Friday, December 26, 2008

And The Answer Is?

At year end I try to figure out what the big themes will be in the coming year. Sometimes I come close and other times I miss by a mile. I think the one question that is on many peoples minds, at the moment is: “What is going to happen to the financial markets in 2009?”

Before I get to the future let me spend a moment on what has happened over the last four months. I have been in this business now for over 35 years and I have seen some pretty ugly markets. What concerns me more than anything else about this correction in 2008 is the fear and panic spread by the financial press. As the market declined, many programs kept using the words “Depression” or “is this the 1930’s again?" At one point I counted in the span of a one hour show the word Depression used over 20 times. That is once every 3 minutes.

I recently heard one reporter make the statement that the Fed was issuing 10’s of trillions of dollars of new debt and then asking how our children will be able to pay off this debt. I call this irresponsible journalism. Let me point out a fact not reported as far as I have seen; the Government invested $250 billion in the “Nine Brothers” and even more in other financial intuitions. They are earning between 5% to 8% on this money. The government is borrowing money at the most, at the moment under 3%. All of the short-term cost of funds to the government is zero percent. If you can borrow at 3% or less and earn 5 to 8 percent, I don’t think you can loose money. Ask yourself, other than here, have you heard this information reported by anyone else?

My point is I don’t want to down play the problems, we have serious problems. I have been writing about the problem in the housing market for the last 2 years. If the media elevates the level of fear by the way it reports what is happening how is that positive? Clearly the press has the right to report, but they also have the responsibility to be fair, balanced, objective, and not create panic.

With that off my chest let me look ahead to 2009. I expect the housing market to stabilize by the beginning of the third quarter. We may well see the cost of a conforming home mortgage at 3.5%. After the first of the year, I would expect to see bank short-term interest rates on money market accounts and CD’s to fall closer to T-Bill rates, zero percent. The banks have been attracting as much capital as they can through deposits as they could before year end. Deposits are a low cost way to strengthen a balance sheet.

The problem is that the banks are paying 2% or more for money market accounts and CD's and not loaning out the money. If they don't start lending they will quickly begin to loose money and will be forced to lower interest rates and to look for positive yield spread opportunities. If the banks are, as reported, unwilling to lend they will be forced to cut the rate of interest they are willing to pay.

The idea that the banks are not lending is bunk. They may not be leaning as much as they had in the past, but they are lending. As another example of misleading press, “Even though mortgage rates are falling, nobody has any equity left in their homes.” If that were a true statement then why are refi applications skyrocketing? If you have been in your house over 5 years you have equity in your house, perhaps not as much as you had, but you have equity to refi and lower your mortgage payment.

The American consumer wallet has benefited from lower gas prices, I do not see them going below one dollar a gallon as many hope. Lower gas prices will increase spendable income. Demand destruction in mortgage interest rates will also increase spendable income for at least half or more of American households if they choose to refi their mortgages.

Therefore, the consumer will save more in 2009. We may in fact bring to an end the negative savings rate that has plagued our economy for many years, if not decades. America will turn into a nation of savers. Even with increased saving I think Americans will spend more than people think they will in 2009. If I’m right on these two items alone the economy will not fall as much as everybody thinks it will in 2009.

My last two items are interest rates and the markets. For interest rates, the question is will this recovery look more like Japan or the typical American economic recovery? I’m going to disagree with the pack and say our recovery will look more like Japan. Interest rates will be low for more than 5 months. I take the Fed Chairman at his word when he said at the last Open Market Committee meeting that he expected interest rates to stay low for an extended period of time.

We will turn into a nation of super savers. In the last 8 years we have had the Internet bust, the real estate bust and the market bust, I think Americans have lost there appetite for risk. So, I expect the stock markets to trade in a fairly wide range, but no new highs or lows for the markets in 2009. Perhaps the largest single opportunity will be the purchase of corporation bonds and preferred stocks. Locked in high rates of interest vs. low interest rates across the yield curve will present significant total return potential.

Dan Perkins

Tuesday, December 23, 2008

Our house has 7 stockings on the fireplace

I realize that this has been a difficult year in terms of the markets and the economy for all of us. I hope that next year will see the return to better times. As I look back at my year, I have many things to be thankful for in 2008. My clients, many who are close friends, who have stayed with me though these most difficult times and my two new daughters are just two examples of the many things that I am thankful for this Christmas.

Last Saturday the 20th, we had a visitor arrive at our house who has changed Gerri and I, forever. That visitor is our granddaughter Charlotte. She will be with us through the 26th and as many of you know, she is the first baby in our house on Christmas in over 25 years.

Yes, we all have a lot on our minds wondering and worrying about what will happen next year. With a baby in the house you change your prospective about life. Charlotte and her parents are the future of American, a future that is full of promise and opportunity. I sometimes cannot see the future as clearly, but it is right in front of our eyes, it is our children and grandchildren.

I hope you have found these blogs helpful. As one client said, "I don't always understand all of what is going on, but I get great comfort knowing you are looking out for our interest." I will continue to write and call things as I see them. We are in this together and I have a responsibility to protect all of our money as best I can. While money is important, as another client said to me after my surgery, "you start with your health and everything else is a bonus."

I want to wish all of you who are clients, friends or just people who just read my blog a Blessed Christmas Season and a healthy and more prosperous 2009.

Dan Perkins

Tuesday, December 16, 2008

Demand Destruction in Reverse

Demand Destruction is a process that causes us to make a change in the way in which we make decisions. This process can be both positive and negative depending on what the consumer is reacting to. When crude oil hit $147 a barrel and gasoline was $4.25 a gallon we experienced “Demand Destruction” in the consumption of oil. At $4.25 a gallon for gas, Americans were forced to change their habits about their consumption of gas. We all know that this shift (Demand Destruction) caused part of the decline in oil prices and in turn the price of gas to the price levels of today.

Today the Federal Reserve cut the Fed Funds interest rate to a range of zero to 25 basis points and they created a new “Demand Destruction” for investors and consumers alike. I wrote recently about two clients who were considering a home equity loan at the prime rate less 25 basis points and more. The prime rate tomorrow will be 3.25% so if you had a home equity line of credit priced at prime less 25 basis points your new rate would be 3%. For most people this will be the lowest rate to borrow in their lifetime.

This unprecedented reduction in interest rates will cause people to destroy their credit card balances. Some people think that all the equity is lost in most American homes. I do not think so. I believe there is still a great deal of equity available, but people have been afraid to borrow money. In difficult times people protect their savings just in case things change at their job. If people are paying 9,10, 11% or more on their credit cards and you can refi that loan for 3% and deduct the interest expense it becomes a no brainer. Look for an explosion of home equity lines of credit marketing from your local bank.

With Fed indication that they were going to start buying mortgages from the agencies along with buying longer dated Treasuries I would expect to see home mortgage interest rates fall through the floor. I think it is possible for 30 year conforming mortgage interest rates to be under 4% by the end of the first quarter 2009. If I am right then virtually every home mortgage is in play to be refinanced. I don’t not think everybody can refi because the banks will be stricter than in the past but millions of Americans will refi and most important of all we have made millions of unsold homes more affordable.

I think the actions announced today may bring us to a bottom in the real estate market sooner than I thought.

Dan Perkins

Monday, December 15, 2008

Sell all of it now before it is all gone!

Some experts are suggesting that you should sell your stocks in the rallies as they come and move all of your money to cash. As of December 9, cash as measured by the 90-day T-Bill was paying zero return and if you had to pay, a fee to buy these T-Bills you would actually have a negative return. A report on Friday the 11th showed that over 500 Treasury-only money market funds were yielding around one-half of one basis point. An additional 45 Treasury-only money market funds had an income of zero. If you sell everything now you may be selling income that, you might never be able to replace in your lifetime.

Let us use an example. My most recent post was called the “Nine Brothers” and it dealt with the purchase of an 8.20% coupon preferred valued at $20 per share with a current yield of 10.25%. This “Nine Brother” preferred was not redeemable until 2045. That means that this “Nine Brother” was going to be paying $2.05 in annual dividends for 37 years.

Let us also say that you, like me, bought that preferred at $25. It is now worth $20. Therefore, on a capital basis you and I who bought the initial position at 8.20% yield, would be down 20% but we are still getting the $2.05 per year in dividends. If we sold this preferred and bought 90 day T-bill both of us will be earning ZERO.

Is there risk, as one reader asked me, that the “Nine Brothers” will go out of business or cannot make the dividend payment? Let me put it to you this way. If the nine largest banks in the United States go belly-up, we have serious problems and our money will not be worth anything. In addition, the Government positions in many cases are junior to other preferred holders. As we have seen recently a great many things we thought could never happen have happened I would never say never but based on what I see at the moment they aren't going out of business.

The point of this Blog is to try to make you stop and think about what you might do out of emotion rather than logic. If I sell the income, how will I live? Ask yourself, "What adjustment will you have to make in your plans if you earn no return or cash/flow on the bulk of your money? How will you have retirement income? You will have to start out by selling assets to produce income.

If your assets produce no cash/flow can you afford to retire? Will you have to work the rest of you life just to make ends meet? I realize these are very scary thoughts. Nevertheless, think about this: the recent CNBC wealth survey across all adult ages and income levels were asked, “Do you feel safe with your money in a FDIC insured banking intuition?” The result of that question was 38% of the time people said no they do not think their money is safe.

Before you throw the baby out with the bath water, you should look at all of your investments as objectively as you can. Separate your investments into to two sections. In one section, list all the investments that pay you a dividend or interest. Look at each investment and try to make a determination as to the ability of the company to continue to make these payments. Look at research reports from brokers and rating services to get the most information you can on the ability of the company to make the payments. Look at the company competitors and see how their stock or bonds are doing relative to yours. If the stock price is much lower than the competitor price then your stock might be a candidate for sale. If you find something that you think has too much risk of the income not being paid then sell it.

As to the other list, these are the ones where you have the most exposure. If you are not getting anything from the stock, (dividends) then you have to have the share price go up in value to make money. Again, look at all the research you can find on the company and then look at how it is doing against its competitors. If the stock has held up well then it probably is a keeper, on the other hand if it is off more that the competitors and the research you have done is not favorable then it is probably is a sale candidate.

When you make a sale try to move the proceeds from the sale from the non-income side to the income side of your ledger. Look at the income investments you already own and if you are keeping them now might be a great time to add to the position from what you have sold. If you have growth stocks, ETF's or index fund that you are keeping you can use some of the cash to expand positions. Before you make any buy decisions look at the balance between cash stocks and bonds, your asset allocation, you might want to re balance your risk profile while you are selling and buying.

Dan Perkins

Tuesday, December 9, 2008

Let me introduce you to the “Nine Brothers”.

You are asking yourself who in the world are the “Nine Brothers” and what is their relevance to making money? Great question! In fact, a question that deserves an explanation. The “Nine Brothers” is my name for perhaps what may turn out to be one of the most significant investment opportunities available right now. I think the “Nine Brother” represent the possibility of at least 50% returns over the next 5 years at a minimum. OK now that I have your attention let me tell you more.

We all should know that the best time to purchase an investment is when nobody wants to own it, like almost everything today. When most people loose their focus then opportunities go by un-acted upon and later when they have started to move then they are discovered. The trick is to find them before anybody else and make a commitment to the investment. The “Nine Brother“ is one of those investments.

The “Nine Brothers” are the original two brokerage firms and seven banks that the Secretary of the Treasury said were too important to fail. Now they are all banks so the "Nine Brothers" are nine banks. They were so important that the United States government invested our money in these “Nine Brothers”. The Government anointed them, as safe places that they were going to keep safe regardless of what happens.

This commitment to the “Nine Brothers” was tested and the government made good on its promise. Citibank is one of the “Nine Brothers” and when all the talk was going around that Citibank was going to fail, what happened? The government stepped in and gave them more money. The government was not going to let one of the “Nine Brothers” fail.

Some of the rest of the “Nine Brothers” are Bank of America, JP Morgan Chase, Wells Fargo, Goldman Sacks, and Morgan Stanley. Secretary Paulson identified these nine institutions as too important to fail. So, what is the opportunity with the “Nine Brothers”?

Many of the “Nine Brothers” have preferred stocks that have a current yield of 10% or more. Today 90 day T Bills were paying one basis point and 30 year T-Bonds were paying 3.13%, not much yield. On the other hand, let us use an 8.20% preferred stock offered by one of the “Nine Brothers”. The current yield is around 10.5% and the stock purchase price, which was originally $25, is now about $20.

If nothing happens over the next 5 years, you would receive over 52% return in dividends. If the rest of the market finds this opportunity then I would expect to see the price rise over the next 12 to 18 month back to its original $25 perhaps higher as demand will be greater than supply.

Why shouldn't I invest outside the “Nine Brothers?” Investing in banks outside of the “Nine Brothers” could have significantly higher risk.

Dan Perkins

Monday, December 1, 2008

What a difference a day makes.

The movement up last week in the markets was a wonderful Thanksgiving gift. Monday rolled around, we had another turkey on our plate, and this one was RAW. The markets had one of the worst performance days in a long time. At the end of the day this is how things stood:

Dow Jones down 680 points -7.70% for the day and down -40% year-to-date

S&P 500 down 80 points -8.03% for the day and down -44% year-to-date

NASDAQ down 137 points -8.95% for the day and down -48% year-to-date

So, you may be asking yourself what changed in one day to make this happen? Most people do not realize that with the close of last Friday all three American stock markets were up 20% or more off their most recent bottom. When you have a run like this, it is normal to expect people to take whatever profits they can if any. While today was not normal the markets the last three months haven't been normal either.

One other factor comes into play at year-end; that is, tax selling as it used to be known. In the past people sold to realize a gain. They were selling to gain a favorable tax rate namely; capital gains taxes, which are lower than ordinary income taxes. Based on what we have heard from the president-elect capital gains tax rates may be higher next year, therefore, if you had a gain you might want to take it this year.

I think there was another factor in the selling today. Those people who saw some price recovery in the value of a stock, sold today, not to take a gain, but to reduce their losses. If a week ago Friday let's say XYZ was selling for $20. Let's also say that you had a cost basis of $30. If last Friday XYZ was at $25, you were only down $5. If you looked at the futures this morning and saw that the indication was for a sharp sell off you might have sold to protect your money.

I expect that the markets still have a little way to go before we stabilize again and try to move higher. The biggest concern this week will be the employment data on Friday morning. As of today, the estimates are for 300,000 additional jobs to be lost this month and the unemployment rate to climb to 6.7%. I think the number of jobs lost might be low and I think that the unemployment rate will be higher than 6.7%. Some of the sell off we saw today was anticipation of bad numbers on Friday. While I think the numbers could be worse that the consensus forecast, there is a part of me that thinks there is a slim chance that the numbers could come in better than expected.

I do believe that some people think the numbers are closer to 500,000 lost jobs and 8% unemployment. If the numbers come in line or a little better than expected I would look for a rally that could start on Friday and carry us into next week. One of the technicals that I look at is the absolute value of the S&P 500. We have tried several times to break and stay above 900 on the S&P. If we could break and hold above 900 on the S&P 500 we could have a nice Santa Claus Rally.

Dan Perkins