Summer Update

These last several months have been full of differing views depending on which media outlets you watch or read. What is most interesting is how most investment professionals lack the quality of being open-minded and believe their opinion to be the only truth. In fact, many follow a herd mentality and anchor on their beliefs to be the only view and will go to any length to prove their point. Recently, I have read some suggestions that our Government along with Wall Street and the Banks have a conspiracy to lie about the state of our economy for their own gain. I would assert that if this conspiracy were to really exist (I doubt that it really does) it is really in the best interest of our people. Many managers have very short memories and tend to forget where we were last October. After the failure of Lehman, AIG and Merrill Lynch were next on the chopping block. If it weren’t for the foresight of Mr. Bernake and Mr. Paulson, we might have had a systematic failure. It is always nice to criticize after that fact but without the intervention, our markets would have failed. There are still many risks that still exist such as the mortgage resets and rising levels of housing inventories. Also, the labor markets are far from being rosy which really impacts the consumer but there is a turn in many leading indicators. The credit markets are the first place to look to see if we are still repairing after the shock we incurred. Spreads continue to narrow in the corporate debt markets and with many securitized products, although some would argue that it is due to the stimulus from our Treasury and Fed. Either way, there is substantial improvement in our credit markets from where we were just a year ago. As the economy improves, so will our stock market and confidence will return to both the consumer and our corporations.

Real Estate Today

Today, many people are talking about the rebound in the Real Estate marketplace that is emerging. I have thought about this and feel that Americans are still very much overextended. Most people have much more debt in the form of mortgages, credit card and auto loans than they do in assets. In Los Angeles, many people I know earn a modest $250,000 and have a house that exceeds $1MM. Their debt level as a function of income is probably around 400-600%. By comparison, we look at the United States with a GDP of $14 Trillion and debt of $11.2 Trillion. That is only 80% of debt to income! This is a great concern because our savings rate is still very small. As the baby boomers get older and need to sell assets to keep up their lifestyle, they will sell their liquid assets and homes. This will keep a long term damper on the prices of homes in the US. We might very well see a stabilization of Real Estate but don't count on a rebound.

Turn of the Millenium

For the last 5 weeks, I have been connecting with something much larger than what our world news agencies have been reporting. Life still goes on and the world still turns. What began in mid-2007 as the beginning of a depression, now looks like it will be a prolonged recession. The economy still looks very bleak although signs of life are springing up in many nooks and crannies. It will most likely be another 6-8 months of labor pains and real estate declines but the stock market has begun what appears to be a turn towards more positivity. It has been noted by many great investors that our markets are Bi-Polar and now we seem to be approaching a more manic stage. The depressive state is subsiding and America is asserting itself as the world leader for the next century. This quarter might mark a return to growth that had fallen off a cliff. We will most likely look back at what Mr. Bernake and Geithner accomplished with much comfort that they staved off a systematic failure. It has been a long time coming with regards to changes in accounting and short selling rules. These changes are necessary for us to move from our current state to a more elastic economy. Using the past to dictate the future is a bad presumption. Learning to live in the present and to stop using models built on past perfomance will no doubt help us out of the mess created by the old guard. With Hedge Funds, Private Equity Funds and Investment Banks all under new regulations, risk taking should take on new dimensions. The next decade will be without a doubt be better than the one we just lived through. Staying positve is the first step.

Bernard Made-Off

All I can say is WOW! For someone to be able to accomplish a fraud like that, many people were well aware of this Ponzi Scheme. What I mean is that there will be a path that unfolds many peculiar aspects of the SEC to the NASDAQ. All money managers of that size are looked at or audited by the SEC and they usually do a very thorough job. Whoever was assigned that task at the SEC was without a doubt in Mr. Maddoff's pocket. My assumption is that almost everyone in the advisory part of this business was well aware of the scheme. I wrote almost two years ago about Hedge Funds and other investment businesses that were taking on too much risk or promised something that was unattainable. Now as the market corrects and deleverages, many strategies have been exposed that they don't work or were fraud. At this point, it becomes very hard to trust anyone with power of the degree of Mr. Maddoff but this should not be the case. Keep in mind there are many people like Warren Buffett to Shelby Davis who are very moral and have a very high degree of integrity. These are the people that we should be listening to and reading about. If you don't take the time to do the homework, you could end up like the investors of Maddoff Securities.

Capitulation?

This year has been historic in many ways, but the most important issue seems to be our economic state. Only since 1931 have we seen drops in asset values from Equities to Mortgage related securities all at the same time. Last Thursday seemed to mark an important day as many well known investors finally threw their hands in the air and believed this was truly the end of capitalism as we know it. We have had many jump starts over the last few months but Thursday's volume surge and large drop seemed to mark an important psychological point. Even Friday many were skeptical that we had seen a bottom as fundamentals diverged from market prices to very wide margins. By the end of the day we had recovered and saw a major bounce in the market averages. Corporate America seems to be doing better than most believe although Americans seem to be feeling very depressed. This feeling is very different than what most felt in the 1990's and what I would call bipolar. I have argued for years that Real Estate was very overvalued but I was not aware that we had leveraged ourselves to levels that were unheard of and our Regulators were supposed to be monitoring. Our Government was well aware of this as I recall Alan Greenspan speaking volumes about how great our Hedge Fund industry was and that liquidity was the most important aspect provided to our markets by many crooked billionaires. A consistent framework is very important so you can trust what you are reading, whether it be ratings from S&P or our own FDIC speaking about how our banking system is in great shape (that is from an interview on Kudlow & Company with Sheila Blair of the FDIC in February of this year). It sickens me that we have lost the trust of our people just because of lack of oversight as the world spins into a chaotic economic frenzy. We have seen similar times before but this time, it is my belief that many should be sent to prison for a very long time (I guess Enron taught us nothing). What has been a relief is the American people taking back their own country through an election to change the very problems that have plagued this Nation for more the 35 years. No longer will we be lead to believe that all is well. Businesses are stocks and should be treated as if we are owners, not passive investors with no say in how things are run. If that was the case, we should ban all Public Pension Funds from owning stocks and other risky investments. It is time to take back our future and it looked to me that the free markets did exactly that. I say this only because it is the crooked billionaires who seem to have really lost as their Hedge Funds have blown up, their tax loopholes will be closed and a better society will emerge. With time we will repair the damage done to our economy and the stock market will once again rebound to higher levels. This time, we cannot forget why we are in this position and I hope that people will begin to believe that this is the greatest country in the world with the best principals. It is this thought that makes me believe we have seen the worst in the stock market and better times ahead. That is why I believe we saw real Capitulation last week for the first time in my life.

The Oncoming Corporate Merger Mania

With the market declining over the last two months and all the cash on the sidelines (approx. $2.35 Trillion), it only make sense that corporate mergers, to some degree, will begin. In the late 80's after the 1987 crash, values dropped and money from Japan and Europe made their way into our markets with many acquisitions taking place from foreign companies. Today, we see a similar pattern taking place although the credit crises has made it more difficult for the LBO style takeover. Also, many companies seem "frozen like a deer in the headlight" as to how they should reallocate their resources, while they assess the availability of credit. Those companies who posses a liquid balance sheet may look to enhance their portfolio of business' by using their cash for investment rather than returning it to shareholders in the form of dividends and buybacks. This in turn could help our stock market as the buyouts will be much higher than the stock prices in our current market. Most likely, this will begin in the new year but it could start sooner. I speak of this only in terms of companies who take a long-term view of value and see that many great franchises are selling for pennies on the dollar. If this does take place, it might be the catalyst to move our stock market much higher. This has nothing to do with the recession taking place today, but more to do with CEO's looking to strengthen their position for the future. For a CEO to buy a business growing at 8-10% and most stocks selling at single digit multiples, it sure makes the present value very compelling. I hope the bankers are advising companies during the tumultuous time as first, a business should not be over leveraged, and second, it should posses the right liquidity to take advantage of the fear gripping Wall St. The argument of Decoupling has been answered and put to bed for now so we must look to see what the future holds for our corporations. This brings me to our current recession. Layoffs and resizing a business tends to happen within two quarters or so. Over time, this quick transition leads to V shaped recoveries in Corporate America, although our consumer is still in a very bad spot. I hope our new administration acknowledges the need further stimulus, just not in the form of direct payments to our citizens, but by using the funds to enhance our infrastructure. This would in turn reduce unemployment and bring life back to certain industries that have been crushed. It was a good idea to make sure our system is recapitalized by sending money to our financial companies (although they are still not lending) but we now need to focus our attention on the people. Using Federal Funds to help our country rebuild it's infrastructure will enhance jobs (of all kinds like construction to engineering) but is necessary for our own safety. Change is here and I think the chance to really make the US a great place can happen and will but it takes our corporations and government working together. Placing a greater safety net is not the answer by bailing out everyone. We need to let the weaker players use the bankruptcy courts to workout their situations and concentrate on how to help the larger percentage of our population.

Spreading the Wealth

Every day I drive home to hear smear campaigns that have no legitimacy. Ads that ATTACK the American People, that they should fear that their personal wealth is going to being distributed throughout society. Well folks, that has been going on for over 100 years. There are many ways our Government spreads the wealth by taxing corporations and individuals and utilizing the money to employ 35% of the workforce. What about Section 8 housing or even the Public Finance in general. We all work hard to build a nest egg so that one day we can retire, but a portion of that income is taxed and sent to the US Treasury and State Franchise Tax Boards. This money is redistributed to less fortunate people or to build new projects like bridges or schools. In the form of Public Finance, it is your property taxes that pay back the General Obligation Bonds that we all vote on to help improve our society. It seems that personal GREED has taken a very dark turn during this election and the use of FEAR seems very unethical. The average citizen in the US has no idea how our own system works, so hearing adds about your taxes going up and a redistribution of wealth taking place is ludicrous. It was proven just 10 years ago, with the fall of the Soviet Union, that having a society where intellect has no value, fails. From an economic standpoint, we can't raise taxes while in a severe recession, but in the future we need to show some responsibility for the last 25 years of spending. The reason for our recession is multi-dimensional but most importantly caused by the American People using too much credit and not saving. In fact, we have the lowest savings rate in the world. The real FEAR is that if taxes do go up, the ability of greedy Americans to service all the debt they incurred, from credit cards to 100% mortgages, will not be sustainable. Trust your Fed President as he understands these problems and how to tackle them. I only write this as we are being sold a false bill of goods during this election. Let's hope the American People can overcome these personal issues and look at our society as a whole to make our country a better place.