One of the hardest things to control in the investment world is the movement to extremes. Sometimes asset classes go parabolic, exploding higher, which leads everyone scrambling to find ways to force a more gradual ascent. Conversely, when the high-fliers take a nose dove, everyone wants it to be a gradual descent, not a crash. Right now, there are dual efforts to limit both the upside and downside in financial markets.
On the upside, there have been Congressional efforts to create more stability in the soaring commodities markets. Lawmakers have discussed everything from banning pension funds from commodities markets (this seems a bit extreme and unlikely to pass) to increasing reporting requirements to setting speculation limits on over-the-counter trading. Yet sometimes the simplest solutions are buried in the conversation.
When I started my career, my stock-trading father marveled at the low margin requirements in the commodity futures and options markets. While poor ol’ Dad had to slap down 50% to trade stocks on margin, my friends and I were only required to put down less than 10% for our trades. I think it’s probably time to increase the margin requirements for commodity futures traders. To that end, Senator Byron Dorgan (D., N.D.), is trying to rally support for raising margins to 25% for any energy traders that aren't commercial producers or purchasers. This would clearly reduce speculative activities, although that does not mean that the price of oil, or any other commodity, will fall. But it might slow down the ride up.
There are also those who believe that evil short sellers are responsible for the current bear market in stocks. I don’t think this is the case, but there has been a significant change in trading rules over the past year. On July 6, 2007 Rule 10a-1 of the SEC 1934 Act, the so-called “Uptick Rule” was eliminated and in my mind, this was a bad decision and has led to increased downside volatility in markets.
The 70 year old regulation attempted to constrain short selling in declining markets by requiring that listed securities be sold short only at a price above their last different sale price. The rule was adopted in response to negative sentiment toward short sellers (sound familiar?) and was enacted to prevent short selling from being used to drive down stock prices in so-called “bear raids” and to limit short sellers from accelerating declines in securities.
The SEC in all of its infinite (and short-sighted) wisdom abolished the rule after determining that it was not necessary. Of course the regulators took this action after a five-year period of rising stock prices and abnormally low volatility. Given the current market conditions, it would seem reasonable to reconsider this decision. With short sales at record levels, rumors swirling on a daily basis and the SEC fighting for its relevancy, it’s time to bring back the Uptick Rule. This action, along with increasing margin requirements, will not stop excesses, but they will help slow them down.
Friday, July 11, 2008
Thursday, July 10, 2008
If it’s Wednesday…
In a continuation of the see-saw markets (mostly saw or down), yesterday’s stock market action more than erased the prior day’s nifty gains. This time there was no blaming speculators, evil hedge funds or spiking oil (August crude oil closed a penny higher at $136.05). No, if it’s Wednesday, then the culprit must be a more fundamental issue, like worries over slowing growth and by extension, corporate earnings.
I know what you are thinking: weren’t we supposed to be scared of inflation and too-hot growth around the globe? That is so last week! As earnings season kicks off this week, the new black for investors is that second-quarter results will stink and may be remain that way for a long time because the economy could remain mired in this messy process of deleveraging (both for consumers and financial companies) well into next year. You would not be wrong in thinking that there seems to be a fairly significant disconnect between market fears and recent data on the health of the US economy.
The US economy has been stronger than anticipated in the first half of the year. It is estimated that real growth for the six months ended in June was an annualized 1-1.25%. That’s certainly well-below the long-term average, but it is not negative and is surprisingly robust given all of the land mines that were lurking. The easiest explanations for the better-than-expected results are: (1) the tax rebates lifted consumer outlays (2) US exports soared and (3) capital spending accelerated in the second quarter, perhaps due to the corporate tax incentives in the stimulus plan. But even with the economy doing well, the doomsayers in the financial markets focused on oil and that pesky issue of investment banks and mortgage lenders teetering on the edge of failure.
Even if the economy did well for the first half, the major concern now is looking ahead at the second half of the year. Unless consumers receive another tax rebate, what will they be spending? At the same time that cash flow tightens, some may find it difficult to reach into their wallets and spend freely. Similarly, as inflation, tighter monetary policies and rising oil sink into the mindset of foreign consumers, they may be less inclined to spend money on imported US goods. In sum, if discretionary income comes under pressure, global demand for US merchandise slows and businesses start cutting back on spending, you can see how the second half could start looking a bit murky.
None of this is new information, but in bear markets, there is usually a period in time known as “capitulation,” “the inflection point,” or the flash point when you should be buying stuff because it is THE LOW. The problem is that this moment is only known in retrospect, or as my father likes to say, “They don’t ring a bell at the top or bottom!” In my experience, when the time comes, investors have to basically force themselves to buy, because fear is rampant and it feels like the only possible direction is down. When you feel like the last thing in the world you want to do is buy, it’s probably getting close to that magical moment in time. Until then, we can expect more Tuesdays and Wednesdays like these.
I know what you are thinking: weren’t we supposed to be scared of inflation and too-hot growth around the globe? That is so last week! As earnings season kicks off this week, the new black for investors is that second-quarter results will stink and may be remain that way for a long time because the economy could remain mired in this messy process of deleveraging (both for consumers and financial companies) well into next year. You would not be wrong in thinking that there seems to be a fairly significant disconnect between market fears and recent data on the health of the US economy.
The US economy has been stronger than anticipated in the first half of the year. It is estimated that real growth for the six months ended in June was an annualized 1-1.25%. That’s certainly well-below the long-term average, but it is not negative and is surprisingly robust given all of the land mines that were lurking. The easiest explanations for the better-than-expected results are: (1) the tax rebates lifted consumer outlays (2) US exports soared and (3) capital spending accelerated in the second quarter, perhaps due to the corporate tax incentives in the stimulus plan. But even with the economy doing well, the doomsayers in the financial markets focused on oil and that pesky issue of investment banks and mortgage lenders teetering on the edge of failure.
Even if the economy did well for the first half, the major concern now is looking ahead at the second half of the year. Unless consumers receive another tax rebate, what will they be spending? At the same time that cash flow tightens, some may find it difficult to reach into their wallets and spend freely. Similarly, as inflation, tighter monetary policies and rising oil sink into the mindset of foreign consumers, they may be less inclined to spend money on imported US goods. In sum, if discretionary income comes under pressure, global demand for US merchandise slows and businesses start cutting back on spending, you can see how the second half could start looking a bit murky.
None of this is new information, but in bear markets, there is usually a period in time known as “capitulation,” “the inflection point,” or the flash point when you should be buying stuff because it is THE LOW. The problem is that this moment is only known in retrospect, or as my father likes to say, “They don’t ring a bell at the top or bottom!” In my experience, when the time comes, investors have to basically force themselves to buy, because fear is rampant and it feels like the only possible direction is down. When you feel like the last thing in the world you want to do is buy, it’s probably getting close to that magical moment in time. Until then, we can expect more Tuesdays and Wednesdays like these.
Wednesday, July 9, 2008
Ben speaks and the market actually rallies!
I woke up yesterday to more bad news: the overseas markets were taking a beating as investor anxiety over the credit crisis and upcoming earnings season were gripping traders from Tokyo to London. The domino effect started in the US on Monday after negative news about the mortgage lenders hit the wires. When nerves are raw and emotions are high, problems can catalyze downside action in a matter of minutes, but in this environment, it feels like seconds.
The trouble started after a Lehman Brothers report estimated that mortgage lenders Fannie Mae and Freddie Mac could be forced to raise approximately $75 billion ($46 billion for Fannie and $29 billion for Freddie) in capital, diluting existing shareholders, if a proposed accounting rule change were enacted requiring companies to move certain off-balance sheet securities onto their books. These were the investment vehicles that were used to sell off, or securitize debt instruments such as mortgage securities. Even without the rule change, some analysts believe that additional capital will be a necessary ingredient for each company’s ability to survive the housing crisis and the associated credit losses. Still, it was the Lehman report on Monday that did the most damage, as both companies fell to their lowest levels in more than 14 years--FNM dropped more than 16% to $15.74 and FRE fell nearly 18% to $11.91.
The selling continued overnight and into Tuesday, as the news sunk in about the two mortgage giants. To add insult to injury, the FDIC announced that it would bar IndyMac Bancorp from making new mortgages, which further fanned the flames for jittery financial sector investors. Japanese markets tumbled Tuesday after a one-day respite, and resumed their two-week slide, sending the Nikkei 225 Stock Average 2.5% lower to close at 13033.10, after falling below the 13000 level intraday for the first time in nearly three months. The results were similar across Europe and within a couple of hours of the US opening, things looked pretty messy.
That’s why the timing of Fed chief Ben Bernanke’s comments at a mortgage-lending forum hosted by the FDIC was particularly fortunate. Bernanke described a plan to expand the central bank’s authority over financial firms and “In doing so, we aim not only to make the financial system better able to withstand future shocks, but also -- by reducing the range of circumstances in which systemic stability concerns might prompt government intervention.”
Given the news swirling on Tuesday morning, investors could be forgiven for being hopeful that Mr. Bernanke would succeed in making “the U.S. financial system itself more stable.” After his comments, the market opened to the upside and traded higher throughout the day, with the S&P 500 closing up 1.7% on the day. Some of that action occurred on the back of nearly $6 drop in crude oil, but for a change, Bernanke’s comments definitely got the day off on the right foot. Of course a day does not make a trend, but it sure is preferable to the alternative!
The trouble started after a Lehman Brothers report estimated that mortgage lenders Fannie Mae and Freddie Mac could be forced to raise approximately $75 billion ($46 billion for Fannie and $29 billion for Freddie) in capital, diluting existing shareholders, if a proposed accounting rule change were enacted requiring companies to move certain off-balance sheet securities onto their books. These were the investment vehicles that were used to sell off, or securitize debt instruments such as mortgage securities. Even without the rule change, some analysts believe that additional capital will be a necessary ingredient for each company’s ability to survive the housing crisis and the associated credit losses. Still, it was the Lehman report on Monday that did the most damage, as both companies fell to their lowest levels in more than 14 years--FNM dropped more than 16% to $15.74 and FRE fell nearly 18% to $11.91.
The selling continued overnight and into Tuesday, as the news sunk in about the two mortgage giants. To add insult to injury, the FDIC announced that it would bar IndyMac Bancorp from making new mortgages, which further fanned the flames for jittery financial sector investors. Japanese markets tumbled Tuesday after a one-day respite, and resumed their two-week slide, sending the Nikkei 225 Stock Average 2.5% lower to close at 13033.10, after falling below the 13000 level intraday for the first time in nearly three months. The results were similar across Europe and within a couple of hours of the US opening, things looked pretty messy.
That’s why the timing of Fed chief Ben Bernanke’s comments at a mortgage-lending forum hosted by the FDIC was particularly fortunate. Bernanke described a plan to expand the central bank’s authority over financial firms and “In doing so, we aim not only to make the financial system better able to withstand future shocks, but also -- by reducing the range of circumstances in which systemic stability concerns might prompt government intervention.”
Given the news swirling on Tuesday morning, investors could be forgiven for being hopeful that Mr. Bernanke would succeed in making “the U.S. financial system itself more stable.” After his comments, the market opened to the upside and traded higher throughout the day, with the S&P 500 closing up 1.7% on the day. Some of that action occurred on the back of nearly $6 drop in crude oil, but for a change, Bernanke’s comments definitely got the day off on the right foot. Of course a day does not make a trend, but it sure is preferable to the alternative!
Tuesday, July 8, 2008
Car Talk
I don’t usually drive that much, but after filling up my Mini Cooper for a grand total of $46 over the long weekend, I started thinking about all of the people who really have to drive. These folks do not have public transportation readily available and must get in their cars daily to earn a living. A lot of them are not in a position to buy a new and/or more fuel efficient vehicle at this point, so here are some tips that I learned when Matt Stone, the executive editor of Motor Trend appeared with me on the same Fox Business News show yesterday.
There are the obvious pointers, like try to carpool with people as much as possible. When gasoline prices plummeted, the idea of sharing your commute with a neighbor or heaven-forbid, a total stranger, seemed onerous. But with the national average for a gallon of gas well over $4, necessity certainly makes for strange bedfellows, or car mates. I understand from friends who are long-time carpoolers that there are some unwritten rules that you may want to know. For example, there is no talking about politics, religion or gossip. In fact, in some cars, there is no talking at all. Additionally, the driver usually chooses the radio station, but most are tuning into news for traffic updates. One woman told me that I should underscore that “back-seat driving is absolutely, positively prohibited under any circumstances!”
Beyond carpooling, Matt Stone’s energy-saving list starts with an interesting tip: driving habits affects mileage more than anything else. He noted that those who tend to drive aggressively are by definition wasting gas because revving the throttle is wasteful. This is another reason to curse those who weave in and out of traffic or be upset with drivers who seems to accelerate and decelerate every 5 seconds. The converse is that those drivers who make smooth transitions on the road tend to be more energy efficient.
Maintaining your car also helps with mileage—that means keeping your tires properly inflated and that wheel balance and alignment are checked; making sure that your filters are fresh and fluids are clean; and that the engine is tuned up and firing on all cylinders. This may seem like a pain, but it requires a quick stop at your local station and may help you save a few bucks over the longer term.
Here is a tip that I will never follow: try to run your car without air conditioning. I will admit that my carbon footprint will never shrink significantly because I am in love with A/C, both in my home and in my car. But for those of you who say, “I don’t like air conditioning” or “we don’t need air conditioning because we’re so close to the ocean!” (You know who you are, you crazy New Englanders) this tip is an excellent rationale for why you are sitting on Route 95, sweltering in ridiculous humidity.
Finally, the last tip gives new meaning to the term “junk in the trunk.” Matt said that one way to improve efficiency is to empty out your vehicle’s trunk. The extra 50 or 100 pounds of junk requires more gas to lug around and frankly, isn’t it time to store the chains and shovels? There will be plenty of time to load it all up again.
There are the obvious pointers, like try to carpool with people as much as possible. When gasoline prices plummeted, the idea of sharing your commute with a neighbor or heaven-forbid, a total stranger, seemed onerous. But with the national average for a gallon of gas well over $4, necessity certainly makes for strange bedfellows, or car mates. I understand from friends who are long-time carpoolers that there are some unwritten rules that you may want to know. For example, there is no talking about politics, religion or gossip. In fact, in some cars, there is no talking at all. Additionally, the driver usually chooses the radio station, but most are tuning into news for traffic updates. One woman told me that I should underscore that “back-seat driving is absolutely, positively prohibited under any circumstances!”
Beyond carpooling, Matt Stone’s energy-saving list starts with an interesting tip: driving habits affects mileage more than anything else. He noted that those who tend to drive aggressively are by definition wasting gas because revving the throttle is wasteful. This is another reason to curse those who weave in and out of traffic or be upset with drivers who seems to accelerate and decelerate every 5 seconds. The converse is that those drivers who make smooth transitions on the road tend to be more energy efficient.
Maintaining your car also helps with mileage—that means keeping your tires properly inflated and that wheel balance and alignment are checked; making sure that your filters are fresh and fluids are clean; and that the engine is tuned up and firing on all cylinders. This may seem like a pain, but it requires a quick stop at your local station and may help you save a few bucks over the longer term.
Here is a tip that I will never follow: try to run your car without air conditioning. I will admit that my carbon footprint will never shrink significantly because I am in love with A/C, both in my home and in my car. But for those of you who say, “I don’t like air conditioning” or “we don’t need air conditioning because we’re so close to the ocean!” (You know who you are, you crazy New Englanders) this tip is an excellent rationale for why you are sitting on Route 95, sweltering in ridiculous humidity.
Finally, the last tip gives new meaning to the term “junk in the trunk.” Matt said that one way to improve efficiency is to empty out your vehicle’s trunk. The extra 50 or 100 pounds of junk requires more gas to lug around and frankly, isn’t it time to store the chains and shovels? There will be plenty of time to load it all up again.
Monday, July 7, 2008
It’s Different This Time
I heard the same four words used to support divergent opinions last week. The first time they were uttered, “Jack” was concerned that the current economic situation was dire and that this bear market was different than all others, or at least the one that he lived through in 2000-2002. A day later, “Ira” weighed in, saying that he vividly remembers the 1970’s and that this bear market was far different—and not nearly as bad as what he went though that time! Both of these interpretations are true.
Part of the difference between the two has to do with age. Jack only started investing in 1992, when he received a large inheritance. He knows that his first bunch of years spoiled him because the market moved up by so much and the gains far outweighed any of the pull-backs that occurred. When the tech bubble burst, Jack said he was scared, but he trusted that we would get him through the pain, which we did. “Things just didn’t seem as bad then as they are now! It’s different this time!”
This is of course the benefit of a healthy dose of amnesia. I had to remind that Jack that the stock market dropped by 55% during the last bear market and the economy was pretty grim. That said, I think what Jack meant was that today’s economic weakness feels more pervasive, as stocks and housing are falling as consumer prices are on the rise. In other words, there is just no place to hide. This may be why some of the confidence numbers are worse today than they have been in many years.
But there are others who have a longer time horizon by which to judge the current situation. Ira has been investing since the early 1960’s and has seen his share of bad markets and recessions. “I have to tell you—I think the media’s comparisons of today to the seventies are way overblown. Back then, I remember waiting in line for two hours to fill up my gas tank, paying my employees more when the company could not afford it and getting a mortgage for 11% and feeling lucky. It’s different this time!”
Listening to Ira, I realized that one of the biggest differences between the seventies and today is that the work force has lost leverage. In the 1970’s, unions had more power and as a result, wage growth regularly jumped above 8% and beyond. Today, employees can not walk into the boss’ office and ask for a raise to cover increased household expenses, because each of us realizes that we are one pink slip away from having our job outsourced. As a result, workers see their energy and food costs rising sharply without a concurrent increase in wages. The good news is that because companies are not paying more, they are not raising prices as much as they did in the past, causing what economists call a wage-price spiral.
Of course, every economic cycle is different than all others. How different may depend on where you are in your life, whether you are an employee or an employer and the sector in which you work. What is NEVER different is something that is worth remembering: the down cycle will end and be replaced by an expansion that makes you forget the pain of the last one.
Part of the difference between the two has to do with age. Jack only started investing in 1992, when he received a large inheritance. He knows that his first bunch of years spoiled him because the market moved up by so much and the gains far outweighed any of the pull-backs that occurred. When the tech bubble burst, Jack said he was scared, but he trusted that we would get him through the pain, which we did. “Things just didn’t seem as bad then as they are now! It’s different this time!”
This is of course the benefit of a healthy dose of amnesia. I had to remind that Jack that the stock market dropped by 55% during the last bear market and the economy was pretty grim. That said, I think what Jack meant was that today’s economic weakness feels more pervasive, as stocks and housing are falling as consumer prices are on the rise. In other words, there is just no place to hide. This may be why some of the confidence numbers are worse today than they have been in many years.
But there are others who have a longer time horizon by which to judge the current situation. Ira has been investing since the early 1960’s and has seen his share of bad markets and recessions. “I have to tell you—I think the media’s comparisons of today to the seventies are way overblown. Back then, I remember waiting in line for two hours to fill up my gas tank, paying my employees more when the company could not afford it and getting a mortgage for 11% and feeling lucky. It’s different this time!”
Listening to Ira, I realized that one of the biggest differences between the seventies and today is that the work force has lost leverage. In the 1970’s, unions had more power and as a result, wage growth regularly jumped above 8% and beyond. Today, employees can not walk into the boss’ office and ask for a raise to cover increased household expenses, because each of us realizes that we are one pink slip away from having our job outsourced. As a result, workers see their energy and food costs rising sharply without a concurrent increase in wages. The good news is that because companies are not paying more, they are not raising prices as much as they did in the past, causing what economists call a wage-price spiral.
Of course, every economic cycle is different than all others. How different may depend on where you are in your life, whether you are an employee or an employer and the sector in which you work. What is NEVER different is something that is worth remembering: the down cycle will end and be replaced by an expansion that makes you forget the pain of the last one.
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