I recently heard a great joke that reminded me of the current economic and market conditions and the emotions surrounding every trading day. I should preface this by saying that if you are not familiar with Bulgarians you should know that they have endured a brutal history, which has earned their citizens a reputation as being some of the most untrustworthy and cynical folks from the former Eastern bloc. Here’s the joke: Two Bulgarians meet each other on the street. The pessimist says, “Things can’t get worse!” to which the optimist says, “I think they can get worse!”
I know that it would have been nice to think that Tuesday’s rally in stocks would be the much-anticipated bottom in the price of stocks. (If you were sleeping for a day, stocks shot up by 3.5-4% after the Fed announced that it was dropping short-term rates to 2.25% from 3%. The Dow enjoyed its biggest point gain since July, 2002 and financial companies reversed Monday’s losses after stronger-than-expected earnings from Lehman Brothers and Goldman Sachs. Even Bear Stearns added 23% to $5.91!) I heard a bunch of pundits quoting the Bulgarian pessimist, noting that the Bear Stearns deal was evidence that perhaps things can’t get worse.
I hate to insult the Bulgarian pessimist or American optimists, but the Federal Reserve’s two-tiered actions--providing financial institutions creative access to liquidity facilities and cutting short interest rates to help beleaguered consumers--can not stop the housing market from falling and the housing data has not yet indicated that the damage is done. In fact, this week it was announced that building permits fell to the lowest level in 16 years in February. From where I sit, the housing market continues to hold the key to providing confidence to investors and by extension, forming a true bottom in stocks.
We should not be surprised that it takes time for recovery. When a good idea (“I should use cheap money to buy assets that I think will rise in value!”) turns into a boom (I’ll only put down 10%) and then a bubble (I don’t have to put down anything!), the aftermath is not pretty. Perhaps that is why Joseph Stiglitz, the Nobel-prize winning economist and former chief economist at the World Bank, told Radio New Zealand “This is clearly the worst financial problem we've had since the Great Depression…More and more Americans are going to walk away from their mortgages, and that's going to undermine the foundations of these banking institutions.” In other words, the Bulgarian optimist may be right---things can get worse.
Thursday, March 20, 2008
Wednesday, March 19, 2008
We Like Good News Too!
My parents have a friend (“JR”) who has a sign on his desk that says: “We like good news too!” It seems lately that investors have been inundated with massive quantities of the bad stuff, so in a nod to J.R, it might be time to trudge out some glimmers of good news.
The Fed is our friend: It may have taken six months for Ben Bernanke & Co. to jump on the problem, but it is now clear that the Fed is acting aggressively and creatively. Whether that means using arcane rules to supply the financial industry with much-needed liquidity, or dropping the Fed Funds rate (the Fed slashed rates by ¾ of a point yesterday to 2.25%, a full three percentage points from last year’s peak of 5.25%). Investors greeted the news with great fanfare, sending stock prices soaring higher!
Some companies are making money: We have not officially entered the statistical definition of a “recession” (the economy has yet to post even one quarter of contraction), but earnings at many firms have already started to contract. While the financial companies are the obvious big losers, there are some companies that continue to thrive, including exporters and large multi-national firms with a major overseas presence. According to Thomson Financial, if you exclude the financial sector, profits for the rest of the S&P 500 companies are expected to have grown nearly 12% in Q4 of 2007 and to grow nearly 9% in the first quarter this year.
Because this slowdown/recession started in the US, there is no way to shield most US companies from the damage, but growth abroad has been a powerful driver for many US firms. Also, US companies came into this period better prepared than in the last recession--based on almost any fundamental metric, corporate balance sheets are healthier today than they were in 2002.
Velocity can work both ways: From the market’s recent peak on Oct. 9, 2007, and recent bottom on March 10, the S&P 500 fell 19%. There have been three other periods in the last 20 years when stocks have lost so much in such a short time: in 1990 (S&L), 1998 (Asian currency crisis) and 2000. The 2000 swoon, prompted by the bursting of the tech bubble, quickly developed into a nasty bear market. But in the other two cases, stocks recovered the next year. In the 12 months after the 1998 sell-off, the S&P 500 soared 40% and 12 months after the end of the 1990 correction, stocks had jumped 34%. The numbers may not work out exactly, but so far, we have in fact been pretty close to them. US stocks have on average peaked four-six months before the onset of recession and troughed eight months after the start of recession. We peaked last October and many believe that we are on target to meet the historical standard.
Negative may be positive: It may sound crazy, but the very fact that people are turning negative may be a positive development for the slumping markets. Often, stock market bottoms form when sentiment is at its worse, hence the old chestnut, “sometimes, when things look bleakest, it’s a sign the market is near a bottom.” We could be a long way from that point, but when you start to hear the words “crash”, “recession”, or data points from the Great Depression, you might think to yourself, we are closer to the end of this mess than the beginning of it.
The Fed is our friend: It may have taken six months for Ben Bernanke & Co. to jump on the problem, but it is now clear that the Fed is acting aggressively and creatively. Whether that means using arcane rules to supply the financial industry with much-needed liquidity, or dropping the Fed Funds rate (the Fed slashed rates by ¾ of a point yesterday to 2.25%, a full three percentage points from last year’s peak of 5.25%). Investors greeted the news with great fanfare, sending stock prices soaring higher!
Some companies are making money: We have not officially entered the statistical definition of a “recession” (the economy has yet to post even one quarter of contraction), but earnings at many firms have already started to contract. While the financial companies are the obvious big losers, there are some companies that continue to thrive, including exporters and large multi-national firms with a major overseas presence. According to Thomson Financial, if you exclude the financial sector, profits for the rest of the S&P 500 companies are expected to have grown nearly 12% in Q4 of 2007 and to grow nearly 9% in the first quarter this year.
Because this slowdown/recession started in the US, there is no way to shield most US companies from the damage, but growth abroad has been a powerful driver for many US firms. Also, US companies came into this period better prepared than in the last recession--based on almost any fundamental metric, corporate balance sheets are healthier today than they were in 2002.
Velocity can work both ways: From the market’s recent peak on Oct. 9, 2007, and recent bottom on March 10, the S&P 500 fell 19%. There have been three other periods in the last 20 years when stocks have lost so much in such a short time: in 1990 (S&L), 1998 (Asian currency crisis) and 2000. The 2000 swoon, prompted by the bursting of the tech bubble, quickly developed into a nasty bear market. But in the other two cases, stocks recovered the next year. In the 12 months after the 1998 sell-off, the S&P 500 soared 40% and 12 months after the end of the 1990 correction, stocks had jumped 34%. The numbers may not work out exactly, but so far, we have in fact been pretty close to them. US stocks have on average peaked four-six months before the onset of recession and troughed eight months after the start of recession. We peaked last October and many believe that we are on target to meet the historical standard.
Negative may be positive: It may sound crazy, but the very fact that people are turning negative may be a positive development for the slumping markets. Often, stock market bottoms form when sentiment is at its worse, hence the old chestnut, “sometimes, when things look bleakest, it’s a sign the market is near a bottom.” We could be a long way from that point, but when you start to hear the words “crash”, “recession”, or data points from the Great Depression, you might think to yourself, we are closer to the end of this mess than the beginning of it.
Tuesday, March 18, 2008
The Bear Necessities
I thought that I had accomplished a lot over the weekend, until I read about the stunning Bear Stearns deal. In a remarkable turn of events, Bear agreed to sell itself two days after receiving emergency funds from J.P. Morgan Chase & Co. and the Federal Reserve Bank of NY.
Actually, the sale wasn’t the shocking part, but the price was: after closing down 47% on Friday to $30 per share, the 85-year old investment banking firm will sell itself for $2 per share to JP Morgan. To help grease the wheels of the deal, the Fed approved a $30 billion credit line to JP Morgan and said that it would effectively take over the huge Bear Stearns portfolio.
Separately, the Fed also lowered the rate for borrowing from the discount window by a quarter of a percent to 3.25%, in order to facilitate smoother financial market operations and further expanded last week’s $200 billion liquidity injection by creating the Term Securities Lending Facility (TSLF). The TSLF will make money available to the 20 large investment banks that serve as primary dealers and trade Treasury securities with the Fed. This program will allow the Fed to hold as collateral a wide array of investments, including the now-tarnished mortgage backed securities, and will have no limit on the amount of money that can be borrowed.
While I understand how many believe that those who created this mess should suffer, officials are thankfully pushing aside the worries about “moral hazard” so that financial system does not become crippled altogether. I see the Fed actions as necessary to help halt the forced sell-off of high quality mortgage backed securities. These moves are less financially-motivated than confidence-builders. Clearly the root of the economy’s fundamental problems can not be solved by the Fed. After all, the central bank can not stop housing prices from falling. But what it can do is provide liquidity to financial institutions which might prevent what is known on the street as a “death spiral”, or a bank run.
If you do not own Bear Stearns stock (which you may, because it was part of the S&P 500 Index), how is all of this going to affect you? Well it has created a ripple throughout the entire financial services industry. Shares of investment banks in the S&P 500 are down almost 30% this year, the overall market (as measured by the S&P 500 index) is down over 12% this year and over 17% from its most-recent high last October. But in a larger sense, the events of the past week imply that the Fed will do everything in its power to stave off financial instability and that is actually a good thing.
Actually, the sale wasn’t the shocking part, but the price was: after closing down 47% on Friday to $30 per share, the 85-year old investment banking firm will sell itself for $2 per share to JP Morgan. To help grease the wheels of the deal, the Fed approved a $30 billion credit line to JP Morgan and said that it would effectively take over the huge Bear Stearns portfolio.
Separately, the Fed also lowered the rate for borrowing from the discount window by a quarter of a percent to 3.25%, in order to facilitate smoother financial market operations and further expanded last week’s $200 billion liquidity injection by creating the Term Securities Lending Facility (TSLF). The TSLF will make money available to the 20 large investment banks that serve as primary dealers and trade Treasury securities with the Fed. This program will allow the Fed to hold as collateral a wide array of investments, including the now-tarnished mortgage backed securities, and will have no limit on the amount of money that can be borrowed.
While I understand how many believe that those who created this mess should suffer, officials are thankfully pushing aside the worries about “moral hazard” so that financial system does not become crippled altogether. I see the Fed actions as necessary to help halt the forced sell-off of high quality mortgage backed securities. These moves are less financially-motivated than confidence-builders. Clearly the root of the economy’s fundamental problems can not be solved by the Fed. After all, the central bank can not stop housing prices from falling. But what it can do is provide liquidity to financial institutions which might prevent what is known on the street as a “death spiral”, or a bank run.
If you do not own Bear Stearns stock (which you may, because it was part of the S&P 500 Index), how is all of this going to affect you? Well it has created a ripple throughout the entire financial services industry. Shares of investment banks in the S&P 500 are down almost 30% this year, the overall market (as measured by the S&P 500 index) is down over 12% this year and over 17% from its most-recent high last October. But in a larger sense, the events of the past week imply that the Fed will do everything in its power to stave off financial instability and that is actually a good thing.
Monday, March 17, 2008
Grin and Bear it
Alan D. Schwartz, the CEO of Bear Stearns seemed stoic as he conducted a conference call Friday to explain the nation’s fifth largest investment bank’s dramatic move: it had received emergency funds from J.P. Morgan Chase & Co. and the Federal Reserve Bank of New York to meet its obligations and to protect against rumors that have been swirling around the firm for the past week. Whether or not the rumors became self-fulfilling prophecies are not yet known, but what is crystal clear is that Bear’s liquidity has fallen so much that it needed cash.
The mainstream media jumped on the story with headlines that repeatedly said the government is “bailing out Bear”. How unfair, said CNN’s Lou Dobbs! Your taxpayer money should not be used to ease the pain of Wall Street-ers! Before you go too crazy with that line of thought, let’s remember that a liquidity crisis that is not contained at Bear could easily spread to other banks, investors or industries, which is why the Fed, the Treasury Department and the SEC were all involved.
Authorities needed to step in because Bear does business with so many large firms (counter-parties) and is a significant player in markets for debt, particularly for securities backed by mortgages. If Bear were to fail, many of the counter-parties would become ensnared, prompting a potential domino effect throughout the brokerage and banking industries. And to the “rescue” of Bear, let’s remember that the stock fell 47% on Friday to a nine-year low of $30 per share and is down a staggering 79% from 52-weeks prior. That seems like a healthy dose of pain and suffering.
The mechanics of the deal involve using a little-used Depression-era provision of the Federal Reserve Act. J.P. Morgan will borrow directly from Fed's discount window and relend to Bear Stearns for 28 days. (Unlike investment banks like Bear, JP Morgan has the advantage of being able to borrow directly from the Fed.) The money that is borrowed will be secured by collateral furnished by Bear, but here is where the accusations of “bail-out” come to light. Under terms of the deal, the Fed, not J.P. Morgan, bears the risk of losses if the Bear Stearns collateral falls in value.
CEO Schwartz noted that the firm is seeking sources of permanent financing “or other alternatives for the company.” In other words, Bear needs a buyer-and fast. The assumption is that this deal is likely to lead to JP Morgan’s acquisition of Bear Stearns, and in a broader sense, perhaps this is the beginning of the bottoming process of the credit crunch.
The mainstream media jumped on the story with headlines that repeatedly said the government is “bailing out Bear”. How unfair, said CNN’s Lou Dobbs! Your taxpayer money should not be used to ease the pain of Wall Street-ers! Before you go too crazy with that line of thought, let’s remember that a liquidity crisis that is not contained at Bear could easily spread to other banks, investors or industries, which is why the Fed, the Treasury Department and the SEC were all involved.
Authorities needed to step in because Bear does business with so many large firms (counter-parties) and is a significant player in markets for debt, particularly for securities backed by mortgages. If Bear were to fail, many of the counter-parties would become ensnared, prompting a potential domino effect throughout the brokerage and banking industries. And to the “rescue” of Bear, let’s remember that the stock fell 47% on Friday to a nine-year low of $30 per share and is down a staggering 79% from 52-weeks prior. That seems like a healthy dose of pain and suffering.
The mechanics of the deal involve using a little-used Depression-era provision of the Federal Reserve Act. J.P. Morgan will borrow directly from Fed's discount window and relend to Bear Stearns for 28 days. (Unlike investment banks like Bear, JP Morgan has the advantage of being able to borrow directly from the Fed.) The money that is borrowed will be secured by collateral furnished by Bear, but here is where the accusations of “bail-out” come to light. Under terms of the deal, the Fed, not J.P. Morgan, bears the risk of losses if the Bear Stearns collateral falls in value.
CEO Schwartz noted that the firm is seeking sources of permanent financing “or other alternatives for the company.” In other words, Bear needs a buyer-and fast. The assumption is that this deal is likely to lead to JP Morgan’s acquisition of Bear Stearns, and in a broader sense, perhaps this is the beginning of the bottoming process of the credit crunch.
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