JPM Getting Out In Front of Mortgage Writedowns

JPMorgan's generosity to homeowners willing to keep paying their mortgages is nice:

The offer extends to customers of Washington Mutual Inc., the savings and loan JPMorgan agreed to buy last month, the New York-based bank said today in a statement. Loan modifications may include interest-rate or principal reductions.

Of course, if they're willing to adjust terms they'll eventually have to write down the $110B value of these mortgages on their balance sheet. That's just as well, since TARP money won't be going to buy up mortgages anyway. Well done, JPM. Now if only Wells Fargo could follow suit instead of unrealistically extending the period during which they recognize a mortgage as non-performing.

Nota bene: Anthony J. Alfidi does not hold any positions in JPM or WFC at the time this commentary was published.

The Haiku of Finance for 10/30/08

Wall Street privilege
Entitled to bonuses
Paid from Fed's bailout

Have Bonus, Will Bailout; No Bonus, Go Boozing

I hate to say I told ya so, and I don't like being right about these things. Tom Wolfe's "Masters of the Universe" think that they're genetically superior to the rest of us, which is why they will never give up their bonuses:

Wall Street's chief executives will hunker down and pay bonuses this year in the face of the worst financial crisis since the Great Depression, a taxpayer bailout and mounting political outcry, industry veterans say.

The threat of Congressional subpoenas doesn't deter these people. They contribute money to Congressional campaigns to forestall just such an outcome. Even though the share prices and earnings of their firms have tanked, they feel the need to be incentivized not to leave Wall Street for greener pastures . . . where? Hedge funds? That sector will be sliced in half within three months. Private equity? M&A deal flow has dried up. Regional banks? TARP money will force larger banks to gobble them up and throw their employees out with the trash. That leaves your local credit union. Ah, yes, picture a bunch of Harvard MBAs disgruntled with Congressional caps on their seven-figure bonuses muscling their way into doing loan approvals down at the corner of 5th and Main. Ain't gonna happen, sports fans.

These people see themselves as indispensible, and their self-importance grows with every new neat idea for bailouts to be covered by the TARP, like this one for mortgage workouts:

The FDIC and Treasury program would provide incentives to mortgage lenders and loan-servicing companies to change their loans, ``along with a framework for modifying them systematically into long-term and sustainable, affordable mortgages,'' Bair said.
(snip)

The plan would apply to banks, savings and loans, hedge funds and other mortgage holders, the people said. While it would provide guarantees for about $500 billion in mortgages, it would cost about $50 billion that would be covered by the bailout package.

Not every Wall Streeter is lucky enough to be raised with a sense of multimilliondollar entitlement. The ones unlucky enough to have no pedigreed connections to bail them out after layoffs are falling back on Plan B for Bartending:

A growing number of out-of-work New Yorkers are turning to bartending, according to school directors. Enrollment in the American Bartending School in Manhattan climbed 53 percent from last October to 84 pupils, the most for the month in five years, director Joe Bruno said in an interview.

Maybe one way to survive Great Depression 2.0 is to cozy up to a pedigreed Wall Streeter and offer to be their footstool. These people are always in need of nannies, personal shoppers, and other peons they can push around. They have plenty of practice pushing around elected officials.

The Haiku of Finance for 10/29/08

Bailouts for mergers
Wall Street business as always
Wasting tax money

Blown Bailout Bucks

Congress has begun exercising its oversight of the financial bailout. Our leaders are becoming alarmed that the almost $350B spent so far is supporting M&A transactions and executive bonuses instead of asset writedowns, so promised by Paulson & Co.:

In a letter today, House Speaker Nancy Pelosi of California and Senate Majority Leader Harry Reid of Nevada urged Paulson to put tougher restrictions on severance pay, or so-called ``golden- parachute'' payments, for executives at participating banks.

In addition to executive pay, the Treasury also came under fire from lawmakers for letting banks use their capital injections to make acquisitions, like PNC Financial Services Group Inc.'s Oct. 24 takeover of National City Corp. in Cleveland after receiving $7.7 billion from the government.

If they didn't know already, our elected leaders are getting a lesson in how Wall Street operates. Greed rules, to put it simply. Brokerages hoodwink clients and investors by overpromising and underdelivering. When caught, they spew weasel-words to make clients think that they asked to be deceived all along. This is why I stated my opposition to the bailout weeks ago. I knew exactly what would happen.

I also think I know what will happen "going forward." (Don't you hate that term? It's gained currency in business reporting in recent years.) Congress will posture in an attempt to assuage popular anger over the misuse of bailout money but will quietly approve as even more money is spent. Goldman Sachs alumni are in charge of all aspects of this bailout, and what Goldman wants, Goldman gets. Brokerage executives will collect their multibillion-dollar bonuses on schedule as a reward for running their overleveraged business models into the ground. The stock market will decline further as Great Depression 2.0 gathers steam, stoking popular anger that the next administration will use to launch a massive fiscal stimulus (infrastructure spending).

Most importantly, the same banks and brokerages receiving bailout money will line up to finance this infrastructure spending with federally-guaranteed credit facilities to the firms involved (construction, engineering, energy, etc.).

Lesson for investors: choose your sector rotation strategy accordingly. Just follow the money.

News Flash: Ecuador Disses Preppies!

I never thought I'd find myself agreeing with a contemporary of Hugo Chavez, but this one is golden:

Leftist Ecuadorean President Rafael Correa welcomed Wall Street investment analysts losing jobs in the financial crisis, calling them lazy yuppies who criticized governments without doing research.

He dislikes preppies almost as much as I do, and for the same reasons. Their smarmy superiority and intellectual laziness have long been a pestilence south of the border.

"When I was minister, it was unbearable to have a line of those kids asking for an appointment so that I could do their job. They'd ask you for your analysis and then present it in a report as if were their own," he added as he hosted fellow South American socialist Venezuelan President Hugo Chavez.

Don't worry, Senor Correa. Preppies are now on a permanent vacation, and they won't be flying down to see you because they've maxed out their rich daddies' American Express Black cards.

The Haiku of Finance for 10/28/08

Emerging markets
Look to the West for credit
You can stop looking

Emerging Markets, Submerging

George Soros, whom I greatly respect for his seminal work The Alchemy of Finance, writes that developing countries need to strengthen the IMF's credit facility to keep emerging markets liquid:

In recent days there has been a general flight for safety from the periphery back to the centre. Currencies have dropped against the dollar and the yen, some precipitously. Interest rates and credit default premiums have soared and stock markets crashed. Margin calls have proliferated and spread to stock markets in the US and Europe, raising the spectre of renewed panic.

The problem with his proposal is that the West may not have a whole lot of liquidity to spare after backstopping their own economies:

Western Europe is on the brink of a recession, exacerbating problems for neighboring emerging economies, which were scorched by investors dumping riskier assets in a flight to safety. Hungary, which first drew up next year's budget expecting 3 percent growth, may now face contraction.

Even if the U.S. takes the lead in bucking up the IMF, Europe may not be able to follow suit. U.S. leadership won't mean much if future revisions to Bretton Woods put more authority in non-U.S. hands. Furthermore, Mr. Soros may be ignoring the role that U.S. regulators have already played in accelerating the spread of the credit crunch to emerging markets:

So the US authorities should have known - and presumably did know - that by allowing Morgan Stanley and Goldman to become banks they were in effect forcing a serious contraction in the hedge-fund industry, which in turn would lead to sales of all manner of assets held by hedge funds and precipitate turmoil throughout the financial economy.

The article points out that curtailment of prime brokerage activity, with the concomitant collapse of leverage available to hedge funds, helped drain liquidity from emerging markets. With banks hoarding the capital they've been handed so far under TARP, there is zero reason to think that additional credit for the IMF will be loaned to companies in emerging markets that need it.

Does Mr. Soros have long exposure to emerging markets that he's trying to salvage? Maybe he and Jim Rogers should talk privately with some Asian sovereign wealth funds and ask them for capital infusions instead of looking to the tapped-out West. SWFs have been disappointed with the stakes they've taken recently in U.S. banks and brokerages. They may have better luck shopping closer to home.

Nota bene: Anthon J. Alfidi holds uncovered short calls on VWO because he is bearish on emerging makets.

The Haiku of Finance for 10/27/08

Zero-cost startup
Entrepreneur in action
Move over, big guys

Business Busts Will Be Booming

A specialist in winding down failed startups drops some hints on why the IPO market will stay comatose for several years (end of article):

During the bubble, something like 1,600 companies were funded. I hear in recent years there’s between 1,200 and 1,300, including some older investments. I see VCs clearing out a minimum of one-third plus of those investments. The banks will tell you the same thing. It’s why you have to keep your powder dry. You really have to watch what’s going on.

Startups that want to survive will hopefully heed Sequoia Capital's advice and have a year's worth of cash on hand. On the other hand, there's money to be made in business liquidation services. Maybe all of those unemployed homebuilders and mortgage brokers can find work packing up the assets of bankrupt startups.

The good news is that serial entrepreneur Jason Calacanis thinks that zero-cost online startups have enormous advantages in a recession. We here at Alfidi Capital couldn't agree more.

The Haiku of Finance for 10/26/08

Dinosaur bailouts
Enormous capital costs
Extinction events

Dinosaur Bailouts Prolong Our Malaise

GM wasn't satisfied with the $25B of our money it got last month to keep it on life support. Now they want more of our tax money to fund their corporate development strategy:

Treasury Secretary Henry Paulson would prefer any assistance to come from the $25 billion low-interest loan plan for the auto industry to build more fuel-efficient vehicles, not the $700 billion bailout of the banking system, said the people, who asked not to be identified because the talks are private.

The requested $10B, presumably from Treasury's TARP, will go directly to Cerberus Capital Management. That's some compensation for about one year's worth of supervising a losing business that they bought for a song:

Cerberus's secretive chief, Stephen Feinberg, essentially paid nothing to DaimlerChrysler AG (now Daimler AG) for an 80.1% stake in Chrysler. He agreed to put $5 billion into Chrysler, and $1 billion into its financing unit. Cerberus secured $10 billion from investors to pull off the deal. Mr. Feinberg's goal was to spiff up the company and sell it or list its shares for a huge profit -- a feat Cerberus had pulled off many times before.

A return of $10B in one year on a $10B original investment will certainly make Cerberus' investors whole. This ROI of 0% would be accompanied by the unfortunate moral hazard of backstopping the private equity business model. Excuse me, aren't LBOs supposed to be high-risk/high-reward propositions?

We can draw several conclusions from this tomfoolery. First, the stated reasons for giving bailout money to corporations with broken business models mean nothing because the rules can be changed at will. GM was supposed to use its part of the $25B loan plan to retool, but now it appears it may use it for M+A adventurism. Second, government agencies will throw good money after bad with little consideration. AIG needs more money too. Finally, piling more money into malinvestment will prolong America's emergence from Great Depression 2.0 and make our industries less competitive when they do emerge.

My solution: No more bailouts for automakers and their private equity enablers. Let failed U.S. carmakers go bust or be bought by healthier foreign firms like Toyota (or even India's Tata Motors). But no one asked me for my input, so that probably means the new loan to GM/Chrysler/Cerberus will be approved. Bummer.

Hey, is that a dinosaur over there? Oh, wait, that's just GM's latest goverment-subsidized showroom model.

Nota bene: Anthony J. Alfidi does not hold a position in GM at the time this commentary was published. He does, however, currently own a Ford Mustang.

The Haiku of Finance for 10/25/08

A surging dollar
Precursor to asset sales
Dangerously high

Hedge Fungus Dingbats and a Dangerous Dollar Make My Life Richer

Hedgies are cratering due to poor performance and client withdrawals, and even the sector's superstars are coming up short:

U.S. hedge-fund managers may lose 15 percent of assets to withdrawals by year-end while their European rivals shed as much as 25 percent, Huw van Steenis, a Morgan Stanley analyst in London, wrote yesterday in a report to clients. Combined with investment losses, industry assets may shrink to $1.3 trillion, a 32 percent drop from the peak in June.

Why would anybody pay a hedge fund manager 2-and-20 to sit at least 70% in cash? I can do that on my own at zero cost. Unfortunately I have to keep my cash in U.S. dollars, which are becoming dangerously overvalued:

The dollar gained the most in 16 years against the currencies of six major U.S. trading partners as a global economic slowdown spurred demand for the greenback as a haven from losses in emerging markets.

A surging dollar cannot last in the face of massively inflationary Fed liquidity measures, nor can its global supremacy survive demands for a restructured global financial system:

Asian and European leaders called for an overhaul of World War II-era banking rules, lending support to French President Nicolas Sarkozy as he pushes the U.S. to embrace greater supervision of global financial markets.

There is no better time to hold a globally diversified portfolio than now. I am staying long the U.S.'s primary creditor (China) and the dollar's primary competitor as a store of value (gold). So what if the past couple of months haven't been kind to them? I'm prepared to wait many years for them to pay off.

Nota bene: Anthony J. Alfidi is long FXI (with covered calls), IAU, and GDX.

The Haiku of Finance for 10/24/08

Preppie hedge fund dude
Unwind your losing stock trades
I'll buy them up cheap

Going With VIX Options

Last Tuesday I hinted at adding a pure volatility play to my investment strategy. Now I can go into more detail as to why this is worth doing. Check out this chart of VIX:IND from Bloomberg:

The latest version of my portfolio report at Alfidi Capital shows that I have added VIX options to my toolbox. I recently sold Nov 08 puts on ^VIX at 28 based on my belief that this market will be wild for the forseeable future. The continuing collapse of the hedge fund industry means forced selling will continue for several months.

Nota bene: Anthony J. Alfidi holds short puts on VIX at the time of publication of this commentary.

Closer and Closer to a Full Mea Culpa

Alan Greenspan may be growing increasingly concerned with his place in history. He is beginning to admit that his low-interest rate bias wasn't a good idea, although not in so many words:

Greenspan told the House Oversight Committee that his belief that banks would be more prudent in their lending practices because of the need to protect their stockholders had been proven wrong by the current crisis. He called this a "mistake" in his views and said he had been shocked by that.

The trouble with economists is that their models take all of the emotion out of economic behavior, which is still ultimately a competition for resources driven by an evolutionary bias for reproduction. Behavioral finance is beginning to account for this gap, but Mr. Greenspan is still bewildered by it in his testimony (end of article):

"It was the failure to properly price such risky assets that precipitated the crisis," Greenspan said.

No, it wasn't a failure of pricing! Easy money drove risky pricing when the Greenspan Fed kept short term rates artificially low after the dot-com blowout. He must be aware of this criticism of him by now, but he wouldn't even address this line of questioning during his testimony.

Give him a few more months. He'll come around when people start calling this "Greenspan's Depression."

The Haiku of Finance for 10/23/08

Greenspan admits "flaw"
Surprised bank lending went wild
Won't admit his guilt

Shipping Stocks Sinking, So Let's Find a Floater

Take a look at the Baltic Dry Index chart from Bloomberg. (I'm too cheap to pay for membership in the Baltic Exchange. Always get a free source!) It's been dropping like a rock lately:





Lower rates for carriers of sea cargo are reflected in the decline of the Claymore/Delta Global Shipping Index ETF (SEA), which has lost over half its value since it debuted in late August this year. The decline in value of a security representing an otherwise indispensible industry doesn't necessarily make it a good buy . . . for me anyway. SEA isn't optionable, but some of its holdings are.


Shipping companies that will do well in Great Depression 2.0 should have market leadership and low debt. I've got a couple of candidates in mind, and I may add them to my portfolio by the end of the year.

The Haiku of Finance for 10/22/08

Get your MBA
No one will hand you a job
You have to earn it

Free Career Advice for MBAs From Alfidi Capital

(Loyal readers, here's an excerpt from a recent I email I sent to contacts in the University of San Francisco's MBA program. I show loyalty to this school because it gave me a research fellowship to defray the cost of my tuition. The school demonstrated faith in my abilities by putting its money where its mouth was, thus earning my support. People and institutions who have failed to support me earn my undying scorn.)

Hey current students! You are your own brand! Check out what Tom Peters has to say at http://www.fastcompany.com/magazine/10/brandyou.html for more wisdom. Rely completely on your own initiative to find a career you like, because no one can do it for you. USF lacks the endowment size and name recognition of Harvard or Wharton, and you have to compete directly against Stanford and UC Berkeley in your own backyard. That means that Fortune 500 companies won't necessarily come to you; you have to go to them. Once you figure out which niche fits your personality, network with every group you can find therein and keep every business card you collect for future updates and informational interviews. Here's where social networking tools like Facebook and LinkedIn come in handy, so check out my profiles there. If a big company isn't for you, there are plenty of startups to meet at SVASE, The Indus Entrepreneurs (http://www.tie.org/), and the VC Task Force (http://www.vctaskforce.com/). Get on their email lists to keep abreast of their many ongoing events. Temp work with firms like Robert Half might be necessary to survive Great Depression 2.0.

The Haiku of Finance for 10/21/08

Preppie analysts
Confused assets with earnings
Please fire these losers

Your Regional Bank is Next in Line for a Bailout

More banks are in trouble:

A bevy of regional banks reported worse-than-expected third-quarter results on Tuesday, burdened by investment losses and higher credit costs — a stark indicator of more loan troubles ahead.
(snip)

Many of the regional banks said they are considering participating in the government's plan, which analysts agree will likely give a boost to earnings going forward and relieve some of investors' concerns surrounding capital levels.

I bolded the nonsense above to show just how clueless some investment analysts can be, and how equally clueless some journalists are for reprinting their guesses. I've been harping a lot on bad earnings news lately as a rationale for keeping new cash out of the stock market (for now). The above AP article's insistence that somehow a capital injection will help earnings is nonsensical. The bailout addresses balance sheets, not income statements. Only someone who flunked Accounting 101 would count a capital infusion toward earnings! Wasn't that one of the tricks that sunk Enron six years ago? Spoiled Ivy League preppies who get hired as analysts must have never paid attention in b-school.

Earnings will continue to suffer as consumers default on credit card debt and auto loans at least through Q209. Watch the headlines for more confirmation.

The Haiku of Finance for 10/20/08

Gimme some credit
With earnings still declining
It won't help at all

Earnings, Not Credit, Scare Bears Away

Some market analysts are pinning their hopes for a renewed bull market on historical analogies, according to this:

Patterns of previous crises in the past half century suggest interbank lending rates tend to reach extremes about two months after a major financial shock, some note. In the past week, incipient signs that credit conditions are easing -- albeit with the help of colossal central bank liquidity injections -- are starting to conform to this pattern.

Traders are counting on a rise in sentiment to push stocks higher when economic fundamentals are still clearly deteriorating. Wall Street expects excess liquidity and wishful thinking to inflate another asset bubble, just as they did after 2002.

Wait a minute. "This time it's different." It's different because U.S. households had a debt service ratio of 13.85% in Q208, according to the Fed. Paying down this debt ratio even to the 10-11% levels of the 1980s requires households to spend less than they earn. This huge hit to consumer spending will soon make its appearance in disappointing corporate earnings reports:

With little question the U.S. is in the grips of a recession, investors this week will lean on a stream of earnings and economic reports to help determine exactly how prolonged and painful the downturn might be.

There's certainly been fresh evidence the credit market has begun to thaw. But, that alone might not be enough to restore confidence in the stock market at a time when investors are clamoring for stronger signs of a bottom.

Good luck finding a bottom. We're just not there yet.

The Paralysis of the Analyst

Analyst overconfidence is a perennial feature on Wall Street:

According to a recent survey by Thomson Financial, Wall Street analysts are expecting earnings for companies in the Standard & Poor’s 500-stock index to soar 40 percent in the fourth quarter, versus the year-earlier quarter, and 20 percent in 2009, versus 2008. Even more astonishing, those consensus 2009 projections have remained fairly steady in recent months, despite growing fears among investors that a recession is unavoidable.

“Wall Street analysts are notorious for being overly optimistic,” said Christopher N. Orndorff, head of equity strategy at Payden & Rygel, the asset manager based in Los Angeles. “However, the cold, hard reality of disappointing earnings will be with us for some time longer.”

This problem was supposed to have been solved after the dot-com bubble burst, when settlements with regulators forced investment banks to put "Chinese Walls" between their analysts and those bankers prepping road shows. Good luck with that one. Sell-side analysts will always be seen as shills for their bankers.

Fortunately some academics have looked into the age-old problem of analyst mis-estimation of covered companies. Simple honesty and a forced distribution of buys and sells seem to work best. Even Merrill Lynch recently tried to get with the program:

But some in the financial industry say it may be too late for research departments at Merrill or other investment banks to reclaim the credibility and prestige they lost after the technology stock bust. Hedge funds, which account for up to 75 percent of trading on some markets, conduct much of their own research and often pay twice the going rate on the Street for analysts. Many banks, by contrast, have cut research budgets.

Now that many hedge funds are snowballing towards an apocalypse, they'll be laying off a lot of those highly paid analysts. So where does this leave the downtrodden i-bank analyst? Will they regain the esteem they had before dot-bombs and hedgies blew away their bonuses? Most of them will be lucky to have any jobs at all after the Sovereignty Crunch makes Wall Street a much less profitable place.

I'll bet my career that independent sources of analysis (like this blog!) are the future. Bloggers' reliance on ad revenue can keep them free from conflicts of interest. Too bad a lot of unemployed preppies won't catch on to the trend. They're not self-starters and would have to have Daddy Warbucks hire a consultant to explain to them what "initiative" means.

The Haiku of Finance for 10/19/08

Preppie banker dude
You're out of work and money
Get out of my way

The Best Writings So Far on the Credit (Sovereignty) Crunch

Here's a Sunday special.

Anna Schwartz has the best prescription on how regulators should handle insolvent financial institutions:

"I think if you have some principles and know what you're doing, the market responds. They see that you have some structure to your actions, that it isn't just ad hoc -- you'll do this today but you'll do something different tomorrow. And the market respects people in supervisory positions who seem to be on top of what's going on. So I think if you're tough about firms that have invested unwisely, the market won't blame you. They'll say, 'Well, yeah, it's your fault. You did this. Nobody else told you to do it. Why should we be saving you at this point if you're stuck with assets you can't sell and liabilities you can't pay off?'" But when the authorities finally got around to letting Lehman Brothers fail, it had saved so many others already that the markets didn't know how to react. Instead of looking principled, the authorities looked erratic and inconstant.

Way to go, Anna! In a just world she'd be Fed Chairwoman or Treasury Secretary. Unfortunately we live in an unjust world, where well-born preppies from "Government Sachs" make decisions with other people's money after they've calculated the impact on their own personal investments and careers:

They note that decisions that Mr. Paulson and other Goldman alumni make at Treasury directly affect the firm’s own fortunes. They also question why Goldman, which with other firms may have helped fuel the financial crisis through the use of exotic securities, has such a strong hand in trying to resolve the problem.

In other preppie-related news, Andrew Lahde's farewell letter to colleagues in the hedge fund industry lambastes the spoiled brats whose stupidity helped him make money:

The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.

I couldn't agree more. I used to think that people from privileged backgrounds had insurmountable advantages in the game of life. Not anymore. Great Depression 2.0 will be the great leveler, laying waste to mountains of "old money". My own new money is coming along just fine. Mr. Lahde, enjoy your early retirement. You've earned it. I'll be right behind you.

The Haiku of Finance for 10/18/08

Hedge funds unwindng
Disgorging their best stock picks
Bargains aplenty

Acquisition Wires: Sources for Special Situation Investing

Some of you may be wondering, "Where does Tony Alfidi get his M&A news?" Okay, even if you're not wondering, I'll tell you.

I check Reuters' Deals page almost daily to see summaries of the latest M&A annoucements for large, publicly traded firms. I will only consider a target company that has agreed to a friendly transaction as a candidate for my arbitrage play. Hostile takeovers entail too much risk. If the target fights the acquisition, or another suitor offers a larger bid, I run the risk of having to unwind a position at a loss.

Once I identify a candidate (usually the target, but sometimes both the target and acquirer) I plug its ticker symbol into Yahoo! Finance and look at its option chains. Nine times out of ten I sell call options to generate arbitrage profits on a deal, as I prefer to buy an underlying stock only on long-term holdings. If I decide to sell an option on a candidate company, I go for the longest possible expiration date that is just above the agreed-upon deal price. This tactic almost certainly ensures that the option will expire worthless when the deal is closed. I say almost because there is no way to eliminate risk entirely from any investment decision.

It's that simple! There are other sources available for M&A news, but I'm not going to pay for them. The best things in life are free. Just like this blog.

The Haiku of Finance for 10/17/08

Buffett says to buy
With hedge funds bleeding out cash
I can wait longer

Uncle Warren Says Buy, But I Say No Thanks

Warren Buffett penned a rare op-ed in the NYT today enjoining investors to start buying stocks again:

To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Mr. Buffett qualifies his advice by saying that "sound companies" rather than "all companies" are a good buy, so he's apparently got a few beaten-down value stocks on his mind. So do I, but I'd like to see my candidates go a bit lower in the short term. Widely followed indexes like the S&P 500 and the Russell 2000 have a bit farther to fall themselves, IMHO.

But will other investors follow his advice? Probably not this time, for a reason I'll discuss below:

In better times, such a clarion call from Buffett -- amplified Friday by repeated commentary on CNBC -- might spark a big stock market rally. Yet stocks ended another volatile session lower on Friday, after fresh economic data elevated worries about a potentially deep recession.

A constant stream of deteriorating macroeconomic news is not the only reason to keep fresh cash away from the markets for now. Hedge funds that are unable to unwind their illiquid positions - derivatives and MBSs- have to meet investor demand for redemptions by selling their equity holdings:

"Forced selling to cover redemptions and delevering by hedge funds has put downward pressure on selected stocks," David Kostin and his colleagues at Goldman wrote in a note to clients earlier this month.
"We expect hedge fund selling/deleveraging to continue," they added, while telling investors to bet against stocks heavily held by hedge funds and to buy stocks with the fewest hedge funds as shareholders.

Thanks for the advice, Uncle Warren, but I think you're still a few months premature. Sound companies are indeed being beaten down by The Great Hedge Fund Unwind of 2008, but why not wait until most of the hedge fund industry has collapsed before going shopping for equities? Mr. Market hasn't quite finished wringing his anxieties out of U.S. stocks, so I'll stay on the sidelines until he's done.

The Haiku of Finance for 10/16/08

Chinese market math
Margin and shorts will add up
To liquidity

The Maturation of China . . . and the Limits of Capital Markets

Chinese regulators are moving to allow margin trading and short selling in China's stock market:

``We must pay attention to the risks involved when we pursue financial innovations,'' Shang said. ``China will study the links between innovation and risks from the financial crisis and the fundamental reason that caused the crisis.''

China's central bank is also showing off its learning curve:

China has already cut interest rates twice in recent weeks, and with the business climate worsening, many economists say a further relaxation of monetary policy as well as tax cuts and increases in public spending are only a matter of time.

Only time will tell whether they truly apply the lessons of the credit crunch. Human greed and hubris always find ways around regulatory mechanisms, so the key to effective regulation IMHO is to build capital markets that are as simple and uncluttered as possible. Maybe the ideal solution is to go no farther than allowing margin, shorting, and simple options in a stock market. Banning any more complex product or procedure will limit the damage that investment banking chicanery can inflict. Clear definitions of permissible securities will make garbage like swaps or bundled derivatives grab the attention of regulators and invite penalties.

Ban all derivatives! Who's with me? Let's hear it.

Nota bene: Anthony J. Alfidi is long FXI (with covered calls) at the time this commentary was published.

The Haiku of Finance for 10/15/08

Bernanke bubbles
Promise you won't inflate more
One is too many

Bernanke Reconsiders Bubbles

Now that Chairman Bernanke is getting valuable first-hand experience in treating the aftereffects of an asset bubble, he acknowledges that it pays to prevent one from inflating in the first place.

Officials should review how supervision and interest rates can minimize the ``dangerous phenomenon'' of bubbles in housing, stocks and other assets that risk bringing the financial system and economy down with them when they burst, Bernanke said.

We have no idea whether the Chairman reads his critics. Note to Ben: It's tougher than it looks. First you have to admit that abnormally low interest rates encourage reckless borrowing.

The article also reveals the extent of his headaches in bailing out "too big to fail" institutions:

The U.S. faces ``a very serious too-big-to-fail problem,'' in which the insolvency of a large financial company could threaten a market collapse, Bernanke said in reply to an audience question. ``There are too many firms that are in some sense systemically critical.''

Mr. Bernanke, the solution is to let failures work they way they always have: Equity shareholders lose their investment, creditors become the new shareholders, and the firm continues to operate under the supervision of bankruptcy courts.

I Knew It Wouldn't Last

The bailout bonanza I mentioned in today's haiku is now in full swing, and yet recession fears have not been calmed. Like I speculated in a post yesterday, the market will eventually weigh in with a bearish forward-looking assessment of the U.S. economy's growth prospects. Asian markets have started to resume their downward trend.

I'm wondering whether the time might be right for a play on market volatility using VIX options. I'll let you know by next week what I decide to do.

The Haiku of Finance for 10/14/08

Bailout bonanza
Buy banks' bad bonds and stock too
Big bucks for buddies

The Haiku of Finance for 10/13/08

Dow rockets upward
But what goes up must come down
In a crash landing

Wow, How 'Bout That Dow

Traders worldwide simultaneously reached liftoff today when the Dow rocketed up in its all-time largest one-day gain. Traders were definitely reacting to the G7 action plan crafted this weekend. Tomorrow is just as likely to see huge index gains as traders anticipate the announcement of TARP purchases of banks' equity, not to mention expanded FDIC insurance.

Does this mean the bear market is over? No way.

"The stock market is a voting machine in the short run and a weighing machine in the long run." The wisdom of Benjamin Graham is useful at times like this.

Panicky traders are voting on short-term liquidity measures, but the market's long-term prospects will be weighed down by declining corporate earnings. Today GE announced a 22% drop in quarterly earnings. Several major banks and corporations will announce 3Q earnings this week, and IMHO the results will not be pretty. Too many people who should know better are still hoping for a V-shaped recession.

I'm still bearish, and I plan to stay that way through 2009.

The Haiku of Finance for 10/12/08

Don't time this market
Leaders change the rules at will
Can't call bottom yet

Fair Value Isn't Always Fair When You Need It To Be

There's a guy over at SeekingAlpha who thinks the market is near a bottom. The author cites a lot of technical data to support his contention that the market is oversold and investors should feel comfortable buying again.

The problem with this kind of analysis is that it's derived from the past performance fallacy: it assumes that future recoveries will be like past recoveries. The difference this time is that the U.S. economy is laboring under a huge debt overhang that needs to be paid down before corporate earnings can start contributing to equity growth again. Treasury's TARP (ugh!) and the Fed's commercial paper facility (double ugh!) haven't even started buying up debt yet. Markets won't be able to judge whether any of these actions are effective until they've been in operation for several months. Even the G7 coordinated rate cuts will have a six-month lag before the economy feels their effects.

Nouriel Roubini also thinks the market is oversold, but then goes on to state that only drastic macroeconomic policies can stave off further declines. He clearly knows that our previous understanding of when equities are "oversold" is about to be seriously tested. Is the S&P 500 fairly valued at 1000? I'm not going to take that bet.

This kind of stuff makes me glad to remain bearish on everything except gold (a true store of value) and China (which holds the largest store of currency reserves).

Nota bene: Anthony J. Alfidi holds short calls on SPY and IWM but does not own the underlying shares; he is long FXI (with covered calls), IAU, and GDX.

The Haiku of Finance for 10/11/08

Finance ministers
Meet to save economy
Too little, too late

The Haiku of Finance for 10/10/08

Bearish on a bank
Recovery in question
Keep that share price low

Wachovia: A Special Situation

"Oh the Wells Fargo wagon is a comin' down the street . . ." Right to Wachovia's doorstep, delivering salvation from insolvency. (My apologies to The Music Man.)

It looks like the dust has finally settled in the Wachovia/Wells Fargo/Citigroup menage-a-trois, although this one was a bit less amorous than a typical dalliance. Federal regulators have offered an early termination of their antitrust review, which means that there is no longer any legal obstacle to the deal. Citigroup abandoned its own bid for the bank yesterday. My best guess is that once Citi saw how hard it would be to raise the capital needed to both shore up its own balance sheet and support Wachovia, they decided to tend to their problems at home.

My play: This situation is no longer as fluid as it looks, so I'm going to treat it as a special situation. I have sold uncovered Jan 11 calls on WB at 10 and 12.50. Why did I pick that date? Because I wanted to capture as large of a time premium as I could. I went out for the longest possible expiration date because Wells Fargo expects the deal to close by the end of 4Q08. Why did I pick those strike prices? Because I don't think they'll be triggered. Wells Fargo had offered Wachovia shareholders 0.1991 shares of WFC for each WB share they hold. I believe the possibility that WB will rise to $10 by Dec. 31 of this year is next to none, because that would mean that WFC would have to rise to $50.22. Such a leap would require a massively positive earnings surprise from the Wells Fargo wagon in 3Q08, and I do not believe that is going to happen in this recession. An additional factor weighing down WFC's share price is Citi's lawsuit seeking damages for horning in on WB. Even if the suit is thrown out as a nuisance, it should add enough uncertainty to this deal that Mr. Market holds WB's price under $10.

On a side note, I can't help but refer to my earlier post about the power of Goldman Sachs alumni to influence the outcomes of deals. Goldman guys won this one, hands down.

Nota bene: Anthony J. Alfidi does not hold a position in the underlying common shares of WB or WFC at the time this commentary was published. He has never ridden in the Wells Fargo wagon (sniff).

The Haiku of Finance for 10/09/08

Exploding debt bombs
Destroy economic growth
Finance in a hole

Sympathetic Detonations

A sympathetic detonation occurs when an explosive charge ignites another nearby explosive. This example from WWII shows that they have a productive use in neutralizing explosive sources that can't be safely disarmed.



Asian markets have opened by selling off on Oct. 10 in response to the Dow's downward move on Oct. 9. The Dow's plunge was the initial charge, and other equity markets are just as pregnant with danger. The difference here is that these explosions are not being set intentionally to reduce harm. They are instead the result of decades of accumulation of DEBT, a supercharged force that is dangerous when stretched, overconcentrated, or otherwise mishandled.

There may be a lesson here for investors.

When you see unexploded ordnance, call your local bomb squad or demolition expert. Just don't go near it.

When you see a debt-laden corporation or national economy, call an expert in international finance and get them to defuse the situation. Just don't go near it.

(And some of you were wondering when I'd throw a military analogy into my blog.)

Nota bene: Anthony J. Alfidi is completely debt-free, unlike many Americans.

The Haiku of Finance for 10/08/08

Shiny solar cells
A bad long term investment
Metals are too rare

Looking for a Solar Energy Play (Long Term Only!)

I like renewable energy, but I have serious doubts about the long-term viability of some energy technologies. Solar energy sure sounds like a neat idea, especially when you read articles like this:

Demand for solar panels still exceeds supply despite a global financial crisis, allowing solar power company Suntech Power Holdings Co Ltd to keep 2009 price declines in the range it had previously forecast.

Chinese solar companies aren't the only ones optimistic about the future:

Solar cell maker First Solar Inc has felt no immediate effect on its business from the financial markets crisis and could take on a role in financing new projects or buying into new technologies, Chairman and CEO Michael Ahearn said on Wednesday.

That all sounds really great, but there's a problem with this latest asset bubble scenario. Thin film solar makers like First Solar depend on rare source materials, and First Solar in particular depends on cadmium telluride. This rare material isn't available in quantities large enough to sustain First Solar's long term economic viability. Solar companies predicting rapid, massive market share growth might be right for maybe the next three years, but after that they will hit a resource supply wall that make them look like low-yield, no-growth utility companies after 2011.

I like Jack Lifton's articles on rare metals. I met him at the Las Vegas Hard Assets Conference this September and I listened closely to his thoughts on resource availability. Read this for some solar sanity:

There is simply no possibility of increasing the production of cadmium, indium, gallium, tellurium, or selenium to any volume remotely near what would be needed to make enough thin film solar cells to make even a dent in total global demand for electricity production. The US today has an installed capacity of 4,200 gigawatts. Of this total, the current total from solar of all types is 0.6 gigawatts.

And this for some more stuff to chew on:

Therefore, assuming that all of the new indium produced in the world could be utilized to produce CIGS thin-film PVSCs, the result would be the production of an additional 10 gigawatts of electricity annually. Although the first year would mean a multiplying of the contribution of ‘solar’ to the electricity supply by 20; the contribution would only double the second year when compared with the first year, and so on until by the 20^th year the additional contribution yearly would be less than 5% of the total supply of solar generated electricity.

Thanks, Jack. I get the point. Solar photovoltaic cells in any form have limited utility in the future due to the scarcity of resources used in their production.

I would like to propose the following general rule: The least complicated technology that uses the most widely available source material has the greatest likelihood of long-term commercial viability. I'm looking for investments in renewable energy that apply this principle.

How about solar thermal technology? Mirrors are simple and cheap to produce, so the materials involved in building the control systems for heliostats are the keys to viability. Google invested in eSolar, a solar thermal startup. More about this technology in a future blog posting.

Nota bene: Anthony J. Alfidi does not hold any position in GOOG, FSLR, or eSolar at the time this commentary was published.

The Haiku of Finance for 10/07/09

Asian stocks still fall
Euro banks now need rescue
We're in for it now

Re-Opening BAC Short Call

I'm still pretty miffed at having to unwind my bearish position on BAC last week, so I've decided to re-start it now that financials are looking a heck of a lot weaker. I sold short Nov 08 calls on BAC at 40, comfortably above the 35 strike price I had the last time. Comfortable for me, that is, given my risk-seeking tendencies.

Could BAC go to $40 by November, thus forcing me into another unwind? Perhaps, but the news out of Charlotte today isn't pretty. Here's an excerpt:

Late Monday the bank announced it would cut its dividend to 32 cents per share, down from 64 cents per share. The move will save the company nearly $6 billion annually in capital. In addition, the bank began a $10 billion sale of common stock.

Cutting the dividend by 50% and diluting shareholders by more than 8% are never good in the short term, even though BofA is doing this to stay healthy in the long term. Ken Lewis did the right thing.

This market is nuts, and I might be nuts for playing it. So what. I can handle the risk.

The Haiku of Finance for 10/06/08

Markets still plunging
Bailout had zero effect
Brace for turbulence

Imclone: A Special Situation

Imclone Systems (IMCL) and Eli Lilly (LLY) announced today that they have agreed upon Eli Lilly's final buyout offer of $70/share for Imclone. Rival bidder Bristol-Myers Squibb (BMY) has abandoned its competing offer and is willing to walk away with a payday from the surrender of its existing stake in Imclone.

My play: Looking at the long-duration option chains, this is a classic special situation play. The longest calls available, Jan 10, haven't been zeroed out yet. Today I placed an order to sell uncovered Jan 10 calls at 75, well above the final agreed-upon acquisition price. I expect the value of these options to fall slightly upon order execution tomorrow, but I should still net something to make this worth my while. I may go long the stock of IMCL in the near term, but the market's continuing weakness means that I'd miss out on some bargains in the widely-held ETFs I'm following. Stay tuned.

Nota bene: Anthony J. Alfidi holds no positions in the common shares of IMCL, LLY, or BMY at the time this commentary was published.

The Haiku of Finance for 10/05/08

Those dark liquid pools
Hide trades, bets, swaps, and fraud too
Uncle Sam fell in

Dark Politicians of Liquidity

Investment analysts sometimes refer to dark pools of liquidity - private trades of liquid securities between financial institutions that avoid the open market. We're going to be seeing a lot more of these in the near future thanks to the bailout, with the crucial difference that a major counterparty will now be the U.S. Government.

Treasury will start implementing the bailout plan this week, with or without a well-defined structure for managing and auditing transactions. Uncle Sam has contracted with BGI and State Street to start the purchases, but are they using the reverse auction process that Bernanke and Paulson outlined in their testimony? I wouldn't bet on it. Those two firms have gigantic internal crossing networks and access to other private networks, and these dark pools of liquidity can hide a lot of transactions from the prying eyes of government auditors. Congress' toothless oversight board won't think about prying into those firms' proprietary crossing networks, and they may need a Congressional subpoena to do so if the thought to peek in actually occurs to them.

Hank and Ben are probably just betting that they can keep Congress in the dark while they keep the banking system afloat by flooding institutions with purchase orders for junk MBSs above fair market value. They're going to have to throw money away to prevent all these banks from failing. They'll also have to buy a lot of non-mortgage debt, so you can count on that $700B bill to double in FY09. They may even try to buy MBSs directly from pension plans, which is where those internal crossing networks will really come in handy. BGI and State Street both manage assets for huge pension plan clients.

Will they succeed? Maybe if every European country legislates bailouts of their own banks. All of this capital that could have gone to productive investment in the public commons - infrastructure, mass transit, green energy, and the like - is now going to cure a hangover.

The Haiku of Finance for 10/04/08

LIBOR basis points
Rise to reflect default risk
TED spread increases

The Haiku of Finance for 10/03/08

Financial meltdown
No way to avoid it now
Invest in canned goods

A Sad Day for America

Today the Emergency Economic Stabilization Act of 2008 became law. A few dozen Congresspersons changed their minds after getting panicked calls from constituents who think that the U.S. Government is responsible for supporting their retirement portfolios. In a big way, that responsibility is now in effect.

Generations of Americans now think of themselves as consumers rather than citizens, and look to their government as the ultimate provider of services and solutions. Entitlement programs like Social Security and Medicare have conditioned people to think this way. Citizenship requires some elements of sacrifice and self-denial, values which many Americans are now constitutionally (pun intended) incapable of rendering.

Americans decided today that future indebtedness to foreign creditors is more acceptable than the short-term pain of liquidating bad assets in a recession. This, my readers, is the essence of what I call the Sovereignty Crunch. Americans have decided to trade away control over their future for the illusion of material prosperity today.

Is Wachovia Worth Fighting Over? Goldman Sachs Sure Thinks So

Today Wachovia (WB) announced that it has secretly agreed to a new buyout offer from Wells Fargo WFC), presumably without informing its previous suitor Citigroup (C).

``Citi has substantial legal rights regarding Wachovia and this transaction,'' the New York-based company said in a statement. ``Wachovia's agreement to a transaction with Wells Fargo is in clear breach of an exclusivity agreement between Citi and Wachovia.''

Yeah, if I were Citi I'd be mad too. Vikram Pandit must be fuming, "How dare they hook up with my prom date!" So what gives? What makes Wells Fargo think it can supercede Citi's offer? Simple. Wachovia's CEO, Robert Steel, is a Goldman Sachs (GS) alum and former colleague of Treasury Secretary Henry Paulson. Goldman seems to be positoning itself as broker-of-record for the project of saving the U.S. financial system, so what Goldman wants, Goldman gets.

In a time when our Treasury Secretary seeks financial powers far beyond what any government official has ever possessed, blowing off a merger deal already approved by the FDIC looks like no big deal to a Goldman alum. If the FDIC's Sheila Blair insists on standing behind the Citi deal, Secretary Paulson may make it tough for her to borrow the money she'll need to replenish the FDIC's insurance reserves. The Wells deal actually does the FDIC a favor by eliminating the need for a guarantee of Wachovia's deposits, thus freeing the FDIC to shore up other troubled banks.

Goldman guys play for keeps!

Nota bene: Anthony J. Alfidi does not hold any position in WFC, WB, C, or GS at the time this commentary was published.

The Haiku of Finance for 10/02/08

Volatility
Plays havoc with strategy
So stick with long plays

Unwinding XLF

Yesterday I sold the long put I had against XLF. I have noticed over the past couple of months that the put's time value was declining even though its intrinsic value was increasing. I decided not to push my luck much farther, as this put has showed an enormous gain since I bought it near the beginning of 2008. I'm glad to pocket the extra cash.

Given the probable success (ugh!) of the revised bailout plan, the share values of XLF's components will probably be propped artificially for months to come. Keeping zombie banks and brokerages alive indefinitely might make political sense to some people, but it makes zero investing sense to me. I'll have to look elsewhere for more special opportunities, because this one in financial services has run its course.

The Haiku of Finance for 10/01/08

Those old bailout blues
Senate went and done us wrong
She done billed us all

I've Got Those Bailout Blues :-(

The U.S. Senate passed the revised bailout bill, laden with pork projects and special interest payoffs. Asian markets were nonplussed nonetheless.

But even if the package is approved, investors are skeptical about the bailout's ultimate impact on a faltering global economy, analysts said.

Investors are skeptical? No kidding? Really? I'm not playing this, no way, no how. Every time I try to do the sensible thing and make some money in a bear market, the referees change the rules. Even if I wanted to act, the SEC continues to restrict the tools I may use. Keep those shorts off:

Federal regulators on Wednesday extended an unprecedented ban against all short-selling in the shares of more than 800 financial companies, keeping it in place at least until after Congress enacts a massive financial bailout plan.

The SEC will end the short ban on Oct. 17, anticipating the bailout to be law by Oct. 14. The bear trap is set, and the Plunge Protection Team is ready to spend serious money to spring it.