Thursday, April 29, 2010

An Opportunity Lost and A Question Answered

Market insights from the folks at PIMCO always have my attention, and Mohamed El-Erian's latest piece answers the question I posed about waiting to see what Greek sovereign debt might morph into, and here is what he says:

"Meanwhile, the disorderly market moves of recent days will place even greater pressure on the balance sheets of Greek banks and their counterparties in Europe and elsewhere. The already material risks of disorderly bank deposit outflows and capital flights are increasing. The bottom line is simple yet consequential: The Greek debt crisis has morphed into something that is potentially more sinister for Europe and the global economy. What started out as a public finance issue is quickly turning into a banking problem too; and what started out as a Greek issue has become a full-blown crisis for Europe."

So now that a lot of easy money has been made on Greece, market participants are positioning Spain and Portugal for the next quick strikes. However, beyond all of this lies a disturbing question. The universal, complacent consensus is that short rates can stay this low because there is no sign of inflation on the horizon. It can't possibly come back because of the high unemployment rates and slack in capacity utilization rates. Everybody agrees, with the exception of one Fed Governor who voted against maintaining short rates at these levels and the Polyannish language about sustaining these rates forever. Does this kind of unanimity and complacency remind you of anything? What about our old consensus that housing prices could only move in one direction?

I think the Fed should have taken a step to move away from its position right now, while things were not in a full blown crisis. A cynic could ask about the upcoming mid term elections. In the absence of government budget discipline anywhere in the US and the EU, it just seems like a debasement of currencies and some significant international dislocations could be coming down the pike later in 2010.

Monday, April 26, 2010

Parasites of Spring

In last week's post, we wrote, "The price of Greek debt is the next worry." As some economic numbers talk of Spring, today's WSJ notes two year Greek sovereign debt quoted at 13.5%! Mama mia! That's a serious risk premium. Of course, it's more than that: it's the speculators taking a run at the Greek nation with a blue and white bulls eye on its back. There is now blood in the water.

Simon Johnson in his blog suggests that US banks at the IMF meetings are even talking their book and whispering about Greek defaults. I've never been a grassy knoll aficionado, but it's quite consistent with Wall Street's unrepentant and unflagging appetite for feeding on carrion. In a way, it's Wall Street saying that it doesn't believe that our politicians have the smarts or the appetite to close the casino. We'll know more as this incipient crisis plays out.

Friday, April 23, 2010

Thoughts of Spring

It's official: my friend who deals with rail cars has said for months that loadings have looked better across all classes of commodities, from back in January. Now, there's official news from Federal Reserve statistics that manufacturing activity is broadly up in the first quarter (autos, computers and equipment, apparel and leather goods, and machinery) beyond inventory replenishment. Another manufacturing friend described it this morning as seeing some pent up demand from his customers. So, the expected first quarter GDP increase should be between 3.5-4%, according to AllianceBernstein.

I'm having trouble following the statistic that exports are up at an annualized rate of 22%--where are these going? Europe is traditionally our largest trading partner, and it doesn't seem to square with their domestic growth statistics, but there it is. Some commodity prices have bounced off their bottoms and appear to be firming. But again, with the market already having had such a strong move up, then these numbers should be already baked in.

The price of Greek debt is the next worry. It seems like the combination of Greek government pig headedness, German and French lack of leadership, and speculators seeing a juicy target may conspire to create the next potential global contagion. Financial press calls for the Obama administration to show leadership on this issue are misguided: if the EU can't find the technical and political wherewithal to defend their own monetary union, there is certainly nothing to be achieved by American jawboning.

Definite signs of economic spring, but stay tuned.

Tuesday, April 20, 2010

Nothing New Here

It's a shame that the SEC has chosen this action against Goldman Sachs as proof that they have reawakened from their multi year slumber. The current SEC Chair is trying to reinvigorate an agency badly damaged by neglect under previous administrations. Her efforts should be applauded.

However, Wall Street has always been rife with conflicts of interest, and the bigger clients come first in every instance. The clients demand this treatment, and if they don't get it, they take their business elsewhere. Remember when Claude Raines says to Humphrey Bogart, as the Nazis are walking into the Cafe Americain? "Monsieur Rick, I am shocked...shocked to find out that there is gambling going on in this establishment!" Nothing new here.

Trying to prove that this case rises to the level of fraud is tilting at windmills. Not to mention, that a retired fighter coming out for her first fight shouldn't take on the world champion! The champ has a lot of strong corner men too, like Robert Rubin, Gerry Corrigan, Bill Dudley.

It's also disappointing that the issue is splitting along party lines. There are myriad significant problems that need to be addressed, and although this case is not the poster child, it is laughable that the parties can't agree on some level of reform of Wall Street.

Tuesday, April 13, 2010

Still Missing the Mark

Brokerage house strategists make a big deal out of announcing their annual projections for earnings of the S&P500. Sometimes firms trumpet the fact that the estimates are "bottoms up," that is put together by sectors, relying on the expertise of analysts following the companies in a sector. Based on these magical numbers, and a wave of the hand to calculate "normalized P/Es" comes the pronouncement that the market is undervalued and the recommendation to mortgage the farm to purchase the firm's Buy List. It was always hard enough to analyze and value individual companies, but put it together into projecting an index and a Ouija board would have been a better tool.

Recent work by the McKinsey Corporate Finance Practice shows that in every year from 1985-2008, the actual S&P 500 earnings number was significantly lower than the earliest estimate for the year, and the estimates migrated only slowly towards the actual number.

Over the past 25 years, annual EPS growth estimates have ranged from 10-12% per year versus actual growth of 6%. This excludes a period of extreme estimate giddiness from 1998-2001!

The McKinsey researchers note that the November 2009 implied market P/E of 14 projected an earnings growth rate of 5%, which is in line with the growth of nominal GDP. Over the long run, earnings can't deviate too far from this growth rate, excluding post-recession snapbacks of earnings.

Executives at firms whose earnings projections are allowed to wander off into fantasy land should hold themselves accountable for not reining in estimates. They should also focus on clearly articulating their business models and on shaping their disclosures to allow capital markets actors to do better at consistently estimating earnings.

Monday, April 12, 2010

Finra Sticks It to Bond Fund Investors

FINRA today announced that certain bond mutual funds must cease providing the average credit ratings for their portfolios, because the companies use different methodologies to compute the averages. If the agency is worth the cost of funding it, why doesn't it come up with an acceptable methodology and tell all the firms to follow it? If there is one average statistic that is useful for a high level view of a bond portfolio, it is the average credit quality of the portfolio. This allows at least a quick and easy comparison between two bond funds. Equity mutual funds need to have some of their portfolio descriptors examined, but the average credit quality, as measured by the average bond rating should be a no brainer. Taking this away from investors seems ill advised.

Now, at the same time, the SEC is proposing to give institutional investors in ABS securities more information for making their investment decisions. Whereas the current regulations require only statistics that describe the overall composition and performance of the asset pools underlying the securities, issuers would now have to provide much more details about individual loans in the asset pool, namely underwriting statistics, as well as payment performance. This seems reasonable and not unduly burdensome for the packagers of these securities.

So why on earth should bond mutual fund investors be left in the dark about their portfolios?

Thursday, April 8, 2010

Buy High, Sell Low

An interview with the manager of Davis Venture Fund featured a reference to two interesting studies. Their own study of ten year performance (ending 2009) of large-cap fund managers showed that 96% of the top performers spent one three year period in the bottom half of their category. Also, 47% spent one three year period in the bottom decile of their category. Of course, most sales and marketing literature, including a lot of the fund rating services, trumpets the past twelve months. Actually, when one looks at ten year periods, it's amazing how many fund managers don't add value for their fees.

They also cite a Delbar Quantitative Analysis of Investor Behavior study (1989-2008) that shows the average fund mutual fund returning 8.9% per year over the period, while the average mutual fund investor over the same period gained 1.9%. The reasons were the tendency to buy what just went up over the past year, as well as dumping an investment class as soon as it tanks. Buy high, sell low--even institutions fall prey to this human foible.

Being an Audit Committee Chair

A new blog entry by Keith Higgins of Ropes & Gray LLP cites the case of Vasant Raval, the audit committee chair of infoGroup, Inc. who consented to an injunction and agreed to pay a $50,000 fine for not stopping $10 million of payments for illegal perks to the CEO along with $9 million in related party transactions. Having been a public company audit committee member and chair myself, it seems rather odd for the SEC to have made an example of the directors and officers of this company, when the folks at Lehman Brothers Holdings (board, officers and auditors) seem to have not suffered even an Excedrin headache for their contributing to the destruction of billions of dollars in value while also cashing out hundreds of millions in stock sales ahead of the collapse. "Bad facts make bad law," according to Mr. Higgins.