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