Simon Lorne, chief legal officer for hedge fund Millennium Management and former general counsel at the SEC, discusses how strong the SEC’s case is against Goldman Sachs.
Case-Shiller:
Annual rates of decline of the 10-City and 20-City Composites improved in February compared to January 2010. For the first time since December 2006, the annual rates of change for the two Composites are positive.
The 10-City Composite is up 1.4% from where it was in February 2009, and the 20-City Composite is up 0.6% versus the same time last year. However, 11 of 20 cities saw year-over-year declines.
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click for larger chart
Annual returns of the 10-City and 20-City Composite Home Price Indices gained 1.4% and 0.6% respectively in February 2010 compared to the same month last year. Eighteen of 20 metro areas and both Composites showed an improvement in their annual rates (Dallas and Portland being the exceptions).
clock for ginormous chart
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UPDATE: One more chart, via Calculated Risk:
More charts after the jump
Comment
The article above cites some earnings numbers that need to be put into context. First, as the next chart shows, the one-year forward estimate has grossly overestimated actual earnings in recent years. In fact, last year saw some of the biggest misses in the history of earnings guesses.
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Second, in a recent Market Talk we pointed out that the yield curve may be the single most important factor in determining earnings for Q4, largely because of its importance in determining profits in the financial sector.
Finally, as the last chart shows, companies always beat expectations. Even when earnings were collapsing in biblical proportions in Q4 2008, 58% of companies still beat expectations. The last time less than 50% beat expectation was 1998!
As we note on the chart, prior to SEC regulation “FD” (aka, Fair Disclosure), roughly 50% of companies beat expectations, as would be the case if analysts were trying to get it right. Now that companies have to disclose to all at the same time, we believe their investor relations departments are masters at “guiding” analysts just below actual earnings. This way the companies “beat” expectations and get the positive press and accolades that come with it. Further, it seems that everyone is happy with this apparent gaming of the system.
This is why we believe the percentage of companies that beat expectations is a meaningless statistic. The game is designed for this to happen, even when earnings are collapsing.
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Air traffic has returned to normal levels in northern Europe. This visualization shows what that looks like:
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Airspace Rebooted from ItoWorld on Vimeo.
via Flowing Data
The price of insurance against a Greek default within 5 years is now approaching the levels of Venezuela and Argentina and their 2 yr bond yield, whose holders will suffer in any debt restructuring, is rising another 155 bps to 14.7%. Greek 1 yr CDS is already priced above those two countries and now Greek 5 yr CDS is at 730 bps vs Venezuela at 820 and Argentina at 830. The pain also continues to spread to the other highly leveraged European countries and European stocks are down as a result. Spain and Portugal CDS are at record highs. The fear of a debt haircut has European banks under pressure. The other spot of focus, China, remains under pressure in response to the property tightening steps being taken. The Shanghai index fell 2% and is now at the lowest level since Oct ’09. It was China that brought the economy off its knees in early ’09 and their market weakness should not be ignored. Copper is at a one month low in response.
Over the weekend, I received several very informative emails from a former SEC attorney. “C” just gave me permission to reproduce it here.
It is a little “inside baseball” as to the process of how the SEC decides to bring an action versus any company, more or less something as large and important as GS. Some of the language has been changed to maintain C’s anonymity.
Enjoy.
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C’s initial email.
Hi Barry,
I am an a avid reader of your blog although I don’t often comment. I spent some time at the SEC, and thought I could add a couple of points to your effort against the overwhelming stupidity in the MSM about this Goldman action by the agency.
After sitting in on every closed meeting of the Commission during my time there, it sure does seem that politics can (and often does) derail an investigation.
But, it doesn’t work the other way.
As you know, it’s up to the lower-level enforcement attorneys to decide when to bring the case to the Commissioners. It is possible that these attorneys saw that it was politically convenient to bring their action now — actually, 8 months ago when they got approval for the Wells notice — but their motivation was not political: It helps their careers (and mental well being) to get their cases approved.
Attorneys are unwilling to put a case up for a commission vote if they didn’t think it was strong enough. These attorneys are judged on the success of the actions they bring and wouldn’t jeopardize that to appease the politicians that are currently serving on the Commission. The senior people who make promotion decisions will see Commissioners and Presidents come and go but senior staff outlasts them all.
The Commissioners power is wielded not to instigate investigations but to kill them by not approving them — this was rampant during the Bush administration.
The other thing I was surprised about when I started at the SEC was how concerned the staff and (usually) the Commission is with precedent on punishment. I guarantee some low level staffer already has a memo prepared: Settlements, administrative decisions and court decisions from similar 10b-5 cases, including how they relate to the seriousness of what Goldman has done, the amount of money involved, etc. (I wrote a number of these when I first started at there).
One of the biggest goals of the enforcement division is to have consistent punishments so that the market players can act appropriately. It helps control behavior in the market and the side benefit is it makes the SEC’s job easier — defendants know when to settle and what punishment to accept. Unless they’re stupid, Goldman will eventually settle, and it will be consistent with other cases with similar circumstances. Goldman may have already made things more difficult for themselves because they’ve decided to play this up in the media. (That gets factored into any settlement as well).
If you’re wondering why I emailed this to you instead of just posting it 1) I didn’t think it was a great idea to publicize talking about closed commission meetings and 2) I don’t like to post anonymously. Anything I mentioned here is not confidential but I didn’t feel comfortable posting it with my name attached.
Keep up the great work on the blog.
Thanks,
C
And of course, I adore the PS:
PS: I should also add that I first found your blog while at the SEC. It was on an SEC list of recommended websites to read.
Awesome.
Lastly, here is C’s email granting permission to republish:
Barry:
Feel free to use what I sent. I’d prefer if you didn’t identify me, but as I said nothing in there is confidential.
To add a little nuance to what I wrote regarding the Commissioners killing investigations: Not surprisingly the reasons given are never overtly political but veteran enforcement attorneys were well aware of certain Commissioners “tendencies” on certain types of investigations and certain types of defendants (if you know what I mean). With these types of investigations it was always easy enough for a Commissioner to find something in the evidence or assumptions that “concerned” them enough to not approve going forward with a Wells notice or the filing of a case.
“C”
Good Evening: After trading in a narrow, fitful range for most of the session, U.S. stocks edged lower on Monday. The earnings news from corporate America continued to be supportive, while a further slide in Greek securities and pending hearings about financial reform added some offsetting weight as the day wore on. After the amazing run equities have enjoyed during the past 13 months, risk appetites among market participants show few signs of waning. Prudence might normally dictate that investors edge toward the exits after an 83% rally in the S&P 500, but good alternatives are hard to find with Fed-engineered short rates still essentially at zero. That prudence was long ago abandoned by our Federal Reserve is one of the central themes of the latest Quarterly Letter by GMO’s Jeremy Grantham.
The major averages in both Asia and Europe were on the plus side overnight, with Japan’s 2%+ gain the standout among them. U.S. stock index futures were also in the green ahead of today’s trading, due to well received earnings news from Caterpillar and Whirlpool. Most companies have been exceeding analysts’ estimates during the Q1 earnings season, and these same seers are busily extrapolating the good news for quarters yet to come. What held equity prices back today, however, were items both political and geopolitical. Germany continues to demand something resembling fiscal discipline before it will give its backing to any bailout of Greece (see below). And while political tensions in Washington are nowhere near as high as they are in Athens, owners of bank stocks fretted today as the Senate geared up for tomorrow’s grilling of executives from Goldman Sachs. The release of some rather basely worded emails by senior Goldman employees about pending GS transactions was the talk of trading desks everywhere. Understandably, the bank stocks fell prey to some profit taking on the news.
After opening in plus territory, the major averages spent the rest of the day wandering above and below the unchanged mark. Some late selling left both the S&P and Russell 2000 down 0.43%, while the Dow and Dow Transports managed to hold on to fractional gains. Treasurys were also essentially unchanged, though the long end fared a little better than the short end of the curve. The dollar rose against the euro but could still only manage a modest overall gain, while commodities edged lower. A $1 drop in crude oil paced the CRB index to a decline of approximately 0.25%.
As the calendar turns to May and spring works its annual magic on foliage in the Northern Hemisphere, investor risk appetites are also in full bloom. Many major stock market averages (Russell 2000, Midcap 400, and Dow Transports) are now more than 100% off their 2009 lows; junk bonds are up almost as much (see below); and commodities like crude oil and copper sport similarly outsized gains over the same period. Bullish sentiment is on a high simmer, at least according to polls by Investors Intelligence. And a falling VIX has been the mirror image of rising sentiment. What all these positive readings have in common, according to GMO’s Jeremy Grantham, is a U.S. central bank with its foot on an accelerator pedal that might just as well have been made by Toyota.
In his latest Quarterly Letter, “Playing With Fire”, Mr. Grantham fingers the Fed as the prime suspect in the price levitation seen in our capital markets since last March. Mr. Grantham, who was one of Alan Greenspan’s earliest critics, pulls no punches when describing the Maestro’s successor, Ben S. Bernanke. He portrays Mr. Bernanke and the rest of the FOMC as purveyors of recklessly easy monetary policies that could cause yet another equity bubble to inflate by next year. Prudent savers are still receiving next to nothing on their cash, which is a doubly cruel penalty on thrift in his eyes. First, savers are foregoing hundreds of billions in lost interest, a total he sees dwarfing what he almost laughingly calls the “profit” earned on the TARP and other rescue programs. How long should the prudent have to keep bailing out the reckless?
Second, and just as pernicious to Mr. Grantham, is that Mr. Bernanke’s zero interest rate policy “begs us to speculate, and we are obedient”. A parched investment landscape, at least in terms of safe and reasonable yields, has left investors thirsty enough to imbibe more perilous alternatives like junk bonds and tech stocks. As the markets rise and more investors feel forced to participate (or be left behind), Mr. Grantham worries that the old highs might be taken out as soon as next year. He thinks the Bernanke Fed will not only tolerate the soon to be towering valuations, they will accommodate — even encourage — a kiting of various asset classes.
Will prices reach the bubble territory Mr. Grantham fears is all too possible? I doubt it, but anything can happen if the Fed keeps the hammer down into 2011. The FOMC could soon reach a point where it is force-feeding risk into an economic and financial system that is unlikely to sustain it without another accident. Mr. Grantham has other pearls of investment wisdom to offer in his letter, but his complaints about the Fed are the most notable. Perhaps I’m just old fashioned, but I think capitalism works far better when the choices made by participants are voluntary. Very few of us make sound investment decisions if they are of the “have to” variety.
– Jack McHugh
Most U.S. Stocks Drop as Financial Legislation Offsets Earnings
Apollo Leads Junk Bond Sales in Record Rally: Credit Markets
Greek Bonds Tumble on Concern Germany May Hold Back on Bailout
“Playing With Fire”, Jeremy Grantham’s Quarterly Letter
Quote of the Day:
“In our experience, Buy Side investors today don’t do business with GS or the other major Sell Side firms because they trust them. They do business with firms like GS because they believe that the firm has better access to information than do the other dealers in the marketplace.
The sad fact is that the trust that once made firms like GS and the old JP Morgan & Co special has long since been lost, leaving the marketplace that remains a hideous, barbaric place that is bereft of honor — and a source of infinite risk to the participants.”
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Discuss . . .
My pal Jon Markman revises the investment classic Reminiscences of a Stock Operator Annotated Edition:
"I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale." -Thomas Jefferson (letter to John Taylor in 1816)
After 3 quarters in a row that averaged just 1.2%, Q4 GDP grew 2.8%, a touch below expectations of 3.0% BUT Nominal GDP grew well below forecasts. Because the price deflator was up just .4% vs the estimate of 1.9%, Nominal GDP was up 3.2% vs the estimate of 4.9%. Personal Consumption rose 2.0% vs the forecast of 2.4%. Fixed Investment rose 3.3% helped by a 5.2% increase in equipment and software spending and residential construction rose by 10.9%. Trade was a slight drag on GDP growth and government spending was as well led by a 12.5% decline on national...
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