Nothing big here, I’m just making a point of reporting my portfolio moves here. Yesterday, near the close, I did a rebalancing buy of Group 1 Automotive. I had a rebalancing sell on GPI recently, so this is part of selling high and buying low.
I still think that the auto dealers are more immune to recession than most players in the auto business. In addition to selling new cars, they sell used cars, and provide service. The latter two services are recession-resistant.
Also, in this environment, I have been deploying my excess cash slowly, and the allocation to Group 1 is a means of taking advantage of a swing down in its stock price.
As I get older, I still have a sense of wonder at the degree to which the US Government is a major lending institution. Today’s poster child is the Federal Housing Administration. What is the FHA?
“The Federal Housing Administration, generally known as “FHA”, is the largest government insurer of mortgages in the world, insuring over 35 million properties since its inception in 1934. A part of the United States Department of Housing and Urban Development (HUD), FHA provides mortgage insurance on single-family, multifamily, manufactured homes and hospital loans made by FHA-approved lenders throughout the United States and its territories.”
How is the FHA funded?
“FHA operates entirely from self-generated income and costs the taxpayers nothing. The proceeds from the mortgage insurance paid by the homeowners are captured in an account that is used to operate the program entirely. FHA provides a huge economic stimulation to the country in the form of home and community development, which trickles down to local communities in the form of jobs, building suppliers, tax bases, schools, and other forms of revenue.”
Well, good that it costs taxpayers nothing, if that is sustainable. The risk in the present environment is twofold. First, FHA is providing a lot of the loans that are getting done tight now. The backup plan is almost the primary plan now in a few places. Here’s an example:
‘David H. Stevens, president of Long & Foster’s affiliated businesses, said his real estate brokerage now holds regular FHA training sessions for its agents and the loan officers at its in-house lender, Prosperity Mortgage.
“Our FHA business in the Washington area went from virtually nothing at the end of 2007 to about 30 percent today,” Stevens said. “In some spots, FHA makes up 50 percent of all our loans.”‘
Now the percentage is much lower across the whole country. As the article points out, the loans have become more common in areas where housing prices are high, and the borrowers can’t come up with a down payment for a conforming loan.
As the number of mortgages originated/insured goes up, it FHA needs more capital to back those loans, all other things equal. The second problem is defaults. (Hat tip: Calculated Risk) Thery are one of the few places providing loans to lesser quality borrowers, so it is no surprise that their loss rate should be up considerably. Here’s the quote that caught my attention:
?Let me repeat: F.H.A. is solvent,? Mr. Montgomery said on Monday in a speech at the National Press Club. ?However, no insurance company can sustain that amount of additional costs year after year and still survive. Unless we take action to mitigate these losses, F.H.A. will soon either have to shut down or rely on appropriations to operate.?
Hmm… it looks like the US Government does not directly stand behind the liabilities of the FHA. Contrary to the original quotation from their website, it seems that in a pinch, they can ask Congress for funds, or, go out of business. (As an aside, I could not find out who regulates the solvency of the FHA. Thoughts?)
Well, not surprising. Our politicians like cheap solutions, which makes them lean on the GSEs and things like the GSEs, in order to get cheaper mortgage financing with dinging taxpayers. That works for a time, but the gambit comes to an end when the solvency of these quasi-public, quasi-private entities becomes threatened.
We’re not done with the fall in residential housing prices yet, and the difficulties at FHA are just another demonstration of that.
To whom it may concern: please send your agent soliciting my proxy to charm school. I don’t like being pushed to give my vote over the phone. I don’t regard it as secure as the internet or paper balloting.
Yesterday was a funny day, I received three communications (in this order) on National Atlantic.
An e-mail from some dear friends pointing out our former employer’s SC 13D/A, declaring their opposition to the deal.
The call from the proxy solicitor.
As I said to my friends: “I suspect that by this time, Gorman [the CEO] plus the arbs hold more than 50% of the shares. I will be voting my 0.15% against the deal, for what good that will do.
There are no appraisal rights, and I think the only possible remedy would be lawsuit alleging fraud, with a temporary restraining order on the deal. I don’t think that a lawsuit would succeed, but the laws of NJ, and the regulators are management-friendly.”
I have already admitted defeat on this one. Should the merger vote fail, I would expect the stock to drop considerably, because without replacing the current management team, there are no good options.
The last few months have seen a change in expectations of FOMC policy. The next expected move is a tightening, while some incremental loosening was expected 2-3 months ago.
One of the reasons for this is that the Fed has managed to calm the short term lending markets. They have also managed to defuse a possible crisis among derivative books by bailing out Bear Stearns with the aid of JP Morgan. Also, GDP growth hasn’t gone negative yet, at least the way the Government calculates it. As a result, Ben Bernanke feels that the risk of a substantial downturn has receded, and so, the next focus of the FOMC will be inflation.
Now, I don’t think the answer for the Fed is that simple. That said, there are many that would welcome a tighter FOMC policy.
China is importing our lax monetary policy, and they are unsuccessfully trying to fight the implications of the policy, because they won’t raise their exchange rate. They will have to eventually, perhaps after the Olympics, but a tighter US monetary policy relieves some of their stress.
Europe would welcome a tighter US monetary policy, because it would relieve pressure on the rising Euro. As it is, the ECB with its single mandate is moving to fight inflation. Even the Bank of England is not loosening aggressively, and their housing problems may be proportionately greater than those in the US.
The Gulf States would like a stronger US Dollar to help arrest the inflation that they are importing.
Savers in the US might like higher rates.
But the trouble is that there are still weak spots that might cause the Fed, which has a dual/triple mandate to not tighten monetary policy. (Dual — inflation and unemployment. Triple — financial system solvency, inflation and unemployment.)
The Fed is not out of the woods yet on real estate related credit. I commented many times at RealMoney that Home Equity Lending would be a big problem, back in 2006. I also warned on option ARMs. Well, both are looming problems now.
I still expect residential real estate prices to fall further.
The correction in commercial real estate prices has only begun.
Also, investment banks are still delevering and taking writeoffs. Lehman is the most recent poster child there, but other investment banks could still be affected.
Beyond that, we have defaults rising in speculative grade credit, which will do damage directly, and through the CDOs that they are in.
I think the Fed has less freedom to act than is commonly believed. As Yves Smith has commented at his blog, the Fed may have painted itself into a corner. I think the risks from inflation, unemployment, and financial system weakness are fairly well balanced. As it stands, the Fed has adopted the following policy:
Don’t let the monetary base grow. Sterilize all new lending programs.
Allow the banks freedom to expand their lendings; informally relax regulations for now.
Bail out any significant systemic risks.
Work out kinks in the short term lending markets through new programs.
The Fed may make some of those new programs permanent, but then they will need to find a new policy equilibrium involving greater tightness elsewhere in their policy tools. They will also need to decide what to do regarding investment bank leverage, both direct and synthetic. They will also have to figure out what comes first if there is a broader banking solvency crisis, and/or significant shrinkage of real GDP with a rise in unemployment.
It is my guess that Dr. Bernanke is talking a good game today, but that the Fed’s policies will be loose toward inflation, should systemic risk or unemployment prove to be more difficult problems than currently advertised today. They are not out of the woods yet.
As value investors go, I am an inclusive kind of guy.? I’m not doctrinaire about what measures constitute value.? What is the correct model?? Well, if you could gather all of the data successfully, it would be something akin to the model Mike Mauboussin’s Expectations Investing.? The easy shortcuts of value investing are stripped-down versions of this (possibly impossible) model.? Oh, shortcuts?? Here are a few:
Price/Earnings
Price/Book
Price/Tangible Book
Price/Sales
Dividend Yield
PEG ratio (Growth at a reasonable price)
The shortcuts are usable, with some discipline.? I’m not sure about the theory itself: I’m sure it is correct; I’m just not sure it can be implemented.? (Hey, maybe Legg Mason has tried to implement it.? Wonder how they have done with it? 🙁 )
More usable are several speeches from noted value investors.? They won’t tell you what stock to buy, but they will teach you how to think about the equity markets.? So, here are three speeches I ran across recently, from:
From my time writing for RealMoney, I know what motivates most investors is the next hot idea.? Sadly, that does not produce value for investors.? Here and at RealMoney, though I will willingly talk about the stocks that I own, I would rather talk about how to think about portfolio management — thinking rationally about what assets will build the most value in the intermediate-term.? That will give readers much more; they will be able to think independently, and create value on their own, using experts as guides, but not being slaves to any other investor, including me.
On Friday, toward the end of the day, I added to my position in Cemex, just to rebalance the portfolio and take advantage of undue weakness in the Mexican stock market.
Earlier in the day, though my timing was good, it could have been better, I swapped my exposure inJapan Smaller Capitalization Fund [JOF] for the SPDR Russell/Nomura Small Cap Japan ETF [JSC]. Given that I like JOF, why did I trade? The premium to NAV got too high — it was 10% on an intraday basis by my calculations, so, I traded. Eventually it will go back to a discount of -5% or so, and I will reverse the trade. I still like Japanese Small caps, but I have my limits when it comes to NAV premiums.
Away from that, I am still considering trading away some/all of my RGA for some MetLife, since I think it will be a cheap way to acquire more RGA. I’m glad the separation has finally come for MetLife and RGA; it was only a question of when. RGA is a unique company; unless Swiss Re, or Munich Re, or Aegon wants to spin out their Life Re business, there are no other pure play life reinsurers out there. Reinsurance of mortality in the present environment is a cozy oligopoly, with one former main player, Scottish Re (spit, spit), badly damaged. (Though I lost badly on Scottish Re, I am still grateful that when I figured out what was going on, I was able to sell at $6+/sh. Current quote: 14 cents/sh, and I hope that MassMutual and Cerberus are enjoying themselves. I took enough lumps for my patronage of Scottish Re, so anyone who sold when I did is at least that much better off.)
Pricing power isn’t anything amazing here, because the life insurers in general have enough capital, and are not ceding as much business to the reinsurers. But it is a steady business, and one with barriers to entry — ACE and XL will try to get into the business, and Scor will try to improve its position, but RGA, Swiss Re and Munich Re will be tough to dislodge.
I am looking forward to the next reshaping, and considering industry trends… I’m really not sure which way the portfolio will go, but I am gathering tickers and industry data, and preparing for the next change.
One last note: did you know that I am overweight financials? Yes, but only insurance companies, and Alliance Data Systems. (I still don’t trust the banks, and particularly not the investment banks.) The insurers that I own are cheap to the point where earnings don’t need to grow much to give me good value over the long run, and are largely insulated from any hurricane activity this year. Now, if the winds blow, you can expect that I will do a few trades to take advantage of mispricing among reinsurance companies. That said, Endurance, Aspen, Flagstone, and PartnerRe look cheap to me at present. Endurance looks very cheap… I have owned all four in the past, and will probably own some of them again in the future. But, no major commitments until the wind starts blowing (hurricanes), or if we get to the middle of the hurricane season (say, mid-September), and nothing has happened. Then it would be time to buy. Damage from windstorm tends to be correlated within years — bad years start early, and are very bad. Good years are quiet, and continue quiet with a few storms doing low levels of damage.
Anyway, that’s what I am up to. Got other ideas? Share them with my readers!
It’s bad enough that nobodies like me criticize the Fed, but what do you do when members of the FOMC criticize?? Two hawks, Lacker and Plosser, criticize the recent efforts to alleviate difficulties in the lending markets because of the potential for moral hazard.? In this case, moral hazard means to banks: “Don’t worry about bad lending as a group.? If you make mistakes, the Fed will rescue you.”
Give Bernanke some credit, because unlike Greenspan, he lets the members of the FOMC speak their minds.? Hopefully the disagreement will sharpen the Fed, and not lead to paralysis or confusion.? For more background on the individuals who are part of the FOMC, please refer to my piece, A Social View of the FOMC.
I agree the the moral hazard is a live issue here.? The real question is whether growing weakness in the lending markets can be tolerated, which might be worse than moral hazard.
Much, but not all of the upset in the lending markets (which, if you look at swap spreads, the current manifestation of the crisis seems to be passing — down 4 basis points today), is from deflating values in housing. My estimate for how much further real estate has to decline on average in the US is 10-20%. We need to find owners for about 4% of the US housing stock that is vacant. The pain that has been felt in subprime and Alt-A loans will get felt in prime loans, and possibly conforming loans as well. Fannie and Freddie won’t get killed, but they will take credit losses.
So, listen to Cody. Residential real estate markets do not clear as rapidly as a futures exchange. The illiquidity and variations in lending standards tends to lead to markets that adjust slowly, and autocorrelatedly. I.e., if it went up last period, odds are it will go up next period, and vice-versa.
It will take a while for the residential real estate market to clear. When the inventory gets down to 3% it will be time to start speculating on homebuilders and mortgage lenders again, but real estate prices won’t start rising in aggregate until the inventory of unsold homes gets below 1.5-2.0%.
Position: none
Well, the chickens are now coming home to roost.? Residential real estate values have fallen enough that it has eaten through much of the equity of prime borrowers, leading to distress on prime mortgage collateral.? If that is not bad enough, the banks are also staring down falling commercial property prices.? Even Fed Governor Kohn is telling us to expect more loan losses, which I expect will cause monetary policy to be confused amid rising inflation.
At present, the fall in housing prices may be self-reinforcing, as lower prices make more homeowners marginal, and with a negative life event (unemployment, divorce, disease, disaster, disability), they can no longer afford their property.? Prime mortgages are no exception here, particularly if bought near the peak of the recent real estate craze.
Just be aware that the fall in housing prices will take a while to work out.? It may cause larger financial institutions to fail.? But eventually, there will be a bottom that can be bought, perhaps in 2009-2010.? Until then real estate related financials will remain under pressure, and some with concentrated interests, like the mortgage insurers, will die.
Even if Ambac and MBIA (the holding companies) survive, the business that used to be profitable for them will be occupied by others. I’ll throw this out as my next prediction in this space: they both go into conservation, and in runoff, claimants get paid off, senior debtholders get nicked, subordinated debtholders lose a lot, and the equity is a zonk.
One last note: the stocks rally after the downgrade. Probably short covering and other derivative-related activity, but you have to admit it is amazing for the stock to go up when the franchise gets destroyed.
Position: none
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Okay, after yesterday’s piece, there was a fast, opportunistic reaction by S&P. Moody’s action gave them cover to downgrade, and S&P took the ball and ran with it. Now that action gives Moody’s the cover to downgrade freely. There is no longer any reason for them to stay at Aaa. There is no money in it, and their reputation can only take further his from here. Rating agencies are like wolf packs — there is safety in the pack. Don’t be an outsider.
From one of my old RealMoney pieces (12/1/2004): Many of the conflict-of-interest problems still exist today. One more example: Could the ratings agencies downgrade MBIA (MBI:NYSE) or Ambac (ABK:NYSE) even if they wanted to? MBIA and Ambac rely on their Aaa/AAA ratings to the degree that they would have a difficult time operating without the rating. Much of the bond market relies on enhancement from MBIA and Ambac. The loss of a Aaa/AAA rating would be a jolt to the guaranteed bonds.
In addition, MBIA and Ambac structure their risks according to models provided by the ratings agencies. It is the models of the ratings agencies that tell the guarantors how much equity must stand in front of the debt that is being guaranteed. The ratings agencies are an inherent part of the business model of the financial guarantors. MBIA and Ambac can’t get along without them.
The ratings agencies derive so much income from these major financial guarantors that their own financial well-being would be affected by a downgrade. I’m not saying that either should be rated less than Aaa/AAA, but there is a cliff here, and I am wary of investing near cliffs.
Well, we came to the cliff, and S&P shoved MBIA and Ambac to the edge. Now Moody’s can push them over the edge. It should come soon. As with the rating agencies actions on the other financial guarantors, once a guarantor is pushed below AAA, the rating no longer matters as much. There are dedicated “AAA only” investors that care about this, and they will be forced sellers now, or, they will modify their investment guidelines. 🙁
Now, as I have mentioned before, stable value funds will have their difficulties here. Some have positioned themselves as “AAA only” funds, and that led to large holdings of MBIA- and Ambac-guaranteed debt. What they do now is beyond me. I suspect they try to modify their investment guidelines. 🙁
Well, at this point, we have to contemplate life without the old guarantors. They will shrink and disappear, while new guarantors, who are all currently skeptical of doing much more than Municipal bond insurance, will grow, and make it impossible for the old guarantors to return, because they are much better capitalized. Once you lose your AAA as a guarantor, you will rarely get it back.
Fifteen years ago, when I was still pretty much a novice investor, I went to an AAII meeting to hear Jeremy Siegel speak about his new book, “Stocks for the Long Run.”? I brought my copy to have him sign it.? I hung around after the talk to? listen to some of the more informal things he might say, and in a dead moment, I asked him (something to the effect of),? “You suggest that young people should lever up to buy stock; do you really mean that?”? His answer was and unreserved “Yes.”
Dr. Siegel is brighter than me.? The guys who write the CXO Advisory Blog are brighter than me as well.? Felix Salmon is clever, and he puts up this supporting piece.
I am here to disagree.? Why?? It is all very well and good for academics to assume that returns occur randomly, but returns occur in streaks.? Think of all of the “lost decade” articles you have seen in the recent past.? Here’s my main reason for not levering up while young: It won’t work well about? one-third of the time, because young people will take humongous losses during a “lost decade,” and in the panic, they will sell at the wrong time.? My secondary reason, is that in really bad markets, such as 1929-32, 1973-4, and 2000-2002, you could be wiped out.
Don’t trust the results that rely on the veracity of Modern Portfolio Theory, when those ideas would have failed off of historical returns.? As I often say, “The markets always have a new way to make a fool out of you.”? This is another example.
One final note, perhaps more scholarly: the idea of levering up requires buying and holding, and that bad markets happen randomly, with no streaks.? Unfortunately, the equity market returns less than a buy-and-hold investor receives, because people buy and sell at the wrong times.? Buy-and-hold investors are daring people; they confront the natural tendencies toward greed and panic, and they do better than average in the long run.? One buying and holding on leverage would have to have a steel gut, which is not characteristic of younger investors.
So, don’t lever up.? I say this to investors young and old, experienced and inexperienced.? Getting an equity-like return is difficult enough in the long run.? Don’t make your life more difficult by levering up.
