Let's take an account of how we are doing this year. Last week ended in typical fashion with the DOW down 4.1% and the S&P 500 down 4.5%. This puts those indices down 19.5% and 18.6% respectively for the first two months of the year. At this pace the market might drop 62% in 2009. So where's the rally? If it comes, it may only be short lived.
GDP was revised downward for the fourth quarter as the decline was greater than 6%. We have been saying the economy is getting worse and it clearly is. Unemployment keeps producing 600,000 plus job losses each week and will likely continue for awhile. The banking system is in a shambles as the equitizing of the Citi balance sheet portends bad news for other large banks. We don't think Citi is free and clear and BofA and Wells Fargo could be next on tap for some new government medicine. This is going to be a long painful process to rid the financial system of the leverage and excesses of the past decade. It can't be fixed over night. Hence, neither can our economy.
Warren Buffett's recent shareholder letter is plain and clear as he says the economy is going to be in bad shape for years to come and he is uncertain as to when the markets will go up. This opinion explains the structure of many of the Berkshire deals in the past six months as Mr. Buffett is buying debt with big coupons and getting equity kickers for potential upside in a company's stock. He is happy to collect a large coupon with a free option on the stock price. We love his thinking. That said, many of Berkshire's other investments are tied to the stock market and could produce red ink in these volatile markets.
We keep searching for the tea leaves but lately it is hard to find any glimmer of hope. We find it a little disturbing that the Geithner plan is rolling out very slowly. Investors need direction and thus will sit on the sidelines until there is some clarity about all the government actions to fix the financial system. The Obama budget also brings bad news. In these difficult times, whether one is rich or poor, everybody is feeling some economic pain. How can this administration propose increased income taxes and capital gains taxes on those earning greater than $250,000? Most Americans are cutting back and the expectations of increased taxes will accelerate the decline in spending while reducing the dollars available to propel the capital markets to function normally. President Obama is keeping his promises to tax the "rich" but it is poor economic policy in these strained economic times. The only worse legislation will be for Congress to jump on the bandwagon and increase the taxes even more. We will wait to see the response from our beloved Senators and Congressmen.
Tomorrow is the beginning of a new month for the markets. It should be a fun day as the snowy weather in the northeast could bring a chill to the week. The government is reporting construction spending, manufacturing activity, and personal income. Let's hope the number are bad but not disastrous. Perhaps a brief rally will appear but the negative news shall persist. The markets need to fully digest the upcoming economic weakness and discount stock prices enough so investors can start to put some cash back into the market. Most sophisticated investors are happy to sit on the sidelines until businesses can once again feel comfortable predicting their futures. Until CEOs and CFOs can foresee how much business they will do next quarter, why should investors throw the die? Let's hope some new tea leaves start appearing soon.
Sunday, March 1, 2009
Friday, February 27, 2009
CitiGovernment Has Been Born
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.
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.
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.
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