The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Wow, wild stuff from Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You with the Bill).

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Yesterday, stocks climbed back from under pressure, closing nearly flat after an earlier shellacking, ostensibly due to the FBI raids of hedge funds. The market action was caused by Traders surprise in learning that some Federal agencies plan to continue enforcing laws, despite the best efforts of bank lobbyists.

Will they be able to repeat that trick today?

Tensions are high following the shooting skirmish between them Koreas. Since this event is 5,000 miles away, and does not involve any banks, it will probably fade rapidly, as it doesn’t really exist unless it trades. “We were watching to see if steel or copper futes rallied, but the shells fired were insufficient in number to really move the needle,” said one trade, who didn’t really exist. Were it to go nuclear, Uranium futures would rally. Traders are comfortable with that outcome.

Cynical?

Perhaps, but as Lily Tomlin once noted, “No matter how cynical you get, it’s impossible to keep up.”

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click for updated futures

by James Bianco
Bianco Research
November 18, 2010

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The Wall Street Journal – Burton G. Malkiel:  ‘Buy and Hold’ Is Still a Winner

An investor who used index funds and stayed the course could have earned satisfactory returns even during the first decade of the 21st century.

“Many obituaries have been written for the investment strategy of buy and hold. Of course, investors would be better off if they could avoid being in the stock market during periods when it declines. But no one—either professional or amateur—has ever been able to time the market consistently. And when they try, the evidence shows that both individual and institutional investors buy at market tops and sell at market bottoms.

Money poured into the stock market at the peak of the Internet bubble during the first quarter of 2000. Stocks and mutual funds were liquidated in unprecedented amounts at market bottoms in 2002 and 2008. Professional investors had large cash holdings at market bottoms but tended to be fully invested during market tops. Buy and hold investors in the U.S. stock market made an average annual return of 8% during the 15 years from 1995 through 2009. But if they had missed the 30 best days in the market over that period, their return would have been negative. Market strategists called for a sharp market decline in late August 2010 as technical indicators were uniformly bearish. The market responded with its best September in decades.”

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Comment: Malkiel is famous for his 1973 classic “A Random Walk Down Wall Street.”  In it he argued for the “strong” form of the efficient market hypothesis which states no one person can outperform the market, so don’t try.  Just own the indicies for long periods of time and you’ll do as well as any active manager.

Malkiel’s ideas spawned the idea of the index fund, starting with the Vanguard S&P 500 index and eventually the ETF.

In the op-ed above Malkiel is “defending his baby,”  asserting that owning indices for long periods is the best investment one can have.  Active managerment does not work.

However, as we detailed in our November Total Return Review, data on stock and bonds goes back to 1803 (no typo!) and the last 30 years (1980 to 2010) is the only 30-year period where bonds have outperformed stocks.  The charts and table below are from that report.

Malkiel argues that a rebalancing technique will produce superior returns.  What he neglects to mention is bonds have outperformed stocks for a generation and counting.  How did that happen?

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Periodic Table of the Elements (Revised) from spellingmistakescostlives.
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hat tip boingboing

The WSJ is reporting the FBI raided the Connecticut offices of two hedge funds amid insider-trading case.

Marketwatch reports that the firms — Diamondback Capital Management and Level Global Investors — were spinoffs from SAC capital.

This which leads to the obvious question: Is the SEC chasing the big dog (Stevie Cohen), or was this merely a coincidence . . .?

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What say ye?

Visit msnbc.com for breaking news, world news, and news about the economy

Congratulations are in order for my pal Paul Kedrosky, who landed a multi-million dollar undisclosed deal to be an exclusive contributor to Bloomberg.com, BusinessWeek, TV/Radio, and Bloomberg data services.

So reports Business Insider, who notes that Bloomberg will also be selling ads on Paul’s blog as well.

What makes this deal so intriguing to me is that Paul isn’t coming from a big firm or the mass media, but from the blogging community.

For those people who have been tracking the evolving blogonomics, its run from modest advertising revenue to branding to books to a few buy outs; Now it moves to full blown media punditry.

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From my perfectly objective, completely disinterested perspective, I expect this will cause a feeding frenzy amongst the big league media for the limited talent pool with both blogging and television expertise. I have no dog in this fight, but I expect the sums that will  get tossed around will be enormous!

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UPDATE: November 22, 2010  12:33

Paul announces he has officially sold out, FAQ included . . .

The Irish bailout for both their banks and sovereign government, now officially requested with terms and size being negotiated, was also meant to stop the dreaded word ‘contagion’ that the Greek bailout was supposed to engineer. Thus, while Ireland clearly needed the money, their ‘just say no’ belief over the past few weeks to outside help was overwhelmed by the wishes of Germany, France and others that want to stop any further spreading at all costs. All eyes now turn to Portugal and very nervously to Spain. The issue with Spain however, if it is to be a future problem, is that it’s too big to bail. In terms of senior lenders to Ireland and their banks, they get saved again but most of the holders of sub debt of the banks will take very large hits. In Asia, the Shanghai index was down only slightly after Friday’s hike in their bank reserve requirements but the banks were down 1%+.

Invictus here.

I’m halfway through Greg Farrell’s Crash of the Titans: Greed, Hubris, the Fall of Merrill Lynch, and the Near-Collapse of Bank of America. Perhaps I’ll post a thorough review when I’m done with it. So far, so good, though I’ll confess it’s a bit like watching one’s own funeral — very morbid; sad memories of a deeply troubling time.

If there is one bone I will pick with Farrell’s work — and I was making this point about Stan O’Neal’s incompetence long before this book came out — it’s that he makes no mention of the fact that Merrill had a Chief North American Economist, David Rosenberg, who saw the housing bubble moving on to his radar screen, like a gathering storm, in August 2004.  Had Merrill heeded its economist’s advice, things would have turned out much differently.  The piece below is, I believe, the first in which he raised the specter of trouble on the horizon; many others followed in the same vein.  That O’Neal ignored his own chief economist and plowed ahead in the CDO market, in addition to buying subprime originator First Franklin in late 2006 at the absolute pinnacle of the market, shows three things:

1. O’Neal was an awful CEO, ignoring his own Institutional Investor top ranked economist and, according to Farrell, squashing any dissent by unceremoniously dismissing any employees who raised concerns about the direction the firm was taking (see:  Kronthal, Jeff, et. al.);

2. He was an incompetent risk manager, who never should have been running a BD.  And he relied on a similarly inept risk manager in Ahmass Fakahany;

3. The compensation structure in corporate America is a joke (admittedly not exactly breaking news).

But back to Rosie’s call. For those who have not seen it, below is his August 6 2004 Market Economist. Pages 5 – 14 are prescient, and that section on the housing market, with an assist to Ron Wexler, deserves a place in the Research Hall of Fame (along with only a handful of other calls in the entire history of research).  Parenthetically, it also puts the lie to comments made by then-CEA Chair Ben Bernanke at this presser in August 2005, in response to a question about the “housing bubble”:

There’s a lot of good news on housing. The rate of homeownership is at a record level, affordability still pretty good [Invictus:  The first half of the second sentence was true, the second half an outright fabrication]. The issue of the housing bubble is one that people have — whether there is a housing bubble is one that people have raised. Housing prices certainly have come up quite a bit. But I think it’s important to point out that house prices are being supported in very large part by very strong fundamentals.

Anyone who read Rosie’s piece (not saying Bernanke did) and came away thinking the housing market was trading on “very strong fundamentals” was, in short, delusional.  In retrospect, this report may have been the seminal work that propelled Rosie on to much greater (and deserved) recognition.

So grab a second cup of coffee and enjoy — it’s a quick read with some straightforward chartwork that even Stan O’Neal should have understood. (In my fantasy world, the one where CEOs and their co-conspirators are actually held accountable for their gross negligence and misdeeds (beyond being drummed out with $161MM parachutes), a document like this would be referred to as “Exhibit A”).

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During the housing boom, banks underwrote over $2 trillion in subprime, alt-A and option-adjustable rate mortgages underwriting could have losses as high as $700 billion, according to Amherst Securities research.

The problem is, they weren’t particularly careful in how they performed their duties.

Administrative and substantive errors, missing trust documents, misleading placement memorandums, all create a potential liability for the banks. The speed over quality underwriting procedures in securitizing and processing that $2 trillion in sketchy mortgages is well over $100 billion dollars. That’s according to an article in Barron’s this weekend, citing research from Compass Point Research & Trading, looking at potential putbacks to the banks.

The folks who bought this mostly AAA rated junk as mortgage-backed securities are not simply going to swallow the losses quietly. These investors –including Fannie Mae, Freddie Mac, Pacific Investment Management (PIMCO) and BlackRock (BLK) are seeking redress. Under certain circumstances, the terms of their purchase agreements allow them to “put back the mortgages to the banks.”

Bank of America, with its still awful Countrywide and Merrill acquisitions, has the greatest exposure, at over $35 billion. Citigroup somehow has a mere $8B in potential putback losses.

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A Potentially Big Hit

Big banks could lose $134 billion if mortgage securities are put back to them, according to Compass Point Research & Trading.

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One caveat: Chris Whalen of Institutional Risk Analytics has looked at the full run of exposure of banks as both underwriters, processors, and trustees. He thinks the exposure is much much greater . . .

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Source:
Banks Face Another Mortgage Crisis
JONATHAN R. LAING
Barron’s, NOVEMBER 20, 2010
http://online.barrons.com/article/SB50001424052970203676504575618621671054514.html