Wednesday, June 27, 2007

Grim outlook continues; is this what the market needs?

Equity markets yesterday did not make it over the hump as a second day of morning hope dissipated as the trading day developed. Overseas markets are extending the slump today. Today's open may not be so hopeful, so the markets follow through as the day develops will be telling.

Durable goods orders, announced at 8:30am, declined more than expected. This is especially troubling given that the Institute of Supply Management reported in mid-June that manufacturing in May accelerated at its fastest pace in a year. Is a parallel with the housing market developing. Homebuilders continue to build new homes and new housing permits issued have continued to grow despite increasing inventories of new and used homes. Manufacturing expands at the same time that business investment spending appears to be decelerating, which logically leads to higher inventories like what has already become evident in the steel industry.

A bad news is good news mindset would focus on the certainty that the Fed cannot raise interest rates with this quandary so obvious, and that the run up in longer term bond yields, if associated with the expectation of a faster growing economy, will back off. Of course sometimes bad news is just bad news and we'll get near term signals on that in this market day.

The most troubling comment of the day from this perspective came from Stan O'Neal, CEO of Merrill Lynch, who spoke at a London conference and stated that there is "no contagion" from the subprime mortgage issues into other parts of the bond and credit markets. While on the surface that appears to be a constructive comment, it is coming from a seasoned administrator at a firm that is not especially noted for its fixed income expertise and not from a market professional at a fixed income heavyweight. It brings to mind Oscar the Grouch's call to action when faced with a crisis, "Let's Panic".

For now we can just hope for a mirror image of the last few days, meaning a market rebound in the afternoon. Stay tuned.

Tuesday, June 26, 2007

I think I can, I think I can

Will the market make it up the hill today?

It's too soon to say, too many important open issues, and a noble effort at the open, again, does not give any message. Pressure on housing stocks will likely continue and the Bear Stearns funds saga is not yet over. Puff, puff,puff.

Monday, June 25, 2007

Interesting market week coming

As the market week begins, it's still not known whether the CDO and CMO markets will have the liquidity to effectively price lower tier securities and provide some certainty to the Bear Stearns funds workouts. Then there is the ancillary issue of whether there is more of this toxic positioning somewhere out there in hedge fund world. This is the cloud over today's market.

Aside from that, we now have a positively shaped yield curve for the first time in about two years. That's supposed to be, historically speaking, a good thing. The inverted yield curve that we have lived with was, historically speaking, supposed to be a bad sign but that did not play out. Since WWII, there have been nine instances of inverted yield curves and seven of them led right into a recession. This time not so. A positive yield curve has generally indicated confidence in a growing economy, but economists and market players today are less certain that old truisms are valid. Will the weak dollar, questionable U.S. consumer, and the housing overhang lead investors to "sell on the news" that traditional bond market metrics suggest continued economic growth?

So that's the playing field for the week. The players are walking out of the dugout on this beautiful summer day and getting ready for the first pitch, an existing home sales number at 10am. More on the BS funds workout will definitely evolve during the game. If these issues don't shock, the game may be entertaining, in a positive way.

Getting beyond these issues will give the market two positives. First, like Amaranth last year, a significant hedge fund problem(as big as LTCM) will have been handled by the market without any kind of radical disruption. Second, investing in U.S. securities will reward those that ante up for longer dated maturies. Those are both healthy signs. Interest rates are by no means high today, despite recent market moves, so if a stabilization in the bond market occurs at these new levels, everyone can relax. That's of course assuming that credit market spreads for higher risk paper don't go through the roof. That's a tangent that opens a Pandora's box of outcomes.

The market's about to open. Have a good week.

Sunday, June 24, 2007

Summer days

Recent posts have been totally focused on the current issues and problems in the capital markets. What a drag that seems to be after such a beautiful summer weekend.

May and June in metro New York have been exceptional. We deserved some good weather after a rainy and constantly overcast April, but the payoff has been big and so enjoyable. Warm weather in the mid-70's to mid-80's, sunny, with nights in the 60's. Who can beat this. Bicyling, walking, waving, running, softball, basketball, Manhattan and Brooklyn shopping and grazing, it's all been so easy, no heat, cold, rain, or even humidity to lean into and rationalize. We're getting spoiled.

The coming week may bring more posts on the financial markets, and may even migrate into the equally disturbing world of politics, but as long as summer remains a continuation of our spring, perspective can be maintained. Well, that may be a stretch.

Friday, June 22, 2007

Bear funds still weighing on market

Issues surrounding the two troubled Bear Stearns hedge funds are still the primary cause of bond and equity market concern. Any other stated reason for today's decline is secondary.

It's troubling to hear so called pundits who have the time to be interviewed by Bloomberg radio, CNBC or other news outlets during the market day make their observations. They are not alarmed. They speak of the issues in the CDO market as just limited to the 2006 "vintage". They are relaxed in a "it's all in a day's work" sort of way. When these lightweights are acting so savvy, it's time to stay worried.

Merrill Lynch was reported yesterday to have pulled back from selling the CDO collateral that they had taken from the Bear funds with the exception of a few pieces of the higher rated paper. That was seen as good news on the surface, and as constructive market participation by Merrill. Forget that. Self interest rules Wall Street. If Merrill pulled back from selling the securities, it's because the prices they could get were so dismal that holding was the only rational strategy. That is troubling, and the real market participants know it.

The Bear funds issue will certainly be digested by the market, with some heartburn. If other funds in the opaque hedge fund world show up with similar problems, this shake-up of fixed income markets could continue for a while. Remember, Bear is one of the leading bond houses on the street. Maybe they felt that their expertise gave them the ability to manage a high risk, high return strategy with low tier CDO's. In light of market events, they failed. If other funds have been following the same path, without the market leading expertise of Bear, this hiccup may get extended. That would be negative of course. Will it happen?

We don't know yet.

All Eyes on BX

After the successful launch of their IPO yesterday, Blackstone Group(BX) begins trading in a few minutes. Priced at $31, the top of the expected range, it's likely that the new stock will trade in the 40's today, maybe higher.

The IPO reportedly had heavy demand from foreign buyers, and in the aggregate demand was as much as 10X supply. Foreign buyers see a leader in a global business that is priced in cheap dollars. Investors in general are buying an investment style that can conceivably be a long term paradigm for profitability. Twenty years ago Berkshire Hathaway(Warren Buffett's investment firm) was trading at $3000 a share. Today's quote is $108,000 a share. A sustainable investment style in a multi-faceted investment entity, if that's what BX possibly is, can be like buying an index on a financial methodology. Whether tax regulation, leadership continuity, and credit availability are such that BX has legs is guesswork at this point, but getting in on the ground floor of a possible long term mega-opportunity is tempting to global investors. Additionally if the opportunity plays out, to have missed it would look foolish in hindsight. So the demand for positions, even small positions that just get investors on the map, is likely to be huge.

It will be interesting to watch, which is the best action that most of us can take on such an opening day.

Wednesday, June 20, 2007

All around bad market day? Maybe not.

Slowly but surely the market slid and finally jumped down today, with stocks falling over 1% in the afternoon and bonds prices falling. They're linked of course, with bonds leading the way for now. A few comments:

---The biggest news by far from this vantage point is the unraveling of two CDO laden Bear Stearns hedge funds and the breakdown of the cohesiveness of the supporting credit group. Merrill Lynch pulled out their collateral and put it on the market, a Wall Street form of taking their ball and going home. Pulling out of a collateralized position before an overall solution had been reached to stabilize and salvage what could be saved of the funds means only one thing---that Merrill saw the possibility of further losses that would lead to a deficit beyond their collateral coverage. That's not good news for the market's view of mortgage securities. Since the major investment firms have many situations in which they have mutual interests and a quid quo pro motivation to work together, Merrill's risk in breaking away was not a small thing, and is noticed by everyone. It's is the biggest negative market moving news of the day. What happens here over the next week, and with any other similarly focused funds out there, is going to be watched with intense market interest.

---The rise in interest rates of late has led some heavyweights in the bond business to make what seem to be inflammatory comments. Note this comment by a PIMCO EVP today on the residential real estate market, "It's a blood bath. We're talking about a two to three year downturn...eventually it will take the stock market and corporate profit". Or a former Clinton official, economist, and NYU professor saying, "It's not just a housing recession anymore, it looks more and more like an economic recession". This is grim commentary for an economy that overall has reasonable profits and growth at the moment, and a stock market that is at an overall 16 p/e, by no means bubble territory by any historic measure. For the negative side to play out, corporate profits will need to fall significantly, and that seems to be less likely in our globalized economy. Old patterns may not apply.

---With that said, Morgan Stanley announced today that it had raised a record $8 billion fund to invest in real estate. Blackstone has so far raised $7.2 billion toward a goal of a $10 billion in two new real estate funds and Goldman Sachs and Lehman are in the real estate fund raising process as well. Are we still in the same post? Billions are being raised for real estate investments just as we hear the Cassandra's chorus in full voice. It's the same post, same day. They are global funds of commercial and residential investments to be made in Asia, emerging markets, and Western developed economies(including the U.S.), likely in that order. The world has not stopped.

Tuesday, June 19, 2007

Contrarian takes on morning market news

Here's a few thoughts on this mornings market moving news:
---Best Buy is selling off due to an earnings report of an 18% decline in profit, and that has impacted the overall market as well. Best Buy also lowered estimates for full year profitability. It makes sense that their stock price would decline, but is this a meaningful signpost for consumer health that should impact the overall market. Maybe not, big maybe not. Best Buy's sales were up 14% year over year, in the expected range, and not a small number. The consumer is still spending. Best Buy's margins were compressed because the consumer bought more lower margin products like laptop computers and because the prices that Best Buy was able to charge for flat screen televisions declined. Could one possibly say that the consumer is still spending, the consumer is spending more on items with a more utilitarian purpose, and that despite market worries about inflation competition is keeping prices well under control. This may not be perfect for Best Buy or other retail electronics chains, but the economic news is not necessarily bad.
---Yahoo is trading up on news that CEO Semel is stepping down and being replaced by co-founder Jerry Yang. Why is this good news? It simply shows further disarray at Yahoo. Semel just said he was in for the long haul a few weeks ago. Yang now says he is, and that he is "digging in" for the fight against Google. Bad choice of words as in wars of attrition the underdog either loses or lures the opposition into mutual self destruction. He'll hire more engineers and grow. That sounds like more expenses directed by a leader who is a technologist through and through by most accounts, and not necessarily a business leader. Yahoo still has an excellent franchise, but on this news one should consider selling into the liquidity of false hopes. Yahoo either needs a new owner, a great partner, or a significant inflow of new blood.
---Housing starts and new housing permits came in around or slightly better than the average of analyst estimates, but they are not encouraging. The news is focusing on the 2% decline in housing starts almost totally as evidence that the slide continues, which was known before 8:30am. The more frightening number by far should be the 3.1% increase in new housing permits. A permit is admittedly a long way from a completed building, but assuming the intention to follow through it shows a housing industry, however diffuse, that in total hasn't got the message that we don't need more inventory. Adjustment will only take place after capitulation.

Monday, June 18, 2007

Equity market up again this week?

Stock index futures suggest that the U.S. equity market will begin the week on a positive note. It's likely that the traders will let the market rise in the morning and then, considering the market gains of last week, take the market back down in the afternoon, leading to a volatile but ultimately uneventful day. Guessing what the market will do on any given day is sort of a joke, but why not. The remainder of the week will continue to be one of shorts versus bulls, continued volatility, and with the bulls coming out on top once again. So the joke continues here.

The situation ruling the market now is the Fed's pickle. The Fed cannot raise rates to slow a strengthening economy with some worrisome inflation concerns. The decent core CPI number, the declining consumer sentiment numbers, high gasoline prices, and the continuing overhang of the residential real estate market's softness mean that any rate rise has serious economic risks. A rate rise could put more pressure on the consumer credit markets and on the longer term bond markets. The Fed cannot lower rates because total CPI, including food and energy, remains higher than is generally viewed as desirable and because the Fed would not want to add liquidity to what at times feels like an emerging commercial credit and equity bubble. Additionally any rate cut would exacerbate pressure on the dollar, which would untimately lead to more inflation pressure. In the short term, the market always likes certainty and unequivocally that's what we have on the Fed front. Trade away.

That does not rule out the possibility that the bond market will continue to take things into its own hands, and push up longer term rates. That can happen in a more meaningful way today, considering that the Fed's control over the banking system's diminished power in a global market is less important(is that a secret?). At the moment, however, one can't predict when or if a meaningful bond market move will occur but, given last week's brief jump up to a 5.3% yield on the ten year, it's one of the scenarios and it would be ugly. The near term horizon doesn't seem to suggest that possibility, but of course what fun would it be if it could be predicted.

For the moment, though, the defensive posture seems to be sitting tight with stock allocations in general, add on dips to large cap multinational names, and look for those one off opportunities in overlooked small and mid caps.

So that's another bland market outlook, and in a few minutes the summer roller coaster ride will start up again. Don't fall off.

Saturday, June 16, 2007

Advertisers to Protect Your Golden Years

It's well known that the banking, investment and insurance industries see the baby boomer generation as a huge opportunity as they begin to retire, or to prepare for their retirement years. The firms that create ways to take market share in this demographic will be big winners most observers think, and those that fall behind will not. In the long term this could be an opportunity for consumers of retirement products as price competition leads to better products. That of course assumes that consumers can, in general, ever really understand these products. What we see today is that the marketing rush is on. The advertising on television, newspapers, magazines and in your mail box can't be missed, and it will continue to grow. Stepping back and thinking about most of this advertising, it's sort of odd.

The television commercials, primarily from large insurance companies, show retirees in idyllic settings. A man finally has his farmhouse, with barn and some beautiful horses alongside it. A couple walks down what looks like a Laguna Niguel type southern California beach, hand in hand heading to their house. A woman with her professional size camera is seen strolling through the exotic bazaars of someplace like Nepal or Bhutan. A man is on a pristine lake is in a boat with his grandson, hauling in a fish. A couple watches from their New England like beach house porch as their grandchildren race up the long grey cedar set of stairs and planks from the beach. Looks like retirement is a wonderful thing. The problem is that people who have the resources to end up with this kind of result actually rarely need the variable annuities, insurance products and investment advice that the commercials are selling. The commercials are attractive but pitch what is unattainable for most. The testing, interviewing and focus groups that go into planning this approach must show that they create some degree of urgency(spouse says why haven't be done anything about this), guilt(but what will I have done for my grandchildren), and keeping up with the Jones panic(we can't be left behind). It could also be that the psychology of showing the most attractive outcome is to also bring to mind the opposite. It's unlikely that a commercial showing a couple eating catfood in a one bedroom apartment with the announcer saying in the background "you could have gone with the Hartford" would be a big winner.

The WSJ major page one article on Friday was entitled "As Boomers Retire, Insurers Aim to Cash In". It was an adequate summary of the free for all underway to take advantage of this market and sell profitable products from the insurers point of view. The issue of how the consumer will understand all of this was not addressed because it seems the reporter had not a clue either. In the final paragraphs he details a couple with an existing pension that takes their excess saving and puts them into annuity. Listen to this. They put up $79,000 and are guaranteed $2500 a year for life that will be adjusted annually for inflation. What's more when they die, their heirs will receive the annuity payment for an additional 10 years. Sounds nifty right, and not a flinch from the reporter. Today's $2500 represents a 3.16% return on the $79000, worse than a bank savings account, worse than the current yield on a non taxable muni money market. With the management skills of a large insurance company the couple has essentially given the company, day one, $79,000 plus a yearly margin. As folks who have dealt with the business press know, many of the writers have little or no financial background. They are looking for the big picture issue with the human interest hooks. Their work is often superficial, and editors pass on it as they must have on the example above.

Attempting to pull together all of this, retirement products are a big business opportunity, the advertising will be overwhelming and exacerbate existing anxieties, it will be a big challenge for consumers to understand their best options, and much of what they read in their efforts to understand will not be helpful. This will evolve, maybe in a better way over time.

Thursday, June 14, 2007

And speaking of hubris...

The prior post discussed the strange morphing of Ken Thompson into a regal CEO. News items in the last week, however, remind us that he is dwarfed in his arrogance by the likes of Steve Schwarzman and Barry Diller.

Yesterday's WSJ had a page one article on Schwarzman, CEO of investment firm Blackstone, in which he is quoted as saying that he is worth every penny of his $7 billion net worth. He also makes choice statements such as he wants to "inflict pain" on and "kill off" his rivals. "I want war" with rivals, he is quoted as saying, "not just skirmishes. I didn't get to be so successful by letting people hurt Blackstone or me". In this lengthy article there is not one touch of humility or gratitude. His highly publicized multi-million dollar 60th birthday party for 350 people at the New York armory is detailed once again but the new nugget of information there is that anyone who chose to make a toast honoring him was warned in advance that no "roasting" or poking fun at the honoree was allowed. Serenaded by hired hands Rod Stewart, Patti LaBelle, and Marvin Hamlisch and surrounded by banners detailing the interior of his huge Park Avenue apartment, everyone obeyed. What happened to money can't buy you love.

And then there's Barry Diller, former media mogul and now CEO of IAC, on 60 Minutes being asked if he deserves the $470 million of compensation that he received last year. "Absolutely" he said, explaining that he has created great wealth over the last 15 years for his shareholders. The fact is that for those lucky enough to be IAC investors for the long term and get in on the ground floor the returns have been phenomenal, as Diller implies. For anyone risking their money with him in the last five years, the results have been above average but not necessarily deserving of the highest paid CEO status. Diller's persona during the interview was one of confident entitlement and bullying brilliance. Really attractive.

What's the point here one could ask. Both of these men have been rewarding their investors, legally making money, and apparently unlike Thompson they understand finance. They may have big egos, but so what. The point is that they are establishing the image for corporate America, flaunting their wealth and power. When the tide turns, their images could overide those of Warren Buffett on the investment side and Bill Gates on the corporate side, of the many hedge fund managers and corporate leaders who prefer to maintain their privacy, stay grounded and keep their profiles low. Even big egos like Sandy Weill and Ted Turner choose to flaunt their significant philanthropy more than themselves.

When history is written are Schwarzman and Diller helping to create a story of the robber barons of this era. Don't they realize that many people outside of their sphere of influence see them at best as unattractive braggarts and at worst as a hated focus of their resentment. Guess, however, that they need to live large.

Tuesday, June 05, 2007

Wachovia's ambitious CEO is in control

Wachovia's 2006 annual report arrived several months ago. It was a startling document, and not because of any of the numbers or words in the report. In the opening sections there was only one photograph of an individual. It was a full page studio head shot of Kennedy Thompson, the CEO. There were no photographs of any other employee or any customer. There is no doubt in most companies that the CEO is in full control, but this was a stunning bit of hubris.

In a large corporation the decision to do this is troubling on several fronts. First, it speaks to the absolute control that Thompson has and the sycophant system that must surround him. It is likely that the Wachovia bureaucracy and their consultants brought this recommendation to Thompson during the lengthy process of planning an annual report. It is unlikely that anyone dared raise the issue of the message that this would send or the missed opportunity that it represents considering the benefits of sharing the spotlight with employees or customers. Second, it is certain that the guy liked the idea, whether he feigned a questionable posture or not, because it would not be there without his unequivocal support. King Kennedy. Third, it does a lot to explain recent expansion actions by Wachovia and the willingness to risk shareholder value for an ambitious personal agenda. But hey, at least it's fair warning to investors who choose to pay attention and who don't believe in Thompson's infallibility.

The most recent large acquisitions are certainly red flags. Last year Wachovia acquired the large thrift Golden West at what can safely now be called the top of the mortgage market. Within a week of that acquisition Wachovia's stock price was down 10% and in the last 12 months the stock has not recovered that loss. Golden West was a fine company with unique management and a strong culture but the price paid was deemed by the market to be too high, and the possibility of not being able to sustain the uniqueness of Golden West's business model within the much larger Wachovia is a question, in fact it's almost impossible one could think. Last week Wachovia agreed to purchase the large regional brokerage firm A.G. Edwards and it's the same m.o. Wachovia stock is down 4% since the announcement. More importantly they are again buying a firm with a very strong culture and a relatively unique business model that will be difficult to maintain, and they may be buying at a market top, maybe not, but they are absolutely buying at a point when the old brokerage model continues to decline, and that will even happen in the traditional midwest markets. In fact, this acquisition will likely lead customers to reexamine the value of their Edwards relationship versus the cost and value of one with E-Trade, Schwab, or Fidelity.

These acquisitions have a manifest destiny approach to them. They may work in the long term strategically, but in the medium term their diminution of shareholder value due to price and integration risk is substantial. Another North Carolinian CEO acquired JPMorgan in 2001 as a strategic coup and the share price of the new JPM is still below the price at acquisition 6 years ago. There may be lesson there.

Wachovia has a good list of top shareholders, a decent dividend, is viewed as low risk and has 8 buy recommendations out of approximately 2o securities analysts that publish on the stock. Sounds good, but watch out for the CEO that enjoys his portrait before retirement.

Monday, June 04, 2007

Summertime Market Coming?

It just feels like the U.S. equity market will take some time off soon. Earnings season is over and the generally good news is factored into prices. The possibility that the Fed will reduce interest rates anytime soon is fading for now, or that seems to be the drift of the market. At the same time it is unlikely that the consumer is going to break out on some spending spree with gas prices at current levels and the housing market still uncertain in most areas. Foreign markets continue to look strong but they too will take a break if the U.S. economy is seen as sluggish at the same time that the Fed is reluctant to ease on rates.

So June may bring some volatility, of course after the run-up this year, but will likely not be too exciting overall barring some important market or geopolitical news. Undervalued and undercovered mid cap and small cap stocks that are fortunate enough to be discovered and promoted by hedge funds may continue to ramp up, but they are not significant enough in the aggregate to make any meaningful difference in the overall market, just in some investors pockets. Unexpected bad news will be punished as always, but perhaps with more of a vengeance due the recent gains that have been thrown at most stocks with a reasonable pulse.

So that's a wimpy outlook, boring, but at least you didn't need to turn on CNN to hear it.