Today was an inglorious start to the holiday weekend on Wall Street. Banking Powerhouse. JP Morgan, reported earnings which quadrupled. In spite of the dramatic increase in revenue, all was not rosy with the JPM report. Although JPM reported considerable earnings increases among its M&A and its investment banking fees, fixed income trading revenues (the prime earnings driver during 2009) fell 45% quarter over quarter. Equity trading revenues were flat. Securities underwriting revenues were strong. JPM CEO Jamie Dimon stated the financial sector may reach an "inflection point" by mid 2010 but stressed that "we're not there yet." He also said that JPM will probably not raise its common stock dividend until the firm saw signs of a sustained recovery. He did not expect that to occur before mid year. I believe that JPM bonds and preferreds are fairly priced if not somewhat rich at current levels.
In response to JPM's earning concerns and unspectacular economic data, the Dow Jones industrial average fell 100.90 points. The long end of the treasury curve rallied sharply as investors pared back inflation bets. All but the most bullish economists are forecasting sustained, but modest growth at levels far below what has come to be expected following a sharp recession.
What is troubling for me is that the current modest expansion is primarily the result of unprecedented Fed easing. I believe the Fed will cause an asset bubble at some point. It may not be a severe asset bubble and it may not be the result of what it has done thus far, but rather the result of what it may or may not do down the road. If the Fed is too slow to remove the stimulus we could experience another asset bubble in housing. However, that will take some time and the bubble is unlikely to be as severe as the one just prior as it is unlikely that investors will delve into the securities and derivative structures necessary to spark such a bubble so soon after the one which just past. That will take a new crew of brainiacs who know much about theory and have little, if any, practical knowledge.
One area where a bubble may exist is in the high yield markets. The extraordinary Fed easing has sent investors peering into the darkest corners of the fixed income markets looking for yield. The result has been a stellar performance among junk credits, in spite of elevated corporate defaults. This could play out one of two ways. On the positive side, distressed companies have been able to borrow and refinance debt making survival and recovery more like it. On the negative side, there are undoubtedly some companies undeserving of investor confidence and could implode a few years down the road once this new debt has to be refinanced at more normal (whatever that means going forward) interest rates.
There are two ways to approach high yield investing. One can pick out high yield credits in strong or necessary sectors, such as utilities or consumer staples. If one does one's homework and does not become a yield hog, one can pick up some yield without incurring an inordinate or reckless amount of risk. For those who are making a truly speculative play where income is a secondary concern a high yield mutual fund probably makes sense.
I have received many calls and e-mails from financial advisers asking for information regarding three to five year GNMA MBS securities. They do not exist. Sometime during the next several days I will compose a primer on MBS and what kind of securities actually being peddled to you and your clients.
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