Wednesday, October 31, 2007

Waiting for the Fed, still obsessing about the $

In two hours we will know the Fed's latest move. Another interest rate cut is generally expected. If it happens there will likely be a reinforcing action by the markets, with the U.S. equity market inching up on the hope for more liquidity for the troubled areas in the securities markets and the foreign markets up on currency valuation. The underpinnings of what value the dollar has will continue to be undermined. Is the short term benefit of an interest rate reduction worth the long term danger of a weakening currency.

An interest rate reduction will not rescue the housing industry from its challenges. Mortgage rates today are still low from a historical perspective. A continued adjustment in housing prices in many markets is almost a cyclical necessity. Inventories in many markets will take at least until 2009 to be worked down to "normal" levels no matter what. An interest rate cut will not reinvigorate the consumer just in time for the holiday season.

The subprime mortgage lending mess and the housing correction are public relations cover for the two reasons that would drive a rate cut. First, the Fed of course has more information and radically different networking insights into the health of the securities markets than the average Joe, or John, and may reduce interest rates based on a more calamitous set of possible scenarios than seem apparent. Rescuing banks is never a good thing, and is always best avoided. Second, systematically weakening the dollar makes U.S. goods more competitive globally and is a boon to exports and to those S&P 500 corporations with multinational operations. Today's surprisingly strong reported growth rate for the economy is largely attributable to this fact, and may bode well for continued good employment numbers.

This is all at the expense of the stature of the U.S. currency. There are many reasons why this is dangerous. Some were discussed in a 9/10 post here. For now, here's just one more example. If a small business or consumer makes money just in U.S. dollars and is not connected to a multinational corporation, their spending power and their savings depend on the value of that dollar. Many goods and commodities are globally priced. So, all things being equal, if the dollar had not declined by 40% over the last five years against a basket of major currencies, the price of a gallon of gasoline, a globally priced commodity, would hypothetically be $2.10 instead of $3.00. That's a big deal, and it's not just confined to energy prices.

In 1962 one of the standard lines inserted into President Kennedy's speeches by his talented staff of writers went something like this---"to be a global leader a strong currency is just as important if not more important than a strong military"---something to think about.

Tuesday, October 23, 2007

Dangerous Barney

Led by House Financial Services Committee Chairman Barney Frank, House Democrats are proposing a broad array of regulatory remedies that are meant to control and punish the mortgage industry as well as provide relief to those consumers caught up in the current subprime mortgage problems. MANY of the measures have constructive intent and are worthy of debate and consideration. ONE is not constructive. That aspect of the proposals, a Barney favorite, is to impose legal liability on investment banking firms that securitize mortgages and to allow homeowners who are NOW in a fix to sue the investment banking firms that securitized their loans.

This is simply a neanderthal's approach to the financial system and shameless politics to boot.

The trial bar lobbies constantly for the opportunity to sue any "deep pockets" for anything. They are huge supporters of the Democratic party. While some of their leading practitioners are now facing jail time for fraud, there's not a peep from the Carl Levin's of the world who reveled in the corporate shenanigans of a few years ago. They still accept the money even from the firms of those indicted. The trial bar's biggest target now is the investment banks who securitize loans. Go Barney, unfortunately not a huggable purple dinosaur, well at least not purple.

No need to bore anyone with a primer on securitization here but here's a couple sentence description. Securization allows for mortgages, student loans, credit card debt, manufactured housing loans etc. to be packaged and sold to experienced investors who can take certain yields, maturities, and risk levels in their portfolios. Securitization provides liquidity that the banking system alone cannot possibly provide.

Regulating mortgage brokers, mortgage banks, and setting standards for origination integrity is all fine depending on how it's done, but opening up securitizations to the trial bar would be a disaster for the financial markets and an incredible windfall for that part(not all) of the trial bar that is without a shred of ethical contraint and support the Democrats who will deliver this bounty under the guise of protecting the little guy. When and if the class actions get tried by "juries of peers" in some litigation friendly southern or midwestern state, the goal of the trial bar, if the past is any guide, is primarily to win, demonstrate their power, and get their massive fees. Maybe they should call it trickle down justice for the people that this is advertised as protecting or reimbursing.

Legislation that encourages the trial bar in this way will also have a serious impact on the availibility of consumer credit, mainly to those consumers without top tier credit records that the House Barney's claim to be saving. Liquidity will be cut back, global investors will pull away, and credit costs for those without stellar credit will rise to a level that allows banks to hold it on their balance sheet, put appropriate capital against it, and have an ROE that allows their shareholders to get an honest return.

Those Democrats and a few Republicans that choose to promote this legislation understand this. From this perspective, their view of the risk/reward trade-off is perverse.

Saturday, October 20, 2007

Friday's market puzzles

The stunning stock market decline on Friday was, from this perspective, the result of two surprises, Caterpillar and Schlumberger. First, here are a few things that the decline was not about. It was not weak bank earnings. It was already clear weeks ago that big banks would post some bad numbers. With additional new accounting rules related to mark to market accounting in 2007, the Sarbanes-Oxley penalities for a miscue, and the fact that markets for many securities are not functioning well, the banks results were already in the cards. A few were worse than expected, a few not so bad, but overall this was not news. It was not Honeywell and 3M. They didn't help the tone of the market, but the misses were modest and related to explainable pressures. It was not Ben Bernanke's comments in which he more or less said that it's not easy to figure this stuff out, not exactly a leadership statement but not news. It was CAT and SLB.

Why? Both had results that had unexpected markers that on the surface were head scratchers. CAT has been in a sweet spot. It is a major global competitor in its business and the weak dollar has made its top quality products immensely competitive. Foreign currency revenues translate back into more and more dollars. Agricultural commodity prices are at or near record highs as global demand, spurred by additional upward pressure from energy related uses for corn, sugar, etc, has meant demand for its products. Infrastructure requirements in developing countries and even in the U.S. use its products. CAT is in great shape, and THEY MISSED AND THEY CUT THEIR EARNINGS OUTLOOK FOR THE YEAR! What? Their explanation was weakness in the U.S. related to a real estate construction slow down, and since everyone and their crazy uncle in the basement has known about the residential housing side of this for months the market drew the conclusion that it was COMMERCIAL CONSTRUCTION. That was chilling, but with all of the wind behind their backs at CAT, to think that this was dramatic enough to cut the 2007 forecast(last checked 2007 was 75% baked) was a shock, something that still needs more explanation, more clarity.

SLB beat the consensus earnings estimates by a huge margin but revenues were modestly less than expected, and they projected some pressure on revenues in the coming quarters. What? This is another company that has had everything going for it. Great products, market leading position, and an energy market that unquestionably has needs for greater development and exploration as the China's and India's soak up anything in their reach amidst global political uncertainties, continued G-7 growth, and varied supply issues. Prices are so good that any government in the world with offshore oil reserves to possibly be developed will spend bundles to try to tap into this resource. And SLB has pricing pressure. How? Why? From whom, since they have the greatest economies of scale in the oil service industry. This one is still a mystery. Does it presage some sort of global slowdown? Is there irrational competition that will lead to earnings misses across the industry? After two days of newspaper reports and pundits jabber it's not clear. Maybe Bernstein, or Bear, or JPM analysts will shed some light on Monday.

Those were, again from this perspective, unequivocally the two events that pushed an already volatile market over the edge on Friday. Depending on how they are clarified, they could either have been catalysts for a sort of healthy sell-off after a tenuous week in a market that had been ramping for a little too long OR they could be markers of two significant events that indicate a real downward turn in this market.

Wednesday, October 17, 2007

Funds' tax planning time

We are now in tax planning, and acting, season for fund managers. For those of us not running a mutual fund or hedge fund with hundreds of millions or billions of dollars, it's time to pay attention to those who do. The funds are not just involved in "window dressing" or "manipulating" period end results. They are taking actions to minimize the impact of taxes on their clients.

It's been an ok year thus far in the equity markets, but no one would say that it hasn't been volatile. There have been big winners and losers, in both sectors and individual stocks. So hypothetically, here's a situation. A hedge fund manager with a concentrated stock portfolio has huge losses in a few stocks related to the housing market that are still troubled. He also has huge gains on some stocks, say, in the mid cap industrial equipment area, stocks that still look strong with decent growth prospects and a sound balance sheet. He wants to clean up some of the exposure to the stocks with losses and perhaps has been doing so already. Preferring to use those losses to generate some value he sells a portion of his stocks with large gains, not because in and of themselves they should be sold but because that serves a larger purpose to his portfolio. They can be bought again anyway.

For us small fries in a year like this, that can put seemingly unexplained pressure on stocks that have everything going for them. It can limit any further upside in the next two months. Since, however, we can trade shares without even our spouses knowing about it much less the market it is a perfect time to take some capital gains, especially long term, by paring back and benefitting from some of our better performers for the year. We can avoid the tax season pressure and anytime after 30 days can choose to reload if we choose. Of course we too can actually also be doing what the pros do as far as balancing losses with gains, especially, especially, if the gains are subject to short term cap gains rates.

Friday, October 12, 2007


It happens periodically. The posts just stop flowing. It began this time with a sense that there was little to comment on about the markets beyond what had already been said here. The dollar's weakness was being ignored. Why comment on the short term when the long term is being trashed. Then came a heightened level of activity around here with a fourteen year old daughter's birthday, or birth week it seemed, an event worth celebrating, and celebrating. That was followed with a stunning announcement by an elderly parent that is still in the process of being finessed or accepted. And so , gradually, the ante was being raised day by day. No ordinary post about the market's daily volatility or the political event or miscue of the day would work. A new post would need to be consequential. That was the thought. The result was the dreaded bloglock.

Will it soon be broken?