Posts filed under “Think Tank”
Good Evening: After yesterday’s launch into space, U.S. stock prices spent Tuesday settling into a comfortable, if slightly lower, orbit. The economic data out today continued to portray a slowing rate of economic decay in the U.S., enough so that some bulls are proclaiming the recession might be over and some bears are rethinking their positions. I will quickly cover today’s rather uneventful activity before reviewing the telemetry of the recent equity rally with a fictional character I introduced back in February. Perhaps this “Warren Buffett of Mars” can give us some perspective on what has and hasn’t changed since his last visit.
The swine flu scare continues to recede, but it didn’t have much impact on overseas bourses. Markets in Asia and Europe were confined to gentle ranges overnight, and our stock index futures were off a bit prior to this morning’s open. The averages opened anywhere from down a fraction to 1% lower, as some speculation about bank capital needs was offset by some conditional optimism from Chairman Bernanke. Stocks received a short-lived boost when the ISM services data came in at 43.7 versus expectations for a reading of 42 (see above). Any figure below 50 is contractionary, but this data point joins many others during the last six weeks that have been less awful than feared.
The arrival of spring has brought with it a lot of chatter about green shoots and a turn in the U.S. economy. As you can read in the above article, Charles Schwab’s Liz Ann Sonders is telling Schwab’s client base that these improving data points might mean the “Great Recession” is now over. With stock prices and bullish sentiment figures rising in tandem, I doubt she is alone in holding this view. I remain skeptical, but there are fewer disbelievers every day.
The 30% rally in equities since the March lows and all of the less bad economic data has caused even the grizzliest of bears to reconsider their views. BAC-MER economist, David Rosenberg, has been among the earliest and most accurate practitioners of the dismal science since housing started to roll over back in 2006. As should all investors, Mr. Rosenberg has decided to question his own arguments, and the piece you see above has him playing devil’s advocate (in this case, Angel’s advocate) with himself. Trying to argue the other side’s case is always a fruitful exercise, lest one become too wedded to certain opinions. Though Mr. Rosenberg ultimately decides to remain skeptical, he is now open to the possibility that the rally under way may continue. I will only say that when bulls are proclaiming to see the sun and bears are questioning their own shadows, a decent top is probably not far off.
Neither of these articles seemed to have much of an impact on the major averages, though, and the indexes bounced around below unchanged for most of the session. They all closed with losses of less than 1%, and even the volatile KBW bank index could only muster a decline of 1.6%. Treasury yields rose only slightly in the wake of yet more supply. A decent 3 year note auction saw yields rise 1 to 2 bps. The dollar was mixed but noticeably higher against the euro, and commodity prices drifted in the opposite direction. A modest decline in energy prices and crosscurrents in the other sectors left the CRB index down 0.2% today.
Back in February of this year, I used a thought experiment to show why the constantly changing plans out of Washington and the ever shifting rules that governed them would present a significant barrier to entry for fresh private capital seeking to exploit a growing number of bargains. The full piece is above, but here is an excerpt of it for any new readers:
“Imagine you run a sovereign wealth fund on Mars, say the “Retired Employees Secure Capital Umbrella Entity”, or R.E.S.C.U.E. fund, for short, and you’ve been sent to Earth by your forward-thinking leadership. Earth is your preferred investment destination because word is starting to get around the galaxy that there is a credit crisis on the Blue Planet that will yield a patient investor a healthy rate of return over the long term. Upon educating yourself about the Earth’s markets and securities, what would you buy? Since you are known as the “Warren Buffett of Mars”, you might shift your gaze to the markets in the home country of the original “Oracle”. The U.S. has the largest and deepest markets, too, which should give an extraterrestrial buyer plenty of choices from which to pick securities with a built-in margin of safety for your investors back on the Red Planet.
“After learning the ins and outs of EDGAR, and after boning up on U.S. financial history by reading the books of exceptional authors like Jim Grant, you might be tempted to have a peek at the latest analytical research from Wall Street…Before asking a kindly U.S. broker to help you identify and then buy the best values, you have one final question for him or her: ‘How is the U.S. government responding to this crisis, and how will these policies impact the values of financial stocks and mortgage-backed securities?’ Momentarily stumped, your broker then takes your question as a cue to launch into a description of the various alphabet soup lending programs put in place by the Federal Reserve, as well as the stimulus package before Congress and the different possible plans recently outlined by Treasury Secretary, Tim Geithner.
” ‘Fine’, you say, ‘but which programs have been settled upon, and what are the details describing how they’ll be implemented? Lastly, and this is important: Are these programs and/or the rules governing them subject to change?’ Upon learning that the United States has a brand new administration at the helm and that they have yet to really determine exactly how they will tackle the myriad challenges before them, our would-be investor from Mars shakes his head and takes a pass. ‘I have to wait’, he tells his distraught broker. ‘I cannot invest until the rules become clearer and the policy proposals stop changing every day. Don’t feel too bad’, he says in trying to comfort his broker. ‘I can tell by reading stories on your internet that it appears all the other nations on earth have the same problem. Call me when you have some clarity on these issues, and I’ll set about investing on behalf of our R.E.S.C.U.E. fund’ “.
Perhaps it would be instructive to update this thought experiment by pretending to listen in as the Martian Buffett (MB) discusses investment ideas with his eager broker-salesperson (BS).
BS: Hey, nice to finally catch up with you again! Things are really starting to pop here on Earth; the S&P 500 is above 900 and the economic data shows the economy is turning around. You need to get in before this market gets away from you.
MB: Really? The U.S. and global economies are growing?
BS: Well, no, but most releases are coming in better than expected and the pace of decline has definitely slowed.
MB: So, the economy is still contracting, but it’s not getting worse as fast as it used to, right?
BS: I guess so, but stocks are up. It’s a well known fact that equities are a discounting mechanism and they are now saying a rebound is on the way. The bottom is in.
MB: Is this the same discounting mechanism that rallied to new all-time highs in October of 2007 — when the credit crisis on Earth was already months old and had much pain to still dish out? And, is this the same forecasting tool that saw stock prices bottom in October of 2002 — more than a year after the 2001 recession was over?
BS: OK, forget stocks; credit spreads are coming in. You should buy some corporate bonds.
MB: Why should I buy a corporate obligation when I read stories about senior secured creditors being forced to stand behind junior creditors in the Chrysler bankruptcy? If I don’t know where I’ll stand in line when it comes time to divvy up the assets, how can I determine a fair price for the risk I’ll take holding the bonds?
BS: Chrysler was just a one-off situation.
MB: A one-off like the AIG bonus situation, which then morphed into bonus restrictions for all employees of TARP participating institutions?
BS: Hey, there’s a new sheriff in D.C. How can I predict how he and Congress will behave at any given time?
MB: Exactly — the rules are still changing
BS: Fine, but if you can’t beat ‘em, join ‘em.
MB: Come again?
BS: Join ‘em — put the R.E.S.C.U.E. fund into the PPIP, the Public Private Investment Partnership.
MB: I agree that some of the terms I’ve read about are enticing, but why are so few firms participating? And why isn’t your government making it easy for individual taxpayers to sign up and invest alongside the big boys?
BS: Dunno — more room for you, though.
MB: Thanks, but I’m guessing that extra-terrestrial investors like me might later be portrayed as carpet-bagging opportunists. What will the tax rate be if we make a lot of money investing in the PPIP?
BS: Stay in for a year or more and I don’t see why you wouldn’t receive long term capital gains treatment, which is 15% right now.
MB: Sounds like a decent opportunity, especially for U.S. citizens if they’re allowed to participate, but I don’t think it will work for the R.E.S.C.U.E. fund. Team Obama promised during the campaign to raise capital gains tax rates. So even if the rules are the same for Martians as they are for Oracles based in Omaha, Nebraska, I still think there is a near certain chance that the rules change again in the future. Given the mood in your Capitol, I see capital gains tax rates rising as soon as next year.
BS: Oh, come on, now! What is it you want, anyway?
MB: During our last conversation, I told you the R.E.S.C.U.E. fund would pass on investing until there is more clarity. Unfortunately, the intervening months have indeed brought some clarity; it’s clear your government wants to play an active role in the economy all the way down to the corporate ownership level. It’s also clear that bondholder rights are weakening, especially in any bankruptcy where Uncle Sam feels the need to weigh in. This form of clarity requires higher risk premiums be built into securities throughout the capital structure, and those prices are higher now than when I first looked at them in February. Sorry, but I still have to pass. Unlike some managers here on Earth that I’ve been reading about, I take my fiduciary role quite seriously.
BS: But…there has to be some security somewhere that interests you.
MB: Perhaps, but only if you can structure it for me. Think your firm can handle it?
BS: Of Course! We’re the best on the Street at customizing securities for investors!
MB: So I’ve heard; some of them will no doubt wash up in the PPIP. But I’m tired and it’s time to call it a night. Why don’t we pick up our conversation tomorrow?
BS: No problem; I’ll call you tomorrow and we’ll be ready to create anything you want.
MB: I doubt it, but let’s talk tomorrow. Good night…
– Jack McHugh
May 5. 2009
Thursday is stress test day. Not on a treadmill, but it may just as well be so.
We are now going to add some Geithner-Bernanke-Summers-esque formula of bank strength or weakness assessment to an already long list that includes Tier 1, Tier 2, TCE, and CAMELS and BOPEC. Tier 1 and 2 capital measures are released by banks in their public disclosures. TCE (tangible common equity) can be calculated from public documents.
Two other ratings are kept confidential. They are critical to regulators; and, in an affront to democracy and transparency, we are not permitted to learn them. Banks are not permitted to reveal them and the penalties for doing so may be harsh. Welcome to modern banking in America.
The BOPEC acronym stands for the five key areas of supervisory concern: the condition of the Bank Holding Company’s (BHC) bank subsidiaries, other nonbank subsidiaries, Parent company, Earnings, and Capital adequacy. BOPEC ratings are assigned according to an absolute scale, from the highest rating of one (indicating strong performance) to the lowest rating of five (very poor performance).
CAMELS ratings are assigned to banks within a bank holding company. Since the condition of a BHC is closely related to the condition of its subsidiary banks, the off-site BHC surveillance process includes monitoring recently assigned CAMELS ratings. The CAMELS system is used by the three federal banking supervisors (the Federal Reserve, the FDIC, and the OCC) and other financial supervisory agencies to provide a convenient summary of bank conditions at the time of an exam. The acronym CAMELS refers to the six components of a bank’s condition that are assessed: Capital adequacy, Asset quality, Management, Earnings, Liquidity, and a bank’s Sensitivity to market risk.
For a critical discussion of the coming stress test environment see Dick Bove’s guest commentary on Cumberland’s website: http://www.cumber.com/special/bove.pdf . We thank Dick for giving our readers access to his essay. We agree with him.
Category: Think Tank
Ben Bernanke and the FOMC have the fed funds rate currently at zero and with a straight face in the Q&A today, he says he’s committed to price stability. He has one unspoken goal in his policies and that is to inflate our way out of this current economic malaise. The Fed and Treasury are…Read More
Market internals continued to be stellar with the NYSE registering an up to down volume ratio of 19.2 to 1, while advancers beat decliners by a ratio of 5.7 to 1. On the NASDAQ up volume bested down volume by a rate of 5.19 to 1, while advancers bested decliners by a 3.47 to 1…Read More
Another day closer to the release of the bank ‘stress test’ brings us another leak in the morning papers and today reveals that 10 of the 19 banks MAY need to raise capital and/or convert preferred to common in order to improve the TCE ratio. The relevance of the outcome is only important for those…Read More
Good Evening: Last Thursday evening, U.S. stock market bulls were fretting an aborted attempt to launch the S&P 500 into the green for the year. I speculated then that some undaunted bulls might trot out another rocket and try again on Friday. So they did, achieving a decent launch profile at Friday’s closing bell. The…Read More
The Fed’s quarterly senior loan officer survey revealed that 39.7% of banks tightened credit standards for businesses, 5.7% considerably and 34% somewhat with the balance unchanged. This is down from a total of 64.1% of banks that tightened standards in the previous quarter and 83.6% in the one before. No bank eased standards and none…Read More
> Here is the S&P 500 Index on a weekly basis since May 1992. The slope of the yearly (52 week) and 70 week (favored by some researchers but more appropriate for commodities, which are more volatile than stocks) clearly defines bull and bear markets. Stocks can rally further and still not be in a…Read More
Category: Think Tank
March Pending Home Sales, a measure of contract signings of existing home sales, rose 3.2% m/o/m vs expectations of flat. The gains were in the high foreclosure areas of the South and West as the Northeast and Midwest saw declines. The average 30 yr mortgage rate according to the MBA was 5.10% in Feb and…Read More
China today is again proving that it’s the most important country in the world right now in terms of being the engine of global growth that can pull the other train cars with it after the CLSA mfr’g PMI index rose above 50 for the 1st time since July (due to the still ongoing massive…Read More