During the stock market decline (or "crash") of October 2008, various media outlets have loudly identified the impact of massive hedge fund liquidations as a key ingredient to the huge equity sell-off.
However, as an "average" individual investor, how well do you really understand how or why these mysterious investment funds have acted in such a brazen manner?
Let's explore five things that you need to understand about hedge fund liquidations.
1. Meeting Redemptions
A hedge fund does not have to continually invest, as a mutual fund does. Rather, a hedge fund will allow its investors (typically "limited partners") to redeem all or part of their investments on a periodic basis. These redemptions usually follow very strict guidelines in accordance with the hedge fund operating agreement.
Typically, limited partners can only withdraw funds on a quarterly or annual basis. Furthermore, advanced notice (30 or more days) for redemption to the hedge fund manager is often required. Just as there may be a "run on a bank" there can also be a run on a hedge fund -- especially when performance is poor. Thus when redemptions occur they tend to be clustered across the entire hedge fund industry in a small window of time.
2. The FOF Effect
There are certain hedge funds which are set up as portfolios of other hedge funds. These are referred to as fund of funds (FOF). The concept is to diversify amongst many hedge funds. However, when a FOF is in redemption mode it has a decision to make: Either the FOF redeems an equal amount of investments across all of its hedge funds or it pulls out larger amounts from a few hedge funds.
Selling a small amount of many funds may have little impact on the liquidity of a single fund. However, liquidating a large portion from one fund could have dire consequences upon that individual fund.
3. Leverage
Average investors are subject to Federal Reserve Regulation T. Under Regulation T an investor can purchase a stock by borrowing money from a broker-dealer in a margin account. Under the margin rules the investor has to put up 50% of the purchase price in cash or other margin collateral. The other 50% is borrowed from the broker-dealer. Thus under Regulation T the investor has 2-to-1 leverage. Theoretically, the investment has to depreciate by 50% in order for the investor to be wiped out of their equity.
On the other hand, many hedge funds are levered through offshore facilities and in derivative contracts, whereby they can obtain leverage far greater 2-to-1. So what? Smaller losses have far greater impact on the equity of the fund.
Let's say a hedge fund's leverage is 5-to-1 and it's redemption time. In order to meet those redemptions, the hedge fund will have to sell at least $5 of investments for every $1 of required redemptions.
As redemptions tend to be clustered, the impact on individual stocks from hedge funds liquidating their holdings (to meet those redemptions) will be a magnified and concentrated hit on those stocks, and potentially the overall market.
Since the hedge funds are more concerned about creating liquidity than preserving the integrity of their portfolios during a crisis, the higher priced stocks tend to get sold first. It is far easier to create $10,000,000 of cash by selling smaller amounts of a $200 stock, say aapl, than larger amounts of a $25 stock, say mo. And before you know it, that $200 stock has become a $100 stock. "Classic" valuation is thrown out the window.
4. The Futures Effect
Liquidating large amounts of stock for an individual fund can be a complex task:
# Many of these hedge funds have outsized positions.
# When another hedge fund sees a commonly held position begin to sell off there is a tendency to also enter the fray, causing a run on the stock.
# Sometimes, there are hedges on the other side of the liquidation. Both sides have to be unwound simultaneously. In a fast or disjointed market this can cause confusion and risk management issues.
And when many hedge funds liquidate simultaneously, we have a rush to exit the markets as if there were a fire in a movie theater.
In order to "front-run" the need to liquidate, some hedge funds will sell index futures in order to hedge or anticipate the required liquidation.
Futures -- especially if sold before the market opens -- can set the markets up for a nasty fall. This has the effect of yelling fire in a crowded movie theater and in investment terms, panic selling may ensue. Once futures are sold off in this dramatic fashion, traditional indexed funds are forced to sell stocks in order to adjust their holdings to the perceived discount to fair value. A self perpetuating sell-off develops and markets rapidly head lower.
5. Extreme Herd Mentality
Hedge funds tend to act as a herd. While this may be no different than how individual investors think and behave, within the hedge fund community, because of these funds' massive sizes and access to lightening fast execution programs this herd phenomena develops in a more concentrated, more leveraged and rapid manner.
While hedge funds are natural competitors with one another, they also share information amongst their brethren. Furthermore, the sell side brokers will tend to market the same trade to many of their hedge fund clients, once they spot what trades are taking place. I have seen this happen time and time again.
For example, if ABC, a successful hedge fund, is buying commodity stocks and shorting retail stocks, then a diligent salesperson will ring up hedge fund XYZ to tell them what the "smart money" is doing. This then has a multiplicative effect and before you know it the entire hedge fund industry is loaded up on the same trade.
As long as the trade works, this is great for the saleperson and for the hedge funds. However, once the hedge funds unwind these concentrated and leveraged trades -- whether having to redeem or deleverage or manage risk -- there is a massive rush to the exits. We call these "Katy Bar the Door" moments (a commonly used Wall Street phrase for when everyone is trying to exit at the same time).
A great example of the herd trend in action is the "carry trade."
In the carry trade hedge funds will borrow money in a low interest currency and buy assets in a higher interest currency. For example, selling Japanese Yen (JPY) at 0.5% and reinvesting in U.S. Dollars at 3%. This trade works well as long as the exchange rate between the two currencies is stable. However, once the trade stops working (or as we say in the industry is no longer "setting up") or there is a coordinated exit from the trade, this will result in huge dislocations in the pricing of these assets without regard to the true fundamentals.
Recall the huge rally in JPY last week, as the carry trade was unwound by liquidating hedge funds. Then noticed what happened to JPY this week, once the unwinding ceased.
Your Homework
# Spot market dislocations related to hedge fund liquidations, as valuations become increasingly cheap and selling seems to become irrational.
A great example of this type of dislocation was FCX's activity, which was recently subject to hedge funds liquidating en masse.
# Identify when futures markets are moving by wide margins, without any associated economic or fundamental news. Instead of panicking and be shaken out of the market, use these situations in an opportunistic way.
Friday, October 31, 2008
October's Over!
After trending higher for almost the entire session following a somewhat weak start to the day, another final hour of random whipsaws threatened to erase the market’s intraday gains, but a late spurt of buying just before the close allowed the major indices to close out the day with solid gains.
As we close out one of the most tumultuous months in market history, plenty of folks are eager to put October behind us and kick off what is historically the strongest season for stocks. As we’ve mentioned on several occasions, there have been some encouraging technical developments in the major indices, and, while the number is small, there are a handful of individual stocks that have developed interesting looking set-ups. Now that the broader market has found some underlying support and has so far held on to Tuesday’s huge bounce, we need to see some consolidation and the trading ranges to narrow. While that has happened to a certain extent over the past couple of days, the action between the bells remains way too random, and we’re still seeing some wild swings at the end of the day. That’s going to have to settle down as we move forward.
Meanwhile, this market is still facing some enormous macroeconomic issues, and we have yet to find out if the weak economic data that is surely coming down the pike has been priced in. The Feds have done just about everything imaginable, and now we need to see if their efforts will help restore a more normal credit environment. We’ll see how things go, especially as the indices start to hit some overhead resistance. That said, perhaps the issues and problems we still face will help to keep sentiment contained enough so that we can start to climb that old wall of worry.
Regardless, at least we’ve put October behind us.
As we close out one of the most tumultuous months in market history, plenty of folks are eager to put October behind us and kick off what is historically the strongest season for stocks. As we’ve mentioned on several occasions, there have been some encouraging technical developments in the major indices, and, while the number is small, there are a handful of individual stocks that have developed interesting looking set-ups. Now that the broader market has found some underlying support and has so far held on to Tuesday’s huge bounce, we need to see some consolidation and the trading ranges to narrow. While that has happened to a certain extent over the past couple of days, the action between the bells remains way too random, and we’re still seeing some wild swings at the end of the day. That’s going to have to settle down as we move forward.
Meanwhile, this market is still facing some enormous macroeconomic issues, and we have yet to find out if the weak economic data that is surely coming down the pike has been priced in. The Feds have done just about everything imaginable, and now we need to see if their efforts will help restore a more normal credit environment. We’ll see how things go, especially as the indices start to hit some overhead resistance. That said, perhaps the issues and problems we still face will help to keep sentiment contained enough so that we can start to climb that old wall of worry.
Regardless, at least we’ve put October behind us.
Thursday, October 30, 2008
The Market's Acting Better, But Still Defies Logic - Last Half-Hour Moves Still Incredibly Violent....
We had another very erratic hour of trading to end the day, but it wasn't quite as dramatic as what we saw on Wednesday. After threatening to break down to new lows, we suddenly spiked up in the last few minutes of trading and went out at the highs.
While the market is acting well, it is slot-machine action. There isn't any logic to some of the moves, but if you hit them right, they can pay off nicely.
We now have three positive days in a row as we approach the end of one of the worst months in the history of the stock market. That might seem a bit manipulative, but clearly, there is plenty of bottom fishing taking place. The issue now is trying to maintain discipline while gaining market exposure. It hasn't been possible, and that is causing frustration for many.
I've often written that market moves usually go further than you think, and it certainly feels that way with the spike-up close today. A little consolidation would go a long way toward giving us a healthy market because it would help restore a bit of logic.
While the market is acting well, it is slot-machine action. There isn't any logic to some of the moves, but if you hit them right, they can pay off nicely.
We now have three positive days in a row as we approach the end of one of the worst months in the history of the stock market. That might seem a bit manipulative, but clearly, there is plenty of bottom fishing taking place. The issue now is trying to maintain discipline while gaining market exposure. It hasn't been possible, and that is causing frustration for many.
I've often written that market moves usually go further than you think, and it certainly feels that way with the spike-up close today. A little consolidation would go a long way toward giving us a healthy market because it would help restore a bit of logic.
Wednesday, October 29, 2008
Was Hoping To Finish In The Black Today..........
Although investors stepped up to buy the big dip following the sell-the-news reaction to the Fed’s announcement that they had cut their target for the fed funds rate by 50 basis points, sending the major indices higher by more than 3% late in the day, a massive wave of selling hit just before the close. In a matter of minutes, both the Dow and the S&P 500 fell by about 4%, into negative territory, while the Nasdaq was just barely able to stay in the green. Of course, we’ve been talking a lot lately about the need for this volatility, and whatever the reason for the late rush for the exits (many are pinning it on comments from GE’s CEO Jeff Immelt), we certainly didn’t get it today.
Yes, the ability of the market to find support around the intraday lows from the 10th leaves us in a position where the charts for the major indices can continue to build bases, but the speed with which this market is moving in both directions is going to have to slow down a bit. Trying to employ any reasonable money management technique at this point is almost a joke, and if you aren’t trading on an hour-by-hour basis, it’s best to just stand aside.
The bottom line, then, is that we can trade with extremely short time-frames, but we’re going to have to be patient if we want to start building position trades. We’ll get there, but as frustrating as it is, there’s no use trying to force that along.
Yes, the ability of the market to find support around the intraday lows from the 10th leaves us in a position where the charts for the major indices can continue to build bases, but the speed with which this market is moving in both directions is going to have to slow down a bit. Trying to employ any reasonable money management technique at this point is almost a joke, and if you aren’t trading on an hour-by-hour basis, it’s best to just stand aside.
The bottom line, then, is that we can trade with extremely short time-frames, but we’re going to have to be patient if we want to start building position trades. We’ll get there, but as frustrating as it is, there’s no use trying to force that along.
Tuesday, October 28, 2008
A "Base" Is Being Built, But Watch Out For Fed-Related Volatility Tomorrow.....
The bulls finally got things running, and when we didn't pull back like we have done so often, the "I'll never be able to buy again" panic buying kicked in. We went out at the highs on some huge percentage moves. Volume could have been higher, and Nasdaq breadth was a surprisingly sedate 2 to 1 advancers, but when you move this big, you can't dismiss it too easily.
Technically, we finally have very good conditions for putting in a solid low that will support some further upside. We have a little double-bottom pattern, and now, with a little backing and filling, we could actually start to build a decent base.
We still have way too much volatility. This market is all about macro news and moves, and it is impossible to focus on individual stock-picking. The market has been moving pretty much as a single monolith, and all you have been able to do is daytrade the swings.
I'm hopeful that maybe we will now hold the lows and finally have the chance to try some position trading. The intraday volatility makes for some great intraday trading, but it's not supportive of building individual positions.
Keep in mind that this is typical bear market action. You don't get huge days like this in a bull market. That doesn't mean we won't have more upside -- in fact, I think we will -- but it is going to take a lot more work before we can declare a major change in market character.
Days like this can be frustrating, because if you have been defensively postured, you will underperform. That is the price we pay for outperforming all the way down, and you still have plenty of flexibility to make some moves.
Tomorrow we have the Fed interest rate decision, which should give us some more volatility, but at least for now the mood has shifted, and the bulls have an edge.
Technically, we finally have very good conditions for putting in a solid low that will support some further upside. We have a little double-bottom pattern, and now, with a little backing and filling, we could actually start to build a decent base.
We still have way too much volatility. This market is all about macro news and moves, and it is impossible to focus on individual stock-picking. The market has been moving pretty much as a single monolith, and all you have been able to do is daytrade the swings.
I'm hopeful that maybe we will now hold the lows and finally have the chance to try some position trading. The intraday volatility makes for some great intraday trading, but it's not supportive of building individual positions.
Keep in mind that this is typical bear market action. You don't get huge days like this in a bull market. That doesn't mean we won't have more upside -- in fact, I think we will -- but it is going to take a lot more work before we can declare a major change in market character.
Days like this can be frustrating, because if you have been defensively postured, you will underperform. That is the price we pay for outperforming all the way down, and you still have plenty of flexibility to make some moves.
Tomorrow we have the Fed interest rate decision, which should give us some more volatility, but at least for now the mood has shifted, and the bulls have an edge.
Monday, October 27, 2008
Unfortunately, Extreme Negativity Can Become More Extreme....
One slight positive today was that volatility slowed just a little. Unfortunately, the price action was still just plain miserable.
Once again, the big move came in the last hour and in fact was mostly contained to a major breakdown in the last five minutes of trading. Breadth ended at close to 4 to 1 negative, and an intraday bounce attempt failed badly. The weak close goes to show how little confidence there is in the idea that tradeable low is close. Everyone is nervous and skittish, and given how fast this market moves, the best thing to do is sell as soon as a bounce fails.
There was some relative strength today in chips, agriculture and base metals, but nothing very dramatic. Biotechnology was slammed. The action in biotechs was so bad that there was some chatter that maybe a big fund in that sector is liquidating. Something unusual is going on in that group, and I suspect we'll see some news about it soon.
The action today just goes to show that extreme negativity is no guarantee that we are going to be able to bounce. The sentiment is as bad as I've ever seen it, but we still can't seem to get sufficiently washed out enough to put in a low that will hold.
Forget all the arguments about why this market can't go much lower. The plain and simple fact is that the action is terrible, and we need to respect that. The best way to lose money is to fight the obviously poor action in front of us.
Don't get discouraged. If you play it safe, the opportunities will eventually come. You just have to be willing to stay in cash and wait.
Once again, the big move came in the last hour and in fact was mostly contained to a major breakdown in the last five minutes of trading. Breadth ended at close to 4 to 1 negative, and an intraday bounce attempt failed badly. The weak close goes to show how little confidence there is in the idea that tradeable low is close. Everyone is nervous and skittish, and given how fast this market moves, the best thing to do is sell as soon as a bounce fails.
There was some relative strength today in chips, agriculture and base metals, but nothing very dramatic. Biotechnology was slammed. The action in biotechs was so bad that there was some chatter that maybe a big fund in that sector is liquidating. Something unusual is going on in that group, and I suspect we'll see some news about it soon.
The action today just goes to show that extreme negativity is no guarantee that we are going to be able to bounce. The sentiment is as bad as I've ever seen it, but we still can't seem to get sufficiently washed out enough to put in a low that will hold.
Forget all the arguments about why this market can't go much lower. The plain and simple fact is that the action is terrible, and we need to respect that. The best way to lose money is to fight the obviously poor action in front of us.
Don't get discouraged. If you play it safe, the opportunities will eventually come. You just have to be willing to stay in cash and wait.
Why FCX Is A Screaming, Table-Pounding Buy Right Now At $25....
Someday the deflationary pressures caused by the Great Unwind of 2008 will subside. And then we will confront the next headwind: inflation. And it'll be nasty.
Do you know the U.S. has borrowed an extra $1.4 trillion during the last 12 months, an annualized growth rate of 15.9%. A week ago gross public debt grew was 14.0%. Two months ago gross public debt rate was growing at "just" 7.1%.
Where is all this money going to go? It will chase real assets, the kind FCX owns.
Here's how I look at FCX. It owns 41 million ounces of gold. At $684 an ounce, the pretax in-ground value is $28 billion. Assume for illustrative purposes only that FCX mines all of its gold in one year and mining expenses are 51% of revenue (the average during 2003-2007). Thus, gross profit are $14.4 billion. Deduct $460 million for overhead (actual, 2007) and you have $14 billion of EBIT, $9 billion after-tax. Meanwhile, FCX's market value is $9.6 billion.
So at $25 a share, you buy FCX's gold mine at market value and get 93 billion pounds of copper and another 2 billion pounds of molybdenum for free. FCX will not be stock of the month in November, but it WILL reward patient investors.
Position: Long FCX
Do you know the U.S. has borrowed an extra $1.4 trillion during the last 12 months, an annualized growth rate of 15.9%. A week ago gross public debt grew was 14.0%. Two months ago gross public debt rate was growing at "just" 7.1%.
Where is all this money going to go? It will chase real assets, the kind FCX owns.
Here's how I look at FCX. It owns 41 million ounces of gold. At $684 an ounce, the pretax in-ground value is $28 billion. Assume for illustrative purposes only that FCX mines all of its gold in one year and mining expenses are 51% of revenue (the average during 2003-2007). Thus, gross profit are $14.4 billion. Deduct $460 million for overhead (actual, 2007) and you have $14 billion of EBIT, $9 billion after-tax. Meanwhile, FCX's market value is $9.6 billion.
So at $25 a share, you buy FCX's gold mine at market value and get 93 billion pounds of copper and another 2 billion pounds of molybdenum for free. FCX will not be stock of the month in November, but it WILL reward patient investors.
Position: Long FCX
Friday, October 24, 2008
Obviously, Hedge Fund Redemptions Are Driving This Market Down
The newspapers blame the weakening economy and somber earnings forecasts for the sharp selloffs we've been experiencing. Declining earnings and recession fears play into the declines, to be sure, but the real story -- which does not get the headlines it truly deserves -- is the mass liquidation that is occurring within the highly leveraged hedge fund community.
The mind-boggling size of the redemptions -- resulting in the need to sell at any price, especially if leverage is involved -- renders obsolete even the most seasoned professional's playbook. Gaming investor sentiment and using valuation as a guide have proved to be folly in the face of the avalanche of forced selling.
The good news is that valuations will matter eventually, and the incredible amount of cash that is currently on the sidelines will be put to work. For now, though, it is imperative that investors realize that the selling we are seeing now is not the work of rational human beings. Rather, it is the result of the largest deleveraging in financial history.
Half a Trillion?
The numbers are staggering. Although estimates vary, the total size of the hedge fund industry was about $1.8 trillion at the end of the third quarter, with about a third of that controlled by funds of funds, which are notorious for their itchy trigger fingers. Redemptions in August and September were substantial, at about $60 billion according to Eurekahedge, with most of the money coming out of long/short equity funds.
The high level of redemptions, together with the negative performance, has resulted in hedge fund assets falling precipitously in the third quarter. The total decline in hedge fund assets was on the order of $160 billion. That was the third quarter. Unfortunately, the damage has been much, much worse so far in the month of October.
Although data are sketchy at this point, many believe that hedge funds are facing redemptions on the order of half a trillion dollars. This is certainly not a surprising number given the amount of money that funds of funds control, and given the fact that many absolute return strategies are losing money -- a lot of money -- institutions and individuals alike have been losing at least a little faith in the entire asset class.
They Aren't Done Yet
The bad news is that the hedge funds are not done liquidating, and the constant selling creates a vicious cycle -- a negative feedback loop -- on both Wall Street and Main Street. Funds are forced to sell as valuations move lower, and Main Street grows ever more frightened by unending incineration of wealth.
The headlines attribute each successive drop in the market averages to the latest earnings disappointment or lowered forecast, but the real story is the forced selling. The forced sales -- especially of the margined funds -- have overwhelmed the market, and the situation is only made worse as programs and humans have piled on to the downside.
Note the extreme moves at the end of each day, as the margin clerks try to give the foundering funds a chance for the market to turn in their favor. Ultimately, however, the collateral must be protected and the funds are forced to unwind their positions.
Sidelined Cash Will Be Put to Work Eventually
The good news is that many in the hedge fund and mutual fund industry have been somewhat ahead of the curve, raising cash on the way down. That means there is currently a tremendous amount of cash on the sidelines. That money at some point will move back in to the market, but so far most trading desks have not been seeing buying of any real consequence.
It will happen, though. There are a great many stocks that are trading at levels that discount the very worst of outcomes. Stable, defensive businesses with high levels of cash and prodigious amounts of cash flow are now trading at extremely low valuations. I will focus on some of those opportunities in future columns, because I am confident that investors will realize sizable gains from these levels over the next few years. So, yes, there is hope.
But for now, valuation and sentiment does not matter. It is imperative for investors to realize that and to acknowledge exactly what they are up against. This is the Great Deleveraging of 2008, the likes of which nobody has ever seen.
The mind-boggling size of the redemptions -- resulting in the need to sell at any price, especially if leverage is involved -- renders obsolete even the most seasoned professional's playbook. Gaming investor sentiment and using valuation as a guide have proved to be folly in the face of the avalanche of forced selling.
The good news is that valuations will matter eventually, and the incredible amount of cash that is currently on the sidelines will be put to work. For now, though, it is imperative that investors realize that the selling we are seeing now is not the work of rational human beings. Rather, it is the result of the largest deleveraging in financial history.
Half a Trillion?
The numbers are staggering. Although estimates vary, the total size of the hedge fund industry was about $1.8 trillion at the end of the third quarter, with about a third of that controlled by funds of funds, which are notorious for their itchy trigger fingers. Redemptions in August and September were substantial, at about $60 billion according to Eurekahedge, with most of the money coming out of long/short equity funds.
The high level of redemptions, together with the negative performance, has resulted in hedge fund assets falling precipitously in the third quarter. The total decline in hedge fund assets was on the order of $160 billion. That was the third quarter. Unfortunately, the damage has been much, much worse so far in the month of October.
Although data are sketchy at this point, many believe that hedge funds are facing redemptions on the order of half a trillion dollars. This is certainly not a surprising number given the amount of money that funds of funds control, and given the fact that many absolute return strategies are losing money -- a lot of money -- institutions and individuals alike have been losing at least a little faith in the entire asset class.
They Aren't Done Yet
The bad news is that the hedge funds are not done liquidating, and the constant selling creates a vicious cycle -- a negative feedback loop -- on both Wall Street and Main Street. Funds are forced to sell as valuations move lower, and Main Street grows ever more frightened by unending incineration of wealth.
The headlines attribute each successive drop in the market averages to the latest earnings disappointment or lowered forecast, but the real story is the forced selling. The forced sales -- especially of the margined funds -- have overwhelmed the market, and the situation is only made worse as programs and humans have piled on to the downside.
Note the extreme moves at the end of each day, as the margin clerks try to give the foundering funds a chance for the market to turn in their favor. Ultimately, however, the collateral must be protected and the funds are forced to unwind their positions.
Sidelined Cash Will Be Put to Work Eventually
The good news is that many in the hedge fund and mutual fund industry have been somewhat ahead of the curve, raising cash on the way down. That means there is currently a tremendous amount of cash on the sidelines. That money at some point will move back in to the market, but so far most trading desks have not been seeing buying of any real consequence.
It will happen, though. There are a great many stocks that are trading at levels that discount the very worst of outcomes. Stable, defensive businesses with high levels of cash and prodigious amounts of cash flow are now trading at extremely low valuations. I will focus on some of those opportunities in future columns, because I am confident that investors will realize sizable gains from these levels over the next few years. So, yes, there is hope.
But for now, valuation and sentiment does not matter. It is imperative for investors to realize that and to acknowledge exactly what they are up against. This is the Great Deleveraging of 2008, the likes of which nobody has ever seen.
The Last Hour Is Like Gambling In A Casino
The final hour of trading today was not too much different than what you see in a Las Vegas casino. This intraday action is so volatile and so fast, it is just gambling.
The last hour today was somewhat wild, with the weekend beckoning and all the chaos in markets worldwide. We now have news about how the TARP program is being expanded and how the Treasury is considering stakes in insurers. Obviously, interest-rate cuts are also forthcoming. Who knows what we may be hit with come Monday morning? That great uncertainty is just going to accentuate the fast swings we should see as we close out the week.
I don't have a whole lot to add at this point. Obviously, long-term investors should be standing aside, and only the very short-term orientated should be trying to game this market.
The most important thing right now is to not worry about trying to catch the bottom. Even though you have highly excited bottom calls by guys like Barton Biggs on Bloomberg right now, there is no big hurry. This market will give you plenty of time to catch the next major uptrend.
The last hour today was somewhat wild, with the weekend beckoning and all the chaos in markets worldwide. We now have news about how the TARP program is being expanded and how the Treasury is considering stakes in insurers. Obviously, interest-rate cuts are also forthcoming. Who knows what we may be hit with come Monday morning? That great uncertainty is just going to accentuate the fast swings we should see as we close out the week.
I don't have a whole lot to add at this point. Obviously, long-term investors should be standing aside, and only the very short-term orientated should be trying to game this market.
The most important thing right now is to not worry about trying to catch the bottom. Even though you have highly excited bottom calls by guys like Barton Biggs on Bloomberg right now, there is no big hurry. This market will give you plenty of time to catch the next major uptrend.
Thursday, October 23, 2008
More Late Day Fireworks
Late day fireworks were on the menu again today. The heavy pressure that we saw late in the morning and for most of the afternoon reversed in the final hour as the indices shot off their worst levels of the session to end the session in mixed territory. Certainly, the fact that both the Dow and the S&P 500 were able to close above support levels is a positive, but this sort of action is just unworkable. It’s hard not to think that, at some point, buyers will simply refuse to step up to the plate when the indices are in the process of breaking to multi-year lows.
As we’ve been saying, however, trying to do too much of anything in such a volatile tape is a recipe for disaster. These violent and sudden moves may be paradise for day-traders, but trying to build decent sized positions with the intent of holding for more than even a few hours is tantamount to gambling. If your timing isn’t just right, then you’ll find yourself getting stopped out repeatedly.
The bottom line here is that only thing we really need to be doing is waiting patiently for the market to show signs of sustained improvement. The chances for a big counter-trend bounce are growing, but given the recent propensity for quick reversals, we’re wondering how much traction one might get. Regardless, the best thing we need to keep in mind is that the primary trend is down, and it’s going to take a lot of work and time before that changes.
As we’ve been saying, however, trying to do too much of anything in such a volatile tape is a recipe for disaster. These violent and sudden moves may be paradise for day-traders, but trying to build decent sized positions with the intent of holding for more than even a few hours is tantamount to gambling. If your timing isn’t just right, then you’ll find yourself getting stopped out repeatedly.
The bottom line here is that only thing we really need to be doing is waiting patiently for the market to show signs of sustained improvement. The chances for a big counter-trend bounce are growing, but given the recent propensity for quick reversals, we’re wondering how much traction one might get. Regardless, the best thing we need to keep in mind is that the primary trend is down, and it’s going to take a lot of work and time before that changes.
Wednesday, October 22, 2008
Another Wretched Day; Rumor is That A Few Quant Funds Blew Up Today....
Even though there was a pretty good bounce in the closing minutes, it was a downright nasty day for the bulls. The point loss was big, breadth horrible and volume increased. The major indices did hold above recent lows, but the more we test these levels, the less likely we will hold. It is not an inspiring technical pattern, and there is no reason to be very optimistic.
The most striking thing about the action today was the aura of hopelessness. Usually when we have a big negative day, there are lots of bottom-fishers anxious to declare a low and jump in. Today, the mood was mostly just exasperation and disgust with a market that is apparently pricing in a huge depression.
Maybe all this negativity is a good contrarian indicator, but the problem is that it has been extremely gloomy for a while now, and it is impossible to precisely time when things are so negative that they can't get any worse. The whole idea of contrary thinking is that when things are at their worst, everyone who is going to sell has done so. That isn't an easy thing to measure, and to a great degree, contrary thinking is in the eye of the beholder.
After the long downtrend and the crash action, we should expect a period of volatility, and then finally some basing action. Unfortunately, the period of volatility is not slowing yet. Emotions are still on edge, and we can't assume that we won't see more downside before it does finally subside.
The key to making money in the market isn't to guess the ultimate low, but to buy when conditions are best for some sustained upside. We sure aren't at that point, so stay cautious and don't be impatient.
The most striking thing about the action today was the aura of hopelessness. Usually when we have a big negative day, there are lots of bottom-fishers anxious to declare a low and jump in. Today, the mood was mostly just exasperation and disgust with a market that is apparently pricing in a huge depression.
Maybe all this negativity is a good contrarian indicator, but the problem is that it has been extremely gloomy for a while now, and it is impossible to precisely time when things are so negative that they can't get any worse. The whole idea of contrary thinking is that when things are at their worst, everyone who is going to sell has done so. That isn't an easy thing to measure, and to a great degree, contrary thinking is in the eye of the beholder.
After the long downtrend and the crash action, we should expect a period of volatility, and then finally some basing action. Unfortunately, the period of volatility is not slowing yet. Emotions are still on edge, and we can't assume that we won't see more downside before it does finally subside.
The key to making money in the market isn't to guess the ultimate low, but to buy when conditions are best for some sustained upside. We sure aren't at that point, so stay cautious and don't be impatient.
Tuesday, October 21, 2008
Every Day We Start Over
True to form, the market moved sharply once again during the final hour, completely negating the progress it had made earlier in the afternoon. By the close, each of the major S&P sectors was in the red while the indices finished with losses of 3.13%, on average. With a loss of over 4%, the Nasdaq was particularly weak as several big-cap tech names fell sharply, which was likely due, at least in part, to the poor earnings report last night from TXN. As we write this, market players are waiting anxiously to see what sort of news AAPL delivers.
Still, despite the losses and continuing whipsaws, credit market conditions continued to slowly improve and the trading range between the bells narrowed a bit once again. What we’d really like to see is for some of this volatility to calm down and for investors to take a break from chasing moves in both directions. If emotions can cool down and we can start to build some tighter ranges, then maybe we can start to see some better set-ups develop. Like we’ve said, we are seeing some improvements, and even though we gave back the majority of yesterday’s gains, today’s action doesn’t change that.
Still, despite the losses and continuing whipsaws, credit market conditions continued to slowly improve and the trading range between the bells narrowed a bit once again. What we’d really like to see is for some of this volatility to calm down and for investors to take a break from chasing moves in both directions. If emotions can cool down and we can start to build some tighter ranges, then maybe we can start to see some better set-ups develop. Like we’ve said, we are seeing some improvements, and even though we gave back the majority of yesterday’s gains, today’s action doesn’t change that.
30 - Year Swap Falls Below a Single Point!
The 30-year swap spread fell as low as 0.5 basis point (bps) today. That means that the fixed side of a long-term interest-rate swap was trading at no premium vs. Treasury bonds. None. Remember that any interest-rate swap has to have a bank or other financial institution standing in the middle.
With everyone scared to death about counter-party risk, it's absolutely shocking that long-term swaps can trade at no premium over Treasuries. By comparison, 2-year swaps have a spread of 104bps, and traded as high as 165bps earlier this month.
This strange anomaly is just another example of what happens when leveraged investors are desperate to unload bad trades into a highly illiquid market. Over the last two years, there were many "range notes" sold that referenced the yield differential between 10-year and 30-year swaps. Now that trade isn't looking so hot, and people want to hedge. Lots of people rushing to leave the building, but a small door of liquidity, and a spread of zero is the result. .
With everyone scared to death about counter-party risk, it's absolutely shocking that long-term swaps can trade at no premium over Treasuries. By comparison, 2-year swaps have a spread of 104bps, and traded as high as 165bps earlier this month.
This strange anomaly is just another example of what happens when leveraged investors are desperate to unload bad trades into a highly illiquid market. Over the last two years, there were many "range notes" sold that referenced the yield differential between 10-year and 30-year swaps. Now that trade isn't looking so hot, and people want to hedge. Lots of people rushing to leave the building, but a small door of liquidity, and a spread of zero is the result. .
Monday, October 20, 2008
It's Unusual To Call This A Calm Day, But It Was
It isn't often that a day with the DJIA up around 400 points can be called "quiet," but that is the case today following the craziness of last week. Volume slowed substantially, and volatility cooled as well, which is exactly what we needed. Market players aren't interested in jumping into a market that is swinging 500 points or more per day. They want to see some stability and less random action. A highly emotional and uncertain market isn't attractive to most investors, so a few quiet days would help quite a bit.
Leadership today was primarily in oil-, steel-, coal- and commodity-related stocks, but breadth was very good overall, and there was little red on the screens. The great difficulty is that this has been a daytrader's market recently, and everyone is ready to hit the eject button at the first sign of problems. Trust levels are low, which means that time frames are extremely short, and that is what has been causing much of our volatility.
Earnings tonight from Texas Instruments and American Express will take center stage, and we'll get some feel for the level of market expectations. No one is expecting a lot of great earnings reports, but we really don't know what degree of badness has already been discounted.
I'm cautiously optimistic, and the action today didn't do anything to change my mind. I'd still like to see some tighter ranges, but at least volatility and volume did slow a bit.
Leadership today was primarily in oil-, steel-, coal- and commodity-related stocks, but breadth was very good overall, and there was little red on the screens. The great difficulty is that this has been a daytrader's market recently, and everyone is ready to hit the eject button at the first sign of problems. Trust levels are low, which means that time frames are extremely short, and that is what has been causing much of our volatility.
Earnings tonight from Texas Instruments and American Express will take center stage, and we'll get some feel for the level of market expectations. No one is expecting a lot of great earnings reports, but we really don't know what degree of badness has already been discounted.
I'm cautiously optimistic, and the action today didn't do anything to change my mind. I'd still like to see some tighter ranges, but at least volatility and volume did slow a bit.
Saturday, October 18, 2008
Friday, October 17, 2008
Buy FCX RIGHT HERE AT 32
There is no doubt that investors' fears of a slowing global economy are valid, as frozen credit markets and a crumbling demand have taken their toll. This reduced demand has resulted in a sharp drop in commodity prices, which in turn has hurt commodity stocks across the board. Although many of these stocks deserve to be trading at current levels, there are others that have valuations that are all too compelling to overlook. Among these is Freeport McMoran (FCX) which is the focus of this article.
Freeport McMoran is one of the largest producers of copper and gold in the world. One of the main reasons for the stock's recent decline is the company's heavy reliance on copper prices. Being an industrial metal, copper prices fluctuate based on prospects for global growth and continued industrialization of emerging economies.
With a clear indication that global growth is slowing, traders have brought copper prices down almost 50% in the last 4 months from over $4.00/lb in July to 2.12/lb yesterday. I am not going to suggest that copper prices will re-test their July highs anytime soon. In fact, it is entirely likely that we may see a stalling of copper prices at these levels, until we get a better indication of what effect a prolonged recession might have. After all, copper production this year has increased quite dramatically compared to actual consumption which has stayed steady.
However, when looking from an individual company perspective, FCX appears extremely cheap. The company has a trailing P/E of 3.90 and a forward P/E of 3.28. This is a steep discount from the stock's historical levels as it had maintained a P/E in range of 7 to 13 over the past three years. The company has been growing cash flow year over year, as it is expected to return a cash flow per share of 14.38 in 2008, a 10% increase from 2007. The company has a ton of cash on the balance sheet, which sat at $1.6 billion at last check, indicating cash per share of $4.30.
When comparing Freeport to the rest of the copper industry, the company is best-of-breed and continues to be among the most inexpensive. The average P/E for the copper industry is around 9.00, which indicates that FCX is trading at a relative discount of approximately 60%. When taking a closer look by comparing FCX to one of its largest competitors, Southern Copper (PCU), we notice that FCX is still cheaper by traditional metrics. PCU has a forward P/E of 5.00, which is a 40% premium over FCX. Further, Southern Copper is actually projected to have negative revenue growth for 2008, while Freeport is projected to grow revenues by 28%. So not only is FCX the best-of-breed company within the industry, but it trades at one of the cheapest valuations in the group.
In addition to falling copper prices, FCX has experienced some operational hurdles, as there have been recent workers strikes that have hindered production and shipments. This includes strikes at their Cerro Verde mining location in Peru as well as a strike at the Chilean mining port of Antofagasta, where a third of the world's copper supply runs through. If you combine this with crumbling stock markets in emerging countries, lowered industry outlooks, and other negative news from mining giants Rio Tinto (RTP) and Companhia Vale Do Rio Doce (RIO), it is pretty safe to say that Freeport has been the victim of a great deal of headline risk.
All things considered, it appears all of this bad news has been priced into FCX given that the stock has slid 76% from an all time high of $125 just 4 months ago. Down here near $30, the risk/reward is very compelling by virtually all valuation metrics. Freeport reports earnings on October 20, which will give some clarity on how the company is weathering falling copper prices. Investors will likely focus on what the company has to say about the direction of copper prices in 2009, as well as updates on how the company is adjusting their capital structure to accommodate this recessionary environment.
Disclosure: Long FCX
Freeport McMoran is one of the largest producers of copper and gold in the world. One of the main reasons for the stock's recent decline is the company's heavy reliance on copper prices. Being an industrial metal, copper prices fluctuate based on prospects for global growth and continued industrialization of emerging economies.
With a clear indication that global growth is slowing, traders have brought copper prices down almost 50% in the last 4 months from over $4.00/lb in July to 2.12/lb yesterday. I am not going to suggest that copper prices will re-test their July highs anytime soon. In fact, it is entirely likely that we may see a stalling of copper prices at these levels, until we get a better indication of what effect a prolonged recession might have. After all, copper production this year has increased quite dramatically compared to actual consumption which has stayed steady.
However, when looking from an individual company perspective, FCX appears extremely cheap. The company has a trailing P/E of 3.90 and a forward P/E of 3.28. This is a steep discount from the stock's historical levels as it had maintained a P/E in range of 7 to 13 over the past three years. The company has been growing cash flow year over year, as it is expected to return a cash flow per share of 14.38 in 2008, a 10% increase from 2007. The company has a ton of cash on the balance sheet, which sat at $1.6 billion at last check, indicating cash per share of $4.30.
When comparing Freeport to the rest of the copper industry, the company is best-of-breed and continues to be among the most inexpensive. The average P/E for the copper industry is around 9.00, which indicates that FCX is trading at a relative discount of approximately 60%. When taking a closer look by comparing FCX to one of its largest competitors, Southern Copper (PCU), we notice that FCX is still cheaper by traditional metrics. PCU has a forward P/E of 5.00, which is a 40% premium over FCX. Further, Southern Copper is actually projected to have negative revenue growth for 2008, while Freeport is projected to grow revenues by 28%. So not only is FCX the best-of-breed company within the industry, but it trades at one of the cheapest valuations in the group.
In addition to falling copper prices, FCX has experienced some operational hurdles, as there have been recent workers strikes that have hindered production and shipments. This includes strikes at their Cerro Verde mining location in Peru as well as a strike at the Chilean mining port of Antofagasta, where a third of the world's copper supply runs through. If you combine this with crumbling stock markets in emerging countries, lowered industry outlooks, and other negative news from mining giants Rio Tinto (RTP) and Companhia Vale Do Rio Doce (RIO), it is pretty safe to say that Freeport has been the victim of a great deal of headline risk.
All things considered, it appears all of this bad news has been priced into FCX given that the stock has slid 76% from an all time high of $125 just 4 months ago. Down here near $30, the risk/reward is very compelling by virtually all valuation metrics. Freeport reports earnings on October 20, which will give some clarity on how the company is weathering falling copper prices. Investors will likely focus on what the company has to say about the direction of copper prices in 2009, as well as updates on how the company is adjusting their capital structure to accommodate this recessionary environment.
Disclosure: Long FCX
mkt today - more sedate, but not by alot
The DJIA had an intraday swing of about 560 points today, which, believe or not, was the narrowest trading range all week. This wild action is obviously due to extreme emotions. On Monday they couldn't buy things fast enough, and we went up 936 points. On Wednesday, they were afraid the economy was falling into a depression, and we fell 733 points. Today we swing up and down and close relatively flat.
This technical pattern is very similar to what we saw in 1987. Eventually the volatility slowed down, and a very good trading environment emerged. I'm hopeful that will be the case again, but obviously the macroeconomic situation is quite different. We are undergoing historic changes in the banking system, and we still have no idea how much all the issues with real estate and bad debt is going to affect the health of the economy. It won't be good, but guys like Warren Buffett are saying that many are too pessimistic. We'll let the chart be our guide, and so far we have reason to be very cautiously optimistic.
We have a slew of earnings reports coming up, and it would be great if the market could shifts its focus to those and away from the macro. Individual stock picking has been pretty irrelevant lately, as the big picture concerns are the only thing that matters. The vast majority of stocks are moving in lockstep, which makes stock-picking largely irrelevant.
This volatility makes for a very tiring market. You have to watch positions like a hawk or risk being whipsawed. The good news is that we are making progress toward a better trading environment, but don't bet the farm on it quite yet.
This technical pattern is very similar to what we saw in 1987. Eventually the volatility slowed down, and a very good trading environment emerged. I'm hopeful that will be the case again, but obviously the macroeconomic situation is quite different. We are undergoing historic changes in the banking system, and we still have no idea how much all the issues with real estate and bad debt is going to affect the health of the economy. It won't be good, but guys like Warren Buffett are saying that many are too pessimistic. We'll let the chart be our guide, and so far we have reason to be very cautiously optimistic.
We have a slew of earnings reports coming up, and it would be great if the market could shifts its focus to those and away from the macro. Individual stock picking has been pretty irrelevant lately, as the big picture concerns are the only thing that matters. The vast majority of stocks are moving in lockstep, which makes stock-picking largely irrelevant.
This volatility makes for a very tiring market. You have to watch positions like a hawk or risk being whipsawed. The good news is that we are making progress toward a better trading environment, but don't bet the farm on it quite yet.
Thursday, October 16, 2008
mkt today - another wild one
The roller-coaster ride continues. One day it looks like the total destruction of our financial system, and the next they can't buy them fast enough.
Volume picked up and, technically, with the dip this morning, we have a half-decent attempt at testing the lows of last Friday. The intraday reversal on higher volume is also a positive, as is the strong finish.
We now have some earnings reports to contend with, and it looks like Google is ok. The initial response is positive, but the conference call will tell the story even though they don't give any earnings guidance.
We also have IBM, which is going to tell the tale about international business. This quarter they won't benefit from currency gains, which has been pressuring the stock.
So far this earnings season, the market has not been "buying the bad news," although expectations are obviously very low. We'll have a better sense of the mood tomorrow, as we digest the GOOG and IBM reports.
Traders are going to be hopeful that the action today was the pullback and retest that gives us a good low. I'm not convinced it will be that easy, but with the way this market is moving around, we could have some pretty big upside moves very quickly if we get just a slight respite from the doom and gloom.
Keep things short term for now, and don't worry about building up big long positions, and you'll be fine.
Volume picked up and, technically, with the dip this morning, we have a half-decent attempt at testing the lows of last Friday. The intraday reversal on higher volume is also a positive, as is the strong finish.
We now have some earnings reports to contend with, and it looks like Google is ok. The initial response is positive, but the conference call will tell the story even though they don't give any earnings guidance.
We also have IBM, which is going to tell the tale about international business. This quarter they won't benefit from currency gains, which has been pressuring the stock.
So far this earnings season, the market has not been "buying the bad news," although expectations are obviously very low. We'll have a better sense of the mood tomorrow, as we digest the GOOG and IBM reports.
Traders are going to be hopeful that the action today was the pullback and retest that gives us a good low. I'm not convinced it will be that easy, but with the way this market is moving around, we could have some pretty big upside moves very quickly if we get just a slight respite from the doom and gloom.
Keep things short term for now, and don't worry about building up big long positions, and you'll be fine.
Wednesday, October 15, 2008
another truly horrible day
After the huge jump in the indices on Monday, some pull back is to be expected, as short-term flippers and those who are looking to reposition exert selling pressure. The important thing is that the pullback not go too far or be too intense. We want to see some dip buying kick in fairly quickly as evidence that there are underlying buyers who are confident enough to put cash to work.
The selling today went further than I'd like to see. The point loss was big enough to call into question the idea that we have some decent underlying support. The buyers showed little conviction and were overwhelmed with what many are calling "forced liquidations." I don't know to what degree the selling is being "forced," but it certainly is at extreme levels, and trying to anticipate when it's going to end is a good way to get crushed.
As I've written often, my style is to not try to battle the market trend. There can be no doubt what that trend is, and unlike many others, I'm not going to try to guess when things will turn. I'll keep looking for signs, but until we get some better action that lasts, I'm not going to be doing much buying. Keep that cash safe, and you'll be in great shape down the road.
The selling today went further than I'd like to see. The point loss was big enough to call into question the idea that we have some decent underlying support. The buyers showed little conviction and were overwhelmed with what many are calling "forced liquidations." I don't know to what degree the selling is being "forced," but it certainly is at extreme levels, and trying to anticipate when it's going to end is a good way to get crushed.
As I've written often, my style is to not try to battle the market trend. There can be no doubt what that trend is, and unlike many others, I'm not going to try to guess when things will turn. I'll keep looking for signs, but until we get some better action that lasts, I'm not going to be doing much buying. Keep that cash safe, and you'll be in great shape down the road.
Tuesday, October 14, 2008
mkt today
After a nasty-looking pullback in the midafternoon, the bulls were able to regroup and kept the damage done to a minimum. While it's a positive that we gave back only a small amount of yesterday's gains, the bulls are going to need to show that they have the resolve to continue to hold this market up. If we fail to make some further headway in the near term, the profit-taking will quickly pick up.
I'm not very optimistic that we will see much more upside in the near term but if we can pullback and find some support that holds for a few days then I'll be feeling more positive.
At this point we have to digest yesterday's big gain and give the flippers and weak hands a chance to exit. If they can do that and there is some underlying support to hold us up without a huge loss that will be what we need to build a good base of support for another assault on the upside.
However the big challenge for the bulls is going to be the news flow. We just had this massive government bailout announced and we pretty much know what all that is proposed. We are unlikely to see any more surprises on that front. We also have earnings reports coming and the big question there is how much bad news is already priced in.
No one is expecting anything upbeat but that might not be a major problem if it is already priced in. I'm not sure that it is and we wont' know until we see a few reports. The report today from Pepsi (PEP) was not a good sign but we'll see what happens on Intel (INTC).
There is no reason to be overly bullish at this point. We still have plenty of work to do before we can trust this market with our precious capital.
I'm not very optimistic that we will see much more upside in the near term but if we can pullback and find some support that holds for a few days then I'll be feeling more positive.
At this point we have to digest yesterday's big gain and give the flippers and weak hands a chance to exit. If they can do that and there is some underlying support to hold us up without a huge loss that will be what we need to build a good base of support for another assault on the upside.
However the big challenge for the bulls is going to be the news flow. We just had this massive government bailout announced and we pretty much know what all that is proposed. We are unlikely to see any more surprises on that front. We also have earnings reports coming and the big question there is how much bad news is already priced in.
No one is expecting anything upbeat but that might not be a major problem if it is already priced in. I'm not sure that it is and we wont' know until we see a few reports. The report today from Pepsi (PEP) was not a good sign but we'll see what happens on Intel (INTC).
There is no reason to be overly bullish at this point. We still have plenty of work to do before we can trust this market with our precious capital.
Monday, October 13, 2008
A big bounce after a massive breakdown like we had today is very tricky to navigate. The reasons that these "V"-shaped moves should pull back fairly fast are obvious. Short-term traders who caught the low will be taking their profits, and longer-term investors who were sweating over their losses will take the opportunity to escape with a little less pain. That is what overhead resistance is all about.
The tricky thing is that there is no easy way to gauge how far a bounce will go. They often have a way of going further than most people think, and that triggers performance anxiety and panic buying, which drives them even further.
Technically, a big one-day spike following a massive breakdown is not a particularly good entry point. Technicians don't tend to trust "V"-shaped bounces to continue, and when they do, it causes a lot of anxiety as folks stand on the sidelines waiting for an entry point.
The bounce is on, and how far it goes nobody knows. In the bigger scheme of things, we are just back to some levels we saw last week, so it's hard to be too trusting that it's straight up from here, given all the overhead. The intraday action was a real buying frenzy, but if you look at the chart of the last six months, it's just a good-sized blip.
The good news is that we have finally stopped going down, and that is the first step in giving us a market where we can find some buys once again. The move today was a bit overheated, but at least we now know that not everyone went broke and is expecting a depression. There are some real buyers out there, and hopefully they will be supportive in the days and weeks ahead.
The tricky thing is that there is no easy way to gauge how far a bounce will go. They often have a way of going further than most people think, and that triggers performance anxiety and panic buying, which drives them even further.
Technically, a big one-day spike following a massive breakdown is not a particularly good entry point. Technicians don't tend to trust "V"-shaped bounces to continue, and when they do, it causes a lot of anxiety as folks stand on the sidelines waiting for an entry point.
The bounce is on, and how far it goes nobody knows. In the bigger scheme of things, we are just back to some levels we saw last week, so it's hard to be too trusting that it's straight up from here, given all the overhead. The intraday action was a real buying frenzy, but if you look at the chart of the last six months, it's just a good-sized blip.
The good news is that we have finally stopped going down, and that is the first step in giving us a market where we can find some buys once again. The move today was a bit overheated, but at least we now know that not everyone went broke and is expecting a depression. There are some real buyers out there, and hopefully they will be supportive in the days and weeks ahead.
Friday, October 10, 2008
mkt today - extremely wide swings in market - dow swung about 12% and nas 9%....
Although we finished the day in mixed territory, the ability of the major indices to finish well off their worst levels was a small victory. After a few fits and starts, the market was able to hold at the lows of the day, not fall apart once the final hour began, and rocket higher as the closing bell approached.
Certainly, it is way too early to think that we may have seen a bottom, but after spiraling downward for days on end, we finally saw a little support and anxiousness on the long side. We still have tremendous strains in the credit market and significant problems in the economy, but at least if this market can stop bleeding here, then we will have made a step in the right direction.
It’s going to be a long time before anyone has confidence in this market again, but as I've been saying all along, that kind of disgust and exhaustion is a necessary stage of a bear market. Should we start to see some action to the upside, plenty of investors will take that opportunity to make a more graceful exit, but as we move forward, that sort of back and forth action, should recent lows hold, will be what builds a base.
The bottom line is that, as long as we can stay patient and not be in too big a rush to dive back in, this market will improve and we will find outstanding opportunities to profit.
Certainly, it is way too early to think that we may have seen a bottom, but after spiraling downward for days on end, we finally saw a little support and anxiousness on the long side. We still have tremendous strains in the credit market and significant problems in the economy, but at least if this market can stop bleeding here, then we will have made a step in the right direction.
It’s going to be a long time before anyone has confidence in this market again, but as I've been saying all along, that kind of disgust and exhaustion is a necessary stage of a bear market. Should we start to see some action to the upside, plenty of investors will take that opportunity to make a more graceful exit, but as we move forward, that sort of back and forth action, should recent lows hold, will be what builds a base.
The bottom line is that, as long as we can stay patient and not be in too big a rush to dive back in, this market will improve and we will find outstanding opportunities to profit.
Thursday, October 9, 2008
Although we were hovering near the lows of the day throughout the afternoon, the indices broke to new session lows about an hour before the final bell, and the ensuing selling was relentless straight into the close. This is truly becoming a crash of historic proportions, second only to the nine day of losses in October of 1987 which totaled 29.57%. As it stands, the S&P 500 has lost 24.99% over the past nine days.
People are starting to get really frightened and want out of this market no matter the price they have to accept to do so. There’s no doubt that we are due for a reflexive rally, but with confidence levels so low, no one is willing to step up to the plate and try to make that happen.
This is truly remarkable action, and trying to apply logic or reason to account for this pressure is futile. The best we can do at this point is to simply stay out of this market’s way and do our very best to make sure our capital is safe. This action will only further set us up for some huge gains down the road, but for the time-being, there’s we see no reason to be risking our capital into this mess.
People are starting to get really frightened and want out of this market no matter the price they have to accept to do so. There’s no doubt that we are due for a reflexive rally, but with confidence levels so low, no one is willing to step up to the plate and try to make that happen.
This is truly remarkable action, and trying to apply logic or reason to account for this pressure is futile. The best we can do at this point is to simply stay out of this market’s way and do our very best to make sure our capital is safe. This action will only further set us up for some huge gains down the road, but for the time-being, there’s we see no reason to be risking our capital into this mess.
One for the books - Another horrible day - Markets today
Our slow-motion crash continues and picks up steam. The S&P 500 finished down for the seventh straight day, but that doesn't begin to reflect the damage we have suffered. We are down nearly 25% over the last nine days. During the crash of 1987, we fell 29.57% in the worst nine-day period before finally bouncing 15% in two days.
By any measure, this is historic action, and there is absolutely no way to apply any logic to it. Many investors are frightened, and they just want out at any price. They have absolutely no confidence, and nothing that the government is doing is helping.
The big question is, when will this market finally stabilize? How do we restore enough trust so that there are at lest enough buyers to stem the waterfall decline? I don't think anyone has a good answer to that, so we just have to stay out of the way.
At this point, all you can do is try to protect your capital as best you can and worry about profits later. The key right now is to simply survive with as much capital as possible. There will be great opportunities down the road, but for now we are observing history.
By any measure, this is historic action, and there is absolutely no way to apply any logic to it. Many investors are frightened, and they just want out at any price. They have absolutely no confidence, and nothing that the government is doing is helping.
The big question is, when will this market finally stabilize? How do we restore enough trust so that there are at lest enough buyers to stem the waterfall decline? I don't think anyone has a good answer to that, so we just have to stay out of the way.
At this point, all you can do is try to protect your capital as best you can and worry about profits later. The key right now is to simply survive with as much capital as possible. There will be great opportunities down the road, but for now we are observing history.
Wednesday, October 8, 2008
Today's market
Hey! Another nasty sell-off in the final thirty minutes erased all of the market’s mid-afternoon gains, turning what was looking like the beginnings of a tradable reflexive rally into another day of losses on heavy volume. While this market has become extremely oversold since the bailout bill was first voted down by the House, there’s no rule against an oversold market becoming even more so.
The biggest problem we are facing right now is a lack of confidence and clarity, and that means that any action to the upside is going to be a struggle. That said, while we were looking for a strong finish to the day, the thing that we have to remember is that an essential part of a bottoming process is for market players to be continually disappointed. At some point, that will only serve to exhaust the selling pressures, but we can’t expect that to happen overnight.
Regardless, it is possible the late selling was due to the fact that the ban on shorting financials will be lifted tonight. Perhaps market players wanted to reduce their exposure ahead of a flood of new shorts, but it’s hard not to wonder how much shorting there will be if there’s no bounce to short into. Regardless, we’ll have to wait until tomorrow to see if the dip buyers are willing to give it another go.
The biggest problem we are facing right now is a lack of confidence and clarity, and that means that any action to the upside is going to be a struggle. That said, while we were looking for a strong finish to the day, the thing that we have to remember is that an essential part of a bottoming process is for market players to be continually disappointed. At some point, that will only serve to exhaust the selling pressures, but we can’t expect that to happen overnight.
Regardless, it is possible the late selling was due to the fact that the ban on shorting financials will be lifted tonight. Perhaps market players wanted to reduce their exposure ahead of a flood of new shorts, but it’s hard not to wonder how much shorting there will be if there’s no bounce to short into. Regardless, we’ll have to wait until tomorrow to see if the dip buyers are willing to give it another go.
hey! a thaw in credit
3 major areas of the credit markets are thawing today, hopefully it continues. t- yields are markedly higher, the 10-year swap rate is plunging, and fnm sold bills today at rates well below recent levels. swaps on fre and fnm also settled on monday.
all of these signals suggest a movement toward risk-taking. if swap rates follow suit, and futures contracts are beginning to show signs investors are betting on a decline in libor - the cuts were announced today AFTER libor was set today (why?) - a substantial rally in riskier assets, such as equities and corporate bonds, will likely follow.
this is short term stuff however. the swap and libor indicators must hold for any lasting improvement in the credit markets, as concerns about near-term risks - heck, near-term complete panic - are subsiding. confidence will feed on itself i suspect, just like fear does.
crucial is today's sharp rise in treasury yields, as investors leave safety and take some risk for a change. rates on 10-years are up a whopping 27 basis points, for example, and 10s have registered a nearly 3-point decline.
the 10-year swap rate has moved remarkably, partly because treasury yields are up. the spread between 10-year swap rates, which reflect the interest rate that debt obligors pay to swap out of a floating-rate obligation into a fixed-rate one (they do this when they are worried about credit spreads), is down a whopping 16 basis points to 45.5 basis points, the lowest level since 1/06, which is, of course, before the credit crisis bloomed last summer.
all of these signals suggest a movement toward risk-taking. if swap rates follow suit, and futures contracts are beginning to show signs investors are betting on a decline in libor - the cuts were announced today AFTER libor was set today (why?) - a substantial rally in riskier assets, such as equities and corporate bonds, will likely follow.
this is short term stuff however. the swap and libor indicators must hold for any lasting improvement in the credit markets, as concerns about near-term risks - heck, near-term complete panic - are subsiding. confidence will feed on itself i suspect, just like fear does.
crucial is today's sharp rise in treasury yields, as investors leave safety and take some risk for a change. rates on 10-years are up a whopping 27 basis points, for example, and 10s have registered a nearly 3-point decline.
the 10-year swap rate has moved remarkably, partly because treasury yields are up. the spread between 10-year swap rates, which reflect the interest rate that debt obligors pay to swap out of a floating-rate obligation into a fixed-rate one (they do this when they are worried about credit spreads), is down a whopping 16 basis points to 45.5 basis points, the lowest level since 1/06, which is, of course, before the credit crisis bloomed last summer.
Thoughts on mark - to - market accounting
Every "solution" comes with its own set of problems. Fair value accounting or mark-to-market was a solution to some of the problems from the scandals earlier in the decade. Unfortunately, the brainiacs that came up with it never anticipated that an entire class of securities could be percieved as being worthless virtually overnight.
Even if you went back to putting them on the BS at cost, that might alter the scramble for new capital at some institutions but it wouldn't necessarily restart a market for the paper.
Of course, it's fine to consider alternatives with care, but it takes some time. Meanwhile we are in a death spiral. One firm makes a distress sale and another has to mark down their assets. Then they have to raise capital at poor prices. Then Paulson and Bernanke decide whether to help out and which shareholders and bondholders are protected.
This process is not fair. It is not capitalism. It is not a free market. We need a time out.
FASB has a pending amendment to FAS 157 that provides an example of valuation of illiquid securities. The comment period ends tomorrow. They will vote on Friday and it will apply to third-quarter reports. It clarifies the rule.
Oh boy, Barney Frank is scheduling some hearings. There will be a change, but it will not help the financial institutions that have been wiped out in the interim.
But then again, one simply cannot have a mark to market when no market exists. There is no problem marking to market for a stock. Take IBM (IBM) for example. If you want to buy or sell 1 million shares, you can easily go through the process of price discovery by going down to the NYSE (NYX) and asking the crowd and specialist and representatives of upstairs sell-side traders where the market is. There are plenty of players to make a market. For the corporate bond market and asset backed securities markets, the market is a fiction. You have very few dealers who will make a market in these securities. If you are a seller - fahgetaboudit. There is not market for those securities. It is a loose confederation of dealers. Price discovery is weak at best. You are at the mercy of a few people who are the "market."
How logical is it to "value" illiquid, long-term assets on the "market" when none exists? To "value" these securities at fire-sale prices, determined by desperate sellers? Why is their value set by the latest sale, by the idiot of the moment?
Even if you went back to putting them on the BS at cost, that might alter the scramble for new capital at some institutions but it wouldn't necessarily restart a market for the paper.
Of course, it's fine to consider alternatives with care, but it takes some time. Meanwhile we are in a death spiral. One firm makes a distress sale and another has to mark down their assets. Then they have to raise capital at poor prices. Then Paulson and Bernanke decide whether to help out and which shareholders and bondholders are protected.
This process is not fair. It is not capitalism. It is not a free market. We need a time out.
FASB has a pending amendment to FAS 157 that provides an example of valuation of illiquid securities. The comment period ends tomorrow. They will vote on Friday and it will apply to third-quarter reports. It clarifies the rule.
Oh boy, Barney Frank is scheduling some hearings. There will be a change, but it will not help the financial institutions that have been wiped out in the interim.
But then again, one simply cannot have a mark to market when no market exists. There is no problem marking to market for a stock. Take IBM (IBM) for example. If you want to buy or sell 1 million shares, you can easily go through the process of price discovery by going down to the NYSE (NYX) and asking the crowd and specialist and representatives of upstairs sell-side traders where the market is. There are plenty of players to make a market. For the corporate bond market and asset backed securities markets, the market is a fiction. You have very few dealers who will make a market in these securities. If you are a seller - fahgetaboudit. There is not market for those securities. It is a loose confederation of dealers. Price discovery is weak at best. You are at the mercy of a few people who are the "market."
How logical is it to "value" illiquid, long-term assets on the "market" when none exists? To "value" these securities at fire-sale prices, determined by desperate sellers? Why is their value set by the latest sale, by the idiot of the moment?
Wild gyrations in the market; emotions are trumping facts at the moment
The lack of follow-through to today's coordinated interest rate cuts is not all that surprising in light of the deeply-rooted anxieties that exist amongst investors -- it will take time for frayed nerves to calm and for emotions to catch up to facts.
What are these facts? The most important include: the U.S. and U.K. injections of public money into the banking system, the U.S. plan to remove troubled assets from the books of financial institutions, the incredibly extraordinary expansion of the Fed's balance sheet, the cut in global interest rates, and the elimination of the virulent worldwide inflation problem and the related excesses in emerging markets that were threatening the secular upturn in the global economy.
And why did the central banks wait until after the LIBOR rates were fixed to make their coordinated cuts? They are out of touch with the reality of the markets.
What are these facts? The most important include: the U.S. and U.K. injections of public money into the banking system, the U.S. plan to remove troubled assets from the books of financial institutions, the incredibly extraordinary expansion of the Fed's balance sheet, the cut in global interest rates, and the elimination of the virulent worldwide inflation problem and the related excesses in emerging markets that were threatening the secular upturn in the global economy.
And why did the central banks wait until after the LIBOR rates were fixed to make their coordinated cuts? They are out of touch with the reality of the markets.
Tuesday, October 7, 2008
Market today - here's the ugly finish....
A lot of market players were hoping for the ugly close on Monday. That didn't happen, but they got their wish today. The reason they wanted the market to close at the lows is that it indicates panic conditions and often feeds on itself the next day. In other words, they are rooting for capitulation with a capital "C."
With the ugly close today on heavier volume, I don't think there is any doubt that market players are panicked and anxious to get out of this market at any price. From a contrarian standpoint, things can't get much more negative than this. One problem is that the volatility measures, most notably the VIX, are barely up. Those who are looking for the bottom would prefer to see it spike even higher than its already rather lofty perch around 53.
From the perspective of those looking for a bottom, the best thing that could happen now is a gap-down panic open in the morning to wash out the last remnants of hope. Given how extreme some of our other readings are, that would certainly be enticing for the contrarian bottom-fishers.
For those of us who aren't trying to be so daring, it is painfully obvious that we are in a downtrend of historic proportions, and we should be in no hurry to put our capital at risk at this time. It is only after the market holds a low and builds a base that we will want to start building positions. Leave the bottom-fishing stuff for the folks who like to roll the dice. There will be plenty of time to rack up gains when we eventually see a better market.
With the ugly close today on heavier volume, I don't think there is any doubt that market players are panicked and anxious to get out of this market at any price. From a contrarian standpoint, things can't get much more negative than this. One problem is that the volatility measures, most notably the VIX, are barely up. Those who are looking for the bottom would prefer to see it spike even higher than its already rather lofty perch around 53.
From the perspective of those looking for a bottom, the best thing that could happen now is a gap-down panic open in the morning to wash out the last remnants of hope. Given how extreme some of our other readings are, that would certainly be enticing for the contrarian bottom-fishers.
For those of us who aren't trying to be so daring, it is painfully obvious that we are in a downtrend of historic proportions, and we should be in no hurry to put our capital at risk at this time. It is only after the market holds a low and builds a base that we will want to start building positions. Leave the bottom-fishing stuff for the folks who like to roll the dice. There will be plenty of time to rack up gains when we eventually see a better market.
Credit market popsicle
Despite its scale, the Federal Reserve's massive injection of financial liquidity of late and its announcement of a new facility that will purchase commercial paper are not registering with investors, who appear to be clamoring for interest rate cuts instead.
This was abundantly evident in the feeble response to news yesterday that the Fed was expanding its term auction facility, the facility the Fed created last December to auction loans to banks. The TAF was increased to a massive $900 billion from $150 billion just two weeks ago. The lack of a response of course also reflects the multitude of problems that exist in the financial system and the fact that financial shocks tend to resonate for a few months.
The TAF announcement and the subsequent deaf-eared response was made more important by the fact that the Fed had simultaneously announced that it would begin paying interest on bank reserves (money set aside by banks as margin against deposits held), an action that enables the Fed to add as much money into the banking system as it desires without the added money having any influence on the fed funds rate.
The combined actions amount to a quantitative easing of monetary policy, with the Fed expanding its balance sheet in order to place new money into the banking system, and the expansion has been dramatic, yet the market response has been feeble.
It is of course up to the banking system to expand the money the Fed injects in the financial system, and this is something that only banks can do, and they are not doing it yet, but it seems a sure bet that they eventually will, given the astronomical amount of money that the Fed has placed in the system. In the meantime, investors and the general public will clamor for what they understand most: interest rate cuts.
A cut of 75 to 100 basis points would do the trick for now. A large cut is the best choice, considering the gravity of the situation and because it is the surest route to a steeper yield curve, which would improve net interest margins and help banks. Moreover, as investors in banks, we the public have a vested interest in the profitability of the banking sector, now more than ever.
Meanwhile, key gauges of the credit market are mixed today, leaning toward slight improvement but so slight that almost no confidence can be gained from them. For example, swap rates, which are a good proxy for sentiment regarding credit spreads, are lower but only slightly lower.
The two-year swap rate, for example, which has been a good gauge of concerns about short-term credit conditions, is down just 2 basis points to 137 basis points over Treasuries. Importantly, the current level is higher than where it was just before the Fed announced it would create a facility to purchase commercial paper. At that time, the swap rate fell to 128 basis points over Treasuries. The current level is down from the cycle high of 165 basis points over Treasuries, set last Thursday.
T-bill rates are higher on the day, with 3-month bills at 0.97%, up 48 basis points, a good sign, but in light of the volatility seen in bill rates recently, and the fact that bill rates remain at least a half percentage point to three-quarters of a point below normal bill rates continues to reflect stress in the financial system.
The amount of basis points paid on credit default swaps for major commercial paper issuers fell after the Fed's announcement, but they remain high. Moreover, the improvement has an isolated feel to them, since the improvement has benefited commercial paper issuers disproportionately.
Eurodollar futures, which are a good gauge of expectations on three-month Libor, are barely changed, indicating that tomorrow's Libor setting won't show much improvement after having soared recently.
Euribor, which gauges euro-based inter-bank rates, are also little changed, also a sign of still-elevated inter-bank rates.
Lastly, no U.S. companies have sold bonds today, the third day with zero issuance. Only about $7 billion of company bonds have been issued over the past three-plus weeks.
This was abundantly evident in the feeble response to news yesterday that the Fed was expanding its term auction facility, the facility the Fed created last December to auction loans to banks. The TAF was increased to a massive $900 billion from $150 billion just two weeks ago. The lack of a response of course also reflects the multitude of problems that exist in the financial system and the fact that financial shocks tend to resonate for a few months.
The TAF announcement and the subsequent deaf-eared response was made more important by the fact that the Fed had simultaneously announced that it would begin paying interest on bank reserves (money set aside by banks as margin against deposits held), an action that enables the Fed to add as much money into the banking system as it desires without the added money having any influence on the fed funds rate.
The combined actions amount to a quantitative easing of monetary policy, with the Fed expanding its balance sheet in order to place new money into the banking system, and the expansion has been dramatic, yet the market response has been feeble.
It is of course up to the banking system to expand the money the Fed injects in the financial system, and this is something that only banks can do, and they are not doing it yet, but it seems a sure bet that they eventually will, given the astronomical amount of money that the Fed has placed in the system. In the meantime, investors and the general public will clamor for what they understand most: interest rate cuts.
A cut of 75 to 100 basis points would do the trick for now. A large cut is the best choice, considering the gravity of the situation and because it is the surest route to a steeper yield curve, which would improve net interest margins and help banks. Moreover, as investors in banks, we the public have a vested interest in the profitability of the banking sector, now more than ever.
Meanwhile, key gauges of the credit market are mixed today, leaning toward slight improvement but so slight that almost no confidence can be gained from them. For example, swap rates, which are a good proxy for sentiment regarding credit spreads, are lower but only slightly lower.
The two-year swap rate, for example, which has been a good gauge of concerns about short-term credit conditions, is down just 2 basis points to 137 basis points over Treasuries. Importantly, the current level is higher than where it was just before the Fed announced it would create a facility to purchase commercial paper. At that time, the swap rate fell to 128 basis points over Treasuries. The current level is down from the cycle high of 165 basis points over Treasuries, set last Thursday.
T-bill rates are higher on the day, with 3-month bills at 0.97%, up 48 basis points, a good sign, but in light of the volatility seen in bill rates recently, and the fact that bill rates remain at least a half percentage point to three-quarters of a point below normal bill rates continues to reflect stress in the financial system.
The amount of basis points paid on credit default swaps for major commercial paper issuers fell after the Fed's announcement, but they remain high. Moreover, the improvement has an isolated feel to them, since the improvement has benefited commercial paper issuers disproportionately.
Eurodollar futures, which are a good gauge of expectations on three-month Libor, are barely changed, indicating that tomorrow's Libor setting won't show much improvement after having soared recently.
Euribor, which gauges euro-based inter-bank rates, are also little changed, also a sign of still-elevated inter-bank rates.
Lastly, no U.S. companies have sold bonds today, the third day with zero issuance. Only about $7 billion of company bonds have been issued over the past three-plus weeks.
Monday, October 6, 2008
mkt today - despite the late bounce, many say this is capitulation
some of the folks, like art cashin on cnbc, who were getting more positive on the market when we were down over 700 Dow points are a little unhappy to see a pretty big bounce in the final hour. That may be an indication that fear isn't as prevalent as thought and the capitulation not a complete one. Ideally, a better low might have come if we had closed near the lows and then gapped down tomorrow morning, but the market seldom acts in expected ways.
As I indicated, I do think that what we saw today was some real capitulation. This was highly emotional and very severe selling. Folks who have been trying to call bottoms in this market all year long finally gave up and then pretended that they've been bearish for a long time.
I suspect that market players were buying in the closing hour in hopes of some sort of worldwide rate cuts tomorrow. We experienced a big turnaround Tuesday last week, and traders like the idea of betting on another one tomorrow. We aren't out of the woods, but I'm sure feeling like we are making some excellent progress.
I would have preferred that we didn't bounce back so quickly and giddily from being down 700 points intraday, but we did manage a brief purge that will make for a healthier market. Now is the time to refine those lists of potential buys so you can act fast as things set up.
As I indicated, I do think that what we saw today was some real capitulation. This was highly emotional and very severe selling. Folks who have been trying to call bottoms in this market all year long finally gave up and then pretended that they've been bearish for a long time.
I suspect that market players were buying in the closing hour in hopes of some sort of worldwide rate cuts tomorrow. We experienced a big turnaround Tuesday last week, and traders like the idea of betting on another one tomorrow. We aren't out of the woods, but I'm sure feeling like we are making some excellent progress.
I would have preferred that we didn't bounce back so quickly and giddily from being down 700 points intraday, but we did manage a brief purge that will make for a healthier market. Now is the time to refine those lists of potential buys so you can act fast as things set up.
Ruminations
There are only a few parallels in stock market history that have resembled the stock market crash of 2008.
The proximate causes are varied:
* an absence of regulatory supervision (and lending due diligence);
* gluttonous public and private sectors' accumulation of debt;
* the proliferation of un- or under-regulated financial weapons of mass destruction (of a derivative kind) in the emerging shadow banking industry;
* a worldwide credit contagion (which debunked the decoupling theory); and
* an asymmetric "heads I win, tails I win" Wall Street and hedge fund compensation structure.
All of these factors have come home to roost, and with them, the world's equity markets have cratered and our credit markets have seized up.
The Great Hedge Fund Unwind
The economic impact of the debt and derivative buildup as well as an almost coordinated push by hedge funds into the popular and crowded commodities and energy trades (from 2005 to mid 2008) is now causing irreparable damage to the markets and to the investment returns, serving to force many of those hedge-hoggers to collectively panic in an attempt to preserve capital (and, in some cases, their businesses). The massive sell orders from the hedge fund cabal, many of whom saw the glass half-full and dismissed the concerns expressed by the splenetic minority have accelerated in recent weeks -- despite the appearance of emerging stock market values.
Even some of the most sizeable and prestigious hedge funds, which have delivered a decade or more of impressive performance, are faced with large investment losses and client redemptions that could undercut their very existence. This is leading to the "great hedge fund unwind," a vicious vortex of selling that, for now, is unresponsive to the possible relief found in rescue packages or in expansive monetary or fiscal initiatives.
It Was Different This Time
It truly was different this time: Stocks were not, as the case has been for a decade, a buy on dips. Mr. Market has left a pool of tears, and it will be a long, winding and difficult road back to the restoration of stock market health. The investment, economic, political and social implications of the market and economic turmoil will be legion and broadly felt for years.
Here are some of the changes I see.
* Credit markets will be slow to normalize. Credit markets remain in disrepair. The commercial paper market (i.e., the straw that stirs our economy) is imploding, Libor is elevated, and (bid-only) capital and credit is nearly unattainable. Even those that can get capital, such as Goldman Sachs (GS) and General Electric (GE) are paying up for it. The outgrowth of the bursting of the housing and credit bubbles will be a lengthy period of deleveraging, so a normalized credit market is, at best, probably six to 12 months away.
* Credit availability will continue to be constrained. The pendulum of credit, which moved to the extreme (read: plentiful) prior to the recent travails, has, not surprisingly, moved toward the opposite end of the scale (read: unavailable). When one combines the still capital short position of the banking industry with a deteriorating loan-loss cycle that stem from the economic downturn, the suggestion is that credit will be dispensed gingerly. Lending institutions will err on the side of "prudence" in their pursuit of re-accumulating internally generated capital, leaving a recovery in credit availability six to 12 months away as well.
* The sharp drop in global stock markets will accelerate the depth of the worldwide recession. My baseline assumption is for a protracted economic recession, which continues far longer (into late 2009/early 2010) and deeper than most expect. As well, corporate profit expectations remain far too elevated. Relying on higher stock prices to sustain economic growth was a slippery slope for both the economy and for investors. We are now falling down the slippery slope. Going forward, many economists are failing to account for the marked impact that lower stock prices will have on consumer confidence, households net worths and on the real economy.
* Investor apathy and disinterest lie ahead. As I have feared, the consequences of the credit morass (among other things) will likely be a growing distrust of Wall Street and of politicians as well as a nearly unprecedented apathy and disinterest in investing, which could extend for years. For some time to come, inflows into mutual and hedge funds will no longer provide support to equities; a period of substandard investment returns (at best) seems a likely outcome.
* Social unrest and demands for change seem likely. The Bearded Prophet of the Apocalypse's gravest predictions of social discontent and rising crime may come to pass and could permanently alter our society's very fabric. There is now little question in my mind that the Democrats will take power in January 2009.
Directly ahead of us likely lies a winter of our investment discontent in which emotion, volatility, indecision and the great hedge fund unwind might overwhelm fundamental considerations. Under the circumstances of a market that is hard to game, those who are convicted (long or short) might be victims of Mr. Market, and those who are opportunistic and facile could reap Mr. Market's rewards.
The deterioration in investor sentiment and confidence is probably one of the most significant short-term factors affecting our markets. Historically, fear and panic (and wild daily and intraday stock market moves) are usually important preconditions to a bottom, and, frankly, so are hastily crafted band-aid policy decisions. For instance, the institution of a ban on short-selling of selected companies by the SEC remains short on logic. In addition to turning the playing field around, the ban has likely contributed to a deterioration of the liquidity in our markets and, quite possibly, in the unintended consequence of lower stock prices.
How to Play It
The next several years will be characterized by inconsistent growth, which corporate managers (no longer the recipients of easy credit and pricing power) and investment managers will find difficult to navigate.
The way for most investors to cope with crisis is to stay out of the crisis. Despite unprecedented short-term trading opportunities, my consistent advice is that investors/traders should err on the side of conservatism as, for now, return of capital trumps return on capital.
The proximate causes are varied:
* an absence of regulatory supervision (and lending due diligence);
* gluttonous public and private sectors' accumulation of debt;
* the proliferation of un- or under-regulated financial weapons of mass destruction (of a derivative kind) in the emerging shadow banking industry;
* a worldwide credit contagion (which debunked the decoupling theory); and
* an asymmetric "heads I win, tails I win" Wall Street and hedge fund compensation structure.
All of these factors have come home to roost, and with them, the world's equity markets have cratered and our credit markets have seized up.
The Great Hedge Fund Unwind
The economic impact of the debt and derivative buildup as well as an almost coordinated push by hedge funds into the popular and crowded commodities and energy trades (from 2005 to mid 2008) is now causing irreparable damage to the markets and to the investment returns, serving to force many of those hedge-hoggers to collectively panic in an attempt to preserve capital (and, in some cases, their businesses). The massive sell orders from the hedge fund cabal, many of whom saw the glass half-full and dismissed the concerns expressed by the splenetic minority have accelerated in recent weeks -- despite the appearance of emerging stock market values.
Even some of the most sizeable and prestigious hedge funds, which have delivered a decade or more of impressive performance, are faced with large investment losses and client redemptions that could undercut their very existence. This is leading to the "great hedge fund unwind," a vicious vortex of selling that, for now, is unresponsive to the possible relief found in rescue packages or in expansive monetary or fiscal initiatives.
It Was Different This Time
It truly was different this time: Stocks were not, as the case has been for a decade, a buy on dips. Mr. Market has left a pool of tears, and it will be a long, winding and difficult road back to the restoration of stock market health. The investment, economic, political and social implications of the market and economic turmoil will be legion and broadly felt for years.
Here are some of the changes I see.
* Credit markets will be slow to normalize. Credit markets remain in disrepair. The commercial paper market (i.e., the straw that stirs our economy) is imploding, Libor is elevated, and (bid-only) capital and credit is nearly unattainable. Even those that can get capital, such as Goldman Sachs (GS) and General Electric (GE) are paying up for it. The outgrowth of the bursting of the housing and credit bubbles will be a lengthy period of deleveraging, so a normalized credit market is, at best, probably six to 12 months away.
* Credit availability will continue to be constrained. The pendulum of credit, which moved to the extreme (read: plentiful) prior to the recent travails, has, not surprisingly, moved toward the opposite end of the scale (read: unavailable). When one combines the still capital short position of the banking industry with a deteriorating loan-loss cycle that stem from the economic downturn, the suggestion is that credit will be dispensed gingerly. Lending institutions will err on the side of "prudence" in their pursuit of re-accumulating internally generated capital, leaving a recovery in credit availability six to 12 months away as well.
* The sharp drop in global stock markets will accelerate the depth of the worldwide recession. My baseline assumption is for a protracted economic recession, which continues far longer (into late 2009/early 2010) and deeper than most expect. As well, corporate profit expectations remain far too elevated. Relying on higher stock prices to sustain economic growth was a slippery slope for both the economy and for investors. We are now falling down the slippery slope. Going forward, many economists are failing to account for the marked impact that lower stock prices will have on consumer confidence, households net worths and on the real economy.
* Investor apathy and disinterest lie ahead. As I have feared, the consequences of the credit morass (among other things) will likely be a growing distrust of Wall Street and of politicians as well as a nearly unprecedented apathy and disinterest in investing, which could extend for years. For some time to come, inflows into mutual and hedge funds will no longer provide support to equities; a period of substandard investment returns (at best) seems a likely outcome.
* Social unrest and demands for change seem likely. The Bearded Prophet of the Apocalypse's gravest predictions of social discontent and rising crime may come to pass and could permanently alter our society's very fabric. There is now little question in my mind that the Democrats will take power in January 2009.
Directly ahead of us likely lies a winter of our investment discontent in which emotion, volatility, indecision and the great hedge fund unwind might overwhelm fundamental considerations. Under the circumstances of a market that is hard to game, those who are convicted (long or short) might be victims of Mr. Market, and those who are opportunistic and facile could reap Mr. Market's rewards.
The deterioration in investor sentiment and confidence is probably one of the most significant short-term factors affecting our markets. Historically, fear and panic (and wild daily and intraday stock market moves) are usually important preconditions to a bottom, and, frankly, so are hastily crafted band-aid policy decisions. For instance, the institution of a ban on short-selling of selected companies by the SEC remains short on logic. In addition to turning the playing field around, the ban has likely contributed to a deterioration of the liquidity in our markets and, quite possibly, in the unintended consequence of lower stock prices.
How to Play It
The next several years will be characterized by inconsistent growth, which corporate managers (no longer the recipients of easy credit and pricing power) and investment managers will find difficult to navigate.
The way for most investors to cope with crisis is to stay out of the crisis. Despite unprecedented short-term trading opportunities, my consistent advice is that investors/traders should err on the side of conservatism as, for now, return of capital trumps return on capital.
the fed is attempting to massage the 'system' with "quantitative easing"
the fed took advantage of the new powers it was granted in the financial stabilization bill by announcing that it will begin to pay interest on reserves it holds on behalf of depository institutions, an action that gives the fed the ability to engage in a quantitative easing of monetary policy and which can be as powerful as interest rate cuts, maybe - maybe - more so in the current environment.
today's announcement has the potential to be powerful, with the fed saying that it will simultaneously boost the size of its term auction facility, the facility the fed created last december, to as much as $900 billion by year's end from the $300 billion size it set last monday, and the $150 billion facility that was in place from may until last monday.
this massive increase in the size of the taf could not have been possible without the newly granted authority given to the fed to pay interest on reserves, a technical provision that gives the fed the ability to literally flood the us financial system with money without it impacting the federal funds rate. this is because banks will "sell" or deposit their excess money at the fed, rather than chase the funds rate lower when they have excess money to sell.
in the past, when the banking system has been flush with cash, banks, particularly smaller banks, have attempted to sell their excess money to other banks, often chasing the fed funds rate lower in an effort to avoid holding balances earning no interest.
in recent weeks, for example, the funds rate has fallen to close to 0% nearly every day because banks are competing with other banks to find buyers (borrowers) for their excess funds.
i said that the increase in the taf to $900 billion could not have occurred without the new authority given to the fed, but this is not entirely true. The fed could have, as has been the case, recently, borrowed money from the treasury department, which has been selling treasury bills and handing the money over to the fed. The problem with that operation is that it is essentially robbing peter to pay paul -- taking money out of one pocket and putting it in another.
second, the fed, by having to rely upon treasury for funds, loses some of its independence, which is, of course, undesirable. now, the fed can just turn on the printing press -- literally.
by going solo, the expansion of the fed's balance sheet will be new money, which if lent can multiply substantially. the rule of thumb is that each dollar of reserves can result in $10 of new lending (because the first bank can lend 90 cents; the second bank 81 cents; and so forth, after deducting the 10% reserve requirement).
whether this happens is, of course, up in the air and depends upon a restoration of confidence first. eventually, to quote adam smith, "the natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security, is so powerful a principal that it is alone, and without any assistance, capable of carrying a society to wealth and prosperity."
before people start behaving as adam smith says they inevitably do, they must get over the shock of recent events, a process that in 1998 and 1987 took about two to three months, judging by libor and the ted spread. frayed nerves will calm in this time frame and catch up to the facts, which is that the fed, with its new authority, is flooding the financial system with money -- literally printing money -- at a time when the treasury is set to remove troubled assets from the banking system. rapid money growth means higher prices, beginning first with financial assets and then real assets.
hearing the printing presses roll at the fed might seem to present an inflation problem, but that is the wrong bet to make right now. the bet to make is on a rise in the prices of financial assets, sticking with the highest-quality equities, agency securities, agency mortgage-backed securities, and even corporate bonds.
the emerging markets will also have their comeback, as the spreading of market-capitalism is a secular idea and has a ways to go. europe looks last in this one because it can't have a uniform banking solution (not as easy as in the us), and because it is lagging behind the us in the economic cycle. the ecb has also been a bit stubborn on rates, to be very nice about it.
i'd very, very much like to see the fed compliment its action with a big rate cut, as much as 100 basis points in order to steepen the yield curve, widen net interest margins and hence make banks more profitable. as investors in banks, we the public have a vested interest now more than ever. today's action reduces the need for a cut, but this is a problem that should be attacked from every front. if markets are still sliding by tomorrow, the fed should act to stabilize markets with a deep rate cut on tuesday morning.
today's announcement has the potential to be powerful, with the fed saying that it will simultaneously boost the size of its term auction facility, the facility the fed created last december, to as much as $900 billion by year's end from the $300 billion size it set last monday, and the $150 billion facility that was in place from may until last monday.
this massive increase in the size of the taf could not have been possible without the newly granted authority given to the fed to pay interest on reserves, a technical provision that gives the fed the ability to literally flood the us financial system with money without it impacting the federal funds rate. this is because banks will "sell" or deposit their excess money at the fed, rather than chase the funds rate lower when they have excess money to sell.
in the past, when the banking system has been flush with cash, banks, particularly smaller banks, have attempted to sell their excess money to other banks, often chasing the fed funds rate lower in an effort to avoid holding balances earning no interest.
in recent weeks, for example, the funds rate has fallen to close to 0% nearly every day because banks are competing with other banks to find buyers (borrowers) for their excess funds.
i said that the increase in the taf to $900 billion could not have occurred without the new authority given to the fed, but this is not entirely true. The fed could have, as has been the case, recently, borrowed money from the treasury department, which has been selling treasury bills and handing the money over to the fed. The problem with that operation is that it is essentially robbing peter to pay paul -- taking money out of one pocket and putting it in another.
second, the fed, by having to rely upon treasury for funds, loses some of its independence, which is, of course, undesirable. now, the fed can just turn on the printing press -- literally.
by going solo, the expansion of the fed's balance sheet will be new money, which if lent can multiply substantially. the rule of thumb is that each dollar of reserves can result in $10 of new lending (because the first bank can lend 90 cents; the second bank 81 cents; and so forth, after deducting the 10% reserve requirement).
whether this happens is, of course, up in the air and depends upon a restoration of confidence first. eventually, to quote adam smith, "the natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security, is so powerful a principal that it is alone, and without any assistance, capable of carrying a society to wealth and prosperity."
before people start behaving as adam smith says they inevitably do, they must get over the shock of recent events, a process that in 1998 and 1987 took about two to three months, judging by libor and the ted spread. frayed nerves will calm in this time frame and catch up to the facts, which is that the fed, with its new authority, is flooding the financial system with money -- literally printing money -- at a time when the treasury is set to remove troubled assets from the banking system. rapid money growth means higher prices, beginning first with financial assets and then real assets.
hearing the printing presses roll at the fed might seem to present an inflation problem, but that is the wrong bet to make right now. the bet to make is on a rise in the prices of financial assets, sticking with the highest-quality equities, agency securities, agency mortgage-backed securities, and even corporate bonds.
the emerging markets will also have their comeback, as the spreading of market-capitalism is a secular idea and has a ways to go. europe looks last in this one because it can't have a uniform banking solution (not as easy as in the us), and because it is lagging behind the us in the economic cycle. the ecb has also been a bit stubborn on rates, to be very nice about it.
i'd very, very much like to see the fed compliment its action with a big rate cut, as much as 100 basis points in order to steepen the yield curve, widen net interest margins and hence make banks more profitable. as investors in banks, we the public have a vested interest now more than ever. today's action reduces the need for a cut, but this is a problem that should be attacked from every front. if markets are still sliding by tomorrow, the fed should act to stabilize markets with a deep rate cut on tuesday morning.
we're off the lows, but if you ever wanted to see capitulation, this is it....
what we are seeing in the equity markets today is quite rare. this is what capitulation looks like. this is what happens when folks give up on the market and are so afraid that they want out at any price. one does not see action like this other than at truly historic times, and that what this is.
that doesn't mean you rush in and buy into the teeth of this decline, but the good news is that if you have cash, you are going to have some fantastic bargains to pick from. the bad news is that there is no way to know how long this will continue before we find a low.
that doesn't mean you rush in and buy into the teeth of this decline, but the good news is that if you have cash, you are going to have some fantastic bargains to pick from. the bad news is that there is no way to know how long this will continue before we find a low.
Friday, October 3, 2008
so far, a vote of no confidence - another bad day
buffett once said that in the short term, the market is a voting machine. The market voted today on the bailout bill, and it was a vote of no confidence. We had a classic "sell on the news" reaction once the bill was passed, and even though there were lots of folks who very much wanted a good close and lots of talk about a "surprise" Fed interest-rate cut early next week, we were unable to bounce back and closed solidly in the red after being up big. That is a very clear message that Wall Street doesn't think that this bailout bill is going to be the magic solution to our problems. The lack of optimism really isn't that surprising, but it does make you worry about how bad this mess is going to get.
The fact that the response on Wall Street to the bailout bill was so poor is going to make many investors even more worried. The big problem we face is that sentiment is so negative, and investors have so little confidence. No one wants to invest their precious cash when the atmosphere is so negative. With the poor response today to the bailout bill, no one is going to be willing to trust this market.
What you have to keep firmly in mind is that in a downtrending market, any bounces or rallies are going to invite selling. Trapped longs want to escape the pain, traders want to flip, and shorts want to put on new positions. It is only after we start seeing a series of higher highs that you can have more confidence that maybe the trend has shifted upward. Right now, it is painfully obvious that we are buried in a very extreme downtrend. .
I'm becoming awfully nostalgic for the days when we could actually hold a long position for a few days. It feels like it was many years ago, but we'll just have to stay patient and not let our hopes and desires drive us to do foolish things in a bad market.
The fact that the response on Wall Street to the bailout bill was so poor is going to make many investors even more worried. The big problem we face is that sentiment is so negative, and investors have so little confidence. No one wants to invest their precious cash when the atmosphere is so negative. With the poor response today to the bailout bill, no one is going to be willing to trust this market.
What you have to keep firmly in mind is that in a downtrending market, any bounces or rallies are going to invite selling. Trapped longs want to escape the pain, traders want to flip, and shorts want to put on new positions. It is only after we start seeing a series of higher highs that you can have more confidence that maybe the trend has shifted upward. Right now, it is painfully obvious that we are buried in a very extreme downtrend. .
I'm becoming awfully nostalgic for the days when we could actually hold a long position for a few days. It feels like it was many years ago, but we'll just have to stay patient and not let our hopes and desires drive us to do foolish things in a bad market.
the fed is clueless
do you see aig sneaking higher and higher? do you see the businesses it is now selling off and how much they are worth?
that's what happens if you have time. that's what should have happened to the too-big-to-fail leh. it would have been the same way. in fact, i would argue that leh had even more saleable assets than aig, assets that if it had a chance to sell -- notably the ones that everyone is bidding for or has bought, and if it could have just been given the same deal -- it would have been a home run. we would not be in this credit crisis if the government had given leh a similar deal. we would not have had the breaking of the buck, we would not have had the insurance collapse, we would not have had the forced shooting of stocks because the hedge funds couldn't get their cash back, we would not have had the runs on gs and ms, and we would not have had a level of turmoil that has frozen all credit markets.
the government's capriciousness is legion: fnm and fre "are well capitalized," then they are seized. bsc is too big to fail at $300 billion in debt, leh is not too big to fail at $700 billion. wm gets seized for bad loans, but dsl and bkuna are allowed to keep playing with their toxic loans. and now that wfc and c want to pay more for wb than the fdic ever thought it was worth shows you that the fdic is every bit as incompetent as the fed and capricious as the treasury. you did not need government assistance to sell wb. that's an outrage, especially given the 9/29/08 tax law change that allows wfc to take a huge tax deduction on all of wb's bad mortgages when it writes them down, drastically reducing its tax bill against ordinary income.
we still don't know the extent of the damage still coming from leh. but we do know that the federal government has made it so we are all afraid. let's hope the new president has a better team.
that's what happens if you have time. that's what should have happened to the too-big-to-fail leh. it would have been the same way. in fact, i would argue that leh had even more saleable assets than aig, assets that if it had a chance to sell -- notably the ones that everyone is bidding for or has bought, and if it could have just been given the same deal -- it would have been a home run. we would not be in this credit crisis if the government had given leh a similar deal. we would not have had the breaking of the buck, we would not have had the insurance collapse, we would not have had the forced shooting of stocks because the hedge funds couldn't get their cash back, we would not have had the runs on gs and ms, and we would not have had a level of turmoil that has frozen all credit markets.
the government's capriciousness is legion: fnm and fre "are well capitalized," then they are seized. bsc is too big to fail at $300 billion in debt, leh is not too big to fail at $700 billion. wm gets seized for bad loans, but dsl and bkuna are allowed to keep playing with their toxic loans. and now that wfc and c want to pay more for wb than the fdic ever thought it was worth shows you that the fdic is every bit as incompetent as the fed and capricious as the treasury. you did not need government assistance to sell wb. that's an outrage, especially given the 9/29/08 tax law change that allows wfc to take a huge tax deduction on all of wb's bad mortgages when it writes them down, drastically reducing its tax bill against ordinary income.
we still don't know the extent of the damage still coming from leh. but we do know that the federal government has made it so we are all afraid. let's hope the new president has a better team.
Thursday, October 2, 2008
very bad mkt today
After hovering near the lows of the session through the New York lunch hour and into the early afternoon, the market broke intraday support and steadily lost steam for the rest of the day, turning what was originally an ugly day into an absolutely dismal trading session. Breadth was right at 5:1 to the negative, volume was heavy, each sector finished in the red and the indices fell 3.9%, on average, leaving them barely above Monday’s close.
Of course, the interesting thing is that the losses came despite the fact the Senate passed their own version of the bailout bill and sent it along to the House. Given the negative response, it would seem that the market has moved past hoping that the government will provide a solution to the mess in the credit market and has instead turned its attention to the likelihood that we are heading into – or are already in – a deep global downturn.
Meanwhile, we have the employment report to contend with tomorrow. The last two reports were much worse than expected, and we suspect that another disappointing reading will not be taken kindly.
Still, as we’ve been saying, the silver lining in all of this dismal action is that this market is finally doing the necessary work of pricing in the very real consequences we are feeling as a result of the collapse of the housing market. At some point, this bear market will come to an end, and we’ll be able to start buying stocks again, but until then, we need to make sure our capital is safe and keep out of the way of this very nasty bear market.
Of course, the interesting thing is that the losses came despite the fact the Senate passed their own version of the bailout bill and sent it along to the House. Given the negative response, it would seem that the market has moved past hoping that the government will provide a solution to the mess in the credit market and has instead turned its attention to the likelihood that we are heading into – or are already in – a deep global downturn.
Meanwhile, we have the employment report to contend with tomorrow. The last two reports were much worse than expected, and we suspect that another disappointing reading will not be taken kindly.
Still, as we’ve been saying, the silver lining in all of this dismal action is that this market is finally doing the necessary work of pricing in the very real consequences we are feeling as a result of the collapse of the housing market. At some point, this bear market will come to an end, and we’ll be able to start buying stocks again, but until then, we need to make sure our capital is safe and keep out of the way of this very nasty bear market.
Wednesday, October 1, 2008
mixed
All in all, it was a rather mixed day. Some big names in the Dow, such as AA, CAT and IBM, saw some big pressure as concerns over global economic weakness continued to grow (which was exacerbated earlier in the day by the very poor ISM reading). However, names like BAC, JPM and C helped to offset those losses as it looks increasingly likely that the Senate’s version of the bailout bill will go through this evening. We guess it was naïve to think that the politicians would have so easily passed it the first time with little political cover and a lack of completely unrelated line items.
Meanwhile, the news about Warren Buffet striking a deal with GE today provided an interesting side story. Still, despite the gushing from the media about the deal and how it must mean that Mr. Buffet feels a bottom is in for the bellwether company, basically, he gave GE a loan. Maybe if he said he bought $3 in common equity, it might be a different story, but he’s getting 10% on the preferred, which, along with his warrants, he can cash in later if the price of the securities rise. The takeaway is that we’re not convinced that this news is market positive, because it makes us wonder how bad things really are in the credit markets if huge companies like GE and GS are having to pay such usurious rates to borrow money.
As we’ve been saying, this whole focus on Capitol Hill is starting to wear on a lot of folks’ nerves, and with the volatility that has resulted from a headline dependant environment, it’s no wonder market participants are finding it difficult to have much confidence – especially given the nasty surprise we got on Monday. The thing that we need to remember, however, is that as frustrating as this market may be right now, we just simply need to stay patient and wait this out. We have little confidence that that the bailout bill will improve conditions all that much, but perhaps if we can get another leg lower after it passes, we can reach a good tradable low.
Meanwhile, the news about Warren Buffet striking a deal with GE today provided an interesting side story. Still, despite the gushing from the media about the deal and how it must mean that Mr. Buffet feels a bottom is in for the bellwether company, basically, he gave GE a loan. Maybe if he said he bought $3 in common equity, it might be a different story, but he’s getting 10% on the preferred, which, along with his warrants, he can cash in later if the price of the securities rise. The takeaway is that we’re not convinced that this news is market positive, because it makes us wonder how bad things really are in the credit markets if huge companies like GE and GS are having to pay such usurious rates to borrow money.
As we’ve been saying, this whole focus on Capitol Hill is starting to wear on a lot of folks’ nerves, and with the volatility that has resulted from a headline dependant environment, it’s no wonder market participants are finding it difficult to have much confidence – especially given the nasty surprise we got on Monday. The thing that we need to remember, however, is that as frustrating as this market may be right now, we just simply need to stay patient and wait this out. We have little confidence that that the bailout bill will improve conditions all that much, but perhaps if we can get another leg lower after it passes, we can reach a good tradable low.
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