No post tonight, because I spent a lot of time today working on my site redesign. I’m afraid most of the time went for naught. I am getting pretty close to completion, though, and when the new design goes live, I would like feedback on it. I will miss some design elements of the current site, and I am still working with the new design to make it look better. It is more functional than the present site, but it is not as pretty, and I’m afraid I’ll have to sacrifice there. (On the other hand, maybe I need to get a book on PHP programming…)
One more note: Remember when I wrote about Timothy Sykes forthcoming book? No? Oh well, it’s for sale now, and there is a link at the bottom of this post.
Oh, wait, one more off-topic comment: be sure and check out this new feature at Google Maps. Suppose I wanted to go from Baltimore to Milwaukee, but I wanted to go through Indianapolis. I can type in “21042 to 53005” to generate a map, but then I can drag the path to Indianapolis, and it calculates the optimal path. Other applications: you are looking at your work commute, and find that the optimal path goes through a construction zone. You can drag the path to avoid the zone, and it calculates a new optimal path. Pretty neat.
How bad will the credit crunch be? Will it last into 2008? Will it be worse than LTCM? Is this the end of structured finance as we know it? My quick answers: Yes, maybe, and no. Structured finance is too useful of a concept to regulate too heavily. Ratings are also difficult to do without from a regulatory standpoint. The concept of “buyer beware” must apply to fixed income managers inside regulated financial institutions. Ratings are ratings and not guarantees; they supply useful summary data, but are no substitute for due diligence.
Now, the ratings agencies’ stocks have been pinched by the crisis. I think that they will bounce back, and on more weakness, I could be a buyer. That said, it is interesting to see them edge away from their aggressive ratings on CPDOs [constant proportion debt obligations], particularly as the prices sink.
There may be some upward drivers for the ratings agencies. After all, investment grade bonds are being issued like mad. (Another reason to favor high quality companies at present.) The head of Deutsche Bank sees the market normalizing. (And maybe if you borrow in euros, it is.) On the other hand, high yield spreads are at a new record for the past few years, and distressed debt is finally arriving in size. (Maybe enough to choke all the vultures?) Risk is real for junk grade companies, and residential real estate related assets. The willingness to take financial risk has normalized; now it is time for the market to go beyond normal to petrified. Now, who can help us more with petrified than Jeremy Grantham? He sounds the alarm on real estate related assets, junk obligations, and the equity markets.
Finally, I should have included this in my last post, but the short term debt markets are rough in the UK as well. UK LIBOR hit a 10-year high recently. When many of the various LIBORs of the world are showing signs of fear, it is possible that a larger trouble is at hand. Until recently, all of the major central banks of the world were tightening, all at once. With the exception of Japan, I expect them all to begin loosening soon, and begin accepting higher rates of inflation. Perhaps I have my next investing theme?
Full Disclosure: long DB
Banks lend to each other short-term in several ways. For banks in the Federal Reserve System, they lend through Fed Funds, of which the Federal reserve provides more or less liquidity as it sees fit. Bigger banks can lend/borrow in the overseas euro-markets at LIBOR [the London Interbank Offered Rate]. This market is unregulated — outside the direct control of the Federal Reserve. It is an independent source of US Dollar liquidity limited only by the willingness of banks to grow/shrink their balance sheets.
The willingness of major banks to grow their balance sheets is in short supply today, so LIBOR is rising. Commercial banks like Barclays have a greater need for short term liquidity at present because they have to bring some short-term financing back onto their balance sheets because of failed conduits. In the bank of England’s case, it was enough to force them to inject some temporary liquidity. There is a secondary relationship between a central bank’s policy rate (like Fed funds) and LIBOR: as a central bank injects more liquidity, the less excess demand there is to borrow at LIBOR by banks. So, as the Fed stays tight, and the need for short term finance grows, LIBOR rises. And as I have mentioned before, the gap between LIBOR and T-bills [the TED spread] is very wide at over 1.5%. Anytime the TED spread exceeds 1%, there is significant worry in the euro-markets over credit concerns. Spreads of around 0.2-0.3% are more normal.
The short end of the credit markets is undergoing the most stress at present. Asset backed commercial paper on ultra-safe collateral is getting refinanced at penalty rates, while ABCP on questionable collateral is not getting refinanced. The reverse repo market is affected as well, as many mortgage REITs have found out, as haircuts on collateral have increased. Even Citigroup could be affected, if they have to collapse some conduits, and bring the assets onto their own balance sheet. The ratings agencies are awake, and are actually downgrading some conduit structures here and there. The ratings agencies do that every now and then, when their franchises are threatened.
With this much pressure on the short-term debt markets, it is my belief that the Fed will do more than they have. Maybe they will cut the discount rate again, or allow even more marginal collateral to be used. On the other hand, since such subtleties are wasted on the public, they will likely have to grab the blunderbuss of lowering the Fed funds target, and fire a few times. It won’t solve the problems of those who are under heavy credit stress, but it will eliminate problems for those with light to moderate credit stress, and begin the overstimulation of a new part of the US economy.
Here are parts one and two of this series. Rather than give a detailed list of what is right with my portfolio, I left the companies that were least likely to have problems for last. The entire portfolio is over at Stockpickr. What I will go through here are the potential trouble spots.
- Jones Apparel
- YRC Worldwide
- Deutsche Bank
- Royal Bank of Scotland
- Sara Lee
- Tsakos Energy Navigation
Barclays plc has already been sold, as have the two auto dealers. Deerfield is too cheap to sell, and I expect that they will not be able to complete their merger, which doesn’t harm Deerfield much, or help them much. Conditions in the
bank debt markets aren’t too cooperative now, and I would expect that there won’t be too many CDOs done in the next two years.
Bad shape: As for Jones Apparel, a lot depends on what they do with the cash from the sale of Barney’s. Personally, I would use it to reduce debt; if they use it to buy back stock, I will be one of the people selling the stock to them. YRC Worldwide is a cyclical company with more debt than I would like; trucking stocks have been weak so I might sell into a rally, or do a swap for a less levered company.
Questionable: None of these balance sheets are in great shape, but aside from the banks, their underlying businesses are likely stable enough to bear the strain. As for the banks, do they really have enough capital to survive through a real crisis? Probably, if only because they are “too big to fail.” Governments will take action to protect their existence, though not necessarily the interests of the current equityholders. That said, I am a little encouraged by Deutsche Bank’s relatively good positioning in this crisis so far, and the CEO’s willingness to encourage transparency.
So, for now, on rallies, I may be lightening some of the above names. I am in no rush at present, and will take my time in adjusting the portfolio.
Full disclosure: long DB RBSPF SLE GMK TNP CX YRCW JNY DFR
Additional tickers mentioned: BCS
I sold my stake in Barclays plc today outright for cash. This was a tough one, but since I also own Royal Bank of Scotland and Deutsche Bank, I wfelt I had enough exposure to global investment/commercial banks in the midst of what is an uncertain situation, with considerable embedded leverage in the investment banks.
I have a rule that when I can’t decide on a course of action, I do an average of what the various options would be. I’m not selling all of my exposure. I’m not hanging onto it all. So, I’m selling part, and Barclays has had the worst recent PR with respect to its conduit and borrowing activities.
Are these names cheap? Yes, and could get cheaper. If the unwind of leverage in the financial sector worsens, all investment banks will get hit. If not, they are cheap. So, I leave some on, and will look for other opportunities later.
Full Disclosure: Long RBSPF DB
Tickers mentioned: RBSPF DB BCS
Before I start this evening, I would simply like to say that revamping the website is more complicated than I initially intended, but I want to do something that looks good, and works well. I also want to get it right the first time, or soon enough after that to have no noticeable glitch in service.
National Atlantic — for any that bought on my words, you can see why I mentioned buying under $9.75. I knew there was a big seller out there, and now I know who it is: Loeb Partners. As of the filing, they still owned 7.1% of the company, and have been sellers well into the 9.70-9.80 region. As a result, there will be pressure on the stock for a while, the same way there was pressure when Commerce Group was indiscriminately selling stock into the market after the failed takeover.
Once Loeb is done, the stock should lift, and it looks like they are somewhat price sensitive. This could take while. If NAHC gets driven below $9, I will be adding more. But there is no new fundamental data driving the stock at present, just a jilted activist.
Assurant will likely be down tomorrow on the suspension of its buyback. I have explained the issues before on the finite reinsurance accounting, and the issues are unchanged since then.
Personally, I think the SEC is trying to make an example out of Assurant, because all of the allegations, if true, aren’t material to the economics of Assurant. They may lose a number of key employees, but their bench is deep, and the business won’t be harmed. The value in Assurant derives from their well-protected leading positions in niche insurance markets; that will not be changed by the SEC investigation, or any fines handed out.
If Assurant drops below $48, I will be adding.
Full disclosure: long NAHC AIZ
Tickers Mentioned: NAHC AIZ CGI
- August wasn’t all that bad of a month… so why were investors squealing? The volatility, I guess… since people hurt three times as much from losses as they feel good from gains, I suppose market-neutral high volatility will always leave people with perceived pain.
- Need a reason for optimism? Look at the insiders. They see more value at current levels.
- Need another good investor to follow? Consider Jean-Marie Eveillard. I’ve only met him once, and I can tell you that if you get the chance to hear him speak, jump at it. He is practically wise at a high level. It is a pity that Bill Miller wasn’t there that day; he could have learned a few things. Value investing involves a margin of safety; ignoring that is a recipe for underperformance.
- Call me a skeptic on 10-year P/E ratios. I think it’s more effective to look at a weighted average of past earnings, giving more weight to current earnings, and declining weights as one goes further into the past. It only makes sense; older data deserves lower weights, because business is constantly changing, and older data is less informative about future profitability, usually.
- I found these two posts on the VIX uncompelling. Simple comparisons of the VIX versus the market often lead to cloudy conclusions. I prefer what I wrote on the topic last month. When the S&P 500 is below the trendline, and the VIX is relatively high, it is usually a good time to buy stocks.
- What does a pension manager want? He wwants returns that allow him to beat the actuarial funding target over the lifetime of the pension liabilities. If long-term high quality bonds allowed him to do that, then he would buy them. Unfortunately, the yield is too low, so the concept of absolute return strategies becomes attractive. Well, after the upset of the past six weeks, that ardor is diminished. As I have said before, to the extent that hedge funds seek stable, above average returns, they engage in yield-seeking behavior which prospers as credit spreads and implied volatilities fall, and fail when they rise. Eventually pension managers will realize that hedge fund returns cannot provide returns over the full length of the pension liability, in the same way that you can’t invest more than a certain amount of the pension assets in junk bonds.
- Is productivity growth slowing? Probably. What may deserve more notice, is that we have larger cohorts entering the workforce for maybe the next ten years, and larger cohorts exiting as well, which will decrease overall productivity. Younger workers are less productive, middle-aged most productive, and older-aged in-between. With the Baby Boomers graying, productivity should fall in aggregate.
- This is just a good post on sector data from VIX and More. It’s worth looking at the websites listed.
- Economic weakness in the US doesn’t make oil prices fall? Perhaps it is because the US is important to the global economy, but not as important as it used to be. It’s not hard to see why: China and India are growing. Trade is growing outside of the US at a rapid pace. The US consumer is no longer the global consumer of last resort. Now we get to find out where the real resource shortages are, if the whole world is capitalist in one form or another.
- Calendar anomalies might be due to greater macroeconomic news flow? Neat idea, and it seems to fit with when we get the most negative data.
- Is investing a form of gambling? I get asked that question a lot, and my answer is in aggregate no, because the economy is a positive-sum game, but some investors do gamble as they invest, while others treat it like a business. Much depends on the attitude of the investor in question, including the time horizon and return goals that they have.
- Massachusetts vs. the laws of economics. Beyond the difficulty of what to do with expensive cohorts in a public insurance system, I’ve heard that they are having difficulties that will make the system untenable in the long run… most of which boil down to antiselection, and inability to fight the force of aging Baby Boomers.
- Rationality is one of those shibboleths that economists can’t abandon, or their mathematical models can’t be calculated. Bubbles are irrational, therefore they can’t happen. Welcome to the real world, gentlemen. People are limitedly rational, and often base their view of what is a good idea, off of what their neighbor thinks is a good idea, because it is a lot of work to think independently. Because it is a lot of work, people conserve on hard thinking, since it is a negative good. They maximize utility where utility includes not thinking too hard. Any surprise why we end up with bubbles? Groupthink is a lot easier than thinking for yourself, particularly when the crowd seems to be right.
- Is China like the US with 120 years of delay? No, China has access to better technology. No, China does not have the same sense of liberty and degree of tolerance of difference. Its culture is far more uniform from an ethnic point of view. It also does not have the same degree of unused resources as the US did in the 1880s. Their government is in principle totalitarian, and allows little true freedom of religious expression, which is critical to a healthy economy, because people work for more than money/goods, but to express themselves and their ideals.
- As I have stated before, prices are rising in China, and that is a big threat to global stability. China can’t continue to keep selling goods without receive goods back that their workers can buy.
- The US needs more skilled immigrants. Firms will keep looking for clever ways to get them into the US, if the functions can’t be outsourced abroad.
- It’s my view that dictators like Chavez possess less power than commonly imagined. They spend excess resources on their pet projects, while denying aid to the people whom they claim to rule for their benefit. With inflation running hard, hard currencies like the dollar in high demand, and the corruption of his cronies, I can’t imagine that Chavez will be around ten years from now.
- Makes me want to buy Plum Creek, Potlach, or Rayonier. The pine beetle is eating its fill of Canadian pines, and then some, with difficult intermediate-term implications. More wood will come onto the market in the short run, depressing prices, but in the intermediate term, less wood will come to market. Watch the prices, and buy when the price of lumber is cheap, and prices of timber REITs depressed.
- Pax Romana. Pax Americana. One went decadent and broke, the other is well on its way. I love my country, but our policies are not good for us, or the world as a whole. We intrude in areas of the world that are not our own, and neglect the proper fiscal and moral management of our own country.
- Finally, it makes sense for economic commentators to make bold predictions, because there’s no such thing as bad publicity. Sad, but true, particularly when the audience has a short attention span. So where does that leave me? Puzzled, because I enjoy writing, but hate leading people the wrong way. I want to stay “low hype” even if it means fewer people read me. At least those who read me will be better informed, even if it means that the correct view of the world is ambiguous.
Tickers mentioned: PCH PCL RYN
When the market gets wonky, I write more about current events. I prefer to write about longer-dated topics, because the posts will have validity for a longer time, and I think there is more money to be made off of the longer trends. Before I go there tonight, I would like to say that at present the Fed says that it is ready to act, but it hasn’t done much yet. As for the Bush Administration, and Congress, they have done nothing so far, and the few credible promises are small in nature. My counsel: don’t be surprised if the markets stay rough for a while.
Onto longer-dated topics:
- Perhaps this should go into my “too many vultures” file, but conservative players like Annaly can take advantage of bargains produced by the crisis. My suspicion is that they will succeed in their usual modest conservative way.
- Falling rates? Falling equity prices? Pension funding declines. This issue has not gone away in the UK, and here in the US, the PBGC is still struggling. As it is, FASB is facing the issue head on (finally), and the result will likely be a diminution of shareholders’ equity for most companies with defined benefit plans.
- China is a capitalist country? Eminent domain can be quite aggressive there. At least now they are promising compensation, but who knows whether the government really follows through.
- Any strategy, like quant funds, can become overcrowded. As a strategy goes from little known to crowded, total returns rise and then flatten. Prospective returns only fall as more and more compete for scarce excess returns. As the blowout occurs, total returns go negative, and more so for the most leveraged. Prospective returns rise as capital exits the trade. Smart quants measure prospective return, and begin liquidating as prospective returns get too low. Not many do that for institutional imperative reasons (investor: what do you mean cash is building up? What am I paying you for?), but it is the right strategy regardless.
- This is a useful graph of sector weights in the S&P 500. If nothing else, it is worth knowing what one is underweighting and overweighting. I am overweight Energy, Basic Materials, Staples, Utilities, and (urk) Financials, and underweight the rest. My portfolio, right or wrong, never looks like the market.
- I’ve written about SFAS 159 before. Well, we may have a new poster child for why I don’t like it, Wells Fargo. Mark-to-model is impossible to escape in fixed income, but I would treat gains resulting from changes in model assumptions as very low quality. Watch SFAS 159 disclosures closely with complex financial companies. If we wanted to repeat the late 90s headache from gain on sale accounting, we may have created the conditions to repeat the experience in a related way.
- How dishonest is the P&C insurance industry? It varies, as in most industries. Insurance is a bag of complex promises, which leaves it more open to abuse. This article goes into some of that abuse, and teaches us to evaluate a company’s claims paying record. You may have to pay more to get Chubb or Stancorp, but they almost always pay.
- China’s financial system is maturing slowly; one example of that is reduced reliance on bank finance, and issuing bonds directly.
- I don’t care what regulations get put into place, capitalist economies are unstable, and that’s a good thing. There are always information asymmetries, and always crowd behavior, such that risk preferences change precipitously. That’s the nature of the system. The only true protection is to be aware of this reality, and adjust your behavior before things get crazy.
- A firm I was with had an early opportunity to invest in LSV and we didn’t do it. The two members of our committee that read academic research thought we ought to (I was one), but the practical men of the committee objected to investing with unproven academics. Oh, well, win some, lose some.
- Speaking of academic research, here’s a non-mathematical piece on cognitive biases. Economists believe that man is economically rational not because of evidence, but because it simplifies the models enough to allow calculations to be made. They would rather be precisely wrong than approximately right.
- Bit by bit, the efficient markets hypothesis get chipped away. Here we have a piece indicating persistence of excess returns of the best individual investors. For those of us that have done well, and continue to plug away in the markets, this is an encouragement. It’s not luck.
I have enough for two more pieces on longer dated data. It will have to come later.
Tickers Mentioned: NLY WFC CB SFG
After fruitlessly trying to revamp the code for the WordPress theme that I like so much, I have concluded that I will have to install a new theme and make all the necessary adjustments to the code to bring back all the functionality the I have at present, while allowing for relatively inobtrusive ads. I will be implementing this next week, though the changes may come a little at a time. Comments are welcome; simply e-mail me at the address listed on the Contact Me page.
I thank you for reading me. Your time is valuable, so I hope this site provides continuing value to you.