Deleveraging Forces Liquidation

Friday, October 31st, 2008

“When investors are in trouble, they sell what they can, not what they would like to.”

The current issue of The Economist features an excellent article about the forced selling that has been the key feature of this bear market, caused by the violent trading days that have come in the wake of the deleveraging of many banks and hedge funds as they need to get their balance sheets in order.

Here are some excerpts:

… the speed of market movements suggests another factor has been even more important. When investors are in trouble, they sell what they can, not what they would like to. It looks as if they have been dumping a whole range of assets.

Emerging stockmarkets, for example, have lost more than half their value this year, while emerging-government bonds were yielding more than eight percentage points above Treasury bonds, at least until a rally on October 28th. Leveraged loans (debts to finance management buy-outs) are trading at just 70 cents on the dollar.

… Who is being forced to sell? One obvious answer is banks that have ended up owning far more risky assets than they would like. Barclays Capital put $970 million of leveraged loans up for sale in October; in the face of disappointing offers, it ended up selling just 30% of the lot. Other banks have been winding down their trading, a big source of revenue earlier this decade, in an attempt to reduce risk.

Another group of sellers is the hedge funds. After a disappointing performance this year, many are facing calls for redemptions from clients and are having to sell assets to raise cash. But their problems also stem from their use of leverage, or borrowed money.

Tags: Banks, Bear Market, Commodities, Dollar, Excerpts, Government Bonds, Hedge Fund, Hedge Funds, Markets, Rally, Trading, Value
Posted in Bonds, Commodities, Emerging Markets, Markets | 1 Comment »

The Teflon Maple Leaf: TD Securities

Friday, October 31st, 2008

Eric Lascelles, TD Securities’ Chief Economics Strategist, points out that the Canada has the highest sovereign debt ratings in the world, in his latest report, “The Teflon Maple Leaf.”

Lascelles points to several key areas:

• A peek at the latest sovereign credit default swap data reveals that Canada is now regarded as quite possibly the world’s safest sovereign country in terms of the solvency of the country’s government.
• On the surface, this seems surprising given how closely Canada is linked into the U.S. economy and into commodity prices, and how both of those two erstwhile pillars have recently crumbled.
• But a closer look reveals that there may be some method to the market’s madness – Canada is indeed in a remarkably good position by several metrics, which we pursue in this piece. 

• We should begin by noting that we believe Canadian bonds should continue to underperform the U.S. because sovereign debt concerns have not played a major role in the market to date, and because Canada’s economic prospects are somewhat better than in the U.S. and so less rate cutting will be needed.
• However, should the market begin to differentiate between countries based upon their debt-to-GDP ratios and other measures of fiscal pressure, Canadian bonds would ultimately be a winner in that contest. At present, there is little evidence that this is happening – case in point, both Japanese and U.S. debt continue to be happily purchased, yet the Japanese debt burden is extremely high and the U.S. debt burden is growing quickly. Nor do we necessarily expect this to change. But should the market grow more fickle about what it buys, there could be a quick reversal and this would prompt us to favour Canada over the U.S. in bonds.
• Third, throughout the credit crunch, Canadian bonds have been less volatile than in the U.S., and this speaks in no small part to the relatively more stable fiscal and economic foundations in Canada. We expect this trend of relative stability to continue.

The Teflon Maple Leaf, October 31, 2008, Eric Lascelles, TD Securities Inc.

Tags: Canada, CDS, Commodity, Credit, Credit Default Swap, Economics, Economy, GDP, Japan
Posted in Bonds, Canadian Stocks, Credit Markets, Economy, Markets | No Comments »

Better To Be Late, Amid Credit Crises: Thomas Barrack, Jr.

Thursday, October 30th, 2008

Thomas J. Barrack Jr., billionaire and Founder of Colony Capital, which controls $39-billion in real estate assets, in his recent newsletter, “Is the world going to an [Extinction Level Event?” provides his assessment of the state of the markets, and shares the following:

Why the Banks Have Most Likely Not Hit Bottom
• Corporate earnings from most sectors will be weak and capex programs will be slashed.
• Hedge funds will continue to be tortured by redemptions and their interplay with banks was
incestuous.
• The effect of hedge funds pulling out of the market will chill many sources of corporate
finance – Redemptions are massive.
• Counterparty risk in the CDS market will remain a bit of a mystery.
> CDS was equally as bad at the plate as equity and debt players
> The governments infusion of equity collapsed the CDS spreads
• CDS payments and failures at levels that are unfathomable – watch Lehman reconciliations on
Tuesday, Oct. 21st.
• The housing market will remain anemic.
• Insurance companies, automakers, airlines and shippers are all in trouble.
• State and municipalities are also Fed borrowers.
• Corporate refinancings at $150 billion a quarter with no one to refinance.
• Massive margin calls on the titans of America which will cause collapse in the corporate
equities they own.
• Forced liquidations.
• LBO restructurings and covenant violations.
• No DIP financing for bankruptcies, only liquidations.

Long-term Consequences

The good news is that all we care about at the moment is SURVIVAL. We need to fight every day to monitor and steward the best deals we can find — the ones we own. However, eventually we will need to examine the long-term effects of our triage.

• Huge inflationary pressures. Inevitable higher interest rates and taxes.
• Massive national debt and budget deficits.
• Are we deferring the pain like Japan did?
• $11.3 trillion national debt is really $55 trillion due to OBL (off balance-sheet liabilities).
• Implications of investment losses for pension funds and endowments?

Bottom Line

The game is afoot and not over. Don’t panic and don’t be euphoric. The discoveries will be constant and unsettling. Fortunately, the world powers have committed to win it. Now we all have to figure out what exactly that means. Based upon our past experience at implementing bank takeovers and “distressed asset” management and dispositions, we suggest that we all buckle our seatbelts for a longer ride with lots of ups and downs before we arrive to safety.

From Bloomberg, October 10, 2008:

“For once, it will be better to be late rather than early,” Barrack said in a four-page letter to investors on Oct. 8, a copy of which was obtained by Bloomberg News. “There is no bottom because no one believes the messenger.’

“As all markets come to the realization that we are now in a worldwide systemic recession — not just a credit crunch — things may get worse,” the Los Angeles-based Barrack, 61, wrote in the letter, titled “In God We Trust — But Not Counterparties.”

“The massive restructurings, refinancings and re-pricings that will now take place, cascading from the financial world to the industrial world, will be legend. The complexities, repercussions and consequences to all parties are indeterminate.”

From Donald Trump’s Blog, the Donald quotes his good friend’s (Thomas Barrack Jr.) newsletter:

Why Can’t Anybody Find the Bottom?

It all boils down to trust! The mantra of the country is “In God We Trust–but not counterparties.” No buyer trusts any seller, banker, insurer or intermediary. No investor trusts any depository, insurer, broker-dealer or advisor. No Main Street citizen trusts Wall Street, and neither Main Street or Wall Street trusts the government. No counterparty in any transaction has confidence in the other. Values at every level have been artificially adjusted and when the air comes out of the “speculative hope certificates” everyone is pointing fingers at each other for fault and retribution.

The Worst is in Front of Us

Counterparties are renegotiating, borrowers are violating covenants, banks are finding any excuse not to fund existing commitments, insurers are negating liability, and renegotiations of  responsibility and liability are being conducted at every level of the capital structure across the spectrum of companies.

There is no bottom because no one believes the messenger. With trillions of dollars of re-pricing occurring in these markets there is no hurry to catch the falling knife. There will be ample time once that last “dead cat bounce” has bounced and the government launches a coherent and consistent program. For once it will be better to be late rather than early.

Bottom Line: This is Not the Bottom.

Thomas J. Barrack Jr., “Is the World Going To ELE?”, October 14, 2008

Source: NakedShorts.com, Colony Capital

Tags: Bankruptcies, Banks, Blog, Bloomberg, CDS, Collapse, Counterparties, Credit, Dollar, Earnings, energy, Fed, Hedge Fund, Hedge Funds, Housing Market, inflation, interest rates, Japan, Markets, oil, Real Estate, Recession, risk, spreads, Trillion, Value, Wall Street
Posted in Credit Markets, Markets, Oil and Gas | No Comments »

The Age of Prosperity is Over: Arthur Laffer

Thursday, October 30th, 2008

Arthur Laffer, the Reagan-era economist, famous for defining Supply-Side economics and developing what is now referred to as the Laffer Curve, has written an Op-Ed piece in the Wall Street Journal (October 27, 2008).

The Age of Prosperity is Over, October 27, 2008. This is a must read.

Seymour Schulich provides a foreword to this article:

“This piece from an American friend gives a clear picture of where the U.S. is heading and the price to be paid for allowing unregulated hedge funds and derivative activity.

The next commodity boom will set new price records. It is galling to see the u.s. dollar sell at a huge premium. I think our Canadian dollar is the best buy in the world today.”

Best Regards, Seymour Schulich

Here are some excerpts:

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When markets are free, asset values are supposed to go up and down, and competition opens up opportunities for profits and losses. Profits and stock appreciation are not rights, but rewards for insight mixed with a willingness to take risk. People who buy homes and the banks who give them mortgages are no different, in principle, than investors in the stock market, commodity speculators or shop owners. Good decisions should be rewarded and bad decisions should be punished. The market does just that with its profits and losses.

No one likes to see people lose their homes when housing prices fall and they can’t afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction. If the house’s value had appreciated, believe you me the overleveraged homeowner and the overly aggressive bank would never have shared their gain with taxpayers. Housing price declines and their consequences are signals to the market to stop building so many houses, pure and simple.

Regarding past Presidents and central bankers:

The stock market is forward looking, reflecting the current value of future expected after-tax profits. An improving economy carries with it the prospects of enhanced profitability as well as higher employment, higher wages, more productivity and more output. Just look at the era beginning with President Reagan’s tax cuts, Paul Volcker’s sound money, and all the other pro-growth, supply-side policies.

Bill Clinton and Alan Greenspan added their efforts to strengthen what had begun under President Reagan. President Clinton signed into law welfare reform, so people actually have to look for a job before being eligible for welfare. He ended the “retirement test” for Social Security benefits (a huge tax cut for elderly workers), pushed the North American Free Trade Agreement through Congress against his union supporters and many of his own party members, signed the largest capital gains tax cut ever (which exempted owner-occupied homes from capital gains taxes), and finally reduced government spending as a share of GDP by an amazing three percentage points (more than the next four best presidents combined). The stock market loved Mr. Clinton as it had loved Reagan, and for good reasons.

Hat Tip: John Budden, BeEarly.com

The Age of Prosperity is Over, Wall Street Journal, October 27, 2008.

Tags: Alan Greenspan, Banks, Canada, Commodity, Dollar, Economics, Economy, Excerpts, GDP, Good Reason, government spending, Hedge Fund, Hedge Funds, Markets, Mortgage, Paul Volcker, REW, risk, Sound Money, Value, Wages, Wall Street, Wall Street Journal
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BRICs Lay Foundation Stability: Merrill Lynch

Thursday, October 30th, 2008

Alex Patelis, Head of Global Economics, Merrill Lynch discusses the strength of BRIC (Brazil, Russia, India, China) countries in the midst of the global credit crisis, and how well suited they are to recover strongly. 

Patelis points out that close to 90% of global GDP growth will come from emerging markets economies in 2009, and goes one step further saying that he would not be surprised if global growth would come exclusively from emerging markets. They are underlevered, strong domestic economies, where consumption growth is being fuelled by income growth, and strong savings rates. In particular, he favours China and India.

Click image to watch video

Tags: Brazil, BRIC, BRICs, China, Consumption, Credit, Credit Crisis, Economics, Emerging Market, Emerging Markets, GDP, GDP Growth, India, Markets, risk, Russia, Savings Rate, Video
Posted in Credit Markets, Emerging Markets, Markets | No Comments »

Resurgent Yen a Global Destabilizer

Wednesday, October 29th, 2008

Once again, volatility favouring the Japanese Yen is having a pronounced effect on what happens in the stock market. There is a well documented history of the relationship that exists between global stock markets and the Yen. There appears to be a well-defined negative correlation between the yen and equity markets. When the yen surges, markets fall, and vice versa.

We have covered this topic on several occasions during this year:

• The Carry Trade and Markets? What is the relationship?,
• Resurgent Yen is Scary News,
• Why the selloff in commodities and emerging markets?,
• More Carry-Trade commentary
• More volatility coming and more ETF options
• Yen’s Strength [has been] profoundly negative for global markets

From the Economic Times, The Group of Seven issued warnings on Monday the yen’s wild swings are threatening financial stability, fanning speculation central banks may intervene to halt a rally in the currency driven by a Japanese exodus from emerging markets.

The yen was the only currency mentioned in a brief G7 statement as it rallied to 13-year high against the dollar, not only threatening Japanese exports as the world’s second-largest economy tumbles toward recession amid the worst global financial crisis in 80 years, but leading to a destabilization of currency related transactions that need to be unwound.

As a matter of background building, we provide below a summary of milestones in the yen’s history:

1871 – The yen became Japan’s currency as part of the Meiji Restoration, which marked the start of Japan’s modernization and opening to the rest of the world. Japan adopted the gold standard.

1949 – After World War Two the dollar’s fixed rate is set at 360 yen via the Bretton Woods system, partly to help stabilize prices in the Japanese economy.

1959 – The dollar/yen exchange rate is liberalized and the margin of fluctuation is set at 0.5 percent on either side of its dollar parity.

1963 – The margin of fluctuation is widened to 0.75 percent. 1971 – United States abandons gold standard, bringing an end to the Bretton Woods system of fixed exchange rates and forcing a realignment of world currencies.

December 1971 – Under the Smithsonian Agreement, the dollar/yen exchange rate is set at 308 yen and is allowed to fluctuate in a wider band between 301.07 yen and 314.93 yen.

1973 – Japanese monetary authorities decide to let the yen float freely against the dollar, and the yen appreciates as far as 263 to the dollar.

1978 – The yen pushes through 200 to the dollar for the first time, strengthening as far as 177.

1980 to 1985 – The yen’s appreciation halts and partially reverses despite Japan’s big trade surpluses. Higher interest rates in the United States prompt Japanese investors to put money in dollar assets.

1985 – The Group of Five industrial nations, the predecessor to the G7, sign the Plaza Accord in which they agree the dollar is overvalued and to weaken it. The yen climbs from its pre-accord level of around 240 to 211 in October and 200 in November, a 20 percent rise in just a few months.

1986 – The U.S. currency falls further to around 190 yen in January, 167 yen in April and 153 yen in August.

1987 – In February, six of the G7 nations sign the Louvre Accord, which aims to stabilize currencies and halt the dollar’s broad decline. The dollar still falls from near 153 to 137 in April and 120.80 by the end of the year.

1988 – On January 4, the dollar falls to a post-war low of 120.45 yen in Tokyo trade, a level that holds as the low for more than five years. The Bank of Japan intervenes to buy dollars and sell yen that day on behalf of the Ministry of Finance.

August 17, 1993 – The dollar declines to a new post-war low of 100.40 yen in Tokyo.

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June 21, 1994 – The dollar falls through the key 100 yen level and touches a record postwar low of 99.85 yen in New York trade before finishing at 100.30 yen.

April 19, 1995 – The dollar hits a record post-war low at 79.75 yen after U.S.-Japanese trade frictions spark heavy selling. By the end of the year it is near 103.40.

June 17, 1998 – As the dollar shoots above 144 yen, U.S. authorities join the Bank of Japan to buy yen, spending $833 million. By August the dollar rises to near 148 yen, partly due to yen carry trades in which investors borrow yen funds at Japan’s near zero interest rates to buy higher-yielding currencies.

1998 – After the global financial market strains from the near collapse of hedge fund Long-Term Capital Management, carry trades are unwound quickly. In one week alone in October, the dollar tumbles from near 136 yen to a low around 111.50 yen.

1999 – The yen strengthens further despite repeated intervention, reaching 102 in November.

2001 – Following the Sept 11 attacks, Bank of Japan intervenes to sell yen for dollars.

2003 – The MOF begins massive intervention to halt the yen’s rise against the dollar, partly to shield Japanese exporters as the economy remains stuck in its post-bubble slump and deflation. The MOF spends 20.4 trillion yen ($200 billion) over the year, nearly all of it to buy dollars and sell yen.

2004 – The MOF spends 14.8 trillion yen ($145 billion) intervening in the first quarter of the year, including 1.67 trillion yen buying dollars on January 9 alone. But the MOF ceases intervention in March and has never since resumed.

2005 – The yen reaches a high of 101.67 yen in January but then starts to fall, hitting 121.40 in December. Yen carry trades and Japanese investors shifting funds into foreign assets drive the slide.

June 2007 – The dollar hits a 4-1/2-year high of 124.14 yen. July 2007 – The yen’s broad depreciation takes it to a 22-year low on a real effective exchange rate basis. Since January 2005 the yen has lost 25 percent of its value on a REER basis.

August 2007 – Strains in financial markets from the U.S. subprime mortgage crisis spark an unwind of yen carry trades.

The dollar falls from near 120 yen to 111.60 yen. The high-yielding Australian and New Zealand dollars tumble nearly 10 percent.

March 13, 2008 – The yen hits an 12-year high of 99.77.

October 24, 2008 – Yen hits 13-year high of 90.87 versus the dollar, while setting an all-time high against the Australian dollar of 55.11, with the Aussie losing almost a third of its value in just a month on a massive unwind of carry trades.

October 27, 2008 – The yen’s surge to 13-year highs prompts the G7 to issue statement to single out the yen in warning on currency market volatility.

The yen has surged nearly 20 percent so far in October on a trade weighted basis, more than twice as big as any month going back to 1970, including the carry trade collapse in October 1998 and the Plaza Accord to weaken the dollar in 1985.

(Sources: Reuters, Bank of Japan, Bank of England)

Tags: Australia, Bank Of Japan, Banks, Blog, Carry Trade, Central Banks, Collapse, Commodities, Correlation, Currency, Dollar, Economy, Emerging Market, Emerging Markets, ETF, Gold, Hedge Fund, interest rates, Japan, Markets, Mortgage, Rally, Recession, risk, SMI, Stock Markets, Trillion, Value
Posted in Commodities, Economy, Emerging Markets, Gold, Markets | No Comments »

China’s Bold Economic Policy Moves

Wednesday, October 29th, 2008

CLSA Asia-Pacific Markets, a division of Credit Lyonnais/Credit Agricole, are one of the best groups of analysts providing background on China.

Included here are excerpts from a report by CLSA’s macro strategist Andy Rothman regarding China’s recent decision to stimulate its housing sector.

Beijing is cutting mortgage rates to as low as 5.23 percent, reducing required down payments to buy a home from 30 percent to 20 percent for first-time buyers, comparatively still far above what most Americans have put up to purchase a house, and also lowering some taxes and fees.

CLSA views the government’s action as a move to get people to invest their wealth in real estate, which will serve to shrink an overbuilt housing inventory and help keep the broader economy from slowing down further.

“Beijing had succeeded in cooling off price growth, taking it from 25 percent year over year last fall to about zero year over year today. And, having achieved the objective of avoiding a bubble, the last thing the Communist Party wanted to do was crash the property market.

“(This week’s) policy changes will have two effects:

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“First, they make home-buying more affordable, with a combination of lower interest rates, lower down payments and lower transaction fees.

“But the second effect is most important, as affordability has never been the big problem in China. (The) measures represent the government reversing its anti-property stance adopted one year ago. Back then, Beijing said, in effect, ‘we will do our best to depress prices and discourage home-buying.’ Consumers responded rationally by delaying purchases.

“Now, the government is saying, (my words), ‘we encourage home-buying and you should anticipate that property prices will start rising again.’

“With affordability good, household debt almost non-existent, and banks ready to lend (they are all controlled by the Party), homebuyers will return to the market in response to Beijing’s message.

“(The) move can be considered part of an overall effort to give a light stimulus to the economy, but in my view is primarily focused on the real estate sector. These changes also illustrate that the Party is capable of taking proactive steps to deal with a changing economic environment.”

Tags: Asia, Banks, China, Credit, economic policy, Economy, Excerpts, Focus, interest rates, Markets, Mortgage, Real Estate, risk
Posted in Credit Markets, Economy, Markets | No Comments »

Mobius: Brazil will Lead Recovery

Wednesday, October 29th, 2008

In a webcast interview with Times Online UK, Mark Mobius discusses why he believes Brazil will lead the recovery in Emerging Markets.

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Tags: Brazil, Emerging Market, Emerging Markets, interview, Mark Mobius, Markets, risk, UK
Posted in Emerging Markets, Markets | No Comments »

Jeremy Grantham: Silver Linings and Lessons Learned

Wednesday, October 29th, 2008

Jeremy Grantham is the Chairman of the Board of Grantham Mayo Van Otterloo, who manage approximately $120-billion in assets, well known among institutional investors but relatively unknown to retail investors. Here are some highlights from both parts of Grantham’s October 2008 newsletter “Reaping the Whirlwind,” and ”Silver Linings and Lessons Learned.”

Part 1, “Reaping the Whirlwind,” published 2 weeks ago:

“At under 1,000 on the S&P 500, US stocks are very reasonable buys for brave value managers willing to be early. The same applies to EAFE and emerging equities at October 10 prices, but even more so. History warns, though, that new lows are more likely than not.

“Fixed income has wide areas of very attractive, aberrant pricing.

“The dollar and the yen look okay for now, but the pound does not.

“Don’t worry at all about inflation. We can all save up our worries there for a couple of years from now and then really worry!

“Commodities may have big rallies, but the fundamentals of the next 18 months should wear them down to new two-year lows.

“As for us in asset allocation, we have made our choice: hesitant and careful buying at these prices and lower. Good luck with your decisions.”

You can read ”Reaping the Whirlwind,” in its entirety by clicking here where Grantham has published his views on the fallout from the financial crisis and the investment opportunities he sees.

Part 2, ”Silver Linings and Lessons Learned”, published early this week:

“When asked by Barron’s on October 13 if we would learn anything from this ongoing crisis, I answered, ‘We will learn an enormous amount in a very short time, quite a bit in the medium term, and absolutely nothing in the long term. That would be the historical precedent.’

“That is unfortunately likely to be the case. But over the next several years at least, there are many silver linings and valuable lessons to be learned.

“Chief among the many benefits of this crisis are unprecedented opportunities for investing in some fixed income areas where some spreads are so wide as to reflect severe market dysfunctionality.

“As of October 18, we also have moderately cheap US and global equities for the first time in 20 years. Probably quite soon, global equities too will offer exceptional opportunities after the additional pain that is likely to occur in the next year.

“We are reconciled to buying too soon, but we recognize that our fair value estimate of 975 on the S&P 500 is, from historical precedent, likely to overrun on the downside by 20% to 40%, giving a range of 585 to 780 on the S&P as a probable low.

“The world faces unavoidable declines in economic activity and profit margins, so this overrun is unlikely to be much less painful than average, although you never know your luck.”

You can read ”Silver Linings and Lessons Learned,” in its entirety by clicking here where Grantham has published his comments on lessons learned from the credit crisis, as well as his proposed strategy.

Source: Jeremy Grantham, GMO, October 2008.

Courtesy: Prieur du Plessis, Investment Postcards

Tags: Barron's, Commodities, Credit, Credit Crisis, Dollar, Economic Activity, Fixed Income, inflation, Investment Postcards, Prieur, risk, S&P 500, Silver, spreads, US Stocks, Value
Posted in Commodities, Credit Markets, Markets | No Comments »

Jeff DeGraaf: Turning Point Tuesday?

Tuesday, October 28th, 2008

Jeff DeGraaf, ISI head of technical analysis says Tuesday’s rally is far more credible than the past rally a couple weeks ago.

“This is the 6^th best rally in the S&P since 1925,” he says. “If you look at volume and breadth it makes me more bullish than I’ve been in quite a while.”

With sentiment so bearish, “we have a condition that would set itself up for some type of mean reversion probably to 1100,” he says.

Short assets vs. assets shows that there is far more money betting the market down than up, and today’s rally is more reliable than the most recent one.

As a result, “the best market strategy right now is a call spread on the S&P selling the upside around 1100,” he concludes.

What’s the bottom line? Sell the rip!

To see DeGraaf’s entire analysis please watch the video.

Tags: Rally, risk, S&P500, Technical Analysis, Video
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Warren Buffett on Charlie Rose

Monday, October 27th, 2008

Warren Buffett, the Oracle of Omaha, interviewed by Charlie Rose earlier this month. This 55-minute in-depth interview is definitely worth watching:

Tags: interview, Video, Warren Buffett
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Paul Krugman on Charlie Rose

Monday, October 27th, 2008

Paul Krugman, 2008 Nobel Laureate for Economics, was interviewed by Charlie Rose late last week. This is worth watching:

Tags: Economics, interview, Paul Krugman, risk, Video
Posted in Markets | No Comments »