Monday, September 29, 2008

When you open the bottle you cannot get the Genie back in.

The US House defeated what has been called the “Wall Street Bail Out” program. The phone calls by the voters were running 10 to 1 against the bill.over the weekend. When the vote took place today, the market sold off 777 points. What is more important than the point sell off was how much money was lost today.

It is projected bail out cost. I can tell that not possible to know how long it would have taken to spend the $700 billion--in one day 1.2 trillion dollars was lost in the US stock market and who knows how much will be lost before something is passed.

The voters were worried about the 700 billion dollars and paid very little attention to the potential impact on Main Street. The issue seems to have two camp; Wall Street and Main Street. For some reason Main Street does not seem to understand that Main Street is Wall Street. Banks are closing and Americans are taking their money out of banks even if they have it in FDIC insured deposit accounts. If the neighborhood bank looses deposits it has less money to lend to people to buy cars, pay tuition and keep money in the ATM machine.

The small business people, perhaps some of you, will find it difficult to get money to run their businesses. They may have trouble making payroll because the bank may not have the cash to cover the checks or the cost to borrow money to fund payroll makes it impossible for the small businessperson to survive.

The 1.2 trillion dollars that was lost today came not from Wall Street, but from your investment account. It came from your company pension or your 401k or IRA. You lost the money not Wall Street. The longer we go without a resolution the longer it will take to build confidence for people to begin to invest again.

Based on what I heard this evening Everybody now believes that something will be done, but know body knows what it will look like and what impact it will have on the markets. nothing will be voted on until late Thursday.Thursday is a long way away from Monday. The markets could sell off over night in reaction to what happened today and that momentum could continue into tomorrow and perhaps Wednesday.
The direction of the market will have a great deal to do with who says what over the next day or so. I think somebody needs to come out and say, “We did not think the reaction would be this bad.” If nobody starts talking then the markets are in for another sell off in the next two days.

What should you be doing at this point? I think you need to make sure any money you have in a brokerage account is not in a money market fund but in an FDIC insured money market account or T-Bills if you can get them. Demand is greater than supply of T-Bills right now. Take an honest look at your investments to try to assess the risk of default.

Money in mutual funds is very difficult to assess because you do not really know what they own. Look at the objective and see how the fund has preformed against the broad market. If the fund says, its benchmark is the S&P 500 then see how close it has preformed against the index.

If after your review, you have candidates to sell then use limit orders close to the market. Do not-- I say again-- do not uses market orders. Market orders give the traders the ability to take advantage of you.

As hard as it is to believe this will pass, I do not know how long it will take,but it will pass. Take deep breaths and keep a brown bag handy.
Dan Perkins

Friday, September 26, 2008

Another long weekend?

I cannot remember the last time I was off for a full weekend. It seemed like every weekend another company goes out of business, is forced to merge, or is taken over by the government. Last night the FDIC took control of Washington Mutual the largest thrift in the United States. This takeover was the largest bank failure in the history of the United States. FDIC sold the deposits to J. P. Morgan Chase and now is trying to figure out what to do with the rest of the assets.

Again, we find ourselves looking to the weekend to see what will happen to the United States and in turn the rest of the world. The Congress is debating what should be done to try to solve the liquidity crisis in American. I heard this morning that 90% of Americans are against the restructuring plan. Let me try to bring the problem to a level we can all understand.

A client of mine called me on Thursday the 18 and asked if I could help a friend of his with a problem. I called the friend she put in $350,000 in a money fund and as of last Thursday she can not get at any of this money and doesn’t know when she will get at her money and what value will it be to her when she can get at the money.

She is not a fat cat in Washington, she is not a Wall Street Executive, she is a nice woman who is scared to death that she will loose this money. She is one of the victims of the problem in the economy. She did not overspend for a house or car, did not take her credit cards to the limit, she is an average American affected by the crisis in America. There is plenty of blame to go around and millions have lost money. We need to have Congress focus on the problem and less time on blame. We can get to the blame later; let us deal with the issues today.

I guess her story was the tipping point for me. Millions of people have been angry at what has happen, including my clients, and me, who saw the value of their saving decline dramatically in the last 6 weeks. I wanted to do something or at least try to do something. I called my lawyer and said that I laid a significant portion of the failure on the credit rating agencies for not doing their job and I wanted to explore how or if I could sue them for their failures.

He put me in touch with a large law firm that specializes in securities litigation. I spent about two hours on the phone with them on Friday the 19 telling them my story as best I could. The firm said that they would look into my issues and call me back. On Wednesday when the Chairman of The Fed was speaking with Congress about the problem, he started his answer with the credit rating agencies and their poor performance. Shortly after that, the lawyers called and they did not have good news.

The researched the law and said while the rating agencies had some degree of guilt they could not see any in which I could sue them. They did say the Attorney General of Connecticut was looking into possible litigation of the credit rating agencies. I think the thing that hurt me the most was the comment by the lawyers, while the impact on my clients and me was significant we did not have enough losses to have standing in the courts. In other words, the losses suffered by institutions were much greater than ours were and bigger institution would represent us.

They did say that there are civil actions being filed and encouraged me to tell everyone to pay attention to mail for notification of actions in various securities. I am disappointed that I was not able to file the suit, but I feel good about looking after your interest to try to do something. I do not know that I could have faced you knowing that I did not at least try to do something for all of us. I will continue to follow the problems and keep you informed. The quote from the movie Network sums up how I feel. “I’m mad as hell and I’m not going to take it anymore” sums up how I feel.

Dan Perkins

Sunday, September 21, 2008

We dodged the end of the world, but…

As we prepare for the coming week, I do think it is worthwhile spending a little time going over what happened and more importantly what didn’t happen last week. While the first three days of the week were the biggest and baddest roller coaster ride I have ever been on, the scariest day of the week was Thursday.

On Thursday, The Reserve Fund, the oldest and first money market fund said that it would have to suspend redemption's and would probably break the sacred $1.00 level. On Friday they suspended redemption's on about 12 of their money funds and warned that some of them might open at between $.91 to $.97 cents on the dollar. Other money market funds last August had the management kick in money to keep the price at $1.00. Many of the funds management companies decided that this time around they were not going to put up any additional funds. I think the reason they backed away was that they could not quantify the amount of the exposure.

We have in excess of $3 trillion dollars in money market funds and if the Fed had not stepped in we would have had a run on the bank, (money market funds) exceeding the great depression. The Fed is going to offer insurance that money funds can purchase to insure the $1.00 value. This insurance will be around for a year and then will disappear.

I think that breaking the $1.00 has forever changed the consumer confidence in money market funds. When these funds begin redeeming shares there will be a small run on the bank with increased withdrawals. The real question is where will investors put their money? The trustable options continue to shrink and for the moment the 90 Day T-Bills are paying a negative return.

I want to make it clear to all of my readers that even though we had a great rally off the bottom last week we are not out of the woods. Congress has to agree to the ideas from the administration and the global markets have to think things will get better.
While I am happy that we had the big rally the broad markets as of the close of Friday are still down over 15% year to date.

I expect to see the market move higher Monday morning as the short sellers will be coming up against the market closing to cover their naked short positions. It would not surprise me for the markets to sell off into the close tomorrow. The big unknown is how many naked shorts there are in the market. Watch for huge volume tomorrow as the shorts are covered.

Dan Perkins

Thursday, September 18, 2008

I don’t understand what is going on, should I be concerned?

As I look at the last three days, I have to tell you that in 35 years in this business I have not seen the level of chaos that I have seen this week. I realize that the markets are in turmoil and though it is not the end of the world, the fear level is high.

I looked this morning at the yield on the 90-day T-Bill and it was just under one/third of one percent, about 30 basis points. Later in the day, you had to go out 11 months to get a positive yield in a T-Bill. If you wanted to buy a 90-Day T-Bill you had to pay the government for the right to buy, you lost money. This level interest rates tells me that the world is in panic. In the crash of 1987 all, the equity markets in the world were coupled in going down.

We know from history that all the markets can go down together for a short period, but they will begin to decouple and sort themselves out. It was a scary time in 1987 and it is a scary time today. Order will return to the markets it will just take some time for it to return.

My wife asked me a question about her account, she said, “If I wanted to take my money out of my account to buy a boat, based on the current value of the assets I couldn’t buy the boat.” I said either she would have to buy a smaller boat or wait a while to buy the boat she wanted. Her real question had nothing to do with a boat, but the income that was coming out of the account and how secure it was. I have had several clients call and ask me a similar question.

I explained to my wife and to my clients that the income you receive in a fixed income investment is not related to the price of an investment. Let me use some examples to illustrate the point. Let us say you by a ten year maturing US Government bond that has an interest payment of 5%. That means for every $1,000 in bonds you own the government will pay you $50 per year. Let us suppose that next year the interest rates for a new bond are 5.5%. Because the new bond pays a higher interest rate, the value of your 5% bond will be reduced to make it equal to the 5.5% bond. The price of the bond might go from $1,000 to $975, but the amount of interest you receive on your bond is still 5%.

Similarly, if next year the interest rates fall and the new bond rate is 4.5% your income will still be $50. The value of your bond may go up or down, but your income does not change. The rate of interest in effect at the time of the purchase is the rate you earn regardless of the level of interest rates in the future. This is true on government bonds, tax-free bonds, corporate bonds and CDs. Any investment that has a fixed rate of return at the time of purchase offers predictable income. Bonds and preferred stocks are fixed income investments that for the most part are the most secure investments in companies.

On the other hand, common stock has the most risk and potentially the most reward in the ownership in the company. For the vast majority of my clients they prefer knowing what rate of interest they are going to be paid. Therefore, to sum up, fixed income investments can go up or down in value, but the income will stay the same regardless of the market value of the investment.

If you have set up an income portfolio the checks will keep coming in every month that is the most important thing. Look at the value of the investments, but remember why you made the investment. Nobody likes to see the markets decline as they have over the last week myself included. The account statements for the month of September will be awful because the markets have been a disaster.

Keep in mind the reasons you invested your money and realize that things will turn around, but perhaps not as fast as we would like.

Dan Perkins

Monday, September 15, 2008

Will the Sun Come Up Tomorrow?

Over the weekend there were many discussion by investment banks and regulators about how to solve the liquidity problem with Lehman Brothers, AIG and Merrill Lynch. Late Sunday night Bank of America and Merrill lynch agreed to make Merrill Lynch a part of Bank of America. The issue of what to do with Lehman and AIG was left unresolved as no buyers were identified to purchase the financially troubled companies. At midnight when I went to bed Lehman had not filed for bankruptcy and to the best of my knowledge through the close of business on Monday they still had not filed for bankruptcy. The fate of Lehman Borthers and AIG are still in doubt.

In speaking with a client earlier today I asked, If I told you on January 2nd that by September, Merrill Lynch, Lehman Brothers, Bear Stearns would be gone you would have thought I was smoking something illegal? All of the stock markets around the world are down today because investors are selling, fearing the worst. While this is scary, nobody likes to loose money and it may feel like the end of the world, it is not.

I remember the panic of October 1987 when the market was off 22% in one day. By comparison today’s decline at its worst was off just over 4.5%. I am willing to admit that to me it feels somewhat like 1987, but in many respects, it is much different. I believe that the economy is slowing down and may well be in recession. The prices of commodities have fallen dramatically. Oil today was down almost $6 and below $100. All the other commodities were selling off which points to lower inflation.

Interest rates fell this morning and in turn mortgage interest rates will be lower going forward. The buzz on the street is that at tomorrow’s meeting of the Fed it will cut short-term interest rates by one quarter of one percent (25 basis points) one/half of one percent (50 basis points). I think it is more likely that the Fed will not lower interest rates tomorrow, but changes its policy statement moving its bias towards cutting interest rates in the future.

Many people are asking why this happened and how all of this came about in such a short period. I think there are several reasons, but most of all I think it was the deregulation of the brokerage business. The cost of transactions was based on a fixed fee schedule. The brokers could figure out how much they could earn from the transactions business. I liken this to the deregulation of the airline industry. When the fixed fare went away, the entire industry had to react to price declines. Over the years, companies came and went out of business because they thought they had a business model that could make money. For the most part these models did not turn out to be realistic. The result of deregulation is fewer airlines with less competition and in turn we now have higher prices.

The brokerage business had other ways to make money and so when they could not make money in stock transactions they developed a vast array of investments designed to produce more income for them and hopefully their shareholders. As these alternatives produced more and more income the firms developed more and more sophisticated investments generating even more cash flow, but more risk. Now many of these structures, like start-up airline companies, didn’t turn out to be as profitable as they thought they would be. As the deals have to be valued for balance sheet purposes their values are coming under scrutiny and downward pricing pressure.It seems ironic to me that the same rating agencies that made many of these investments AAA now rate them to "Junk" in a matter of days.

How about an example: Let's say you spend $100 to buy something today that you think will go up in value and which you hope to sell later for something higher. What happens if you have to sell it sooner than you expected? You may not be able to sell it for the price you wanted and in fact you may have to sell it for less than what you paid for it in the first place. This a simple illustration of what is going on in the financial markets today. Theses firms borrowed significant sums of money to build investments that they hoped would turn out to make them and their investors more money. These investments, in some cases, didn’t work out and now when the firms want to sell them because they need the money to pay other obligations and nobody wants to buy these investments at anywhere near the purchase price.

The rest of the world is looking to American to figure out how to deal with this problem because they may well be going through the same thing in the very near future. It will take time to figure things out. The most important ting to do at the moment is not to panic sell. Look at each of your investments and try an be as objective as possible to look at the prospects for the investment. Ask, does the company have a viable long-term business and what percentage of my total assets is in each position? Limit your exposure to no more than 5% of your portfolio in any one investment.

If you decide to sell an investment take the money from the sale and invest it in 90 Day T-Bills. The next thing to do is to figure out where you want to invest your cash when the time comes. You could add to your existing holdings or look for something new. Take your time and ease your money into investments. There is no rush. Lastly, take a deep breath and realize that things will be different 6 months from now.

Dan Perkins

Monday, September 8, 2008

Is big brother out of control?

Last week the two Government Sponsored Entities, (GSE's) Fannie Mae and Freddie Mac told us that they did not need additional capital. These entities also reported that they were experiencing the best net profit margins in ten years. The credit rating agencies had all the preferred stocks rated AA, second highest in investment quality. Because of this news both the common and preferred stocks rallied nicely. On Sunday, Fannie Mae and Freddie Mac were taken over by Treasury Secretary Henry Paulson and the Federal Government. They suspended the dividends on both the common and preferred stocks in their take over.

Many people, including many of my clients and myself saw the value of our preferred stock fall by 75% on Monday with no certainty as to when if ever we will ever get our money back. In fact, the discussions as to what to do with the GSE’s will not begin in earnest until the new Congress is sworn in January, 2009. No one knows what the outcome will be from these discussions in Congress or how long it will take Congress to come up with the answers.

When Secretary Paulson was asked today, “What should happen to the two entities?’ he responded, “I don’t know.” It seems to me that if you don’t know what to do with something when you take control of it you shouldn’t take control. In my opinion somebody was lying to us. How can investors make decisions if they do not have accurate information. If we can’t trust the companies and the rating agencies especially after the Bear Stearns and the sub-prime problems, then who can we trust?

I have to admit I was angry on Sunday afternoon when I read the announcement, because the companies and the rating agencies told us that things were OK. Yes, there were problems in the mortgage market, but when you hear statements from the companies that their margins were the best in 10 years.” You have to wonder if you have been lied too. When major investment banks say they will be OK and when the Chairman of the House Financial Service Committee, Mr. Barney Frank, says thing will be OK, you have to wonder how all of these forecasters got it wrong.

In American we pride ourselves that we have the greatest transparency of all the markets around the world. Where do you draw the line between what is being said to the public and what is going on in the bowels of the company that may be withheld from the investors? Do I feel like I have been lied to in this case? Yes and I think by a great many people.

The reason I bought these preferred stocks was because I have always seen them as debt instruments. Unlike common stocks, which are direct ownership of the company, preferred stocks are higher up the credit list than common stocks so you do not have the risk of common stock ownership. I could understand the elimination of the dividend on the common, but not the preferred's.

I am sure that many people and institutions feel the same way I do and they are angry about the way they have been treated. You make investment decisions on what you have been told. If the information is false then you have a right to know why it was wrong and you should not have to pay the price if you were misled. We need some appeal process to get all the facts and some level of restitution.

The market implications to this decision are vast and may be very dangerous both near-term and long-term. Let me give you some examples:

Bank and insurance companies bought these preferred to back up their liabilities to policyholders and depositors. We know that the Bank regulators have already sent notices to all banks that they must market their investments to the market reflecting the decline in value of the preferred. I fully expect the state insurance departments to issues similar orders for Life and P&C companies.

Some corporations have purchased these investments under the marketable securities section of the balance sheet. These balance sheets will have to be adjusted and the report to the public show the significant decline in value. Lastly, lets look at all the foreign investors including governments who have purchased these investments and now have them at to 30 cents or less on the dollar. What is the likelihood that they will want to buy other fixed income securities from the United States again? How will the rest of the preferred market be affected?

Is it possible that what they are doing will really work to solve the problem in housing? What if it does not, what else does the government want to own? Is this another case of "Big Brother" reaching beyond where it should?

We lost Bear Sterns because the market was concerned about sub-prime risk and the Fed stepped in, took control, and sold the company to JP Morgan Chase. We apparently did not have a problem with the GSE at least by public account, but the Treasury found a problem, stepped in, and took control again at a significant cost to investors. In both cases, the investors lost money and in the case of the GSE’s I still question the validity of the decision.

I fully expect that there will be legal action on behalf of the common stockholders and the preferred shareholders who have born the brunt of the loss while the bond holders are secured by the government. Every investor has to make his own decisions, but I for one will join the suit if there is one filed.

Dan Perkins