Tuesday, March 31, 2009

Are Corporate Bonds a Screaming Buy?

I've had two "screaming buys" since I've started EconomPic. The first was on October 9th, with my post Muni Close-end Funds SCREAMING Buy? Since that date, the muni close-end fund I was tracking is up more than 40%.

The second screaming buy was on November 11th, titled Are Convertible Bonds a "Screaming Buy"? Since that date, convertible bonds are up 6%, significantly more than equities.

What this shows is two-fold:

  • My screaming buys are batting 1000
  • I'm lucky
Please keep in mind that there are no guarantees in this world (especially when that information is from a blog) BUT, with the price of corporate bonds implying default rates on investment grade rated bonds anywhere between 6-10% and those on high-yield corporate bonds between 30-40% (the wide range allows for a plug figure for recovery given default - the more money you get back given default, the less it will impact the pricing of a security), compared with the historical defaults below... corporate bonds are my next SCREAMING BUY.

EconomPic is far from alone on this call. In fact, Aleph Blog goes one step further:
At a time like this, I reissue my call to sell stocks and buy corporate bonds, even junk bonds. When the advantage of corporate bond yields are so large over the earnings yields of common stocks, there is no contest. When the yield advantage is more than 4%, bonds win. It is more like 6% now, so enjoy the relatively stable returns from corporate bonds.
A real threat I see in the short-run is that cheap investments CAN (and often DO) get cheaper. In addition, a lot of corporations are issuing new debt into an illiquid market, increasing the likelihood of short-term volatility. In the longer run a legitimate threat is the duration risk associated with corporate bonds (i.e. the likelihood of interest rates rising).

Overall, I am invested at a ratio of ~70% investment grade / ~30% high yield via an assortment of close-end funds trading at a discount. For the record I do not shy away from risk, so my recommendation would be to tone down the high yield exposure if you are more risk averse.

I hope I'm still be batting 1000 when I offer my next "screaming buy".

Source: Moodys

Chicago PMI to the Downside

ForexTV reports:

Business activity in the Chicago area suffered more than economists expected in March, with the Chicago Purchasing Managers Index down to 31.4, against expectations of a 34.3 reading.The index came in at 34.2 in February.

The largest drop was in order backlogs, down to 21.3 from 29.3. New orders climbed marginally to 30.9 from 30.6. Falling inflation continues, with the prices paid component dropping to 34.1 from 37.8. Production was down to 32.7 from 34.7.

Inventories climbed to 34.9 from 33.0, and the employment component improved to 28.1 from 25.2.

Source: Econstats

Case Shiller Price Index Level at -5% YoY in January

Full details of the Case Shiller price index can be found here. Here's the jist:

I took reported YoY CPI and backed out the YoY change in U.S. Housing CPI at the 23.942% weighting. I then took this result and added the YoY change in the Case-Shiller Home Price Index at that same weight.
With data from the new Case Shiller release, we see a leveling off of deflation (as measured including home prices) as the second derivative of the year over year change in home prices has begun to level out.

Source: S&P

China Isn't the Issue... Part II

Last week I detailed in China Isn't the Issue with regards to the United State's need for massive demand to take down all the new Treasury issuance:

We should be less concerned with China (they NEED to buy) and more concerned
that major investors continue to pile out.
Brad Setser with more evidence in money market space:

US money market funds holdings of Treasuries and Agencies rose by close to 350% in 2008, as their combined Treasury / Agency portfolio rose from from $392b to $1334b. That pace of growth of growth won’t be sustained. The large rise came from a low base.

But money market funds did hold more Treasuries and Agencies ($1357b) at the end of 2008 than China ($1233b) did.

Again, I am not arguing that China IS a major player (they are), but the marginal buyer over the past year that drove interest rates down to low (at times negative) levels were private investors. The key question to ask is what happens when they start to move back out along the risk spectrum? As Brad details, while the selling by foreign holders of Treasuries would have an impact:

So too could an end to the surge in Treasury demand from US investors …

Source: Federal Reserve

Monday, March 30, 2009

TARP Running Dry

First the WSJ details:

The U.S. Treasury Department said it expects to have about $134.5 billion left in its financial-rescue fund, giving the Obama administration a cushion as it implements a range of expensive programs aimed at unlocking the credit market and boosting ailing industries.
If you think $134.5 billion left sounds like the well is running dry, then take a look at what Keith Hennessey (former director of the National Economic Council) believes that figure is closer to:
When President Obama took office, $387 B of the $700 B of available TARP funds had already been publicly committed. Here’s the breakdown.

This meant that the Obama team had $313 B left to commit before reaching the $700 B limit.
Since January 20th, Keith estimates that the Obama administration has committed as much as an additional $280.

If this is correct, we have less than $35 billion remaining in the TARP. Back to Keith:

There’s some uncertainty around the $80 B figure to further expand TALF, because the Administration has been ambiguous about how big the new TALF would be in total. I’ll bet they’re scrambling this week trying to figure out what they actually meant.

They can create some wiggle room for themselves if they say that the $15 B for small businesses and the $5 B for auto parts suppliers are a subset of the $100 B (in total) for “consumer credit.” This uncertainty and ambiguity should not obscure the critical point: they’re almost out of money.

Wealth Concentration in the U.S.

Marketing Charts (via Businessweek) details:

Five towns in California and four on New York’s Long Island have made it into the top 10 wealthiest towns in America, according to a recently released list from BusinessWeek.

The annual rankings of the top 25, which were compiled by The Gadberry Group, are based upon the average 2008 net income and 2008 net worth of the towns’ residents.

Exclusive Brookville, N.Y. tops the list as America’s wealthiest town, with an average annual income of $328K (seventh highest) and an average net worth of $1.67 million, the highest on the list. The non-commerical municipality, which is located on Long Island’s north shore 25 miles from midtown Manhattan, is the home to celebrity Jennifer Lopez and is known for its extreme privacy, country-like setting and good schools.

What struck me was how "little" wealth (I understand it IS A LOT, but I am speaking in relative terms) these families had considering the average income they were making. Bear with me for a minute... the average family in the U.S. makes ~$50,000 and has net wealth in the multiple of 2-4x that (i.e. $100-$200,000) because most of that money NEEDS to be spent to survive. However... if you were making $300,000 a year at the beginning on 2008, chances are you have been doing quite well for yourself for a number of years, thus I would have expected net wealth to have been many multiples higher as you don't "need" to spend all that money to survive. My thought was everyone had to "keep up with the neighbors" (i.e. the Mercedes and private school for the kids).

It will be interesting to see how the wealth in these towns has held up. Businessweek details:
Income and net worth data were collected before the economy collapsed at the end of 2008, and that subsequent news and events indicate that the residents of these affluent communities are most likely now feeling the pain of the recession.

Box Office Bonanza Continues

We've mentioned the strength the box office has shown in recent months a few times. Box Office Guru details the continued strength:

Following a very pricey marketing campaign, DreamWorks Animation's 3D animated film Monsters vs. Aliens delivered on its promises and attracted the largest opening weekend of any film this year leading the overall marketplace to its best performance in over a month. Big muscles were also flexed by Lionsgate which enjoyed one of its biggest horror openings ever with The Haunting in Connecticut which landed in second place with a powerful launch of its own. The top ten films sold $135M worth of ticket stubs making it the best non-holiday tally of 2009.

Source: Boxoffice Mojo

Friday, March 27, 2009

EconomPics of the Week (3/27/09)

Banks Buying Assets to Sell Through Gov't Programs… Does It Matter?
Public Private Partnership: Cheap Financing = Lower Discount Rate = Higher Asset Prices

Economic Data
Michigan Consumer Confidence Stabilizing
Personal Consumption Holding Steady
Q4 GDP Final vs. Advanced
Crude Oil Inventories at 16 Year High
State Per Capita Incomes
Durable Goods: Good News Alert? Not Necessarily
Japanese Export Dive or Just a Reversion to Mean Growth
Existing Home Sales Breakdown
Maybe This Inflation Thing Wasn't Actually Quashed...

Asset Returns
A Chart Worth 1000 Words? Corporate Bond Spreads
Pre-Market Equity Boom
Equity Market Boom... Ready for Bust
Last Weeks Treasury Rally that Wasn't Abroad
Corporations as Investors: Buy High... Sell Low

Corporate Profits Dropped Most Since 1953
"Oh Why Must I Feel this Way... Must be the Money"...

Michigan Consumer Confidence Stabilizing

Yahoo Finance reports:

U.S. consumers' mood brightened a bit in March, nudged up by increased confidence in government economic policy, but overall sentiment remained near an all-time low, a survey showed on Friday. The Reuters/University of Michigan Surveys of Consumers said its final index of sentiment rose to 57.3 in March from 56.3 in February. This was a touch above economists' median expectation of a 56.6 reading, according to a Reuters poll. The survey hit a record low of 51.7 in May, 1980.

The index of consumer expectations rose to 53.5 from 50.5. Survey director Richard Curtin said confidence in the Obama administration's economic policies improved consumers' mood, with 22 percent of those surveyed rating policy favorably in March, compared with 7 percent in January.

Looking at the year over year change in the Michigan Consumer Confidence Index, we see the second derivative (i.e. the change of the change) turning positive. With expectations improving and spending stabilizing, my own expectations are improving from their lows.

Personal Consumption Holding Steady

WSJ reports:

Americans spent at a slower rate in February as their income fell and they saved money at a historically elevated level to cushion against the recession. Personal consumption rose 0.2% compared to the month before, the Commerce Department said Friday. Spending had increased a revised 1.0% in January; originally, spending was seen up 0.6%.

Personal income in February fell at a seasonally adjusted rate of 0.2% compared to the month before. Income increased a revised 0.2% in January; originally, income for that month was seen 0.4% higher.

Personal saving as a percentage of disposable personal income was 4.2% in February, the Commerce Department said. It was 4.4% in January. The last time the saving rate exceeded 4.0% two straight months was August and September 1998, up 4.3% and 4.2%, respectively.

How is it possible to spend more, save more, all the while earning less? Taxes paid down and social benefits up...

Source: BEA

Corporate Profits Dropped Most Since 1953

WSJ reports:

U.S. corporate profits fell by $250 billion in the closing months of 2008, a staggering decline that many businesses are still struggling to offset.

Profits at corporations in the fourth quarter fell 16.5% from the previous quarter, the Commerce Department said Thursday. In the financial sector, profits fell by $178 billion -- and that figure doesn't reflect the industry's massive write-downs as the value of assets soured. The drop in pretax corporate profits was the steepest in 55 years. Compared with the same quarter in the previous year, the decline was more than 20%.

"It's horrendous," said Joshua Shapiro, chief U.S. economist at forecasting firm MFR Inc. in New York. "It destroys the ability of corporations to pay salaries, invest in equipment and do everything else that helps the economy grow."

Source: BEA

Thursday, March 26, 2009

Corporations as Investors: Buy High... Sell Low

WSJ reports:

Retail investors are sometimes characterized as the worst kind of investor, because they’re more likely than not to buy aggressively when share prices are high, only to panic when the market sells off dramatically. Whatever their faults, they’re not as bad as U.S. corporations.

Share repurchases by components of the Standard & Poor’s 500-stock index fell to lowest level in the fourth quarter of 2008 since the third quarter of 2004, according to S&P, as companies retreated into a hole, preserving cash as the market tanked.

Banks Buying Assets to Sell Through Gov't Programs... Does It Even Matter?

FT Alphaville (via Zero Hedge):

Shows Goldman’s estimates for how banks are carrying assets like commercial mortgages and consumer loans on their books. According to the table, they’re carrying those assets at ludicrously optimistic averages of between 89 per cent and 96 per cent of their original purchase price. Yeah. Right.

That preposterous positivity has huge implications for Tim Geithner’s toxic asset plan, or PPIP.
The chart below details one such asset, commercial mortgages, are still priced at or near par, which I'll agree is a joke...

BUT, (fortunately or unfortunately), I don't think this will have any impact on the Public Private Investment Program "PPIP". Why? Because it turns out banks may have no intention of using the program for these assets. Dealbook with the details:
The Treasury Department recently unveiled its plan to lift mortgage-linked securities off banks’ balance sheets. But Citigroup and Bank of America have been buying those assets in a hurry from the secondary market, The New York Post reported.

The two banks, which have each received $45 billion in federal bailout money, have been buying up AAA rated securities, including some based on alt-A and option adjustable-rate mortgages, the paper said.

One trader told The Post that Citi and Bank of America were sometimes paying higher than market rate for the securities. A Bank of America spokesman said that the purchases would help increase liquidity in the mortgage market.
But does it even matter? Lets visit both sides.

"Yes... it Does matter!" Camp

Yves at Naked Capitalism has a view similar to my initial reaction:
It certainly looks as if Citigroup and Bank of America are using TARP funds, not to lending, which was one of the primary goals of the program, but to scoop up secondary market dreck assets to game the public private investment partnership.

And it fleeces the taxpayer a second way: the public has spent enough money on both banks so that in an economic sense, they ought to have been nationalized, yet for reasons that are largely ideological and cosmetic (the banks' debt would need to be consolidated were nationalized), they remain private. So not only are they seeking to extract far more than was intended even with the already generous subsidies embodied in this program, but this activity is also speculating with taxpayer money.
While I do understand why Yves is so critical and my personal distaste for the system (and banks in particular) is growing each and every day, lets go to the opposing camp as played by my alter-ego...

"Only Injecting Liquidity and Propping Up Prices" Matters Camp

According to the Treasury, the goal of the PPIP is:
To restart the market for legacy securities, allowing banks and other financial institutions to free up capital and stimulate the extension of new credit. The resulting process of price discovery will also reduce the uncertainty surrounding the financial institutions holding these securities, potentially enabling them to raise new private capital.
How can this be accomplished by banks selling legacy assets at above market value and not by banks buying assets at above market value, only to sell to investors at an even higher value (all made possible by subsidized loans)? My view is it works in either or neither scenario. In both cases the PPIP is able to transfer liquidity into the market, which props up asset prices. The main difference is whether the process is contained in the banking system or not. In the latter, if a pension plan and/or mutual fund can sell assets at an above market price to the banks, then those pension plans and/or mutual funds were provided "liquidity". If this results in a higher clearing price and additional cash to spend on new issues... great!

As detailed at the start of this post, in either scenario banks weren't going to sell assets held on their books for remotely their fair value. In the first scenario, the clear winners involved were:
  • Banks (they were provided a way to recapitalize via selling assets at above market prices)
  • Investment managers (they get to market a new revenue generating fund to investors)
  • Wealthy investors (they receive a taxpayer subsidized loan - I say wealthy because like investing in a hedge fund, to qualify you will likely need to be wealthy)
It is clear who were not the big winners. The average investor who owns a lot of these "toxic assets" in their pension plan or in a mutual fund. They likely would have only seen the benefit if and when the PPIP helped increase the performance of the security via secondary effects to the broader economy.

In other words, this only shifts around when and where the money is going, not the mechanism created to add liquidity. Assuming the banks aren't just buying / selling from each other (I don't see the benefit of that), but accumulating these assets for the PPIP, then it may also result in the following:
  1. The liquidity in the market increases (i.e. it becomes not only a one-way seller's market)
  2. The market value of these securities increases (more buyers = increased demand = higher prices)
  3. The banks will in turn sell these new assets at a premium through the PPIP to those that would not have been natural buyers of these securities
  4. Rinse repeat, until asset values reach a new equilibrium price
  5. Marginal assets previously overstated on balance sheets are now closer to the new equilibrium (refer back to #2)
Trust me, things will never work out this perfectly, but why should the banks and "wealthy" investors have all the fun?

Q4 GDP Final vs. Advanced

Source: BEA

Crude Oil Inventories at 16 Year High

WSJ reports:

Crude oil futures ended lower Wednesday as U.S. inventories soared to 16-year highs, but they found support from a sharp drop in stockpiles at a key oil hub.

The federal Energy Information Administration reported that U.S. crude oil inventories jumped 3.3 million barrels to 356.6 million in the week ended March 20, more than double analysts' forecasts, to send stockpiles to the highest level since July 1993.

However, crude inventories at Nymex delivery point Cushing, Okla., were down 2.2 million barrels, while gasoline and distillate levels also fell much more than expected.

Source: EIA

Wednesday, March 25, 2009

State Per Capita Incomes

The BEA reports:

The range of state growth rates was wide. The high end included oil producing states such as Alaska, Wyoming, Oklahoma, and Texas which benefitted from the rise in oil prices, which peaked in the first half of 2008. Annual employment levels in 2008 in these states exceeded their 2007 levels. At the other end, personal income growth was less than the 3.3 percent national inflation rate in 13 states in 2008. These states include Florida, Arizona, Michigan, and Nevada which had among the largest percentage declines in employment in 2008.

Per capita personal income (personal income divided by population) grew 2.9 percent nationally in 2008 down from 4.9 percent in 2007. Across states, per capita personal income growth rates ranged from 0.4 percent in Arizona (down from 1.7 percent) to 9.0 percent in North Dakota (down from 11.9 percent).
Change in Per Capita Personal Income by State (YoY)

Personal income declined nationally and in 41 states in the fourth quarter of 2008. The 0.2 percent national decline was the first since 1994Q1 and contrasts with a 0.2 percent increase in the third quarter. Personal consumption prices fell 1.3 percent in the fourth quarter of 2008, the largest quarterly decline ever.

The largest contributors (by industry) to the decline in personal income were the cyclically sensitive manufacturing and construction sectors as well as the trade sector, at both the wholesale and retail levels.
Change in Personal Income by State (QoQ)

Finally, for those interested in how your state stacks up in per capita personal income, have at it (gotta love those politician's raking it in).

Per Capita Personal Income by State

Source: BEA

Durable Goods: Good News Alert? Not Necessarily

WSJ reports:

Durable goods orders unexpectedly climbed during February, but demand in the prior month was revised down deeply, an adjustment countering the idea of a rebound in the slumping manufacturing sector. Manufacturers' orders for long-lasting goods increased by 3.4% last month to a seasonally adjusted $165.56 billion, the Commerce Department said Wednesday.

The 3.4% increase was a big surprise. Wall Street expected a decline of 2.0% for February. It was the largest increase since 4.1% in December 2007. But durables, which are goods designed to last at least three years, plunged 7.3% in January, revised way down from a previously estimated 4.5% decrease. Year over year, February durables were 28.4% lower, in unadjusted terms.

Source: Census

Japanese Export Dive or Just a Reversion to Mean Growth?

Bloomberg reports:

Japan’s exports plunged a record 49.4 percent in February as deepening recessions in the U.S. and Europe sapped demand for the country’s cars and electronics. Shipments to the U.S., the country’s biggest market, tumbled an unprecedented 58.4 percent from a year earlier, the Finance Ministry said today in Tokyo. Automobile exports slid 70.9 percent.

The collapse signals gross domestic product may shrink this quarter at a similar pace to the annualized 12.1 percent contraction posted in the previous three months, the sharpest since 1974. Prime Minister Taro Aso is compiling his third stimulus package as companies from Toyota Motor Corp. to Panasonic Corp. fire thousands of workers.

I chose to show it in linear scale because I don't necessarily believe trade is based on compounded growth (such as the case with GDP or equity price levels), BUT I was requested to do so, so here is...

In this case, it appears Japan has in fact reverted well through the long term pattern.
Is it possible this is just the end of the "globalization bubble"?

Source: TSOJ

"Oh Why Must I Feel this Way... Must be the Money"

While I posted Cash Rules Everything Around Me a few weeks back detailing those entities holding the most cash, Sandeep Shroff (via Felix Salmon) goes one step further, detailing net cash (cash, short-term investments, marketable securities less current debt and capital lease obligations) by those corporations with the most, and least:

As Felix details:

This possibly helps explain why General Electric stock has done so badly of late, and also why GE is not like all those other triple-A companies. But it doesn't shed much light on things like car companies: I don't think the fact that Ford has lots of cash and rising necessarily makes it a more solid automaker than Toyota, which has a negative cash position and falling.
Source: Market Movers

Tuesday, March 24, 2009

Existing Home Sales Breakdown

Yesterday, CNN Money reported:

Sales of existing homes unexpectedly rose in February, recovering from a sharp drop in the previous month, according to an industry report released Monday.

The National Association of Realtors said that existing home sales rose last month to a seasonally adjusted annual rate of 4.72 million million units, up 5.1% from a rate of 4.49 million in January. February sales were down nearly 5% from year ago levels.
The biggest increase came in the south, up a seasonally adjusted 6%.

The good news is these sales, while down year over year, weren't at fire sale prices (i.e. California'ish), as prices were up slightly despite the jump in sales.

Finally, looking at the relative prices in all regions, the chart below shows the "spread" of regional prices to the national average, with the West showing relative weakness.

Source: Realtor.org

Maybe This Inflation Thing Wasn't Actually Quashed (UK CPI Up)

Anytime I can use the word "quash", I am a happy man. ForexPros details the surprise jump in the UK's CPI:

"The U.K. Consumer Price Index moved higher in February, to 3.2%, from 3.0% one month earlier. Even though the CPI declined at a record pace last month, this month the inflation gauge rose. In addition, the Core CPI, which excludes volatile items, rose to 1.6% from 1.3% last month. To some extent, the CPI number does not justify the BoE’s concern of “undershooting” the inflation target.

The largest upward pressure on the CPI annual rate came from food and non-alcoholic beverages. The effect was widespread but the largest individual factor was the price of vegetables, which rose by more than a year ago. The only large downward pressure on the CPI annual rate came from housing and household services.

Equity Market Boom... Ready for Bust

Bloomberg details (via The Big Picture):

U.S. stocks rallied, capping the market’s steepest two-week gain since 1938, as investors speculated the Obama administration’s plan to rid banks of toxic assets will spur growth and investor Mark Mobius said a new bull market has begun. Treasuries and the dollar fell.

Bank of America Corp. and Citigroup Inc. both soared at least 19 percent as the U.S. Treasury said it will finance as much as $1 trillion in purchases of distressed assets. Exxon Mobil Corp. and Chevron Corp. jumped more than 6.7 percent after oil rose to an almost four-month high. The Standard & Poor’s 500 Index extended its rebound from a 12-year closing low on March 9 to 22 percent as all 10 of its main industry groups advanced.

Which gets us back to a level not seen since... mid-February.

If I didn't know better I'd say that the S&P index is smiling at me letting me know it's time to get short...

Source: Yahoo

A Chart Worth 1000 Words? Corporate Bond Spreads (Now vs. Then)

Update: I received some feedback questioning where on the corporate curve I was pulling my data, so I've provided the detail for the original (five year maturity) and update (full corporate and high yield indices).

The spread of a AAA rated corporate bond today = the spread of a single B corporate bond less than two years back.

Original: Spread to Treasuries (5-Year Maturity)

Update: Spread to Treasuries (Full Indices)

Source: Barclays

Monday, March 23, 2009

Last Weeks Treasury Rally that Wasn't Abroad

While Treasuries have performed admirably in dollars (as defined by iShares Barclays 7-10 Year Treasury - IEF), they have SOARED over the past 6 months in Euros due to the strengthening of dollars.

Interestingly enough, while Treasuries soared last week (in dollars), those same foreign investors lost money on their investment due to the dollar sell-off after Ben's quantitative easing announcement.

Pre-Market Equity Boom

With the latest Private Public Partnership to be announced this morning at 8:45 AM, equity markets like what they hear. The Big Picture details:

Good Monday Morning. Looks like we have green on the screen this morning, with markets recovering from Friday’s sell off in the early going.

Asian markets were up huge: The Nikkei 225 had gains of 3.39%, the Hang Seng Index up 4.78%, and the S&P/ASX 200 Index tacking on 2.44%.

Nothing like the prospect a trillion giveaway to get the animal spirits moving . . .

Sunday, March 22, 2009

Private Public Partnership: Cheap Financing = Lower Discount Rate = Higher Asset Prices

Before I dive in, I am not making the case that the Private Public Partnership likely to be announced Monday morning will in fact work. In addition, I am not making the case that the government should be providing a subsidy to private investors. What I am attempting to do is detail how it can work.

Thus, while I don't typically disagree with Yves from Naked Capitalism, her post Investor on Private Public Partnership: "One would have to be a criminal to participate in this" misses a HUGE detail of the plan (to be fair, I believe she nails it in a previous post here). First the basic assumptions in her example:

  • Citi holds $100mm of face-value securities, carried at $80mm.
  • The market bid on these securities is $30mm.
  • Say with perfect foresight the value of all cash flows is $50mm.
  • The investor buys the assets for $75mm, putting only 3% down and borrows the rest from the government (FDIC and Treasury) at a low rate.
Yves makes the case that this investment will no doubt result in a loss of $25mm. The line "say with perfect foresight the value of all cash flows is $50mm" combined with Yves stating the example “did not allow for time value of money” reveals her example is oversimplified to the point of missing what I feel is the most important part of the plan... that the plan reduces the rate at which the cash flows of the assets are discounted, which increases the present value of those cash flows.

Cheap Financing = Lower Discount Rate = Higher Asset Prices

In the example, the securities will only have $50mm in total cash flows, which equals the present value of those cash flows due to the ignoring of the time value of money. That makes the Private Public Partnership seem like a loser... if there are only $50mm in cash flows and an investor pays $75mm, the plan would be foolish.

However, even at low market prices, cash flows are MUCH HIGHER than $50mm. A current $30mm market bid doesn't mean that the security will have $30mm (or $50mm) in cash flows. It means the present value of all future cash flows discounted at the required rate of return on capital is $30mm. A security that pays $5 each year for 10 years and $50 in year ten may be worth close to $30 if discounted at 16%, but the cash flows are the full $100.

Visually, the chart below details the present value of a security that pays out that $5 per year for 10 years and then $50 in year 10 using a variety of discount rates. While the present value of these cash flows (i.e. the price of the security) is close to $30 assuming a 15% required return, it becomes clear that the value changes based upon the required return of the investor.

And that is the point of the Private Public Partnership. The government has a VERY low required return on investment, which it is providing to the private sector via the partnership. How low? As of Friday, the U.S. government was able to borrow over 5 years at 1.64% and over 10 years at 2.63%. Thus, if the government makes a return above these levels on an investment, it MAKES money. On the other hand, a private investor (or bank) requires a substantially higher return (let's call it 15% in the case of these bad assets) from an investment or asset because their cost of capital is substantially higher.

The Mechanism; 97% Cheap Financing

Calculated Risk reports that:
The FDIC plan involves almost no money down.

The FDIC will provide a low interest non-recourse loan up to 85% of the value of the assets. The remaining 15 percent will come from the government and the private investors. The Treasury would put up as much as 80 percent of that, while private investors would put up as little as 20 percent of the money ... Private investors, then, would be contributing as little as 3 percent of the equity, and the government as much as 97 percent.
Thus, rather than discounting the cash flows at the required rate the private market requires (i.e. 15%), cheap government financing allows the cash flows of the security to be discounted at a much much lower rate (a weighting of 3% at the private rate and 97% at the government's much lower rate). This lower rate in turn props up the present value of all those cash flows (i.e. the asset price) AND makes it possible that BOTH the private investor and government can make money paying $75mm for assets currently priced significantly lower.

Is the program perfect? Not at all. For starters, I'd prefer the government go ahead and buy 100% of the assets and take 100% of the upside, but I understand the preference is to keep the assets in the hands of private investors. The important thing to remember is THERE IS NO PERFECT SOLUTION in the current environment and it is important to analyze how and why these plans may work before completely dismissing them.

Friday, March 20, 2009

Inflation Expectations Normalizing

California Downgraded

Reuters reports:

Ahead of a major bond sale next week by California, Fitch Ratings on Thursday cut its "A+" rating on $47.4 billion of state general obligation debt to "A" with a stable outlook, citing falling revenues and the weak economy in the most populous U.S. state.

Fitch analysts in a report noted California's "economic performance and revenue expectations have continued to decline since the state developed its current revenue forecast in November 2008," and pointed to a state unemployment rate of 10.1 percent and a recent state legislative analyst's warning of a "sizable" revenue shortfall in the next fiscal year.

Men's Apparel Sticker Shock and Interview Sweaters

Forget gold as the store of value... Highbeam reports:

Retail prices for men's apparel in February increased a seasonally adjusted 1 percent against January, well ahead of the average price for all consumer goods, which advanced 0.2 percent, the Labor Department reported Friday in its monthly Consumer Price Index.
On a year-over-year basis, however, men's apparel prices last month lagged that of the overall inflation rate, increasing 1.2 percent against February 1995 as prices for all retail goods rose 2.7 percent. Although men's wear retailers are pushing through moderate price increases, they are still under pressure to give value to consumers. Prices for boys' apparel in February reflected deep.
In looking at the six month change in the 'men's apparel' portion of CPI vs. the index, we see a spike that is unprecedented.

So what's the deal? My guess was that the demand for suits was rocketing as individuals are being thrown out of the workforce and once again interviewing (and suits being expensive would push the average price level higher). However, looking at the data we see that it isn't suits that are on the rise... it's shirts and sweaters. The WSJ asks:
What is going on with the price of mens’ shirts and sweaters? Over the last two months these prices are up at a 64% annualized rate. Mens’ apparel more generally is up at a record 29% rate, contributing to the strong 1.3% sequential increase in apparel prices in today’s report.

On a side note; while I will admit my explanation was wrong, in doing some more research I discovered that men are actually interviewing in sweaters these days (have I been in finance and New York City too long?). AskMen.com with the details in 'Dressing for a Job Interview':
With comfortable, professional clothes in mind, it is OK to wear a blazer or sweater over a tie and chinos when dressing for a job interview in the service industry. You want to look responsible and well-pressed as well as approachable to the public.
Not sure what I understand less; why men's apparel is on the rise or why people wear sweaters to interview. But while interview sweaters are a fascinating concept, if I can figure out why the price level of men's apparel is on the rise, I may be able to make some money buying the right retailer.

Any ideas?

And You Thought 8.1% Unemployment was Frightening?

While national unemployment is 8.1% and rising, the BLS reports many areas are facing a much more difficult environment:

Overall, 157 areas posted unemployment rates above the U.S. figure of 8.5 percent, 209 areas reported rates below it, and 6 areas had the same rate.

Two manufacturing centers in Indiana recorded the largest jobless rate increases from January 2008, Elkhart-Goshen (+13.0 percentage points) and Kokomo (+8.9 points). An additional 12 areas registered over-the-year unemployment rate increases of 6.0 percentage points or more, and another 26 areas had rate increases of 5.0 to 5.9 points. Waterloo-Cedar Falls, Iowa, was the sole area without an over-the- year rate change.

Elkhart sound familiar, the Indy Star reports:
President Barack Obama fanned the town of Elkhart’s hopes for relief on Feb. 9 by making it the poster child for his economic-stimulus bill. A month later, however, the city with a 19 percent jobless rate still is waiting for the promise of economic relief, Bloomberg reports today.
The problem lies in the lag between when the needs of states and municipalities are identified and how quickly decent (i.e. not completely wasteful) projects can be rolled out.
Jane Jankowski, a spokeswoman for Daniels, told Bloomberg that the state is “trying to sort through a lot of those same things to find answers to questions about how this will all be working.” She said that 40 counties will be aided by the 55 highway infrastructure projects they’ve announced so far.

White House officials say the city needs to be patient because help is on the way.
Source: BLS

Thursday, March 19, 2009

NCAA First Round Winning Percentage by Seed

Leading Economic Indicators (February)

RTT News details:

Thursday morning, the Conference Board released its report on leading economic indicators in the month of February, showing that its leading indicators index fell by less than economists had been anticipating.

The report showed that the leading index fell 0.4 percent in February following a downwardly revised 0.1 percent increase in January. Economists had been expecting the index to fall 0.6 percent compared to the 0.4 percent increase originally reported for the previous month.

Source: Conference Board

New York City Condos Ready to Collapse?

WSJ reports:

Moreover, Fannie and Freddie are both set to increase fees on condo buyers next month. Buyers without at least a 25% down payment will have to pay closing-cost fees equal to 0.75% of their loan, regardless of the borrower's credit score. The companies say these fees are necessary to protect against higher default rates.

The changes come as cities brace for a new flood of condo supply. Reis Inc., a New York-based real-estate firm, estimates that 93,000 new condo units will be completed this year, a 28% increase in new inventory from last year. More than 12,000 units will be completed in New York and northern New Jersey by year's end. Chicago will add 5,500 units, Seattle has 3,000 units coming online, and Los Angeles is readying 2,600 units, according to estimates provided by Reis.

Tougher credit standards, slowing economy, increase supply... not a good scenario for NYC housing to say the least.

Treasury Rally and Equity Markets

WSJ reports:

The Fed said that over the next six months, it would buy as much as $300 billion of Treasury's in maturities from two to 10 years, starting as early as next week. (See related article on the Fed's moves.)
The yield on the 10-year Treasury, which is used as a benchmark for mortgage rates, fell close to half a percentage point, its largest one-day point decline since Oct. 20, 1987.

So what does this all mean for equity and risk markets? Using history as a guide (data since 1962), when the 10-year Treasury Bond rallied by similar amounts, the equity market (as defined by the S&P) has tended to outperform over the next three months.

My thoughts? This isn't like those past situations. Rather than a Treasury rally due to a flight to quality, (which historically likely coincided with an equity sell-off, thus the next three month outperformance being a reversion to the mean), this was likely a flight ahead of the Fed / a lot of short covering. In addition, it coincided with a continuation of what very likely will be written in the history books as just another equity dead cat bounce. To brag a bit (I am wrong enough that I need to brag when I appear to have been right), just two weeks ago I made this comment in response to feedback on my post regarding hedge fund performance in February:
I will be more clear in my prediction. The market will bounce 20% back within the next month up from whatever low is hit this month. After the 20% is covered, I am shorting the crap out of this pig.
Unless the Fed begins buying actual equity, I still expect this rally to lose steam regardless of what the Fed does to help the economy.

Wednesday, March 18, 2009

Golden Bubble Cont'd (Part II)

Another case for gold entering bubble territory. Tim Iacono at Seeking Alpha with the details:

To me, it's just fun to watch their stash grow as inventory at the world's most popular gold ETF passes holdings by central banks all around the world. Switzerland, you're next! Soon, GLD will be number six in the world and then it'll be a long way to go in relative terms to catch Italy at almost two and a half thousand tonnes but, at the rate they're going in 2009, that'll happen by this fall. Then it's just a chip-shot away to surpass France.

With net assets of over $33 billion, GLD is already the second largest ETF in net assets according to Yahoo! Finance behind only its SPDR brother SPY at about double that figure. Somehow, it seems like that gap might narrow rather quickly over the next year or so.

AIG... By the #'s

Infectious Greed details:

  • The top recipient received more than $6.4 million
  • The top seven bonus recipients received more than $4 million each
  • The top ten bonus recipients received a combined $42 million
  • 22 individuals received bonuses of $2 million or more, and combined they received more than $72 million; 73 individuals received bonuses of $1 million or more
  • Eleven of the individuals who received "retention" bonuses of $1 million or more are no longer working at AIG, including one who received $4.6 million.
In total, 11 of 73 received a $1 million bonus and no longer work there... the chart below shows roughly the same ratio; 6 of 36 to put that in perspective.

Apparently, the $1 million "retention bonuses" weren't enough. After AIG became the "poison ivy" of the financial community, cash in hand no longer served any purpose to stay.