Decoupling

I was wrong back in June about how the market would break. I guess I was too optimistic as we saw the opposite of what I thought would happen, a 25% drop in the S&P. This has actually created many opportunities in both the credit markets and stock markets. It was thought just six months ago that by investing in BRIC countries you would protect yourself from our downturn. In fact, I argued with a PM at WAMCO about decoupling and how we buy the goods from the rest of the world. Meaning, if we go into a recession, theirs will be deeper and longer. This is now the case as everything as correlated. As fear abounds, smart investors are buying great franchises like American Express or Costco at bargain prices. I believe we are nearing the bottom of the margin calls and a turn in the market. Look for great returns over the next 5-15 years.

BofA aquistions of Merrill

The last few months have given us many surprises, one of which is the acquisition of Merrill Lynch by BofA. What I am having a hard grasping is that Countrywide had one of the riskiest mortgage books in America and for some reason BofA bought them at a very hefty premium, given the fact they were facing bankruptcy. As the management team at BofA reflect on how they can fix their financial strength, I laugh. Now they are going to buy Merrill Lynch for $50 Billion? It is my understanding that most of the Private Client groups will move and the Bankers (whom I just had dinner with) are leaving for Goldman Sachs, Morgan Stanley, Lazard and Evercore. What bankers like Ken Lewis don't understand is that their mindset is very different from an Investment Bankers and a very simple strategy of arbitrage from the Fed, borrowing cheap and lending at higher rates to individuals and companies isn't the same as Investment Banks who value Intellectual Capital with an entrepreneurial spirit. These differences make it impossible for BofA to really make something great with Merrill(not to mention Ken Lewis' ego). In the meantime, many firms will benefit from the brain suck that will happen at ML/BofA. I feel sorry that Main Street has got the short end of the stick again.

July 15th, 2008

This day will go down in history as capitulation was finally reached on the Financial Sector (not in the VIX). It is interesting that David Tice, Portfolio Manager of the Prudent Bear Funds (Short the Market) sold his company to Federated Investors the same day that Tom Brown of Second Curve Capital called a bottom, July 15th. If David really thought the market was going much lower he would have held the company closely while his shorts profited. Instead, he opted for a paycheck and less risk as a manager.

This brings me to commodities and hard assets. Most likely, commodities will come crashing back to earth, but Institutions are waiting to see which way the market breaks. We are at a critical point with $4Trillion in cash and the 10 day moving average just crossed the 30 day on the SPY so we are at a critical spot either up or down 20%. My belief it will be to the upside as all the durable goods orders and ISM numbers have been looking pretty good. Seems to have many similarities to 1974 when the Fed's actions were already helping the economy but not enough for Ford to win the election. By 1975 things were in an upswing but most didn't buy it. Sounds similar to today but staying out of the game does no good but promise you a loss at future buying power.

Naked Shorting

It sure is interesting that our SEC and our largest financial institutions are still under an "Emergency SEC Rule" against naked shorting. This is an illegal activity that has never been enforced though the average investor doesn't have access to this trade. DTC, the 19 Primary Dealers and many others have been engaged in a deceptive practice that is very profitable for them and their Hedge Fund clients. If Adam Smith were to see how we conduct ourselves on Wall Street, he would have flipped! The rich get richer and the poor get poorer.

Go back to July 9th of last year when the SEC did away with the "downtick rule" and think of the increased volatility since. Go to http://glickreport.blogs.foxbusiness.com/2008/07/29/the-sec-and-naked-shorting/ and listen to the CEO of Overstock.com at the bottom. It is understandable to see the declines of our banks given the nuclear waste they created but having two sets of rules in a supposed open market is absolute nonsense. Capitalism in America is not what most think it is. The destruction naked shorting has created is even more than the losses reported by our banks. This needs to be enforced for the whole market and rules need to be adhered to by all participants. A more detailed post is on the way but this has been on my mind for sometime.

Profits from Nowhere

I have discussed the gloom in the credit market for sometime but we can finally see the light. Wall St. is all about guessing too much, and usually they are wrong. For this purposes I introduce financial innovation. Financial Innovation got us to this spot, not to mention the governments prodding of subprime lending, but using our brains is the best way to contain a castasrophy. It seems that today markets are much faster moving and can fix themselves. That brings me to today. It looks like high quality bonds, real estate, and commodities have all run their course. Look for the dollar to increase against the EURO and the Pound and Domestic Stocks to surprise everyone. Stay high quality with good balancesheets and the returns will be great. Also, look that Private Equity stocks have to deleverage. With that, good luck over the next few months.

Government Bailout?

It has been a few months since I last posted anything about the markets. As I have said in the past, government intervention will be the main stimulus that will insulate the markets from major declines. Deleveraging is very painful and we are in the middle of repricing risk. That is why anyone you talk to that in the credit/real estate markets believe that a depression is on the horizon. History does rhyme but it never happens excatley the same. I would note that Wall St. has become to sophisticated for their own good. Structured finance might be the culprit but this was brought on by greed from Brokers, Appraissers and people in general. This will be the largest worldwide bailout in our worlds history.

Credit Crunch Revisited

Today, fear seems to be in abundance in our marketplace. The credit crunch has become increasingly risky to the continued growth of our economy as the Real Estate market continues to decline in value. The danger is that this credit readjustment has an impact on the business environment and that companies start to hold back investment and R&D spending. Also, many families are finding themselves with mortgages that reset from fixed rate to adjustable rate at much higher interest rates. With this backdrop, people have growing concerns about their ability to sustain their current lifestyle. It should be noted that adjustable mortgage resets peak in February 2008 at $52 Billion. With the Fed lowering rates, people are banking that all the adjustable rate loans can be refinanced into fixed rate loans like 2001-2005. Unfortunately, credit has been repriced in the market and spreads have widened to compensate for the risk of the borrower defaulting. This means mortgages are between 6.5%-10% depending on individual credit. The widening of interest rates and credit risk has spread to the banking segment of our economy. There are $750 Billion of M&A loans that need to be securitized along with all the real estate loans that haven't been able to be sold in the marketplace. This backlog needs to be worked off before Wall Street starts to make new loans. Credit problems seem to arise in mid-economic cycles as earnings from companies slow. Most of the problems we are seeing today in our markets are due to the lack of information available to the public from the banks and investment community. With time, this will pass and confidence will return to our financial markets. For the last 30 years, the Central Bank has done whatever it takes to get the markets moving again and this time is no different. It is my belief that the Holiday Season will be much better for retailers than expected and that our exports will help offset the Real Estate decline. This is where I differ greatly from most of Wall Street. Our economy is very resilient as exemplified by post 9-11. In fact, the S&P grew it's earnings by 105% from 2002-2007. Mid-cycle slowdowns are scary but a necessary part of a healthy economy. This slowdown is no different from others we have experiened over the last seventy years.