Tuesday, December 30, 2008

S&P and Moodys - Death of Bond Rating Agencies

In all the carnage of 2008 - the bankrupted companies, the government bailouts, the mortgage foreclosures, the ratings agencies have been consistently behind the ball regarding reacting to the changing financial landscape. Moreover - the analyses of the companies these bond rating agencies conducted will likely show that they too were asleep at the switch as this crisis emerged. Current credit watches are just prime examples.

Today's headline from Bloomberg details the fewer than a dozen companies left worldwide who still hold the coveted Aaa rating. GE has been in the spotlight lately because it has desperately tried to hold on to its Aaa rating - a grade it has held since the 1950's - amid worry about its huge financial services arm. The implication being that the borrowing costs of their future debt issuances will escalate if they are downgraded even one level costing them about 1.1% more than if the were to keep the Aaa rating.

The crazy thing about the Aaa rating or lack thereof - is that it should be largely irrelevent at this point. The stock market has put its own downgrade on many of these Aaa companies far sooner than S&P or Moody's - making the sudden wash of downgrades and negative credit watches seem tongue and cheek.

Furthermore, the notion that a company could issue some debt today while it still had a Aaa rating and save 1% in interest over the same debt issued the day after a downgrade is ridiculous. There is too much being put on the difference in borrowing costs, but it shouldn't have anything to do with the rubber stamp of S&P, so much as the health of the overall credit market. Case in point - GE's borrowing costs have been rising all year, so what did the Aaa have to do with it?

The fact is - nothing. Bond ratings are dinosaurs of a by-gone era where access to financial information was not easy to come by and markets less fluid in pricing in information. All the ratings agencies now are is trumped up analysts and cheerleaders of companies cheering or booing after the play has already happened. In this way, their ratings changes are like Monday-morning quarterbacking companies financial position. Their stamps of approval have probably led to unfortunate ill-guided and researched investment positions which are now being brought to light not by the ratings agencies, but by the rest of the information available all year long.

Though ratings are needed in some form because they allow companies to be evaluated generally, their ratings serve more for eye-pleasing cursory ratings - and their changes are too static. What would be of better value would be daily updated composite indicators which compare companies on a variety of factors - this is in fact what the open market for debt issuance does - it would be more helpful to see the results of this in a consolidated form and would likely treat every company more fairly than the discreet bond ratings levels currently being used.

Sunday, December 28, 2008

Legg Mason Value Trust LMVFX

As I approach the end of the year, I'm sure I'm not the first to go off on Bill Miller, but I have to wonder if Bill feels his fund's objective - "The investment seeks long-term growth of capital" is a bit tongue and cheek.

Seriously - is this not a complete statement of the obvious for the entire investment world? Also - could it be more nebulous?

I'll throw one more stone before I ask some questions, not about Bill's long term performance, but instead - what has he been thinking lately?

10 yr performance = -48%
5 yr performance = -53%
1 yr performance = -59%
6mo performance = -39.42%
3mo performance = -33.49%
1mo performance = 4.94%

By lately - I mean the last 3 months. I'm sure some will say he bought into what he thought was "deep value", but c'mon - you had screamers all over warning it was coming and you tanked your fund early in 2008 buying into it (it being the eye of the credit storm). But then you didn't sell - and got killed again. I guess now everyone in the fund is has assets that are classified as "value" NOW, but I think the idea would have been to buy the cheap assets when they're down and sell when they've appreciated - not the opposite!

My question is - why not sell off some stuff in 2007 when you're 5yr return had you at 40%? Wouldn't it be time for some sector rotation after a 7yr bull market? That would have saved everyone the +40 to -60% turn that ensued.

Also - "value" seems to imply good ways to invest your money - steady returns that don't chase whatever bubble seems to be bubbling...not quite fitting the bill here either Bill.

My only question now is - what do you think is going to happen to your reputation when investors actually think about putting money back to work. Do you think you're going to be their guy? Sure - if that guy is the one who laid them in front of the tracks of the latest bubble while calling the fund "value". I'm sure there will be at least one sucker. All the others will be just praying their investments come back - giving new meaning to the fund objective of "seeking long term capital appeciation".

Thursday, December 25, 2008

Exodus - "Movement of the People"

As in any recession, there is typically a re-aligning of people who lose their jobs and move to new ones. The interesting part of this exodus is the mass amount of people who move from / within the financial services industry. If I'm at all right about the this (which I think I am) - you'll see the lower "expendable" grunts get the can by the higher up personnel who've made a name for themselves.

The potential problem and opportunitiy with this is - the expendables have probably been slaving away and working hard and watching the higher up personnel in their recent progression to folly. Basically - the bench players have practiced with and seen all the "professionals" playbook and know all the flaws. This makes them better able to write the next chapter where profit will be made.

Its not that the power players don't have talent - its that they lack some degree of detail during the good times. The guy in the back room making all the models for the big wigs probably included the cautionary statements...do you think the big wigs included those cautionary statements in their pitches? Hell no - thats not how you get to be a big wig.

So what you get is - talent at the bottom, rolodex at the top. The issue now is - with the amount of money being lost by big money players - how much of everyone's rolodex has been shredded? How much are the "big wigs" worth in the long run versus the up-coming little people who actually know how the whole thing happened and can avoid it next time around?

I'm not saying bottom vs. top or the opposite - I'm just saying that CEO's know nothing about the potential details of Value at risk calculations. They don't know where the next punch is coming from to "cold cock" them...and neither do their direct reports. This is simply because too many layers of management separate the knowledge from the decision...and this says to me that flatter and smaller is the new new thing.

So - if you're trying to build another Goldman or Merrill - look for the middle guys and put the hard questions to them - they're free of their employer and ready to tell you how it is - if you ask them to tell you. This could be the best defense going forward we all could ask for....it surely isn't Robert Rubin.

Tuesday, December 16, 2008

Bottom is In - "Yep", now what?

As a follow up to my prior post - let me say Ben Bernanke made it completely clear this afternoon that the bottom is indeed in and dares us all to figure out the biggest question of all "what's next?"

Just a quick summarization of Bernanke's move - he's daring you to put money in a "safe" haven like treasuries. He knows its all there now, whether it be the you or the world at large that is hoarding into the treasuries for safety - he is using the psychology of fear to start the printing presses to effectively sell your feeling of security in the U.S. (through your demand for treasuries) when the market is high for them, to buy everything that has been crushed which explicitly will include Fannie and Freddie debt, but could include basically whatever!

So - for all you people looking to buy security through t-bills, STOP IT, YOUR LOSING MONEY! Take advantage of what the Fed is now doing to rewind the tape back to 2002! Keep in mind you've seen this movie before and so has the fed. Rates will remain low until the first sign of recovery appears. Once this happens rates will then rocket back to levels more accustomed to historical levels and perhaps higher.

For those not yet getting my drift - deny the adjustable rate option on your mortgage - find a 30yr and fast! Don't plan on euphoria forever - that is just stupid - plan for a government repayment period when the economy seems likely to handle it - that means higher taxes wherever possible.

Ok, so now that you've refinanced and you're wondering what next? Duck and cover - take advantage of balance transfer offers if they make sense, consolidate your debt as soon as possible. Do this and you'll be much better off for the next hangover which will come much quicker than the one we're in now relative to the last boom.

Now - stock you shouldn't buy if you plan to own them in a year:

Home Builders - you have to know this next affordability push won't last beyond the first steady signs of recovery. That is - there is no bright future here.

Commodities - buy now if you're aggressive - you'll get a ride. Hold for the anti U.S. inflation protection (oil), but don't expect $150 oil anytime soon. Too much government and consumer "memory" about this situation.

Banks - big yes! They're covered because they're the market maker for everything and their nemesis - homes - is going to get cleaned up in large part. Don't get greedy, get early!

Construction/Industrial - yes. This includes the cement and asphalt companies on roads etc. This also includes semi-green companies - those that have existing businesses, but also have green-ready segments. Look at AMAT.

Emerging Mkts - Yes. They win, we lose - long term. Buy them now, buy emerging market bonds (conservatively) and some indexes and you'll be happy.

Dollar - No. Buy the UDN (bear dollar index) or commodities. The beauty of anti-dollar indexes is they HAVE to do the work to move against the dollar, whereas oil could in some weird investment universe collapse with the dollar (think U.S. armageddon).

More to come here - but start with this.

Friday, December 05, 2008

The Bottom is In

Yep, it is in. Not today, but the low's give our take 100-200 points on the Dow. Don't laugh - 100-200 isn't an equivocation its just actually a fairly tight range given the Dow has been moving 200-600 points per day regularly for the past 2 months.

So, every time anyone makes a bold prediction like this, I always instantly want to know why so I can mentally lambast them for putting so much hubris on the line. Since I'm being so bold - I'll indulge all those like myself.

For months we've heard of pundits and talking heads stating that this could be the worst recession since the Great Depression. I promise you that you can find an almost endless list of "worst since" statistics that eclipse even the capabilities of baseball commentators statistics spewing while filling dead air-time between pitches. Only someone living under a rock hasn't heard of the trouble we're in and everyone who cares has heard enough bad news and seen enough retirement exploding statement declines to know and act on the worst case. I won't even bore you with stats on mutual fund redemptions blah blah blah...just watch the television.

The fact that today the market rallied in spite of a massive suprise in the number of job losses (and not the good suprise) as well as a revision of the prior months losses to the upside signals that the psychology of the investment community has moved from shock to recovery. They know its going to be bad, they're ready for more of it - and they've ACCEPTED it. Think I'm crazy - ask yourself "what other choice do they have, but opportunism?" When people start to think like this - they've reconciled their losses and have moved to the phase of "how do I get back on track".

I blame it on the unconditional eventual optimism of humanity. I'm not being teary-eyed and optimistic - its hard-wired and predictable. Once you stare into the abyss and see the potential for doom, you panic, and then if it isn't the abyss and you're still alive - you move to survival mode - "what do I do now", and start planning for the future - one day, then one week and so on. Don't believe me then answer this - If you thought the future was doomsday - why are you going to work on monday? Because you're unconditionally optimistic, no matter how cautiously. If the present is tough you think of the future while you struggle to get there. This is "expectation" and its the basis for the stock market - your expectation for the future has to be brighter strictly from psychology - how else would 6 in 10 people think they'll be a millionaire someday even though only 2 will actually become a millionaire? Bet on this drive - its simple, non-specific, but its buried deep in human drive and it is the real engine of the U.S. economy and in many places the world economy.

So, people have seen losses, they've suffered the abyss. They will be tested again, but we've already been tested enough that some people have come to the realization that some sort of world will go on and they're figuring out how to benefit from it. That is why the bottom has been reached, we may scrape along the bottom, perhaps drop below for a brief few moments (a day or two), but make no mistake - it is in.

Thursday, December 04, 2008

Its Time For The Realtors to Share the Pain

Something occured to me last night when I heard that the National Association of Realtors was pushing for a plan to have Fannie Mae and Freddie Mac (the Government) work to produce a plan whereby new homebuyers could get 30yr fixed loans at somewhere between 4 to 5%. Before I tell you, a slight digression on this suggestion is in order.

First, this plan touches what I feel is the main issue - a glut of homes, but the manner in which they suggest it and the source from which it comes is both unrealistic, harmful, and more greedy and self-interested than anything the U.S. auto industry could concoct for themselves. Believe me, that is saying something!

First - the manner in which it was suggested was somehow leaked such that it could be mis-construed as an actual plan from Treasury. This confusion is simply wreckless at a time when banks are trying to dip their toes back into the water with lower rates for new mortgages. The Fed lowered rates to give them another nudge, but by saying the government is going to buy mortgages through the maligned bellweathers of this crisis at rates more than 200 basis points below the current market is ludicrous. This sends a message to any private money interested in buying these mortgages that they should stop, take 2% less and get a sudo-treasury at a time when the 10 year t-bill is being bought so feverishly its yield is below 2%. Nice trick, but this is the opposite of helping the banks get back to responsible lending precisely because its an artificial subsidization of the mortgage market which makes them unable to compete. Why give them money, then make it impossible for them to profitably invest it? Worried banks are hoarding the bailout TARP money - do this and you'll assure it and only because you're wrecking their market! Think I'm siding with the banks? Well, if 30yr rates went to 4.5% - it would be the lowest in almost 70 years.

Now, if you believe the plan is ridiculous, now see where it came from - the realtors. I'll be short but incisive here - have you seen ANYTHING from the national realtor association saying they'd be willing to lower commissions by 50% for the next year to entice people to sell rather than walk away? I sure as hell haven't. Lets put this idea in perspective to normal people - selling a home using a realtor entails a typical 6% fee. on a $200K home - that is $12000 - not exactly chump change! If this were cut to $6000 (3%) it would effectively cause the price of home declines to instantly increase by 3%!!!! Considering we're dealing with a national decline average of 10% - this change would reduce this number and accelerate the adjustment and increase the volume of homes sold immediately!

I work in the retail industry and when demand flags we see retail cuts and cost cuts. We share in the cuts, and it helps in increasing volume. Its time the realtor industry joined in this - don't cry about the lack of homebuyers - cut your commissions and put it on the sellers price or toward closing costs in a transparent manner and you'll be amazed. As our customer says in my industry - you'll make the cost reduction up in volume. Time to get on board.