The above graph shows the difference in yields between a current coupon 30-year FNMA pass-through security, and a 10-year on-the-run FNMA senior note.? It is a good proxy for how much value is available in agency mortgages versus the debt that they issue.? Now, in mid-March, spreads were particularly high, because mortgage REITs and other leveraged holders of agency mortgages were forced to sell because of rising haircuts on repo financing.? Today, the furor is over the solvency of the agencies themselves.
I would not be worried about the creditworthiness of agency mortgages.? The US Government is not going to let the senior liabilities of the agencies be questioned as to creditworthiness.? To do so would incite panic among investors in many financial institutions that own agency debt and agency guaranteed mortgages.
Here is a graph of the Lehman Brothers Swaption Volatility index:
Now, in March, there was panic in the mortgage market, leading to high implied volatilities.? Today, it is more quiet.
I don’t agree with everything El-Erian of PIMCO says, but I think he is right when he believes that the senior portions of capital structures at the agencies will not be harmed.? It sounds high to me, but according to the article, 61% of PIMCO’s Total Return Fund is in mortgage bonds.? I can support an overweight position in agency mortgage bonds, the yields seem attractive at current levels of volatility.
June was a good month for me, but in the middle of June, it felt like something was shifting in the markets, and it was showing up in my portfolio.? Then, July hit me like a ton of bricks.? The market was down, but I was way down.
Now, I have a number of disciplines that help me on average and over time as I manage equity money.? That doesn’t eliminate the “pit in the stomach” when nothing seems to be working.? It does give me something to do about it, though.? Evaluate poor performers (“what, down so much on no news!”), do some rebalancing trades (“ugh, cash is shrinking… will I have to move into concentration mode as I did in 2002?), and search for errors in my macro views (“why do I have so much cyclicality in the portfolio?”).
My performance versus the market as a whole tends to streak.? There are several reasons for that:
The portfolio has a value tilt.
Market capitalizations are smaller than the S&P 500.
I concentrate the industries that I invest in.
I turn over my portfolio more slowly than most investors.
But, as of Wednesday, as the market bounced back, my portfolio did even better.? I’m behind the S&P 500 by less than a percent now.? But this is what puzzles me here: ordinarily, I expect to outperform more in bear markets than in bull markets, but it seems to be flipped here.
I am overweighted in financials — though all of them are insurers, and none in the financial guarantee business.? Given all of the basket and ETF trading that goes on today, maybe my insurance names are getting dragged along with the banks.? In the short run, that can persist, but eventually industry performance emerges in stock prices.? That’s my best explanation for now.
Away from that, I did a rebalancing sale on YRC Worldwide today.? First rebalancing sale in a while.? Trucking is a volatile industry.? Then again, in cyclical industries, it is always a question of value over the cycle.? The stocks move more than the industry prospects do, so if you resist trends with companies strong enough to survive the cycle, you will make money in the long run.
Full disclosure: long YRCW, and many insurers? (full portfolio available at Stockpickr.com)
I haven’t written about the Fed much recently, largely because little has changed.? The Fed is frozen in its position.? Can’t raise rates because the banking system is on edge (and now the Fed informally cares for the systemic risk created by the investment banks).? Can’t raise rates because labor unemployment is rising.? Can’t lower rates because inflation is moving up.? Can’t lower rates because the dollar will dive.? What a pickle!
This is my monetary aggregates graph over the last year.? Growth of the monetary base is anemic, but that is intentional.? Rather than let the monetary base grow through the purchase of Treasuries, the Fed is using its balance sheet to add liquidity to certain money markets.? When was the last time the Fed did a purchase of Treasuries?? 5/3/07.? I think this is the longest period in the Fed’s history without a purchase of Treasuries, and I have written the Fed to ask, but alas, no answer.? For comparison purposes, there is a tool at the NY Fed website that allow you to look at permanent open market operations after August 25, 2005.? How many purchases of Treasuries during the tightening/flat period from 8/25/05 to 5/3/07?? Fifty-nine.? Fifty-nine during a predominantly tightening period, and not one during a loosening period?
I point this out because the Fed is behaving very differently under Bernanke than any Fed Chair since the Great Depression.? Part of it is the situation in the capital markets.? Leverage got too high among a number of big capital markets players, and the SEC didn’t do diddly.
But under this new arrangement, liquidity goes out to the capital markets through the Fed’s new programs, but not out (at least not directly) to the commercial banking system and the general economy.? The balance sheets of some financial entities get relief, but not much stimulus makes it into the general economy.? What liquidity that is created gets extinguished by the Fed, because they sell/lend Treasuries to fund their lending programs.
It’s an inflationary world, and one of the reasons that the US is not feeling it as bad is that we are the world’s reserve currency.? So long as China and OPEC keep buying US debts, the game can go on, but woe betide us if the music stops.
At present, Fed funds futures indicate a Fed that is frozen.? No more moves in 2008.? Using my “pain model” for the Fed (the Fed acts to minimize its political pain), I would concur.? When you don’t know what will work, doing nothing seems like a great plan.
A great plan for now, that is.? My guess is that the Fed can’t be out of step with the rest of the world for too long, and in 2009, they will begin tightening, even if the economy and the banks are weak.
