Saturday, January 26, 2008

And Now Some Words From The Sponsor: "Greed".

A new Disney thrill ride.

Just when we thought the markets couldn’t be more volatile along came this week. If this week was a thrill ride at Disney I’m not sure anybody would be in line to take their turn. The swings in emotion were incredible. Panic, fear, optimism, and despair were all exhibited in vast quantities throughout the week sometimes within seconds of each other. So, did we hit bottom? I’m afraid I don’t think so, says the perennial BEAR.

I was speaking to a client on Wednesday and after the huge swings on Tuesday I asked him this question, ”Have we fixed all the problems that were in place last Friday?” The answer is no. We are continuing to gather the detail of what happened first, before we try and fix the problem. What is the problem? In a word “Greed” and unlike the quote from the movie “Wall Street” it is not good. I was amazed at how many times people on CNBC, guest included, would talk about the markets problems, but nobody mentioned the word “Greed” was at fault. One word that was mentioned extensively was “Stupidity”. I agree that a lot of people were stupid, but that stupidity was driven by “Greed”.

Let’s look at one example of how “Greed" and perhaps "Stupidity" together may have destroyed segment of the financial service industry. Financial Guarantee Insurance Companies sometimes referred to as monoline insurance companies were in the single business of insuring municipal bonds issued by states, cities and many other municipal issuers across the United States. By all accounts a boring, but and, I underline profitable business.

For some strange reason some and eventually all of these companies decided that they new how to insure the payments on Collateralized Debt Obligations (CDO) and Credit Default Swaps (CDS). They moved away from their core business and went into a line of business that put their capital to work and at much greater risk than the risk they were taking in insuring muni bonds. Why? That word “Greed”.

Over the last 26 years long-term interest rates have been falling. As interest rates fell companies, and for that matter individuals, had increasing expenses and therefore a need for higher income. Falling Treasuries yields were not providing enough cash/flow to meet obligations. It was difficult if not near impossible to cut expenses so the quest for “more” began.

Investors started by dipping their toe in the waters of higher yield and higher risk and by January 2008 some companies found themselves over their head in the waters of high risk and did not know what to do about their financial problems because they never really understood the business they were in. They never envisioned the risk they could find themselves today, when the started a new direction.They had no clue that they were betting their companies and their careers in making these higher risk decisions for more earnings. Pressure from stockholders to perform, earnings, was also part of the problem. In the past companies made decisions looking out years in advance, now we find the future is 90-days out.

It took 26 years to get us to this point of financial crisis and as typical Americans we want it over and done with overnight. What took 26 years to set up cannot be unwound in a day, a week, or a month. I believe we still do not know the full extent of the problem and in turn the impact on the United States and the rest of the world's economies.

It is true that we live in a global economy that has evolved over time. "Greed" is not limited to the good old USA. As economies have grown and expanded over the last quarter century "Greed" has spread throughout the world and I think the world will have to pay for the mistakes.

As bad as the week was we are still in a correction and a bear market that will take perhaps years to unwind. Think about the NASDAQ market in 1999. This market index was around 5,000 here we are 7 years later at 2,600, will we ever see 5,000 again? Not in my lifetime. We are still paying for the greed of the 90”s.

I have to ask myself if we are still paying for the greed of the NASDAQ how can we expect that everything will be OK in a month or so—this is going to take time and I believe more time that most people are thinking about at the moment. Will Rodgers had a famous quote."Americans should be more concerned about the return of their money than the return on their money." This is going to be a hard lesson to learn.

Dan Perkins

Sunday, January 20, 2008

No "Fat Lady"in the House Yet.

I have not posted my thoughts during the most recent stock market downturn because I have been in the hospital with Thyroid surgery. I am home now and recuperating and should be fine in a few weeks. I hope to start going back to the office part-time next week and build up my strength.

While I was totally out of it on Monday and Tuesday of this week because of the surgery, I began to focus somewhat on what was going on Wednesday. As a result of the August significant correction I had suggested in previous posts, that we had to go back and test the previous lows to confirm the strength in the market (the Bull Market). I was very concerned and wrote to you about the fact that we had too quick a recovery in September and October from the August lows. Then we had an attempt at a second test of the August low in November and December. The year ended with the assignation of the former prime minister of Pakistan and the markets spoiled our New Years Eve and set us up to spoil the first part of 2008.

So far this year the equity markets have been scary. The number of triple digits days down has set a record. The markets tries to rally in the mornings and then finishes the day substantially down. This past Friday, because of earnings and projections from IBM and GE, the markets were up at one point about 125 points. By the end of the day the Market was off about 60 points.

The chart below shows the performance of the S&P 500 over the last 2 years. If you look carefully you will see that we have given back all of the return of last year and also part of 2005. If you committed to the market in December of 2005, as of the close of business on Friday, your return would have been about ZERO. Look at the last line on the chart, the line on the right hand side of the chart. That point is we are as of the close on Friday. If you look to the left come straight across and look for a level equal to were we are today that is December 2005. That point on the chart is major support for the market. Movement down from that point will be little steps down at a time not the major swings we have seen in the first two weeks of this year.

This slow movement in the markets is sometime referred to as a grinding down. This grind may take several weeks to several months before we have a solid bottom. I don’t want to mislead you about the bottoming process. I’m not looking this time for a quick recovery like we saw in September and October but rather a slow bases building process before we see any significant recovery.

Tuesday will be a major inflection point for the markets. If we don’t get some sort of sustained relief rally we could well breakdown to new lows for the markets.

You know that I have been concerned about the credit markets beyond the sub-prime mortgage market for some time. This past Thursday Moody’s warned one of the bond insurance companies of a possible credit downgrade. If this happens then the all of then bonds insured by this company may well also be down graded, This downgrade could effect billions of billions of dollars of tax-free bonds held by individuals and intuitions like insurance companies and may force intuitions to re-value their market value of these bonds thus causing another wave of write downs.

I realize that the stock markets performance or lack thereof in the first two weeks of this year have been scary, but I do want to point out that the “Fat Lady” has yet to sing, she is not even in the building. We are far from out of the woods.

Dan Perkins

Friday, January 4, 2008

Perhaps the Third Time is not a Charm

On Friday, the markets had two shocks, first the employment data that showed a low number of jobs created and some downward revisions from the previous month. The most disturbing news to me, was the unemployment rate jumping to 5%. For the first 4-trading day in the New Year, the Dow Jones is off 486 points. The Dow Jones, S&P 500 closed the week near the August lows.

In the last 5 months there have been three corrections of at least 10%.The question for Monday morning is will the third assault result in a oversold rally or are we headed much lower? I was watching an interview with Wayne Angle the former Federal Reserve Governor. He said and I quote, ”At the January meeting the open market committee needs to cut the Fed Fund interest rate by 100 basis points”.

I understand his point that the Fed has to shake the markets and tell the markets the Fed knows what it is doing. While Mr. Angel is an important person I think a move of 100, basis point would shock the market to lower lows. I do think the Fed is behind the curve, but 100 basis points may be the right amount for the first 6 months, but not in one shot.

The Fed Funds Futures are pointing to a better than 50% chance of a 50 basis points cut on January 30. I think we are not in the same position we were in August. The credit markets are in much better shape than they were in August. I do not want to lead you to believe that we have solved all of the problems with the banks and investment banks we have not. In fact, we will get a better idea how bad things are when the banks and the investment banks report earnings later this month.

For those of you who read this Blog that are my clients you understand my investment approach is to be paid while we wait. The power of earning interest and or dividends came home to roost this week. Those companies that paid a high level of dividends fared much better in the decline of this week.

If the Fed does reduce, interest rates by 100, basis points during the first half of the year those investments that pay a high yield will out perform those that do not. Therefore, not only will you get paid while you wait but also you could see some nice appreciation.

Depending on what you watched or listened to today the results of the Iowa primary captured more time than the decline in the market. How was it possible for Hillary to come in third? I did see one of the money show hosts asked the question “Was the sell off because of the results out of results in Iowa?” The answer was no, but lets see what happens next Tuesday.

I said in a posting earlier this week that I felt we may not yet know the party candidates yet. Clearly, the initial results in Iowa showed that the traditional Democrats and Republican parties were rejected in Iowa.

Dan Perkins

Wednesday, January 2, 2008

ISM Index Falls Below 50 For The First Time In Almost 4 Years

The ISM Index was reported today at 47.7%--anything below 50% and the economy is considered to be contracting. The stock market didn’t like the ISM number and in response to the ISM number the Dow Jones was off 220 points and it closed close to the low for the day. This 220-point decline in the Dow Jones, for the first trading day of a new year, is one of the largest declines in history. We have to go back to 1938 to find a worse opening day for the market on the first trading day of the year.

In this decline there wasn’t a typical flight to quality, selling stocks and buying T-Bills, as we have seen in the other declines during the last 6 months. I do need to clarify that statement to make sure you understand what I just said. In the past when the stock markets have had a significant sell off, investors moved their money into Treasuries out of stocks investors were selling risk, stocks and buying safety Treasuries. It is more common for investors, in the flight to quality, to buy the shorter term T-Bills, less than 6 months, because they may want to move back into the stock market and the liquidity of short term of T-bills gives investors the flexibility to sell their T-Bills and buy stocks at a moments notice.

Today was different. The short end of the yield curve, meaning 3 month to 6 month T-Bills were almost unchanged in yield. If we look out in yield curve we find that longer-term Treasuries rose in price dramatically with yields falling. The yield on the 10 year T-Bond was below 4% prices were up just about 1 percent. Why the shift?

If, as was indicated above, when the ISM Index falls below 50%, that is a signal, not the only signal, that the economy is contracting and we may, if the index continues to stay below 50%, be headed for a recession. If the chances increase for a recession then the Fed may have to be more aggressive in reducing interest rates. Lower interest rates mean rising fixed income prices. Investors, at least for today, were saying that there is more opportunity for return in owning T-Bonds than common stocks.

Over the last week we have seen a decline in excess of 500 points in the Dow Jones. The 220-point decline at the start of the New Year digs us a whole that may be difficult to recover from for the full year and produce a positive return for 2008. Later this week we have the jobs number on Friday, but almost as important as the jobs number is the outcome in Iowa on Thursday night. We may wake up on Friday morning with a whole different set of players and questions about other candidates that we didn’t have today.

If as the pundits say, on the Democratic side in Iowa it is dead heat between Barack Obama and Hillary Clinton and Hillary doesn’t win, the markets could take another tumble. All in all this the election, unemployment, and the jobs report could make for a rough start to the New Year. There is an old saying that says so goes January so goes the year. We could be in for a rocky ride in 2008.

Not that anybody noticed, but the price of crude oil traded at $100 today and the sold off to $99.60. Two major milestones reached today, one of the worst starts to a year since 1938 and oil over $100. I think there is better chance of oil continuing to rise than there is upward momentum for stocks for a while.

Dan Perkins