Oil Drillers Hit a Rough Patch

The underwater blowup that recently sank the BP Deepwater Horizon is now sinking drilling stocks:

Investors sold shares of companies with ties to oil drilling in the Gulf of Mexico as the industry came under greater scrutiny as oil from a massive spill reached the marshlands of Louisiana.

Shares in Apache (APA) sold off, which is probably unfair as they drill in shallower water and are exposed to less risk of a similar incident.  Even very diversified supermajors weren't immune to the selloff today.  Chevron (CVX) was down even though it doubled its Q1 profit:

Chevron Corp. said Friday its first-quarter profit more than doubled as oil prices soared over the past year.

That first sentence is the only excerpt we need from that article as it highlights a salient point about resource exploration.  The single most important determinant of a natural resource company's market value is the current market price of the commodity it produces.  Subtracting a company's cost of extraction from the value of its economically recoverable proven reserves yields a rough estimate of the company's intrinsic value. 

The price of oil is currently over $86 from expectations of stronger economic growth.  Anything that disappoints those expectations, like continued weakness in GDP growth or consumer sentiment, will hurt the price of oil and the value of companies pumping it. 

Full disclosure:  No current position in BP, APA, or CVX.

Wounded Warriors Polo Benefit 2010

I don't normally plug charitable causes on my business blog, but I'll make an exception for this one.  I strongly encourage my readers in Northern California to attend the Wounded Warriors Polo Benefit 2010 in Santa Rosa on June 20.

This event will raise money for the rehabilitation of American servicemembers who have been wounded in the nation's recent wars.  In addition to a live polo match, there will be a silent auction, a champagne divot stomp, some Argentinian BBQ, and loads of fun for rich and poor alike.  I will be there to support the cause and provide personal demonstrations of my amazing wit and enormous intellect.  I have also discovered from past experience that numerous attractive women from the Junior League and other social sets attend polo matches at this particular club.  Ladies, prepare yourselves for the mind-bending awesomeness that is Alfidi Capital's CEO.

Buffett's Realistic Position on Goldman Sachs

Warren Buffett prepares to weigh in on the controversy surrounding Goldman Sachs: 

Warren Buffett, who called Goldman Sachs Group Inc. an “exceptional institution” when he invested $5 billion in the firm, will have his biggest platform to discuss the bank after it was sued for fraud by regulators and pilloried in Congress.

I like Warren Buffett partly for his realism.  His visit to GS as a ten-year old was probably the first of many impressions he got of Wall Street's amorality, avarice, and ruthlessness.  That's why he's always shied away from working there himself, and why he could only stomach a short stint as Salomon's interim chairman.  The finance sector is just another industry to him, to be analyzed for opportunities on its own terms.  Investment bankers and traders serve a useful social function but attract personalities who range from unpleasant to uncontrollable.  The end state of analysis is to determine whether this natural state of affairs leads to profitable outcomes.

This is why we must put Warren Buffett's $5B GS investment in context.  His life's work is to find good investments that maximize value for his shareholders.  Here's what I'd say if I were in his place at Berkshire's annual meeting.

"Fellow shareholders, I'm sticking with my bet on GS.  I realize they're a vampire squid sucking the life out of our economy and all that, but that's what the financial sector has become.  Of course they've bought off Washington and forestalled any meaningful regulatory reform.  That's just a smart business move to protect one's franchise.  They've successfully penetrated government offices at all levels with former employees who still have deferred compensation arrangements through GS.  This gives them the ability to defend their competitive advantage as the world's leading investment firm."

Go for it Warren.  I won't hold it against you.  It's just business. 

Full disclosure:  No position in GS or Berkshire Hathaway at this time.

The Haiku of Finance for 04/28/10

Greek bailout cost soars
So where will they get the cash?
From the Fed, of course

Bond Investors Flee to Places Unknown

Bond buyers are freaking out over spiking Greek debt yields:

The decision by the leading credit rating agency Standard & Poor’s to cut Greek debt to junk and reduce the sovereign rating for Portugal sent investors scurrying to the safer havens of UK gilts, German bunds and US Treasury bills.

This so-called flight to quality will have a limited shelf life.  Let's leave aside for a moment the risk that German bond yields may eventually spike the more Germany entangles itself in an EU bailout of Greece.  That might be mitigated if near-term German elections bring new leaders to power who can scuttle such a bailout. 

The U.S. and U.K. have massive debt problems of their own, but the relative unattractiveness of other sovereign bonds artificially keeps up demand for gilts and Treasuries.  That relative advantage is temporary.  The sovereign credit problems facing the Anglo-West are not lost on the Chinese, who have discovered that they must raise interest rates to clear their bond inventory. 

I would not want to be in the Fed Chairman's seat when he comes to the inevitable point of raising rates.

Full disclosure:  No positions in U.S., U.K., German, or Chinese bonds at this time.

American Mortgage Acceptance Company REIT Bites The Dust

Here's more bad news for property owners.  A mortgage REIT is going bankrupt:

Real estate investment trust American Mortgage Acceptance Co filed for Chapter 11 bankruptcy protection on Monday, blaming a sharp drop in property values.

A quick look at their financials brings no surprises.  Their last three balance sheets showed increasingly negative retained earnings and free cash flow.  Their net income went sharply negative in 2007 and then their financial statements seem to disappear, with the exception of a few SEC filings in 2008 that indicate the likelihood that the company's operations will cease.  Numbers that bad never lie.   

REIT investors can look forward to more disappointing stories like this one.  Investors enticed by the cash flow of REITs should proceed with extreme caution.

Full disclosure:  No position in AMOA.PK.  Long puts against IYR. 

Newspaper Biz Continues to Spiral Down

In good news for bloggers like yours truly, the reading public continues to abandon newspapers:

Circulation continues to drop severely at U.S. newspapers, though the rate of decline slowed from the previous six-month reporting period.

Figures released Monday by the Audit Bureau of Circulations show average weekday circulation fell 8.7 percent in the six months that ended March 31, compared with the same period a year earlier. Sunday circulation fell 6.5 percent.

Keep up the good work, print media.  Oddly enough, that old stalwart the Washington Post Co. (WPO) has an ROE of 3% but is trading within 97% of its 52wk high.  Some folks are getting irrationally exuberant here.  Hey, WPO, don't forget to turn the lights off on your way out.  I'll be sure to let your last advertisers know that there's some space for rent here on my blog. 
 
Full disclosure:  No position in WPO.

The Haiku of Finance for 04/26/10

Hertz buys Dollar cars
But rental cars face Peak Oil
Guess they won't run far

Germany Throws Monkey Wrench at Greece

Germany continues to be reluctant to throw its hard-earned money into Greece's money pit:

German Chancellor Angela Merkel said she won’t release Greek rescue funds until the country shows it’s got a “sustainable, credible” plan to cut its budget deficit. A decision may be in a “few days,” she said.

Merkel's determination not to be steamrolled into bankrolling Greek profligacy is the reason the IMF will be leading the Greek debt rescue and not the EU.  Kudos to German leaders who continue to look out for their taxpayers' best interests. 

Elites on both sides of the Atlantic are desperate to keep the PIIGS' debt bomb from exploding, which is why the U.S. recently agreed to support a massive expansion of the IMF's standing credit facility.  The Anglo-West is going to try every trick in the book - along with some new ones they're still testing - to prevent Great Depression 2.0 from breaking out.  I do not think they can ultimately succeed.  We will all be poorer in some way whether we know it or not. 

New Flowchart on Financial Services Career Progression

In my never-ending quest to provide the financial community with much-needed assistance, I've published a new flowchart on career progression for financial services professionals at Alfidi Capital.  This flowchart should serve as a handy reference tool for aspiring bankers, traders, client relationship managers, analysts, and other types who wish to climb Wall Street's corporate ladder.  Alternatively, it can also serve as a warning of what to expect for employees who do not possess appropriate credentials, i.e., aristocratic pedigrees, lack of conscience, etc. 

Bankers Assemble Monster Products for Amusement

SEC actions are always a fun way to pull back the curtain and see how Wall Street really works.  Peering inside the Goldman Sachs sausage factory, we see how bankers put together their wonderfully innovative products:

As the U.S. housing turned downward in January 2007, a Goldman Sachs trader wrote in e-mails to a woman he apparently was courting that investments he had sold were "like Frankenstein turning against his own inventor."

Apparently when sharp MBAs get bored with ripping off their clients and hoodwinking regulators, they create mystery products that serve no useful purpose but somehow command a premium.  They then create proprietary indexes against which they can measure the performance of their mystery products, and these indexes are just as meaningless as the products.

Does any of this matter to investors?  Only if they're dumb enough to buy these Frankenstein securities.  Smarter investors (like yours truly) just wonder what all the fuss is about and move on. 

Full disclosure:  No position in GS at this time. 

Dodd Bill's Limits Take Shot at Fed's Independence

What's this I hear about the "reform" bill limiting the Fed's regulation authority to large banks?

A bill sponsored by Senate Banking Committee Chairman Christopher Dodd of Connecticut would limit the Fed’s authority to 36 of the country’s largest banks, those with assets of at least $50 billion, tying the Fed nameplate to firms such as Goldman Sachs Group Inc. and JPMorgan Chase & Co.

The Fed currently uses data from smaller banks to help assemble reports tracking the health of the economy.  The regional banks' "Beige Books" take into account inputs from many local sources, including contacts in the financial community. 

Arbitrarily limiting the Fed's authority to large banks makes little economic sense.  This is probably a political ploy, but who benefits?  The TBTF institutions would probably like having their own dedicated case manager at the Fed who isn't distracted by demands from smaller banks.  This would make it easier for Goldman Sachs et al. to dump degraded mortgage assets on the Fed when it's time for the next bailout. 

I guess community bankers didn't spend enough on campaign contributions to members of the Senate Banking Committee.  They have every right to worry that regulatory favoritism will be shown to larger competitors if this "reform" bill becomes law. 

The Haiku of Finance for 04/22/10

Greece set to blow up
Take notes and prepare yourself
Contagion will spread

Greece's Day of Reckoning Approaches

Will this Greek drama (pun intended) ever reach its denouement?  The entities that agreed to bail out Greece may now wish they hadn't done so, as concerns mount over rising spreads on Greek government bonds:

The International Monetary Fund has warned that Greece’s debt crisis risks spinning out of control, threatening to spill over across the region unless action is taken soon to restore confidence.

Consider the secondary effects that concerns over debt default are having on that country's equity markets:

Greek stocks declined for a second day today with the benchmark ASE Index falling 3.9 percent to 1,860.76, leaving it down 15 percent on the year. At 10 percent, Greece’s two-year bonds now yield more than the 10-year debt, indicating investors don’t believe the EU bailout plan will be enough to sustain Greece. Credit-default swaps to insure against a default in the coming year leaped 104 basis points to a record 744.7.

The lesson for American investors is that they should expect the same stock market reaction here when investors in our own government bonds eventually figure out that our social Security and Medicare programs are Ponzis that require more funds than the U.S. taxpayer can mathematically provide.

Just get this over with already!

Some Good Earnings Results, But . . .

In normal times, one would expect that reports of rising 1Q profits at eBay, solid 2Q earnings at Qualcomm, and a big government loan repayment from GM would allay fears of a double-dip recession and power the stock market to new highs.  Unfortunately these times aren't normal anymore.  The Dow closed up a very negligible 0.07% today. 

Can you see the future?  I can't, but futures traders certainly are trying.  Futures markets outside the U.S. remain concerned about a potential default on Greece's sovereign debt. 

Nota bene:  Anthony J. Alfidi has no positions in any stocks mentioned in this particular post.

The Haiku of Finance for 04/20/10

Volcano blew up
Cast a shroud over flying
Sinking air travel

New Alfidi Capital Flowchart on MBA Recruiting

I finally got around to publishing another funny flowchart.  Check out my corporate flowchart page.  The latest one provides some guidance for HR professionals looking to hire the latest crop of MBA talent. 

I long ago came to the conclusion that corporate recruting of MBA graduates is a well-organized circus.  Recruiters only pay serious attention to graduates of the top 25 schools; anybody with a degree from anywhere else wasted their time and money getting a piece of paper.  Even the best MBA grads can end up in environments that undervalue their potential and exploit their productivity.

I got off the recruitment treadmill two years ago when I founded Alfidi Capital.  No more career fairs for me, thank you very much.  Those of you still running in place for someone else's corporate amusement should read my flowchart and see what might be in store for you. 

Financial Oligarchs Thank You For Letting Them Rip You Off

Today a big-shot CEO thanks the taxpayer for enabling his bank's risk-free profits:

US banking giant Citigroup said Monday it had returned to profit after two years spent largely in the red, posting a profit of 4.4 billion dollars in the first quarter of this year.
(snip)

Chief Executive Vikram Pandit said the company had now turned a corner.
(snip)

"All of us at Citi recognize that we would not be where we are without the assistance of American taxpayers, said Pandit.

"We owe taxpayers a huge debt of gratitude for assisting us at a critical time. We are determined to repay this debt by continuing to build a strong company and contribute to America's economic recovery."

I love it when financial titans come clean about how they make money.  In a roundabout way, Citigroup picked the pocket of the American taxpayer.  How many Ivy League MBAs work there?  They've paid themselves big bonuses in one final rip-off blowoff before everything heads south again. 

I'd sure like to see Citigroup "contribute to America's recovery" by making more business loans available, but I won't hold my breath.  Mr. Pandit is correct about Citi being a very different company from what it was two years ago, as its stock price is now about one-sixth of its value in April 2008.  Good job Citi!  You've done poorly for your investors but had terrific results for your managing directors. 

Refreshing The Alpha-D For Apr. 2010

All of my covered option positions expired unexercised this past week except one:  My FXI holdings were called away.  I bought almost all of it back today in a wash sale but left a small capital gain on the table.  This continues my gradual reduction in FXI given the likelihood that China's economy is in a serious bubble.  I also refreshed my short straddle in FXI options.

I renewed the following option positions that had expired:

Short straddle on GDX.
Short puts under KEX (at 35) and TDW (at 45).

I also initiated a new option position.  I sold short puts under FLIR at 25 with an expiration date in May 2010, and I will likely keep renewing this until I'm ready to go long FLIR.  I have chosen FLIR Systems as an eventual inclusion in my long equity holdings as I believe it is seriously undervalued, much like KEX and TDW, and I wouldn't mind going long FLIR at 25.

I continue to hold long puts against IYR and LMT as bets against bubbles in real estate and defense spending.  I am convinced that investors going long either of those sectors now will regret their decisions within a couple of years.

The Limerick of Finance for 04/18/10

Goldman Sachs just got slapped with a suit
They got greedy for way too much loot
Other countries now probe
What Goldman sold 'round the globe
We shall see if this action bears fruit

Goldman Sachs' Invincibility Challenged

Who ever would have thought, in an era when Wall Street's oligarchy has captured the democratic process, that an arm of the government would ever dare to fulfill its mandate to look out for the general public's interests?

The Securities and Exchange Commission announced Friday civil fraud charges against Goldman Sachs and one of its vice presidents. The agency alleges that the company marketed complex subprime mortgage securities and failed to disclose to investors that a major hedge fund had bet against the securities.

Announcing charges is only the first step in a long dance.  Goldman has access to the most competent defense counsel in the world, so the search for justice in the court system will be long and tiring.  A few corrupt execs (Enron, et al.) were subjected to the perp walk in the aftermath of the dot-com bust and various accounting scandals, mainly to throw a bone to the public.  I guess campaign contributions only buy legal immunity for a limited time. 

Unhappy News For Tax Day

Income taxes are due to the Internal Revenue Service today.  In that vein, let's do a quick check on the health of the U.S. taxpayer.  Home foreclosures are picking up:

A record number of U.S. homes were lost to foreclosure in the first three months of this year, a sign banks are starting to wade through the backlog of troubled home loans at a faster pace, according to a new report.

I guess lots more former homeowners can forget about taking the mortgage tax deduction on next year's tax return.  Meanwhile, China continues to lose its appetite for U.S. Treasuries:

China trimmed its holdings of U.S. Treasury debt 1.3 percent in February, the fourth consecutive decline. Those reductions are raising concerns that the U.S. government could face higher interest rates to finance its soaring budget deficits.

Higher interest payments to foreign bondholders will require a greater contribution from U.S. taxpayers.  Rising tax rates after 2010 are thus inevitable, either from Paul Volcker's proposed VAT (a good idea IMHO) or some other source.  Forget about revived consumer spending.  If your kid wants an iPod or some other cute trinket next year, tell them to go mow somebody's lawn and earn it themselves.  When they grow up to pay their own taxes they might ask you about what life was like in the good old days, before real hardship.  You can tell them we're living in the good old days right now. 

The Haiku of Finance for 04/14/10

Superb China growth
But can we trust the numbers?
Some of it is fake

Another YRCW Casualty

I recently wrote about the trouble at YRC Worldwide.  It's not looking any better with the departure of a key executive:

Timothy A. Wicks resigned his post as president and chief operating officer of YRC Worldwide today to return to his former employer, United Healthcare.

 

A shake-up in senior leadership is very bad news for a company at this late stage of executing a turnaround, especially when the executive who leaves was apparently the author of the turnaround plan.  CEOs of troubled companies do not need the added distraction of an executive search. 

Nota bene:  Anthony J. Alfidi has no position in YRCW at this time. 

A Moment Of Clarity On Interest Rates

Sometimes traditional media gets it right.  Here's the NYT giving a wake-up call to consumers:

Even as prospects for the American economy brighten, consumers are about to face a new financial burden: a sustained period of rising interest rates.

That, economists say, is the inevitable outcome of the nation’s ballooning debt and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.

The shift is sure to come as a shock to consumers whose spending habits were shaped by a historic 30-year decline in the cost of borrowing.

Consumer indebtedness has become a trope by now.  What is not widely realized by market commentators cheering a recovery is that consumers will not be able to lead future GDP growth if higher interest rates choke off their credit.

How do you think Joe Six Pack will take this news?  Probably with a snore until he sees his credit card bill in November and decides to cut back on Christmas spending.  That's just as well if Joe no longer has a house where he can store all of those holiday goodies he really doesn't need.  See, rising mortgage rates will put even more homeowners underwater.  Will Joe notice that?  You betcha.

The article above will soon be a meme, building on the meme of a declining standard of living for residents of the American Empire.

The Haiku of Finance for 04/12/10

Debt traders prosper
Greek fire still threatens to burn
Don't go up in smoke

Banks' Debt Traders Ride The Tiger of Potential Sovereign Defaults

Banks have convinced themsleves that happy days are here again thanks to the brilliance of their prop trading desks:

Chief Executive Officer Oswald Gruebel, who joined UBS in February 2009, is relying on a recovery in fixed-income trading to help the bank reach an annual pretax profit of 15 billion francs in the next three to five years. The debt unit, headed by Rajeev Misra and Dimitri Psyllidis since January, reaped about $2.3 billion of revenue in the quarter, people familiar with the matter said on March 29.

Please recall that "You and BS" created an internal hedge fund called Dillon Read that blew up about three years ago because it's investment bankers didn't have a clue what they were doing.  Everybody seems to be getting excited about the latest iteration of the Eurozone's Greek rescue plan, thinking this will stabilize the debt markets and make trading revenue more predictable.  They're ignoring the inconvenient details:  The rescue plan has so many caveats that getting unanimous agreement is probably a bridge too far.  Thanks to Karl Denninger's Market Ticker for finding that very important article. 

Investment bank EVPs are overruling their risk managers once again.  Riding a tiger can be exciting until you try to get off.  The big cat may then decide to eat you. 

Nota bene:  Anthony J. Alfidi has no position in UBS at the time this article was published. 

The Limerick of Finance for 04/11/10

The Greek crisis is supposed to be solved
Of worries, Greeks should be absolved
But the battle's not won
The euro might be done
As soon as the IMF gets involved

SandRidge's Pursuit of Arena Resources Masks Deeper Problems

SandRidge Energy (SD) wants to buy oil and gas producer Arena Resources (ARD) for 4.7771 shares of SD plus $2.50 for each share of ARD.  Is this deal worth doing?

Here are the pros.  SD expands its existing reach in the Permian Basin with ARD's reserves of 69.5mm BOE.  Recent natural gas discoveries in North America will keep a ceiling on that commodity's price, so diversifying into a scarcer resource makes some sense. 

Now for the cons.  The dilutive effect on existing SD shareholders (after issuing 185.3mm new SD shares brings the total shares outstanding to 395.71mm) is 53%.  Existing shareholders are asked to surrender 47% of the combined company's earnings per share.  SD earned -$1.776B in 2009 and ARD earned $42.29mm; this equates to an underwhelming -$4.38 EPS combined after dilution.  Compared to SD's current EPS of a whopping -$10.20, that's hardly worth cheering.  This is at best a superficial improvement, as SD in its current form has experienced massively negative free cash flow for two years and has increased its long term debt for three years running, all while its net income turned severely negative.  SD is therefore betting that the acquisition of a minor oil producer will mask its own operational difficulties long enough to try to put its own house in order.  ARD shareholders are asked to surrender ownership in a marginally profitable oil driller for shares in a larger company where cash flow, net income, and retained earnings are all negative. 

The market will gradually come to grips with these risk factors. SD closed at $7.85 on Apr. 1, before announcing this acquisition, and has closed below that price every day since then while its daily trading volume has spiked by 200% to 500%.  It's hard not to believe that SD is largely in the hands of arbitrageurs looking for a quick buck.  It's just as hard to see how SD plans to work its way out of its own operational problems.  It's very hard to ask ARD owners to part with what they have in hand now. 

Nota bene:  Anthony J. Alfidi holds no position in SD or ARD at the time this post was published. 

Intermodal Drop Heralds Slowdown In Phantom "Recovery," But Knight Prepares To Buy Something

Folks, I've been skeptical about this so-called "recovery" given the continued weakness in employment data.  Increased railcar loadings and rising ocean-going shipping rates have signaled that more goods are moving, but the consumer spending driving those orders comes from decreased savings and money diverted from mortgage payments.  That's not healthy, people!  Now here's a sign that freight orders are dropping off:

Intermodal loadings by the major North American railroads slowed last week to the weakest levels since snowstorms rocked the freight system in early to mid-February.
(snip)

Rail freight traffic has maintained most of its recent strength, especially in carloads of bulk materials and equipment. Yet carloadings also slowed some for the North American majors, to 372,270 units in the April 3 week from 383,109 in the week ending March 27. The latest carloads are the lowest since Feb. 20.

Best case:  This is bottom-bouncing.  Worst case:  Traffic is peaking.  I consider logistics data to be forward-looking, because purchasing managers estimate future demand before they order goods to replenish inventories.  This implies the retail picture two to three months from now will look poorer.  That's why I can't believe in any recovery.  Proceed at your own risk. 

Speaking of logistics, I'm intrigued by the possibility that Knight Transportation (KNX) is considering an acquisition.  The target is hard to discern, but the clues are tantalizing:  a truckload carrier, 2009 revenue $450mm, negative net income, 2500-3000 trucks, dry vans and flatbeds, primarily in the Southeast and Midwest.  My internet searches have turned up nothing solid so far. 

Another Fruitless Pilgrimage to Beijing

Marco Polo traveled the Silk Road to develop trade and cultural links between the West and China.  My, how things have changed.  Now the West's leaders head to China to kowtow before the Middle Kingdom:

U.S. Treasury Secretary Timothy F. Geithner embarked on a previously unscheduled trip to China as the world’s third-largest economy weighs letting its currency appreciate.

This trip was "unexpected" only to those who are willfully blind to Uncle Sam's unfundable debt burden.  China will entertain our Secretary and ask him which part of our empire we are prepared to surrender in exchange for the possibility of maybe allowing the yuan to appreciate just a teensy bit more.  China is moving its chess game along by raising the yield it offers on three-year bills:

China’s central bank will sell three-year bills for the first time since June 2008 at a yield of 2.75 percent, according to a survey of traders.

.

Asian markets are responding in kind to this news by selling off.  Lots of Asian exporters are undoubtedly worrying about replacing the U.S. with China as their primary export market and eventual hegemon.

Nota bene:  Anthony J. Alfidi is long FXI (with a short straddle) at the time this post was published. 

The Argentinian Option In America's Future

It's easy for commentators and polemicists to use the word "bankruptcy" in the context of sovereign debt obligations.  I've done it myself in my lazier moments.  A more appropriate description for what happens when governments can't pay their bondholders would be "default," not bankruptcy.  Given the U.S. government's massive unfunded liabilities, bond investors must consider a default on Treasuries as a possibility.

How would a U.S. default affect bondholders?  Argentina shows us one case:

Argentine bonds and stocks rose on Monday and the country risk narrowed to its tightest since July 2008 on expectations for a high rate of acceptance in a planned swap of up to $20 billion in defaulted bonds.

Locally traded bonds closed up 1 percent on average as investors continued to buy sovereign debt in the run-up to the exchange, which is set to launch on April 14

.
The initial announcement of default always roils the bond market, driving up interest rates and crowding out private borrowers as investors shun all kinds of debt.  Greece is still in the early stages of its default, which I believe will proceed apace regardless of what the EU's leaders say they will do.  The U.S. has yet to begin its sovereign default drama, although the curtain will go up on the opening act once Social Security starts to have trouble covering its payments. 

Defaults hurt in the short term.  Argentina shows us that there is life after default, with investors ready to exchange devalued bonds and participate in issues from a newly creditworthy government.

I believe that U.S. Treasuries with maturities longer than one year pose a default risk, so I'm not buying them.

Want More Yield? Look Outside U.S.

Fixed income investors fed up with the Fed's ZIRP may wish to look elsewhere for additional yield, like Down Under:

Australia’s central bank raised its benchmark interest rate for the fifth time in six meetings, dismissing warnings that higher borrowing costs are already eroding consumer spending.

Governor Glenn Stevens increased the overnight cash rate target to 4.25 percent from 4 percent, the Reserve Bank of Australia said in a statement in Sydney today. The decision was predicted by 13 of 23 economists in a Bloomberg News survey.

Hey, 4.25% isn't bad compared to darn near zero Stateside.  Professional bond managers are beginning to come around too:
 

Pacific Investment Management Co., which runs the world’s biggest mutual fund, favors currencies in China, Brazil, Canada and Australia on expectations they offer attractive returns amid an uneven global economic rebound.

 
 
Earth to Fed:  Indefinitely holding the target rate at zero will hurt the U.S. whether or not there's a recovery.  Indeed, U.S. Treasuries are no longer considered a safe haven due to the U.S.'s increasing sovereign default risk.  Unattractive yields may be the trigger that sparks a run on the dollar if foreign investors decide they've had enough of holding dollar reserves that earn nothing. 

The Haiku of Finance for 04/04/10

Recovery?  Where?
Futures bet on more job gains
Net of Census hires

Census Jobs Fuel Greater Fools

Now why is it that job growth might only encourage investors for a short time?

The Labor Department's report Friday that March saw the biggest increase in jobs in three years has boosted expectations for the economy. Investors dumped safe investments like bonds and pushed the dollar higher in a sign of confidence in the recovery. The stock market was closed for the Good Friday holiday but stock futures contracts -- investors' bets on what they think the market will do later -- blipped higher.

All signs point higher for the stock market. The trouble is that some buyers have been looking a little winded lately. Stocks may get a bounce from the jobs numbers but some analysts warn that any gains will be hard to hold onto.

Could it be because much of the job growth was Census-related hiring?
 

This once-a-decade temporary work force is giving a timely boost to the battered job market. Census workers accounted for nearly a third of the jobs added in March, when hiring occurred at the fastest pace in three years.

 
Sometime jokes write themselves.  I can't joke about a head-fake economic recovery that's eventually going to disappoint a lot of investors.

Bloomberg Summarizes A "Rebound"

Pronouncements of a rebound are at best premature and at worst blithely optimisitc.  That won't stop news outlets from finding something to print:

Evidence of a global economic rebound leads a review of the week’s top stories. Reports showed a recovery in manufacturing in the U.S., China, Japan and Europe. American companies added 162,000 jobs in March, the most in three years.

I don't see nearly as much evidence for recovery as these folks do.  The added jobs included Census jobs, which are almost all low-paying temp jobs (I know because I did some Census work in the Spring of 2000).  Manufacturing data is showing more evidence for inflation than for increased volumes of orders, with inventories and prices showing the largest category increases in the March 2010 ISM Report.  I have been watching shipping and railroad traffic, which has been expanding steadily for about two months (a good sign, I'll admit).

I'm not about to call a recovery.  My impression is that the U.S. is bottom-bouncing while businesses await more clarity about the broader economic picture.  That could come in a very bad way if some black swan upsets the financial system all over again.  Remember, the PIIGS' sovereign debt problems haven't been solved and the U.S.'s sovereign debt problems are just beginning! 

The Haiku of Finance for 04/02/10

New jobs report out
Lots of temp Census workers
Skew numbers upwards

Grandma's Moving In With You

Attention Generation X!  Clear out whatever spare room you may have been using for storage, video games, your meth lab, whatever.  Your parents - the Baby Boomers who didn't save for retirement - are moving in with you:

The multi-generational American family household is staging a comeback -- driven in part by the job losses and home foreclosures of recent years but more so by demographic changes that have been gathering steam for decades.

The Pew Research Center misses a couple of points.  Seniors aren't able to stretch their Social Security checks as far as they used to because the government's CPI numbers deliberately understate inflation.  Young men and women are marrying later because a single paycheck isn't enough to raise a family.  Aside from these minor things, the report tells us something very important about American society in the 21st Century.  Mobility and generational independence were temporary phenomena, abetted by cheap energy and several decades of indebtedness.  Family life in the 21st Century will increasingly resemble its precursor in the 19th Century. 

Can we tease some investment ideas out of these findings?  I'd be very reluctant to invest in retirement communities, especially those in remote or resort-like locales.  Boomers moving back with their kids won't be throwing down $500k plus annual homeowner association fees to retire to some gated geezerville with indoor water aerobics.  I'd also be reluctant to invest in businesses related to child care or elder care (except for specialized medical services, you know, hospices and the like).  Why pay for day care when Granny and Gramps are home all day with nowhere else to go?  And why pay for elder care when your teenagers are around?  It's not like your teens will have anywhere to go after school since you won't be able to afford cars or cell phones for them anymore.  The kids shouldn't worry about looking foolish with their peers if every teen on the block has to stay home on Friday to give Granny her meds. 

I'm free of both kids and debts.  Don't congratulate me just yet, as I have another three decades or so to figure out a way to sustain myself in my old age.

CRE Trouble Justifies Pessimism

Yesterday a friend of mine asked me why I'm so pessimistic on the economy.  Part of the explanation is that I'm not amenable to the positive spin that mass media reports put on most economic news.  It's an election year, and most journalists (including financial journalists) are in the camp of the incumbent party. 

Furhtermore, I can't help but notice items like this one on the dangers posed by delinquent commercial mortgages:

According to a report from the analytics firm Trepp, spiking delinquencies in CMBS could cause bank failures to increase as much as 30% in 2010. The delinquency rate for loans in commercial mortgage-backed securities (CMBS) spiked to 7.61% in March from 6.72% in February, according to the report.

Private analysts aren't the only ones with concerns about the banking system's stability:

By the end of 2010, about half of all commercial real estate mortgages will be underwater, said Elizabeth Warren, chairperson of the TARP Congressional Oversight Panel, in a wide-ranging interview on Monday.

The TARP's chief overseer has admitted that none of the banking system's problems have been solved.  The U.S. banking system is still insolvent, and any seemingly minor hiccup can push us right back into crisis.  Now you know why I'm still a pessimist on the economy.

Both Dumb Money And Smart Money Rush Into Distressed Property

Happy days are here again, or so the thinking goes among real estate "investors."  People who imagine themselves to be experts in real estate appraisal and management - and are probably as skilled in analysis and risk management as their day-trading equivalents in the stock market - are jumping into foreclosed properties:

Improbable as it sounds, house flipping -- that hallmark of American real estate mania -- is making a comeback. All around the country, but especially in some of the regions hit hardest by the housing slump, investors are swooping in on distressed properties and banging them into shape for sale to first-time home buyers, vacation-home seekers, and people looking for rental income.

Trouble is, the FHA's waiver of anti-flipping rules is exactly the kind of bad policy the nation's housing market doesn't need.  The market needs honest price discovery and equilibrium, not artificial support, but smart policy is too much to expect in an election year. 

Big-shots can't resist getting a piece of the action too.  Serious investors are putting serious money together:

The Starwood Global Opportunity Fund VIII, which will target distressed debt and property, took in more than $1.8 billion, according to a person familiar with the effort. The Hospitality Fund II, which will invest in hotels, attracted almost $1 billion, said the person, who declined to be identified because the deal is private.

The big funds might have some potential if they're designed to replace bankrupt hotels with low-cost apartments.  Trouble is, a lot of bankrupt properties are probably far from the dense communities and mass transit that would make them viable in some other configuration.  That's part of the reason they went bankrupt.  Duh. 

It's ironic that stories about investors like these start appearing the day after the Fed ceased purchases of mortgage debt:

Yields on Fannie Mae and Freddie Mac mortgage securities jumped by the most relative to benchmark rates in five weeks as the Federal Reserve’s unprecedented buying of housing debt drew to a close today.

I'd love to see the looks on all of these people's faces as the long, slow increase in interest rates grinds them all into insolvency. 

It's nice to know that some things never change. 

Nota bene:  Anthony J. Alfidi is long puts against IYR at the time this post was published. 

A Brief Word On Biting Into CKE Restaurants

Carl's Jr. has always served some pretty good burgers.  I've been a fan of their Western Bacon Cheeseburger for decades.  Their Six-Dollar Burger started the trend of mega-sized burgers that other chains started copying.  I'm not as fond of the Hardee's chain, which Carl's Jr. bought years ago to extend their menu and brand worldwide.  The combined entity, known as CKE Restaurants (CKR), is one big juicy hunk of grilled beef. 

It looks like I'm not the only one who wants to bite into what CKR has to offer.  A private equity firm named THL Partners offered to buy them recently, and their only realistic competition for the bid is about to drop out:

Investor Nelson Peltz has reportedly lost interest in making a bid for CKE Restaurants , which is parent to the Hardees and Carls Jr. burger chains.

The New York Post reports that a source close to the process said that while Peltz whose investment firm owns Wendys/Arbys Group - had considered a making a bid to rival THL Partners, he has decided to pass after conducting due diligence.

CKR is still accepting competing bids until April 6, but this is probably the end of the acquisition dance.  Thus, $11.05 is all CKR shareholders will get. They should feel grateful given the poor condition of CKR's balance sheet; negative retained earnings for three years straight is very bad even though the trend is back to positive territory thanks to positive contributions from net income. It will take a long time for CKR to get its share price back up over $20 at this rate, so a buyout is probably the least bad choice.

Nota bene:  Anthony J. Alfidi holds no position in CKR at the time this post was published.