Friday, May 29, 2009

Krugman vs. Faber vs. Reality

As I write this the market is flat, two of the world's most recently prominent economists argue deflation versus hyperinflation, and the reality of of a woeful economy persists despite a market that continues to hold ground.

Paul Krugman's weekly op-ed piece this week refuted claims for possible inflationary pressure despite unprecedented money pumping by the government. That money is not being circulated by banks he claims, so it has no impact at the present while prices continue to fall. Yes, home prices and the prices of bankrupt car companies do continue to fall, while oil will achieve it's largest one-month gain in 10 years by the end of today. Gas will hit $2.50/gallon before June, and the price of grains are insidiously rising again. You know, Paul, stuff people actually have to buy to live and work.

Meanwhile, Marc Faber is pushing a "Zimbabwe" like hyperinflation scenario due to our government's printing press with dire ramifications. After a rebound call in the markets, Dr. Doom has returned to his bearish ways.

Why such discrepancy in the interpretation of the same events? First of all, as we've discovered quite clearly over the last 2 years, economists work off of flawed models based on past events. The forecasting ability of these models to predict future events given never-used-before inputs is worthless. Second, deflation as pointed out by Itulip on a daily basis, is commonly referenced in regards to all goods and services in total, such as housing. A decrease in home prices is not deflationary if it's the result of an implosion of home equity losses and foreclosures, at least not for the people going bankrupt or homeless as a result. Meanwhile, paying more for health insurance and gas while wages go down, is inflationary.

Perhaps there's a reason why John Paulson (made billions betting on housing collapse) and David Einhorn (predicted demise of Lehman and Allied Capital, now betting against Moody's) have just bought huge stakes in GLD, our gold ETF. They not only think this rally is garbage, but that when inflation kicks in, they'll have a very nice hedge.

Despite it's lofty rise, the markets couldn't be happy with reality numbers this week. "A record 12 percent of homeowners with a mortgage were behind on their payments in the first quarter, the Mortgage Bankers Association said Thursday." That's 1 in 8 homes. But even more disturbing is those with "good" credit are now hitting a 6% delinquency rate. Despite massive sales of foreclosed homes (45% of all recent used home sales), home sales are not rising rapidly. Add in the Case-Schiller numbers that are somehow still declining in this crater (I thought we'd seen the bottom, right?), and people are just nuts to think this economy is improving. Even the CEO of McDonald's said there is no sign of a bottom, despite the company's ability to undersell Starbucks lattes by $3.

Saturday, May 23, 2009

Too Many Holes, Not Enough Fingers

The dam is still bursting, albeit more slowly with the creation of new government "fingers" to plug the holes on a weekly basis. Despite this intervention however, the real economy continues to deteriorate on multiple fronts.

GM will be bankrupt as early as next week. Why people pushed the stock up to $2 before a near 50% plunge I'll never know. More job losses on top of the 637K level we just saw. Just as a reminder for anyone who can read a graph. The job losses over the last 18 months show a shooting line up and to the right. Based on our population, it is not feasible to lose many more jobs on a monthly basis (say, 1 million/month) than we are now. This has to level off at some point. Don't mistake that for economic improvement any more than a leveling off in the decline in housing prices. This number can't reach 100%.

California is bankrupt. But so soon will be Ohio, Michigan, Indiana, and based on the number of Illinois banks getting shut down on a weekly basis, I would bet that they're not doing too well either. As local and state governments fail to meet budget restraints caused by huge shortfalls in tax revenue, what will our national government do? Yes, bail them out. But where will it end and how much more pain is the American taxpayer willing to to take?

Speaking of us, the taxpayers, did anyone like Timmy Geithner's response as to whether or not TARP repayments will be used to pay down national debt? I hope not, as he seemed to think those payments will just reinflate the value of his credit facility, not give us our money back. Combine that with the fact that warrants are being paid back at potentially pennies on the dollar and we see that none of this will be very profitable for main street.

The credit card legislation is being pushed through at warp speed. Consumer protection measures are good, but let's not forget what credit is. It's money that's not yours. My coworker was arguing with me about a sudden change in her terms that she she can't afford and may have to default on her payments. She was a little surprised when I didn't offer her sympathy, but instead the advice to not spend money she doesn't have. More so than personal changes, I'm curious to see how card companies respond to the legislation and subsequent effects on retailers.

That Florida bank failure took a week longer than expected, but doesn't anyone seem to care that Bank United is the largest failure since IndyMac, and will cost the FDIC $5 billion?

Wednesday, May 20, 2009

4 Things That Should Make You Angry

1. The Pension Benefit Guaranty Corporation is $33.5 billion dollars in debt. Furthermore, the geniuses in charge were paying large fees to the likes of Goldman for investment advice over the last few years, leading to an implosion of their holdings. So, for those of you like myself in your mid-30s or so, add an unfunded pension to the demise of Social Security and Medicare by the time we've put in our 30 or 40 years.

2. Alan Grayson. No, he shouldn't make you angry, just his unanswered questions to officials in the Fed and Treasury. Actually, you should add him to the short list of politicians (Kucinich, Paul) who actually seem to be disturbed by the illegal use of powers those institutions have employed during this crisis. When asked by Grayson where the $1 trillion in direct balance sheet holdings and $9 trillion in off-balance sheet holdings have gone, Inspector General of the Federal Reserve Elizabeth Coleman said, "Uh, I don't know." Grayson then asked, who would know? No answer. This is Paulson all over again. We are printing money and giving it to the banks without any concessions or even Congressional approval.

3. Lost in the post bailout euphoria is not only the issuance and subsequent devaluation of common shares by large banks, but the sudden huge increase in insider selling by the C-levels of those banks. Quite the opposite of Vikram Pandit buying shares ahead of leaked good news, these guys are dumping shares after the recent run up at all-time rates. "Insiders from New York Stock Exchange-listed companies sold $8.32 worth of stock for every dollar bought in the first three weeks of April, according to Washington Service, which analyzes stock transactions of corporate insiders for more than 500 institutional clients." Very nice boys, glad we were able to salvage your bonuses after all.

4. Credit card reform, if you're like me and just use your credit card as a delayed debit transaction without accruing fees but while accruing bonuses, may not be so good for us. When companies can no longer zap their deadbeats for higher interest payments or one-time fees, they'll start looking towards their "good" customers for new ways to generate revenue. I've even read that they may start charging interest from the point of purchase. It would be interesting to see if these reforms actually destroy consumer spending, particularly on-line transactions even using PayPal (Max, perhaps you can comment on this in the actual comments section of the site, not in a direct response to me, would be helpful to all readers).

Friday, May 15, 2009

Green Shoots

After a huge runup over the last 10 weeks, the market ran out of steam this week despite "glowing" economic data such at flat CPI (only so because of YOY energy comparisons), a decrease in retail sales (can anyone be surprised by this?), and a sudden spike in weekly jobless claims (only the result of the Chrysler bankruptcy). Well, when one of the largest employers in the country goes bankrupt, that counts. Ditto 2 weeks from now when GM goes under and the combined 1900 dealerships are closed. That's a lot of jobs directly, and even more indirectly when you factor in suppliers. GM also didn't win any points when they announced that they'd consider importing cars from China. Thanks guys.

Meanwhile, we've discovered that Citi was able to negotiate their capital needs from $35 billion down to $5.5 billion. Interesting that Ken Lewis was unable to do the same for his dying company. And a mere week after the stress tests were released, banks are scrambling to raise capital as Fitch today downgraded the credit of those very banks we were just told had solid capital ratios. Right.

Oil did hit $60 this week and gold is above $930 again. Doesn't sound like a deflationary environment to me. More money was doled out today to insurers, who now need a bailout. Trucking company YRC want a billion dollars in TARP funds. Why not?

The SEC will soon be investigating, the SEC. Nice to know that our financial "watchdog" is looking into insider trading by two of its lawyers on info about the very companies they were watching over. Fills me with confidence that our government will set a strict new set of guidelines for Wall Street. At least they've finally gotten around to investigating the orange man, Angelo Mozilo, former CEO of countrywide. When he wasn't giving free loans to Senator Dodd, he was selling his bankrupt company to BAC without letting his shareholders know.

Sheila Bair, head of the FDIC, hinted today that some of the CEOs from distressed banks may be replaced in the next few months. The FDIC immediately refuted this report as the CEOS let the FDIC know that Sheila Bair may need to be replaced if she doesn't play nice with Timmy and Benjy.

Oh, and S&P said the banking crisis may persist until 2013, but only if you counts stuff like losses and bad loans. In about 5 minutes we'll find out that several Florida banks have failed. Green shoots.

Sunday, May 10, 2009

No Spendee, No Ponzi

Lost in all of the stress test buildup last week was the largest decrease in consumer credit ever recorded, $11 billion in March. This means people are actually attempting to pay off credit cards and not taking on new debt. Interesting, yet we're told that banks need to get a lendin' again to free this credit up, stoke our GDP, and allow the overbuild of inventories to add multiple points to the bottom line of our Ponzi economy, built on 70% consumer spending.

Well, it won't be so easy. Inventories will not ramp up to the unprecedented levels seen before the collapse. Oil will hit $60 again, possibly this week. Banks are hesitant to lend to the deadbeat consumer. Gone are the days of walking into Best Buy or Rooms to Go and using your 500 credit score to secure 18 months of interest-free payments. No ticky, no laundry as my father-in-law likes to say.

But as we've seen over the last 2 months, even with unemployment hitting almost 9%, the market doesn't always deal with reality, and certainly can't "predict" a thing, let alone six-months into the future. I'm not convinced the optimism over bank profits will dissipate tomorrow, and certainly may ride through the false allure on the no-shorting/uptick rules waiting to take shape. With this in mind, I'm ready to roll our profits from last week into a new hedge.

You may recognize the major player, Citi. Citi treated us well by shooting up Thursday, putting our calls into 200% return territory. But at $4, I'm not sure Citi is done with its CDS plunging in price (optimism over no nationalization) and the sale of large assets such as Smith Barney pending. We all expect the crash, and it may be even harder now than we thought, but it may not be tomorrow. Phase 1, 9/09 $5 calls at roughly .40.

The other half of the hedge is no stranger either. FAZ is the triple inverse financial ETF and has been getting hammered (aside from us buying it and selling it for profit on Thursday). Now at $4.49, it seems that even a 10% pullback in financials (a roughly 30% gain for FAZ) could be leveraged with calls out to 1/10 where the $5 calls are trading at roughly $2. If Citi explodes, we win, if it crashes and burn, we win, if it explodes and BAC crashes, we win twice. And, these scenarios are not mutually exclusive, as Citi may run through June and then crash. These longer-dated options give us some time for more extreme events. Obviously it would be wise to not purchase these things on the same day, as a rise in one probably means a fall in the other.

And thank you all for your continued support, we received our all-time high viewership last week.

Friday, May 8, 2009

Mediocristan or Extremistan?

In his book The Black Swan, Nassim Taleb refers to the two worlds above. Mediocristan encompasses the vast majority of bankers and traders, who mistakenly believe that their success is tied into some sort of patterned knowledge and "intuitiveness" of markets, never believing that their success is purely luck. Then Bear Stearns fails and all of their gains for the past 100 years are wiped out.

In Extremistan, seemingly unthinkable events play out with huge banks failing, stock markets crashing, and the U.S. running debt levels to that of a third world country.

I mention these because we made two trades that at least doubled our money over the last 10 days and a third that made us a nice profit in one day. Citi soared at the open yesterday before plummeting back to $3.50 at one point, and Fifth Third went from $3.70 to the mid-$6s (Dr. Mike predicted BAC would be the most volatile player under the stress test charade and with futures leaning towards $15, his call is looking excellent). FAZ soared after the initial bank run yesterday, and $6 calls at 10 A.M. doubled your money by 2. So, my "if you can't beat em', join em'" theory proved to be dead on, and thankfully, both of my brothers and Anonymous joined us for the ride. But my brother insisted on asking the question, "are we still in Mediocristan, a.k.a. did we just get lucky," and it's a good one.

I would argue yes and no. The results of the stress tests proved entirely predictable, and as my other brother pointed out, seemed "choreographed." Sources close to the banks kept leaking out possible results which turned out to be incredibly accurate. Geithner chimed in a few times, stating results would be "reassuring." So no, the actual results were certainly no black swan event. But I would argue that our government being forced through public outrage to conduct the charade of putting our banks through a test, an industry that has internal and external regulators, may be an event we might never see again. Once that mechanism was put in place, the outcome was inevitable.

So now we are stuck in no man's land. The sigh of relief has come, but everyone knows the tests were useless. Unemployment rose to 8.9% this morning. Gold and oil are climbing rapidly, not only on tepid recovery optimism, but belief in inflation. As oil head back towards $60 and unemployment coasts towards 10%, anybody still believe in this rally? I don't, but with the SEC still holding onto their no short card, I'm biding my time in commodities and watching Build-a-Bear head back to $4.

Saturday, May 2, 2009

What If They Don't Print It?

In 3 Days of the Condor, Robert Redford discovers a secret plot to invade the Middle East, which he relays to the NYT. Cliff Robertson, his branch director, asks him, "What if they don't print it? You can run, but how far if they don't print it?"

Well, the government is trying to see how long they can go without printing it, the stress-test results that is. The release has been delayed until Thursday after market close. They don't want too volatile a reaction to the news, but odd that they are releasing it during the week, especially prior to the April jobs numbers, which I suspect will be artificially low.

It's also interesting to note how much market sentiment has changed as GDP numbers were downright horrible at -6.1%. Markets still climbed on that news and fought through the Chrysler bankruptcy as well. Compare this to the initial Q4 GDP release of -3.8%, which was so blatantly false, the markets pummeled it. Optimism reigns over the big decrease in inventories, as the assumption is that reloading will spur GDP. Right, companies that are barely making at are going to load up on unsold inventories in our now booming economy....

Banks will spend the next five days trying to convince the government not to release bad results. Estimates on Citi range from a need to raise $10 billion, to a $500 million cushion. Estimates on BAC are all over the map, with the most dire predictions necessitating the need for $70 billion more. Fifth Third is on one analyst's upgrades, another analyst's list for possible nationalization.

At least some semblance of reality has returned, with BBW losing 30% this week. Turns out when malls keep closing and nobody goes to the ones that are open, it's tough to sell stuffies. Sales YOY down 20%.

This week promises to be incredibly volatile between the banks begging for mercy, the results that are released, the "real" results which we might never know, and the jobs report. Should be fun.