The stock market is up approximately 57% since its March lows. One would forgiven if they assumed that investors were pouring money into equity mutual funds. Actually it is bond funds which have garnered investors's attention. Morningstar reports that bond funds have received net deposits totalling $209.1 billion while stock funds attracted $15,2 billion in deposits. Why have many investors shunned equities, especially with its sharp rise, and have flocked to bonds?
The answer is two-fold:
1) Baby Boomers are aging. They will focus less on stocks and more on bonds. An aging population means more focus on bonds.
2) Not everyone buys into the recovery story. In fact, it is mostly equity oriented money and fund managers who talk the V-shaped recovery story.
It is true that the bond guys have fund managers talking their books and the markets higher. PIMCO's Bill Gross is one. However, not everyone on the bond size of the business is talk a book. Art Laffer, Alan Greenspan and even Ben Bernanke, to name a few, are warning of sluggish growth once government stimulus ceases. The plain truth is that there can be no sustained strong growth or core inflation pressures (at least not at first) without job growth and either wage growth (which has been sluggish during the past two decades) or easy access to increased amounts of leverage. The Fed decided to focus on cheap leverage to stimulate the economy, cycle after cycle.
The problem with using ever cheaper leverage to reinvigorate the economy is that it is a finite proposition. After all, interest rates cannot be lowered ad infinitum. At some point rates will approach zero and the ability to stimulate the economy ceases. Another factor in the economic growth experienced during the past two decades is securitization. Securitization enables lenders other than traditional banks and finance companies to write loans to risky borrowers, securitize the loans, sell them off and loan the proceeds to new borrowers. Again, leverage is not forever. eventually these borrowers have to make payments on these loans. Paying debts would strain family budgets. The Fed's answer was to lower rates again. Wall Street would find new ways to lend to who really should be unlendable. Home prices would rise due to low interest rates and easy loan terms attracting more buyers. Now the existing borrower could refinance their mortgages and spend either the new budget surplus or spend the increased home equity resulting from Fed policy.
We have hit bottom. No longer can the Fed lower rates from here. No longer can loans requirements be lowered to the point where the unemployed were receiving credit. Wages have little chance of growing as companies keep a tight hold on expenses. The consumer is out of the game. The treasury market is right. The economy will be sluggish once again. Today's poor ADP Employment report and Chicago Purchasing Managers' report is only the beginning. I am looking for more poor data during the next several quarters.
Wednesday, September 30, 2009
Tuesday, September 29, 2009
Here's A Little Song I Wrote
I have received many questions regarding the credit markets. Let's discuss:
1) Allianz has decided to delist its AZM preferred. This has nothing to do with the health of Allianz, but rather the burdensome reporting requirements required to list a security on a U.S. exchange. Allianz has decided that being listed on the NYSE is not worth the time, effort and money required to list AZM.
2) Will RBS or ING suspend preferred dividends? From an economic perspective, both of these firms are unable to pay preferred dividends. Payments are being made using government aid money. Thus far, the British and Dutch governments have permitted such payments. If the political winds shift the dividends could be suspended. Only own RBS, ABN AMRO or ING if you have faith in national governments. Freddie and Fannie preferreds have taught me not to touch governments.
3) What preferreds to I like? Most preferreds are no longer cheap. The two which I think may offer the best values are National City NCCprC (PNC) and Countrywide CFCprA (BAC).
Do not be lulled into a false sense of security (don't panic unduly either). My fear is that investors are increasingly densistize to risk. This happened between 2003 and 2oo6. Invetsors, reaching for yield, would invest in securities inconsistent with their risk tolerances to pick up yield. That could be a dangerous proposition this time around (but bot yet).
Long-term treasuries yields will remain low (for now), but when it pops it could be ugly. Remember, a 10 year noncallable bond will experience of about 3 to 5 points of price decline for a 50 basis point rise of its YTM. Although I agree that PIMCO is mostly right in stating that low long-term interest rates will probably be with us for awhile. Please e-mail or post questions.
1) Allianz has decided to delist its AZM preferred. This has nothing to do with the health of Allianz, but rather the burdensome reporting requirements required to list a security on a U.S. exchange. Allianz has decided that being listed on the NYSE is not worth the time, effort and money required to list AZM.
2) Will RBS or ING suspend preferred dividends? From an economic perspective, both of these firms are unable to pay preferred dividends. Payments are being made using government aid money. Thus far, the British and Dutch governments have permitted such payments. If the political winds shift the dividends could be suspended. Only own RBS, ABN AMRO or ING if you have faith in national governments. Freddie and Fannie preferreds have taught me not to touch governments.
3) What preferreds to I like? Most preferreds are no longer cheap. The two which I think may offer the best values are National City NCCprC (PNC) and Countrywide CFCprA (BAC).
Do not be lulled into a false sense of security (don't panic unduly either). My fear is that investors are increasingly densistize to risk. This happened between 2003 and 2oo6. Invetsors, reaching for yield, would invest in securities inconsistent with their risk tolerances to pick up yield. That could be a dangerous proposition this time around (but bot yet).
Long-term treasuries yields will remain low (for now), but when it pops it could be ugly. Remember, a 10 year noncallable bond will experience of about 3 to 5 points of price decline for a 50 basis point rise of its YTM. Although I agree that PIMCO is mostly right in stating that low long-term interest rates will probably be with us for awhile. Please e-mail or post questions.
Thursday, September 24, 2009
And It Makes Me Wonder
Today's 7-year treasury auction went very well. The new 7-year U.S. treasury note drew a yield of 3.005 versus an expected 3.047. The financial media was eager to explain the strength of the auction away. For instance, Bloomberg News credited (blamed) weaker-than-expected existing home sales data for the flight to U.S. treasuries. If one merely looks at the surface, that explanation would appear to be accurate. However, we do not stop at the surface around here.
A dead give away that existing home sales were not the driving force behind the strong 7-year auction is the indirect bid data. Indirect bidders, which includes foreign central banks, purchased 61.7% of the new issue. According to U.S. treasury data, indirect bidders purchases an average of 46.2% of the past seven 7-year auctions. Although some smaller investors may have been motivated to participate in today's auction because of today's existing home sales data. Foreign central banks take a big picture approach to treasury purchases and it is very likely that the majority of today's indirect participation was decided upon days in advance (if not longer) of today's auction.
What do foreign central banks know which would encourage them to continue to purchase large quantities of U.S. treasuries at historically low yields in the face of a strong stock market. The answer is that indirect bidders may buy treasuries, but they do not buy the V-shaped recovery argument.
Foreign central bankers know that U.S. economic growth will be hindered by poor consumer activity over the next several years. They know that problem is not a lack of bank lending, but a rediscovery of prudent lending standard. The U.S. economy (and global economy) has enjoyed ever-cheaper credit and ever-lax lending standards. The party is over folks. Look at all the charts you want, the past IS NOT an indication of the future (man, I sound like a mutual fund). Seriously, one cannot look at past cycles, isolate a repeated trend and automatically assume it has to happen again and again. One must also consider the extenuating circumstances. The Fed is not perfect, but I believe it to be accurate when it states that growth will be modest in the near future.
It is the possibility, if not probability, of muted growth that is keeping long-term yields low, for now. This leaves fixed income investors in a quandary. Overweight the long end and you are caught with your pants down when long-term yields finally move higher. Overweight the short end of the curve and your income stream is so low it is almost impossible to catch up even if one extends out on the curve at a later date at higher yields. We would need Carteresque economic conditions to make market timing rewarding in the treasury markets.
Also, investors should understand the difference between fixed income investments which are interest rate products and those which are credit products. U.S. treasuries are interest rate products as they have no credit risk. Short-term securities, such as T-bills and short-term notes, trade at yield levels which reflect Fed policy. Longer-term yields, such as those found with 10-year notes and 30-year government bonds reflect inflation expectations. If bond investors believe that inflation pressures are going to be mild, they are willing to invest on the long end of the curve at modest yield levels as they do not believe inflation will be present which will erode the value of their fixed cashflows.
Credit products, such as corporate bonds, trade at yields which reflect interest rate projections AND the perceived creditworthiness of the issuer. It is possible for corporate bond yields to behave quite differently than treasury yields. We have had two good examples during the past year. Last year as the banking system was pushed to the brink of collapse, credit spreads for financial companies widened out. This caused corporate bond yields to rise. At the same time, treasury yields fell as the Fed lowered short-term rates and investors bought treasuries across the yield curve in a flight to safety from corporate debt to government debt. Corporate bond yields moved in the opposite direction of treasury yields. This makes some portfolio stress tests useless as they tend to stress a fixed income portfolio for specific moves in interest rates,. Most stress tests cannot account for the behavior of credit yields. Many do not account for the changing shape of the yield curve due to Fed policy and inflation expectations. Long-term and short-term yields more often than not do not move in lock step with each other. In fact, they may not even move in the same direction. Always contact a fixed income professional before venturing into the fixed income markets.
So which market is correct in its forecast for the U.S. economy? Don't bet against the bond market.
A dead give away that existing home sales were not the driving force behind the strong 7-year auction is the indirect bid data. Indirect bidders, which includes foreign central banks, purchased 61.7% of the new issue. According to U.S. treasury data, indirect bidders purchases an average of 46.2% of the past seven 7-year auctions. Although some smaller investors may have been motivated to participate in today's auction because of today's existing home sales data. Foreign central banks take a big picture approach to treasury purchases and it is very likely that the majority of today's indirect participation was decided upon days in advance (if not longer) of today's auction.
What do foreign central banks know which would encourage them to continue to purchase large quantities of U.S. treasuries at historically low yields in the face of a strong stock market. The answer is that indirect bidders may buy treasuries, but they do not buy the V-shaped recovery argument.
Foreign central bankers know that U.S. economic growth will be hindered by poor consumer activity over the next several years. They know that problem is not a lack of bank lending, but a rediscovery of prudent lending standard. The U.S. economy (and global economy) has enjoyed ever-cheaper credit and ever-lax lending standards. The party is over folks. Look at all the charts you want, the past IS NOT an indication of the future (man, I sound like a mutual fund). Seriously, one cannot look at past cycles, isolate a repeated trend and automatically assume it has to happen again and again. One must also consider the extenuating circumstances. The Fed is not perfect, but I believe it to be accurate when it states that growth will be modest in the near future.
It is the possibility, if not probability, of muted growth that is keeping long-term yields low, for now. This leaves fixed income investors in a quandary. Overweight the long end and you are caught with your pants down when long-term yields finally move higher. Overweight the short end of the curve and your income stream is so low it is almost impossible to catch up even if one extends out on the curve at a later date at higher yields. We would need Carteresque economic conditions to make market timing rewarding in the treasury markets.
Also, investors should understand the difference between fixed income investments which are interest rate products and those which are credit products. U.S. treasuries are interest rate products as they have no credit risk. Short-term securities, such as T-bills and short-term notes, trade at yield levels which reflect Fed policy. Longer-term yields, such as those found with 10-year notes and 30-year government bonds reflect inflation expectations. If bond investors believe that inflation pressures are going to be mild, they are willing to invest on the long end of the curve at modest yield levels as they do not believe inflation will be present which will erode the value of their fixed cashflows.
Credit products, such as corporate bonds, trade at yields which reflect interest rate projections AND the perceived creditworthiness of the issuer. It is possible for corporate bond yields to behave quite differently than treasury yields. We have had two good examples during the past year. Last year as the banking system was pushed to the brink of collapse, credit spreads for financial companies widened out. This caused corporate bond yields to rise. At the same time, treasury yields fell as the Fed lowered short-term rates and investors bought treasuries across the yield curve in a flight to safety from corporate debt to government debt. Corporate bond yields moved in the opposite direction of treasury yields. This makes some portfolio stress tests useless as they tend to stress a fixed income portfolio for specific moves in interest rates,. Most stress tests cannot account for the behavior of credit yields. Many do not account for the changing shape of the yield curve due to Fed policy and inflation expectations. Long-term and short-term yields more often than not do not move in lock step with each other. In fact, they may not even move in the same direction. Always contact a fixed income professional before venturing into the fixed income markets.
So which market is correct in its forecast for the U.S. economy? Don't bet against the bond market.
Wednesday, September 23, 2009
Another Tricky Day
Today, the Fed left the Fed Funds rate at 0.00% - 0.25%. This was expected. What was not expected by the markets, especially the equity markets, was the Fed's lack of color on how and when it will remove stimulus. Yes, the Fed said it would scale back the purchasing of agency debt and agency MBS and be finished with the program by the end of the first quarter 2010. The FOMC also stated that the economy was exhibiting some strength. On the release of the FOMC statement the equity markets sold off and the bond market rallied. Why the counterintuitive response from the markets?
The answer is because the markets, especially the equity markets, believed that the Fed would announce that it would, at worst, announce that it would end its purchases of agency debt and MBS by this October as originally planned or, at best, announce that the economy was recovering sufficiently for the Fed to begin selling its portfolio of agency debt and MBS in the near future. As is typical, the equity markets were overly optimistic (they are also often overly pessimistic) and as a result, the equity markets trended lower. Of course the media published headlines that the Fed said the economy strengthened. Here is the actual FOMC statement:
For immediate release. September 23, 2009.Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve's purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
The real keys to the FOMC statement was that conditions are likely to remain week for sometime and that resource slack continues. The Fed has NO plans in the foreseeable future to raise the Fed Funds rate. It knows what I know. It knows that the consumer is not rescuing the economy this time. It knows that if the Fed stimulus was withdrawn now, the housing market would collapse.
I am not alone in this opinion. CBRE President, Ethan Penner has concerns that real estate problems are not over. In his most recent report he explains how securitization made traditional portfolio lending obsolete and how now that securitization has failed, the global financial system was doomed. He sums up the real estate situation with the following bullet points:
"We are in a process of correcting from historical high valuation - losses cannot be avoided"
"Recent lending standards stunk and most loans originated since '05 are horrible"
" Legacy CMBS market is fragile. PPIP will delay the inevitable."
"Legacy Loans are worth a fraction of face value; less than 80% even for performing loans."
"Unprecedented defaults and loss severity numbers are a certainty."
"TALF is the new repo facility for the bond market and will inspire financing activity once the market clearing begins."
"Cap rates are mostly 8.5% or higher."
"Today because of the shortage of lender equity and the system's need to equitize the lending business, leveraged first mortgage investing provides superior risk-adjusted returns to an equity stratgey."
"The bond market, through CMBS, will not have the day for RE as it didi in the early 90s."
I don't pretend to be as knowledgeable as Mr. Penner (I had the privilege of speaking with him about two years ago and I can attest he is very bright). However, I have long been of the opinion that there is no way to avoid losses due to fundamentals. If a property is only worth "X" in an environment of prudent lending standards then it is worth "X" and there is no way to make it worth more other than repeating the mistakes of the past. We are unlikely to see a repeat performance, at least not this soon after the crisis as investors are wise to just what kind of assests are used in the securitizion process and understand the risks.
The bottom line is that the consumer will be under pressure from declining and lower home values and a VERY poor jobs market. Banks will take more losses as loan valuations will be lowered. This will hold down broad-based inflation. This should keep long-term interest rates from rising too far too fast. Most inflation will be in commodities such as metals and oil as well as food. Price increases of food and energy will crimp growth by acting as a regressive tax on consumption. Those who believe business will pull us out of this economic much are dreaming. Business is reactive to consumers, not proactive.
The recession may have ended, technically, based on GDP, but modest growth due to depleted inventory replacement fueled by record economic stimulus is nothing to write home about. This is why long-term rates remain low and large treasury buyers, especially large foreign investors, continue to buy long-dated U.S. treasuries.
Stay liquid and DO NOT extend far out on the curve as long-term rates will eventually pop. Low-coupon preferreds are especially vulnerable. CDs on the short end, agency bonds 3 - 5 years out and high grade corporate bonds 6 - 10 years out are the best values in the bond market.
The answer is because the markets, especially the equity markets, believed that the Fed would announce that it would, at worst, announce that it would end its purchases of agency debt and MBS by this October as originally planned or, at best, announce that the economy was recovering sufficiently for the Fed to begin selling its portfolio of agency debt and MBS in the near future. As is typical, the equity markets were overly optimistic (they are also often overly pessimistic) and as a result, the equity markets trended lower. Of course the media published headlines that the Fed said the economy strengthened. Here is the actual FOMC statement:
For immediate release. September 23, 2009.Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010. As previously announced, the Federal Reserve's purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
The real keys to the FOMC statement was that conditions are likely to remain week for sometime and that resource slack continues. The Fed has NO plans in the foreseeable future to raise the Fed Funds rate. It knows what I know. It knows that the consumer is not rescuing the economy this time. It knows that if the Fed stimulus was withdrawn now, the housing market would collapse.
I am not alone in this opinion. CBRE President, Ethan Penner has concerns that real estate problems are not over. In his most recent report he explains how securitization made traditional portfolio lending obsolete and how now that securitization has failed, the global financial system was doomed. He sums up the real estate situation with the following bullet points:
"We are in a process of correcting from historical high valuation - losses cannot be avoided"
"Recent lending standards stunk and most loans originated since '05 are horrible"
" Legacy CMBS market is fragile. PPIP will delay the inevitable."
"Legacy Loans are worth a fraction of face value; less than 80% even for performing loans."
"Unprecedented defaults and loss severity numbers are a certainty."
"TALF is the new repo facility for the bond market and will inspire financing activity once the market clearing begins."
"Cap rates are mostly 8.5% or higher."
"Today because of the shortage of lender equity and the system's need to equitize the lending business, leveraged first mortgage investing provides superior risk-adjusted returns to an equity stratgey."
"The bond market, through CMBS, will not have the day for RE as it didi in the early 90s."
I don't pretend to be as knowledgeable as Mr. Penner (I had the privilege of speaking with him about two years ago and I can attest he is very bright). However, I have long been of the opinion that there is no way to avoid losses due to fundamentals. If a property is only worth "X" in an environment of prudent lending standards then it is worth "X" and there is no way to make it worth more other than repeating the mistakes of the past. We are unlikely to see a repeat performance, at least not this soon after the crisis as investors are wise to just what kind of assests are used in the securitizion process and understand the risks.
The bottom line is that the consumer will be under pressure from declining and lower home values and a VERY poor jobs market. Banks will take more losses as loan valuations will be lowered. This will hold down broad-based inflation. This should keep long-term interest rates from rising too far too fast. Most inflation will be in commodities such as metals and oil as well as food. Price increases of food and energy will crimp growth by acting as a regressive tax on consumption. Those who believe business will pull us out of this economic much are dreaming. Business is reactive to consumers, not proactive.
The recession may have ended, technically, based on GDP, but modest growth due to depleted inventory replacement fueled by record economic stimulus is nothing to write home about. This is why long-term rates remain low and large treasury buyers, especially large foreign investors, continue to buy long-dated U.S. treasuries.
Stay liquid and DO NOT extend far out on the curve as long-term rates will eventually pop. Low-coupon preferreds are especially vulnerable. CDs on the short end, agency bonds 3 - 5 years out and high grade corporate bonds 6 - 10 years out are the best values in the bond market.
Thursday, September 17, 2009
Train Kept A-rollin'
There is a belief among many investors that the markets always accurately represent the fair value of asset. We know that to be untrue. If stock and bond prices were always correctly valued there would very little market volatility. There would be no bubbles or corrections. We would have never has a tech bubble and severe correction. There would have been no real estate bubble and catastrophic retrenchment. There are times market prices are based on value. However, we are in markets driven by momentum traders.
There is an old saying among traders which states: "The trend is your friend". In other words, one may not agree that market prices are based on fundamental values, but if the trend is moving in a particular direction (up or down), one has to trade accordingly. Remember, there is a difference between a trader and an investor.
An investor looks for long-term value or income. He or she will seek vehicles which address particular financial needs and tweak their portfolio as necessary. Risk, yield and fair value are very important. A trader does not care whether or not an assets should be priced at a particular level. A trader only cares which direction the price of said asset. A trader may view a stock priced at $50 as being over valued, but if the momentum appears ready to push the stock to $60, the trader climbs aboard. If momentum is poised to push the stock lower, a trader may flatten his position or even go short. No matter how much momentum may be present during an asset's or market's most frenetic period, calmer heads will eventually prevail and say enough is enough.
When the value of an asset or market rises or falls well beyond what fundamentals indicate to be fair value, the prices moves (corrects) to reflect fundamental valuations I.E. tech bubble and housing bubble. Given the economic data we have seen in recent months, the severe bear market which troughed in March 2008 may have overshot to the downside (hindsight is 20/20), but the data doesn't bear out further increases in equity prices or tightening of corporate bond and preferred security spreads. Fixed income market participants and experts have been very vocal about their tempered forecasts for economic growth.
The other day, Fed Chairman, Ben Bernanke warned that although the recession may be technically over, growth will be tepid during the next several years and inflation pressures will be subdued. Today, former Fed Chairman and current presidential economic adviser, Paul Volcker gave his less-than-thrilling assessment of forthcoming U.S. economic growth. At a financial conference held in Beverly Hills, California, Mr. Volcker had this to say:
There is “long way to go” before economic growth returns to normal (whatever that is going forward).
“It will be a long slog -- a matter of years -- with the risk of some relapses along the way.”
Mr. Volcker also warned that it will be along time before it is business as usual and he favors trading and risk restriction on banks deemed to big and important to fail. You go Paul!
Bank of America Chief Economist, Ethan Harris told Bloomberg News:
"We have a deep hole to dig our way out of." He believes the U.S. labor market is "in a severe bleeding mode." He predicted that unemployment would peak at 10.2% in the first quarter 2010 before moderating very slowly.
Let's be clear, the economy's recovery prospects are limited unless jobs come back and these jobs pay well enough to promote discretionary spending. I think this is highly unlikely. Why? First; business do not hire proactively. They hire reactively. This is why the Fed has, for nearly three decades, to spark spending by lowering rates during recessions. The thinking is that those who have cash or (especially) access to credit spend, generating demand and jobs. Those days are gone. Rates are near their historic levels. There is not much spendable income available among U.S. consumers and those who have access to credit has fallen as lenders require more than a foggy mirror to obtain a loan or credit cards.
No, this economy is mired in an economic swamp, one which will require much time from which to emerge. Asset prices among corporate credit prices are (by and large) fairly priced or rich versus fundamental. Corporate bond and preferred investors should be looking toward the treasury market and not the equity market for guidance on where the economy is going.
Inflation should remain subdued, making most TIPs unattractive. Some believe that printing of money and issuance of debt will cause inflation. Although government actions such as these could put upward pressure on prices, but wage stagnation (or worse) and a poor labor market will keep many consumers on the sidelines. This makes the 10-year area of the corporate credit curve attractive, but mainly in the acquired subsidiaries of larger banks).
Instead of a V-shaped recovery, we could have an O-shaped recovery. Round and round she goes.
There is an old saying among traders which states: "The trend is your friend". In other words, one may not agree that market prices are based on fundamental values, but if the trend is moving in a particular direction (up or down), one has to trade accordingly. Remember, there is a difference between a trader and an investor.
An investor looks for long-term value or income. He or she will seek vehicles which address particular financial needs and tweak their portfolio as necessary. Risk, yield and fair value are very important. A trader does not care whether or not an assets should be priced at a particular level. A trader only cares which direction the price of said asset. A trader may view a stock priced at $50 as being over valued, but if the momentum appears ready to push the stock to $60, the trader climbs aboard. If momentum is poised to push the stock lower, a trader may flatten his position or even go short. No matter how much momentum may be present during an asset's or market's most frenetic period, calmer heads will eventually prevail and say enough is enough.
When the value of an asset or market rises or falls well beyond what fundamentals indicate to be fair value, the prices moves (corrects) to reflect fundamental valuations I.E. tech bubble and housing bubble. Given the economic data we have seen in recent months, the severe bear market which troughed in March 2008 may have overshot to the downside (hindsight is 20/20), but the data doesn't bear out further increases in equity prices or tightening of corporate bond and preferred security spreads. Fixed income market participants and experts have been very vocal about their tempered forecasts for economic growth.
The other day, Fed Chairman, Ben Bernanke warned that although the recession may be technically over, growth will be tepid during the next several years and inflation pressures will be subdued. Today, former Fed Chairman and current presidential economic adviser, Paul Volcker gave his less-than-thrilling assessment of forthcoming U.S. economic growth. At a financial conference held in Beverly Hills, California, Mr. Volcker had this to say:
There is “long way to go” before economic growth returns to normal (whatever that is going forward).
“It will be a long slog -- a matter of years -- with the risk of some relapses along the way.”
Mr. Volcker also warned that it will be along time before it is business as usual and he favors trading and risk restriction on banks deemed to big and important to fail. You go Paul!
Bank of America Chief Economist, Ethan Harris told Bloomberg News:
"We have a deep hole to dig our way out of." He believes the U.S. labor market is "in a severe bleeding mode." He predicted that unemployment would peak at 10.2% in the first quarter 2010 before moderating very slowly.
Let's be clear, the economy's recovery prospects are limited unless jobs come back and these jobs pay well enough to promote discretionary spending. I think this is highly unlikely. Why? First; business do not hire proactively. They hire reactively. This is why the Fed has, for nearly three decades, to spark spending by lowering rates during recessions. The thinking is that those who have cash or (especially) access to credit spend, generating demand and jobs. Those days are gone. Rates are near their historic levels. There is not much spendable income available among U.S. consumers and those who have access to credit has fallen as lenders require more than a foggy mirror to obtain a loan or credit cards.
No, this economy is mired in an economic swamp, one which will require much time from which to emerge. Asset prices among corporate credit prices are (by and large) fairly priced or rich versus fundamental. Corporate bond and preferred investors should be looking toward the treasury market and not the equity market for guidance on where the economy is going.
Inflation should remain subdued, making most TIPs unattractive. Some believe that printing of money and issuance of debt will cause inflation. Although government actions such as these could put upward pressure on prices, but wage stagnation (or worse) and a poor labor market will keep many consumers on the sidelines. This makes the 10-year area of the corporate credit curve attractive, but mainly in the acquired subsidiaries of larger banks).
Instead of a V-shaped recovery, we could have an O-shaped recovery. Round and round she goes.
Wednesday, September 16, 2009
It's Been A Long Time
I have heard from a number of readers that they are concerned that my writing has become more sporadic. Unfortunately, I have been very busy with health issues. I came down with a case of bronchitis a few weeks ago and was under the weather again the past week. One of my son's also had health issues which kept me away from the computer. Another reason for my lack of writing is that there is not much new to report. Let's recap recent events.
Inflation: Inflation, as measured by CPI and PPI was relatively modest. Much of their increases were energy related. Tepid demand (once the replacement phenomenon and government stimulus run their courses) will pull against the inflationary effects of printing money and issuing government debt to keep inflation modest, at least initially.
Growth: Many pundits point to the stock market as a sign that the economy is about to take off. Many of us veterans look at the stock market and few much of the last six months' gains as a bounce back from the abyss in the first quarter of this year and cannot be sustained. Consumer demand has been weak, even with governments stimuli such as cash for clunkers. Stimulus should act like priming the economic pump. However, it is now the only factor keeping the economy above water at all. Fed Chairman Ben Bernanke, PIMCO's Bill Gross, Goldman Sachs and RBS all expect modest growth and tame inflation.
Value: The bond market appears to be fairly valued - rich. Safer names are already trading in the wide end of their historical spreads versus treasuries, possibly too tight considering the potential economic speed bumps which may lay ahead. Psst, the banks are not all that healthy. The stress tests and the movement of balance sheet equity from one bucket to another do not make banks any more healthy than they were before. It is all eye candy..
Until next time.
Inflation: Inflation, as measured by CPI and PPI was relatively modest. Much of their increases were energy related. Tepid demand (once the replacement phenomenon and government stimulus run their courses) will pull against the inflationary effects of printing money and issuing government debt to keep inflation modest, at least initially.
Growth: Many pundits point to the stock market as a sign that the economy is about to take off. Many of us veterans look at the stock market and few much of the last six months' gains as a bounce back from the abyss in the first quarter of this year and cannot be sustained. Consumer demand has been weak, even with governments stimuli such as cash for clunkers. Stimulus should act like priming the economic pump. However, it is now the only factor keeping the economy above water at all. Fed Chairman Ben Bernanke, PIMCO's Bill Gross, Goldman Sachs and RBS all expect modest growth and tame inflation.
Value: The bond market appears to be fairly valued - rich. Safer names are already trading in the wide end of their historical spreads versus treasuries, possibly too tight considering the potential economic speed bumps which may lay ahead. Psst, the banks are not all that healthy. The stress tests and the movement of balance sheet equity from one bucket to another do not make banks any more healthy than they were before. It is all eye candy..
Until next time.
Thursday, September 10, 2009
She Cried More, More, More
Today's $12 billion auction of 30-year U.S. government bonds went exceedingly well. In fact, demaind for the longest dated U.S. government debt drew the strongest interest since November 2007. The price of the long bond rose over two points as its yield fell to 4.20% late Thursday afternoon.
Who was buying long-dated treasuries? Many institutional investors, especially foreign investors including central banks. Some foreign central banks are doing what they can to manage (I didn't say manipulate) their home currencies versus the dollar. They know full well that U.S. consumers will not be spending like drunken sailors any time soon and exporting nations need to maintain or capture as much share of the shrunken market as possible. This is yet another example of the difference of opinion between the bond market and the stock market. I would bet on the bond market being correct yet again.
More data supports the idea of a slow economic recovery. Consumer credit continues to shrink, new foreclosure filings topped 300,000 yet again (357K), jobs are scarce and mortgage delinquencies are on the rise. One only needs to listen to Treasury Secretary Tim Geithner to understand the challengers facing the economy. He warned that banks still have to deal with toxic assets, today's stimulus has to be paid for down the road (higher taxes) and that the recovery will be gradual. For baby boomers and gen-xers whose market knowledge only goes back as Paul Volcker or Alan Greenspan. Anything but a V-shaped recovery is a foreign concept. Sorry folks, rates cannot get cheaper and credits standards are not going back to foolishness (yet).
Mr. Geithner summed it up this way:
“Given the extent of damage done to the financial system, the loss of wealth for families and the necessary adjustments after a long period of excessive borrowing around the world, it is realistic to assume recovery will be gradual, with more than the usual ups and downs.”
He also stated:
"We are not close to being through this."
The proposed FASB rule which will require banks to place what have been until now off balance sheet loans onto bank balance sheets slated to go into effect this November. Economic discomfort lies ahead. I would especially beware regional banks.
I have been asked many questions regarding foreign bank preferreds. I would be very concerned with preferreds issued by RBS, ING and ABN. All are on life support and the plug could be pulled by year end. Why? Way too much leverage and mounting credit-related lossed.
Who was buying long-dated treasuries? Many institutional investors, especially foreign investors including central banks. Some foreign central banks are doing what they can to manage (I didn't say manipulate) their home currencies versus the dollar. They know full well that U.S. consumers will not be spending like drunken sailors any time soon and exporting nations need to maintain or capture as much share of the shrunken market as possible. This is yet another example of the difference of opinion between the bond market and the stock market. I would bet on the bond market being correct yet again.
More data supports the idea of a slow economic recovery. Consumer credit continues to shrink, new foreclosure filings topped 300,000 yet again (357K), jobs are scarce and mortgage delinquencies are on the rise. One only needs to listen to Treasury Secretary Tim Geithner to understand the challengers facing the economy. He warned that banks still have to deal with toxic assets, today's stimulus has to be paid for down the road (higher taxes) and that the recovery will be gradual. For baby boomers and gen-xers whose market knowledge only goes back as Paul Volcker or Alan Greenspan. Anything but a V-shaped recovery is a foreign concept. Sorry folks, rates cannot get cheaper and credits standards are not going back to foolishness (yet).
Mr. Geithner summed it up this way:
“Given the extent of damage done to the financial system, the loss of wealth for families and the necessary adjustments after a long period of excessive borrowing around the world, it is realistic to assume recovery will be gradual, with more than the usual ups and downs.”
He also stated:
"We are not close to being through this."
The proposed FASB rule which will require banks to place what have been until now off balance sheet loans onto bank balance sheets slated to go into effect this November. Economic discomfort lies ahead. I would especially beware regional banks.
I have been asked many questions regarding foreign bank preferreds. I would be very concerned with preferreds issued by RBS, ING and ABN. All are on life support and the plug could be pulled by year end. Why? Way too much leverage and mounting credit-related lossed.
Johnny Mack, You Won't Be Coming Back
Morgan Stanley's board of directors told Johnny Mack he had better pack. Following a poor 2009 earnings (thus far) and policies which prevented its bond traders from taking advantage of market conditions Morgan Stanley's board has decided to take the firm in a new direction, almost 180 degrees.
Morgan Stanley's board named co-president and wealth management chief James Gorman CEO affective January 1st, 2010. Fellow co-president Walid Chammah will relinquish his title of co-president, but will retain his position of chairman of Morgan Stanley International in London. The board's the decision to go with a retail brokerage expert versus a bond guy (Mack) or an asset-backed pro (Chammah) is a major sea change.
This truly is a big shift as retail wealth management had been treated with some contempt since the "merger" with Dean Witter. It has been widely known on the street that legacy Morgan Stanley personnel had little tolerance for Dean Witter people. This had been of much concerned on the Street as Morgan Stanley's "joint venture (take over on the installment plane) with Smith Barney had been met with much skepticism due to Morgan Stanley's ill treatment of its retail investment advisers and retail staff.
Before wealth management types begin the celebration, there are a few issue with which to be concerned. First: A lack of focus on trading means a lack of revenue for the firm. It is true that trading of certain asset-backed structures did much damage to MS (and to many other firms), but it is traditional securities trading and underwriting which pays the bills more so than any other part if the investment banking business. Cut back on trading and resource and flexibility dwindle. So does product choices an pricing power for advisers and clients.
The challenges facing Mr. Gorman are daunting. He must revitalize Morgan Stanley's trading operation, improve the relationship between wealth management and the capital markets unit and integrate over approximately 13,000 Smith Barney brokers, most of whom are accustomed to service and expertise at levels currently unavailable at Morgan Stanley. He must do all of this while simultaneously keeping investors and regulators happy. Good Luck Jamie.
Morgan Stanley's board named co-president and wealth management chief James Gorman CEO affective January 1st, 2010. Fellow co-president Walid Chammah will relinquish his title of co-president, but will retain his position of chairman of Morgan Stanley International in London. The board's the decision to go with a retail brokerage expert versus a bond guy (Mack) or an asset-backed pro (Chammah) is a major sea change.
This truly is a big shift as retail wealth management had been treated with some contempt since the "merger" with Dean Witter. It has been widely known on the street that legacy Morgan Stanley personnel had little tolerance for Dean Witter people. This had been of much concerned on the Street as Morgan Stanley's "joint venture (take over on the installment plane) with Smith Barney had been met with much skepticism due to Morgan Stanley's ill treatment of its retail investment advisers and retail staff.
Before wealth management types begin the celebration, there are a few issue with which to be concerned. First: A lack of focus on trading means a lack of revenue for the firm. It is true that trading of certain asset-backed structures did much damage to MS (and to many other firms), but it is traditional securities trading and underwriting which pays the bills more so than any other part if the investment banking business. Cut back on trading and resource and flexibility dwindle. So does product choices an pricing power for advisers and clients.
The challenges facing Mr. Gorman are daunting. He must revitalize Morgan Stanley's trading operation, improve the relationship between wealth management and the capital markets unit and integrate over approximately 13,000 Smith Barney brokers, most of whom are accustomed to service and expertise at levels currently unavailable at Morgan Stanley. He must do all of this while simultaneously keeping investors and regulators happy. Good Luck Jamie.
Tuesday, September 8, 2009
The Summer's Gone
With the passing of labor day the summer has gone and market participants are wondering if the rose that is the equity markets is set to fall. There has been much debate during the past week of whether or not there will be a V-shaped recovery. Before this question can be answered, we must first agree on what will experience a V-shaped recovery, the financial markets or the economy.
Market participants, investors and economic cheerleaders tend to treat the economy and the equity markets as being one and the same, or at least as being reflective of each other. This is not the case and history supports this. If markets were always efficiently prices, by that I mean reflecting economic conditions and business prospects of companies, we would never have bubbles and corrections. Volatility would be at a minimum and investor angst would be reduced, but so would opportunities. Of all the mistakes made during the past two decades has been the effort to reduce investing to mathematical equations. Markets and market pricing is not an exact science. Human emotions, such as fear and greed, play an enormous role in the pricing of assets. Nobel laureate economist Paul Krugman is of this opinion as well.
These are strange times when I am in agreement with a Keynesian such as Mr. Krugman. As my readers well know, I am no Keynesian (even Keynes wasn't a Keynesian later in life), but I must concede that Mr. Krugman made several valid points in his article published in the most recent edition of New York Times Magazine. In the article entitled "How Did Economists Get It So Wrong" Mr. Krugman states:
"During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year."
Mr. Krugman is spot on. Assets can be overprices by greed and undervalued due to fear. No model can discern the truth. Only careful analyses of the facts can properly value assets.
He continues:
"As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth."
Mathematical models are only as good as the input data. Because future occurrences are not yet known, the data used is backward looking. Although mathematical models can tell us how markets and assets MAY perform under certain known conditions (providing people (remember them?) behave the same way each time), they cannot help us forecast or deal with new, never before experienced conditions, many of which were actually caused by blind adherence to the very models designed to cover all bases.
Mr. Krugman makes more valid points when he states:
"Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation."
Although I am not in favor of heavy regulation, banks and investment banks behaved much in the way critics predicted they would in a less regulated environment. Banks took on huge amounts of risk, moved the most risky off balance sheet and kept what they thought were the better assets on their balance sheets. After all, the models don't lie. They may not lie, but they are limited. It is because markets are inefficient I believe that the recent stock market rally is not indicative of a V-shaped economic recovery, but of an asymmetric V-shaped stock market recovery.
There are too many headwinds holding back the economy. Critics blame the banks' lack of lending for holding the economy back. Banks are in fact lending, but only to those who are creditworthy. The problem is that the economy is built on consumer spending which is only possible through dramatic wage increases or large quantities of leverage. Neither is poised to occur.
In fact, it is joblessness which may be precipitating another leg down for the economy. The Wall Street Journal reports that mortgage and credit card delinquencies among prime borrowers are increasing at a faster pace than among subprime borrowers. This is due to the large number of unemployed borrowers who simply cannot make their payments. This will hold back the economic recovery and bring more losses to banks and investors of some asset-backed securities.
We may yet see a V-shaped economic cycle, except that the V is inverted and we are near the peak.
Market participants, investors and economic cheerleaders tend to treat the economy and the equity markets as being one and the same, or at least as being reflective of each other. This is not the case and history supports this. If markets were always efficiently prices, by that I mean reflecting economic conditions and business prospects of companies, we would never have bubbles and corrections. Volatility would be at a minimum and investor angst would be reduced, but so would opportunities. Of all the mistakes made during the past two decades has been the effort to reduce investing to mathematical equations. Markets and market pricing is not an exact science. Human emotions, such as fear and greed, play an enormous role in the pricing of assets. Nobel laureate economist Paul Krugman is of this opinion as well.
These are strange times when I am in agreement with a Keynesian such as Mr. Krugman. As my readers well know, I am no Keynesian (even Keynes wasn't a Keynesian later in life), but I must concede that Mr. Krugman made several valid points in his article published in the most recent edition of New York Times Magazine. In the article entitled "How Did Economists Get It So Wrong" Mr. Krugman states:
"During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right. There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year."
Mr. Krugman is spot on. Assets can be overprices by greed and undervalued due to fear. No model can discern the truth. Only careful analyses of the facts can properly value assets.
He continues:
"As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth."
Mathematical models are only as good as the input data. Because future occurrences are not yet known, the data used is backward looking. Although mathematical models can tell us how markets and assets MAY perform under certain known conditions (providing people (remember them?) behave the same way each time), they cannot help us forecast or deal with new, never before experienced conditions, many of which were actually caused by blind adherence to the very models designed to cover all bases.
Mr. Krugman makes more valid points when he states:
"Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation."
Although I am not in favor of heavy regulation, banks and investment banks behaved much in the way critics predicted they would in a less regulated environment. Banks took on huge amounts of risk, moved the most risky off balance sheet and kept what they thought were the better assets on their balance sheets. After all, the models don't lie. They may not lie, but they are limited. It is because markets are inefficient I believe that the recent stock market rally is not indicative of a V-shaped economic recovery, but of an asymmetric V-shaped stock market recovery.
There are too many headwinds holding back the economy. Critics blame the banks' lack of lending for holding the economy back. Banks are in fact lending, but only to those who are creditworthy. The problem is that the economy is built on consumer spending which is only possible through dramatic wage increases or large quantities of leverage. Neither is poised to occur.
In fact, it is joblessness which may be precipitating another leg down for the economy. The Wall Street Journal reports that mortgage and credit card delinquencies among prime borrowers are increasing at a faster pace than among subprime borrowers. This is due to the large number of unemployed borrowers who simply cannot make their payments. This will hold back the economic recovery and bring more losses to banks and investors of some asset-backed securities.
We may yet see a V-shaped economic cycle, except that the V is inverted and we are near the peak.
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