Saturday, December 29, 2007

Terrorism is Alive, Dangerous, and Impacting the Markets.

The death of the former prime minister of Pakistan Benazir Bhutto's and the subsequent decline in the world equity markets should serve as a wake up call to all of us that the Taliban is serious about what they want to do to us. One of the reasons she was attacked was because she was a woman and in a leadership position something the Taliban cannot accept. In covering this horrific event the press, at least what I saw in the US press, was more concerned about how it happened and was less concerned about the message from the terrorist.

The coverage on CNN was so focused on how that they actually brought in an expert to review the film frame by frame to try and figure out if she died from a gunshot or something else. The constant playing of the frames, reminded me of the Zapruder Film of the John F. Kennedy assignation. The attention to detail of how it was accomplished ignored the real issues.

No matter how much we want to ignore terrorism it is still out there and impacts our lives and our investments. Just when we think things are moving the right direction an attack like this one sends a message that takes away our confidence. As much as we would like to think we have terrorism under control we don’t. We have been successful in keeping attacks out of the United States but they continue in other parts of the world,

I thought it was interesting to watch the presidential candidates reaction to the assignation or perhaps the lack of reaction. Perhaps the shock of the act has stunned the candidates to rethink some of their positions on terrorism and how to deal with this serious problem. With the Iowa primary in a few days’ comments about the attack will be muted at best from the Democrats. On the other hand Republicans may be more aggressive on the subject.

We have one last trading day in 2007 I don’t expect any significant rally. What I’m concerned about is how will this terror event impact the first weeks of the New Year? We still have the problems of the sub-prime issue. Housing continued to deteriorate and more banks will have to report losses on SIV’s. Stock prices may look cheap based on projected earnings for 2008 if those earning due in fact materialize.

In mid January the retail sales for December will be reported and most of the banks will report any write-downs from housing and other loans. I would be surprised if the Holiday sales were much improved over last year. In addition we will want to see fourth quarter earnings for the retailers to get some idea of the markdown necessary to attract buyer. Rumors on the street suggest that Merrill Lynch my report as much as an additional $15 billion in write-downs, and a major European bank is in trouble.

I don’t think we are out of the wood and most of the talk in the coming week will focus how slow will the slowdown really be and for how long. I wish I had better news to start the New Year but I’m afraid that many of the problems we discovered in the last 4 months of 2007 are still unresolved. I expect that 2008 will be a year of continued volatility and that being paid interest and or dividends will be a great thing for investors.

Dan Perkins

Thursday, December 20, 2007

Who is going to own who when this is all said and done?

In 2005 and 06 $1.2 trillion in sub-prime mortgages were sold to somebody.

OK this week we had Morgan Stanley and Bear Sterns report in excess of $10 billion in write-downs of sub-prime mortgages. So far, including this week, about $50 billion has been written down. Moody’s said yesterday that they were reviewing about $173 billion in mortgage-backed securities for possible down grades. Investment banks including Bear Stearns Cos., Deutsche Bank AG and Lehman Brothers Holdings Inc. sold $1.2 trillion of these securities in 2005 and 2006.

The most recent number as to the size of the problem in the sub-prime markets I saw was upwards to $500 billion. If there has been reported about $50 billion in write offs then we have only see 10% of the potential problem. Citibank and Morgan, in order to replace some of their lost capital, sold to Asian and Middle Eastern investor’s minor ownership interest in their firms.

What concerns me is if the number of $500 billion is reasonably correct then we still have $450 billion or so to go, who is going to own who when this is all said and done? The European central banks loaned out this week $500 billion dollars to provide liquidity. The rumor on the street is that a major European bank is in deep trouble because of their exposure to the sub-prime market. I think it is important to understand that the problems in the mortgage market are not isolate to the United States.

Cheap money and skyrocketing real estate price was a global opportunity or perceived to be opportunity. The chickens are coming home to roost and are bringing home with them all the debt that has to be paid off and the money is not there to make the mortgage payments. We as Americans want tings over and done with so we can move on to the next thing whatever it is. The problem with sub-prime loans is that it does not matter how much we want the sub-prime problem to be over with it, but it just will not go away.

The other rumor on the street is that the additional write down for Merrill Lynch, to be reported by the end of the month, could be an additional $8 billion to $15 billion. When you couple the $8 billion already announced at the high end that would take the loss to $23 billion dollars—if correct then Merrill would be forced to find additional capital.

I bring this to your attention because the credit markets and the world central banks know there is a huge problem and they are trying to keep it contained. I believe the pressure is building for a major credit collapse on a global basis, which I believe, will lead to a recession late next year.

Dan Perkins

Friday, December 14, 2007

We had a difficult week this week

The Dow was off 300 points for the week and if that isn't bad enough we closed on the low for the week and the day on Friday. I was explaining to a client recently how volatile the markets have been over the last 4 months. During that time we have seen two ten percent corrections and we may have started a third with the performance this week.

Over Time,
One Week or Four Months Disappears on the Charts

Let’s look at two days this week and see just how volatile the markets are. On Tuesday, more commonly called “Fed Day” the Open Market Committee cut the Fed Funds interest rate by 25 basis points (one quarter of one percent). The markets did not like the small cut in the Fed Funds interest rate and no cut in the discount rate. The result was that the stock market closed down just under 300 points for the day. Wednesday morning the market surged off the wimpy Fed move the day before, at one point, the Dow Jones was up about 250 points. Then it gave all that back and was down about 80 points. The market closed on Wednesday up about 45.

You Do the Math

So, in the matter of two days, the market went down 300, up 250, down 325, and then up 40 points. We took a slight breather on Thursday and then went down 178 points on Friday closing at the low for the day and the week. These market swings can drive you nuts! If you let them get to you. If you pull back to a year and look at the chart of the market, it will be hard to see what happened this week, and the further out you go in time the less you notice the volatility of this week.

My point is that if you have a longer term view the weekly or monthly movements have little impact on returns. I know it is hard to watch all this turmoil in the markets, that is the reason by and large I don't pay that much attention to short-term changes in the market. What I ask myself is: do I want to continue to own what I own? I do expect that the markets will continue to be ranged bound till the end of the year. I also expect the volatility we have been experiencing to continue.

Credit Markets Say the Trouble Isn’t Over

Recently I wrote about Special Investment Vehicles (SIV) that is off the balance sheets assets of the banks and brokers. Two weeks ago E-Trade sold $8 billion of SIV’s for 29 cents on the dollar. On Friday Citibank announced that they were moving about $43 billion in SIV’s to their balance sheet out of Level Three accounts. Level three assets are assets that the bank can carry at any price they choose. Many of the investments in Level Three usually have no market and therefore it is very difficult to establish their value.

By moving assets out of Level Three to Level Two they now have to figure out a price. Some people think that the value of these SIV’s is between 50 cents to 70 cents on the dollar. When Citibank moved these assets Moody’s lowered the credit rating of the bank. The credit agencies think the bank will have other write downs because of this movement of assets.

When Citi took their write downs for sub-prime loans they left the value of the SIV’s alone ($83 Billion) and carried them at par or face amount, no loss. As other banks will be forced to follow Citibank lead we will get more information as to the magnitude of potential losses in SIV’s. It may well take several quarters into next year till we find out the extent of the credit problem.

Dan Perkins

Charlotte Hope Perkins Born 12/7/2007

I have not updated recently because I have been preoccupied with the birth of our first grandchild. Charlotte Hope Perkins, was born around 9:30 PM on Friday, December 7. Roughly 21 inches long and just under 9 pounds.

Try this link to see pictures of Charlotte.

She came home with her parents on Sunday, but was back in the hospital on Monday afternoon with Jaundice. She came home again on Wednesday and is settling in with her parents. We will see her again in a week or so, but it was hard for both of us to leave her on Wednesday.

For some reason I never thought much about being a grandparent, but when I held her on Sunday morning, we became fast friends. In the hospital Gerri, worked with Jen on feeding the baby and I was able relieves mom and grandma to hold her when she got fussy. At just under 9 pounds, when you think about it, she was a big baby, but when you hold her 9 pounds in your arms she is very small.

Dan Perkins

Thursday, November 29, 2007

Citibank raised the cost of the solution.

Is CitiBank now a junk bank based on their cost of replacing their capital?

On Monday, Citibank sold a stake in the bank for $7.5 billion dollars. They paid the investor 11% dividend for about 5 years. The bank needed to replace some of the capital they wrote down in the subprime mess. Because Citi was the first they set the benchmark for others to follow, it appears to me that Citi is either in much worse shape then they have let on, or they were had based on the cost to other banks this week. As I was speaking to a client on Wednesday I said, at the price Citi paid it now becomes a “JunkBank”.

As other banks and mortgage provides were looking to raise money they had to pay more than they thought they would have to pay. Barclays bank came to the market today with a QDP preferred at 7.75%. Freddie Mac the second largest mortgage buyer came today with a non-convertible preferred at 8.38% yield.

Citi paid 2.79 times the yield on the 10-year T Bond

IThe 10-year Treasury Bond its yield today is 3.94%. If you look at what these banks had to pay to rebuild capital, it was very expensive. Barclays paid 1.96% times the 10-year T-Bond rate and Freddie Mac paid 2.12 times the 10–year rate. On the other hand, Citi paid 2.79 times the 10-year rate.

The risk premium in the credit markets has expanded, perhaps much wider than it should be, only time and more disclosure will tell if these were in fact the right prices.

Dan Perkins

Dogging the SIV Part 2

SIV Update

SIV holdings have fallen at least $75 billion since July to $320 billion, as the companies were unable to borrow. The net asset value of SIVs has fallen to 69.7 percent from 100 percent in July, according to Fitch Ratings. As I explained yesterday the banks like Citi that has $83 billion in SIV is caring the value at par. The bank has not taken down the value of these SIV, at least for now.

Home Equity in Trouble

Wells Fargo announced yesterday that they were taking a $1.4 billion write down on their home equity portfolio. To my knowledge, I know of no other bank that has reported problems with home equity. What is significant about this write down is that most home equity is help by the originating institution and not always securitized. A wave of write-offs in home equity will slow the economy. My guess with this $1.4 billion write down Wells Fargo will tighten its credit standards and it will make less home equity loans.

Home Price Fall Again

The consumer has been tapping their home equity in order to continue his lifestyle. With a 5.45 decline in the value of housing on a year over year basis reported yesterday by the National Association of Realtors the consumer will find they have less equity in their home. With less equity and higher standards, the consumer has less money to spend slowing consumer spending means a slower growth rate in the economy.

Unemployment and the Fed

We had a big jump in the number of new claims for unemployment benefits today and now the focus will turn to the November employment data, which will be reported on Friday the 7. The outcome of this report will likely have a significant impact on the Fed interest rate decision on December 11. Without the jobs, number the market sees over a 100% chance of the Fed cutting by 25 basis points. Some people point to the fact that today the 90 T-Bill rates is under 3% while the current Fed Funds Rate is 4.50% to show how far behind the Fed is on the rate curve. I suspect that unless we see an ugly number next Friday the Fed will only go 25 basis points and then another 25 in January

Equity Market

If the markets close on the upside, today I expect a bear squeeze tomorrow and the bears will have to start covering their short positions. Look for this market, not all at one time, to test the highs before the end of the year.

Dan Perkins

Wednesday, November 28, 2007

Watch out for the oncoming SIV not the SUV

Last week I brought to your attention the potential problems with Special Investment Vehicles (SIV). These investments are not currently on the balance sheets of the banks or investment banks. The result of this off balance sheet financing is that nobody knows for sure how much is out there. I thought it might be important to get some information to you so as more and more information comes out about SIV you are knowledgeable. I have collected information from several sources about SIV to give you diverse background.

Offshore Companies

SIVs are typically offshore companies created by banks and other firms to sell short-term debt to buy mortgage securities and finance company bonds with higher yields. They profit on the spread between the two.

Banks such as New York-based Citigroup, which manages $83 billion in SIVs, collect fees for running SIVs while keeping their contents off the bank's books. SIVs finance themselves by selling asset-backed commercial paper, or short-term loans backed by collateral such as mortgages.

When the subprime debt market blew up in August, investors stopped buying SIV commercial paper. As a result, in September and October, SIVs didn't have the cash to pay debt holders of more than $8 billion of their paper.

The banks had also peddled SIV paper to their clients, including state officials who oversee pools of taxpayer funds like Florida's. The $27 billion Florida pool, the largest in the U.S., has invested $2 billion in SIVs and other subprime-tainted debt, state records show. About $725 million of these holdings have already defaulted.

Yesterday, Governor Charles Crist held a public meeting disclosing that 4 percent of the state's short-term investments, including those in the state pool, had been downgraded by credit rating companies.

`Would be Devastated'

State pool losses may hit taxpayers in places like Jefferson County in the form of reduced services or higher taxes.

Jefferson County's Wilson says he still trusts the Florida pool managers and will keep the school's money in the fund. ``I really hope this isn't any worse than we know today,'' he said after the Nov. 14 meeting. ``If something happened to that investment, our county would be devastated.''

State officials have no business putting taxpayer money into debt investments that have baffled even the most seasoned Wall Street executives, says Joseph Mason, finance professor at Drexel University in Philadelphia and a former economist at the U.S. Treasury Department.

Municipalities shouldn't be playing like they're expert investors, squeezing the last penny out of SIVs,'' Mason says. ``They're making a giant jump into a new product area which has unknown, unforeseen risks.''

Cheyne Default

Thousands of school, fire, water and other local districts across the U.S. keep their cash in state- and county-run pools. These public accounts, modeled after private money market funds, are supposed to invest in safe, liquid, short-term debt such as U.S. Treasuries and certificates of deposit.

All told, there were about 100 such pools, containing more than $200 billion at the end of 2006, according to Westborough, Massachusetts-based iMoneyNet, a research firm that tracks these funds.

Public fund managers say they've bought SIV debt because it had the safest credit ratings and offered higher yields than other short-term fixed-income investments.

SIVs, many of which are assembled by London-based bankers, had a low profile until some of them collapsed. The $7 billion Cheyne Finance SIV, incorporated in Delaware, defaulted on Oct. 17.

`High-Risk Investments'

Among the places caught up in the SIV and subprime snarls are Connecticut, Florida, Maine, Montana and King County, Washington. Public funds hold $1 billion of defaulted asset- backed commercial paper, including $273.5 million from SIVs. Montana entrusted $465 million, or 19 percent of its $2.5 billion investment pool, to SIVs.

Someone once said that"if it sounds to good to be true then it must be." As people shopped for yield they didn't ask the question, "What are they doing with my money to get a higher return?" When thing went bad we always hear the same statement, "Nobody told me the risk I was taking."

Dan Perkins

Monday, November 26, 2007

Will we ever hear the Fat Lady sing?

Today was another brutal day for those of you in the markets, if you are heavy into stocks waiting for a chance to get out with a bounce. A positive day if you only owned Treasuries. (None of us has enough: well except Noelle) Most people own some Treasuries, but not enough and as each day sees a decline in the stock market, we wish we had more.

One down two to go

The S&P 500 index turned negative as of today in terms of price for the year-to-date time-frame. The Dow Jones is less than 300 points from turning negative for the year and the NASDAQ is within 90 points of turning negative. Could the latter find new lows tomorrow? At some point in time, I would expect a bounce just because the sellers will run out of steam. When will that happen? Your guess is as good as mine is. We are in a momentum market now the momentum is negative and something has to turn the momentum.

Bonds Smoked

Up until today, all the action was in the short-end of the Treasury market but look at the results as of the close today. The 30-year T-Bond was up two and seventeen thirty-seconds, this is a huge move and one of the largest I have seen in a long time. Look at the yield on the rest of the curve. The 10-year is approaching 3.75%, which would be significant if we had a housing market.

2-Year 3.625 10/31/2009101 2.89 103/4

3-Year 4.5000 5/15/2010103-30 2.84 14 .

5-Year 3.875 10/31/2012102-31 3.21 28.

10-Year 4.250 11/15/2017103-11 3.84 1-10

30-Year 5.000 5/15/2037111-29 4.28 2-17

What if the Treasury doesn't expand the supply of 90-day T-Bills

As long as the bond market continues to rally as it has with a flight to quality, the equity market will continue to be volatile. At some point in time, the bond market will run out of gas like the stock market and there will be more pain. The short end of the yield curve will have the least amount of pain for investors, but what happens if the Treasury does not offer any more bills?

If you wanted to fund long-term obligations and you look at the yield above were would you want to sell bonds? One thing going on in the background that not many people are talking about is the declining Federal Budget deficit. Do not be surprised that sometime soon the Fed says they are only going to rollover the existing T-bills and not add to supply.

The demand will out strip supply and we could see the 90-day T-Bill below 3%. Keep in mind that momentum does run its course and this to will pass it will just take time. These market gyrations sure make it difficult to go Christmas shopping when your portfolio just went down again. Look at what you own if it was good when you bought and after review, it is still good then keep it you do not need to participate in a fire sale.

Dan Perkins

Saturday, November 17, 2007

Wells Fargo says Housing worst since the "Great Depression"

Up 360 and then give it away

The volatility bandwagon continues to roll on Wall Street. The market was up one day this week over 360 points and then we gave almost all of it back the rest of the week. On Thursday the Treasury added $48
billon dollars liquidity to the system and this amount was the largest infusion by the Treasury in history, even greater than the infusion after 9-11, you remember September 11, 2001.

Not to be out done by the Treasury, Wells Fargo, one of the largest mortgage originators in the nation, said that the housing decline was the worst since the “Great Depression”. The markets are still trying to get a handle on the magnitude of both the sub-prime and housing problems. Goldman said on Friday that they figure that when it is all said and done the impact of the sub prime and housing issues will mean a loss of about $2 trillion dollars.

This past week I had the opportunity to teach a class at Florida Southern University in The School of Journalism. The subject of my class was “Is the sub prime problem a cover for the real problem in housing’? I think the sub prime issue is the result of greed by many players in the housing sector.

"Greed is Good"

In the movie “Wall Street”, the most famous quote about Wall Street is “Greed is good”. If you think of Greed as a pendulum that swings back and forth, at the height of the housing bubble the Greed pendulum had moved to far in one direction. As we learned in high school physics class every, action has an equal and opposite reaction. The pendulum is swinging back towards the middle and it will probably swing to far the other direction before it is all said and done.

We had a scare again in the credit markets this week in money market accounts. Legg Mason reported that it had to infuse over $300 million in two of their money market accounts to keep the par value of one dollar. On the other hand GE Capital broke the $1.00 level when it reported that it had sub prime asset backed paper in their money market account. The last reported price for the fund was $.96.

The big question face investors between now and the end of the year is were will the $ 2 trillion in short-term money market investments go when they rollover? When the markets go up we seem to think that the problem with the credit markets is over and then something like the events of this week and the markets fold as fear takes hold again and people don’t know what to do with their money.

90 Day T-Bill could break 3% by year-end

I think the demand for short Treasury Bills will be high for the rest of the year. If another shoe were to drop more and more people will run to the short end of the n curve and put tremendous downward pressure on short interest rates. The old law of supply and demand is at play for now in the short-term credit markets. We may well see the 90 day T Bill yield below 3% by the end of the year

Dan Perkins

Friday, November 9, 2007

Don't try and catch a falling knife

Shoeshine boys were giving stock tips

Stay off the ledge, regardless of how high it is off the ground. In the 1930's when the stock markets crashed, some people jumped out of buildings because they lost everything speculating in the stock markets. Prior to the crash the shoeshine boy were giving stock tips.

Go out and do some Christmas shopping

I am not saying that we are in another 1930’s crash, but we are in a great deal of turmoil now with a bias to the downside. The best thing you can do now is go out and do some Christmas shopping. I do not believe that you should sell at this level or even if the markets goes down further, you should sell then, this is not the environment to make sell or for that matter, some buy decisions.

You have to look at what you own and make a decision as to the prospects of the company in a different economic environment. If the bulk of your money is in quality fixed income then spend a little more on Christmas. If on the other hand you have raised a significant amount of cash and you are looking for something to buy go out and do some Christmas shopping

Income tax of 15%

Tax qualified stocks, including preferred, offer a maximum income tax of 15% regardless of your tax rate on other income. Therefore, if you have to pay 38% on other income and only 15% on tax qualified investments you can see why tax qualified investments would be attractive.

Triple tax-free bond at an interest rate of 5.10%

I recently purchased some Puerto Rico triple tax-free bond at an interest rate of 5.10%. These are zero coupon bonds so they pay no current income but appreciate over time. You buy a zero coupon at discount, something less than face amount and then at maturity you get the face amount. In this example, I paid 9.5 cents on the dollar. If I hold the bond until maturity then I will get just over 10.5 times on my money.

If you look around you will find things to do with your money, even in difficult times like today. Picking what stocks to buy could be difficult, a friend of mine said he liked a stock and bought some last week, bought some more at a lower price early this week and today he can buy it at an even better price.

In turbulent times as we are experiencing now, sometimes the baby gets thrown out with the bath water. As I said above, look at what you own, if you still like it and you have the cash, then average down and take the reduced price as an early Christmas gift and buy more.

If you do not own a stock and do not know anything about it, then read the headline, and do not try to catch the falling knife of picking a stock to buy in today’s market. The cut could be deadly to your financial health.

Dan Perkins

Thursday, November 1, 2007

Highlights from RealtyTrac Inc Report on Foreclosures

  • One property can have more than one mortgage and therefore more than one foreclosure notice
  • A total of 446,726 homes nationwide were targeted by some sort of foreclosure activity from July to September, up 100.1 percent from 223,233 properties in the year-ago period, according to Irvine-based.
  • The current figure was 33.9 percent higher than the 333,731 properties in foreclosure in the second quarter of this year.

  • There was one foreclosure filing for every 196 households in the nation during the most recent quarter

  • In all, 635,159 filings were reported in the third quarter, up 99.5 percent from the year-ago quarter and up 30 percent from the second quarter of this year.

  • RealtyTrac reported that three states with the highest foreclosure rates during the third quarter were Nevada, California and Florida.

  • Nevada reported one foreclosure filing for every 61 households, with 16,817 filings on 12,982 properties.

  • California led the nation in total foreclosure filings and reported one filing for every 88 households. The state had 148,147 filings on 94,772 properties, an increase in filings of 36 percent from the previous quarter and nearly four times more than the year-ago period.

  • In Florida, there were 86,465 foreclosure filings on 60,992 properties. Foreclosure filings rose 51.5 percent from the previous quarter and more than doubled from the same quarter last year.

  • Florida's foreclosure rate amounted to one filing for every 95 households.

The bottom line is that based on these number reported from RealtyTrac Inc. the implosion in the housing market seem to be accelerating rapidly.

Dan Perkins

Tuesday, October 30, 2007

Markets are climbing the wall of worry.

Will the Fed stop after tomorrow? What happens if oil goes to $100? Can stocks go up in the face of the sub-prime problem? Merrill Lynch may have to take another $4 billion dollar write down in the fourth quarter due to losses because of sub-prime issues.

Wal-Mart has already cut the prices of their Christmas, I’m sorry, Holiday toys by 20% and it is not even Thanksgiving in fact we are three weeks away from Thanksgiving. The upscale department stores had a terrible September so how could anybody be positive.

I have found over my 35 years of investing in the markets that the markets rarely do what the consensus think they will do. Most people feel we are in a trading range somewhere between 12,750 and 14,200 on the Dow Jones Index. Until the economy gives us a clear direction, we are not going to break out of the trading range.

We could flirt with 14,500 maybe even 15,000 on the Dow but I think there is still way to much cash on the sidelines and the market needs to suck in more cash before it will punish people. The Fed cutting interest rates on a methodical basis will support the markets. Large interest rates cuts will spook the markets around the world.

Just as the Fed was slow and steady in increasing interest rates they will, I believe, be slow and steady in lowering interest rates. Once the markets have sucked in enough capital, they will go down. Be careful of the pundits who tell you the correction is over you having to get in or you will miss the market.

Therefore, will we get a Santa Clause, I am sorry again, Holiday rally? I think so. I do not expect it to be up 400 points in a day, just as I said that the Fed will be slow and steady so will the market climb to the end of the year. I expect some tax selling late in the year to knock it down a little and then a first of the year rally and then we have to be very careful.

Dan Perkins

Monday, October 29, 2007

Fithch Changes its Mind

Fitch Ratings said it might cut ratings on $36.8 billion of collateralized debt obligations (CDO) linked to residential mortgage securities.

Fitch, a unit of Paris-based Fimalac, follows Moody's Investors Service, which last week cut ratings of CDOs linked to $33 billion of subprime mortgage securities. Lower ratings may force owners to either mark down the value of their holdings, or sell the securities. Moody's, Fitch and Standard & Poor's in July began lowering ratings on hundreds of mortgage-linked securities after their value tumbled as much as 80 cents on the dollar.

``The market at this point no longer believes the rating agencies when it comes to mortgage-related products,'' said David Castillo, who trades CDOs in San Francisco at Further Lane Securities. ``It's merely forcing the hand of investors who are ratings-driven from an investment-criteria perspective.'' If they don't believe the CDO ratings then how can an investor trust the ratings on other bonds?

AAA Cuts

All AA, A and BBB rated CDOs are likely to be cut to below investment grade, Fitch said. Speculative grade, or junk, issuers carry ratings of BB+ or lower. About two-thirds of the AAA securities are either mezzanine securities or CDOs of CDOs and are likely to be sliced to between BBB and BB-, Fitch said.

The most severely affected are recent CDOs, which had both the worst-performing subprime mortgage bonds and the highest percentage of those securities as assets, Fitch Ratings Managing Director John Schiavetta said.

``It is clearly subprime that is causing this,'' said Schiavetta, who is based in New York. ``And most of that is from 2005 onward with the bulk of it in '06 and `07.''

Schiavetta predicted that there will be CDOs that will default, including the top-rated AAA parts.

One has to wonder how something that was rated AAA in the spring of 2007 could be worth nothing in October of 2007. Is this a case of throwing the baby out wit the bath water or are we in more serious trouble than anyone thought? I have been concerned that the pendulum was swinging to far in one direction with all of the rating downgrades. I am not so sure now that the pendulum has moved as far as it seems.

If you read the announcement from Fitch more closely, you will see that they are downgrading CDO’s with an AAA rating to junk status. Somebody needs to ask how Fitch and others rated this CDO AAA in the first place. If the rating agencies used basic criteria to rate CDO’s did they use the same criteria to rate other bonds? What else is out there that we don’t know about that has not come to the surface yet?

Dan Perkins

Wednesday, October 24, 2007

Home Sales Plunge by 8 Percent

The weakness in sales translated into further pressure on prices. The median price fell to $211,700 in September, down by 4.2 percent from the sales price a year ago. It marked the 13th time out of the past 14 months that the year-over-year sales price has decreased. These guys are good they expected a 4.5% decline and got 8%. Just like Merrill Lynch today reported that they thought they had about $3.5 billion in write-downs on bad loans and reported today, whoops, it is about $8 billion we think, we will let you know by the end of the year or later.

Analysts blamed the bigger-than-expected slump on the turmoil that hit credit markets and mortgage markets in August as worries increased over rising mortgage foreclosures. Have you ever closed a mortgage in 30 days? I have once in my life. I do not think the numbers reflect what happened in August and September and I would look for numbers that are even more terrible over the next few months.

Lawrence Yun, senior economist for the Realtors said, "Mortgage problems were peaking back in August when many of the September closings were being negotiated and that slowed sales notably in higher priced areas that rely more on jumbo loans," The real estate problem may peak in August but not 07 more like 09.

The slowdown in sales meant that the inventory of unsold homes rose to 4.4 million units in September. At the September sales pace, it would take 10.5 months to eliminate the overhang of unsold homes, a record length of time. Is it possible that the backlog will be 12 month by the first quarter 2008? Home builders can slowdown their construction of single-family homes but the condominium builder cannot stop. More and more inventory is coming on to the market each month and I think it may well take into 2009 before we see any significant decline in condominium backlog.

Mr. Yun said,” that the price declines should be put into perspective in that they are occurring after a five-year housing boom which pushed prices up to record levels”. What he did not say was that is true unless you bought in the last two years and if that is the case, you had no boom but pure bust. The Realtors are predicting that at year-end we will have the first year of a year over year decline in the price of housing in 40 years. I think we may well be in for a couple more year over year declines.

Dan Perkins

Saturday, October 20, 2007

New Disney Thrill Ride Called The Stock Market

If you look back at other postings on this Blog you will see my warnings on the markets and the real estate problem that have been by and large ignored or minimized. Why is it that when the brokerage firms reported their problems and announced their write downs on sup-prime mortgages they and the markets went up--while when the banks reported their problem they and the markets tanked?

How bad was it today?

The S&P 500 fell 3.9 percent this week and the Dow average lost 4.1 percent. The Nasdaq declined 2.9 percent.

All 10 industry groups in the S&P 500 decreased today, with 481 of the index's 500 members posting declines. Energy shares posted the steepest decline after crude oil retreated from a record. More than 17 stocks dropped for every one that gained on the New York Stock Exchange. A gauge of stock-market volatility rose the most since March 13.

On the surface the decline would look ugly the problem for me is that I don’t think we are yet halfway thought this correction. By the end of the month we could test the August low and there is a chance that it might go lower.

People remember the August meltdown and the quick run up in the market in less than two month to new highs. I think the decline of Friday will feed on itself next week. You will see more selling as people who have profits will want to sell to protect their profits.

As the economy showed signs that it may be stronger than it was originally thought and therefore the Fed might not cut interest rtes on their Halloween meeting as of the close of the markets on Friday the futures we suggesting a 92% chance of a 25 basis points cut. Give the decline in interest rates across the entire curve on both Thursday and Friday the bond markets are pricing in much more than the 25 basis points already expected.

Gas at $4 a gallon or higher

With the move to almost $90 dollars a barrel in crude oil you have to start wondering when we will see a spike up in gas prices. We have oil at record prices yet gas is considerably lower than it was when oil was $65 after the hurricanes a few years ago. If crude were to hold in the $85 to $90 a barrel we could see $4.00 gasoline or more. With energy prices moving up at some point in time the cost of energy will impact the ability of the majority of Americans to spend. Those people at the higher income levels will not change their spending habits because gas goes to $4 a gallon or more. The question is, “How much can the high income people carry the rest of the economy?”

Inflection Point

The problems of the housing market are not just a United States problem. In the past people have been saying that the problems are contained and will not affect the rest of the economy. Clearly the housing problem is more that just the sub-prime issue. On Tuesday S&P downgrade over $23 billion dollars of mortgage bonds issues in 2007 including some that were AAA rated previously by S&P. The real estate problem is growing and people are now beginning to understand two things about this problem. First, it is far from over and second we still don’t know the total magnitude.

I would like to hope that this correction will be as quick as the one in August and it may turn out that we hit bottom by the end of October. If in fact we do hit the bottom by the end of the month the psysocilogy of the market will not at that point in time allow a quick rebound to a new high. It is entirely possible that we may have seen the high in the markets for this year. The Fed action and the policy statement by the Fed after the meeting will give us a good idea how concerned the Fed is about the economy. Strap in for a very serious volatility in this thrill ride called the market.

Dan Perkins

Wednesday, October 17, 2007

Are S&P Earings Real or Imiganed?

Almost one-half of the earnings of the S&P 500 Index come from foreign sales. As the dollar declines, the profits they earn in Euros and other foreign currency translates into higher dollars. So, are these real earnings or just paper profits?

These currency translations remind me of the earnings reported by companies in the 1990’s from the out performance of their pension funds. Companies could report, in their current earnings, the amount of unrealized profits their pension funds made in excess of their target returns.

If a company had a target investment return in their pension fund of eight percent and produced 10% then the company could inflate their current earnings by the two percent above the target rate of return. In today’s market, any earnings that are earned in local currency are counted at the currency exchange rate. If the company for example sells in England, it is paid in pound sterling. When the company calculates the value of their foreign earnings in pounds and converts those earnings to the US Dollar, they get over inflate earnings by the decline in the dollar vs. the local currency they made the sales.

The dollar will not go down forever and at some point in time, the dollar will reverse direction. The disadvantage of foreign earnings will work against the income statements of those companies that are benefiting from a weak dollar.

Why is all of this important?

The forecasters are looking for earnings for the third and fourth quarter to slowdown, but they will still be positive or at least many people hope they will be positive. The fundamental people look at the price to earnings (PE) ratio to evaluate the pricing in the market. If they believe that a fair value for the market is 18 times PE multiple and the current market is 15 then they say we have upside.

However, what if the current 15 times PE are in fact built on the sand of the dollar decline? If you take out some of the advantage of the currency then the real earnings may not be growing at all. If earnings were not really growing, then a normal PR Ratio would have to be less than 18 time earnings.

With all the bad news, the market seems to want to go higher. In my 35 years of investing when I have seen a total disregard for risk watch out because many people will be burned. If you are distracted from the risk, you are taking in stocks because of the concern you have with the value of your first and or second home you are likely to be burned in both investments.

The news in the real estate market continues to get worse and worse. I sill think we are not yet half way through the problem and a great deal more damage will be done to the homeowner. The stock market may begin to realize after earnings season the difference between real and ginned up earnings.

Dan Perkins

Thursday, October 11, 2007

U.S. home foreclosures doubled to 223,538 in September from a year earlier

I came across this story tonight that I thought was shocking. I have listed some high lights but take the time to ready the whole article.


Some securities have dropped by more than 50 cents on the dollar.

``This asset class has taken a bullet in the head,'' said Christopher Whalen, an analyst for Institutional Risk Analytics

Losses from seriously delinquent loans will be 40 percent to 50 percent, up from a traditional level of about 35 percent

If in fact U.S. home foreclosures doubled to 223,538 in September from a year earlier than means that the banks now have in inventory of at least 223,538 home to be sold as quickly as possible. This inventory has to be moved by the banks and they will drive the prices down to get this inventory off their books. The result will be more pressure on selling prices.

Dan Perkins

Oct. 11 (Bloomberg) -- Moody's Investors Service lowered ratings on $33.4 billion of securities backed by subprime mortgages, the biggest downgrade yet, saying losses on delinquent home loans will continue to rise.

The 2,187 securities were issued in 2006 and represent 7.8 percent of the original dollar volume of the debt rated by Moody's, according to a statement today by the New York-based credit ratings company. Moody's affirmed ratings on about $280 billion of securities.

Moody's, a unit of Moody's Corp., cut the securities after increasing its assumptions for losses on delinquent home loans and tightening its ratings criteria. The reductions, the most sweeping among the three top ratings companies, follow similar moves by Fitch Ratings, which last week lowered rankings on $18.4 billion of subprime bonds.

``This asset class has taken a bullet in the head,'' said Christopher Whalen, an analyst for Institutional Risk Analytics, a research firm in Hawthorne, California. ``The unfortunates who have this will not want to hold the paper any more. These bonds are going to trade like orphans.''

Moody's, Standard & Poor's and Fitch, a unit of Paris-based Fimalac SA, were criticized by investors and lawmakers for awarding excessively high ratings to subprime securities and failing to predict that lax lending standards may increase the change of home-loan delinquencies. Subprime mortgage defaults reached record highs this year and some securities have dropped by more than 50 cents on the dollar.

Foreclosures Rise

The downgrades came the same day that RealtyTrace Inc. said U.S. home foreclosures doubled to 223,538 in September from a year earlier as subprime borrowers struggled to make payments on adjustable-rate mortgages. Mortgage servicers are also unlikely to modify loans to help borrowers avoid default, Moody's said, citing a recent survey.

One percent of U.S. subprime mortgages with interest rates that began to adjust in January, April and July were modified to help homeowners avoid default, Moody's said.

The company now expects losses from seriously delinquent loans will be 40 percent to 50 percent, up from a traditional level of about 35 percent.

``It is very challenging to come up with an assumption for losses because we don't have many yet,'' said Nicolas Weill, Moody's chief credit officer for structured finance. ``To come up with an assumption we talked to a lot of servicers and we do have some losses coming in. We know that some areas will have more than 40 percent and others will have less.''

Moody's affirmed securities rated Aaa and Aa. They represent about 75 percent of Aaa bonds rated by Moody's and 52 percent of those rated Aa.

On Review

About $23.8 billion of securities were placed on review for a cut, including 48 classes rated Aaa, Weill said. Most of the securities downgraded were originally rated Ba, Baa, or A, Moody's said.

About 755 bonds were lowered to Caa1 or below, a designation that means bonds are of ``poor standing,'' or there may be ``elements of danger with respect to principal or interest.''

``The lower ratings are being affected more and deeper, which is appropriate,'' Weill said. ``The higher ratings are being affected less.''

Moody's said last month it expects to lower ratings on more subprime-mortgage securities, and will assume its rankings for many such bonds issued since July 2005 are too high in assessing new collateralized debt obligations. CDOs package pools of mortgage securities and slice them into pieces with varying degrees of risk, from AAA to unrated portions.

Running Models

``Now a CDO manager will have to run the value model and revise it in light of the new evaluation,'' said Joseph R. Mason, associate finance professor at Drexel University in Philadelphia. ``The rating agencies are going to have to do the same thing. Now, they're going to have to go back and rerate the CDO and we have not yet seen those results.''

The downgrades of the 1,003 bond classes represented 11 percent of the entire $173 billion of securities from 2006 that were rated by Fitch.

Saturday, October 6, 2007

One Plus One Equals 89,000, New Government Math.

Yesterday the government announced that the jobs number that they reported in September of a decline of 4,000 jobs was off just a tad. When the government put a fresh battery in their calculator then pushed the enter button, the new number was plus 89,000. In any other part of our economy should a company not be able to count anything correctly somebody will loose their job, not so in the government.

What was the impact of this lack of ability to count? The Federal Reserve Open Market Committee saw the number and cut interest rates by 50 basis points. The question is would they have made a move at all, or of that magnitude they made, if they had known that the number was off 93,000?

The Fed has indicated that they are “data dependent” so how can the Fed make decisions based on data when the data is as far off as the jobs number was in September? In a period of about 30 days the markets were whipsawed by the data and the actions based on bogus data. We went from the “sky is falling” to “the sky is the limit”.

Investors like you and me make investment decisions based on the actions of the Fed and the perceptions of what is likely to happen to the economy based on what we heard, we are also data dependent. The bond markets were pricing in additional cuts in interest rates based on the August employment data. Now the bond markets are thinking that things will not be as bad as they originally thought, based on the September jobs number.

How do investors who made decisions based on the data and the position of the Fed get back the money they lost because the government got the number wrong? We try and make decisions based on what we believe to be correct information. I wonder if the federal government should start adding disclaimers to their reports much like Wall Street has been forced to add to their data reporting?

Earlier this week I heard the discussion between Larry Kudlow of CNBC and a professor from the University of Pennsylvania, Wharton School. They were discussing the phone calls taken by the Chairman of the Fed from outsiders in the private sector. The question that Larry Kudlow was asking was, “did the phone calls the chairman received from the private sector banks, hedge funds and mortgage bankers change his mind and caused the Fed to cut interest rates by 50 basis points?”

Did the people who made the phone calls have the general good in mind when they called the chairman or were they more interested in protecting their own companies? You might ask the same question to Mr. Rubin from Citibank would he have made the call if he knew that the jobs number would be revised to plus 89,000 new jobs? I would like to think he would still make the call but perhaps he would not have been as concerned about the markets and the economy and his bank.

The markets, based on the revised jobs number set a new high and everything is fine and its up and up from here. The Fed will probably not have to cut interest rates again at the Halloween meeting or in the future they are truly one and done. I don’t think so!

The jobs number hasn’t solved the housing problem and as I have said before we are not half way through the housing problem. It is true that the yield curve has returned to traditional steep position but interest rates above the short-term sector are rising. Enjoy the euphoria while it lasts at least till the next revised data point.

Dan Perkins

Friday, September 28, 2007

Unsold Homes Increase 2,000 per Month

The National Association of Home Builders reported on Thursday the 27 of September, that the level of newly constructed unoccupied homes in the United States now stand at 200,000. They also reported that about 2,000 new homes are added to inventory every month. Based on current inventory levels there is about 8.5 month of sales on hand.

Let us look at one city and see what is happening in the residential real estate market. During 2005 and 2006, one-half of all home and condominium sales in Las Vegas were to speculators. In the third quarter of 2004, priced rose 44% not annualized, but 44% in a 90-day period.

As of this week there were 24,241 single family homes and 6,221 condominium’s for sale. Why is this important? While real estate is a local market, more and more markets prices are coming under pressure. California the most real estate sensitive and expensive markets in the country, we have seen prices fall from the top of the market by 15% in some areas of the state.The average price of a single family home in California is $500,000 dollars. A 15% decline equates to a loss of market value of $75,000 and in some cases 100% of the equity a buyer put down to buy the property.

I was speaking with a client yesterday and she asked, “Why do you write so much about real estate?” For many American their home is their largest asset. Our homes unlike stocks or bonds are not for sale every day. If the value of our home declines, we get concerned about our future. Because the home is the largest investment, decline in the value of their home may have an impact on the quality of life in retirement for boomers.

The decline in the stock markets at the turn of the century saw many retirement accounts decline in value by 40% or more. While the Dow and the S&P 500 have set new highs, many millions of Americans have yet to get even, much less make a gain in their retirement accounts. Now add to that a decline in the value of their home and retirement may not look as good as it did just a few years ago.

The problem in real estate is not just the decline in the value of the home, it is that plus the impact on all the other related industries that go along with real estate. As I said in an earlier blog, I think we have not yet seen the bottom. In my hometown five new houses were built at the same time on the same street, all empty, one has been on the market for over a year and the other are getting long in the tooth. The market will hit bottom when all five are sold. Look at the new homes for sale in your neighbor hood and see how long it takes to sell. The one setting empty is counted in the 200,000 of unsold homes the big question is will we continue to see the number rise above 200,000? My guess we have a lot more to go.

Dan Perkins