Jan

20

Desperately Seeking… Answers

Teresa Lo @ 10:32 PM | | Leave a Comment

Both Trader Mike and Barry Ritholtz reported a big spike in traffic to their blogs over the past few days. We’ve experienced the same thing.

What are people looking for? Answers? Well, if that is the case, then I have to invoke the Justin Mamis response: by the time you know the “why”, it’s too late. That’s why traders always shoot first and ask questions later.

The monoline insurer camel is about to be shoved through the eye of the needle. With these companies effectively belly up, the cards will finally be laid out face up on the table. There will be blood on the streets, but the potential is there for the event to mark some sort of milestone in the ongoing credit derivative saga that began last summer.

As the process of creative destruction continues to unwind the financial sector, it is becoming very obvious that there are limits to engineered returns, that is, the type of financial alchemy that has been practiced over the past ten years has proved to be exactly that: it only works when the market is going up.

Before I went into the securities industry, I spent six months in the banking business as a lending officer trainee at the Royal Bank of Canada. I learned about the Five Cs of Lending, namely:

Capacity - Can the borrower repay the loan? Is he able to meet future obligations?
Credit - Has the borrower repaid loans in the past? Has he met all past obligations?
Collateral - In the event of default, can the bank liquidate the asset and recover the principal?
Capital or Conditions - Is the borrower putting in enough of his own money? Are general business conditions good or bad?
Character - In the event of tough times, will the borrower struggle to meet obligations or will he walk away?

In 1986, a lending officer lent out depositors’ money. We had to do a good job because we faced our depositors frequently. Mrs. Smith would stop by to say hello. Mr. Johnson would tell us about his grandchildren. We didn’t lend out their money willy nilly.

The stock market always sucked when real estate was booming. To make extra money, I did mortgage banking on the side. In 1988/89 there was a huge bubble in real estate in my area. It got to the point where mortgage applications from Hong Kong buyers were shooting out of the fax machine faster than I could staple them together. By that time, we had developed a no-questions-asked lending policy: if the buyer put 40% down on the property, we would look the other way.

I remember asking my boss how this would all resolve. He sort of shrugged his shoulders and said, “I just hope you and I are not here in 20 years’ time.”

By the mid-1990s, bank stocks had experienced a huge boom. The move was attributed to deregulation and the disinflationary economic environment, something like, “rates are dropping, and banks will be able to make tons of money.”

And then came securitization. All of a sudden, the critical failsafe, the thing that kept all of us lending officers honest was removed. You see, we were no longer lending out depositors’ money. The money we lent out belonged to no one. No wonder lending criteria went out the window; there was simply no incentive to enforce the Five Cs.

To make a long story short, I think the loan default data used by modern-day quants must have been based on numbers from past cycles when the Five Cs were in effect. Without accountability, the fear of get fired for making bad loans was gone. The only thing that mattered in this cycle (or bubble) was how much money a lender could push upon the borrower. The more the better. And someone forgot to factor in a big cushion for losses stemming from this fundamental change in lending practices. OOPSIE!

So where do we go from here? As luck would have it, Ben Inker, Director of Asset Allocation at GMO has just released Our Financial House of Cards [DOWNLOAD PDF]. The white paper “looks beyond the current credit crisis in the financial industry to surface broader questions about our financial system: What does it do? How big should it be? And, beyond the current crisis, what is its sustainable level of profitability?”

The key point Mr. Inker makes is this: U.S. financial company profits as a percentage of GDP was at historical highs. Big time. And with contraction in securitization, how will the companies keep up their earnings? If their earnings go back to historical levels, a lot of people currently working in financial services will no longer be required, and the outlook for stock prices is, well, not so good.

The Five Cs are back. They can’t make AAA bonds out of junk anymore. The game is over. It’s time to move on. Perhaps to export-related industries.

P.S. 2008.01.22 Bloomberg just published an excellent article: “Structured-finance adviser Adelson says analysts failed to see that the mortgage market was becoming riskier. They relied instead on models to predict the performance of CDOs based on historical defaults, recovery rates and correlation risks for various credit ratings. They didn’t consider how piggyback loans, which are loans used to borrow a down payment, would perform when extended to people with a history of not paying their bills…”

Jan

18

Market Digest for Friday

Pete @ 4:27 PM | | Leave a Comment

It was another down day in the U.S. equity markets ahead of a long weekend. No surprise there.

U.S. President Bush called for a $140 billion stimulus package. Given this is an election year, bipartisan support appears to be forthcoming as lawmakers from both sides are keen for re-election.

The domino effect is shining a bright light in the nooks and crannies of the credit markets. Bond insurers Ambac and MBIA are under seige as rating agencies take away a few As from their former AAA ratings, raising the spectre that guarantees the companies have written on a trillion dollars of private and public-sector bonds might be twisting in the wind, necessitating a government bailout.

If there is a silver lining, it would be the rally in U.S. Treasuries that has taken 10-year yields back down to historic lows, giving some (but not all) relief to those facing mortgage resets.

The idea that economies around the world would somehow decouple from U.S. weakness is disappearing fast. Apparently, the U.S. economy is still the 800-pound gorilla:

Wipro Has Slowest Profit Growth in 3 Years on Rupee
Wipro said banks and financial firms, the biggest clients for computer-services, will cut spending this year on networks and software as the U.S. economy falters. Shares have fallen further this year after the rupee’s advance triggered the biggest drop in software exporter stocks since 2001.
Canfor closing two more mills in Fort Nelson, B.C.
Canfor has been slashing production in recent months as a downturn in the U.S. housing market dried up demand for wood and sent prices falling. Troubles have been compounded by a 15 per cent export tax and strength in the Canadian dollar that as eroded the value of exports to the United States.
Mark Mobius Says Emerging Market Stocks May Drop 20%
Mark Mobius, who oversees $45 billion at Templeton Asset Management Ltd., talks with Bloomberg’s Flavia Lima and Guillermo Parra-Bernal in Sao Paulo about the outlook for stocks in emerging markets and Federal Reserve monetary policy.

All is not well in China and Brazil. Japan has sucked for years and there might be a huge pocket of air below India’s meteoric performance.

While it is not a surprise to see U.S. funds experience continued redemptions, I think it would be a good idea to keep eyes on fund flows in emerging market funds and ETFs as investors have chased performance overseas for several years.

To end the week, Brett Arends looks on the bright side of the housing debacle. He wrote in WSJ that perhaps it is time to nibble on the homebuilders. Right or wrong, he makes an important point by saying, “It would be nice if Wall Street would sell us shares cheaply when things are booming, but markets, alas, are not so obliging. It requires patience, discipline and a lot of nerves to buy when the outlook seems terrible, but that’s the only time the shares are cheap.”

Yes folks, this is how the sentiment cycle works. After panic is discouragement. It always looks the best at the top, and near a tradeable the bottom, the bad news seems like it will never end.

18

Industrials SPDR (XLI): The Domino Effect?

Pete @ 11:19 AM | | Leave a Comment

Two of the weakest sectors of late have been the financial and consumer discretionary. What could be next?

Today, we zoom in on the industrials sector by taking a closer look at the Industrials SPDR (AMEX: XLI) and its components.

The Select SPDR currently accounts for 11.37% of the S&P 500 index representing 56 companies of the $SPX, and includes “aerospace and defense, building products, construction and engineering, electrical equipment, conglomerates, machinery, commercial services and supplies, air freight and logistics, airlines, marine, road and rail, and transportation infrastructure companies.”

Let’s examine the price action of some of the XLI components.

18

PetroChina Company (PTR): Out of Gas?

Pete @ 10:34 AM | | Leave a Comment

The talk of the investment world last year was China. “Hot money” was flowing into the country like there was no tomorrow.

While there is still plenty of talk about the future of investing in China, let’s look at one of the biggest companies at this moment in time: PetroChina Company Limited (NYSE:PTR).

People are starting to get concerned about recent price action. No doubt, the message boards are filled with “Why is this happening? This is a terrific company. China is a must!” type statements by investors that own the stock.

17

Stocks to Watch for Friday

Teresa Lo @ 5:03 PM | | Leave a Comment

The stock scan conducted after the close on Thursday found 10 winners and 207 losers.

Our scan criteria incorporates price movement, range and liquidity (500,000 shares on the day, 20-day average of 1.5 million). They are ranked and sorted by performance against the S&P 500 and the NASDAQ 100 indexes, from best to worst. Click on the column headers of the table below to sort the winners list.

Ticker		Volume	Trades	AvgTrade	Close
QID	UltraShort QQQ ProShares	48,000,656	116,957	410	48.02
SDS	UltraShort S&P 500 ProShares	38,556,559	115,631	333	64.85
DXD	UltraShort Dow 30 ProShares	8,849,901	36,747	241	59.31
MCK	McKesson Corp	1,889,258	11,955	158	66.63
FRX	Forest Labs	5,492,424	23,816	231	40.13
AGN	Allergan, Inc	3,512,388	14,486	242	67.9
ABC	AmeriSourceBergen Corp	1,587,100	9,844	400	46.64
CREE	Cree Inc	2,386,976	8,781	272	26.31
MYL	Mylan Inc	5,688,604	16,702	341	15.21
$SPX.X	S&P 500 Index				1333.28
$NDX.X	Nasdaq 100 Index				1842.1
BIIB	Biogen Idec	4,614,261	26,546	174	61.05

Become a client, and get the buy and sell signals for each of these stocks, along with ranked and sorted lists of the largest 300 ETFs by assets under management, the constituent stocks of the NASDAQ 100 and the S&P 100 indexes, futures and optionable CBOE, AMEX and PHLX indexes.

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Jan

17

Thursday Market Digest: Puke-o-Rama

Pete @ 4:09 PM | | Leave a Comment

We finally saw the fear gauge go up a bit, with $VXO closing above 30.

Over the past few weeks, we’ve watched with interest the apparent divergence between price and fear. Steven Sears wrote about it in yesterday’s The Striking Price and came up with some anecdotal explanations which I will take with a grain of salt. Perhaps the Fat Lady has yet to hit the high note.

Kudos to Abhijit Chakrabortti from Morgan Stanley, whose December 18 downside target of $SPX 1350 was hit:

American Gangster - Inflation Risks Compound Earnings Drag At the current headline level (4.3% YoY), inflation is now running 1% above the long-term average. Based on our valuation model, this has the effect of reducing the fair value P/E by 1 point. Assuming flat reported earnings growth in 2008 (and this may well prove optimistic), this points to downside for the S&P 500 at 1350 ($83 reported earnings and 16.3x P/E). Clearly, not an outcome widely anticipated.

It’s refreshing to read analysis (right or wrong) that actually comes with an explanation more than the standard “The Bull is Dead Because I Said So” seen so often in blogs.

Today featured earnings from Merrill Lynch. CEO John Thain was on CNBC [VIDEO] and discussed the outlook for the company. While he made no absolute promises, the fact is that he’s done his best to deliver a kitchen sink quarter much like Citi a few days ago. Note the focus is now on risk management and the assumptions made going forward to 2009. They are pricing for Armageddon:

Citi’s New Mantra: Risk Management
One measure of that came in a detail of the write-downs Citi announced. At the end of September, it put the value of some mortgage securities it owned at $2.7 billion. It had purchased those securities intending to repackage them as part of collateralized debt obligations and sell securities in the C.D.O.’s to investors. The collapse of the C.D.O. market made such sales impossible, and Citi still owns the securities. But it has decided they are worth about 5 percent of what they had been, and has taken a write-down of $2.6 billion. Many of the assumptions were not disclosed, but Mr. Crittenden did say that Citi was assuming that home prices would decline 6.5 percent to 7 percent in 2008, and by a similar amount in 2009.

Thain also noted that they raised more money than they lost, most of it from foreign investors and institutions. To date, this group has had a poor track record, but at least this time, they are stepping in after a long downward trend:

Higher U.S. Investment Yields Won’t Allow Continued Large U.S. Current Account Deficit
Their explanation for this is that investors in foreign countries, and especially in developed countries, have shown a lack of aptitude in shifting between U. S. bonds and equities. Curcuru, Dvorak, and Warnock find that foreigners tend to have a relatively high equity weight when U.S. equity prices have already peaked and a relatively low equity weight when U.S. equity prices are about to rise. This finding strongly suggests that foreign investors have exhibited poor timing in their portfolio decisions. “Should foreign investors improve their timing,” they write, “the U.S. external position would worsen at a faster pace. Our estimate of poor foreign timing is stable over our 12-year sample, but we have no confidence in its permanency. Increasing financial integration, cross-ownership of financial institutions, as well as improving information flows suggest that any skill advantage is unlikely to persist.” This means that the returns differential experienced by the United States would no longer be insignificant, but would in fact turn negative. U.S. investors therefore could no long count on earning more on their foreign investments than they pay on their foreign liabilities.

Retail investors won’t get much of a chance to buy paper, even if they want to. The reason? They don’t matter:

Do Retail Investors Matter Anymore?
The bottom line is that the majority of capital raising now occurs on the private market, and when it does occur on the public markets, it is mostly not through retail investors. In a recent speech, Brian G. Cartwright, general counsel of the Securities and Exchange Commission, cited figures indicating that retail investors hold only 30 percent of publicly traded securities, compared with as much as 90 percent in prior years.

Even high networth individuals in the U.S. are being dumped off. UBS is pulling out of the U.S. while Credit Suisse is expanding to China, India and Russia.

My fave Mark Tinker was on Bloomberg overnight:

Tinker of Axa Favors Energy, Asian Stocks, Shuns Retail
Mark Tinker, fund manager at Axa Framlington Ltd., talks with Bloomberg’s Sara Walker and Mark Barton in London about Federal Reserve and European Central Bank monetary policies, the outlook for stocks and his investment strategy. Fed Chairman Ben S. Bernanke may encourage lawmakers to stimulate the economy when testifies to the House Budget Committee in Washington today. Tinker manages the Axa Framlington Gemini Worldview Fund.

…while one of the more interesting articles is about car values in Venezuela where it is apparently backwards world:

Is Akerlof Wrong?
However, in Venezuela, the opposite holds – once you take a new car out of the dealership, its price goes up. For example, a used 2007 Ford Explorer XLT commands a 28% premium over a brand new one; in the case of a second-hand 2007 Ford Explorer Eddie Bauer Edition, that figure is 23%. Is Akerlof wrong? We don’t think so. There are long waiting lists to get a new car in Venezuela; in the case of a popular model, they can stretch up to a year. So, consumers are willing to pay a premium in order to avoid delay. This is clearly a case of excess demand for cars in Venezuela, which is explained by a series of distortions that engulf the Venezuelan economy. Our concern is that these distortions may take a more meaningful toll on the Venezuelan economy in the medium term, although in the short term it will dance to the tune of oil prices.

Last, but not least, there was an interesting interview after the close on CNBC:

Economic Reality Check
A look at the current economic environment, with Laura D’Andrea, of the Tyson Haas School of Business at UC Berkeley, and Lakshman Achuthan, of the Economic Cycle Research Institute

17

Gold: Bullish Producers Reduce Hedging

Teresa Lo @ 4:03 PM | | Leave a Comment

Further to last week’s gold sentiment analysis, Dow Jones reported a very interesting factoid today:

Producers Trim Gold Hedge Book By 418 Tons In 2007-GFMS
LONDON (Dow Jones)–Gold producers cut their outstanding hedge positions by a provisional 418 metric tons during 2007 to leave the outstanding gold hedge book at under 1,000 tons for the first time since 1992, metals consultancy GFMS said Thursday.

This is slightly below the 422-ton peak cut by gold producers measured in 2004, GFMS said, bringing the net decrease in outstanding hedged gold positions since the end of 2005 to some 791 tons.

For years, gold miners would hedge production - selling gold futures on the open market at a locked-in price to source liquidity. But with gold prices tripling over the last six years, many have opted to close these positions to gain exposure to the rising market. As producer dehedging is essentially a source of gold demand, it has been one factor contributing to gold’s soaring bull run.

Approximately three-quarters of the dehedging took place in the first half of 2007, said GFMS, noting that three miners have now closed their hedgebooks entirely - Newmont Mining Corp. (NEM), Lihir Gold LTD (LGG.T) and Gold Fields LTD (GFI).

In the second half, most dehedging was done by Newcrest Mining Ltd. (NCM.AU), partly offset by an increase in AngloGold Ashanti Ltd.’s (AU) options book, GFMS said.

“The move by Newcrest signaled the beginnings of a large-scale buyback of its position with a view to becoming completely unhedged going forward,” GFMS said in the second update of its Gold Survey 2007.

During 2008, GFMS expect a relative slowdown in the pace of dehedging. “The expectation for the first half of 2008 is broadly in line with the previous six months’ activity,” said Executive Chairman Phillip Klapwijk.

Klapwijk warned that GFMS’s forecast could be materially changed depending on AngloGold Ashanti, whose management have indicated a preference for a lower level of hedge cover and which the miner will clarify at some time in February.

In the nine months to September, Newcrest had cuts its hedgebook by 86 tons, with 52 tons remaining. Barrick Gold Corp. (ABX) had trimmed its position by 80 tons, leaving it with 295 tons still hedged. Newmont closed its hedgebook with 62 tons, Lihir Gold by 44 tons, Gold Fields by 25 tons. Compania de Minas Buenaventura SAA’s (BVN) still has 29 tons to go after cutting its book by 31 tons, GFMS said.

Jan

16

Stocks to Watch for Thursday

Teresa Lo @ 4:39 PM | | Leave a Comment

The stock scan conducted after the close on Wednesday found 9 winners and 180 losers.

Ticker	Description	Volume	Trades	AvgTrade	Close
TWM	ProShares Ultra Short Russel2k	12,562,763	45,484	276	83.7
QID	UltraShort QQQ ProShares	55,691,893	143,848	387	46.6
SDS	UltraShort S&P 500 ProShares	35,961,847	111,972	321	61.49
DXD	UltraShort Dow 30 ProShares	7,034,902	26,933	261	56.5
MCK	McKesson Corp	2,186,107	12,523	175	67.92
BAX	Baxter Intl	6,671,176	29,993	222	64.91
AGN	Allergan, Inc	3,263,690	16,472	198	68.69
FRX	Forest Labs	7,604,120	31,835	239	39.9
MYL	Mylan Inc	8,102,821	24,178	335	15.35
$SPX.X	S&P 500 Index				1373.19
$NDX.X	Nasdaq 100 Index				1872.29

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Jan

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