Today the broad market fund was up about 75 basis points, which isn’t that amazing. Leading the parade were Cemex, Fresh Del Monte (that has been on a tear), SABESP, and Lyondell Chemical. Bringing up the rear were… wait, none of my stocks were down more than a percent yesterday. That’s a pretty broad based rally.
In general, the markets feel like the majority of players are concluding that they don’t have to worry about systemic risk for the nonce. Swap spreads, bond spreads, implied volatility, and other variables show a continued willingness to take risk. I wouldn’t want to say that I like being a short term bull; there are many worries in the present environment. But at present, the willingness to take risk and finance risk taking persists. That may change, but until then, the bull market continues. I will combat risk through my ordinary risk control mechanisms, as described in my eight rules.
I’m going to have to defer on my industry models for one more day because of time constraints.? Apologies.
Full disclosure: Long CX FDP SBS LYO
I wanted to avoid a sub-prime question (my brain is jello!! lol); but as an institutional investor I’m curious as to your position on this. Since the providers of the warehouse lines of credit are primarily the investment banks it would make sense to me that these guys can pick through the competent smaller cap players; accumulate a large position and clean out the shorts and weak holders cheap. With reasonable lending standards these players are fine as long as liquidity is available (which the large shareholder provides) and there doesn’t seem to be a lack of buyers of the securitized paper.
As a mortage bond manager in your past life do you see the shut-down of credit sufficient enough to only have “prime” sub-prime borrowers? What do the yields need to be to compensate for risk in your opinion? I’m not familiar with the rules of % ownership limits once you hit the 10% mark; when I see P/B at 30% to 50% there has to be opportunity for these investment banks even assuming large addition to reserves. Are regulatory hurdles preventing this? This is assuming they don’t view the sector as radioactive for the remainder of modern capitalism. Would they even (in your experience) want the business or is it too “personal banking”?
Dear Paul, this may not be what you want to hear, but yes, in general only the best subprime and Alt-A borrowers are getting financing. Even GE is reducing exposure to subprime.
As for P/B , one thing I learned while becoming a value investor was that there are often reasons for a discount to book. Reason #1 — earnings insufficient to justify the book capital employed. Reason #2 — insufficient liquidity to allow the value of the company to be realized. This can be too much leverage, which means a small adjustment in the value of the assets means a large diminution of book equity.
I got whacked on Scottish Re this past year. It deserves to trade at a discount to book for the reason listed above. So do many of the subprime lenders. Most of what they do can be replicated easily by other lenders, so there is no franchise value. Most of their recent loans are low quality, so they deserve to trade at a discount to assets, forcing a bigger discount to equity.
I see where you are coming from on this; my position in this is far from fatal so it doesn’t bug me (too much); but the chaos is fascinating! If I read you correctly the investment banks will NOT see franchise value and would rather wait for the next crop of lenders to evolve and they can lend to them during the next credit cycle. No interest on their part to own the equity.
Thanks again David
They won’t see much franchise value, partly because there will be significantly reduced volumes for the next 2-3 years. They wouldn’t want to carry that much fixed expense with low revenues, and there is too much ease of entry and exit.
I think that the investment bankers that snapped up subprime lenders on the way down were hasty, and are regretting it now. They might make money on those purchases, but with a much longer time horizon, and at a lower IRR than if they had waited one year to buy them.
Thanks David; enjoy your weekend!