The economy is sinking and the economic outlook is bleak. The markets are going through a bottoming process but it is likely to be lower before it goes much higher. Until there is some sense that unemployment is slowing, the financial crisis is improving, and housing is at a trough, investors will keep most of their cash on the sidelines.
Better times are ahead but the consumer is weak and companies are bleeding right now. More pain is inevitable but eventually there will be light at the end of the tunnel. It just won't happen until 2010.
The next few months will keep the market on a yo-yo string until there is some clarity to the Obama/Geithner plan. The economy is sinking and the economic outlook is bleak. The markets are going through a bottoming process but it is likely to be lower before it goes much higher. Until there is some sense that unemployment is slowing, the financial crisis is improving, and housing is at a trough, investors will keep most of their cash on the sidelines.
Better times are ahead but the consumer is weak and companies are bleeding right now. More pain is inevitable but eventually there will be light at the end of the tunnel. It just won't happen until 2010.
Here Come the Bankruptcies
Paul Allen, the co-founder of Microsoft, has been one of the worst investors of all time. For well over a decade he has made many poor investments but his biggest albatross has been Charter Communications. This cable company has been in poor financial straights for as long as we can remember. Mr. Allen has financed this company with increasing amounts of debt for years and is finally ready to put the company into bankruptcy. In stronger markets, overleveraged companies like this have been bailed out time and time again through the refinancing of debt. However, happy times are not here anymore and the high yield market is not open to weak companies with too much debt.
Charter may be the biggest name announcing an imminent bankruptcy but the rush to Chapter 11 is accelerating with names such as Muzak, Aleris, and Midway Games. General Growth and Sirius-XM radio are still seeking financing to avoid the same fate. We expect this trend to continue throughout 2009 and 2010. Many of these companies will restructure and become leaner organizations with lower leverage. This process is healthy for the economy long-term but could lead to many more layoffs in the short-term.
Charter may be the biggest name announcing an imminent bankruptcy but the rush to Chapter 11 is accelerating with names such as Muzak, Aleris, and Midway Games. General Growth and Sirius-XM radio are still seeking financing to avoid the same fate. We expect this trend to continue throughout 2009 and 2010. Many of these companies will restructure and become leaner organizations with lower leverage. This process is healthy for the economy long-term but could lead to many more layoffs in the short-term.
Thursday, February 12, 2009
The Markets Dissect the "Plan"
The stock market was volatile yesterday and will likely remain that way as investors digest the Stimulus Plan and get more details on the Geithner Plan. The objectives expressed by our new Treasury Secretary have many facets but no specifics yet. We believe the structure of each part will be crucial to fixing the credit markets, improving the banking system, and re energizing our economy.
We have been thinking about the Public-Private Investment Partnership to buy toxic assets from the banks. The government needs to attract as many investors as they can in order to grow this fund to a size that will be large enough to effectively clean up bank balance sheets. Given this objective, Mr. Geithner needs a very flexible structure to capture the diverse investment styles and needs of private equity funds, hedge funds, and many other investors.
The distressed assets held by the banks are predominantly either mortgage related or corporate bonds/loans. Generally the investors for these securities are not the same as the vultures who might participate may not want to buy a package of mixed securities. Hence, we would advise Mr. Geithner to create many investment funds which will be segregated by different classes of securities. This will maximize the investor base as specialized funds can buy what they want while multi-strategy funds can participate in many partnerships to buy a diverse set of securities.
The investor universe also has different risk/return profiles. Some investors want leverage while others don't. Therefore, the government needs to offer a leverage option to any investor who wants it but not make it a requirement for everyone who participates in the fund.
Finally, the enormous quantity of toxic assets will scare many institutions from wanting to be first in to buy these securities. No investor is wants to be the first to buy a pool of securites when billions if not trillions more will be for salethe next day, at perhaps lower prices. We would suggest Mr. Geithner should offer some loan loss protection for the first buyers and as assets are removed from the banks' books, the loan loss protection should decline.
Under our framework, the government would create a leveraged loan partnership. The investors in this fund would have the option of receiving some amount of leverage from the government at low interest rates. The early investors could get somewhere between 20% and 50% of downside protection. This will get private investors to be excited to join the government in its quest to clean up the mess. After the first slug of assets are bought by the partnership, the government will likely be able to reduce the loan loss protection and perhaps even the leverage as a larger universe of investors will want to join the partnership. This concept is very similar to the marketing concept of the early adopter.
The above strategy should be used for each asset class that the government pursues from the balance sheets of the banks. A committee of investors should determine the price to bid for each security as they will have the expertise to value them. The government should also commit a large amount of capital to each of the partnerships. This program is the one which will likely be profitable for the U.S. taxpayer and perhaps make up for some of the other losses.
If the government acted alone to buy these toxic assets, they would be assuming 100% of the losses as well as any upside. The public would be distrustful of the prices they paid and perhaps this plan could fail quickly. Therefore, our suggestion to initially offer large loan loss protection wouldn't put the government at any greater risk than if they had purchased all the securities without the help of the private sector. A combination of enough loan loss protection and leverage should be enticing enough for the private sector to partner with the government in its pursuit to clean up the bank balance sheets. If executed well, asset prices will rise as more of them move off the books of the banks. The result will be an improvement in credit markets and a stronger banking system. Of course, the government will need to inject more capital into many financial institutions as these assets are written down by the banks.
We have been thinking about the Public-Private Investment Partnership to buy toxic assets from the banks. The government needs to attract as many investors as they can in order to grow this fund to a size that will be large enough to effectively clean up bank balance sheets. Given this objective, Mr. Geithner needs a very flexible structure to capture the diverse investment styles and needs of private equity funds, hedge funds, and many other investors.
The distressed assets held by the banks are predominantly either mortgage related or corporate bonds/loans. Generally the investors for these securities are not the same as the vultures who might participate may not want to buy a package of mixed securities. Hence, we would advise Mr. Geithner to create many investment funds which will be segregated by different classes of securities. This will maximize the investor base as specialized funds can buy what they want while multi-strategy funds can participate in many partnerships to buy a diverse set of securities.
The investor universe also has different risk/return profiles. Some investors want leverage while others don't. Therefore, the government needs to offer a leverage option to any investor who wants it but not make it a requirement for everyone who participates in the fund.
Finally, the enormous quantity of toxic assets will scare many institutions from wanting to be first in to buy these securities. No investor is wants to be the first to buy a pool of securites when billions if not trillions more will be for salethe next day, at perhaps lower prices. We would suggest Mr. Geithner should offer some loan loss protection for the first buyers and as assets are removed from the banks' books, the loan loss protection should decline.
Under our framework, the government would create a leveraged loan partnership. The investors in this fund would have the option of receiving some amount of leverage from the government at low interest rates. The early investors could get somewhere between 20% and 50% of downside protection. This will get private investors to be excited to join the government in its quest to clean up the mess. After the first slug of assets are bought by the partnership, the government will likely be able to reduce the loan loss protection and perhaps even the leverage as a larger universe of investors will want to join the partnership. This concept is very similar to the marketing concept of the early adopter.
The above strategy should be used for each asset class that the government pursues from the balance sheets of the banks. A committee of investors should determine the price to bid for each security as they will have the expertise to value them. The government should also commit a large amount of capital to each of the partnerships. This program is the one which will likely be profitable for the U.S. taxpayer and perhaps make up for some of the other losses.
If the government acted alone to buy these toxic assets, they would be assuming 100% of the losses as well as any upside. The public would be distrustful of the prices they paid and perhaps this plan could fail quickly. Therefore, our suggestion to initially offer large loan loss protection wouldn't put the government at any greater risk than if they had purchased all the securities without the help of the private sector. A combination of enough loan loss protection and leverage should be enticing enough for the private sector to partner with the government in its pursuit to clean up the bank balance sheets. If executed well, asset prices will rise as more of them move off the books of the banks. The result will be an improvement in credit markets and a stronger banking system. Of course, the government will need to inject more capital into many financial institutions as these assets are written down by the banks.
Tuesday, February 10, 2009
We Got the Geithner Objectives but Where's the Plan?
Treasury Secretary Geithner finally had his moment in the sun today to explain the long awaited plan to fix the financial system and end the credit crisis. How did he do? Not very well as the S&P dropped 4.9% while the DOW skidded 4.6%. Mr Geithner articulated his objectives clearly but when trumpeting his plan he lacked details.
Investors have lost faith in the government and were anxiously waiting to here what the new regime had to say. Perhaps all government officials should find a speech coach. John Q Public is ready for fresh ideas and specific details on improving the economy and ending the financial crisis. It would have been better to delay the new plan than to build up expectations for new solutions and let everyone down with scarce details.
We happen to like many of the ideas the Obama crew has announced but most investors are too skittish to trust the government again. The credit crisis and the weakened financial system is not easy to fix. It is easy to knock Secretary Paulson but our country could have easily fallen into a depression with a failed banking system. He was fighting fires for nine months and probably made mistakes but every day had a new crisis and quick decisions were warranted. He ended up with some good decisions and some bad but most investors have concluded he did a horrible job. It is easy to be a Monday night quarterback when the gun isn't pointed at your head 24 hours a day.
Secretary Geithner had many months to learn from some of Paulson's mistakes and today he really got an education on the job. This country wants answers and it wants them now. He needs to take charge and set expectations accordingly. It is easy to under promise and over sell. Unfortunately today he did the opposite. He will get it right in time as the objectives to shore up the banking system, support consumer and business lending, and partner with the private sector to buy up toxic assets are on target. These broad ideas if crafted intelligently will improve the banking system, stem the housing decline, instill consumer confidence, and stimulate corporate spending. The result will be a bottoming of the economy and an improved stock market.
The objectives will take time and the economy won't turn around until 2010 but perhaps we have some basis for optimism.
Investors have lost faith in the government and were anxiously waiting to here what the new regime had to say. Perhaps all government officials should find a speech coach. John Q Public is ready for fresh ideas and specific details on improving the economy and ending the financial crisis. It would have been better to delay the new plan than to build up expectations for new solutions and let everyone down with scarce details.
We happen to like many of the ideas the Obama crew has announced but most investors are too skittish to trust the government again. The credit crisis and the weakened financial system is not easy to fix. It is easy to knock Secretary Paulson but our country could have easily fallen into a depression with a failed banking system. He was fighting fires for nine months and probably made mistakes but every day had a new crisis and quick decisions were warranted. He ended up with some good decisions and some bad but most investors have concluded he did a horrible job. It is easy to be a Monday night quarterback when the gun isn't pointed at your head 24 hours a day.
Secretary Geithner had many months to learn from some of Paulson's mistakes and today he really got an education on the job. This country wants answers and it wants them now. He needs to take charge and set expectations accordingly. It is easy to under promise and over sell. Unfortunately today he did the opposite. He will get it right in time as the objectives to shore up the banking system, support consumer and business lending, and partner with the private sector to buy up toxic assets are on target. These broad ideas if crafted intelligently will improve the banking system, stem the housing decline, instill consumer confidence, and stimulate corporate spending. The result will be a bottoming of the economy and an improved stock market.
The objectives will take time and the economy won't turn around until 2010 but perhaps we have some basis for optimism.
The market Wait and See
We had calm markets yesterday as investors anxiously wait for the final details of the stimulus plan and more importantly, the Geithner bailout plan. Details from the Treasury Secretary will emerge in a speech today and the next phase of the financial crisis will be unveiled. Banks will get recapitalized again and the bad assets will be ejected from balance sheets. This is what the financial system needs but it won't be an easy process.
In the meantime, the credit markets were once again successfully tested as Cisco raised $4 billion. High quality companies with strong balance sheets are in great demand by investors. This is a mini step to improving the credit markets as the extensive fear leads investors to safe places to put cash in addition to treasuries. As investors begin to move down the quality spectrum and many more non-investment grade bonds are issued, the stock market will begin to end its bottoming process and start a sustained march upward. However, we are not there yet and the weakening economy will keep the volatility in the market and cap any rally.
In the meantime, the credit markets were once again successfully tested as Cisco raised $4 billion. High quality companies with strong balance sheets are in great demand by investors. This is a mini step to improving the credit markets as the extensive fear leads investors to safe places to put cash in addition to treasuries. As investors begin to move down the quality spectrum and many more non-investment grade bonds are issued, the stock market will begin to end its bottoming process and start a sustained march upward. However, we are not there yet and the weakening economy will keep the volatility in the market and cap any rally.
Monday, February 9, 2009
This Is The Government's Week
The final touches are being put on the stimulus package. We don't think it will have much effect on the markets as it won't create enough new jobs to make a difference. The government needs to spend money now on projects to get the money flowing again in this country. Consumers are scared. They are focused on saving assets and not spending them. Any tax cut won't lead to new discretionary purchases but perhaps reducing debt or squirreling the money away under their mattresses. The government should consider an idea we casually mentioned last week. Instead of a $400 tax credit, lets give American families a $400 gift card to spend at any retailer in the United States. Spending will increase, retail sales will rise, manufacturers will move inventory, profits will increase, and the circulation of dollars will expand. Also, perhaps some jobs will be saved.
Treasury Secretary Geithner will also announce his new Bank Bailout Plan. On September 29th we wrote that the bank problem can't be solved until bad assets are written down to levels where private investors see value. That process will also require banks to take more write-downs which in turn will result in the need for more capital to be injected. We have also proposed a joint fund where investors and the government can jointly buy distressed assets at fair market prices. It looks like the government is finally moving in that direction. The details of the plan will be discussed tomorrow and the markets will be anxiously waiting. Until then, we will need to focus on corporate earnings or more likely losses.
Treasury Secretary Geithner will also announce his new Bank Bailout Plan. On September 29th we wrote that the bank problem can't be solved until bad assets are written down to levels where private investors see value. That process will also require banks to take more write-downs which in turn will result in the need for more capital to be injected. We have also proposed a joint fund where investors and the government can jointly buy distressed assets at fair market prices. It looks like the government is finally moving in that direction. The details of the plan will be discussed tomorrow and the markets will be anxiously waiting. Until then, we will need to focus on corporate earnings or more likely losses.
Thursday, February 5, 2009
The Volatility Continues
Cisco reported decent numbers but had some concerning words about the economic environment and its effects on business in the foreseeable future. With that back drop, the markets braced for a weak day. As the morning progressed stocks dropped over 1% until rumors about the upcoming government plan started to spread. The hearsay that began to lift the markets was that the mark-to-market accounting rules would be revised to give some relief to distressed assets on bank balance sheets. This may be a short-term band-aid but more aggressive medicine is needed to clear away the toxic assets.
Stocks ended the day up well above 1% as hope that fresh government initiatives would bring stability to the markets while fostering growth in the economy. Tomorrow morning we will find out how many jobs were lost in January and unless it is a really ugly number, the markets could ride into the weekend with expectations of some good news next week. This short-term trade could develop legs but in the end, it is still "all about the economy" and earnings announcements continue to be sour and business is retrenching. Expect the stock market to ultimately test new lows and likely break them in the next couple of months. Until then, perhaps we will see a rally.
Stocks ended the day up well above 1% as hope that fresh government initiatives would bring stability to the markets while fostering growth in the economy. Tomorrow morning we will find out how many jobs were lost in January and unless it is a really ugly number, the markets could ride into the weekend with expectations of some good news next week. This short-term trade could develop legs but in the end, it is still "all about the economy" and earnings announcements continue to be sour and business is retrenching. Expect the stock market to ultimately test new lows and likely break them in the next couple of months. Until then, perhaps we will see a rally.
Tuesday, February 3, 2009
We May Have Been Too Optimistic
For many months we have been saying the recession will be longer and deeper than most economists and analysts anticipate. How many times have we repeated the term "It's All About The Economy"? We have been right about those predictions. However, we have been talking about a bottoming process for awhile and it looks to us that the bottom may not have come yet and the process of the stock market gaging the extent of the current crisis and discounting such results may take many more months.
We have suggested that the credit markets will lead the way and loans and bonds are the place to benefit from the unfreezing of the credit crisis. In the past month those markets have rallied about 10% and a number of high yield companies have been able to access the new issue market to raise fresh capital. This bodes well for the financial crisis but the economy remains extremely weak and we anticipate the news to continue to be bleak throughout 2009 and possibly into a good part of 2010. Unemployment could reach 11 or 12% as businesses pare their work forces while trimming many expenses. Very few industries have been spared from the impact of the financial crisis. Health care, for-profit education, and some consumer durable (but not all) companies have maintained some growth in this sour economy.
The credit market remains the best opportunity to garner decent returns but excessive profits may not come in these markets until 2010. In December ,we recommended two closed-end bond funds which were trading at a discount to net asset value. They were PTY and PCN both of which are managed by PIMCO. With the recent rally, the prices of these funds have skyrocketed such that they are now trading for around a 30% premium to net asset value. Too many investors are looking to migrate into fixed income securities and they have elevated the prices of these funds to levels that are too high and they should be sold as the downside risk is greater than any upside gains.
We were at the JP Morgan Credit Conference this week and the investors were optimistic about the opportunity in the credit markets over the next few years. However, nobody seemed to be anxious to deploy too much capital too quickly. Most companies expected weak results for this year and into next year. A few lectures by professionals who have contact with numerous corporate clients also indicated the economic picture is clearly in for worse times ahead.
The government is desperately trying to figure out what to do with the toxic assets on the balance sheets of banks on one hand while negotiating with Congress over a comprehensive stimulus plan. We contend that whatever the plans are they won't be enough. In fact, it is likely the government will likely need to deploy trillions more before the financial crisis is over and the economy is lifted out of the doldrums. Many banks are going to fail and others will need additional capital infusions. Investors will sit on the sidelines until the magnitude of the toxic assets is known and it becomes apparent that the mess is close to being cleaned up. This will take a long time and as a result the economy may remain weak for at least another year.
As Republicans, we generally like the concept of cutting taxes to accelerate the economy but it is not the correct medicine for the stimulus plan. This country needs new jobs and an improvement in the housing market. We do not need a plan to appease each Senator and Congressman in office. A new tax cut will give the consumer fresh cash to put under his mattress. We need consumers to spend money to increase the velocity of the money supply. The consumer is in savings mode so a tax rebate will not lead to new jobs nor will it stimulate economic growth. The government would be better off giving consumers gift cards to the local retailer if it wants to help the consumer and stimulate the economy. We believe the stimulus plan needs to focus on jobs and infrastructure projects are definitely the way to go. The spending should be on projects that have been in the planning stage but can be accelerated. Our roads and bridges clearly need improvement and so does the power grid. Let's improve America now and spend the taxpayers dollars wisely as we try to pull our country out of this economic slump.
Unfortunately, for the stock market none of the above is encouraging. The markets expect a resumption of growth in the second half of 2009 and unemployment to peak at 8-9%. It looks like those numbers are optimistic. We haven't even begun to see the effects of the impending commercial real estate crisis nor have we factored in the impending escalating corporate defaults and consumer defaults on credit cards, auto loans, student loans, and home equity loans. Volatility will certainly remain high and some rallies may ensue with hopeful Obama plans but for investors, cash will remain king and we would suggest caution over the next few months as investors start to realize that 2009 will not be the year the economy hits bottom.
We have suggested that the credit markets will lead the way and loans and bonds are the place to benefit from the unfreezing of the credit crisis. In the past month those markets have rallied about 10% and a number of high yield companies have been able to access the new issue market to raise fresh capital. This bodes well for the financial crisis but the economy remains extremely weak and we anticipate the news to continue to be bleak throughout 2009 and possibly into a good part of 2010. Unemployment could reach 11 or 12% as businesses pare their work forces while trimming many expenses. Very few industries have been spared from the impact of the financial crisis. Health care, for-profit education, and some consumer durable (but not all) companies have maintained some growth in this sour economy.
The credit market remains the best opportunity to garner decent returns but excessive profits may not come in these markets until 2010. In December ,we recommended two closed-end bond funds which were trading at a discount to net asset value. They were PTY and PCN both of which are managed by PIMCO. With the recent rally, the prices of these funds have skyrocketed such that they are now trading for around a 30% premium to net asset value. Too many investors are looking to migrate into fixed income securities and they have elevated the prices of these funds to levels that are too high and they should be sold as the downside risk is greater than any upside gains.
We were at the JP Morgan Credit Conference this week and the investors were optimistic about the opportunity in the credit markets over the next few years. However, nobody seemed to be anxious to deploy too much capital too quickly. Most companies expected weak results for this year and into next year. A few lectures by professionals who have contact with numerous corporate clients also indicated the economic picture is clearly in for worse times ahead.
The government is desperately trying to figure out what to do with the toxic assets on the balance sheets of banks on one hand while negotiating with Congress over a comprehensive stimulus plan. We contend that whatever the plans are they won't be enough. In fact, it is likely the government will likely need to deploy trillions more before the financial crisis is over and the economy is lifted out of the doldrums. Many banks are going to fail and others will need additional capital infusions. Investors will sit on the sidelines until the magnitude of the toxic assets is known and it becomes apparent that the mess is close to being cleaned up. This will take a long time and as a result the economy may remain weak for at least another year.
As Republicans, we generally like the concept of cutting taxes to accelerate the economy but it is not the correct medicine for the stimulus plan. This country needs new jobs and an improvement in the housing market. We do not need a plan to appease each Senator and Congressman in office. A new tax cut will give the consumer fresh cash to put under his mattress. We need consumers to spend money to increase the velocity of the money supply. The consumer is in savings mode so a tax rebate will not lead to new jobs nor will it stimulate economic growth. The government would be better off giving consumers gift cards to the local retailer if it wants to help the consumer and stimulate the economy. We believe the stimulus plan needs to focus on jobs and infrastructure projects are definitely the way to go. The spending should be on projects that have been in the planning stage but can be accelerated. Our roads and bridges clearly need improvement and so does the power grid. Let's improve America now and spend the taxpayers dollars wisely as we try to pull our country out of this economic slump.
Unfortunately, for the stock market none of the above is encouraging. The markets expect a resumption of growth in the second half of 2009 and unemployment to peak at 8-9%. It looks like those numbers are optimistic. We haven't even begun to see the effects of the impending commercial real estate crisis nor have we factored in the impending escalating corporate defaults and consumer defaults on credit cards, auto loans, student loans, and home equity loans. Volatility will certainly remain high and some rallies may ensue with hopeful Obama plans but for investors, cash will remain king and we would suggest caution over the next few months as investors start to realize that 2009 will not be the year the economy hits bottom.
The New Wall Street--Part II
It is clear nobody in government understands what drives Wall Street employees. Of course, the common thinking is it is greed and that is true. Sometimes such greed can lead to too much risk and large losses. That is what helped create the financial crisis in which we find our country. However, not everybody employs undue risk to make outsize profits.
Many successful Wall Street pros utilize sophisticated risk management techniques coupled with their intelligence to return high profits. The new administration and its congressional counterparts want to punish Wall Streeters for their previous misdeeds by limiting bonuses to $400,000. This may still seem like a lot of money and the government, who has saved many of the banks from demise with TARP funds, believe they have the right to set these policies.
We disagree as the brain drain from Wall Street will not only occur in droves but it will lead to reduced profitability at the banks and raise the risk of U.S. taxpayers losing TARP money. Here is why. Let's use a simplistic example. Suppose Wall Street Firm "A" has 2 employees. One employee is extremely bright who carefully manages risk while investing firm money. He generates $20 million in profits and deserves a bonus of 10-20% of these gains. The second employee takes excessive risk and loses $10 million. He deserves no bonus. Under this scenario, employee number 1 would get a bonus of $2-4 million whereas employee number 2 gets no bonus. The firm would have earned $10mm less employee 1's bonus resulting in net earnings of $6-8 million.
Now the government steps in and imposes a $400,000 maximum bonus on all employees at this TARP funded bank. Employee number 1 will be extremely upset as he knows his hard work and intelligence generated $20 million in profits for his firm. He also realizes he can either set up his own firm or move to another firm which doesn't have any bonus restrictions. Upon his exit, Wall Street Firm "A" is left with employee 2. The firm now would generate a loss of $10 million. Certainly such an adverse event will not lead to the payback of TARP money. In fact, such a result is likely to occur at all TARP funded banks and once again, the government will have tried to appease the general public but wind up losing taxpayer money as it weakens the banks that are already in financial distress.
Many successful Wall Street pros utilize sophisticated risk management techniques coupled with their intelligence to return high profits. The new administration and its congressional counterparts want to punish Wall Streeters for their previous misdeeds by limiting bonuses to $400,000. This may still seem like a lot of money and the government, who has saved many of the banks from demise with TARP funds, believe they have the right to set these policies.
We disagree as the brain drain from Wall Street will not only occur in droves but it will lead to reduced profitability at the banks and raise the risk of U.S. taxpayers losing TARP money. Here is why. Let's use a simplistic example. Suppose Wall Street Firm "A" has 2 employees. One employee is extremely bright who carefully manages risk while investing firm money. He generates $20 million in profits and deserves a bonus of 10-20% of these gains. The second employee takes excessive risk and loses $10 million. He deserves no bonus. Under this scenario, employee number 1 would get a bonus of $2-4 million whereas employee number 2 gets no bonus. The firm would have earned $10mm less employee 1's bonus resulting in net earnings of $6-8 million.
Now the government steps in and imposes a $400,000 maximum bonus on all employees at this TARP funded bank. Employee number 1 will be extremely upset as he knows his hard work and intelligence generated $20 million in profits for his firm. He also realizes he can either set up his own firm or move to another firm which doesn't have any bonus restrictions. Upon his exit, Wall Street Firm "A" is left with employee 2. The firm now would generate a loss of $10 million. Certainly such an adverse event will not lead to the payback of TARP money. In fact, such a result is likely to occur at all TARP funded banks and once again, the government will have tried to appease the general public but wind up losing taxpayer money as it weakens the banks that are already in financial distress.
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