I am back from my trip. I had the pleasure of visiting lovely Green Bay, Wisconsin. In the time I was away we had a few economic reports. Most recently we had Personal Income, Personal Spending, Consumer Confidence and Case Shiller Housing.
The Case Shiller data came in better than expected, but the data indicates that the pace of the housing recovery is slowing. A large overhang of homes on the market and a winding down of government stimulus (some of which is leading to rising mortgage rates) continues to weigh heavy on the housing market.
Personal Income came in essentially flat, but Personal Spending was up slightly. This has some pundits lauding the return of the consumer, but at least one guest on Bloomberg Radio pointed out that increased spending without increased income leads to more borrowing, which is what got us into this mess. That may not be the case yet as consumer spending dropped below the replacement spending, but at some point spending will level off, unless wages increase or lending standards become a joke once again.
The famous Bill Gross uses D.H. Lawrence's "The Rocking Horse Winner" to describe the situation confronting nations which acted irresponsibly and over-borrowed. He refers mainly to Greece, but alludes to the problems facing the U.K. and the U.S.
I will go one further and apply the story to consumers. Although the original story involves a rocking horse which when ridden will give the winners of upcoming horse races. In Mr. Gross's version, the rocking horse answers that to get more money, one needs more and more leverage (credit). At the end the rider falls off the horse from riding too hard and dies. In other words, once the credit was gone there was no other way to obtain disposable cash. That is where we are today.
It is for this reason I believe that the Fed will keep short-term rates low for (as Chairman Bernanke says) an extended period of time. That, combined with the Fed ending its treasury purchases should cause the yield of the 10-year treasury to breach 4.00% and may even run up to 4.50% during the forthcoming economic cycle, but unless there is a big boom in spending (not likely) or a severe weakening of the dollar (not likely given problems in Europe and an asset bubble brewing in China). Basically, avoid investing on the extreme ends of the yield curve. 2-years to 10-years should be the short and long ends for most ladders or bar bell strategies. The very short end should only be used for cash management purposes and the long end should probably be avoided or seldomly considered.
On Thursday I will be attending a special event for financial professionals at the New York Auto Show. The event includes a grand tour and seminar. In my past life I wrote extensively about the auto sector. I even had a few articles published on the renown automotive website "The Truth About Cars" Hopefully I will have some good info to discuss when I get back.
Tuesday, March 30, 2010
Wednesday, March 24, 2010
Bank on It
Banks were among the few companies demonstrating gains in the stock market today. With long-term yields rising due to a better-than-expected Durable Goods report, confidence in the banks caused credit spreads to tighten throughout the sector. What was the cause for the optimism in the financial sector? It was Dick Bove' and his prediction that bank share prices will quadruple the next four years. Although I agree that banks will continue to improve, a quadrupling of bank share prices is an aggressive call. Mr. Bove' has been consistently optimistic and incorrect for the last two years. The banks have headwinds which will slow, but not stop their recovery.
First there is new legislation. The Dodd bill will limit the leverage a bank can take. It will also restrict certain activities, such as proprietary trading. These changes will impede the banks' drive for profit. However, the new rules should result in less risk and cleaner balance sheets. This is good news for bond holders.
Secondly there are troubled. loans. Many people believe that loans which were considered to be troubled in 2008 and 2009 are all right now. This is not the case. What has changed is that profits (for most, but not all large banks) has enabled banks to offset losses. Some reports that severity among home equity loans may be approximately 90% . Not good for profits.
Banks will; be profitable and offer good values in the fixed income market, but be cautious of outrageous claims.
Speaking of banks and outrageous, did anyone see the new JPM preferred today? If you did you missed it. JPM issued a $25-par trust preferred with price talk in the 6.875% to 7.00% (bet on the low side). The deal is fairly large at 20mm shares, but it went quickly as many firms (but not all) gave their clients notice that the deal was coming. By 3:10 EDT the deal was done. This was just over an hour after Bloomberg News published a story featuring unofficial details.
Having deals sell out quickly is going to be the norm for the foreseeable future. There is just too much money chasing too few ideas. Investors who purchased shared for income should not be disappointed, but trading opportunities are few and far between.
I will be off line for a few days as I will be on the road. See you all next week.
First there is new legislation. The Dodd bill will limit the leverage a bank can take. It will also restrict certain activities, such as proprietary trading. These changes will impede the banks' drive for profit. However, the new rules should result in less risk and cleaner balance sheets. This is good news for bond holders.
Secondly there are troubled. loans. Many people believe that loans which were considered to be troubled in 2008 and 2009 are all right now. This is not the case. What has changed is that profits (for most, but not all large banks) has enabled banks to offset losses. Some reports that severity among home equity loans may be approximately 90% . Not good for profits.
Banks will; be profitable and offer good values in the fixed income market, but be cautious of outrageous claims.
Speaking of banks and outrageous, did anyone see the new JPM preferred today? If you did you missed it. JPM issued a $25-par trust preferred with price talk in the 6.875% to 7.00% (bet on the low side). The deal is fairly large at 20mm shares, but it went quickly as many firms (but not all) gave their clients notice that the deal was coming. By 3:10 EDT the deal was done. This was just over an hour after Bloomberg News published a story featuring unofficial details.
Having deals sell out quickly is going to be the norm for the foreseeable future. There is just too much money chasing too few ideas. Investors who purchased shared for income should not be disappointed, but trading opportunities are few and far between.
I will be off line for a few days as I will be on the road. See you all next week.
Tuesday, March 23, 2010
Economic Fantasy - 3/19/10
Inflation, Where Have You Gone?
This week's inflation data (PPI and CPI) indicate that inflation is very tame. In fact, inflation as measured by CPI is nearly non-existent. This led some pundits to call for an inflationless recovery. I agree that inflation is now and will likely to be tame for some time. However, I question the recovery or at least the definition of recovery.
It is true that the markets have recovered. The Fed's easing, both traditional and quantitative, along with the ability of banks not to acknowledge losses (since loans and asset-backed securities can be marked to whatever model an institution chooses to use at a given time they can report profits, but ignore losses) have brought the markets back from the depths of early 2009. Very low borrowing costs is fueling a stock market recovery by encouraging speculation using leverage. A relatively weak dollar is and cheap financing due to investor appetite for yield is improving the prospects for large companies while smaller firms languish. This is why employment continues to be lackluster.
What the Fed has engineered is a markets recovery. Mr. Bernanke is hopeful that fundamentals catch up with the capital markets. How that will happen isn't clear. One thought is that business to business activity and international activity would generate employment and that would start the ball rolling. However, productivity gains is allowing companies to do more with less. I conducted a conference call yesterday with a financial adviser and her client who happened to run a medium-sized business. He stated that although his business has increased, he does not have to hire due to productivity gains. His suppliers and customers tell similar stories. Word is that they all have significant excess capacity even with current staffing levels.
Cramer is right, psychotic, but right.
Earlier this week, CNBC's Jim Cramer advised investors to seek out high-quality, dividend-paying stocks. I think Jim is correct. In fact, swapping out of industrial sector corporate bonds into high-quality dividend-paying stocks may be advantageous for investors for whom equity investing is appropriate.
Jim is concerned with a market correction. So am I, but we are concerned for different reasons. he believes that Obama care and tax increases for capital gains and dividends will drive investors from the equity markets. For sure that will cause some investors to seek shelter elsewhere in the markets, but most market participants have been aware with the Democrat's platform on taxes for a long time now. I believe a correction will come later this year or early next when the Fed finally raises rates. However, money market rates are too low to leave large sums of money in that sector. Buy big, dividend paying stocks, 10-year financial bonds and don't forget the muni market. State G.O.s, various revenue bonds and some taxable Build America bonds may be attractive.
This week's inflation data (PPI and CPI) indicate that inflation is very tame. In fact, inflation as measured by CPI is nearly non-existent. This led some pundits to call for an inflationless recovery. I agree that inflation is now and will likely to be tame for some time. However, I question the recovery or at least the definition of recovery.
It is true that the markets have recovered. The Fed's easing, both traditional and quantitative, along with the ability of banks not to acknowledge losses (since loans and asset-backed securities can be marked to whatever model an institution chooses to use at a given time they can report profits, but ignore losses) have brought the markets back from the depths of early 2009. Very low borrowing costs is fueling a stock market recovery by encouraging speculation using leverage. A relatively weak dollar is and cheap financing due to investor appetite for yield is improving the prospects for large companies while smaller firms languish. This is why employment continues to be lackluster.
What the Fed has engineered is a markets recovery. Mr. Bernanke is hopeful that fundamentals catch up with the capital markets. How that will happen isn't clear. One thought is that business to business activity and international activity would generate employment and that would start the ball rolling. However, productivity gains is allowing companies to do more with less. I conducted a conference call yesterday with a financial adviser and her client who happened to run a medium-sized business. He stated that although his business has increased, he does not have to hire due to productivity gains. His suppliers and customers tell similar stories. Word is that they all have significant excess capacity even with current staffing levels.
Cramer is right, psychotic, but right.
Earlier this week, CNBC's Jim Cramer advised investors to seek out high-quality, dividend-paying stocks. I think Jim is correct. In fact, swapping out of industrial sector corporate bonds into high-quality dividend-paying stocks may be advantageous for investors for whom equity investing is appropriate.
Jim is concerned with a market correction. So am I, but we are concerned for different reasons. he believes that Obama care and tax increases for capital gains and dividends will drive investors from the equity markets. For sure that will cause some investors to seek shelter elsewhere in the markets, but most market participants have been aware with the Democrat's platform on taxes for a long time now. I believe a correction will come later this year or early next when the Fed finally raises rates. However, money market rates are too low to leave large sums of money in that sector. Buy big, dividend paying stocks, 10-year financial bonds and don't forget the muni market. State G.O.s, various revenue bonds and some taxable Build America bonds may be attractive.
Double Dip?
The markets and financial media didn't know what to make of today's Existing Home Sales data. One news story from the Wall Street Journal bemoaned the fact that existing home sales fell yet again. However, later in the day (as the equity market was rallying) the Journal published an article stating that market participants were optimistic because existing home sales declined at a slower pace than last month and than what was forecast. I understand that deceleration is acceleration in the opposite direction, but considering the amount of stimulus the federal government is pumping into housing, the recovery in housing is anemic. There is fear in the market that once the stimulus is removed the anemic recovery in housing will simply evaporate. There could even be a double dip in housing prices.
Some like CNBC's Larry Kudlow believe that the way to spur home prices is to remove stimulus and permit prices to fall to levels at which buyers who can get credit come in off the sidelines. This is something I suggested two years ago this month. However, doing so would be to acknowledge that models used to evaluate bank assets were flawed. It would also result in realized losses for institutions holding existing troubled mortgages, many of have never been marked down.
If there is a double dip recession housing would be the likely cause. I don't think that happens as the Federal Government will keep Freddie, Fannie and their possible successor buying mortgages when no one else will. This has treasury secretary Geithner concerned. He said today that although The GSEs cannot exist in their past or current forms, they are necessary in providing mortgage capital.
Healthcare and financial reform legislation could also weigh heavy on the economy. Not too long ago I opined that we could be looking at a 1950s-type recovery. Now the economy could be shaping up to be 1970s-like. I don't believe that we will experience 1970s inflation, but 1970s stagnation is a possibility, unless consumers become flush with cash from either credit or wages, but neither seems to be likely at this time.
Strategy: Large dividend paying stocks and laddered fixed income portfolios. Boring, but effective.
Some like CNBC's Larry Kudlow believe that the way to spur home prices is to remove stimulus and permit prices to fall to levels at which buyers who can get credit come in off the sidelines. This is something I suggested two years ago this month. However, doing so would be to acknowledge that models used to evaluate bank assets were flawed. It would also result in realized losses for institutions holding existing troubled mortgages, many of have never been marked down.
If there is a double dip recession housing would be the likely cause. I don't think that happens as the Federal Government will keep Freddie, Fannie and their possible successor buying mortgages when no one else will. This has treasury secretary Geithner concerned. He said today that although The GSEs cannot exist in their past or current forms, they are necessary in providing mortgage capital.
Healthcare and financial reform legislation could also weigh heavy on the economy. Not too long ago I opined that we could be looking at a 1950s-type recovery. Now the economy could be shaping up to be 1970s-like. I don't believe that we will experience 1970s inflation, but 1970s stagnation is a possibility, unless consumers become flush with cash from either credit or wages, but neither seems to be likely at this time.
Strategy: Large dividend paying stocks and laddered fixed income portfolios. Boring, but effective.
Tuesday, March 16, 2010
No Rates A-Risn'
No Surprises From The Fed
To the astonishment of no one, then Fed left the Fed Funds rate unchanged in a range of 0% to .25%. The FOMC also stated that such accommodation will remain in place for "an extended period of time". Some market participants were hopeful that pronouncement would not appear in today's statement. The Fed is not as optimistic as the numerous Pollyannas who pervade the market.
The following paragraph says it all:
"Information received since the Federal Open Market Committee met in January suggests that economic activity has continued to strengthen and that the labor market is stabilizing. Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly. However, investment in nonresidential structures is declining, housing starts have been flat at a depressed level, and employers remain reluctant to add to payrolls. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability."
To me it sounds as though the Fed may be more concerned with deflation than with inflation.
Too many people look at one side of the inflation coin. They look at the amount of debt the government is issuing and the amount of dollars it is printing and automatically assume that prices must rise. This may be true of imported commodities, which are all denominated in dollars, but as we have seen with the disconnect between the Producer Price Index and the Consumer Price Index, prices cannot always be passed onto consumer. Demand has just as much to do with pricing as supply. If a significant number of Americans are unemployed or underemployed, demand will be slack and prices will be little changed on a broad measure.
Even the Obama administration believes that unemployment maybe high for a prolonged period of time.
Treasury Secretary Timothy F. Geithner, White House budget director Peter Orszag and Christina Romer, chairman of the Council of Economic Advisers, said in a joint statement"
The percent of Americans who can't find work is likely to "remain elevated for an extended period," The officials said unemployment may even rise "slightly" over the next few months as discouraged workers start job-hunting again.
"We do not expect further declines in unemployment this year," the officials said in testimony prepared for the House Appropriations Committee. They also predicted the economy would add about 100,000 jobs a month on average -- not enough to bring the jobless rate down substantially
So why did the equity market rally, albeit modestly, following the Fed's statement? Because the cost to borrow will remain cheap (Three-month LIBOR is about 0.26%). It is cheap for market participants to borrow and play the markets. This is how asset bubbles develop. Whether or not the equity markets develop into a true asset bubble depends on whether real economic growth catches up to the markets. Both the FOMC statement and the joint statement from Treasury Secretary Timothy F. Geithner, White House budget director Peter Orszag and Christina Romer cast doubt on this.
So what should investors do? Buy large cap, blue chip, dividend-paying stocks. Do this until the Fed removes the cheap leverage punch bowl. At that time, there could very well be a correction of some kind. When that happens, jump in with both feet.
In this environment fixed income investors are truly income investors. Market timers can get their clocks cleaned. Investors staying exclusively on the short end of the curve will earn so little in the way of yield, Arthur Burns would have to rise from the dead and re-assume control over the Fed to make rolling at higher rates profitable. Investors pegging the long end of the curve could get hammered should the economy unexpectedly gain traction and inflation materializes. What about LIBOR-based floaters? Ha, ha, ha, ha!!!
Fixed income investors should ladder or barbell their portfolios. CD's short, callable agencies intermediate and bank and finance corporate bonds in the 10-year area. Avoid the long end as one is not sufficiently compensated in terms of yield. Subordinate debt issued by high-quality banks offer decent yield pick up.
Investors looking for floating-rate obligations should look for structured bonds, such as range accrual notes which pay an attractive rate of return (fixed or adjustable) as long as the observed benchmark remains within the stated range. Doing this can enable investors to avoid the hazards of having long-term security with coupon adjusting off of a short-term benchmark. If you want to float off of rising long-term rates (when and if that occurs), buy a security which adjusts off of a long-term benchmark.
Happy St. Patrick's Day!
To the astonishment of no one, then Fed left the Fed Funds rate unchanged in a range of 0% to .25%. The FOMC also stated that such accommodation will remain in place for "an extended period of time". Some market participants were hopeful that pronouncement would not appear in today's statement. The Fed is not as optimistic as the numerous Pollyannas who pervade the market.
The following paragraph says it all:
"Information received since the Federal Open Market Committee met in January suggests that economic activity has continued to strengthen and that the labor market is stabilizing. Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly. However, investment in nonresidential structures is declining, housing starts have been flat at a depressed level, and employers remain reluctant to add to payrolls. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability."
To me it sounds as though the Fed may be more concerned with deflation than with inflation.
Too many people look at one side of the inflation coin. They look at the amount of debt the government is issuing and the amount of dollars it is printing and automatically assume that prices must rise. This may be true of imported commodities, which are all denominated in dollars, but as we have seen with the disconnect between the Producer Price Index and the Consumer Price Index, prices cannot always be passed onto consumer. Demand has just as much to do with pricing as supply. If a significant number of Americans are unemployed or underemployed, demand will be slack and prices will be little changed on a broad measure.
Even the Obama administration believes that unemployment maybe high for a prolonged period of time.
Treasury Secretary Timothy F. Geithner, White House budget director Peter Orszag and Christina Romer, chairman of the Council of Economic Advisers, said in a joint statement"
The percent of Americans who can't find work is likely to "remain elevated for an extended period," The officials said unemployment may even rise "slightly" over the next few months as discouraged workers start job-hunting again.
"We do not expect further declines in unemployment this year," the officials said in testimony prepared for the House Appropriations Committee. They also predicted the economy would add about 100,000 jobs a month on average -- not enough to bring the jobless rate down substantially
So why did the equity market rally, albeit modestly, following the Fed's statement? Because the cost to borrow will remain cheap (Three-month LIBOR is about 0.26%). It is cheap for market participants to borrow and play the markets. This is how asset bubbles develop. Whether or not the equity markets develop into a true asset bubble depends on whether real economic growth catches up to the markets. Both the FOMC statement and the joint statement from Treasury Secretary Timothy F. Geithner, White House budget director Peter Orszag and Christina Romer cast doubt on this.
So what should investors do? Buy large cap, blue chip, dividend-paying stocks. Do this until the Fed removes the cheap leverage punch bowl. At that time, there could very well be a correction of some kind. When that happens, jump in with both feet.
In this environment fixed income investors are truly income investors. Market timers can get their clocks cleaned. Investors staying exclusively on the short end of the curve will earn so little in the way of yield, Arthur Burns would have to rise from the dead and re-assume control over the Fed to make rolling at higher rates profitable. Investors pegging the long end of the curve could get hammered should the economy unexpectedly gain traction and inflation materializes. What about LIBOR-based floaters? Ha, ha, ha, ha!!!
Fixed income investors should ladder or barbell their portfolios. CD's short, callable agencies intermediate and bank and finance corporate bonds in the 10-year area. Avoid the long end as one is not sufficiently compensated in terms of yield. Subordinate debt issued by high-quality banks offer decent yield pick up.
Investors looking for floating-rate obligations should look for structured bonds, such as range accrual notes which pay an attractive rate of return (fixed or adjustable) as long as the observed benchmark remains within the stated range. Doing this can enable investors to avoid the hazards of having long-term security with coupon adjusting off of a short-term benchmark. If you want to float off of rising long-term rates (when and if that occurs), buy a security which adjusts off of a long-term benchmark.
Happy St. Patrick's Day!
Monday, March 15, 2010
The Week Ahead
The private sector increased purchase of U.S. treasuries among foreign buyers.
According to January data, foreign purchases of U.S. treasuries declined. This was particularly true of foreign governments. However, foreign private investors actually increased their purchases of U.S. treasuries, purchasing $60,709B. This was up from $48,060B in December. Private investors have been increasing their purchases of U.S. treasuries in recent months, purchasing $86,638B last November. This is a marked increase from $23,745B last October and $25,120B last September.
Market participants are concerned that China's efforts to slow its domestic economy, it will not be able to purchase sufficient quantities of U.S. treasuries to keep interest rates under control. Market participants are also becoming uneasy at the prospect of not having the Chinese economy leading the world toward recovery. Doubts that the global economic recovery may not be sustainable is evidenced by today's data which indicated that foreign purchases of U.S. equities fell to $4.3B in January, down from $20.1B last December. Comments made by Chinese Premier Wen Jiabao that the global economy could experience a so-called "double-dip" recession and that China is becoming increasingly concerned over its U.S. dollar holdings rattled the overseas markets and pushed U.S. equities lower early in the day.
What is real and what is an illusion?
Lackluster job growth, potential restrictive legislation governing the financial sector and proposed changes to FASB rules which would require banks to value assets more accurately based on performance rather than to a model or mark to maturity threatens to derail or at least hamper the market's recovery. In my opinion, a market rising because negative issues are being ignored or explained away is like a house of card waiting to Fall. Even financial sector apologist Dick Bove told CNBC today that there is no way to truly know how much the economy and lending has recovered because the GSEs mission of acting as the lender / securitizer of last resort is probably responsible for a major portion of the recovery experienced thus far.
Take Nothing For Granted
An article in this week's Barron's advises investors wishing to speculate in AIG due so by investing on the debt side of the balance sheet, including the trust preferreds AVF and AFF as the are technically ahead (more senior of the capital structure) than the government's preferred investment. Although I do not think the government intends AIG to not make its creditors whole, there are ways it can do so.
First, let's address the idea of being senior to the government. Technically the E-TRUPs, AVF and AFF are senior to the government, but as we have already seen with GM and Chrysler, capital structure may not matter that much where the government is concerned. Both Chrysler's secured creditors and GM's creditors (including bondholders) where "crammed-down" to receive less in the way of compensation than both the unions; and the government's equity claims. Nothing is impossible.
Also, unsecured corporate bonds are general obligations of the issuer. They are only as good as the assets and cash flows within. In the past two weeks, we have seen AIG engage in asset sales. AIG has said that the proceeds of these sales would be used to pay back the government Although it is good to get the government off of one's back, what has happened here is that the government (an preferred equity investor, will receive compensation ahead of creditors.
Sorry
It has been very difficult to write at night after long, frustrating days. I know the quality has not been what it was years ago when I was writing every day for a major bank (in the morning). It is not easy trying not to come across as depressing when one is not a believer in a v-shaped recovery. I am considering suspending publication. Feed back on the subject would be appreciated.
According to January data, foreign purchases of U.S. treasuries declined. This was particularly true of foreign governments. However, foreign private investors actually increased their purchases of U.S. treasuries, purchasing $60,709B. This was up from $48,060B in December. Private investors have been increasing their purchases of U.S. treasuries in recent months, purchasing $86,638B last November. This is a marked increase from $23,745B last October and $25,120B last September.
Market participants are concerned that China's efforts to slow its domestic economy, it will not be able to purchase sufficient quantities of U.S. treasuries to keep interest rates under control. Market participants are also becoming uneasy at the prospect of not having the Chinese economy leading the world toward recovery. Doubts that the global economic recovery may not be sustainable is evidenced by today's data which indicated that foreign purchases of U.S. equities fell to $4.3B in January, down from $20.1B last December. Comments made by Chinese Premier Wen Jiabao that the global economy could experience a so-called "double-dip" recession and that China is becoming increasingly concerned over its U.S. dollar holdings rattled the overseas markets and pushed U.S. equities lower early in the day.
What is real and what is an illusion?
Lackluster job growth, potential restrictive legislation governing the financial sector and proposed changes to FASB rules which would require banks to value assets more accurately based on performance rather than to a model or mark to maturity threatens to derail or at least hamper the market's recovery. In my opinion, a market rising because negative issues are being ignored or explained away is like a house of card waiting to Fall. Even financial sector apologist Dick Bove told CNBC today that there is no way to truly know how much the economy and lending has recovered because the GSEs mission of acting as the lender / securitizer of last resort is probably responsible for a major portion of the recovery experienced thus far.
Take Nothing For Granted
An article in this week's Barron's advises investors wishing to speculate in AIG due so by investing on the debt side of the balance sheet, including the trust preferreds AVF and AFF as the are technically ahead (more senior of the capital structure) than the government's preferred investment. Although I do not think the government intends AIG to not make its creditors whole, there are ways it can do so.
First, let's address the idea of being senior to the government. Technically the E-TRUPs, AVF and AFF are senior to the government, but as we have already seen with GM and Chrysler, capital structure may not matter that much where the government is concerned. Both Chrysler's secured creditors and GM's creditors (including bondholders) where "crammed-down" to receive less in the way of compensation than both the unions; and the government's equity claims. Nothing is impossible.
Also, unsecured corporate bonds are general obligations of the issuer. They are only as good as the assets and cash flows within. In the past two weeks, we have seen AIG engage in asset sales. AIG has said that the proceeds of these sales would be used to pay back the government Although it is good to get the government off of one's back, what has happened here is that the government (an preferred equity investor, will receive compensation ahead of creditors.
Sorry
It has been very difficult to write at night after long, frustrating days. I know the quality has not been what it was years ago when I was writing every day for a major bank (in the morning). It is not easy trying not to come across as depressing when one is not a believer in a v-shaped recovery. I am considering suspending publication. Feed back on the subject would be appreciated.
Thursday, March 11, 2010
Can't Get Enough
It takes a big man to admit he is wrong. Fortunately for me, I have had much practice over the years. A few days ago I opined that we could see a softening of demand for longer dated U.S. treasuries as the modest recovery takes hold. That is not how things played out.
Yesterday's 10-year auction generated much interest from foreign central banks. In fact, 35% of bids for the reopening of the 10-year treasury were indirect bids. Indirect bidders consist mainly of foreign central banks. With no safer place to park their dollars (generated from selling goods in the U.S.) and not wanting to convert dollars to their home currencies, thereby strengthening their currencies versus the dollar, harming exports. Foreign central banks were also strong buyers of the 30-year government bond. The bid to cover ratio was 2.89 versus an average of 2.48 during the last 10 auctions. Although it is true that indirect bids of 23.9% today was down from the 28.5% seen when the current long bonds were originally issued in February, this is not a poor result for long paper in the midst of record stimulus and deficits.
Professional fixed income investors, including foreign central banks do no fear robust growth and sky-rocketing inflation. The moderating effects of deleveraging, slow job growth and the potential for anti-growth legislation weigh heavy on the minds of fixed income market participants. This is in sharp contrast to equity bulls who have now taken to touting the belief that the government will guarantee that no large institution will fail as a strategy (heard this on Fast Money on 3/9/10).
This is not to say that we are heading for a stock market crash. It is quite likely that equity markets continue to advance, but the advance will be at a pace which is slower than to what we have become accustomed. Investors should be thankful that the equity markets have rebounded the way they have during the past year.
However, investors must face the fact the the equity market recovery, indeed the economic recovery as a whole, has thus far been due to government economic stimulus. The Fed has caused an asset bubble in stocks, preferreds and corporate bonds (and possibly treasuries). The Fed's hope is that fundamentals materialize to justify current asset valuations so it can remove the stimulus without disrupting the markets. The risk is that investors become impatient and begin to sell assets.
Impatience may come from employment data. Much has been made this week about the opinion on Wall Street that the March Nonfarm Payrolls data may indicate that the economy added 300,000 jobs. What is glossed over, but reported, is that the reported jobs gains may be due in large part to the models used and their results generated using post-snowstorm data. NFP is a contrived report using much mathematical smoothing. A better indication of the employment situation may be jobless claims. The following is good summary of Jobless Claims by Bloomberg News:
"Jobless claims remain stubbornly high, pointing to continued slow bleeding for payrolls. Initial jobless claims totaled 462,000 in the March 6 week, about what was expected and driving up the four-week average by 5,000 to 475,500 for the highest level since November when claims first broke below 500,000. There won't be much hope for payroll gains until claims move convincingly below 450,000."
"An emerging negative may be continuing claims where declines have fizzled out. Continuing claims in the Feb. 27 week rose 37,000, marking the fifth increase out of the last eight weeks. The four-week average has stabilized the last two weeks at 4.581 million. The unemployment rate for insured workers is unchanged at 3.5 percent."
"This report was unusually choppy week-to-week during February and unfortunately, in the first week of March at least, has stabilized at uncomfortably high levels. Equities and commodities fell as did the dollar in reaction to today's report."
Yesterday's 10-year auction generated much interest from foreign central banks. In fact, 35% of bids for the reopening of the 10-year treasury were indirect bids. Indirect bidders consist mainly of foreign central banks. With no safer place to park their dollars (generated from selling goods in the U.S.) and not wanting to convert dollars to their home currencies, thereby strengthening their currencies versus the dollar, harming exports. Foreign central banks were also strong buyers of the 30-year government bond. The bid to cover ratio was 2.89 versus an average of 2.48 during the last 10 auctions. Although it is true that indirect bids of 23.9% today was down from the 28.5% seen when the current long bonds were originally issued in February, this is not a poor result for long paper in the midst of record stimulus and deficits.
Professional fixed income investors, including foreign central banks do no fear robust growth and sky-rocketing inflation. The moderating effects of deleveraging, slow job growth and the potential for anti-growth legislation weigh heavy on the minds of fixed income market participants. This is in sharp contrast to equity bulls who have now taken to touting the belief that the government will guarantee that no large institution will fail as a strategy (heard this on Fast Money on 3/9/10).
This is not to say that we are heading for a stock market crash. It is quite likely that equity markets continue to advance, but the advance will be at a pace which is slower than to what we have become accustomed. Investors should be thankful that the equity markets have rebounded the way they have during the past year.
However, investors must face the fact the the equity market recovery, indeed the economic recovery as a whole, has thus far been due to government economic stimulus. The Fed has caused an asset bubble in stocks, preferreds and corporate bonds (and possibly treasuries). The Fed's hope is that fundamentals materialize to justify current asset valuations so it can remove the stimulus without disrupting the markets. The risk is that investors become impatient and begin to sell assets.
Impatience may come from employment data. Much has been made this week about the opinion on Wall Street that the March Nonfarm Payrolls data may indicate that the economy added 300,000 jobs. What is glossed over, but reported, is that the reported jobs gains may be due in large part to the models used and their results generated using post-snowstorm data. NFP is a contrived report using much mathematical smoothing. A better indication of the employment situation may be jobless claims. The following is good summary of Jobless Claims by Bloomberg News:
"Jobless claims remain stubbornly high, pointing to continued slow bleeding for payrolls. Initial jobless claims totaled 462,000 in the March 6 week, about what was expected and driving up the four-week average by 5,000 to 475,500 for the highest level since November when claims first broke below 500,000. There won't be much hope for payroll gains until claims move convincingly below 450,000."
"An emerging negative may be continuing claims where declines have fizzled out. Continuing claims in the Feb. 27 week rose 37,000, marking the fifth increase out of the last eight weeks. The four-week average has stabilized the last two weeks at 4.581 million. The unemployment rate for insured workers is unchanged at 3.5 percent."
"This report was unusually choppy week-to-week during February and unfortunately, in the first week of March at least, has stabilized at uncomfortably high levels. Equities and commodities fell as did the dollar in reaction to today's report."
Tuesday, March 9, 2010
Mojo Rsing
This week the Treasury will reopen its current 3-year and 10-year notes along with its 30-year bond. With the economy stabilizing (albeit at below trend level) and our foreign trading partners (China) managing their currencies to reflect a desire to slow down their domestic economies and a willingness of hereto for risk averse investors to seek out higher returns the demand for longer dated treasuries could be softer this time around. This could cause the yield curve to steepen in the near term
Although the yield curve may steepen in the near term, I would caution against worrying that long-term rates are going run dramatically higher. Appetite for long-term treasuries may lighten, but indirect bidders (which include central banks) are not going on a U.S. treasury hunger strike.
One fear out in the markets is the question of how will rates be affected when the Fed sells it huge position in U.S. treasuries. Why sell when the Fed can borrow money from market participants, using its treasury positions as collateral. This has two benefits. It removes money from the system (the Fed is borrowing money) thereby tightening monetary policy without raising the Fed Funds rate and it also keeps long-term rates from rising sharply buy not dumping U.S. treasuries into the market. Instead, these treasury securities will be held by counterparties as collateral. In return, the Fed's counterparties will earn a money market-type rate for engaging in the the transaction. Such a transaction is known as a repurchase agreement or "repo".
Until now, Fed repos have usually occurred between the Fed and primary dealers of U.S. treasuries. However this time, the fed is permitting money market funds to engage in repurchase agreements with the Fed. To accomplish this, a money market fund will lend money to the Fed, receive interest paid by the Fed at an overnight rate and will receive U.S. treasuries and agency paper as collateral. A money market fund could lend the Fed $10 million, get paid 1.00% on its money and hold 10-year notes or long bonds as collateral. By permitting money market funds participate in Fed repos, possible homes for long-dated treasuries are increased.
Investors tend to become myopically focused on Fed Fund rates, amount of debt issued, deficits, etc. Although all of the aforementioned factors are important, the Fed has many more arrows in its quiver to keep rates under control and moderate (but not eliminate) their rise. Look for long-term rates to rise modestly and moderately, but for short-term rates to remain stubbornly low. Not good for already rich LIBOR floating rate preferreds and bonds.
Although the yield curve may steepen in the near term, I would caution against worrying that long-term rates are going run dramatically higher. Appetite for long-term treasuries may lighten, but indirect bidders (which include central banks) are not going on a U.S. treasury hunger strike.
One fear out in the markets is the question of how will rates be affected when the Fed sells it huge position in U.S. treasuries. Why sell when the Fed can borrow money from market participants, using its treasury positions as collateral. This has two benefits. It removes money from the system (the Fed is borrowing money) thereby tightening monetary policy without raising the Fed Funds rate and it also keeps long-term rates from rising sharply buy not dumping U.S. treasuries into the market. Instead, these treasury securities will be held by counterparties as collateral. In return, the Fed's counterparties will earn a money market-type rate for engaging in the the transaction. Such a transaction is known as a repurchase agreement or "repo".
Until now, Fed repos have usually occurred between the Fed and primary dealers of U.S. treasuries. However this time, the fed is permitting money market funds to engage in repurchase agreements with the Fed. To accomplish this, a money market fund will lend money to the Fed, receive interest paid by the Fed at an overnight rate and will receive U.S. treasuries and agency paper as collateral. A money market fund could lend the Fed $10 million, get paid 1.00% on its money and hold 10-year notes or long bonds as collateral. By permitting money market funds participate in Fed repos, possible homes for long-dated treasuries are increased.
Investors tend to become myopically focused on Fed Fund rates, amount of debt issued, deficits, etc. Although all of the aforementioned factors are important, the Fed has many more arrows in its quiver to keep rates under control and moderate (but not eliminate) their rise. Look for long-term rates to rise modestly and moderately, but for short-term rates to remain stubbornly low. Not good for already rich LIBOR floating rate preferreds and bonds.
Let It Snow
Nonfarm Payrolls came in at a relatively (for these days) -36K jobs. Most economists blamed the snow for the negative print. They say that if not for the large snow storms in the eastern half of the country last month, we may have seen a positive nonfarm payrolls print. This is good news. Now we must hope that the government does not introduce anti-business legislation.
Other than concerns that consumer activity will be lower than in the past two hedonistic decades, businesses fear legislation which will make them less profitable and less competitive with foreign companies.
The Wall Street Journal printed an excerpt from Sears Holdings CEO, Eddie Lampert to share holders:
"Sears Holdings shares the stated goal of many public officials of creating jobs. But, we don't believe that we need large government programs to generate these jobs. Public officials often fail to recognize the obstacles they place in the way of job creation. For example, over the past year proposal after proposal has been put forward to reform health care, reform the financial system, increase taxes, and add regulations, all with the intention of making the United States a better and stronger country.
"Yet, as a business, trying to understand which of these proposals might become law, what their impact might be on business prospects and competition, and what additional costs they might impose creates a great deal of uncertainty. It has led our management team and board (and I am sure those managements and boards of other companies) to spend inordinate time trying to determine which investments we should make, defer, or cancel and which jobs to create, maintain, or eliminate. The removal of this uncertainty and the constant drumbeat of new threats against various businesses would go a long way to allowing American entrepreneurial energy to be unleashed."
Bad legislation has me concerned about the financial sector. This is a mid-term Congressional election year. Politicians running for re-election want to portray themselves as champions of the people. If there was ever a time in which we could see anti-business and anti-bank legislation this is it.
When investing in corporate bonds and preferreds, stay away from most regional banks and large banks with large government ownership positions. Also, invest in banks with the most traditional business model.
People continue to ask what bonds can I buy to make money over a shirt period of time. In my opinion the bond market is rich. There may be recovery stories, such as Ford (although the jury is still out on Ford's long-term viability). Investors looking for capital gains should buy large cap, blue chip equities, collect the dividends and wait for gradual and fundamental appreciation. Patience is a virtue and good things come to those who wait.
Other than concerns that consumer activity will be lower than in the past two hedonistic decades, businesses fear legislation which will make them less profitable and less competitive with foreign companies.
The Wall Street Journal printed an excerpt from Sears Holdings CEO, Eddie Lampert to share holders:
"Sears Holdings shares the stated goal of many public officials of creating jobs. But, we don't believe that we need large government programs to generate these jobs. Public officials often fail to recognize the obstacles they place in the way of job creation. For example, over the past year proposal after proposal has been put forward to reform health care, reform the financial system, increase taxes, and add regulations, all with the intention of making the United States a better and stronger country.
"Yet, as a business, trying to understand which of these proposals might become law, what their impact might be on business prospects and competition, and what additional costs they might impose creates a great deal of uncertainty. It has led our management team and board (and I am sure those managements and boards of other companies) to spend inordinate time trying to determine which investments we should make, defer, or cancel and which jobs to create, maintain, or eliminate. The removal of this uncertainty and the constant drumbeat of new threats against various businesses would go a long way to allowing American entrepreneurial energy to be unleashed."
Bad legislation has me concerned about the financial sector. This is a mid-term Congressional election year. Politicians running for re-election want to portray themselves as champions of the people. If there was ever a time in which we could see anti-business and anti-bank legislation this is it.
When investing in corporate bonds and preferreds, stay away from most regional banks and large banks with large government ownership positions. Also, invest in banks with the most traditional business model.
People continue to ask what bonds can I buy to make money over a shirt period of time. In my opinion the bond market is rich. There may be recovery stories, such as Ford (although the jury is still out on Ford's long-term viability). Investors looking for capital gains should buy large cap, blue chip equities, collect the dividends and wait for gradual and fundamental appreciation. Patience is a virtue and good things come to those who wait.
Thursday, March 4, 2010
Cool Water
Nary a day goes by when we don't hear about banks' unwillingness to lend. We hear about the huge cash positions among banks and we hear about tight (actually traditional and prudent) lending standards. What we don't hear is the consumer demand for credit is soft.
It is true that there are people (and businesses) desperate for credit, but these are impaired borrowers. They are already over-leveraged and often upside down with their home mortgages (they owe more than the home is worth).Truthfully, it is probably impossible to save many of these unfortunate people. It probably isn't smart either (when demand for a commodity falls prices must fall until new demand is kindled).
However, there is another, much larger group of people. These are people who may be able to obtain credit, but do not desire credit. The lack of desire stems from several factors. There are jobs concerns. As we will probably see tomorrow, the employment situation in the U.S. remains troubled. There is also a move toward financial responsibility. Many people have seen the consequences of over-borrowing and do not want to meet a similar fate. Then there is the cost factor. Lenders want to know you can actually repay the loan (as do the investors who provide the capital banks lend to consumers). This requires proof of employment and income, as well as down payment.Consumers have become accustomed to little or no money down loans. Many cannot source the required down payment. In the rare instance of a low documentation, no down payment loan can be written, the interest rate is punitively high to compensate the lender / investor for their increased risk.
I do not consider these lending standards to be tight. These are the lending standards our parents and grandparents faced. Some consumers will be able and willing to borrow in this environment, others will not. This will keep the demand for credit low.
If these lending standards are "normal" why all the fuss? The concern is that for the past two decades the high level of economic activity to which we have become accustomed has been due to ever lower interest rates and ever easier lending standards. The party is over folks. This is your grandfathers economy.
So how will Granddad's economy affect the markets. Growth will be more gradual and measured. Booms and busts will be much more muted. Business which had relied on high volume sales (auto industry) will either suffer or they will become leaner and more efficient (Ford is doing just that).
This also means that we will see more consolidation. Large balance sheet cash positions and the desire to become more cost-efficient will encourage corporate mergers. Although this will help corporate profitability and viability undoubtedly, there will be job cuts, at least among the merging companies.
All is not negative here. Once trimmed down and consolidated, stronger companies will be in place. Stronger companies mean that the jobs which remain are on more solid footing. Workers who feel more secure in their positions are more likely to spend and borrow, albeit more responsibly than in the recent past.
This is good news for all markets. Investors should be optimistic, but they should also manage their expectations. It is unlikely we will see our 401Ks double every year, two or three as to what had become accustomed. However, gains of 3% to 6% are possible.
Gradual growth and recovery (combined with greater dysfunction than our own in Europe) should result in modestly rising treasury yields with a mild bear flattening of the curve beginning later this year. This should result in tighter credit spreads between corporate bonds / preferred securities and treasuries. Typically, this results in rising corporate bond and preferred prices, but this time could be different. The credit markets have recovered significantly since the depths of the depths of the crisis in late 2008. Absolute borrowing yields for corporations are historically low. I believe the most likely scenario is for treasury yields to rise toward corporate borrowing yields. This will result in corporate bond and preferred prices being little changed in the near future. LIBOR-based floating rate preferred shares have probably had their run. With prices of some of these securities above 23, price gain potential is too small to sit with coupons which will be stuck at their 3.50% to 4.00% floors for at least the next year and may not rise much above their floors during this economical cycle.
I'll be back in a few days to discuss Non-farm Payrolls.
It is true that there are people (and businesses) desperate for credit, but these are impaired borrowers. They are already over-leveraged and often upside down with their home mortgages (they owe more than the home is worth).Truthfully, it is probably impossible to save many of these unfortunate people. It probably isn't smart either (when demand for a commodity falls prices must fall until new demand is kindled).
However, there is another, much larger group of people. These are people who may be able to obtain credit, but do not desire credit. The lack of desire stems from several factors. There are jobs concerns. As we will probably see tomorrow, the employment situation in the U.S. remains troubled. There is also a move toward financial responsibility. Many people have seen the consequences of over-borrowing and do not want to meet a similar fate. Then there is the cost factor. Lenders want to know you can actually repay the loan (as do the investors who provide the capital banks lend to consumers). This requires proof of employment and income, as well as down payment.Consumers have become accustomed to little or no money down loans. Many cannot source the required down payment. In the rare instance of a low documentation, no down payment loan can be written, the interest rate is punitively high to compensate the lender / investor for their increased risk.
I do not consider these lending standards to be tight. These are the lending standards our parents and grandparents faced. Some consumers will be able and willing to borrow in this environment, others will not. This will keep the demand for credit low.
If these lending standards are "normal" why all the fuss? The concern is that for the past two decades the high level of economic activity to which we have become accustomed has been due to ever lower interest rates and ever easier lending standards. The party is over folks. This is your grandfathers economy.
So how will Granddad's economy affect the markets. Growth will be more gradual and measured. Booms and busts will be much more muted. Business which had relied on high volume sales (auto industry) will either suffer or they will become leaner and more efficient (Ford is doing just that).
This also means that we will see more consolidation. Large balance sheet cash positions and the desire to become more cost-efficient will encourage corporate mergers. Although this will help corporate profitability and viability undoubtedly, there will be job cuts, at least among the merging companies.
All is not negative here. Once trimmed down and consolidated, stronger companies will be in place. Stronger companies mean that the jobs which remain are on more solid footing. Workers who feel more secure in their positions are more likely to spend and borrow, albeit more responsibly than in the recent past.
This is good news for all markets. Investors should be optimistic, but they should also manage their expectations. It is unlikely we will see our 401Ks double every year, two or three as to what had become accustomed. However, gains of 3% to 6% are possible.
Gradual growth and recovery (combined with greater dysfunction than our own in Europe) should result in modestly rising treasury yields with a mild bear flattening of the curve beginning later this year. This should result in tighter credit spreads between corporate bonds / preferred securities and treasuries. Typically, this results in rising corporate bond and preferred prices, but this time could be different. The credit markets have recovered significantly since the depths of the depths of the crisis in late 2008. Absolute borrowing yields for corporations are historically low. I believe the most likely scenario is for treasury yields to rise toward corporate borrowing yields. This will result in corporate bond and preferred prices being little changed in the near future. LIBOR-based floating rate preferred shares have probably had their run. With prices of some of these securities above 23, price gain potential is too small to sit with coupons which will be stuck at their 3.50% to 4.00% floors for at least the next year and may not rise much above their floors during this economical cycle.
I'll be back in a few days to discuss Non-farm Payrolls.
Tuesday, March 2, 2010
Friday Focus
The markets ended the day pretty much where they began. Ford surpassed GM in sales. GM blamed the snow and Ford benefited largely from fleet sales indicating that consumers remain under stress. It is because consumers are strained that the markets are focused on this Friday's employment data. Judging by recent news stories and comments made by corporate executives, employment does not appear ready to make a comeback. Unless a new technology spurs on the economy or consumers are able and willing to borrow and spend well beyond their means, jobs will be slow to return.
This does not mean that the economy will experience a double dip recession, but it probably means that the U.S. economy will grow as the population grows, assisted by replacement spending. After all, some items, such as clothing, appliances and vehicles wear out.
OK, so how should one approach fixed income investing. One should be an investor. There truly are not that many trading opportunities in the taxable fixed income markets. Some banks (BAC / CFC, PNC / NCC, MS, MER and GE Caoital) offer some spread tightening potential. However, spreads could tighten by having treasury yields rise toward corporate bond yields. This would not result in price gains for corporate bonds. In fact, bonds with little tightening potential are likely to lose value as their yields move higher along with treasury yields (albeit modestly).
I am often asked about high yield bonds. Most sectors have already been played out (although I cannot justify the strong recovery in this sector fundamentally). Here may be some upside in the auto finance companies and related companies such as Good Year Tire. Please understand that these bonds would be suitable for aggressive, equity oriented investors more interested in total return (possibly at less than par in a distressed scenario) rather than for reliable income. In this environment fixed income investors should be just that and not attempt to be traders.
I have also been asked about AIG's sale of its Asia insurance united to Prudential PLC of the UK. This is good news for tax payers are the proceeds will be used to pay back the government (although it only makes a modest dent in the over all amount owed). However, the sale of this attractive asset with the proceeds going to the government means that there are fewer assets to back unsecured bondholders (most corporate bonds). There are ways that the government can pay itself back, secure policy holders ./ customers of AIG and its counterparties without making bondholders whole. In fact, proposed bank legislation introduced by both parties include provisions which would cause creditors (including bondholders) to absorb a larger portion of the losses from a failure and break up of a bank while wiping out shareholder. Extending such policies to creditors of AIG is not far-fetched. I am not saying that haircutting AIG creditors is the most likely scenario, but it can happen. Just ask GM and Chrysler creditors.
My prediction for Nonfarm Payrolls: Somewhere between the street consensus of -50k and -100K. It is not all weather related either.
This does not mean that the economy will experience a double dip recession, but it probably means that the U.S. economy will grow as the population grows, assisted by replacement spending. After all, some items, such as clothing, appliances and vehicles wear out.
OK, so how should one approach fixed income investing. One should be an investor. There truly are not that many trading opportunities in the taxable fixed income markets. Some banks (BAC / CFC, PNC / NCC, MS, MER and GE Caoital) offer some spread tightening potential. However, spreads could tighten by having treasury yields rise toward corporate bond yields. This would not result in price gains for corporate bonds. In fact, bonds with little tightening potential are likely to lose value as their yields move higher along with treasury yields (albeit modestly).
I am often asked about high yield bonds. Most sectors have already been played out (although I cannot justify the strong recovery in this sector fundamentally). Here may be some upside in the auto finance companies and related companies such as Good Year Tire. Please understand that these bonds would be suitable for aggressive, equity oriented investors more interested in total return (possibly at less than par in a distressed scenario) rather than for reliable income. In this environment fixed income investors should be just that and not attempt to be traders.
I have also been asked about AIG's sale of its Asia insurance united to Prudential PLC of the UK. This is good news for tax payers are the proceeds will be used to pay back the government (although it only makes a modest dent in the over all amount owed). However, the sale of this attractive asset with the proceeds going to the government means that there are fewer assets to back unsecured bondholders (most corporate bonds). There are ways that the government can pay itself back, secure policy holders ./ customers of AIG and its counterparties without making bondholders whole. In fact, proposed bank legislation introduced by both parties include provisions which would cause creditors (including bondholders) to absorb a larger portion of the losses from a failure and break up of a bank while wiping out shareholder. Extending such policies to creditors of AIG is not far-fetched. I am not saying that haircutting AIG creditors is the most likely scenario, but it can happen. Just ask GM and Chrysler creditors.
My prediction for Nonfarm Payrolls: Somewhere between the street consensus of -50k and -100K. It is not all weather related either.
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