Holding Up FASB Rule 157
Posted on November 5, 2008 , filed under Stocks | Leave a Comment
The SEC is in talks again about possible adjustments to the Mark to Market accounting standards that are held up by FASB (Financial Accounting Standards Board) Rule 157. Any suspension of FASB 157 would have dramatic implications on our economic recovery. Book value for many publicly traded companies would once again shoot through the roof. This would create a false sense of security and credit quality. What companies like Blackstone (BX), AIG (AIG) and even General Electric (GE) are looking for is a source of affordable credit so they can slowly spread out the eventual further writedowns they will likely need to take. Although a tremendous amount of new liquidity has been injected into banking markets, lenders are increasingly fearful of servicing new loans and have set very tight internal qualification standards. Relaxing or suspending FASB 157 would allow firms to gain easier access to bank funds. Executives, commercial loan officers and credit origination teams would be able to go back to the Board of Directors of their banks and say “the borrower legally met our internal qualifications”. People want to do business, but in this fragile credit market, many need a scapegoat before being willing to take the risk of a borrower defaulting.
Taken from this Marketwatch article, Mark-to-market manipulation:
A movement spurred by bankers including Aubrey Patterson, chief executive of Bancorpsouth Inc. (BXS) , and Wall Street power brokers including Blackstone Group (BX) Chief Stephen Schwarzman are arguing for at least a temporary suspension of Financial Accounting Standards Rule 157.
Patterson and other supporters argued for the rule’s suspension in a Securities and Exchange Commission roundtable Oct. 29. Other critics of FAS 157 included Damon Silvers, AFL-CIO general counsel, and Bradley Hunkler, an insurance executive from Western & Southern Life.
Simply put, these guys want the government to stop requiring mark-to-market accounting so the financial industry can put blinders on to the deep trouble that lies on its balance sheets. Not surprisingly, the proponents of a suspension would also apparently benefit from it.
For guys like Patterson, it would mean his bank wouldn’t have to take big charges each quarter to build reserves. Bancorpsouth increased its reserves by 50% to $16.3 million to gird against loan losses at the end of the third quarter.For Schwarzman, suspension of the accounting rules might allow banks to start lending willy-nilly again — and that would mean a return of the cheap financing that fueled the private-equity buyout boom between 2005 and 2007. Private equity now must re-fund many of those deals with new loans or debt extended at much higher interest rates.
To learn more about FASB Rule 157 visit: FASB, Summary of Statement 157
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Loading ...New Accounting Practices Will Boost Bank Equity Values
Posted on October 25, 2008 , filed under Stocks | 1 Comment
Incase you missed it, the SEC has announced new accounting rules that will help companies value illiquid assets.
Taken from this article, Rethink of rules on value boosts banks
The Securities and Exchange Commission said on Tuesday that managers could use their own judgment when valuing securities in illiquid markets, which means they can use measurements other than actual market prices.
I believe this is utter hogwash. Bank managers should never be allowed to use a measurement other than Mark to Market to value an illiquid asset. This kind of accounting applied to a typical wholesaler would create a huge mis-valued inventory. Lets say I owned a company that sold sportswear, if there was suddenly no market for my particular brand of sportswear, the new accounting rules would allow me to book a subjective value for the inventory assets instead of basing them on true closeout prices.
The new rules will benefit most of the large banks such as JP Morgan (JPM) and Goldman Sachs (GS). I’m not sure if the SEC’s decision is wise, since it will just mask the problem of investor confidence and an on-the-brink failure of the OTC derivatives market. I believe the new rules will also give leeway to possible accounting manipulation. For investors, the rules further obscure our ability to determine the value of a companies equity.
Mark to Market is an important principal behind our financial ecosystem. To read more about Mark to Market, I suggest this article, Financial Crisis: Mark to Market Accounting Demystified.
Taken from the article:
[Mark to Market]…was primarily intended to prevent shady accounting practices that hide underlying liabilities. The Accounting Standards bodies were concerned that companies were keeping “bad” assets on their books instead of “writing them down” to their real value (assigning a new, lower value to the asset). Mark to Market gives investors a much better “picture” of the health of the company if their assets are correctly priced (i.e. market price).
(1 votes, average: 5 out of 5) Loading ...Congressman Ron Paul, A US Dollar Crises
Posted on October 25, 2008 , filed under Stocks | Leave a Comment
Raw Greed readers should pay special attention to the Fox Interview below where Texas Congressman Ron Paul speaks about a US Dollar crises.
Here are some notable quotes taken from the interview:
“What we are doing here is guaranteeing the devaluation of the dollar.”
“This country is bankrupt and we wont admit it.”
“Eventually the dollar will go bust.”
“We are on the verge of destroying our dollar.”
If our global lenders lose faith in the US Dollar it will no longer carry any worth. I believe a dollar collapse is unlikely, however some degree of hyperinflation has been guaranteed by the Fed’s actions. Lowering the Fed funds rate and printing money at a veracious pace will ease access to credit and has been the formula for recovery since the Greenspan era of the Fed.
(1 votes, average: 5 out of 5) Loading ...The Collapse Of The Great British Pound
Posted on October 22, 2008 , filed under Stocks | Leave a Comment
The speed at which the Great British Pound is falling against the US Dollar is staggering.
Historically, the GBP has fallen under 1.4 twice in the past 16 years. Current levels are a stark contrast to the levels set at the end of 2007, when the GBP traded a bit higher than 2.1. In less than a year the GBP has fallen roughly 23%. I believe there is a possibility that we may revisit the sub 1.4 levels.
This is an extreme oddity, considering that the Fed Funds Rate stands at 1.5% and there is a possibility that the Fed may cut rates to 1%.
Taken from this Reuters Article, US RATE FUTURES-Bets tilt further toward 50 bps Fed cut:
WASHINGTON, Oct 21 (Reuters) - U.S. short-term interest rate futures on Tuesday tilted further toward an aggressive rate cut at next week’s Fed policy meeting, picking up on prospects for an protracted slowdown in the U.S. economy.
For the first time, futures suggest more than a 60-percent chance for the Fed to lower rates by one-half percentage point at the Oct. 28-29 meeting, backing up a similar-sized emergency cut on Oct. 8.
Normally falling interest rates would cause the base currency to fall in value against higher yielding currencies. In the past year when the Fed started dropping interest rates the USD fell against higher yielding currencies such as the New Zealand Kiwi, the Australian Dollar and the Great British Pound.
There is a market expectation that governments around the world, and especially in those with a high yielding currency, will drop rates aggressively similar to the USD.
The USD strength is non-indicative of a Fed Funds Rate of 1.5% and possibly lower. The Fed is now creating and pumping cheap money into the financial system at a breakneck pace. The debt racked up by the credit crises is close to getting out of control and we still haven’t faced the full brunt of a possible OTC derivative collapse. To compound the problem of the influx of new money, the Fed has announced the possibility of a second stimulus package.
Taken from this Forex Article: Mid-Day Report: Dollar Strengthens on Talk of Second Stimulus Package
Dollar strengthens in early US session after Fed Chairman Bernanke said that additional fiscal stimulus package should be considered to help improve “access to credits” by consumers, homebuyers, businesses and other borrowers given the “extraordinarily uncertain” economic outlook. In his testimony to House Budget Committee, Bernanke said that such actions might be “particularly effective” at promoting “economic growth and job creation.” Dollar index soars to as high as 82.92.
The USD Index has broken the 85 level and may well be on its way back to the 90 level. If the USD does break 90, we should see the GBP fall under 150 and possibly 140 if GBP rates are slashed aggressively in the near-term.
(1 votes, average: 5 out of 5) Loading ...A Note of Appreciation
Posted on October 7, 2008 from Malaysia , filed under Stocks | Leave a Comment
Raw Greed readers may have noticed that a few of the graphical and plug-in glitches with the blog have been fixed. The changes were handled by Vladimir Prelovac, a Wordpress Services provider. I highly recommend Vladimir if you have any WordPress development needs.
(1 votes, average: 5 out of 5) Loading ...Piling On The Debt
Posted on September 24, 2008 , filed under Stocks | Leave a Comment
The U.S. is currently racking up a massive amount of new debt. Here is the current tally taken by Alex Patelis, an economist at Merrill Lynch:
Treasury buying mortgage-related assets: $700bn
Potential supplementary stimulus package favoured by Democrats: $100bn
Insuring money market funds: $50bn
Treasury fortifying the Fed’s balance sheet: $100bn
Expansion of temporary swap lines with central banks: $180bn
Loan to AIG: $85bn
Fed purchase of agency discount notes & ABCP: amount not specified
Fed loans through the Primary Dealer Credit Facility: $20bn through Sep 17
Fed’s discount window: $33bn balance
Treasury purchase of GSE MBS this month: $10bn
Potential cost of Fannie/Freddie bailout: $200-$300bn
The grand total of the above list is roughly $1.5 Trillion USD and I’m sure the U.S. isn’t done yet. If the government were to completely bailout Fannie Mae (FNM) and Freddie Mac (FRE), the resulting bill would amount to $5.2 Trillion or double our national debt. My guess is that the total cost of the government bailouts, if a $700 billion package to purchase mortgage backed assets is approved, will run close to $2 Trillion before the end of 2008.
In regards to the subsequent inflation from printing all this new money, Monty Guild of jsmineset.com says:
“INFLATION IS AHEAD OF US AND IT WILL BE A BIG PROBLEM
Not for the next few months, but in coming years, inflation will be a big problem…and we had all better prepare for it. You may be getting tired of hearing us beat this same old drum but if you prepare for the next problem before it arrives, you will be much more financially secure.
The only solution for the current crisis is to liquefy the global economic system and liquefy it to an extreme never before experienced. You think that the mortgage bubble was a big one? Wait until you see the next bubbles.
The U.S., Europe, Australia, Japan, Canada, and others will all join the parade to fiscal and monetary irresponsibility by inflating their money supplies and creating our next big investment opportunity.”
All this new money entering the system to “fix” previous problems will lead to new bubbles and massive inflation. This is a formula that has been repeated in nearly every modern economic crises. Low interest rates and a “fix” of printing new money has lead to bubbles in the past. Look at how we moved from a tech bubble collapse to the problems we face with the credit bubble. I’m not sure how we are fixing a problem by covering it up in the same manner.
(1 votes, average: 5 out of 5) Loading ...Credit Default Swaps, The Show Isn’t Over
Posted on September 16, 2008 , filed under Stocks | Leave a Comment
If you haven’t read my previous article, The Greatest Show on Earth, please do yourself a favor and give it a read.
In this post, I am going to expand on watching CDS (Credit Default Swaps) with banks. What CDS can tell you is how much money a person is willing to pay to insure the debt of a bank. The healthier a bank is, the lower the premium will be to insure its debt. If a banks financial situation sours, the higher the premium will be to insure its debt.
Monitoring CDS is essential to determining the health of our financial investments. With the rapid falling value of bank equities, it pays to look at CDS as an early indication of whether a bank may go out of business. CDS tied to banks are one of the most heavily traded form of derivatives.
In addition to reading traditional news media, waiting for earnings results, and for a bank to announce whether or not it has additional write-downs, you should watch CDS as it can give you a glimpse at trading activity between people who may have advanced daily knowledge of a banks operations. The CDS market is laxly regulated in comparison to common equities trading.
Let’s look the current CDS premiums for some of the worlds major banks.
Looking at the CDS premium for Lehman Brothers on 9/12 before it collapsed, we can see that figures grew well above the levels of HSBC (HBC) and JP Morgan Chase (JPM). The list above can be viewed as a most healthy to least healthy list of banks.
This also demonstrates that traditional media unfairly lumps “Banks” into one simple category. A well diversified bank like HSBC with strong retail banking, commercial banking and wealth management divisions is different from an investment bank that mainly derives its revenue from dealer-broker, trading desk, underwriting and structured finance offerings. When determining possible continued or new investment in bank equities and bank debt offerings, it pays to give CDS premiums a quick glance to see an immediate outlook on a banks health.
For further information about the CDS market, please read Credit Default Swaps: Evolving Financial Meltdown and Derivative Disaster Du Jour. In the article, the author Dr. Ellen Brown says, “CDS are private bets, and the Federal Reserve from the time of Alan Greenspan has insisted that regulators keep hands off.
The sacrosanct free market would supposedly regulate itself. The problem with that approach is that regulations are just rules. If there are no rules, the players can cheat; and cheat they have, with a gambler’s addiction. In December 2007, the Bank for International Settlements reported derivative trades tallying in at $681 trillion - ten times the gross domestic product of all the countries in the world combined. Somebody is obviously bluffing about the money being brought to the game, and that realization has made for some very jittery markets.
“Derivatives” are complex bank creations that are very hard to understand, but the basic idea is that you can insure an investment you want to go up by betting it will go down. The simplest form of derivative is a short sale: you can place a bet that some asset you own will go down, so that you are covered whichever way the asset moves.
Credit default swaps are the most widely traded form of credit derivative. They are bets between two parties on whether or not a company will default on its bonds. In a typical default swap, the “protection buyer” gets a large payoff if the company defaults within a certain period of time, while the “protection seller” collects periodic payments for assuming the risk of default.”
I believe we are facing a global derivatives problem of $1,140 trillion and upwards. To echo the sentiments of my previous article, monitoring the health of your investments, especially if they are related to financial services, is of paramount importance in times of crises. Based on the CDS list, I have a stronger feeling that Intel (INTC) will be around, instead of Washington Mutual (WM) in the future.
(1 votes, average: 5 out of 5) Loading ...The Greatest Show on Earth
Posted on September 15, 2008 , filed under Stocks | 1 Comment
I would like to say “the circus” in reaction to the title of the post, but sadly today we are looking at the collapse of Lehman Brothers (LEH) and the worsening of the current credit crises.
Currently out of the top 5 investment banking firms in the U.S., (Goldman Sachs (GS), Morgan Stanley (MS), Merrill Lynch (MER), Lehman Brothers and Bear Stearns), only two will remain in business going into the fall of 2008. The source of all of this is of course the over leveraged nature of investment banks. At the end of 2007, Lehman Brothers was leveraged 31:1. Lehman turned $1 into $33 through the magic of leverage. On a mark to market basis, every bank with exposure to complex CDO (Collateralized Debt Obligations) and derivatives is prone to an amazing loss of value at staggering speeds.
It’s important to understand what mark to market means. Investopedia states mark to market as “The act of recording the price or value of a security, portfolio or account to reflect its current market value rather than its book value.”
In a bullish market, the investment banks and stock market participants valued portfolio’s of mortgage securities and other derivatives far greater than its book value. In a bearish market, a portfolio of these securities falls far below book value. Since most investment banks trade on margin a drop in mark to market forces the investment bank to write down the value of the security or portfolio as a defensive measure against even greater losses. A rapid drop in mark to market can also force a margin call as some hedge funds for example do not have sufficient additional collateral to protect against the margin call. Creditors who have lent money to investment banks will require certain margin and capital ratios and will refuse to extend additional credit to funds or investment banks as the value of their assets dwindle.
Holding a portfolio of CDO’s and MBS (Mortgage Backed Securities) was a threat to investment banks since the beginning, due to the difficult nature of determining the actual owners of the collateral behind the security. A mortgage portfolio was often divided into pieces and packaged into MBS products, then sold and repackaged several times into other securities. The investment banks were essentially playing a game with each other with the lack of regulation and reporting in the structured finance market.
Holding a portfolio of common equities is much easier to value in comparison to CDO and MBS assets since you can take into account traditional valuation methods such as earnings and cash to debt ratios. Interestingly MBS were regarded as rock solid since the collateral behind the mortgages, physical property, was previously regarded as good as cash. With the fear of mortgage defaults, MBS values are falling faster than the actual physical property values. This has lead to recent buying by private equity funds seeking to buy distressed mortgage backed assets for pennies on the dollar.
What we have witnessed with CDO’s and MBS doesn’t stop there, similar problems exist for the entire OTC derivatives market. As stated by this Market Watch article: Buffett and Gross warn: $516 trillion bubble is a disaster waiting to happen.
In the words of Pimco’s bond fund king Bill Gross: “What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.”
I’ve written about derivites in a past article in which I said:
Because derivatives are just contracts, just about anything can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.
Estimates vary on the potential total economic risk derivatives present. I like to use the largest figure I’ve found. As of December 2007, The Bank of International Settlements estimated that the amount of listed credit derivatives, i.e. tradable in some form through an exchange, stood at roughly $548 trillion. The amount of OTC derivatives was estimated at $596 trillion notional value. This brings the total derivatives estimate by The Bank of International Settlements to 1,140 trillion.
With the possibility of a global financial meltdown it’s important to educate yourself on how to anticipate the failure of a business or bank. You need to know what is, and what isn’t at risk. It’s definitely not enough to read the news, since the figures you need to watch are often found buried in balance sheets.
-On the top of my list is leverage and in a bear market less is better. This applies to all businesses and banks.
-High capital reserve ratios. The more cash a bank has the better.
-Diversified currency base. A bank or business holding a variety of foreign currency reserves has a better chance to hedge Forex risks, enhance liquidity and security.
-Low exposure to derivatives and complex structured finance products.
-A diversified business model to protect against falling earnings. It’s better to seek-out banks and businesses that have a variety of income streams.
-Operation in international markets. If a bank is limited to business in the U.S. or Europre for example, it is at greater risk at suffering a loss from an economic downturn.
-For banks you must have a careful watch of CDS (Credit Default Swaps). A credit default swap is the cost to guarantee a banks debt.
In examining where the potential risks are, we can help protect our own investments and determine which investments are safer bets. As we look at Asian banks for example, we can see that state owned Chinese Banks are flush with RMB and far less exposure to derivatives. Many chinese banks have diversified lines of business and derive income from retail banking services, an early credit card market with low penetration and a growing wealth management divisions. European banks such as UBS (UBS) also enjoy many of the same advantages in a far different geographical location.
Forbes published an article today titled: “UBS Likely To Avoid Lehman’s Fate” The Forbes author goes on to say:
“The reason for this lies in UBS’ diversified business model, which brings in a relatively safe stream of profits from wealth management and private banking–despite that its investment banking division is in meltdown. This in turn has helped the bank avoid the kind of crisis in confidence faced by Lehman Brothers Holdings (nyse: LEH - news - people ), which threw in the towel and filed for bankruptcy over the weekend as its shares tanked and its credit default spreads widened.”
“Credit default spreads for UBS are still relatively low,” said Dirk Becker, an analyst with Landsbanki. “They are still in the region where they can stay in business.”
Chinese and European banks are of course getting sold off along with the fall in financial markets. Investments in ETF’s that do hold these securities offer an opportunity to cycle out of U.S. financial equities if you decide that your portfolio should include a portion in the financial services sector.
With all of the bad news emerging from U.S. financial markets, I can’t help but draw the conclusion that the USD is due for a major fall in value. The U.S. literally doubled its national debt with the bailout of Fannie Mae (FNM) and Freddie Mac (FRE). We are printing dollars at an exceedingly rapid pace, the Fed has expanded its loan window to distressed investment banks and now we may be faced with another quarter point interest rate cut. All of this is dollar negative. As we watch the financial turmoil unfold and wait for markets to repair themselves, you may have already looked at currency diversification as part of your investment strategy. Before making money, capital preservation has and will always be of the upmost importance.
(1 votes, average: 5 out of 5) Loading ...Fully Accountable
Posted on June 26, 2008 , filed under Stocks | 2 Comments
The largest gripe that I’ve had with Wall Street Analysts is that they lack accountability. They flip-flop around their investment thesis and fundamental analysis of a situation. In my regard, the individual investor has many reasons to completely tune out all the noise that they hear and draw their own conclusions from macro-economic events and their own due diligence of a companies released earnings.
Over the past 400+ articles, I’ve mostly posted my buys and sells, with exact prices. This is to establish accountability and to form a track record. I’ve always said, regardless of how a person finds their stock picks, all that matters is performance in B&W. It doesn’t matter if you employ throwing darts or advanced quant analysis. The best written article and in-depth analysis is worthless if it consistently loses you money in investing.
My approach has always been basic and straightforward. Buy cash rich companies with low debt or entire sectors that have been shorted due to unfavorable market conditions. I know that my own track record is far from perfect, however I have the same conviction and passion for each investment I make even if the last was losing.
In the market, a loss is never a loss until you sell. If you are confident you bought a stock at good value you will be able to sleep well at night and won’t be afraid to buy more at low prices. You never buy more just because the price drops, you buy more because the company continues to be a good value. If the company stops being a good value, you cut your losses and sell, regardless if the price is high or low.
I do see a crash coming and with the same accountability I am going to post my targets as I always have.
My price target for gold is $1,100 by the first quarter of 2009. My top picks continue to be Yamana Gold (AUY) and Barrick Gold (ABX).
My target for silver is $25 by the first quarter of 2009. My top picks continue to be Pan American Silver (PAAS), Silver Wheaton (SLW) and Hecla Mining (HL).
My favorite base metals stock is Lundin Mining (LMC). I’ve written in detail about the stock in the past, so use the search function on my blog. Today the stock is trading in the mid $6 range. I fully expect LMC to break $10, a 50% gain, in the next 6-12 months.
I would like to remind readers that the first time I bought Yamana, Pan American Silver and Silver Wheaton some continued to drop from my purchase price almost 30%. In retrospect, I saw the value in strong earnings and smelled a good value brewing. All of the stocks above returned 40% or greater for me in a matter of months. I see the same opportunity today in precious metals stocks. It will not be a smooth ride given the volatility in precious metals. Unusual volatility means strong swings in both directions. The farther it falls the faster it will rise as a sector. There are plenty of precious metal stocks, especially juniors and mid-tier producers that are trading as if gold were in the $600-$700 range and silver were in the $12-$14 range. In light of the strong earnings almost the entire sector is undervalued and soon Wall Street will come to realize and report about it. There is real possibility of war between Israel and Iran. There is a real possibility of economic disaster. There is strong threat of inflation. All of these are positive for precious metals.
I am going to start entering positions in July and hopefully 2008 will be another top notch year for myself and fellow Raw Greed readers. Gradual accumulation and diversification is key. A year from now those who have the conviction to buy will be happily rewarded.
Finally, I will share a thought left to me by the former CIO of General Motors Asset Management. He asked me, “is an entrepreneur risky?”. His answer was solidly no. An entrepreneur fully believes in what they are doing or they wouldn’t do it at all, so they are not risk takers. A conservative entrepreneur and those who are fully accountable should be followed carefully. Individual investors are very much mini-entrepreneurs putting their money to good use.
Disclaimer: The author currently holds a long position in Lundin Mining.
(No Ratings Yet) Loading ...A Possible Economic Crash
Posted on June 25, 2008 , filed under Stocks | 1 Comment
There are a number of startling factors for investors to consider when evaluating the possibility of a larger looming economic crises. A few authors have guessed that the majority of writedowns are now done and that the worst may be past us. From the most recent news, I believe we may extend losses past the most recent credit crises fueled by collateralized debt. We may soon face a banking crises larger than the Savings and Loan crises of the late 1980’s.
Here are a few factors to consider:
1) The Fed may increase interest rates in the near future. An increase in rates is bullish for the dollar and necessary to fight inflation. An increase would add tremendous pressure to an already fragile housing market by making payments on adjustable rate mortgages more expensive. Increases would also make borrowing more expensive and would restrict access to already tight credit. The potential impact of rate increases is unknown.
2) Any failure in the derivatives market would signal the beginning of an imminent crash. Estimates vary wildly over the total value of the derivatives market. The Financial Times recently estimated that the size of the derivatives markets stood at roughly $450 trillion dollars. As of December 2007, The Bank of International Settlements estimated that the amount of listed credit derivatives, i.e. tradable in some form through an exchange, stood at roughly $548 trillion. The amount of OTC derivatives was estimated at $596 trillion notional value. This brings the total derivatives estimate by The Bank of International Settlements to 1,140 trillion.
Taken from Investopedia:
[A]…derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage.
Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Because derivatives are just contracts, just about anything can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.
Due to the complex structure of derivatives it becomes very difficult to evaluate the underlying assets of many derivatives. Problems in the industry could lead to massive derivative writedowns by banks. Derivatives could form an extension of the collateralized debt obligation (CDO) and mortagage backed security (MBS) problems that fueled most of the recent writedowns by financial institutions. If there are too many sellers and not enough buyers in the derivatives market, investments become stagnant and pose the possibility of devaluation if anxious sellers seek to cash out.
My guess is that the derivatives estimate from The Bank for International Settlements is the most accurate. Taken from The Bank of International Settlements website: The Bank for International Settlements (BIS) is an international organization which fosters international monetary and financial cooperation and serves as a bank for central banks. The bank was established on May 17th, 1930 and is headquartered in Switzerland. BIS is the world’s oldest international financial organization and currently includes 55 member central banks.
3) Leverage is out of control. As we learned from the Bear Stearns Crash, leverage can turn against you very quickly. Bear Stearns leveraged 11.8 billion to control a balance sheet of 395 billion. Carlyle Capital leveraged its balance sheet 32 times to own $21.7 billion in mortgage backed securities, primarily AAA-rated bonds guaranteed by Fannie Mae (FNM) and Freddie Mac (FRE). Carlye Capital’s portfolio was backed by just $670 million in equity. The problem of leverage is prominent by all major big balance sheet banks such as Goldman Sachs (GS) and JPMorgan Chase (JPM) is very real as they provide access to credit and frequently loan money between each other. Any devaluation of assets or calls for more collateral on loans could lead to forced margin calls and major additional writedowns for banks.
4) Credit ratings on bond insurers Ambac (ABK) and MBIA (MBIA) fall. Ockham Research wrote on February 28th, 2008:
“Citigroup (C), Wachovia (WB), and UBS (UBS) among others need to keep Ambac healthy as the ripple effect from an Ambac bankruptcy would be massive. Oppenheimer estimates that the major banks have $70 billion of exposure to Ambac and the bonds they insure.
Clearly, Ambac losing its credit rating of AAA or declaring bankruptcy would be catastrophic. If the worst were to occur it would make the housing crisis pale in comparison. The banks act as underwriters for billions of dollars in corporate bonds of which Ambac and MBIA are the two main insurers.”
Banks like UBS (UBS), Citigroup (C) and Merrill Lynch (MER) buy bond insurance as a hedge from Ambac and MBIA. If the insurer were to go out of business, 100% of the default risk is exposed to the bank. Banks have taken insurance on trillions of dollars of collateralized debt obligations and other mortgage backed securities. The potential impact of bond insurers going out of business for banks is tremendous. Market Watch is reporting that Ambac’s drop from AAA to AA is going to cost UBS, Citigroup and Merrill Lynch an estimated additional $10 Billion in new writedowns. This is money that the banks can’t afford to continue losing.
5) The Fed is printing money at an ever quicker pace. I’ve covered most of this in my previous article on How to Predict the Price of Goods. An increase in the money supply helps to alleviate access to credit and offers additional available cash to banks in the form of Fed loans. Increases also lead to an inflationary economy and possible drop in the dollar.
6) Inflation is out of control. Basic necessities like food and energy prices have skyrocketed 300% or more in recent years.
7) Eli Hoffman reported that financial performance of mutual funds in 2008 may be worse than the year of the .com crash. Eli writes that “As of January, 2007, nearly 1,400 mutual funds were earning 15% or more. This January, just 270 funds hit that number — an 80% decline. From December 2000 to December 2001 — the bursting of the tech bubble — the 12-month drop was only 57%.”
There are many situations that may play out. The extreme economic collapse would be a failure of the banking system that would mean massive bank runs and a large devaluation of the dollar. Since the risk of an economic crash is very real, and may be the worst since the great depression, I am continuing to recommend cycling into physical assets and a diversified portfolio of non-cash assets.
Food for thought: Stocks and bonds are held in a clearing account by your bank or brokerage. If a bank run causes you to lose your money, eventually your stocks and bonds will be returned to you since technically they can be delivered in the form of stock certificates and paper contracts. Picking the correct recession resistant investments will be key to preserving capital in the event of an economic crash.
The good news is that if we are able to quickly emerge from a recession, every post economic recovery has lead to higher wages and asset appreciation. This has been true all the way from the Great Depression to the .com lead recession.
*Disclaimer: The author does not own a position in any of the stocks above.
(1 votes, average: 3 out of 5) Loading ...Hyperinflation Here We Come
Posted on June 17, 2008 , filed under Stocks | Leave a Comment
I started writing on the subject of hyperinflation almost 4 years ago. One definition of hyperinflation, offered by Wikipedia, is “a cumulative inflation rate over three years approaching 100%”. Investopedia defines hyperinflation as “Extremely rapid or out of control inflation.” Anyone who was expecting a recession in the U.S. should also be prepared to look at the process of recovery. A trend has been set since the Al Greenspan era to flood the U.S. economy with newly printed dollars and access to cheap money through low interest rates. It seems that Ben Bernanke is following the same trend of increasing the money supply and keeping interest rates low till we emerge from recent economic problems.
The beginning of hyperinflation is evident from the chart below. Of the 30 cars below, it now costs $114 to fill up a Toyota Sequoia SUV in California. The Toyota stands firmly in the middle of the list, with 21 out of the 30 models costing more than $100 to fill up.
I firmly believe that we are looking at the value of money dropping 10 times in the next decade. I believe $100 will be worth roughly $10. There is simply too much new money being printed by the Fed competing for the same goods. If we look at our emergence from the 2001 recession, we already saw the cost of property, luxury goods, travel and in some cases food increase 300-400%. Now that we are entering a new recession, when we recover the price of goods should again dramatically increase. Holding cash at the moment is the worst possible thing a person could do. I suggest buying anything, from stocks to property that you believe is a reasonable quality investment. When we emerge from a recession, stocks, property, and a variety of other investments will adjust themselves to reflect the true value of future dollars.
There will come a time when a $1,000,000 a year salary will be as common as a $100,000 a year salary today. The problem is no one sees it coming. It typically happens in a short time-frame and catches investors off guard. Many of us ignored the opportunity to buy property or stocks in 2001 when prices were low. Many of us will now miss the chance to buy property or stocks in 2008-2009.
Raw Greed’s investing has been focused on identifying trends in advance and setting up strategies to take advantage of oversold conditions. Five years ago, I was buying in and out of technology and airline stocks. For the past three years, I have been buying in and out of precious metals stocks. I believe that we are approaching a mania phase for energy and precious metals. In the next year or two I am guessing that I will exit precious metal stocks and start to invest in financial and home building stocks.
At the moment there are an incredible amount of deals in the market with some sectors off a staggering 70% or greater. Good and bad stocks, bonds and property have been lumped together and sold off. I don’t believe we have hit a bottom yet, but I do believe we are approaching one. Since no one knows when the exact bottom is, I believe investors should begin to build their positions while the economy is slumping. The old saying “the baby will be thrown out with the bath water” is going to apply very soon. Investors will may have a chance to buy GE, General Electric Company or HD, The Home Depot, Inc. at a P/E under 10. Insurers like AIG, American International Group, Inc. and financials like LEH, Lehman Brothers Holdings Inc. and C, Citigroup, Inc. are all down in the 60-70% range compared to year ago highs. If these stocks were to slide another 20-30%, we would firmly be 80-90% off from year ago highs indicating a permabear mentality.
It seems that whenever a person decides to buy a stock in a slumping market, the stock will keep falling, causing some degree of fear and angst. Investors should take comfort in knowing they paid .10-.20 on the dollar for a stock that will likely survive and thrive when the economy recovers. There may be another Bear Sterns collapse in the meantime, so diversification is key. Lets say you took a dollar and broke it into 10 varied investments that were down 80-90%. If one were to go out of business you would be left with 9 investments that will likely return multiple times your cost as we emerge from a recession. If you are buying .10-.20 on the dollar, only one out of your ten investments has to recover halfway from year ago prices to bring you to a breakeven point to prevent loss from one going out of business. The chances are solidly in favor of the investor who can look past the bearish mentality.
I have no idea if companies like AIG or Lehman Brothers will ever drop to the point where I can buy them .10 on the dollar compared to year ago prices. At the moment, I am going to consider beginning to build a position in these stocks as we are down 60-70%. This range is my initial buy-in with aggressive buying at .10 on the dollar.
At the moment there are people forced to pay $168 to fill up a Chevy Suburban 2500 in California. I’m not sure how much longer can this last until all the new money the Fed is printing goes towards increasing salaries. The recent economic relief checks have been completely absorbed by a months driving for some households. Once we recover and people are able to afford paying $100+ to fill up it will be too late for investors to capitalize on the missed chances. The lost money just by sitting on the sidelines will be very real.
*Disclaimer: The author does not own a position in any of the stocks above.
(No Ratings Yet) Loading ...Falling Global Stock Prices
Posted on June 16, 2008 , filed under Stocks | Leave a Comment
Some of my readers have asked me if I would be afraid that the market would continue falling 50% or greater. I’m sure to their surprise my response has been “I hope so”.
It is human psychology that leads us to believe that buying in a market where prices are up 300% is safer than buying when the market is down 80%. When markets are dramatically up there is a sense of confidence in the air, when the markets are severely down the confidence is replaced with fear.
If we look at the past decade, many investors missed the chances to buy stocks following the .com crash, 9/11, Tsunami, SARS and now the credit crises. Many investors I knew felt more comfortable buying Pets.com stock at its height instead of buying Amazon (AMZN) when the Nasdaq crashed 80%.
In addition to my typical look at high cash, low debt, high ROE and high ROI, a few simple rules should be stuck to when buying during a market crash.
1) Stick to big names and blue chips stocks.
2) Find companies that have built irreplaceable business models, distribution, infrastructure, support networks and brand names.
3) Buy low and don’t be afraid to buy lower.
By far the credit crises is the most globally wide spread of the problems we have faced since the Nasdaq crash. If the markets continue to fall there will be a chance to start building positions in American Express (AXP) that has built an irreplaceable transaction network, or FedEx (FDX) and UPS (UPS), that have built irreplaceable shipping networks.
Negative pessimism will always pass and when it does the stock market will rally back to previous highs and onward to new highs. If you invest in a basket of stocks, there is always the chance that a few will go out of business. You should keep in mind though that as long as your remaining stock investments recover to previously set highs you will recover your losses. The discount to previously set highs is your hedge.
Lets say you buy 10 blue chip stocks at a 50% discount. If 5 go out of business and 5 recover to original levels you break even. If you buy at a 60%, 70%, 80% or greater discount your hedge grows. At 80% off previous high’s, if you bought 10 stocks, 8 can go out of business and if 2 recover you will break even. The odds are squarely in your favor.
As readers have followed along with Raw Greed, investors know that I often recommend stocks when they have fallen 60% or greater and I’m not afraid to recommend buying more to lower your cost basis. Alternatively, if you’re not sure what to invest in during a market crash, buy an index fund.
Remember that a solid company makes a solid investment long-term. The fun of investing is buying at a discount to what you consider fair value. When broad markets sell off its easier to find those opportunities than when broad markets are setting new high’s.
*Disclaimer: The author does not own a position in any of the stocks above.
(No Ratings Yet) Loading ...Investing in China’s Falling Stock Market
Posted on June 14, 2008 , filed under Stocks | 1 Comment
In a follow-up to my article, A True China Bear, I recommend investors to set their sights on China since there may be tremendous upside in the emerging economy. The Shanghai Composite Index (000001.SS) has fallen to 2868 from a high of 6124, a drop of over 50%. The drop below 2900 marks a new 52-week low.
Long-term i’ve written that China may follow and overtake the performance of the Hang Seng Index (^HSI).
Amazingly in 1973 the HSI was valued at a low of 153. Since 1990 the HSI has returned over 15x times its previous value. As we can see with the HSI chart, these opportunities to invest when the market falls don’t come very frequently. As history has shown the market has always rallied to new highs.
Investors can consider purchasing the Morgan Stanley China A Share Fund, Inc. (CAF) or the iShares FTSE/Xinhua China 25 Index ETF (FXI). CAF and FXI trade closely with the performance of the Shanghai Composite Index.
*Disclaimer: The author does not own a position in any of the stocks above.
(No Ratings Yet) Loading ...A Great Gold and Silver Hedge
Posted on June 7, 2008 , filed under Stocks | 1 Comment
I’ve written previously about using financial stocks as a hedge against the falling price of gold and silver equities. Gold and silver stocks are currently rising over an unstable global financial climate, rising inflation and a falling dollar. As the financial environment attempts to stabilize, we have seen the recovery of many bank stocks and the fall of most precious metal stocks.
While financial stocks are a great way to hedge a portfolio of gold and silver stocks, I believe I have found another sector that can be used as a more efficient hedge. When we look at creating hedges, I believe looking at volatility is very important. When your hedge moves up 8%, you want your gold and silver positions to move down by a similar amount and vice versa.
One of the primary factors behind the runaway inflation we are experiencing is the rise in oil prices. The inflationary effect of rising oil is positive for gold and silver investors, but negative for sectors like airlines where on average 1/3 of the cost of operating an airline is tied to the price of jet fuel. Oil has been on a tear recently, with some analysts expecting the price of oil reach $200 by the end of the year. As speculation grows over the price of oil, airline stocks have come under pressure and have approached heavily oversold territory.
The airline sector is very cyclical and prone to high volatility. Airlines have been so oversold, that any good news that comes out can cause the entire sector to rally. In the event that oil continues to rise we should see major positive performance from gold and silver stocks. This may be especially true going into the fall which is the traditional season high for physical gold and silver prices. I’ve posted in the past about the historical 10:1 oil to gold ratio and here is the chart again.
I believe oil may trade in the $150-$160 range by the end of 2008. This isn’t a far stretch since oil is now at $139 and another 10 percent move would put the price of oil in the $150-$160 range. The Fed would have to again boost the number of dollars in the economy in order to help people absorb the inflationary effect of rising oil prices. With everything in favor of a falling dollar and an inflationary environment, I would be surprised not to see gold over $1000 again and silver over $20. My own price target for gold is $1100 and silver at $19 by the end of 2008.
If the opposite trend were to occur and oil prices were to drop, easing inflation, I would expect airline stocks to experience a major rally due to the oversold conditions in the entire sector.
Looking at the performance of AMR, AMR Corporation, better known as American Airlines, Inc., and CAL, Continental Airlines Inc. accurately paints the picture.
American Airlines has dropped from a one year high of $29.32 to the current price of $7.13, a drop of 75.68%. Continental Airlines has dropped from a one year high of $38.79 to the current price of $13.87, a drop of 64.24%. In the short-term as you build a hedge using either financial stocks or airlines, there is likely additional room to drop. In the long-term the likelihood of a rally and making money from buying into today’s prices is higher than the probability of sustained lower prices. Looking at the historical charts for C, Citigroup Inc., UBS, UBS AG, AMR and CAL confirms this. The resulting rally out of all the recessions the U.S. has faced has resulted in higher prices.
Having patience is key to buying into a falling market. No one knows when we will reach a bottom, but picking and sticking with your entry prices is key to earning a long-term gain. Very few people can become wealthy overnight, so I always stress buying quality companies at a price you believe is fair. For me I have a chance to begin building a hedge using airlines at a 70% or greater discount on average for an entire sector.
I always keep a practical piece of advice from my parents in mind, “nothing goes up forever”. Having a hedge doesn’t mean you won’t make money, quite the contrary. Either your hedge or main portfolio investment will produce gains. In the stock market nothing is a true loss until you sell. This is why picking quality companies with long-term sustainability is key to seeing an entire sector go through a fall and rise. No one can be right all the time, it’s more a game of who’s turn is it to be right. No matter what angle you look at it from, certain sectors are down 70% or more. The same oversold conditions that formed in 1999-2001 are forming again in different sectors in 2007-2009.
In today’s market I am reminded of a quote from kitco’s Doug Casey for successful investing, “be bold when everyone else is timid and timid when everyone else is bold”.
*Disclaimer: The author does not own a position in any of the stocks mentioned above.
(No Ratings Yet) Loading ...How To Predict The Price Of Goods
Posted on May 17, 2008 , filed under Stocks | Leave a Comment
While everyone is focused on stagflation and the possibility of recession, I’m looking past that and toward an eventual recovery. In order to avert the possibility of a systemic economic collapse, the Fed is currently printing money at an alarming rate. The increase in the money supply means more dollars competing for the same goods.
I caught the below chart from ZealLLC.com that clearly shows the dramatic increase in money supply from the Fed.
The chart above illustrates MZM, or money of zero maturity. MZM is essentially all of the money available for spending not in time deposits or money market funds. The chart is also linked to an interesting article discussing the subject of money inflation.
Taken from the article:
Then in early January 2008, the global stock markets sold off aggressively. Fears of an impending US recession drove heavy selling overseas. This worldwide selloff was so extraordinary that we are unlikely to see anything resembling it again for decades. But instead of reining in monetary growth, the Fed accelerated it. Absolute annual MZM growth peaked at a staggering 16.7% in March 2008!
You read that right. There were 16.7% more US dollars available for spending this March than last! This is incredible, especially during challenging times when the US economy was barely chugging along around 2.2% growth for all of 2007. Sooner or later all this excess money will eventually bid up prices. Some of this inflation will be perceived as good, primarily the part that flows into stocks. But the part bidding up scarce food and energy is not going to make Americans very happy.
If we look at the past effect of increasing money supply, we can see that it lead to the recovery of the recession lead by the .com crash. Without the ability to earn a rate of return exceeding the actual rate of inflation, we are losing money each year. How we can combat the effect of a growing money supply and inflation, is to own the goods that are in competition for our money. While overall prices will rise, earning a greater rate of return means second guessing whether you think the price of oil, agricultural goods like rice, stocks, or a fixed asset like property will rise the most. It may seem counterintuitive, but my primary guess on which asset will rise the most as we emerge from a recession is property.
Looking back at the money supply chart we can see MZM reaching 21.8% at the end of 2001. In the period between 2001 and 2005, we saw property prices double and sometimes triple in certain locations. During this period, the Fed also steadily increased interest rates to the point where deposit rates were over 5%. By the time deposit rates were so high, it was too late for property investors to jump in the market. I made a dear mistake at this time, purchasing an investment property nearly at the markets high.
Pessimism will undoubtedly keep property from being a favored asset class in the short-term. I believe the second half of 2007, marked the beginning of opportunity for property investors holding on to cash. This opportunity stems from the combination of cheap money from falling interest rates and money supply growing at over 16% so far this year. I’ve taken the Fed’s interest rate cuts to nearly 2% as the key indicator to being looking for new opportunities.
Here is another quote from the ZealLLC article:
But all this excess cash had to go somewhere too. Eventually all money the Fed creates will bid on something. Greenspan’s massive monetary growth in 2001 directly led to the housing bubble that he brazenly tries to accept no responsibility whatsoever for today. The torrents of excess money, which the Fed refused to take back out of the system after 9/11, flooded into real estate. And then that bubble started crashing in late 2006.
See the pattern here? The Fed gets scared because some speculators might actually lose on their bad bets so it floods the system with money to help them. But all of the money created in these huge surges eventually has to find a home somewhere, so another bubble is born. And then that bubble pops, scaring the Fed more. So it ramps money growth again, birthing a new bubble. It is a nasty vicious circle.
As a value investor, I’ve learned to disregard my emotional response to market gyrations. I see pessimism as opportunity. I see broad-based sell offs as the easiest time to profit. I’ve learned from my own previous mistakes that it’s much easier to profit by buying and holding onto oversold conditions, than to try and catch an investment opportunity when it may have reached a top. We are currently in a strong buyers market and value investors should consider purchases when no one else wants too.
I have confidence that the housing market will recover as we emerge from a recession. Having a chance to purchase highly desirable properties, such as a park view apartment or ocean front property in a buyers market may be a one of a kind opportunity.
Kudos to ZealLLC.com author Adam Hamilton for writing such a clear article on money inflation.
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