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."
Tuesday, June 30, 2009
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.
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