$ic Money

Worst to First

2009-09-16T23:07:00.004-05:00

This rally has been fueled by the companies that got hit the hardest in the downturn, that is, the most cyclical companies and the most debt-laden companies. Yes, the “strong” companies did not get hit as hard when things turned south (and many of these “strong” companies were consumer staples companies), but these same companies have yet to bounce with the rest of the market. Looking forward, the upside for these highly-levered companies relies heavily on many quarters of robust economic growth and I just do not see that happening. We have way too many big picture issues to sort out before we can move higher (i.e. healthcare reform, bank regulation/standards, energy independence, national debt burden, etc.). I am looking to buy dividend-paying companies with strong balance sheets, such as Proctor & Gamble, Bristol-Myers Squibb, and PepsiCo.

Is Employment a "Green Shoot?"

2009-09-10T08:25:00.000-05:00

I am still a little torn on the unemployment situation in America and some consumer spending habits. Yes, nearly 10% of Americans are officially unemployed (really it is about 17%), but I feel like the other 90% might be okay. This is my one “green shoot” for future growth as consumers account for about 70% of our gross domestic product. If you still have your job and your dividend paying stocks are still handing out cash, not much has changed for you other than the value of principal in your account is lower. Look at Apple's latest quarter...someone is still buying iPhones hand over fist! I am not sure if Apple is an anomaly or an indicator that the top 90% are better than most think (it also helps that Apple is part of a huge move toward mobile internet).

Unemployment data is a numbers game and the media often distorts it. If unemployment goes from 5% to 10%, we say it has doubled or gone up 100%. At the same time, though, the employment rate goes from 95% to 90% -- only a 5.3% decrease! Everyone knows job losses have slowed, so it is not really news. The big issue is job creation and when will it occur.

The Charts Can Lie

2009-09-01T14:41:00.000-05:00

When people say you need to buy stocks because you do not want to miss the move or because prices are trending higher...WATCH OUT! For a trader, this is heaven, for a long-term, buy-and-hold investor like most Americans, UH OH! The average, everyday investor is the one who buys at the top and gets burned. I am not saying we will test the March lows again (mostly likely that will be the low for years to come), but the potential for upside in stocks is very, very limited given what available information we have. Yes, businesses are poised for ridiculous bottom-line growth given they have been stripped down to almost nothing, but ultimately, the top line drives the bottom line. Top line growth prospects are not on my radar screen given tepid consumer spending. The only sector that has some nice growth prospects is the technology sector, especially the mobile internet companies (some alternative energy companies might be sitting pretty, but they are too speculative/the government has too much influence for my liking right now), but these stocks are already trading at very high multiples.

Why I am staying away from stocks…

2009-08-20T16:09:00.000-05:00

The monster move in stocks from the March low was people realizing the world was not going to implode (thank you, Ben Bernanke) and equity prices needed to be re-valued accordingly. People are misrepresenting this straight-lined “rally” with a robust, straight-lined recovery. This “growth” everyone is talking about is merely a bounce from unbelievably low levels, and looking forward, the growth prospects are very grim outside of government stimulus. A good analogy is like shattering your leg. The economy/stock market broke its leg in about twenty places and has about ten steel rods in it (relate the rods to new government programs to prop things up) and more surgeries will mostly likely be necessary in the future. You do not go from bed-ridden to playing sports in five months (hopefully technology will be that good someday though). You make the most progress, in terms of healing, in the first few months (because you are coming off such low levels), and stock prices are the first things that heal. Be patient, a true economic recovery will take some time -- maybe a long time. Wait for the fundamentals to improve or the prices to pullback.

Market Summary: Wednesday, June 3, 2009

2009-06-03T22:35:00.003-05:00

Private employers cut 500,000+ jobs in May and some say the economy is recovering!?

Americans are saving a lot more of their money.

Auto sales on the rise. People are still buying cars from bankrupt companies.

Stephen Schork on oil…he’s a smart guy.

Cool CNBC slideshow that looks at revenue and income per employee for the best and worst companies within various industries.

Jim Rogers thinks the S&P 500 could rally to 50,000 if the government prints enough money...laughable

The Bear State

2009-05-31T22:04:00.006-05:00

The eight largest economy in the world in 2005 according to the CCSCE(1) , responsible for 13% of the United States GDP, the world’s fifth largest supplier of food and agriculture commodities, home to the aviation and entertainment industry and 21% of the U.S. oil reserves, is the Bear Flag Republic of California. With all these advantages and resources, how is California on the brink of bankruptcy? To understand this you must review California’s state taxes, gargantuan spending habits, and inept politicians.

California’s income and sales tax is the highest in the nation. The income tax is 10.55% while sales tax increased to 9% this past April. Many businesses as well as residents are fleeing the state to California’s tax friendly neighbors, Nevada and Arizona. The graph on the right shows the amount a single individual is taxed at the highest marginal rate. From 2000 to 2007 California lost 1.2 million residents, approximately the size of San Diego, to domestic migration(2). In that same time period California has grown by 7.5%, which equates to 2 million new legal immigrants(3). With California’s high tax rate, the state is taxing the established residents right out of the state.

California’s current budget deficit is $21.3 billion, down from $33.9 billion earlier this year. California has always had budget problems. In 1991, Gov. Pete Wilson faced a $14.4 billion deficit, and in 2003 Gov. Grey Davis received a special election to be kicked out of office because of a $35 billion deficit. Then came Arnold and his $21.3 billion deficit. California deficits seem to come and go with recessions, while the surpluses usually come in good economic times. However, the surpluses always seem minute compared to the deficits. To close the deficit politicians in Sacramento have resorted to budget cuts and accounting gimmicks, and then they asked Californians to vote for a tax hike. It was not well received as you might imagine. The most recent attempt, voted on Tuesday, May 19th, was Propositions 1A, B, C, D, E, and F. All but Prop 1F failed. Prop 1A was for California to set up a rainy day fund, except it allowed state legislature to raid rainy day funds when needed. Prop 1B allowed $9.3 billion from the rainy day fund to be diverted to education. Prop 1C, D, and E allowed the state to raid trust funds and use surpluses to pay current general fund bills. The only proposition to pass was 1F, which blocked pay raises for lawmakers if they failed to balance the budget – finally some accountability. I wonder if Washington is watching? Decidedly not with another $50 billion marked for Grand Misappropriation…whoops, I mean GM. With these measures voted down by California residents, the Govenator is turning to new and creative ways to reduce the budget gap.

The state’s current plan calls for major cuts to education, healthcare and borrowing from municipal governments. This will, however, only get California a third of the way to break-even, maybe halfway if the cuts are large enough. The other half or so will come from bonds, elimination of the Cal grants, and loans from Wall Street, according to Arnold. Arnold was recently in Washington lobbying the Feds to back California’s next $6 billion bond issuance. A Wall Street loan might be too pricey for California which could result in a federal bailout. Can the American people stomach another bailout? Only if Obama wills it. California has also discussed releasing prisoners to save extra money. The last ditch effort calls for selling state infrastructure such as fair grounds and racetracks. My personal favorite is selling the LA Coliseum for $400 million, last appraised in 2001 at $16 million and depreciating. So how does California become Golden once again?

The first step is for California to stop paying for local education. The state currently pays for education from its general budget unlike other states that use local property taxes. Proposition 13 was passed in 1978 placing strict limits on property taxes with those taxes going to local communities. When the proposition passed it reduced property taxes by 57% on average statewide. If Prop 13 gets repealed California could obtain enormous amounts of funding for its school districts and cut primary and secondary education entirely from the budget leaving only higher education. California currently spends about 52-55% of the State General Fund Budget on K-12 and higher education(4). The state can also cut teachers’ salaries and benefits, which currently rank 35% above the national average. But with the Teachers Union running the show in Sacramento it is doubtful that will happen, unless done by federal mandate. Until then Sacramento’s best bet is to break into the U.S. mint in San Francisco and print its own money.

1)Center for Continuing Study of the California Economy, January 2007
2)Demographia State Domestic Migration 2000-2007 December 27, 2007
3)Demographia State Domestic Migration 2000-2007 December 27, 2007
4)http://www.dof.ca.gov/HTML/BUD_DOCS/question.htm#question7

Weekend Commentary

2009-05-31T21:50:00.001-05:00

Let me first touch on Treasurys. Everyone “knows” Treasury prices are going lower because the Treasury is issuing massive amounts of debt to pay for all of its bailouts and to keep the economy afloat. It is simple Econ 101 supply & demand – the supply of available Treasurys is increasing (and demand is weakening as people fear a downgrade of America’s credit rating and because of heightened inflation worries); therefore, prices will be lower. But are they already “lower?” Has the market already taken all of this information into account? I think it has.

Benjamin Graham said it best: “While it may seem easy to foresee which industry will grow the fastest, that foresight has no real value if most other investors are already expecting the same thing. By the time everyone decides that a given industry is ‘obviously’ the best one to invest in, the prices of its stocks have been bid up so high (or low in our case) that its future returns have nowhere to go but down.” (p. 16-17 of The Intelligent Investor)

You must remember that markets are forward looking and anticipate the future. See crude oil – prices have risen sharply but demand has yet to pick up. Given this, I am not surprised at the rebound in Treasury prices Thursday and Friday. Yields peaked at 3.75% Thursday afternoon and finished the week at 3.47% (bond prices and yields move inversely). Everyone “knows” the Treasury is going to issue record amounts of debt this year (and probably for the next few years too) but the easy money has already been made.

Now I’ll touch on a piece of information that was completely overlooked Friday. The Chicago PMI (purchasing managers’ index) was extremely weak. The May reading was 34.9 compared to 40.1 in April. The estimate was 42.0. Any reading below 50 signifies overall business contraction. I did not hear one person mention this very bearish data and pretty much every asset class rallied Friday in the face of this news. The economy is still very weak and people are getting ahead of themselves with their second half recovery talk.

Market Summary: Friday, May 29, 2009

2009-05-29T21:22:00.002-05:00

Some links thanks to Dave…

The moral of the story is do away with pensions. 401(k)s are less expensive and give people the opportunity to manage money to fit their risk tolerance, and upon retirement to move that money to an IRA and manage it however they want. The argument about bondholders being diversified and former employees not is dead-on but not in the way he meant it – there is no reason anyone should be solely dependent on any one company (also see Enron – about time we learn from this).

Mean Street: the new conflict of interest in GM

GM/Chrysler checks and balances on the bailouts. When you need checks and balances you obviously need Ralph Nader (who now lists his title as “consumer advocate”).

Treasurys and mortgage rates on the up…not good for housing problems.

Felix one-liner on Treasurys – looks at the moves in the 7- and 10-year over the last two weeks

Just when you think he’s down, Buffett’s Coke round 2?

Still waiting for sorry from Clinton

Market Summary: Wednesday, May 27, 2009

2009-05-27T20:54:00.004-05:00

Two great videos covering credit markets, rising Treasury yields, the Fed’s monetary policy, our trade deficit, and other macro economic issues: Video 1, Video 2

An in-depth look at malls and why so many are closing

A piece on inflation and rising bond yields

Home prices are back to “normal” levels but there is still a ton of mortgage debt out there

Jeff Macke, one of the talking heads on CNBC, went crazy last week

Nice summary of today’s action

More chatter on newspapers

2009-05-27T07:14:00.004-05:00

Talk over the "death of" the newspaper industry is getting to be a bit worn as it enters its nth week of doom-saying, but I bring it up again because Congress, chaired by John Kerry, who was concerned losing the Boston Globe, has finaly sparked an interest and held a few hearings.

My journalism-student friend who showed me footage of a speaker at the hearings who really impressed me. David Simon, who used to be a reporter for the Baltimore Sun, made an enthralling and insightful speech about his take on the environment, and the many sins of both sides. Mr. Simon doesn't hold the same conflict of interest as current-day newspapermen, having left newspapers in the mid-90sand. He has since gone on to create and write the acclaimed HBO series, The Wire. Sweet.

Check out this video of his full speech here, David is an enthralling speaker.

Unfortunately, despite doing a fantastic job defining the context and urgency of the issue, and fairly painting both sides as to blame, I don't think David Simon offers a feasible solution.

I'll leave the context painting to David, and jump to his 3 proposed solutions, which he gives near the end of his speech. Again, if you're not familiar with the matter, or if you want to get the skinny from someone who can really sum up the entire problem from both sides in a fair and balanced manner, please watch the video.

1. David says:

"...a non-profit model intrigues. Especially if that model allows for locally based ownership and control of news organizations. Anything the government can do in the way of creating non-profit status for newspapers should be seriously pursued."

Interesting idea, but how would it work? This seems to conflict with a sentiment he expressed right before saying this - that newspapers should bite any hand that feeds them. Who would own them?Corporations? Wealthy locals? And what local interests would be willing to fund journalism on an international scale?

And what type of non-profit would newspapers be classified as? 501(c)(3) non-profits are strictly prohibited from engaging in politics. I'm classifying newspapers as a 501(c)(4) might work,despite the fact that (c)(4)'s are not allowed to further the private interests of those with financial stakes in them. This happens at public accounting firms, and essentially would mean that folks who work at newspapers can't own stock in anything their newspaper is reporting on whose story they can influence. However, C-4s are at least allowed to lobby and campaign politically.

Otherwise, Congress could simply write newspapers in as their own new 501(c), the real challenge remains figuring out how to finance the non-profit, all this would do is ease their tax burden.

2. Another of David's ideas:

"And further, anything that can be done to create financial or tax based incentives for bankrupt or near bankrupt newspaper chains to transfer or donate non-profitable publications to locally based non-profits should also be considered."

A short term solution, not one which is going to do anything but save a few brands and create tax haven for inventive accounting schemes. Such regulation issues could stem far into the future unless you set a real short sunset-clause on such a bill. How many companies that put out "news" or that own subsidiaries that are news organizations do you think will try to take advantage of a hastily drawn bankruptcy loophole in tax law?

And to what end would this serve, anyway? We are simply handing off a broken business model to some other company who won't know what to do with it. Such scaling back by a new owner would likely follow a Private Equity model, which would break any unions in bankruptcy court, then strip the company of assets and lay off a ton of people, building operations from the ground up again. I doubt this is what anyone has in mind for saving the "industry."

3. Third Simon idea, and this is the big one:

"Lastly, I would urge congress to consider easing anti-trust prohibitions to that the Washington Post, The New York Times, and various other newspapers can openly discuss protecting copyright from aggregators, and plan an industry-wide transition to a paid, online subscriber base."

Simon says it costs money to maintain the current model sending people places. That's abosultely right, it does cost money to do this, and it will always cost money to do this. But how in the world are you going to prevent people from accessing this information for free?

Let's look at how things work, currently. Information is released to the public through the website, and the two prevailing ideas are either people pay a flat-rate for all access, or make micro-payments for each article.

WSJOnline works with the flat rate for all access, and hybridizes the model by letting some of it remain free to the public, probably trying to incent new customers to subscribe by giving them a taste, while supporting the free part somewhat through banner ads. I have my doubts on this model, as I have not heard it working too well for WSJ, and nobody else seems to want to try it. Perhaps the micro-payments option could "work" once the infrastructure is in place (i.e., people find it easy and convenient to pay a few pennies to click on a link). This system can and will be developed, and I'm sure if newspapers won't pioneer this technology, amazon or ebay will, as they make the online payment process faster and easier. It's another question entirely as to whether or not customers will buy-in.

However, I think these suggestions are treating a symptom, not the disease. So people aren't paying for newspaper articles online. Fine, there's the symptom. The disease comes from the fact that readers are just getting the information from elsewhere. As David Simon explains, the blogosphere

"does not deliver much first generation reporting. Instead, it leeches that reporting from main-stream news publications whereupon aggregating websites and bloggers contribute little more than repetition, commentary, and froth. Meanwhile, readers acquire news aggregators, and abandon its point of origin, namely the newspapers themselves."

This is not only absolutely true, but describes what our website does in it's entirety!

Can we stop blogs from doing this? Look at how difficult it has been to police illegal music and movie file-sharing. And that's data where the content (i.e. the syntax) doesn't change. Imagine how difficult it would be to police for stolen semantics? That aside, by chasing quotes or hyperlinks alone, our government would need to invest in an incredibly expensive and difficult-to-maintain technological regulation program that would almost certainly infringe on our first amendment rights. In fact, the mere act of policing for everything written in newspapers sounds in itself, to pull from Simon's panoply of references, Orwellian.

This is why, although David Simon can complain and enlighten, he does not deliver a feasible solution. Technology is always going to be disruptive. I'm fully aware how frightening that this time, it is disrupting an important and necessary public good, but that isn't going to turn back the tide.

Is this death of journalism as we know it as bad as everyone assumes it to be? Ask yourself how mediocrity was allowed to flourish prior to the internet, which is what Mr. Simon purports. What do you need to combat that mediocrity? Obviously, newspapers aren't the best answer - otherwise we wouldn't have had an industry which "butchered itself" (Simon's words) in quality. And certainly, this is not a sin of the newspaper industry limited to our times, lest I cite the period of "yellow journalism" at the turn of the 19th century.

Isn't it clear that the best model will come from one which people can describe as important to them as soon as it happens, and which the powers that present the issues can aggregate these concerns and speak about them in one cohesive voice? Mr. Simon recalls when Baltimore newspapers stopped reporting on social services, despite the fact that 50% of adult black males in Baltimore were without a job, or now newspapers were ignoring the Baltimore criminal courts, despite the high degree of crime in the city. Contrast this with Google, which now can literally save lives by tracking when and where spikes of "flu symptom" search queries appear, and notify the CDC or regional health care groups, who can act to combat an outbreak before it becomes an issue. Whatever solution to journalism comes about, if its input is crowd-sourced, it will truly have a finger on the pulse of what people care about. Thic can easily be done by noting what people talk about in a traceable public forum (like the blogosphere and twitter) that would help whatever replaces the current journalism model concentrate its efforts.

Obviously, news does much more than this, by also enlightening its audience on issues people who didn't know they cared about. I don't know how this can be done reliably. However, to the extent that these issues are corruption, I think we can at least start by trying to better frame the problem. I think that journalism fights corruption in places where there isn't enough transparency. The real issue in solving corruption, therefore, must be in increasing transparency. This is something technology is very good at doing.

Lastly, I take issue with Simon's opinion of the quality of the blogosphere - not in terms of how it gets its information, Snow describes our sins with great accuracy there, but rather by the manner in which people treat the writing. I find it quite easy to know when to stop reading a blog post, or a comment on a blog post, as I've developed an eye for a quality argument. There are enough bloggers out there who I have grown to trust and respect who add value even if it isn't first-generation news. I also find it much easier in this new technological environment to do the appropriate fact-checking, or get a contrary opinion. And hopefully, as more data is published on the interenet and search becomes more inteelligent, that fact checking will have to rely less and less on other journalist articles, and more on the real, unbiased data or record (take, for example, what is expected of data.gov, especially considering when powerful search tools like Wolfram|Alpha integrate with those services).

Anyway, the same skepticism over honesty, integrity, and completeness has always held true over newspapers as well. Why else do people complain over Fox News, or say that one does not get a real perspective of a news story unless they read 2 or 3 different papers?

How do we save newspapers? I guess Simon has cited the best ideas the industry has going it - force paid content and imbibe the industry with tax exempt status. Will that actually work in the long run? Doubt it.

Maybe we should be asking how else the world can find out about what is going on...

Market Summary: Tuesday, May 26, 2009

2009-05-26T21:54:00.002-05:00

Bill Ackman talks about his Target proxy fight and being an activist investor…FANTASTIC, Video 1, Video 2

Home prices continue to fall. Take it with a grain of salt because this data is from March so it’s a little backward-looking.

Not everyone is happy with Obama’s appointment to the Supreme Court.

Consumer confidence soars and sparks a huge rally on Wall Street.

Kim Jong-Il keeps trying to scare the you know what out of everyone.

GM and Chrysler update; GM bondholders reject offer.

Facebook valued at $10 billion.

Are the "Green Shoots" Wilting?

2009-05-25T20:47:00.002-05:00

Do you believe what everyone is saying about a second half recovery? Do you think the worst is behind us? Do you think we are out of the woods? Not so fast!

In early March, when the stock market bottomed, everyone was talking about how Armageddon was upon us. Now, just two and a half months later, everyone is talking so optimistically about how the economy is recovering nicely.

This bear market rally – yes, we are still in a bear market and will be for some time – was caused mostly by short covering. That is, people who were betting stocks would fall reversed their bets when the market turned higher after Citigroup said it was “profitable” the first two months of the year (I’ll touch on the banks’ false profits later). Some of the worst performers from 2008, which were the most heavily shorted stocks, have led the market higher.

I am not a buyer of this false rally and all the economic “green shoots.” Right now, the path of least resistance for stocks is lower because all the “good” news has been priced into stocks. Everyone is a little too optimistic about a recovery in the near term (I think we will be trending sideways for a long time) even as some economic indicators are worsening.

The stock market has rallied 31% from its recent low, but it will not go much higher. Current earnings estimates for the S&P 500 are $56.94 for 2009 and a whopping $73.37 for 2010. (source: Thompson Reuters) Is it realistic that companies will improve their earnings 29% over the next 18 months? I do not think so! Earnings estimates will come down; therefore, stock prices will come down too. Here’s why:

1) Companies are selling assets to raise cash (especially banks) and they will not have the same earnings power going forward.

2) Unemployment is expected to go to at least 10%. Even though initial jobless claims are “stabilizing,” continuing claims hit a new record every week. As more and more people lose their jobs, spending will decrease causing corporate earnings to decrease.

3) Taxes will go up to help offset the government’s massive debt. Obama already said this is going to happen; it is a matter of when not if. As personal income taxes go up, the consumer will get pinched and decrease spending. Corporate taxes will also go up which will cause companies’ bottom lines to shrink. To offset decreased profits, price increases (inflation) are very likely which will also hurt the already ailing consumer.

Also, who wants to invest when the government keeps changing the rules and intervening? First were restrictions for financial companies that took (or, rather, were forced to take) TARP money. Next were the automakers. The government should just cut its losses and forget about setting up a government-owned auto company that will buy GM’s “good” assets when it files for bankruptcy. Ridiculous if you ask me. Government cannot run government. How is it going to run an auto company? Now it is the credit card companies and new legislation preventing rate hikes when people miss their payments (in no way, though, am I saying what credit card companies were doing was right).

Let me briefly touch on the banks’ “false” profits. Goldman Sachs (GS) reported better than expected earnings because it shifted its fiscal calendar so December results were not included in its most recent earnings release. GS had a $780 million after-tax loss in December that will go largely ignored. (source: nytimes.com) Citigroup and Bank of America were profitable because they were able to book “gains” (thanks to mark-to-market accounting rules) as their CDS spreads deteriorated. Basically, they lowered the value of the liabilities on their books and this reduction was treated as a gain on the income statement. (source: Portfolio.com)

That is enough negativity for now. Let’s focus on some positives. Below are some recent fundamental improvements in the economy.

1) Banks have been able to raise capital successfully in the equity market to meet the government’s stress test requirements. Many of these offerings have been over-subscribed – a sign that investors have a higher appetite for risk. Most notably, Bank of America raised $13.5 billion, Wells Fargo raised $8.6 billion, Morgan Stanley raised $4 billion, and U.S. Bancorp raised $2.5 billion. (source: Bloomberg.com)

2) Banks are not afraid to lend to one another anymore. The overnight LIBOR rate currently sits at 0.46%, down from its high of 4.82% after the collapse of Lehman Brothers. (source: Bloomberg.com)

3) Corporations have been able to issue debt. Recently, Microsoft issued $3.75 billion and Wal-Mart issued $1 billion. However, only companies with the most pristine balance sheets have been able to access the debt market. (source: Bloomberg.com)

4) IPOs have started to pick up again after being non-existent for some time. There were 296 IPOs in 2007, 57 IPOs in 2008, and eight so far this year. Seven of the eight IPOs this year have taken place after the market bottom in early March. (source: MSNBC.com)

5) Mortgage rates are still near historic lows even as yields on longer term Treasurys have steadily risen. The average 15-year fixed rate mortgage is 4.64% and the average 30-year fixed rate mortgage is 5.00%. (source: Yahoo! Finance)

6) Commodity prices are rebounding with the biggest gains coming in the energy complex. Gasoline futures are up 132% from their late-December low of $0.785 and crude oil futures are up 89% from their mid-December low of $32.40. Demand from the emerging markets remains strong as they avoided a lot of this financial mess, and OPEC is talking about cutting production again. There is also talk that the “evil” speculators are back and they are the reason prices have rallied so strongly. (source: Barchart.com)

Even though there may be signs that the economy is “not as bad” as before or that it is “stabilizing” (two phrases that I hate and hear way too often on television), there are many fundamental problems that remain. Do not get caught up in the media’s effort to talk-up the stock market or the economy. If you turn your head to the problems that still exist, like the media is doing, you will get burned when everyone finally realizes we are not out of the woods just yet.

Gold Rally

2009-03-01T16:39:00.001-06:00

The easy money has been made with the gold trade. Futures hit a low of $681 in late October and have since rallied to $1008 (02/20/09). The government has flooded the economy with dollars and future inflation is evitable (Obama’s pledge to cut the federal deficit in half by the end of his first term is laughable). Everyone knew gold should go higher and it did – a 48% rally trough to peak. Gold has also been bid up as it is also a flight-to-safety trade given the highly uncertain and tepid equities market. However, gold is still off its all-time high of $1034 (March 17, 2008, Bear Stearns collapse).

Five years from now, I believe, gold and other precious metals will be trading at much higher levels, but recently, the gold trade has become very crowded. That is, everyone (and I mean everyone), is buying gold or on CNBC saying you should buy gold. Gold has since pulled-back to $930.

Here's the rule to follow: Do not chase what everyone else is buying (or saying to buy). Just because other people are buying does not mean you have to buy. The thesis may be correct, but the price may not be correct. When people say to buy something, it is probably too late. Wait for the pullback and the pounding-the-table "buys" to subside to get a good entry point.

Financial folly: A (meager) defense of the nationalization of banks.

2009-02-02T01:24:00.004-06:00

The famous John Bogle, founder of Vanguard Mutual Fund group, reminds his readers in Enough of an epigram from 18^th century Britain:

Some men wrest a living from nature and with their hands; this is called work.

Some men wrest a living from those who rest a living from nature and with their hands; this is called trade.

Some men wrest a living from those who wrest a living from those who rest a living from nature and with their hands; this is called finance.

Of course some people have always been skeptical of the real value finance holds. Tim O’Reilly, who, while being a very smart guy, is certainly not a finance guy, and about a month ago put out an essay on his blog likening our global economy to a Ponzi scheme in itself. Tim cites former World Bank economist Herman Daly, who was griping about the global crisis back in October last year.

As Daly puts it “Real wealth is concrete; financial assets are abstractions—existing real wealth carries a lien on it in the amount of future debt.” And while Daly made this statement to set up an obvious argument about how debt works, this point is illustrative for a different reason – why are financial assets abstractions?

Gao Xiqing, the president of China Investment corporation, a SWF that manages $200billion of China’s foreign assets, and makes the most newsworthy of China’s foreign investments (Blackstone, Morgan Stanley, etc), described financial assets in a recent Atlantic article this way:

First of all, you have this book to sell. [He picks up a leather-bound book.] This is worth something, because of all the labor and so on you put in it. But then someone says, “I don’t have to sell the book itself! I have a mirror, and I can sell the mirror image of the book!” Okay. That’s a stock certificate. And then someone else says, “I have another mirror—I can sell a mirror image of that mirror.” Derivatives. That’s fine too, for a while. Then you have 10,000 mirrors, and the image is almost perfect. People start to believe that these mirrors are almost the real thing. But at some point, the image is interrupted. And all the rest will go.

These assets are nothing more than contracts, and are conceived in acts of financial wizardry as quickly as they can be sold. Daly addresses this point head on:

Can the economy grow fast enough in real terms to redeem the massive increase in debt? In a word, no. As Frederick Soddy (1926 Nobel Laureate chemist and underground economist) pointed out long ago, “you cannot permanently pit an absurd human convention, such as the spontaneous increment of debt [compound interest] against the natural law of the spontaneous decrement of wealth [entropy]”. The population of “negative pigs” (debt) can grow without limit since it is merely a number; the population of “positive pigs” (real wealth) faces severe physical constraints.

Fine. We get it. These things can be dangerous. Dividends in particular are financial weapons of mass destruction, as Buffet put it like a million years ago. But our economy creates a lot of really valuable stuff that only exists as an idea, as bits of information, not in any warehouse. Through an accountant’s eyes, how are derivatives fundamentally different from software, or insurance, or a new drug? Leverage is a complex and value-adding technology; one must know how much of it, of what type, and how and when to re-position it. Our problem with leverage was not that we had too much, but that we didn’t understand it. As entities de-lever, they are returning to positions where they won’t be in as much hot water the next time they get it wrong. This is akin to releasing a drug too soon, and finding out that it has a chance of killing people.

What’s the solution? Well, we can start with improving our financial regulation, which has proven pretty soundly that it is less than useless – it’s dangerous. I don’t have the time in this article to discuss the many things we should probably be doing to fix regulators and rating agencies, but I do want to address one concern: complexity. The GAO (Government Accountability Office) had this to say in a recent report entitled A Framework for Crafting and Assessing Proposals to Modernize the Outdated U.S. Financial Regulatory System:

As new and increasingly complex financial products have become more common, FASB and SEC have also faced challenges in trying to ensure that accounting and financial reporting requirements appropriately meet the needs of investors and other financial market participants. The development and widespread use of increasingly complex financial products has heightened the importance of having effective accounting and financial reporting requirements that provide interested parties with information that can help them identify and assess risk. As the pace of financial innovation increased in the last 30 years, accounting and financial reporting requirements have also had to keep pace, with 72 percent of the current 163 standards having been issued since 1980—some of which were revisions and amendments to recently established standards, which evidences the challenge of establishing accounting and financial reporting requirements that respond to needs created by financial innovation.

CFO Blog mentioned this report two weeks back (it’s where I found that quote), and elaborated:

Accounting rulemakers have struggled to keep pace with financial innovation… But missing from this statement of the bleeding obvious is the fact that many of the 'financial innovations' in question were innovative because they were slick end-runs around accounting rules. Structured finance, by definition, is some form of leverage whose structure is complex enough that the letter of accounting rules does not apply. Ditto for hybrid securities, intended to win preferential accounting and tax treatment.

What does this issue have to do with nationalizing our banks? Nassim Taleb, recently stated on Charlie Rose that banks should be treated as utilities. The entities that take the real risks, the sophisticated investment vehicles like hedge funds, will still have role, albeit significantly smaller, and under the explicit understanding that they will never be bailed out again. Could this stronger control restrain us from making big bets on complexity that we do not yet understand? Could government oversight allow for economists to have a greater sense of how finance works, and allow for us to design better models for control? Perhaps, although we can probably be just as certain of the inefficiencies and restrained growth that comes with bureaucracies and government oversight.

Should we nationalize banks? Should bank holding companies just be plain-vanilla utilities? I have no idea, but I do know that we don’t seem to understand how the modern capital markets really function. And even if we do, we definitely don’t have the transparency and the appropriate control systems in place to organize this system to our predictions and analysis will be relevant. Would having our government oversee these capital markets help our economists develop the appropriate theories to understand our world? If so, it sure sounds a lot like communism. Not that we’re not pushing that envelope anyway.

Bringing it all back to Tim O’Reilly and Daly’s arguments, they promote a “steady state” economy. With the arguments I have made in this post, I will continue this week to discuss the merits and the issues with a steady state model as I see them.

Market Summary: Mon. Jan. 26, 2009

2009-01-26T23:07:00.001-06:00

Something I noticed today that was not talked about too much in the news was the significant amount of job cuts announced.

1) Home Depot will lay off about 7,000 workers (2% of workforce), and it will exit its EXPO business.

2) Caterpillar will eliminate 20,000 jobs (almost 18% of workforce). The company also reported earnings that missed expectations. Q4 net income was $1.08 per share (compared to $1.50 per share a year earlier) while analysts were expecting $1.30 per share.

3) Sprint Nextel will cut 8,000 jobs (about 15% of workforce). The job cuts will save the company about $1.2 billion each year.

4) GM will cut 2,000 jobs (3% of 64,000 employees) at plants in Ohio and Michigan. The last time GM made a profit was in 2004 when the company employed 111,000 workers.

5) Deere will cut about 700 jobs (just over 1% of workforce) at factories in Brazil and Iowa.

6) ING, a Dutch financial company, will lay off 7,000 workers (about 5.5% of workforce).

7) IBM reported that it eliminated 1,400 sales jobs (about 3.5% of workforce) last week.

Companies are going to great lengths to lower costs and the easiest and fastest way is to reduce the number of employees. Obviously, these companies are behind the curve, but I look at it as a positive sign.

I became much less bearish on my outlook for the economy and the stock market after I attended University of Illinois’ town hall meeting where the school’s budget and plan to cut cost and over the next few years was discussed. It takes a great deal of time for large institutions to make changes (especially financial ones), and when these big institutions finally realize they need to make changes the worst is already behind them. In no way am I saying that the economy will bounce back and the stock market will zoom higher, but for now, people know things are bad and they are finally making the appropriate decisions to deal with the stagnant economy.

Re-inventing economics: Part 1

2009-01-25T10:32:00.002-06:00

One of my favorite bloggers, Fred Wilson, recently questioned the relevance of economists, especially after their inability to predict, as well as (arguably) correct this current global economic crisis. Fred cites Umair Haque, who griped that “We can't fix today's problems unless we change yesterday's rules. But economists -- and the models they rely on -- are bounded by yesterday's rules.”

Now I’ve got no patience for people who try to ignore the past because they of sensationalism or some naive idea that this time it’s all different. However, we can always improve on the past, so in this post is the first of two very potent ideas I’ve read about recently pertaining to a shifting opinion in modern economics.

Nobel Laureate Joseph Stiglitz (well, Economics isn’t one of the REAL Nobel Prizes, but everyone treats it that way) has put out a paper with a handful of other clever clogs describing a fresh look at economics based on modern networks theory. They developed their paper using data pulled from banks and certain firms in the 2004 Japanese credit market.

The paper basically argues that the old way of looking at markets through “the average, or most probable, behavior of the constituent” does not best describe the true “dynamics of the system,” when that system is made up of autocatalytic processes. Autocatalytic processes are simply processes that grow on their own (self-perpetuating), and in this case, they become very important when they grow faster than the average, or most probable process. This type of growth can be “scale-free” or “scale-invariant,” which means the bits and pieces that make up the whole all grow at different rates, so after time some processes become more important than others.

So to put it simply, Stiglitz & co basically said that we should use a theory that doesn’t ignore the rare (i.e. not average or most probable) processes, when those processes can grow at astonishing rates, and become very important (e.g. processes that caused this crisis). “The real world is controlled as much by the tails of distributions as by means or averages” (page 2).

And not that this is new: apparently “the relevance of scale free distributions in economics (e.g. of firm size, wealth, income, etc.) is now extensively recognized, and has been the subject of thorough investigation in the econophysics literature” (page 2). I don’t even want to imagine what econophysics is. Regardless, people apparently haven’t given much consideration to how this type of thinking relates to credit markets, UNTIL NOW! The authors purport “…Japanese credit market shows that the credit relations between banks and firms are scale-free, and the standard representative agent plus normal distribution framework is badly equipped for dealing with it” (page 2).

I could be wrong, but I’m pretty sure this is basically chaos theory (which has been around for decades) meets the credit market.

An example the authors give is “the failure of a firm heavily indebted with a bank may produce important consequences on the balance sheet, or the financial status, of the bank itself. If a bank’s supply of credit is depleted, total supply of loans is negatively affected and/or the rate of interest increases, thus transferring the adverse shock to the other firms. Therefore the study of structure of the links and their weights allows to gain some insights in the financial stability of the economic system and to develop new economic policy tools” (page 2). This all looks to be pretty obvious – surely anyone with a passing interest in economics or finance recognizes the interrelatedness of these processes. Joe and Co just look like they’re one of the first guys to decide to map out and measure those links and their weights, this time in a controlled experiment (2004 Japan).

Network theory is an analysis of the interrelationship between nodes and links. In the case of this paper, nodes are banks and firms, while links are debt/credit contracts those banks and firms hold.

I don’t have the patience (or probably the intelligence) to wade through the actual research, but the conclusion offers some interesting opinions on how lessons learned from this data can maybe produce useful tools to stem future crises.

Basically Joe & Co think that “instead of a helicopter drop of liquidity, one can make “targeted” interventions to a given agent or sector of activity.” Presumably, if you use network theory to understand how problems of, say, liquidity arise, then you can surgically fix the problem at its source. Of course, in order to put this into practice, economists would both need to satisfy a tall list of demands:

1. Have at hand all of the relevant data (this probably means every balance sheet for every relevant institution as well as every debt contract [both of which of course must include homeowners’ personal finances and their mortgages]
2. Intimately understand all of these autocatalytic processes (of which in a modern economy there must be potentially millions)
3. Be able to act quickly enough to solve the problem before it gets out of hand

Sounds like the job for a totalitarian, dystopian, and super-intelligent government. But let’s be honest, wouldn’t access to that degree of information be every economist’s dream? Or perhaps this will all be possible, now that we are building petaflop computers that can probably manage the work, and we own all of the banks anyway…

Market Summary: Fri. Jan. 23, 2009

2009-01-23T20:07:00.000-06:00

Capital One (COF), a credit card company, reported poor fourth quarter earnings and gave a very negative outlook. For the quarter, COF lost $3.74 per share while analysts were expecting a profit of $0.33. The company set aside $1 billion for bad loans, and expects unemployment to rise to 8.7% and home prices to decline another 10%. The company’s CFO said that “the really big risk to our outlook isn’t 2009, but it is what 2010 might look like.” The company also said that 7.08% of its credit card and auto loans were in default. During the third quarter, this figure was only 5.85% (Source: WSJ).

Based on what Capital One said, we should not expect a quick recovery anytime soon. 2009 just began and COF is already preparing for a bad 2010. Many analysts are expecting credit cards and auto loans to be the next shoe to fall.

Citigroup tapped the government’s Temporary Liquidity Guarantee Program for $12 billion. This money is guaranteed by the Federal Deposit Insurance Corp. (FDIC) making it the highest rated debt. This is the largest debt offering under this program since its inception on November 25, 2008. When will the government just cut its losses and let Citigroup go under?

Freddie Mac also announced it will need $35 billion of government TARP money.

Market Summary: Thurs. Jan. 22, 2009

2009-01-22T23:13:00.000-06:00

Negativity returned to the market today, but stocks managed to finish well off their lows. Stocks were down more than 3% this morning, but only finished down 1.5%. Even though stocks lost ground, there was no flight-to-quality trade as investors actually sold Treasurys today (yields up). When investors are willing to take on more risk – financials, growth names (infrastructure, energy, and materials), and emerging markets – the market will turn higher.

Down-beat news from Microsoft set the tone for the markets today. The company announced that it “will cut as many as 5,000 jobs, the first companywide firings in its 34-year history.” Net income for the fourth quarter was $0.47 per share, but analysts were looking for about $0.50. Revenue also fell short of expectations by about $500 million. The stock finished down 12% and did not rally when the market turned higher in the afternoon. It actually closed near its lows.

Recently, there has been a clear divide between the tech winners and losers. Winners: Apple, IBM, Google, Hewlett-Packard, and Research In Motion. Losers: Microsoft, Intel, Dell, and Yahoo.

Worse-than-expected economic data also weighed on the markets. Initial jobless claims were 589,000 last week – 46,000 more than expected. Also, continuing claims increased to 4.61 million. December housing starts and building permits were both below expectations. Crude oil inventories increased 6.1 million barrels last week – 4.7 million more than expected (Source: Briefing.com).

The most surprising news story of the day was John Thain, the former Merrill Lynch CEO, getting fired from Bank of America. Much controversy has surrounded the Bank of America acquisition of Merrill Lynch because Merrill reported a $15.4 billion fourth quarter loss. What problems did Merrill Lynch have that Bank of America did not know about? Was Merrill hiding something? On top of his firing, it was reported that Thain spent over $1.2 million to redecorate his office when he became CEO. He spent $87,000 on area rugs and $25,000 for a table. Ridiculous! He deserves to get fired.

After hours Google reported stellar earnings that handily beat expectations.

Market Summary: Wed. Jan. 21, 2009

2009-01-21T19:19:00.001-06:00

We saw a relief rally from yesterday’s massive sell-off, although stocks are still down over the two-day period. Stocks got a little over-sold yesterday (especially the financials), and investors went bargain hunting today to buy the stocks of good companies on the cheap.

Here’s the news:

1) FDIC Chairman Sheila Bair commented that “banks are solvent” and “well-capitalized overwhelmingly.” Either she is lying to assuage Americans’ concerns or she does not know what she is talking about. Banks are in desperate need of capital, especially the large institutions with lots of mortgage-related securities, as they are rapidly burning through the TARP funding that was just distributed.

2) Talks of forced nationalization of UK banks continue to scare investors. Barclays was down 19% and Lloyds was down 12.5%. The UK government owns a 70% stake in Royal Bank of Scotland and a 43% stake in Lloyds.

3) Financials led the market higher after news broke that several bank insiders purchased shares. JPMorgan’s Jamie Dimon bought $11.5 million of stock, and Bank of America executives purchased about $3 million of stock. Insider buying is considered a bullish sign for a stock.

4) Shares of Wal-Mart were downgraded because “the incremental benefit it realized from consumer trade-down in 2008 might not repeat itself in 2009.” I agree with this analyst. Wal-Mart has rallied significantly from its September 2007 lows even though its earning have not kept pace. When the market turns Wal-Mart will be left behind along with many of the defensive stocks.

5) Warren Buffett purchased another $272.2 million of Burlington Northern (BNI) shares. Buffett’s 21.75% ownership in BNI makes him the company’s largest shareholder.

6) US Bancorp reported quarterly profit of $0.15 per share, which fell short of the $0.18 estimate. During the quarter the bank quintupled the amount set aside for loan losses. Shares were down 20% in the morning, but actually finished the day in the green. This is one financial company that actually made money in the fourth quarter. Pretty impressive!

7) Apple reported quarterly results after the bell that handily beat estimates. Despite Steve Jobs’ illness, the company is still performing and remains a “buy.” The company reported earnings of $1.78 per share. Analysts were expecting $1.40. Revenue also beat expectations and rose 5.8% year-over-year. Quite impressive numbers given the state of the consumer and economy.

8) Intel announced it may cut up to 6,000 jobs.

9) Hedge fund investors withdrew a record $152 billion in the fourth quarter of 2008.

Market Summary: Tues. Jan. 20, 2009

2009-01-20T18:52:00.004-06:00

As I said in my last post, as the financials go so does the market. Stocks finished the day down 5.3% and the financials (XLF) were down 16.5% (when I say stocks I am referring to the S&P 500). Today’s news simply reiterated the fact that all financial institutions are in trouble (at home and abroad) and remain a “sell.” They are simply not investable. How are they going to make money in the future? Will they even be public companies?

The big losers:

- State Street Corp -59.04%

- Barclays -42.62%

- PNC Financial Services -41.40%

- Bank of America -28.97%

- Regions Financial -24.22%

- Wells Fargo -23.82%

- JPMorgan -20.73%

- Citigroup -20.00%

- Goldman Sachs -18.96%

European banks have been under pressure too. Concerns are mounting that Royal Bank of Scotland may be nationalized by the British government. The company lost $41 billion in 2008 and the British government is exchanging its preferred shares of common shares that could give it 70% ownership in the bank. Because of this news the British Pound was crushed today. It trades at its lowest level versus the Dollar in almost eight years.

The U.S. government is way ahead of European governments in terms of financial aid and bailouts. Look for weakness in Europe, specifically Britain, to continue.

- Fiat is in talks to acquire a 35% stake in Chrysler. There is no cash involved with this transaction, and it is not a merger. The companies would get access to each other’s plants and technology.

- Meredith Whitney explained what is going wrong at Citigroup. Its “core problem is that it simply doesn’t make money in any of its businesses except Smith Barney, which it is in the process of selling.” After the bell, Citigroup announced it is cutting its dividend to $0.01 from $0.16.

- Here is a good article that discusses the oil market. There is an estimated 80 million barrels of oil being held on offshore tankers in order to take advantage of the steep crude curve. That is, buying cheap crude today (spot market), storing it on these tankers, and then selling it in the future at a higher price.

- After hours, IBM reported earnings that beat estimates. Shares are up 4% in after hours trading.

- Obama took office today. But guess what? Nothing changed about our economy. It still stinks!

- The government has given Citigroup $45 billion in loans, but the company’s market cap is only $15.3 billion. The government should just buy the company outright, do what it wants with the good and bad assets, and avoid all the added uncertainty and fear that is plaguing the financial markets.

Market Summary: Fri. Jan. 16, 2009

2009-01-16T21:07:00.008-06:00

Citigroup and Bank of America led the markets lower in the morning; however, a midday reversal (for the second day in a row) helped stocks finish in the green. The financials are to blame for the steep declines in the stock market as concerns mount about the health of these large institutions.

Let’s wind the clock back to November 4 when the S&P 500 closed at 1,005.75. Everyone was concerned about Citigroup’s capital position, and on November 21 when the government finally stepped in to help Citigroup the market bottomed at 741.02 – a 26.3% decline. During this same time shares of Citigroup were down 74.3%.

We have recently found ourselves in a similar situation, this time it involves Bank of America and its need to raise more capital to help with its acquisition of Merrill Lynch. Also, concerns at Citigroup about selling assets to raise capital have weighed on the market. On January 6, the S&P 500 closed at 934.70. On Thursday the market bottomed at 820 – a 12.3% decline. During this same time shares of Bank of America were down 49.7% and shares of Citigroup were down 53.1%.

Here’s the news:

- Citigroup announced that it will split into two companies, Citicorp (good bank) and Citi Holdings (bad bank). “Citicorp will be home to the company's retail banking and credit card businesses, its corporate and investment bank, Citi Private Bank and a transaction services unit. Citi Holdings would house brokerage and asset management units…and a 49 percent stake in a new brokerage venture with Morgan Stanley. It would also hold local consumer finance operations…Citi Holdings would house $301 billion in assets that received government backing in a November rescue package.”

- Citigroup also reported a quarterly loss of $1.72 per share. Analysts were predicting a loss of $1.32 per share.

- Bank of America (BAC) received $20 billion in TARP money and a guarantee from the government on $118 billion of its assets. BAC received this money to help with its Merrill Lynch acquisition.

- Bank of America reported a quarterly loss of $1.79 billion and Merrill Lynch (B of A’s newest acquisition) reported a quarterly loss of $15.31 billion. BAC also reduced its quarterly dividend to $0.01 from $0.32 to preserve cash. Some are questioning whether or not the CEO’s knew that the Merrill results were going to be horrific and why they would let the acquisition get done. Merrill lost $16.4 billion in failed hedges.

Is the worst behind us? Or is there more pain to come from the banks? The talk is that Wells Fargo (WFC) will need to raise more capital to help with its acquisition of Wachovia. WFC reports its quarterly results on January 28. On December 1, the well-renowned analyst Meredith Whitney was asked if she could sell one bank which one would it be. Her response was Wells Fargo. On January 14, Whitney reiterated her negativity towards the financials. In other news…

- Chrysler Financial received a five-year $1.5 billion loan from the government in order to entice buyers with no-interest financing.

- Circuit City will close all of its stores after it failed to find a buyer.

Market Summary: Thurs. Jan. 15, 2009

2009-01-15T21:50:00.000-06:00

The Dow and the S&P 500 finished up a few points, but the tech-heavy NASDAQ was the winner finishing up 1.5%. Stocks reversed on little news midday after being down about 2%.

Here’s the news:

1) JPMorgan reported fourth quarter income of $0.07 per share. Not including a one-time gain, the company actually lost $0.28 per share. JPM wrote down $2.9 billion worth of assets and tripled its loan-loss provisions for bad debt. CEO Jamie Dimon said the company remains committed to paying its dividend. Shares finished the day down 6%.

2) Bank of America is close to receiving $15-20 billion in TARP funds from the government. The company could also receive $120 billion in guarantees on losses from bad assets. When Citigroup received its bailout money, it got $20 billion and $306 billion in guarantees. Shares of BAC were down 18.5% on the day.

3) As expected, the European Central Bank cut its benchmark interest rate 50 basis points to 2%. President Jean-Claude Trichet said inflation risks are “broadly balanced” and he does not expect rates to go to zero. The Euro was unchanged on the day as this move was expected.

4) General Motors lowered its U.S. auto sales estimate to 10.5 million units in 2009 from its previous estimate of 12 million. GM will receive a $5.4 billion loan from the government on Friday as part of a previously announced rescue package.

5) Shares of Wells Fargo finished the day down 12.5% after an analyst said the company may need to raise $10 billion and cut its dividend in order to complete its acquisition of Wachovia.

6) Shares of Citigroup were down as much as 25% today on concerns the company might need more government assistance. Citi has already received $45 billion from the TARP.

7) Apple was only down 2.3%, much less than some people thought, after CEO Steve Jobs announced he will be taking a leave of absence until July. There was a report that Jobs may be having his pancreas removed. Jobs had pancreatic cancer in 2004. Here is an article that discusses the premium built into Apple stock because of Steve Jobs.

8) Crude oil for February delivery fell below $34, but March crude oil (the more frequently traded contract) finished at $43.50. Crude oil futures are at about the same prices as they were one month ago when the January contract was expiring.

9) Mortgage foreclosures were up 81% in 2008.

10) Motorola announced it would cut another 4,000 workers.

11) The Senate voted 52-42 in favor of releasing the second $350 billion of TARP funds.

12) House Democrats are planning an $825 billion stimulus package which includes $275 billion of tax cuts.

Market Summary: Wed. Jan. 14, 2009

2009-01-14T23:58:00.000-06:00

Stocks had their worst day of the year finishing down just about 3%. Continued worries about financial companies’ health dragged the markets lower. The decline was broad based as 95% of the S&P 500 stocks were lower on the day. The majority of commentary I hear on CNBC is now bearish (finally) and stocks are at a much fairer value today than they were early last week. I have begun to make my “wish list” of stocks I want to buy on any further weakness – you should do the same. I do believe, though, that stocks will continue to decline as more and more companies report poor earnings, give cautious 2009 guidance, and lay off more workers. Nothing new, but the market needs to do a little catching up to the downside.

Here’s all the bad news from today:

1) December retail sales fell 2.7%. Analysts were expecting a decline of 1.2%. Everyone knows retail sales have been weak, so this really should not have been that big of a surprise.

2) Crude oil dipped below $36 per barrel. Once again, today’s inventory report was bearish, that is, it showed signs of increased supply.

3) Nortel Networks filed for Chapter 11 bankruptcy. “Nortel Networks Capital has more than 100 creditors owed $100 million to $500 million.” Watch out for companies with too much debt. With expensive credit any company that has debt coming due this year should be sold.

4) Deutsche Bank announced it lost $6.3 billion in the fourth quarter and will only issue a $0.50 dividend compared to 2007’s $4.50 pay-out. Shares of DB were down over 9% on the day. Barclays, another European bank, was down 14.5% after announcing 2,000+ job cuts.

5) Shares of Citigroup were down 23% today! There is talk that the company will get broken up even further, and investors are becoming more and more displeased with CEO Vikram Pandit.

6) After the bell, there was a report that Bank of America is close to receiving a second round of TARP funds from the government. The reason? BofA needs more cash to help with its Merrill Lynch acquisition. Shares are down more than 25% in the last five days.

7) After the bell, Apple announced Steve Jobs will be taking a leave of absence until July because his health problems are “more complex” than he had thought. Shares are down about 7% in after hours trading. Some are saying Apple mishandled this situation because just last week Jobs was healthy but had a treatable hormone imbalance.

8) Under Armour, Tiffany, and Bunge issued earnings guidance that was below analysts’ estimates.

Market Summary: Tues. Jan. 13, 2009

2009-01-13T22:51:00.001-06:00

Stocks were flat on the day, but energy and financial names were the leaders. Morgan Stanley agreed to pay Citigroup $2.7 billion for a 51% stake in Smith Barney. After the market close, Citigroup announced it is also considering selling CitiFinancial, its consumer lending unit. Citigroup is slowly shedding assets to raise much needed cash.

In a speech today, Federal Reserve Chairman Ben Bernanke said “more capital injections [into banks] and guarantees may become necessary to ensure stability and the normalization of credit markets.” He also explained that “fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system.”

Let’s go back to “The Dollar versus the Euro (and Yen)” from my January 4^th post. So far the Dollar has rallied significantly against the Euro. The Euro finished the day at 1.315, well off its December 18^th high of 1.4687. During that same time, gold (a hedge against inflation) is down $55. In regards to pumping trillions of Dollars into the economy, people are focused on the near term effects (economic stimulation) rather than the long term effects (inflation).

According to Treasury Inflation Protected Securites (TIPS), traders are expecting consumer prices to only increase 1.66% over the next five years. That is, they expect minimal inflation. How can you figure out this number? A 5-year US Treasury note yields 1.46%. A 5-year TIPS yields 1.13%. The difference between the two yields is the expected annual inflation rate over the duration of the securities. Right now traders believe we are in and will remain in a deflationary period.

I heard some CNBC commentators debating about Obama’s stimulus package and the proposed tax rebates/credits. Obama believes these tax rebates/credits will stimulate spending, but I do not think so. The recipients have two options – spend it or save it. I would bet that the majority of the baby boomers will be saving their tax rebates/credits. They need to make up for the 30-40% decline in their retirement portfolios. Sorry, Barack, saving the economy is not as easy as you think!

After Hours: Alcoa's Earnings Report

2009-01-12T23:27:00.000-06:00

After the bell Monday, aluminum producer Alcoa reported earnings that missed expectations. AA reported a loss of 28 cents; Analysts had predicted a loss of 11 cents. Shares are down 1% in after hours trading.

Market Summary: Mon. Jan. 12, 2009

2009-01-12T20:33:00.003-06:00

Financial stocks as well as the commodity-related stocks led the market lower today. With today’s 2% decline, stocks are down about 3.5% year-to-date. The talk on the street has reverted back to a prolonged recession. Just two weeks ago everyone was optimistic for a big market rally and an economic recovery in the second half of this year…not so fast though!

Commodities were the biggest losers. Crude oil futures for February delivery fell 8%. The futures curve continues to steepen as traders are getting paid to wait to sell their oil as demand wanes. The difference between the February and March contracts is 16% and between the Feb ’09 and Feb ’10 contracts 56.5%. Wheat, soybeans, and corn were limit down (the maximum amount by which the price of a futures contract may decline in one day) thanks to a bearish crop report. Fertilizer, infrastructure, and steel stocks were also very weak. Natural gas futures actually finished the day up as the nation is being hit by a severe cold front. Gold and silver were also down big.

Money flowed back into the Treasury market as the flight-to-safety trade resumed. The yield on the 10-year note fell to 2.31% from 2.41%, and the yield on the 30-year bond fell to 2.99% from 3.055%. As yields decrease, prices increase.

In my opinion, as well as many of the analysts, the three financial companies with the fewest problems are JPMorgan (JPM), US Bancorp (USB), and Wells Fargo (WFC). However, these three names have led the market lower recently. USB actually made a new closing low today. Since the December 8^th highs, JPM is down 34%, USB is down 27.5%, WFC is down 27.3%, and the XLF (financial ETF) is only down 20.75%. Is this decline in the best-of-breed companies telling us something – that the worst is yet to come? Or is the market wrong?

After the bell, JPMorgan announced it will release its fourth quarter results this Thursday instead of next Wednesday. I see this as a positive. JPMorgan might surprise investors with better-than-expected results and to prevent a further slide in its stock price it will report sooner rather than later.

The big financial news, though, had to do with Citigroup and Morgan Stanley. The two companies are near a deal that would involve Citigroup selling a majority stake of Smith Barney, its brokerage division, to Morgan Stanley for $2.5-3.5 billion. Why is this big news? Why did shares of Citi fall 17%?

Citigroup is in desperate need of more capital. The company has already tapped the federal government for $45 billion, and some are saying it will need more money to cover future losses. From this deal, Citigroup may recognize a gain of $10 billion after taxes.

What does not make sense, though, is why has Citigroup decided to sell its best business at the market bottom? Just a few weeks ago, CEO Vikram Pandit said Smith Barney would not be sold. It seems as though someone, most likely the government, is holding a gun to Citi’s head and forcing it to sell Smith Barney in order to improve its cash position. Morgan Stanley, on the other hand, is getting an absolute steal. The newly converted bank holding company is expanding its clientele and diversifying its business model. Last quarter, Smith Barney generated $2.576 billion in revenue which is about the price Morgan Stanley will pay for the business. A pretty sweet deal if you ask me.

Weakness in the financials could also be attributed to President Elect Obama asking Congress for the second $350 billion of TARP money. Stocks reacted negatively because the conditions for using the second allotment of TARP money will be very restrictive and unfavorable for the financial companies. In the letter to Congress, Obama’s team explained that there will be: 1) strict and sensible conditions of executive compensation and dividend payments, 2) full accounting of how money has been spent, 3) more transparency to measure lending by firms receiving financial rescue funds, and 4) sweeping efforts to address the foreclosure crisis (Source: CNBC TV). Obama also explained that he wants to enter his presidency with “ammunition” if problems were to arise.

An interesting piece of information: Today’s change in JPMorgan’s and Well Fargo’s market caps – 3.85B and 4.46B, respectively – exceeds General Motor’s total market cap of 2.5B. Market cap is the value of a company.

Market Summary: Fri. Jan. 9, 2009

2009-01-09T23:04:00.000-06:00

Stocks traded lower all day thanks to a dismal unemployment report. The non-farm payroll number was not as bad as some people were expecting. 524,000 jobs were lost in December while some people were calling for 700,000+. However, downward revisions for the October and November reports subtracted another 154,000 jobs. The unemployment rate rose to 7.2% from November’s 6.7%. The average estimate was for 7.0% unemployment in December.

The growth stocks that led the market higher the last few weeks as people were optimistic about a recovery – materials, energy, commodities – were the laggards today as the unemployment data suggested it might be longer than people think before a recovery occurs.

Oil stocks were weak thanks to oil dipping below $40 per barrel. Just one week ago oil was trading at $50. On top of falling oil prices, Halliburton and Schlumberger, two of the biggest oil services companies, announced they will be cutting jobs. SLB will cut 1,000 North American jobs - more than 5% of its domestic work force. HAL did not disclose how jobs will be cut.

Continuing with the job loss theme, Boeing announced it will cut about 4,500 jobs which is about 3% of its global work force. Boeing also reported a 15% decline in passenger jet deliveries for 2008.

On the earnings front, some notable companies disappointed:

1) Coach lowered its profit expectations. It now sees Q2 profit of $0.67 per share. Its previous estimate was $0.77 per share. Comparable store sales for December declined 13%.

2) Best Buy narrowed it full-year profit expectations. The company now sees profit of $2.50-2.70 per share. The previous estimate was $2.30-2.90 per share. December same store sales declined 6.5%.

3) CVS was down 12.5% on the day after the company forecasted 2009 profit of $2.35-2.43 per share. This range is below analysts’ average estimate of $2.56 per share.

Market Summary: Thurs. Jan. 8, 2009

2009-01-08T21:27:00.002-06:00

Stocks opened lower this morning after Wal-Mart announced its fourth quarter earnings will miss analysts’ forecasts. The company expects profit to be $0.91-$0.94 per share. This range is down from the company’s November estimate of $1.03-$1.07 per share. Also, Wal-Mart’s December same store sales disappointed investors. Analysts were expecting an increase of 2.6%, but Wal-Mart only reported a 1.7% increase. Over the last year, Wal-Mart has been the quintessential recession-proof stock, exceeding expectations nearly every quarter. Wal-Mart remains the premier retailer in these tough times – I’d use this weakness to buy.

A better-than-expected initial jobless claims number gave reason for investors to turn positive, and by the end of the day stocks closed near the unchanged mark.

Other news:

1) The Bank of England cut its benchmark interest rate 50 basis points to 1.50%.

2) The Treasury sold $16 billion of 10-year notes at 2.419%

3) Financial stocks were mixed on the day, but for the third day in a row JPMorgan was the laggard finishing the day down 3%.

4) Walgreen's announced they will cut 1,000 management jobs in 2009.

5) The Federal Reserve purchased $10.2 billion of mortgage-backed securities to help the ailing housing industry. The Fed plans to buy $500 billion of these securities by June 30^th. Here is a very good explanation of why the Fed is buying these bonds.

6) Citigroup announced they will “support legislation that would let bankruptcy judges cut mortgage rates for at-risk borrowers.” If Citigroup wants more of the TARP money they better publicly “support” the government’s proposal.

7) After the bell, Chevron announced that its fourth quarter earnings would be “significantly lower” than the third quarter’s earnings because of lower oil and gas prices.

8) Here’s the full text of Obama’s stimulus package speech.

Market Summary: Wed. Jan. 7, 2009

2009-01-07T22:22:00.001-06:00

Another set of bad news sent the markets lower and took some of the euphoria out of the bulls’ sails. It was about time we saw a significant pull back after a 27% rally from the November 21^st bottom.

Why did the market sell-off 3%?

1) Intel led tech stocks lower after it warned revenues will come up short of expectations. The company said fourth quarter sales declined 23% which was more than predicted (and more than in 2001 when the tech bubble burst). This is the second time Intel has cut its fourth quarter revenue estimate. Intel is absolutely dominant (80% market share) in the chip space and this warning does not bode well for the tech sector.

2) The ADP employment report showed that 693,000 private sector jobs were eliminated in December which was far worse than expectations. The government will report non-farm payrolls on Friday (private sector plus government jobs) and I have heard one “expert” on CNBC say that this number could be 1 million!

3) Crude oil fell 12% after an extremely bearish inventory report. The estimate was for a supply increase of 800,000 barrels, but the actual increase was 6.68 million barrels. Simple supply and demand here – more supply equals lower prices.

4) Meredith Whitney, an influential analyst who covers financial stocks, said banks will need to raise more capital because she estimates $40 billion of write-downs due to downgrades of mortgage-backed securities last quarter. JPMorgan and Wells Fargo were once again the laggards in the sector. Financials (XLF) were off about 5% on the day.

5) Time Warner announced it will have an annual loss due to a $25 billion write-down. In November the company anticipated a profit of $1.07 per share. How quickly things can change! The company also noted that the slowing economy hurt advertising revenue more than expected.

How about some good news? Monsanto surged almost 18% after reporting earnings that beat analysts’ expectations and raising its full-year guidance. Profit increased to $556 million ($1 per share) last quarter. This compares with $256 million in profit the same period a year earlier. Estimates called for earnings of 60 cents per share.

Even though money came out of the stock market, there was no flight-to-safety bid in the Treasury market. This action is a bearish sign for Treasuries. Here’s the catch 22 for the government: As the Treasury Dept. continues to issue more debt (increase supply) to pay for all its bailout and stimulus packages, Treasury prices will decline (yields increase). However, as yields increase so do the interest payments that must be paid to the bond holders. This increase in interest payments is very unfavorable for the government and will result in more debt issuance to pay for the higher interest payments. Quite the vicious cycle! The budget deficit will exceed $1 trillion sooner than people think.

Market Summary: Tues. January 6, 2009

2009-01-06T18:28:00.001-06:00

What has changed fundamentally about the economy and prospects for growth in the last few weeks? NOTHING! The only thing that has changed is people are more optimistic and therefore bidding up stock prices. Just two months ago people were predicting Armageddon, and now everyone is ignoring all the negativity that is still out there. We went from too pessimistic two months ago to too optimistic.

Once again, all the early cyclical stocks (the growth stocks that thrive during economic expansion) were the leaders – technology, energy, commodities, and materials. The safe, defensive stocks (the ones that fare well during slowdowns) were the laggards – Coca Cola, McDonald’s, Altria, Pfizer, Proctor & Gamble, AT&T, and Wal-Mart. The market has this one wrong. I’m a buyer of these strong names on any further pullback.

Reality check – the worst is not behind us…

1) Alcoa: After hours the company announced it will lay off 13,500 workers (about 13%), reduce capital expenditures by 50%, cut metal production by 18%, and incur a $950 million restructuring charge.

2) Bank of America: Ken Lewis, the CEO, announced his company will not meet its 2008 profit forecast. Currently, the average estimate is 15 cents per share. This number is down from 69 cents per share just three months ago. Look for more loan loss provisions. BAC reports quarterly results January 20^th.

3) Even Ben Bernanke and Co. believe the economy will sputter for some time. According to the FOMC minutes from Dec. 15-16, “the economic outlook would remain weak for a time and the downside risks to economic activity would be substantial.” Some Fed officials saw “the distinct possibility of a prolonged contraction.”

4) Mosaic, a fertilizer company and one of the hottest growth stocks in 2007 and early 2008, provided a pretty dismal outlook. Here’s a comment from the CEO:

“Toward the end of the quarter…worldwide crop nutrient sales activity dropped sharply, and it is expected to remain weak through at least the third quarter. Because of these conditions, we are reducing our production to manage excess inventories, reducing capital expenditures, and working to maintain financial strength and flexibility.”

Just like yesterday, the economic data was dismal, but nothing too surprising to move the markets significantly. The market mover will be Friday’s unemployment data, which is expected to be very poor.

Market Summary: Mon. January 5, 2009

2009-01-05T22:54:00.003-06:00

Uncertain Apple investors, including me, finally got some clarity when it comes to CEO Steve Jobs’ health. Many have been concerned that Jobs’ cancer has returned, but fortunately, his recent weight loss has been caused by a hormone imbalance. So far in 2009 shares of Apple are up almost 11%.

Money continued to flow out of the Treasury market. The 30-year Treasury yield finished the day at 3.04%, up from last Tuesday’s close of 2.58% (bond prices move opposite of yields). However, demand for short-term Treasuries remains high as seen by today’s auction of three- and six-month T-bills. The bid-to-cover ratio, which measures the demand versus supply, was 3.11 for three-month bills and 3.26 for the six-month bills. Fixed income trading desks need to put their money somewhere, and right now the U.S. government is the only institution that is issuing debt.

December auto sales were extremely poor, but that was not really news because the market was expecting poor numbers. GM’s sales dropped 31%, Ford’s fell 32%, Chrysler’s fell 53%, Toyota’s fell 37%, Honda’s fell 35%, Nissan’s fell 31%, and Hyundai’s fell 48%.

The energy, commodity, and material stocks were the market leaders today, while the big money center banks – JPMorgan, Wells Fargo, and USB – were the laggards. AT&T and Verizon were also weak after a downgrade to “market perform.”

The Dollar rallied on reports that President Elect Obama will include $300 billion worth of tax rebates in his stimulus package. Gold finished the day down 2.5%.

Even though stocks finished the day modestly lower, there were twice as many advancers on the NYSE as decliners.

What to Watch for in 2009

2009-01-04T22:45:00.001-06:00

Don’t read too much into the 3% rally we saw on the first trading day of the new year as volume was very light. Look at any chart – it was a trader’s dream. Stock charts went from the bottom left to the upper right in a near-perfect line. A better indicator of which way stocks will trend in the near term will be Monday’s action. Personally, I think people are a little too optimistic about a recovery.

Here’s what the market is pricing in: Basically, everyone on CNBC is expecting the economy to turn mid-year (I should really say “hoping” instead of “expecting”). That means the stock market should begin to trend upward as it anticipates the future. If you think the economy will be better six months from now, then you should be a buyer of stocks. However, if you disagree with the majority you should be a seller of stocks on any rallies. I see the market rallying in January and peaking in February when the stimulus package is finalized. Companies will continue to lay off workers left and right and many more businesses will disappear. Unemployment will continue to rise and we will be stuck in this sideways market.

What to watch for in 2009:

The Dollar versus the Euro (and Yen):

The trillions of Dollars the U.S. government is pumping into the economy will eventually cause inflation, but at what point will inflation kick in as we are still in a deflationary period? Will gold be the beneficiary (however, according to the charts gold is still in a bearish trend)? Much more downside risk remains in the Eurozone and the ECB will have to cut rates further creating relative Dollar strength.

Crude Oil:

The bubble has been broken. Don’t expect oil to be at $147 anytime soon. Many of the speculators that bid up oil have been washed out of the market. When all the so-called experts were calling for $200 per barrel, oil peaked. Now I see the reverse happening. These same experts have recently called for $20 per barrel and OPEC has pledged to significantly reduce output. Oil looks as if it might be bottoming. However, there is ample supply waiting to flood the market. Because of the steep contango in the futures market, the big oil players have been buying oil at very low prices ($30-40), storing it on tankers, and waiting to sell it at higher prices ($50-60) in the future.

TARP $ and The Banks:

Where will the government allocate its remaining $350 billion (assuming Congress approves)? How much consolidation in the banking industry will occur? Will small, regional banks go bankrupt? Will the banks begin to lend to the average, everyday consumer again?

The Big Three:

It is just a matter of time before these jokers are back in Washington asking the government for more money. Will a merger occur? Will they file for chapter 11 bankruptcy protection? Will they stop making cars that no one wants to buy?

Obama’s Stimulus:

I’ve been hearing $750 billion. I’ve also heard $1 trillion. Either way, it will be a lot of money. Pay attention to his tax cuts and infrastructure plans. Look for the commodity/material/energy names to continue to rally into Obama’s inauguration. Sell the news! What happens if the stimulus doesn’t work? What does the government do then?

Mortgage Rates & Housing:

What will the government do to lower mortgage rates and stimulate home buying? Will any homebuilders go out of business (I hope so)?

The Bond Market:

Toward the end of 2008 everyone wanted to own Treasuries (the safest investment out there because they are backed by the U.S. government). Interest rates on short-term maturities were and still are near zero. Cash flooded into this market in recent months. Will a mass exodus occur in 2009 to the stock market? Or will interest rates remain at historic lows? If the latter, don’t expect any significant or sustainable rally in equities.

Employment:

Watch the weekly initial jobless claims number to gauge the strength of the economy. This is the most up-to-date metric. Will unemployment tick up to 8-9% like some people think? Or will Obama’s pledge to create 3 million jobs prevail?

What we need…

2008-09-30T13:23:00.000-05:00

Below I will lay out what, in my opinion, would help our market and economy recover in a timely manner. Some of the parts are more critical than others.

We need…
1. The government to buy mortgages- The bill that failed in congress today actually had a decent plan for this. They were giving an unprecedented amount of money to the Secretary of the Treasury, Hank Paulson, with which he was to buy mortgages. The government would then be in a position renegotiate terms with the borrowers, keeping more people in their homes. By buying the mortgages, banks would be able to lend again because they’re already paid back for these loans that they thought were going to go bad, be it at some amount of cents on the dollar.

2. Congress to wake up! The size of this problem should have put politicing at the very, very, very back of anyone’s mind… but it didn’t. The bill, even though it was far from perfect, would have done a lot to help banks be able to lend again, housing prices to slow their fall, and our economy to begin a recovery. Think of anything you need a loan to buy: car, home, tuition, you name it. And do it again for businesses. Right now BANKS CANNOT LEND MONEY, they do not have it, they are just trying to stay afloat and meet their reserve requirements. How much is your house worth if you try to sell it and someone who wants to buy it cannot take out a loan? It’s worth whatever someone can pay in cash. No help will result in real estate values being cut in half, to start with. How many people are going to show up and offer a couple hundred grand in cash for your house? Welcome to a deflationary environment. Seriously, this is the environment we are in RIGHT NOW, and will continue to be in for 4-7 years without some help from the government. Not to mention, with out any help, many of our banks will go under in the next 6-12 months. I hate government intervention as much as anyone. The government being involved with Fannie and Freddie worked out great. But right now, they’re the only friendly balance sheet big enough to help.

3. People to listen to Paulson. Hank is the smartest financial mind in the federal government. He made himself hundreds of millions of dollars, a lot of it off the buildup of this problem. Now let’s let him help us fix it.

4. Minimize moral hazard. This is part of what congress has been complaining about, CEOs getting big severance packages. They think the whole bill was a bailout of financial firms that took on way too much risk. It is, but the people who took on the risk have already been punished, any net worth they accumulated through options is gone. The government can reposses executive shares as part of the deal, I don’t care how we do it, but making sure no current executives walk away with posh deals is important. However, this is not a reason to not pass the bill. The bill is not for the Wall St firms, it’s for every American who owns, or wants to own an asset of significant value. This is closer to an investment than a bailout, and the more our government is willing to invest, the quicker the housing market will turn around, the quicker the economy will turn around and the more money the government will make off their investment.

5. Europe to watch us. They’re next, about 12 months behind. A British lender and a Dutch bank both had to have government rescues over the weekend…

6. People with a backbone in regulatory positions. Fire Christopher Cox. “Naked shorting” is, and has always been illegal. To short you first have to borrow the stock you want to sell. In the past it’s been ok to sell short if you say you’re “in the process” of borrowing the shares. Check the filings, the vast majority of short positions, including ones that have been on for weeks, are still in the process of borrowing the shares. They’re naked shorting (shorting without borrowing the shares) because they know the SEC under Cox’s astute leadership won’t do jack! Pull Elliot Spitzer out of jail and make his sentence house arrest at the SEC for a few years, he’ll slap hundreds of millions of dollars of fines on firms playing games like the one above before they turn around. McCain says he’ll appoint Cuomo, current NY Attorney general, but why not go for the ultimate white collar crime fighter in Spitzer and save the penitentiary system a few bucks, just a thought.

7. People to forget it’s an election year. The most frustrating thing about the bill not passing is because a big reason it didn’t pass was politicing between congressmen. It’s an election year and these guys are going home soon to campaign. Sometimes it’s the role of an elected official to do what’s right even if their constituents don’t immediately agree. In an election year, politicians aren’t willing to do this because they want to be reelected.

What? We can be funny?

2008-09-25T09:42:00.003-05:00

Scott Green is the man. Read this article from the DI. Now. That is of course, if you haven't already read it between sudokus while you weren't paying attention in class.

Afterward, check this out. The irony to Scott's story is how much money Nintendo's employees (not even including the Brothers) actually do make for their company. It's even more per capita than Goldman, apparently.

Where are we now?

2008-09-24T21:17:00.004-05:00

So what's going on right now? Paulson will be doing his best to fight back the swarms of angry Congressmen, and broker deals with banks left and right... for the moment, the dust is starting to settle, and now we're seeing politicians squabble over power.

Maybe people have a right to be mad. Apparantly, these fallen titans doled out $39 billion in bonuses to their employees in 2007. Talk about a job well done!

If there is any type of article you should be reading, it is this one. Without a doubt, this entire problem occured because people didn't understand risk and statistics, and because of that:

"The banking system (betting AGAINST rare events) just lost > 1 Trillion dollars (so far) on a single error, more than was ever earned in the history of banking. Yet bankers kept their previous bonuses and it looks like citizens have to foot the bills."

You read that correctly. While banks certainly handled more than $1trillion over their collective history, the money they made by handling that money has just been eclipsed by the staggering loss they are now responsible for.

Or are they responsible for it? Could this have been the government's fault? This article insinuates that mark-to-market, or the act of valuing a difficult-to-value asset by matching it to the price it would fetch on the market. An accounting rule called FAS157 was responsible for implementing it, and beyond financial instruments, it is actually a very useful, fair value approach to accounting. I disagree largely with this arguement, because the implementation of FAS157 is a step forward to more accurate accounting.

Whether or not you think this was all the government's fault, it's clear that the government still has a golden opportunity to make a mess of things at this point. I agree with Mean Street, who thinks congress should back off and let Paulson do his thing. However, this is largely becuase I think a speedy solution at this point is more important than a more thought-out one. Waiting too long might do even worse damage around the world to an already broken system. This article does a good job at describing the motivations of the actors in this Greek tragedy. I think their arguement is persuasive as to why Hank needs as much bargaining power as he can get, and why the liberal solution to this problem is nonsensical.

But what can go wrong? Freakenomics, backed with a letter to congress from, literally, hundreds of prestigious economists has this to say: it looks really unfair, we have no idea how this bailout (the government buying up a staggering amount of toxic debt) will be structured (implying that it probably will be structured really poorly), and the effects of this bailout will be felt for ages, as the government's balance sheet tries to accomodate the incredible loss it will most likely incur.

So it is a race against time, and everyone knows it.

Will this solution probably be unfair? Yes. Are we basically forcing the innocent tax-payer to bail out these greedy bankers, who are largely responsible for this whole mess to begin with? Yes. But if we wait too long, then we may be dealing with far too many defaults for society, let alone the capital markets, to sustain.

Greed

2008-09-18T18:40:00.002-05:00

We are in a very complex and dire situation. By we, I mean Americans, and I also mean just about ever other developed country. We are growing closer to having a truly global economy, which is great when everything is going well, but it also raises the pain level when we hit rough seas.

How did we get into this mess? That’s a long story. In two words: we’re greedy. I’m not trying to be condescending, I’m a greedy person too. And not everyone is greedy, there are a lot of people living in developed economies that don’t care about material possessions and money, but by and large, we’re greedy people.

Mortgages
In the late ‘80’s “genius” investment bankers started packaging mortgages and reselling them. These investments, called mortgage-backed securities, were fixed income investments very similar to bonds. They were very profitable for the investment banks, but their real benefit was enabling banks to make more loans. For example, after the bank lent someone a mortgage, they would give them the cash and keep a piece of paper that was a promise to pay. In the old days, the bank would have to wait for the mortgage to be paid back before making another loan. Now, as soon as the borrower walked out, the bank would call the investment bank sell them the mortgage for 90 some cents on the dollar. The bank got their money back right away so it could make another mortgage loan and repeat the whole process over again.

The process described above had several effects. It increased leverage (the level of debt) in our society, banks we’re able to lend more, increasing the level of debt in our economy. It also made lending mortgages much more profitable. The increased profitability of mortgage lending led to many more mortgage brokers popping up, and growing much larger. The mortgage brokers were not banks, who relied on customer relationships, they just lent the mortgage, sold it to the investment bank (who sold it to investors) and moved to the next person in line waiting for a mortgage. These brokers (Countrywide e.g.), in many cases, skirted the due diligence they should have done on the person asking the mortgage, such as asking if they had a job, how much money they make, do they have other homes, etc. This is what led to the boom in subprime mortgages, mortgages lent to people in a not-solid financial position.

Why didn’t these brokers care that much about a lenders’ financial position? Well this is in the 2004 - 2006 time frame when it seemed that real estate value went up every single year. Therefore, if someone did not pay, they could foreclose and resell the house for more than the value of the mortgage. In order to entice more people to take out a mortgage, they offered mortgages that started with a very low interest rate for the first 2-5 years, the interest rate would then reset much, much higher, but that was in small print, after all, it was a few years off. Now not only could someone that wasn’t fit to have a mortgage get one, they could afford a really nice house too!

Now, it is unfair to blame the whole mess on the brokers. Many banks did their fair share of this practice too. Overall, however, banks (especially smaller and local ones) did a much better job of sticking to lending standards than mortgage brokers did. All you have to do right now to get a good approximation of how well someone stuck to lending standards and making good loans is to look at a stock chart. Compare U.S. Bank (USB) to Thornburg Mortgage (TMA) since January 2007.

Who helped make sure the whole securitization process ran smoothly? Well that is the job of Fannie Mae and Freddie Mac. Fannie and Freddie were government-sponsored entities that were created to help more people be able to buy a home. Then even Fannie and Freddie got greedy and started keeping some of these mortgages on their balance sheet to boost returns. It’s funny how the ones that didn’t fly off the shelves turned out to be some of the worst loans.

As you can see, our housing market saw quite the bubble form over the prior few years. As more and more people could get loans, they could pay more for housing, making the value of real estate inflate. These increased real estate values were really driven almost entirely by leverage. Leverage was not only at work with people and their homes, it was also at work with corporations.

Investment Banks
In addition to starting the mortgage securitization process and seeing a boon in that business, investment banks were also seeing pressure on their main business model. Investment banks are strategic advisors to companies. They get paid fees for things like: helping a company buy another company, issue stock, buy back their stock, etc. Many of the big banks also have a balance sheet (money to lend to companies). These banks would also make loans to companies to help them achieve their goals. The banks historically made a little by lending, but it was nothing compared to a M&A (buying another company) or IPO (issuing new stock to take a company public) fee.

The investment banking model is entirely dependent on relationships. All the investment banks have basically the same capabilities, with some variation, but that makes the bank getting hired almost entirely dependent on whether the company’s management likes it. Companies and banks acknowledge the give and take relationship. Companies need to borrow money, but banks don’t make a lot on lending money. However, the banks willing to lend money to the company when they need it coincidentally have the best chance to get the big fee engagements when the time is right for the company.

Over the last few years, up through July 2007, debt was readily available. Interest rates were relatively low, banks had lots of cash and companies knew it. If a company needed a loan, it would go to their main bank and say how much they wanted. If the bank said “no”, the company would go down the street to the next bank, the next bank would lend to them no questions asked and in the process put themselves front and center as the main bank ready to reap the big fees when they came along. Therefore, the main bank couldn’t say no. It would lose it’s customer before the “o” in no came out. Banks, like Citi, like JP Morgan, made lots of loans to companies knowing that they were going to lose money on the loan, but that was ok because they would make back way more then they were losing with the next big fee engagement.

Again, this business model, like lending mortgages to anybody works great as long as the economy is going strong. But, when the economy slows down, those big fee engagements don’t come along. This way of conducting business and the mortgage mess drove leverage to unprecedented levels in the history of mankind. Leverage, the level of debt, increases the risk of a firm going bankrupt. Purely looking at leverage, the risk of a going concern going bankrupt had never been higher than it was in summer 2007.

Credit default swaps
Credit default swaps (CDS) are a specialty financial product the essentially provides insurance on an asset defaulting. For example, if you bought a corporate bond you could buy credit default swaps and lock-in a return, albeit a smaller one. Credit default swaps have been used on all types of fixed-income assets, including many mortgage backed securities.

As our economy has levered up for the past several years, more and more companies, including insurance companies like AIG began issuing credit default swaps. It was, after all, a very profitable business. So we have increasing leverage, meaning and increasing risk of bankruptcy, or default, and some of the biggest financial firms are taking positions worth hundreds and hundreds of billions insuring against default.

Credit default swaps have become a favorite gauge of how likely it is that a certain bank will go under in these trying times. As the spread (the premium) on a given bank’s credit default swaps rises, so does the market’s perceived risk that the firm will go under.

Out of bounds
One of the major issues leading to this crisis is firms stepping out of their normal area of business in order to boost profits. AIG, unlike most insurance companies, began doing credit default swaps. Many bond insurers, like MBIA (ticker: MBI) who used to insure municipal bonds, started insuring mortgage-backed securities. The list goes on and on. Why did these firms enter new markets? Simple, there was a lot of money to be made. There is nothing wrong with that, this is capitalism after all. But in true capitalism it’s a live or die world, and if the firms that stepped over their bounds went bankrupt or almost went bankrupt, the next time new opportunities presented themselves, there would be a hell of a lot more due diligence done before those markets were entered.

But we now live in a world where firms can grow to be “too big to fail”. I agree, AIG was too big to fail. There were too many counterparties all over the world who had contracts with AIG, our financial world would be in chaos had the firm gone out of business. How have we not had a problem with this in the past? Is anti-trust growing more and more lax? Probably a little, but that is not the problem, AIG had lots of competition. How do companies like Citi and AIG operate in so many geographies, markets and products yet remain organized, focused and profitable and why wasn’t anyone ever able to do it before? Some would say they don’t, but if you give them the benefit of the doubt, the only answer is technology. We’ve never had a problem this big before because we’ve never had the technology to allow firms to grow as big as they are now. Our own advances in technology gave corporations enough rope to hang themselves, and many of them succeeded. Firms had the capacity to expand product offerings across more markets fast and more efficiently than ever before and handsomely increase profits. Stocks, bonds, all forms of money are not transferred in hard form anymore, they are ones and zeros going from computer to computer.

Firms took full advantage of technology and market conditions (low interest rates and a strong housing market) fill their greedy desires and maximize profits. There is nothing wrong with using technology to get bigger, taking advantage of market conditions or being greedy. This is capitalism.

The hammer
The sledgehammer that broke the proverbial camel’s back was the housing market. When the housing market turned downward in summer 2007, the value of mortgage backed securities went down because the value of mortgages went down. Some people’s mortgages were now worth more than the underlying home. Why pay it off? The economy was starting to weaken. At the same time, lots of those adjustable rate mortgages discussed above were re-setting to higher interest rates, making the interest payment unaffordable to many homeowners, driving more of them closer to defaulting.

As more of the mortgage backed securities weakened, first the mortgage brokers were hit hard, then the insurers. Now, with the credit default swaps through the roof, all the issuers of the credit default swaps are being forced to post cash collateral, driving them to insolvency (they don’t have any more cash)

What needs to happen?
We went through a multi-decade levering process that needs to be at least partially unwound. What does that mean? Profits will go down because businesses can’t finance expansion as regularly. This will drive stock prices down. Academically, as leverage increases, returns on equity increase and with it the firms’ stock price. That unwinding will take equities lower as well.

Am I saying the Dow goes to 8,000? No. But will the recovery be as quick as the drop? Not in my opinion. However, there are, and will continue to be tons for great buying in the stock market.

What will start the turn back towards a more normal state will be when the housing market begins to turn. That will ease some of the stress in the system. However, by that time we may be in a recession. Stay tuned.

...and then there were two

2008-09-17T21:40:00.002-05:00

Of the five big stand-alone investment banks, only Goldman Sachs and Morgan Stanley remain. Even these folks have been hit, though. Goldman has shown a 70% drop in third quarter net income. Morgan is looking at Wachovia for a merger, who, interestingly enough, has hired Goldman to look for potential merger partners. How has Goldman done so well? A commentator noted how Goldman mentioned last year that they were net short, effectively shorting indexes of all of the bonds which they were selling. I had mentioned this concept only a few weeks ago, but cited it only as a general business strategy. The commentator in fact saw it as a "predatory" action, due to the fact that Goldman is selling to customers (the bond purchasers) products which they personally don't have faith in.

If we are going to see Morgan and Wachovia merging, and perhaps Goldman at some point down the road, this brief article does a good job at describing the nature of combining investment and commercial banks, as it pertains to risk and loans.

“There’s a prevailing sense that the business model of the free-standing, highly leveraged investment bank that funds itself in the wholesale financial markets is virtually kaput,” Willem H. Buiter, a professor at the London School of Economics, told the New York Times this week.
“The pure investment bank was an American specialty,” he added. “But we’ve now seen three major American investment banks go down, so this model looks like a weakness, not a strength in a down market.”

What is the advantage of a merger with a commercial bank? To cite this article, the large pools of capital that come from retail banking deposits - your and my money. Because there is so much stable money in retail banking, made safe by the FDIC's insurance, retail banks receive greater credit ratings, which makes it easier for them to raise capital.

Goldman doesn't necessarily need these deposits:

That’s because a large amount of what Goldman Sachs invests in is considered riskier than the bread-and-butter loans that commercial banks make with deposits. If Goldman were to become part of a commercial bank, those deposits couldn’t be used to support the vast majority of its investments.
Meredith Whitney, an analyst from Oppenheimer, was quick to respond on the conference call, telling Mr. Viniar, “Obviously, you can’t fund capital market activities with deposits, but your overall credit rating as seen by the rating agencies would improve because of diversification. So there would be a benefit.”

Whether or not Goldman's shareholders will agree to this when a good purchase offer comes around is a different story.

And finally, this comment comes from Judey, and one which I'm sure we'll be hearing a lot more of, as the fallout of this market tends to lead towards more conservatism.

The Glass Stiegal was put in place during the Depression for a reason. Having banks which have access to low cost federally insured deposit funds is just another way to have a government subsidy for investment banking.Its repeal was dangerous. Merging with banks is another even more insidious way to to subsidize risk taking.We need to learn from history. We must stop and investigate and regulate market manipulation. We must put the brakes on short sellers. The bear raids must be stopped. The uptick rule must be restored in addition to stopping naked shorts. And the uptick should be at least .05.

Most people expect this crisis to take ages to finally erode away, but I have more faith than Judey in the after-shock. People will be looking for a solution, and I'm sure that is going to come from strict regulation changes. Most likely, as the US continues to switch to IFRS accounting standards (a topic that has obviously taken a back seat to the credit crunch and sub-prime write downs), I believe will see a more international standard of regulation as well.

Musings

2008-09-17T13:29:00.004-05:00

This is one of the most historic weeks in US financial history. That was a period. And I'm not excluding black monday, the great depression, the S&L crisis, or any of the other monumental events that shaped our financial history. If you're not reading every possible thing you can get your hands on, if you're not reading the Journal and soaking it up, you're an idiot. That was a period.

I'm not going to reiterate everything that's happened over the last few days, if you don't know go read the news paper.

-The housing starts number sucked today. Guess what? That's great news. Housing starts will be the last part of the housing market to recover. Right now the biggest problem in housing is the inventory (the amount of houses on the market). If more homes are being built, that number goes up by more. Starts going down let's us rip through the inventory and go through the price discovery process. Let's not forget what started this shit show, housing. What's going to lead us out? Housing.

-The journal had a phenomenal article on the AIG mess front and center on pg 1. Go steal a journal from the front of an apartment building or go to this thing they call the library. Read the article, study the chart at the top of the second page of the article, it's a great simplification of how AIG got in trouble. AIG got killed by the credit default swaps they helped create, which are basically insurance on banks' debt, or in other words: insurance against a firm going bankrupt. Think about how the value of that has changed over the last few months.

-Barclays got the deal of the century yesterday. They bought the good parts of Lehman for $1.75bn. Included in this is Lehman's main office building which the Journal reported valued at $600-900 million. Essentially, Barclays bought one of America's best financial services institutions and investment bank for $1.15BN max. And they didn't have to tke any of the toxic paper with them because LEH was already in bankruptcy. For comparison purposes, Bank of America paid in the neighborhood of $50BN for Merrill Lynch. In my opinion Barclay's got a much better deal than even JP Morgan did when they were wed with Bear Stearns.

Those are some of my quick musings. I will write another post about the underlying theme of this whole mess, greed, shortly.

What in the world...

2008-09-15T08:42:00.002-05:00

I hope you're all turning your attention to the news.

Lehman's finished. Merrill has been bought by BofA. AIG is looking for more capital.

It's recruiting season over here at school, but don't expect to find many finance jobs, considering how many thousands of former Lehman workers are now going to be pushing out new hires for cheap banking jobs.

This was a historic weekend, following a previous historic weekend. I'll be sure to slap something together soon.

Google blows up UAL

2008-09-13T13:11:00.002-05:00

Let's avoid the giant elephants in the room for a moment (Fannie Freddie Lehman Merrill), so I can point out another technical folly that has come out of the woodworks.

On Monday, UAL's stock price was essentially wiped out this week by an error in the systems that track news stories on the internet.

Here's a breakdown I'm citing form the LA Times:

Back in 2002, United was verging on bankruptcy, and South-Florida Sun Sentinel newspaper, a subsidiary of Tribune group, published an article about it. The Google News search algorithms came across the article early Sunday, and by opening it, probably pushed it to the "most viewed" section of the webpage. From there, other news aggregators that just search over "most viewed" lists picked up the article and, due to a mis-dating on the original article, presented it as current news to Income Securities Adivsors, inc. Bloomberg news picked up the "story" from there, and automatic trading algorithms that are programmed to respond immediately to certain news events, like bankruptcies, dumped shares, cutting away 75% of UAL's market cap before trading was manually frozen.

Things are back to normal now, but this brings to light some pretty interesting considerations, as the effects that automated information system processes have on our lives increase.

These systems work fine, as long as they are designed perfectly, but when you incorporate human error, like mis-dating an old news article from a tiny newspaper, the shock waves that can be made are staggering. This is especially true in capital markets, due to the affect information has on liquidity. In spite of all of it's value in maintaining fair value, liquidity also has the adverse effect of draining a security of value, whether the information causing the change is accurate or not.

How will we solve these issues? Insurance first comes to my mind as a "solution," but it exists more to treat the symptoms, not the cause. I imagine that more and more adaptable circuit breakers will need to be put in place. We will need to find innovative new solutions that fight to maintain a fair market value that still has a solid, auditable foundation of value. Perhaps we can use historic data to statistically model past market responses to news items like bankruptcies, and design a circuit breaker that prevents a stock's price from swinging too far past that average?

Maybe such intervention sounds too manipulative, even for these times. Speaking of market manipulation, I'll try to throw something together about the big news stories soon.

The Economics of Crowded Markets

2008-09-04T22:52:00.002-05:00

I read a great article on O'Riley Radar about how the big players (read: Google and the New York Times online) on the Internet are behaving like the big banks, who, when facing a turn in the tide against ridiculous growth, used subversive tactics to try to maintain that growth.

What atrocity could golden Google possibly commit? Well, as a high-flying public company with several years of growth, Google started to slow down late last year. That slow down was occurring as the "product life cycle" signaled that web search may have been beginning to mature. Tim O'Reiley, in his infinite wisdom, was able to notice their actions as early as then, and cited another clever clogs called Bill Janeway, who drew parallels to Google with the banks' actions a few years ago.

As Bill explains:

"The price of a trade a generation ago was regulated by the exchanges: it cost approximately 22 cents per share to trade an institutional-size block of stocks on the New York Stock Exchange. The ability to fix commissions reflected the historical fact that the brokers had long been large, relative to their customers. Unable to compete on price, some firms competed on the quality of their investment research, and brokers’ relations to clients were based on the information and insights they could provide (others competed in less respectable ways).

As pension funds, mutual funds, and other institutional investors grew to dominate trading, they successfully broke the NYSE cartel. Once the exchanges no longer regulated the price of a trade, prices fell over time to current levels of a fraction of a cent per share: for large trades, effectively zero. As a result, some sell-side firms tried to charge directly for research and found that their buy-side clients were unwilling to pay. Instead, they were investing money saved from commissions to build their own research staffs. Two other things happened. Seeking an alternative subsidy for sell-side research, most firms repositioned their research staffs as marketing arms of their corporate finance firms, a strategy that blew up spectacularly with the Bubble in 2000–2002. More important, firms began to trade against their clients for their own account, such that now, the direct investment activities of a firm like Goldman Sachs dwarfs its activities on behalf of outside customers."

One thing innovation does is drive out older inefficiencies, and charging someone $.22 to transfer information from one party to the other is the definition of waste. And when a company's means of subsistence proves to be inefficient, and starts to get squeezed, it is only natural for that company to fight back. There are two solutions: fight to maintain the status-quo, or wriggle free through innovation and invention. The latter is of course the harder of the two, and is the reason why entrepreneurs are so successful at being "destructive creators."

Google is responding to their pinch releasing more and more products that maintain focus - and web traffic - on their products:

Google's announcement of Knol shows that they understand some of their key business drivers very well; With as much as 5% of the search result links for popular terms going to Wikipedia pages, a solution to capturing some of that traffic in an environment that Google can control and display ads on makes good business sense...

Now the last thing I want to do is imply that Google doesn't innovate - I think Google is our generation's proudest example for innovation. In fact, I believe that this issue has largely been resolved, thanks to Google's new browser, Chrome. The potential Chrome will realize in freeing up system resources for more advanced web applications is a discussion for a different time.

We can't say the same f0r the New York Times online, which people are complaining about sacrificing their journalistic quality by keeping all of the links in their articles internal. This practice redirects readers to other related articles, which increases web traffic, however at the cost of relevance to the story.

However, I'm more optimistic than O'Reiley. Switching costs are as low on the Internet as they possibly could be - the only thing keeping people looking at the New York Times is the New York Times' brand power. If this practice continues to dilute that brand, then we should see consumers shift to a different service. The same goes for O'Reiley's complaints about other web services that attempt to lock people into their brand - the very nature of search should allow them to seek quality elsewhere.

The web is the most meritocratic economy man has ever developed. This only means good news for us.

Ballad of a Thin Man

2008-08-25T22:30:00.001-05:00

For all those Bob Dylan fans, here's Mr. Jones' take on the economy

Back from London

2008-08-01T09:45:00.002-05:00

Well I'm back from my 1 month work rotation in London, so I'll be posting again and trying to get out of this summertime slump.

In the mean time, here is a really short op piece about Mr. Bernanke's situation. It's a pretty insightful commentary on the behavioral side of economic predictions and the market movements that happen in result.

There's no need to describe the article, as it is only a few paragraphs long to begin with. I think this only shows how erratic and unfounded so much of this market analysis really is. It's already difficult enough to analyze objectively the condition of an economy, due to the bluntness of our models, and the limits of data penetration. But when one incorporates simple psychology, and how Wall Street and Bernanke are, on one level, playing mind games with each other, I wonder how anyone can say with any confidence that the market is reacting to reality.

These past two years makes me think Wall Street lives in its own convoluted universe, which skips blindly like a spinning stone over the real world, occasionally changing direction when the natural laws of reality pull it back to Earth.

Market Summary: Fri. July 11, 2008

2008-07-11T22:17:00.000-05:00

DJIA 11,100.54 -128.48 (-1.16%)
Nasdaq 2,239.08 -18.77 (-0.84%)
S&P 500 1,239.49 -13.90 (-1.12%)
NYSE Composite Volume 1.73 bln

2-Yr Note 2.59% +0.15
10-Yr Note 3.96% +0.13
30-Yr Bond 4.52% +0.10

Dollar Index 72.096 -0.397
Crude Oil (Aug) 145.08 +3.43
Nat Gas (Aug) 11.904 -0.396
Gold (Aug) 960.60 +18.60

Market Summary: Thurs. July 10, 2008

2008-07-10T20:45:00.001-05:00

DJIA 11,229.02 +81.58 (+0.73%)
Nasdaq 2,257.85 +22.96 (+1.02%)
S&P 500 1,253.39 +8.70 (+0.69%)
NYSE Composite Volume 1.53 bln

2-Yr Note 2.44% +0.03
10-Yr Note 3.83% -0.02
30-Yr Bond 4.42% unch

Dollar Index 72.493 -0.087
Crude Oil (Aug) 141.65 +5.60
Nat Gas (Aug) 12.300 +0.294
Gold (Aug) 942.00 +13.40

Market Summary: Wed. July 9, 2008

2008-07-10T18:44:00.000-05:00

DJIA 11,147.44 -236.77 (-2.12%)
Nasdaq 2,234.89 -59.55 (-2.66%)
S&P 500 1,244.69 -29.01 (-2.33%)
NYSE Composite Volume 1.49 bln

2-Yr Note 2.41% -0.06
10-Yr Note 3.85% -0.06
30-Yr Bond 4.42% -0.04

Dollar Index 72.580 -0.432
Crude Oil (Aug) 136.05 +0.01
Nat Gas (Aug) 12.006 -0.362
Gold (Aug) 928.60 +5.30

Market Summary: Tues. July 8, 2008

2008-07-08T17:55:00.000-05:00

DJIA 11,384.21 +153.25 (+1.68%)
Nasdaq 2,294.42 +51.10 (+2.23%)
S&P 500 1,273.70 +21.39 (+1.68%)
NYSE Composite Volume 1.72 bln

2-Yr Note 2.47% unch
10-Yr Note 3.91% -0.04
30-Yr Bond 4.46% -0.05

Dollar Index 73.012 +0.342
Crude Oil (Aug) 136.04 -5.33
Nat Gas (Aug) 12.368 -0.609
Gold (Aug) 923.30 -5.50

Market Summary: Mon. July 7, 2008

2008-07-07T21:48:00.000-05:00

DJIA 11,231.96 -56.58 (-0.50%)
Nasdaq 2,243.32 -2.06 (-0.09%)
S&P 500 1,252.31 -10.59 (-0.84%)
NYSE Composite Volume 1.52 bln

2-Yr Note 2.47% -0.07
10-Yr Note 3.95% -0.04
30-Yr Bond 4.51% -0.02

Dollar Index 72.670 -0.061
Crude Oil (Aug) 141.37 -3.92
Nat Gas (Aug) 12.977 -0.600
Gold 927.30 -4.60

Market Summary: Fri. July 4, 2008

2008-07-06T20:00:00.001-05:00

I became a little less negative on the stock market following the ECB statement Thursday morning. Everyone has been hoping for a dollar rebound to help stabilize the economy and stock market. So far, no luck. The Fed was ‘talking up’ the dollar because they could not raise rates and this tactic worked until two weeks ago when Trichet (ECB President) announced he would raise rates in the Eurozone. Foreign rates going higher make the dollar less attractive to investors.

As expected, Trichet and the ECB raised rates a quarter point to 4.25% Thursday morning, but it was the rhetoric that was positive for the dollar. Trichet commented that he has “no bias” for further rate hikes and he expects inflation to stabilize because of this one rate increase. The dollar index rallied 1% Thursday because of Trichet’s bullish commentary.

I was very worried about what Trichet might say. His goal is to combat inflation, but I was concerned that his rate hike would be counter-productive. The rate hike, and possible further rate hikes, would make the dollar relatively weaker, and seeing that commodities are denominated in dollars, he would be fueling inflation. However, my concerns were eased when he mentioned that no more rate hikes are on the horizon.

Market Summary: Thurs. July 3, 2008

2008-07-03T19:12:00.000-05:00

DJIA 11,288.54 +73.03 (+0.65%)
Nasdaq 2,245.38 -6.08 (-0.27%)
S&P 500 1,262.90 +1.38 (+0.11%)
NYSE Composite Volume 931 mln

2-Yr Note 2.54% -0.06
10-Yr Note 3.99% unch
30-Yr Bond 4.53% +0.02

Dollar Index 72.742 +0.713
Crude Oil (Aug) 145.29 +1.72
Nat Gas (Aug) 13.577 +0.188
Gold (Aug) 931.90 -12.90

Market Summary: Wed. July 2, 2008

2008-07-02T18:08:00.000-05:00

DJIA 11,215.51 -166.75 (-1.46%)
Nasdaq 2,251.46 -53.51 (-2.32%)
S&P 500 1,261.52 -23.39 (-1.82%)
NYSE Composite Volume 1.52 bln

2-Yr Note 2.60% -0.03
10-Yr Note 3.99% -0.02
30-Yr Bond 4.51% -0.04

Dollar Index 72.029 -0.340
Crude Oil (Aug) 143.57 +2.60
Nat Gas (Aug) 13.389 -0.116
Gold (Aug) 944.80 +2.30

Bulls vs. Bears: Beginning of the quarter repositioning

2008-07-01T20:03:00.001-05:00

The bulls on Wall Street were glad to see the second quarter come to an end yesterday. The bulls that have been talking up stocks in the face of tremendous economic headwinds are way too optimistic. The market will continue to trend lower as more and more companies either miss earnings expectations or give sub par guidance.

The VIX, a measure of volatility (aka fear), is no where near its March 17^th level when Bear Stearns was bailed out by the Federal Reserve. The sellers have not all been washed out of the market yet because we have not seen a heavy volume down day.

Also, all the market pundits that appear on CNBC say the market will turn later this year or sometime next year. For the market (and economy) to get back on track there needs to be a catalyst to cause this reversal to occur. Unfortunately, there are so many areas of our economy that are struggling I do not think one catalyst will suffice. The one area that could turn things around is a rebound (or at least no more declines) in housing, but this is a slow process that I do not see occurring anytime soon.

Today, why did we see stocks like U.S. Steel and Potash, two big winners from the first half of the year, significantly underperform the major averages on no big news reports?

The money managers want to show their investors they knew what they were doing by owning these stocks. When the quarter ends, they either take profits or dump the stock. Then with the extra cash, they buy up the losers from the previous quarter, e.g. financials. This explains why we saw Lehman Brothers up 6% today. Nothing about this company changed from yesterday when we saw it decline 11%. Look at CIT, another financial company. This stock was up about 30% today.

Do not expect the rally in these ‘loser’ stocks to last more than a few days. We saw this same pattern at the end of the first quarter/start of the second quarter when the financials rallied (this rally lasted about a month and a half until the bad news resurfaced. By the end of the second quarter, the financials were still toxic and should not have been touched.

Market Summary: Tues. July 1, 2008

2008-07-01T16:58:00.000-05:00

DJIA 11,382.26 +32.25 (+0.28%)
Nasdaq 2,304.97 +11.99 (+0.52%)
S&P 500 1,284.91 +4.91 (+0.38%)
NYSE Composite Volume 1.64 bln

2-Yr Note 2.63% unch
10-Yr Note 4.01% +0.02
30-Yr Bond 4.55% +0.02

Dollar Index 72.369 -0.094
Crude Oil (Aug) 140.97 +0.97
Nat Gas (Aug) 13.505 +0.152
Gold (Aug) 942.50 +16.30

Why is the Dow the underperformer?

2008-06-30T19:59:00.004-05:00

The U.S. recession talk has been going on since last October, so this topic should be nothing new if you have been keeping up with the markets. Really, it is just a matter of when not if anymore. During this same time, everyone was advising to put money overseas in the stronger emerging markets (China, Russia, Brazil, and India) and avoid the frail American economy. Recently however, there are now talks that the U.S. slowdown will spill over into the global market.

The rise in commodity prices, especially crude oil, has crimped the American economy – consumer and corporation. The analysts are now expecting the emerging markets to slow with the American economy.

The Dow Jones Industrial Average contains 30 stocks which have enormous overseas exposure. The S&P 500 contains many of the same stocks, but there are also smaller, more domestically based companies that will not be as affected by slowing global demand. So relatively, the S&P 500 components are not as dependent on the global markets as the Dow components are.

For instance, Alcoa, Boeing, Hewlett-Packard, IBM, Intel, Coca-Cola, McDonald’s, and Proctor & Gamble (just to name a few) are all Dow components that rely heavily on international sales (and the weak U.S. dollar). These companies almost rely more on their international sales than their domestic sales (some actually do more business overseas).

This change in the global growth forecast has negatively affected American companies, especially ones that sell goods to these once-growing, now thought to be slowing, emerging economies.

Also, you can look at the Russell 2000 Index which tracks small cap stocks (minimal international exposure). This index has outpaced the S&P 500 by 4% over the last month and a half.

Market Summary: Mon. June 30, 2008

2008-06-30T19:14:00.000-05:00

DJIA 11,350.01 +3.50 (+0.03%)
Nasdaq 2,292.98 -22.65 (-0.98%)
S&P 500 1,280.00 +1.62 (+0.13%)
NYSE Composite Volume 1.61 bln

2-Yr Note 2.63% -0.02
10-Yr Note 3.99% unch
30-Yr Bond 4.53% unch

Dollar Index 72.463 +0.103
Crude Oil (Aug) 140.00 -0.21
Nat Gas (Aug) 13.353 +0.155
Gold (Aug) 926.20 -3.10

Market Summary: Fri. June 27, 2008

2008-06-27T17:39:00.000-05:00

DJIA 11,346.51 -106.91 (-0.94%)
Nasdaq 2,315.63 -5.74 (-0.25%)
S&P 500 1,278.38 -4.77 (-0.37%)
NYSE Volume 2.24 bln

2-Yr Bond 2.65% -0.03
10-Yr Bond 3.99% -0.08
30-Yr Bond 4.53% -0.09

Dollar Index 72.360 -0.127
Crude Oil (Aug) 140.21 +0.57
Nat Gas (Aug) 13.198 -0.050
Gold (Aug) 931.30 +16.20

Market Summary: Thurs. June 26, 2008

2008-06-26T20:58:00.000-05:00

DJIA 11,453.42 -358.41 (-3.13%)
Nasdaq 2,321.37 -79.89 (-3.44%)
S&P 500 1,283.15 -38.82 (-3.03%)
NYSE Volume 1.54 bln

2-Yr Bond 2.68% -0.14
10-Yr Bond 4.07% -0.05
30-Yr Bond 4.62% -0.03

Dollar Index 72.487 -0.446
Crude Oil (Aug) 139.64 +5.09
Nat Gas (Aug) 13.248 +0.382
Gold (Aug) 915.10 +32.80

Cool Numbers: Tech

2008-06-25T21:36:00.003-05:00

"Worldwide, people sent 1.9 trillion text messages last year" <- That's a lot of money spent. That stat comes from this article, written in last month's Technology Review, a fantastic magazine put out by MIT (I guess it's like their Harvard Business Review, my all-time favorite publication).

Another cool article in the same magazine talks about the founder of modern venture capital, a Frenchman by the name of Georges Doriot. He earned his stripes in the US in the 20s-40s. They mention a biography in the article that I might pick up. I recently read Faust In Copenhagen: A Struggle for the Soul of Physics, that discusses the lives and discoveries made in the community of theoretical physicists at the beginning of the 1920 and 30s, when quantum mechanics were pioneering a new understanding of our universe. The first half of the century must have been incredibly exciting for developments in science and business, but it is nothing like we're seeing now... especially in areas where they merge so closely, like the web. Here's one last fantastic (huge) article about concerns over monetizing Web 2.0.

The biggest issue? Advertising, which these types of websites are depending on for income, is being ignored by users. Basically, the best model is Google's Adwords Auction.

"Advertising on Google works because visitors come to Google looking for specific information. If a user who types "scooter" in the site's search field is hoping to buy a scooter, the keyword ads that appear at the right of the search results can be more useful than the results themselves. In social networks, on the other hand, users show up to find friends; ads are, at best, irrelevant to that goal. The click-through rates on social-networking sites bear this out. While around 2 percent of Google users actually click on a given ad (and the number is much higher when users are conducting searches for purchasing reasons), fewer than .04 percent of Facebook users do, according to a media buyer's report obtained last year by the Silicon Valley blog Valleywag."

THIS is intelligent advertising, because Google is taking advantage of people who are actively looking for something, while the Web 2.0 companies have to depend simply on a large user base. The only difference between advertising on Facebook and advertising on CNN is Facebook can better target people with specific ads - but the nature of the advertising remains the same.

The article is long, and talks about some of the interesting failures to address this issue, like Facebook's ill-fated Beacon program, and MySpace's HyperTargeting system. I'll leave it to you to read it.

Market Summary: Wed. June 25, 2008

2008-06-25T18:37:00.000-05:00

DJIA 11,811.83 +4.40 (+0.04%)
Nasdaq 2,401.26 +32.98 (+1.37%)
S&P 500 1,321.97 +7.68 (+0.58%)
NYSE Volume 1.40 bln

2-Yr Bond 2.82% -0.05
10-Yr Bond 4.12% +0.02
30-Yr Bond 4.65% unch

Dollar Index 72.933 -0.308
Crude Oil (Aug) 134.55 -2.45
Nat Gas (Aug) 12.866 -0.260
Gold (Aug) 882.30 -9.30

Market Summary: Tues. June 24, 2008

2008-06-24T21:35:00.001-05:00

DJIA 11,807.43 -34.93 (-0.30%)
Nasdaq 2,368.28 -17.46 (-0.74%)
S&P 500 1,314.29 -3.71 (-0.28%)
NYSE Volume 1.34 bln

2-Yr Bond 2.87% -0.11
10-Yr Bond 4.10% -0.09
30-Yr Bond 4.65% -0.06

Dollar Index 73.241 -0.193
Crude Oil (Aug) 137.00 +0.26
Nat Gas (Aug) 13.126 -0.196
Gold (Aug) 891.60 +4.40

Those Hedge Fund Guys

2008-06-24T19:54:00.002-05:00

American icon Tom Wolfe (think Electric Cool-Aid Acid Test, Ken Kesey, 1969) put out an awesome article for Conde Nast about the characters of the uber-rich titans who manage hedge funds, lambasting them for their coarse attempts at high-culture, and their towering hubris. "These people" are, to Mr. Wolfe, the American Pirates, burning and raiding companies

It's long, but it's a classic read.

So do yourself a favor and read it.

Here's an excerpt:

"The freebooters have only contempt for other types of money managers, who always play it safe. They reserve a special scorn for mutual fund managers, a breed they call “pure vanilla.” Corporate C.E.O.’s don’t come off much better, not even “superstars” such as Lee Iacocca and Jack Welch...C.E.O.’s are people who expend their energies in binges of insincerity, holding the hands of shareholders and board members, constantly “negotiating” with government, with labor, and with God knows who else, constantly temporizing, compromising—resorting to flattery and “charm,” both of which are unmanly—striving to look dignified, clad in the obligatory dark suit, white shirt, and red or Arctic-blue necktie. That goes for C.E.O.’s and everybody else who works in investment banking, for the Merrill Lynches and Morgan Stanleys, with one exception: the traders.

THE TRADERS ARE ON THE FRONT LINES moment by moment, pulling the trigger with only seconds to think about it. They are our kind! They are aggressive—real men! Their plain vanilla C.E.O.’s know it too. They will pay a daring, battle-hardened trader $50 million and up per year to keep him from defecting to our pirate fleet. They pay them more than they pay themselves, because they are worth more, because they are real men, because they are willing to fight."

Market Summary: Mon. June 23, 2008

2008-06-23T20:23:00.000-05:00

DJIA 11,824.36 -0.33 (-0.00%)
Nasdaq 2,385.74 -20.35 (-0.85%)
S&P 500 1,318.00 +0.07 (+0.01%)
NYSE Composite Volume 1.09 bln

2-Yr Note 2.98% +0.10
10-Yr Note 4.19% +0.03
30-Yr Bond 4.71% unch

Dollar Index 73.434 +0.404
Crude Oil (Aug) 136.74 +1.38
Nat Gas (July) 13.203 +0.209
Gold (Aug) 887.20 -16.50

Cool Numbers: Giving

2008-06-22T21:49:00.002-05:00

Remember these? I barely do either... But either way, here is another cool number!

According to GivingUSA, charitable giving in 2006 reached a record $295.02 billion, which Slate's Moneybox noted was something like 2.2% of our nation's GDP. Excluding disaster gifts from the year previously, (remember 2005?), that's a yoy increase of 6.6%. Pretty cool, yeah? Now, part of that 2006 record comes from Warren Buffet's 1.9billion donation (which will amount to $30 billion over the next 20 years).

The Moneybox article's focus is actually less uplifting - the author suggests that our economic turmoil has recently, and will continue to hurt charitable giving in the near future. This is because, not surprisingly, "...philanthropy is tethered directly to the health of the overall economy, and in particular to the health of the upper-middle-class consumer."

Gone Bananas!

2008-06-21T10:59:00.002-05:00

There was a pretty cool Op-Ed in the Times recently about bananas. Not surprisingly, rising fuel costs have hurt banana distribution, and is affecting the value of publicly traded companies, like Cincinatti-based Chiquita. The Wall Street Journal attributes Chiquita's 29% dip in stock price to recent bad weather and a spike in demand for milk and meat (my guess due to the rising disposable income of people in developing countries).

Bananas, traditionally the cheapest of America's popular fruits, actually have a pretty interesting economic history.

From the NYT:

"That bananas have long been the cheapest fruit at the grocery store is astonishing. They’re grown thousands of miles away, they must be transported in cooled containers and even then they survive no more than two weeks after they’re cut off the tree. Apples, in contrast, are typically grown within a few hundred miles of the store and keep for months in a basket out in the garage. Yet apples traditionally have cost at least twice as much per pound as bananas...

They became a staple only after the men who in the late 19th century founded the United Fruit Company (today’s Chiquita) figured out how to get bananas to American tables quickly — by clearing rainforest in Latin America, building railroads and communication networks and inventing refrigeration techniques to control ripening. The banana barons also marketed their product in ways that had never occurred to farmers or grocers before, by offering discount coupons, writing jingles and placing bananas in schoolbooks and on picture postcards. They even hired doctors to convince mothers that bananas were good for children."

The article also briefly describes the terrifying control the United Banana had over the many "banana republics" in Latin America, which kept costs low by denying many human rights to the citizens of the countries they grew bananas in. One startling example was the 1954 overthrowing of the democratically elected government of Guatemala by United Fruit. And apparantly "labor is still cheap in these countries, and growers still resort to heavy-handed tactics."

Banana companies are also able to optimize economies of scale (most notably by controlling ripening rates) by only selling one species of banana, the Cavendish. Prior to that, the only thing you could get was the Gros Michel, but a blight known as the Panama disease wiped them all out. I've written previously about the growing concern over massive food loss due to disease, and it look's like the Cavendish banana's goose is cooked. The disease, which is killing off plantations of Cavendish crops as we speak, is expected to reach Latin America (where the US gets its bananas) in the next 5-20 years.

The only thing that can probably be done is to start growing a different kind of banana - but to do that, genetic engineers must research other under-used strains of banana (of which there are many), to find a more resistant cousin. This will undoubtedly be of incredible importance to the banana industry in the coming years, although some say the big companies are not moving fast enough.

A side note, ff you're really interested, the book Banana: The Fruit That Changed The World is supposed to be pretty interesting. How silly it is the titles publishers and media-makers dream up to grab our attention. And just to seal the deal on how ridiculous this article is...here's some mildly interesting banana trivia

Market Summary: Fri. June 20, 2008

2008-06-20T21:11:00.000-05:00

DJIA 11,842.69 -220.40 (-1.86%)
Nasdaq 2,406.09 -55.97 (-2.33%)
S&P 500 1,317.93 -24.90 (-1.89%)
NYSE Composite Volume 2.01 bln

2-Yr Note 2.88% -0.11
10-Yr Note 4.16% -0.06
30-Yr Bond 4.71% -0.05

Dollar Index 73.030 -0.453
Crude Oil (July) 134.62 +2.69
Nat Gas (July) 12.994 +0.133
Gold (Aug) 903.70 -0.50

Market Summary: Thurs. June 19 2008

2008-06-19T19:34:00.000-05:00

DJIA 12,063.09 +34.03 (+0.28%)
Nasdaq 2,462.07 +32.36 (+1.31%)
S&P 500 1,342.83 +5.02 (+0.37%)
NYSE Composite Volume 1.29 bln

2-Yr Note 2.99% +0.10
10-Yr Note 4.22% +0.06
30-Yr Bond 4.76% +0.04

Dollar Index 73.483 +0.043
Crude Oil (July) 131.93 -4.75
Nat Gas (July) 12.861 -0.349
Gold (Aug) 904.20 +10.70

Market Summary: Wed. June 18, 2008

2008-06-18T19:00:00.001-05:00

DJIA 12,029.06 -131.24 (-1.09%)
Nasdaq 2,429.71 -28.02 (-1.15%)
S&P 500 1,337.81 -13.12 (-0.98%)
NYSE Composite Volume 1.28 bln

2-Yr Note 2.89% -0.05
10-Yr Note 4.16% -0.07
30-Yr Bond 4.72% -0.06

Dollar Index 73.440 -0.074
Crude Oil (July) 136.68 +2.67
Nat Gas (July) 13.210 +0.258
Gold (Aug) 893.50 +6.60

Market Summary: Tues. June 17, 2008

2008-06-17T18:50:00.002-05:00

DJIA 12,160.30 -108.79 (-0.89%)
Nasdaq 2,457.73 -17.05 (-0.69%)
S&P 500 1,350.93 -9.21 (-0.68%)
NYSE Composite Volume 1.09 bln

2-Yr Note 2.94% -0.08
10-Yr Note 4.23% -0.02
30-Yr Bond 4.78% +0.01

Dollar Index 73.514 -0.096
Crude Oil (July) 134.01 -0.60
Nat Gas (July) 12.952 +0.019
Gold (Aug) 886.90 +0.60

Market Summary: Mon. June 16, 2008

2008-06-16T19:47:00.000-05:00

DJIA 12,269.08 -38.27 (-0.31%)
Nasdaq 2,474.78 +20.28 (+0.83%)
S&P 500 1,360.14 +0.11 (+0.01%)
NYSE Composite Volume 1.16 bln

2-Yr Note 3.02% -0.03
10-Yr Note 4.25% -0.02
30-Yr Bond 4.77% -0.02

Dollar Index 73.610 -0.536
Crude Oil (July) 134.61 -0.25
Nat Gas (July) 12.933 +0.308
Gold (Aug) 886.30 +13.20

Market Summary: Fri. June 13, 2008

2008-06-13T20:10:00.000-05:00

DJIA 12,307.35 +165.77 (+1.37%)
Nasdaq 2,454.50 +50.15 (+2.09%)
S&P 500 1,360.03 +20.16 (+1.50%)
NYSE Composite Volume 1.22 bln

2-Yr Note 3.05% +0.02
10-Yr Note 4.27% +0.04
30-Yr Bond 4.79% +0.02

Dollar Index 74.146 +0.287
Crude Oil (July) 134.86 -1.88
Nat Gas (July) 12.625 -0.173
Gold (Aug) 873.10 +1.10

Market Summary: Thurs. June 12, 2008

2008-06-12T20:51:00.000-05:00

DJIA 12,141.58 +57.81 (+0.48%)
Nasdaq 2,404.35 +10.34 (+0.43%)
S&P 500 1,339.87 +4.38 (+0.33%)
NYSE Composite Volume 1.33 bln

2-Yr Note 3.03% +0.20
10-Yr Note 4.23% +0.13
30-Yr Bond 4.77% +0.05

Dollar Index 73.859 +0.650
Crude Oil (July) 136.74 +0.36
Nat Gas (July) 12.798 +0.138
Gold (Aug) 872.00 -10.90

Market Summary: Wed. June 11, 2008

2008-06-11T19:54:00.000-05:00

DJIA 12,083.77 -205.99 (-1.68%)
Nasdaq 2,394.01 -54.93 (-2.24%)
S&P 500 1,335.49 -22.95 (-1.69%)
NYSE Composite Volume 1.39 bln

2-Yr Note 2.83% -0.08
10-Yr Note 4.10% -0.01
30-Yr Bond 4.72% +0.02

Dollar Index 73.209 -0.487
Crude Oil (July) 136.38 +5.07
Nat Gas (July) 12.660 +0.225
Gold (Aug) 882.90 +11.70

The Fed & Interest Rates

2008-06-11T19:52:00.002-05:00

In the last few trading days, expectations about Federal Reserve policy have changed drastically. When the Fed cut its target rate to 2%, Bernanke mentioned that the risks to inflation and growth were about equal. Most people took his comments as meaning that there would be no more rate cuts and rates would remain at 2% for some time (at least until the health of the economy looked a little more promising).

On Friday, the European Central Bank (ECB) President Jean-Claude Trichet made a statement hinting that the ECB will be raising rates at its next meeting. This news, coupled with the poor employment number, equaled trouble for the dollar at the end of last week. However, over the weekend Bernanke and his colleagues at the Federal Reserve stepped in and made comments that supported the dollar. Bernanke also hinted that rates could go higher to combat inflationary pressures. In a matter of three days, the dollar went from free-fall to near bull mode. All the interest rate futures are now pricing in multiple rate hikes by the end of the year. The Fed is expected to keep its target rate at 2% at its meeting later this month, but by the end of the year traders are betting on a 75 basis point increase. In my view, I think the traders are getting ahead of themselves.

As of right now, the Fed needs to keep its target rate at 2% for the following reasons:

1) Five consecutive months of contraction in the job market. The only statistic that remains strong is the initial jobless claims number which is holding steady and still above typical recessionary levels.

2) Continued weakness in the housing market. Mortgage rates are resetting and if the Fed raises rates, the delinquency rate on sub-prime loans will surely increase.

3) GDP at a standstill and a struggling consumer. With record commodity prices, the consumer has begun to shift its spending habits and many businesses are expected to slow because of this adjustment.

4) A broken financial system. When the Fed cuts rates (and the yield curve becomes steeper) banks can make more money in their lending businesses. However, if the Fed raises rates, the fragile banks will face another unneeded headwind.

5) Finally, in my opinion, if the Fed raises rates 75 basis points by the end of the year (which is very wishful thinking barring no extraordinary events) it will just look bad. What’s the point of raising rates when we just finished lowering them 325 basis points? Typically, everyone says rate cuts take about 9 months to take effect so the economy is just beginning to feel these rates cuts. It is too early for the Fed to tighten its monetary policy.

The market has been extremely choppy and volatile of late, mostly due to uncertainty about the economy, surging energy prices, continued weakness in the housing market, and renewed concerns among the financials.

Market Summary: Tues. June 10, 2008

2008-06-10T19:31:00.001-05:00

DJIA 12,289.76 +9.44 (+0.08%)
Nasdaq 2,448.94 -10.52 (-0.43%)
S&P 500 1,358.44 -3.32 (-0.24%)
NYSE Composite Volume 1.39 bln

2-Yr Note 2.91% +0.18
10-Yr Note 4.11% +0.09
30-Yr Bond 4.70% +0.06

Dollar Index 73.696 +0.842
Crude Oil (July) 131.31 -3.04
Nat Gas (July) 12.435 -0.169
Gold (Aug) 871.20 -26.90

Market Summary: Mon. June 9, 2008

2008-06-09T23:04:00.001-05:00

DJIA 12,280.32 +70.51 (+0.57%)
Nasdaq 2,459.46 -15.10 (-0.61%)
S&P 500 1,361.76 +1.08 (+0.08%)
NYSE Composite Volume 1.36 bln

2-Yr Note 2.73% +0.33
10-Yr Note 4.02% +0.08
30-Yr Bond 4.64% -0.01

Dollar Index 72.854 +0.464
Crude Oil (July) 134.35 -4.19
Nat Gas (July) 12.604 -0.089
Gold (Aug) 898.10 -0.90

Unbelievable...

2008-06-09T12:21:00.003-05:00

I'm averse to making short posts, but this is just too unreal, and really needs no amount of introduction, nor any kind of "analysis."

Check. This. Out.

Market Summary: Fri. June 6, 2008

2008-06-08T17:41:00.002-05:00

All I can say is ‘wow!’ Thursday morning crude oil was just below $122 per barrel and Friday it touched $139 per barrel. That is a 14% move in less than two days! The Commodity Futures Trade Commission (CFTC) has mentioned price manipulation in certain markets and I am becoming more and more convinced with this recent move in crude oil prices. To put this move in perspective, just ten years ago crude oil was at $11 per barrel. On Friday the price of one barrel increased by $11. Off of this ridiculous move in crude oil prices, the national average for a gallon of gas surpassed $4 for the first time.

Thursday, the markets got a nice boost from Wal-Mart and CostCo after the companies posted better-than-expected same store sales for May. Oil did manage to gain $5 on the day thanks to comments from the European Central Bank President Jean-Claude Trichet. Trichet said the ECB might raise rates to combat inflation. This statement put downward pressure on the dollar because the Euro will become relatively stronger and consequently, commodity prices rallied. I was a little surprised the markets did not sell off in the afternoon after the release of this statement. Also, S&P finally lowered its ratings on Ambac and MBIA, but it was not too much of a market moving event because S&P and the other credit rating agencies have been so far behind the curve.

Friday was a completely different story for the markets as they finished down about 3%. The unemployment number came in at 5.5%, much higher than the expected 5.0%. This unexpected news caused the markets to open significantly lower and the selling pressures increased when Morgan Stanley said it expects oil prices to be at $150 by July 4^th. Off of this news, the dollar and stocks tanked while crude oil surged to another new record.

Financials were also very weak the entire week. There have been concerns regarding Lehman Brother’s liquidity and speculation that the company will be raising capital. Washington Mutual and Wachovia both gave their CEOs the ax. Right now, the markets are on edge waiting for the next shoe to drop in the financial sector. Adding to the uncertainty is surging crude oil and gas prices which are significantly pinching the consumer.

Obama vs. McCain: Economics

2008-06-07T23:03:00.004-05:00

The first of many posts, no doubt, here is a quick breakdown of some important economic differences between John McCain and Barack Obama.

This WSJ article has done a good job of laying out the differences, although I am sure positions will change as we approach November.

Concerning taxes, Obama is following the traditional Dem policy: lower taxes for middle class, and raise for the wealthy. In terms of business, Obama wants to support a capital gains tax on private equity and hedge funds, and an overall raise for capital gains and dividend tax rates from 15% to somewhere between 20% and 25%.

Now hedge funds and PE shops are pretty easy targets for politicking liberals. They have gotten some bad press (I remember reading a lot of griping over the winter) about the meager taxes they pay, relative to other financial companies. However, as David Rubenstein, co-founder of Carlyle Group, noted, private equity has grown to be an incredibly important part of the US economy, and is one of the last bastions of US business dominance. Furthermore, private equity has largely been financed by investments from pension funds, who have grown dependent on PE's high returns; so taxation would inadvertently hurt retirees dependent on their pensions.

McCain wants to lower the corporate tax from 35% to 25%, and require a 3/5 majority in Congress to raise taxes in the future. McCain cap gains and dividends tax the same as it is. This would (probably) do a lot of good to foster growth in our near-recessionary economy (although the verdict is still out on whether or not this "recession" is limited to housing and finance).

In terms of trade, the Journal suggests that this is a matter of pro- and anti-globalization, although that may be putting words in Obama's mouth, who is arguably anti-globalization. Trade hasn't been much of an issue recently, as exports are up 15.5% this year (probably due to our weak dollar more than anything else).

Obama said in Pennsylvania in April that “trade should work not just for some Americans, but for all Americans, not just for Wall Street, but for Main Street,” and is a proponent of including labor and environmental provisions in trade agreements with other countries. Elsewhere, Obama has promised that he “will fight for a trade policy that opens up foreign markets to support good American jobs,” although I have no idea how he expects that to happen, as opening up foreign markets would do anything but support costly American jobs.

McCain expresses a much less isolationist rhetoric, stating that "the U.S. should engage in multilateral, regional and bilateral efforts to reduce barriers to trade, level the global playing field and build effective enforcement of global trading rules." The result of this rhetoric is theoretically healthier and more competitive multinational corporations (many of which are based in the US), as well as raising the standard of living in developing countries through increased foreign direct investment (a good thing).

Now as a good college student, I am naturally leaning towards Obama, and look forward to seeing how his rhetoric (hopefully) shifts towards the center as debate heats up between the two. It is worth mentioning as well that McCain is notoriously ignorant of economics, which is also pretty disappointing.

And something of a surprise, guess who Mr. Murdoch is leaning towards....

The January Effect

2008-06-07T18:54:00.003-05:00

I learned this at work the other day and thought I would share. Turns out taxes do more than just take your money away. The January effect is a bounce in stock prices in January due to the absence of abnormal selling pressure taxes create. This does not happen in all stocks; you see the most results from small cap stocks that have gotten beaten down during the previous year, although mid to larger cap stocks are affected also, just not as much. There are a couple reasons for this phenomena. First is because of window dressing from professional investors that manage large funds. They eliminate their losses from their portfolio and add winners to improve their perceived performance. This is because professional investors are evaluated on both their investment results and consistency of their investment philosophy. This also occurs at the end of each quarter because of professional investors; however, it does not result in the same increase in stock prices. The second reason is because of abnormal selling pressure prior to the end of the year. This pressure is a result of taxes. People/investors want to sell their stocks that have lost them money during the year to obtain the tax losses. Thus, towards the end of the year everyone sells their losers which causes them to go down more. When the New Year begins there is no abnormal selling pressure from taxes. This lack of selling pressure results in increased prices of stocks that were affected from the abnormal selling pressure. The bounce usually occurs within the first 10 – 14 days of the year. If no bounce occurs within the first two weeks, there usually will not be a bounce. Here is a good example of the January Effect on Las Vegas Sands Corp (LVS). Back In 2005 LVS hit a high of $49.05 in Feb; hit its low of $31.37 in Oct.; rebounded to 45.51 on Nov 25 and closed two weeks later at $38.73. This decrease could have resulted from the abnormal selling pressure. The last trading day of the year, Dec 30, the stock was at $39.47. By January 6, ’06 the stock price was at $41.61, by Jan 13 it was at $48.35, and by Jan 20, $49.66. After looking at past predictions for possible Jan. Effect stocks, the best way to win by using this theory is to use a basket of stocks that you have researched and that you believe could bounce in Jan. Some of our own Professors and alumni at U of I have written on the topic as well.

Market Summary: Thurs. June 5, 2008

2008-06-05T22:56:00.000-05:00

DJIA 12,604.45 +213.97 (+1.70%)
Nasdaq 2,549.94 +46.80 (+1.84%)
S&P 500 1,404.05 +26.85 (+1.91%)
NYSE Composite Volume 1.31 bln

2-Yr Note 2.52% +0.05
10-Yr Note 4.06% +0.08
30-Yr Bond 4.75% +0.04

Dollar Index 73.038 -0.386
Crude Oil (July) 127.79 +5.49
Nat Gas (July) 12.519 +0.140
Gold (Aug) 875.50 -8.30

Market Summary: Wed. June 4, 2008

2008-06-04T20:24:00.000-05:00

DJIA 12,390.48 -12.37 (-0.10%)
Nasdaq 2,503.14 +22.66 (+0.91%)
S&P 500 1,377.20 -0.45 (-0.03%)
NYSE Composite Volume 1.29 bln

2-Yr Bond 2.47% +0.02
10-Yr Bond 3.98% +0.08
30-Yr Bond 4.71% +0.04

Dollar Index 73.424 +0.184
Crude Oil (July) 122.30 -2.01
Nat Gas (July) 12.379 +0.158
Gold (Aug) 883.80 -1.70

Market Summary: Tues. June 3, 2008

2008-06-03T18:54:00.003-05:00

Lehman Brothers and General Motors were the two stocks that caused the market to be lower today. If it wasn’t for a better-than-expected factory orders number, we would have seen 2+% declines in the major indices.

As the market rebounded in April and May, news – especially bad news – from the financials was essentially non-existent. In the last few weeks, the financials have come back to the spotlight amidst new liquidity rumors. The most frightening one is Lehman Brothers because its business is so similar to Bear Stearns’ business. David Einhorn, a billionaire hedge fund manager, has been short Lehman and has been coming on CNBC talking about how Lehman will take larger-than-expected write-downs when it reports earnings.

Rumors circulated today that Lehman borrowed funds from the Federal Reserve’s discount window. But Lehman came out and said it did not access the lending facility. Remember, just days before Bear Stearns’ collapse its CEO said the company’s liquidity position was adequate. Well, this story sounds eerily similar. Maybe that’s why the $2 put options for Lehman traded over 1,000 contracts on the day! Shares of LEH closed the day at $30.61.

The Wall Street Journal also reported that Lehman will be raising $4B of additional capital through an equity offering; Lehman did not dispel this rumor, though. LEH finished the day down over 9%.

The automakers, specifically General Motors (GM), also weighed on the markets. The

Asian automakers, Honda and Toyota, had their May sales increase 3.7% while the American automakers, GM, Ford, and Chrysler, had their May sales decrease 21%. With gasoline at $4 per gallon, consumers are switching from SUVs and trucks to more fuel efficient sedans. GM announced is will close four of its truck plants and it is considering selling its Hummer brand. When GM’s CEO made his comments around noon the markets began to sell-off.

Oil continued its slide ending the day $3.45 lower. I am very cautious on all commodities now; I’m least cautious on natural gas, though. I feel there is too much downside risk thanks to possible government intervention. The Commodity Futures Trading Commission (CFTC) is already looking into price manipulation for crude oil and other commodities that soared last year. When crude oil spiked to $135 per barrel, the news stations led their broadcasts with oil-related stories. Today, the carmakers are already feeling the pain and I expect it to spread even further. The consumer has already cut back and I expect demand to decline. I have also heard rumors that China and some other countries might stop subsidizing oil (should lower global demand because prices will not be kept artificially low). I’m letting all the speculators unwind their positions before I make any moves.

DJIA 12,402.85 -100.97 (-0.81%)
Nasdaq 2,480.48 -11.05 (-0.44%)
S&P 500 1,377.65 -8.02 (-0.58%)
NYSE Composite Volume 1.29 bln

2-Yr Bond 2.45% -0.06
10-Yr Bond 3.92% -0.06
30-Yr Bond 4.63% -0.05

Dollar Index 73.240 +0.311
Crude Oil (July) 124.31 -3.45
Nat Gas (July) 12.221 +0.252
Gold (Aug) 885.50 -11.50

A few interesting plays

2008-06-02T19:13:00.003-05:00

Here are things that I am watching closely:

-J Crew (JCG) got hit for 20% on Friday on lowered guidance. It's the best operator in the space, it targets and gets rich clients that are loyal and it is still growing at a 18% clip going forward. The revised guidance brings it's forward multiple back equal to it's growth rate and I can see this one springing back nicely. I took my first bite this morning. If you like the "rich people are still going to shop" theory, the other one I like is Coach (COH). The ones I would pass on are TIF, JWN and SKS.

-DryShips (DRYS). I started building in a position in this one last week, and I have not even done comps on shippers yet. It trades around 5 times forward earnings from continuing ops... dirt cheap. The catalyst: it's in the process of building the only exclusive deepwater drilling company (i.e. they don't even do the shallow water stuff; they are only where all the demand is building). They plan to spin off this subsidiary in about a year. I think it gets up near 200 in that time frame. The downside: just about the only shipper with a bad yield. I will post a full write up on DRYS when I have time to do comps.

-Chesapeake (CHK). Just about the only thing that worked today was natural gas. CHK's CEO made another multimillion dollar purchase of the stock last week. It is real close to the trend line it pulls back to, and this is a great time to get in a leading nat gas company. XTO and APA are also cheap, I'd watch out for SWN and UPL. I am long CHK.

-If you want to play steel the 2 cheapest companies out there are MTL and MT. I would go with MTL between these two. MTL is a vertically integrated (aka not getting killed by raw material prices) steel manufacturer in Russia. Personally, I own SID, which is a vertically integrated steel manufacturer in Brazil because I have more faith in that country's operating environment. You have a golden opportunity to get in SID right here where it is now.

-There's a nice long/short set up in the rails if you were to go long NSC and short KSU, the cheapest and most expensive of the major rails, respectively. On top of it, NSC has a 1.7% yield while KSU has none.

Those are some names peaking my interest right now.

Market Summary: Mon. June 2, 2008

2008-06-02T18:40:00.000-05:00

DJIA 12,503.82 -134.50 (-1.06%)
Nasdaq 2,491.53 -31.13 (-1.23%)
S&P 500 1,385.67 -14.71 (-1.05%)
NYSE Composite Volume 1.15 bln

2-Yr Bond 2.51% -0.15
10-Yr Bond 3.98% -0.08
30-Yr Bond 4.68% -0.04

Dollar Index 72.929 +0.050
Crude Oil (July) 127.76 +0.41
Nat Gas (July) 11.969 +0.266
Gold (Aug) 897.00 +5.50

New Opportunities for China's Banks

2008-06-02T18:39:00.004-05:00

I wrote an economics term paper while studying abroad in Singapore about the huge menace that non-performing loans (NPL) were to China's banking system during its post-Mao economic reform. In 2004, NPLs accounted for anywhere between 11 and 26% of China's GNP, depending on how the loans were classified. This is obviously a pretty staggering concern (and especially interesting, considering how China overcame these large defaults, in comparison to how the US has been handling the recent wave of home mortgage defaults, which of course resulted in this "subprime crisis").

To offer a brief history lesson, before 1978, the majority China's GDP came from its state-owned enterprises. These companies were big, inefficient (quota rather than profit driven), corrupt, communist manifestations that were funded by the central bank (as one would expect for a controlled economy). After Mao died, China set on a slow and deliberate change from a planned to a market economy. They mostly have Deng Xiaopeng to thank, although Zhao Ziyang officially kicked things off. China designed a very clever "dual track system" (shuangguizhi) to ween companies off of planned economics piecemeal. If you're interested in how this worked, email me, but the explination is too long for this post. After this policy was implemented, the previously monopolistic SOEs started to beat up by the new market competition. Because they were losing money, the SOEs decided paid off less and less of their bank debt, and instead, because of remnant bureaucratic inefficiencies, piled on more debt to finance their operations. As a result, the debt/equity ratio ballooned from 12% in 1978, when policy change began, to 211% in the early 90s. China ended up stepping in and infusing these insolvent banks with cash.

With this history lesson, I found it interesting to read today a McKinsey Quarterly report entitled "Global Investment Strategies for China's Financial Institutions," which had a lot to say about far financial institutions in China had come. As the report put it:

The shift from investment target to investor came suddenly and many Chinese institutions are not fully prepared for their new role. Not long ago, state-owned Chinese banks were saddled with nonperforming loans, which effectively blocked their global aspirations. But the level of bad loans has dropped rapidly—from about 30 percent of total loans in 2001 to 7 percent in 2007, according to official figures...

Why is this important? Well, this global credit crisis is creating great investment opportunities for cash-flush companies like China's financial institutions. McKinsey also notes that these purchases will do much to also bring in needed expertise, particularily in areas such as risk management, IT, product development, and customer service.

What I found most interesting about this report was in the suggestions McKinsey had for these banks' strategy. They are currently looking at investment opportunities on a case-by-case basis, without enough regard towards a larger strategy. As McKinsey puts it: "Chinese managers [should] consider how many deals they want to complete in the medium term, what type, and in what markets. They should also think about how deals can add value not only in a portfolio but also independently. With a better game plan, they can weigh opportunities against their longer-term goals and become much less reactive." If you have been reading this blog religiously, you may be wondering how this relates to US anxiety over the security ramifications of foreign SWFs strategically investing in different companies.]Well, these are just banks, not sovereign wealth funds, and therefore do not carry the same type of political tension, because they cannot possibly have any "devious political motives," as some hawks might suggest SWFs have.

The report goes on to suggest that China looks beyond mere portfolio returns when choosing deals. Buying minority stakes in companies across the world would allow access to many companies' inner workings via seats on the BOD. Through these investments, China can have access to important management and human capital opportunities - including hiring one of us to go out there one day...

An Underappreciated Industrial Revisited

2008-06-01T20:38:00.002-05:00

Let's take a look at Trinity Industries (TRN), a stock Dave Light suggested to buy May 14th at $35.08 (5/14 closing price). Since then, TRN has rallied to $40.85 (5/30 closing price)

If you took Dave's advice you would have caught a quick 16.4% gain. During this same time, the S&P 500 declined 0.7%. You would have handily beat the market.

Nice pick Dave!

Market Summary: Week Ended 05/30/2008

2008-06-01T20:29:00.002-05:00

Here is a link for a CNBC.com market recap for the week that was. It takes a look at earnings reports, economic data, best and worst performers, and even a look at the week ahead.

Market Summary: Fri. May 30, 2008

2008-06-01T20:28:00.000-05:00

DJIA 12,638.32 -7.90 (-0.06%)
Nasdaq 2,522.66 +14.34 (+0.57%)
S&P 500 1,400.38 +2.12 (+0.15%)
NYSE Composite Volume 1.41 bln

2-Yr Bond 2.66% -0.01
10-Yr Bond 4.06% -0.02
30-Yr Bond 4.72% -0.04

Dollar Index 72.879 -0.144
Crude Oil (July) 127.35 +0.73
Nat Gas (July) 11.703 +0.229
Gold (Aug) 891.50 +9.80

Market Summary: Thurs. May 29, 2008

2008-05-31T18:36:00.000-05:00

DJIA 12,646.22 +52.19 (+0.41%)
Nasdaq 2,508.32 +21.62 (+0.87%)
S&P 500 1,398.26 +7.42 (+0.53%)
NYSE Composite Volume 1.21 bln

2-Yr Bond 2.67% +0.23
10-Yr Bond 4.08% +0.05
30-Yr Bond 4.76% +0.05

Dollar Index 73.023 +0.476
Crude Oil (July) 126.62 -4.41
Nat Gas (July) 11.474 -0.521
Gold (June) 877.2 -23.30

Market Summary: Wed. May 28, 2008

2008-05-28T23:59:00.000-05:00

DJIA 12,594.03 +45.68 (+0.36%)
Nasdaq 2,486.70 +5.46 (+0.22%)
S&P 500 1,390.84 +5.49 (+0.40)
NYSE Composite Volume 1.19 bln

2-Yr Bond 2.34% -0.21
10-Yr Bond 4.03% +0.10
30-Yr Bond 4.71% +0.06

Dollar Index 72.547 +0.209
Crude Oil (July) 131.03 +2.18
Nat Gas (June) 11.916 +0.115
Gold (June) 900.50 -7.40

The World isn't just GE and Google?

2008-05-28T22:10:00.003-05:00

I've forgotten that being a business student and only knowing about the business world form business media, creates a pretty myopic view of the business world. Tom Peters, the "Management Guru"(a term he seems to have much disdain for) discusses how many more people are working in small and mid-size firms than large ones, and how important those firms are, despite largely being under the radar of business media. Thank god for entrepreneurs! Heres the audio clip. Here's the (brief) article from the FT.

On a completely separate issue, if you aren't reading Seth Godin's blog, you should be. I follow nearly 70 blogs on my RSS feed, and although he isn't the most consistent poster (I have Deal Journal, Deal Book, and Lifehacker to thank for drowning me daily in TMI), I most often am sharing his posts, proportionally speaking.

The Perfect Hedge: How to Beat Crude Oil Volatility

2008-05-28T21:10:00.007-05:00

What has been moving the market lately? Crude oil prices and that is pretty much it. Crude oil has been very volatile of late (+/- 3% swings) and I have been asking myself: Knowing that crude oil moves the market, how do I take advantage of this?

Try a hedge…sounds complicated, but it’s not. Here, we won’t short any stocks; rather, we will be long two stocks. One that you expect to go up when oil goes up and one you expect to go up when oil goes down.

Typically, when oil goes up, all the agriculture and materials/minerals names move up as well. Retailers and other stocks dependent on consumer spending are the laggards. The reverse is true when oil sells off.

Here are the hedges to try:

Buy Apple (AAPL) or Research in Motion (RIMM) and Mosaic (MOS) or Potash (POT). All these stocks are high growth, high momentum for the more aggressive investor.

If you don’t like the agriculture stocks, substitute them for a natural gas/oil stock such as Anadarko (APC), Apache (APA), or Petrobras (PRB). I'd definitely use put protection if you select a natural gas/oil stock (see below for explanation).

If you are a more conservative investor, then try buying Monsanto (MON) or Deere (DE) - probably Monsanto given that Deere is in the dog house after sub-par guidance last quarter - and CostCo (COST) or Wal-Mart (WMT). Monsanto and Deere are both agriculture-related plays and usually trade with oil, but they are much less volatile. CostCo and Wal-Mart are direct consumer spending plays and both stocks are best-of-breed.

As long as oil remains volatile (not necessarily going higher) you should be able to limit your losses when the market sells off and maximize your profits when oil rallies. For someone who might like to try an aggressive strategy, consider buying a put option on the U.S. Oil Fund ETF (USO) which mimics the price of crude oil. The put option will increase in value when crude oil declines and decrease in value when crude oil rallies.

Right now, the path of least resistance for crude oil (in the near term) is lower so the put option might be a good idea. However, my long term view of oil remains intact (bullish) and this pull-back is merely a correction, a very much needed one.

"The new financial system.... failed the test of the marketplace"

2008-05-27T17:39:00.003-05:00

Once again, old Marty Wolf has written another awesome column in the FT. Here's the link, but unfortunately, you have to register to read the whole thing... So instead, I'll pull the good bits out, quoted of course, and comment on them...

He mentioned 7 facets of regulation that need to be improved in order to avoid another financial crisis like this last one (or the 5 year cycle we seem to be pretty good at going into).

"First, coverage. Perhaps the most obvious lesson is the dangers of regulatory arbitrage: if the rules required certain capital requirements, institutions shifted activities into off-balance-sheet vehicles; if rules operated restrictively in one jurisdiction, activities were shifted elsewhere; and if certain institutions were more tightly regulated, then activities shifted to others. Regulatory coverage must be complete. All leveraged institutions above a certain size must be inside the net."

This is a definite concern, but difficult to put into practice, as it really gets deep into the accounting and legal mumbo-jumbo and jibber-jabber. The principles-based GAAP the US will soon be adopting should help some, by ceasing the expensive-to-audit proliferation of rules designed to box in companies to restricted accounting practices. However, I imagine that this will continue to be a constant struggle between regulators and accounting/legal teams at CPA firms who are going to keep wriggling free (for competitive reasons - you have to convince customers to buy your services somehow). Just as there is no perfect contract, there is also no perfect accounting standard.

"Second, cushions. Equity capital is the most important cushion in the financial system. Also helpful is subordinated debt. If Bear Stearns had had larger equity capital, the authorities might not have needed to rescue it. Capital requirements must be the same across the entire financial system, against any given class of risks. But there must also be greater attention to the adequacy of that other cushion: liquidity."

We can probably put legal limits on how levered a company can be, can't we? This sounds like a good, old fashioned no-brainer.

"Third, commitment. The originate-and-distribute model has, it is now clear, a huge drawback: originators do not care sufficiently about the quality of loans they plan to offload on to others. They do not, in Warren Buffett’s phrase, have “skin in the game”. That makes for sloppy, if not irresponsible or even fraudulent lending. Originators should be required, therefore, to hold equity portions of securitised loans."

I personally see this at the biggest reason why everything went to hell in the first place. I heard a great NPR report on the drive home from school about mortgage lenders, and how these 'no documentation' loans kept getting fed to wall street in tranches because markets were so hungry for any type of asset backed security. If the jerks writing these loans had some skin in the game, things wouldn't have gotten so bad. This is another no-brainer for me.

Fourth, cyclicality. Existing rules are pro-cyclical. Capital evaporates in bad times, as a result of write-offs, thereby forcing contraction of lending, worsening the economic slowdown and further impairing assets. Mark-to-market accounting, though inherently desirable, has a similar effect. One solution could be to differentiate between target levels of capital and a lower minimum level. Institutions that have minimum capital in bad times would only be required to aim for the higher target level over an extended period.

Considering how psychological markets are, I doubt cyclicality can be conquered. Admittedly, I don't quite understand how Mr. Wolf's solution works, beyond trying to convince stakeholders that their efforts to increase their target level of capital is the acceptable... Any insights?

Fifth, clarity. Lack of information, asymmetric information and uncertainty are inherent in financial activities. These are why they are vulnerable to swings in collective mood. The transactions-orientated financial system is particularly vulnerable, because information has to flow freely across arms-length markets. So a big challenge is to generate as much clarity as is possible. One issue is the calamitous recent role of the rating agencies and the conflicts of interest under which they operate.

I don't know how Marty expects this to happen. Admittedly, much can be done to clean up 10ks and 10qs which "disclose" everything they have to, but go about in a very convoluted fashion, blending up information, and spreading it across dozens of pages and footnotes. Some things are just really tough to value, and nobody has a very good idea about how to best do this, aside from mark-to-market, which adds to volatility, and feeds issue #4: cyclicality, when markets devalue assets.

Sixth, complexity. Excessive complexity is a significant source of lack of clarity. It is particularly damaging, as we have seen, to the originate-and-distribute model, because markets in complex securitised products may, at times, seize up, forcing central banks to become “market makers of last resort”, with all the difficulties this entails. One possibility then is to insist that all derivatives be traded on exchanges.

The originate-and-distribute model is the practice of financially-inclined companies taking all of their income-generating financial assets (like car loans, credit card receivables, etc.) and selling it all to a Special Purpose Vehicle (aka an SPV, which is supposed to be a different company), which finances the purchase of these assets by selling bonds to other financial institutions (e.g. pension funds, banks, etc.). The assets that these SPVs buy off of the original company have varied levels of risk (they bought a car loan from a doctor and a homeless guy, say, so one will be more likely to pay back the car debt, and is therefore less risky). These assets, of varied risk, are smashed together and then chopped up into tranches and sold or re-tranched, making it very complicated to understand their risk, because of their complexity. I don't know how insisting that all derivatives should be traded on exchanges, though. How is a marketplace of people who probably don't understand them going to help? I don't think collective intelligence surpasses collective greed...

Seventh, compensation. On this I can do no better than quote Mr Volcker: “In the name of properly aligning incentives, there are enormous rewards for successful trades and for loan originators. The mantra of aligning incentives seems to be lost in the failure to impose symmetrical losses – or frequently any loss at all – when failures ensue.” Whether regulators can do anything effective is unclear. That this is a challenge is not.

'Nuff said.

Market Summary: Tues. May 27, 2008

2008-05-27T15:47:00.000-05:00

DJIA 12,548.35 +68.72 (+0.55%)
Nasdaq 2,481.24 +36.57 (+1.47%)
S&P 500 1,385.35 +9.42 (+0.68%)
NYSE Composite Volume 1.12 bln

2-Yr Bond 2.55% +0.09
10-Yr Bond 3.93% +0.08
30-Yr Bond 4.65% +0.08

Dollar Index 72.338 +0.450
Crude Oil (July) 128.85 -3.34
Nat Gas (June) 11.801 -0.056
Gold (June) 907.9 -17.90

Market Summary: Fri. May 23, 2008

2008-05-23T20:26:00.000-05:00

DJIA 12,479.63 -145.99 (-1.17%)
Nasdaq 2,444.67 -19.91 (-0.81%)
S&P 500 1,375.93 -18.42 (-1.34%)
NYSE Composite Volume 1,110,000,000

2-Yr Bond 2.46% -0.10
10-Yr Bond 3.85% -0.07
30-Yr Bond 4.57% -0.06

Dollar Index 71.888 -0.389
Crude Oil (July) 132.19 +1.38
Nat Gas (June) 11.857 +0.160
Gold (June) 925.8 +7.50

Market Summary: Thurs. May 22, 2008

2008-05-22T19:25:00.001-05:00

DJIA 12,625.62 +24.43 (+0.19%)
Nasdaq 2,464.58 +16.31 (+0.67%)
S&P 500 1,394.35 +3.64 (+0.26%)
NYSE Volume 3,958,122,000

2-Yr Bond 2.56% +0.15
10-Yr Bond 3.92% +0.11
30-Yr Bond 4.63% +0.08

Dollar Index 72.277 +0.339
Crude Oil (July) 130.81 -2.36
Nat Gas (June) 11.697 +0.057
Gold (June) 918.30 -10.30

Market Summary: Wed. May 21, 2008

2008-05-22T02:32:00.002-05:00

Every single stock on my watch list was red today. The culprits were crude oil’s march to $133 per barrel and the release of the Fed minutes. Also, adding to the selling pressure was bad news from the airlines. There was basically no good news that crossed the wire. Bonds even sold-off. We have finally gotten the pull back that I have been anticipating and I’m looking for stocks to come in a little bit more before I start buying.

Crude oil was flying high all morning and it got an added boost from a very bullish inventory report. The Energy Department reported that crude oil inventories fell 5.32M barrels last week. The consensus estimate was for an increase of 300K barrels.

American Airlines announced it will reduce its fourth quarter domestic capacity by 11-12% because of record fuel prices. The company also plans to eliminate “thousands” of jobs and retire about 85 jets. It will also begin charging $15 for customers’ first checked bag. AMR, the parent company of American Airlines, and UAUA, United Airlines, were off about 24% on the day.

Stocks were trading about 0.5% lower until 1pm when the Fed minutes were released. Investors then sold the heck out of stocks and the major indices finished the day down about 1.5%. Why all the selling? Here is the excerpt that frightened investors:

“Most members viewed the decision to reduce interest rates at this meeting as a close call…Several members noted that it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term.”

Basically, it looks as if the Fed is done cutting interest rates. Inflation is a key concern and reducing rates any further will hurt the dollar and commodity prices will continue to rise. The Fed looks as if it is out of bullets - I expect rates to remain at 2% for a while.

From Briefing.com, “The Fed expects 2008 real GDP growth of between 0.3% and 1.2%, which is down about 1% from their previous forecast. The 2008 inflation outlook was increased, as was the unemployment rate forecast.” With oil at such high levels, economic growth will be stagnant as consumer spending slows.

DJIA 12,601.19 -227.49 (-1.81%)
Nasdaq 2,448.27 -43.99 (-1.80%)
S&P 500 1,390.71 -22.69 (-1.63%)
NYSE Volume N/A

2-Yr Bond 2.41% +0.07
10-Yr Bond 3.81% +0.03
30-Yr Bond 4.55% +0.02

Dollar Index 71.938 -0.467
Crude Oil (July) 133.17 +4.19
Nat Gas (June) 11.640 +0.275
Gold (June) 928.60 +8.40

Market Summary: Tues. May 20, 2008

2008-05-21T00:39:00.002-05:00

The markets sold off hard as crude oil rallied to record prices once again. Adding to the sell-off was a worse-than-expected Core Producer Price Index report.

Why are stocks selling off as crude oil rallies? Here’s the thesis many are using, including myself: as oil goes up, gasoline also goes up and the consumer will get pinched (it is much more psychological than anything else). This increase in prices will cause the consumer (consumer spending makes up about 2/3 of GDP) to stop spending and the economy will slow. The slowing economy will also cause the dollar to decline further. The Fed will not be able to raise interest rates until crude oil prices stabilize.

The other side of this argument is that as the economy slows, demand and therefore prices for oil will decrease. However, the global demand for oil is far too great to be affected by the slowing American economy. Everyone is worried about the future supply of oil, not what is available today. People want to get their hands on oil now because it might not be available in a few years. This is why we see crude futures for 2016 delivery exceeding $140/barrel.

Now, back to the rally in crude oil fueled by predictions. Boone Pickens, a billionaire oil mogul, said in a CNBC interview he expects to see oil at $150 by the end of the year. Also, Societe Generale and Credit Suisse both increased their price targets for oil. Everyone seems to be following Goldman Sachs’ lead. Just the other day Goldman raised its target for crude to $141. I’m also following their lead because in April 2005 when crude was $50 per barrel Goldman said prices were going to $105 per barrel. They have been right all along and I do not see a reason to go against them.

Keep an eye on the dollar. It is quickly approaching its all-time lows once again. Everyone is talking about the dollar stabilizing and possibly rebounding as the Fed raises interest rates, but as long as crude continues to rally don’t look for a rebound anytime soon.

From Briefing.com, “The April Producer Price Index rose 0.2%, while [the] core-PPI, which excludes food and energy costs rose 0.4%. Economists expected the opposite, forecasting a 0.4% rise in PPI and a 0.2% rise in core-PPI. The difference in total PPI and core-PPI is largely due to a 0.2% drop in energy costs on a seasonally adjusted basis. On a non-adjusted basis, energy prices are up 2.9%.”

Today, the financials were weak again…

- AIG announced it will raise $20B worth of new capital; Merrill Lynch cut its earnings estimates for AIG; shares fell to a 10-year low

- Oppenheimer’s Meredith Whitney said, “the real harrowing days of the credit crisis are still in front of us and will prove more widespread in effect than anything yet seen.” Whitney cut earnings estimates for Bank of America, Citigroup, JPMorgan Chase, Wachovia, and Wells Fargo.

- Lehman Brothers cuts earnings estimates for Goldman Sachs and Morgan Stanley.

- Bank of America plans to sell $2.7B in preferred stock.

In earnings news…

- Hewlett-Packard reported earnings that matched its pre-announcement on May 13.

- Home Depot’s Q1 net income fell 66%, but was less than analysts predicted. However, shares of HD were down 5.5% on the day.

- Staples reported earnings that met analysts’ expectations. Its Q1 profit increased 1.5% while its revenue increased 6.4%.

- Target reported earnings that topped analysts’ expectations, but income was down from the same period a year ago.

- Saks missed analysts’ expectations and the CEO said the consumer is acting as if there is a recession even if there isn’t one.

In today’s down market, there were a few bright spots. The winners were the stocks/sectors that have a strong long-term theme. Oil and gas, infrastructure, minerals, agriculture were all relative winners as the market sold-off. Some of the material names – Alcoa and Freeport McMoRan – were off in the morning after a downgrade, but managed to recover as the day progressed. These sectors have been the market leaders the last 12 months and they will continue to be the relative winners.

DJIA 12,828.68 -199.48 (-1.53%)
Nasdaq 2,492.26 -23.83 (-0.95%)
S&P 500 1,413.40 -13.23 (-0.94%)
NYSE Volume 3,861,710,000

2-Yr Bond 2.34% -0.08
10-Yr Bond 3.78% -0.05
30-Yr Bond 4.53% -0.03

Dollar Index 72.405 -0.640
Crude Oil (June) 129.07 +2.02
Nat Gas (June) 11.365 +0.411
Gold (June) 920.20 +14.40

Market Summary: Mon. May 19, 2008

2008-05-19T19:54:00.001-05:00

Stocks got off to a great start today thanks to a better-than-expected leading indicators reading. The leading index increased 0.1%, better than the flat reading analysts were expecting. I wouldn’t read too much into this piece of data, though, because it is pretty much a compilation of previously announced data. For some reason, CNBC kept highlighting it and said stocks were trading higher because of it.

The main reason stocks were higher in the morning was upgrades to technology stocks. Amazon.com was added to Goldman Sachs’ “conviction buy” list and had its price target increased to $98. AMZN was up about 10% midday. Goldman also upgraded the entire chip sector. Texas Instruments was upgraded to “buy” from “hold” at Citigroup and it was also added to Citi’s top picks list. Merrill Lynch also named technology as its top sector. All the tech names got a big boost from this news, but don’t chase these names. The NASDAQ has had a huge run up lately and these big banks are just a little late to the game. The easy money has already been made.

At about 12:30 pm, the market began to sell-off after the SanDisk CEO said sales were “soft” last month. Shares of SanDisk finished the day down 7.5%. Technology stocks went from market leader to market laggard. The CEO blamed rising gas prices as the reason why consumers have tightened their budgets. This news caused a large sell-off that caused stocks to finish mixed. The major indices were up about 1% midday.

Financials were also weak on the day after Citigroup cut earnings estimates at Goldman Sachs, Morgan Stanley, and Lehman Brothers.

Crude oil was once again in the news. OPEC President Chakib Khelil said “there is no shortage (of supply).” Also, Saudi Arabia’s oil minister Ali al-Naimi said production will increase in June by 300,000 barrels per day. Qatar’s oil minister Abdullah al-Attiyah said “the market doesn’t need more oil,” and Iragi’s oil Minister Hussain al-Shahristani said “there is more oil in the market than consumers want.” All of these comments helped crude oil hit new record prices.

The Microsoft-Yahoo deal was back in the news. Microsoft proposed a new deal that would not involve buying Yahoo outright. Instead, Yahoo would just carry search ads from Microsoft.

In other news:

- Lowe’s reported earnings that beat analysts’ expectations, but the company offered very cautious guidance.

- Union Pacific was upgraded to “buy” from “hold.” This upgrade caused the transports to rally and hit a new all-time high.

- Take a look at Solar Fun. This stock has been up 50% the last few trading days.

- The Senate announced a $300B housing bill that will be sponsored by Fannie Mae and Freddie Mac to help troubled home owners.

Talk on the street:

- Why are the transports rallying to record highs with crude oil approaching $130 per barrel? Usually, the transports are a leading indicator for the economy and with them rallying to record prices is the economy in better shape than some think? Railroads are moving this index higher because there is high demand to ship commodities across the country.

- Is Cisco going to buy EMC?

- The economy is ready to rebound. The recent Fed rate cuts will soon be felt by big businesses and the tax rebates will stimulate consumer spending. Too many people are bearish right now and the market continues to rally. Just wait until these bears turn into bulls. Then the market will really take off higher.

DJIA 13,028.16 +41.36 (+0.32%)
Nasdaq 2,516.09 -12.76 (-0.50%)
S&P 500 1,426.63 +1.28 (+0.09%)
NYSE Volume 3,718,190,000

2-Yr Bond 2.42% -0.05
10-Yr Bond 3.83% -0.02
30-Yr Bond 4.56% -0.02

Dollar Index 73.045 +0.201
Crude Oil (June) 127.05 +0.76
Nat Gas (June) 10.954 -0.140
Gold (June) 905.80 +5.90