Friday, August 24, 2007

Bill Gross Throws in the Towel

I had to remove a trusted advisor from my list yesterday. For over five years I have read the commentary and analysis of Bill Gross of Pimco (one of the largest bond fund managers in the world with close to $1 Trillion under management). I was dissapointed yesterday to see him advocate for a massive federal government bailout of the mortgage industry and indirectly as a result the holders of mortgage backed securities and homeowners.

Maybe I am not on the frontlines enough to understand the implications of what is going on or I am naive as to the potential repercussions of the housing bust for all Americans. Still I feel that we have to experience somewhat of the real estate bust and subsequent recession to allow the correct reallocation of capital and resources to productive sectors of the economy. This type of transition of the workforce and capital out of real estate and into a more productive use such as capital spending for productive business will take years not months.

I guess if anything I am not surprised, but dissappointed. With someone as knowledgeable and as informed as Bill Gross, I felt that he sacrificed a lot of his reputation and integrity for a short term goal. Still I realize my view may be the short-sighted one. Even if the bailout was to be a huge deficit spending subsidy for the wrong speculative actors in the economy it could also prevent a severe recession that could take years to end. The world is complicated sometimes. But we can now put Gross clearly in the pro-bailout camp along with the rest of Wall Street, realtors, mortgage lenders, homeowners, and banks. That is a pretty powerful lobbying group.

Expectation: We will see several more steps and progressions in the bailout before the end of this year.

-BG

Sunday, August 19, 2007

A Framework For the Next 6 Months

After reviewing some video interviews on the internet this weekend where some of my favorite market commentators are featured - re: Jim Rogers, Peter Schiff, Marc Faber, etc. and then also reading the internet commentary from Bill Cara, Bill Fleckenstein, John Hussman, etc. - I realize that I am now in a different camp from basically everyone whose opinion I most trust. I figure that it is important to outline my general view now. Not for its predictive value, but to be able to look back 6 months from now to see how I reconciled uncertain outcomes ex ante amid a huge divergence of opinion - both bullish and bearish.

Again a quick summary of both sides of the coin here:

Bulls - Indicating that this is a once in a lifetime buying opportunity for bank stocks as they have never been so attractively valued. Federal Reserve will ease throughout the remainder of the year sending the market to new highs - re: 15K on the Dow, etc. Solution - buy financials.

Bears - This is friggin armageddon incarnate. Dow will finish the year below 10K, many financial firms will go bankrupt - re: Countrywide, WAMU, maybe Bear Stearns or another major broker, etc. Solution - buy gold buy gold buy gold.

And now my outlook (Ben) -

I see the market bouncing here off the 200 day moving average where it found price support after the fed intervention. I am not sure how long the market will rally. I also expect the Federal reserve to ease aggresively for the remainder of the year bringing the Fed Funds rate down to 4.25% or lower. I expect the massive weakness in housing and the credit markets to dictate the action for the remainder of the year. I think we will see accelerating foreclosures and continuing home price declines as mortgage rates continue to spike (Jumbo loans at least) and many mortgages begin their adjustable reset period.

The take away is that we are going through a classic debt deflation / liquidation scenario, where asset must be sold due to excessive leverage and inability to service the underlying debt. This cycle must be permitted to run its course in order to reach a stable level for asset prices - mainly real estate, although the credit markets and equity markets will likely follow suit.

How do we play this in the market? I think you have to keep doing what has been working since January 2007 - that is short financials and anything related to real estate. Market has still not bounced quite enough, but after a rally of a couple weeks near the former highs there should be a fabulous opportunity to get short again on WAMU, CFC, and several of the mortgage insurers via put options. I have no desire to short the overall market when the underlying fundamentals for the real estate market / credit markets are this poor.

WAIT - I haven't mentioned gold or precious metals as part of the outlook - whats going on? Any buying of gold or precious metals over the next six months is what I believe will be a value play. I expect metals price to correct significantly - potentially falling 10-20% over the coming months. Gold bulls are basically frothing at the mouth as this point because Fed easing is expected to create an imminent run on the dollar and a zoom in the gold price from the $650 level to over $700 again.

I believe this to be wishful thinking. In the difficult stock market that awaits us I believe that investors abroad and at home will be seeking the safe haven of US treasuries despite the poor underlying fundamentals of the Dollar and the Solvency of the US government. As a result I think you have dollar strengthening continued amid the clamor for treasuries.

For those that do not feel comfortable shorting stocks or trading put options I think that raising cash on this next rally will be important because it will give you some firepower to acquire high dividend yielding quality stocks when the firesale time does arrive.

It was great to layout these expectations. I can't wait to see how things unfold.

-BG

Friday, August 17, 2007

Step 1 of the Bailout Plan

This morning I woke up to see the market up over 200 points in the USA. Last night I had seen that the Japanese Stock Market (Nikkei) was down over 5% before I went to bed. It actually closed down 5.42%. That is a huge move down. I had expected another major decline in the USA today, but instead the market was rallying huge. I didn't know why. Then I received a phone call from a friend telling me the Fed had cut the discount rate from 6.25% to 5.75%. I am not going to use this article to explain the discount rate mechanism or dispute the significance of this action, I will leave that to the pundits which are having a field day with the news.

I think what we want to focus on is the psychology behind this statement. The Fed and the Government have told use for months that the USA economy has never been better. Unemployment rate is at record lows, Corporate Profits are at all time highs, and the US economy was supposed to be so hot that the Fed had to tighten just to simmer things down a bit. None of these underlying metrics have really changed YET. What did chance is we have seen the panic in the credit markets over the past few weeks and the major market declines in Asia last night. I think the Fed has committed to propping up asset prices via growth in the money supply and jawboning. I guess the takeaway here is that they CANNOT PREVENT a collapse in asset prices by the bailout alone. The bust is already underway and in force, but their best bet is they have decided to attempt to ensure an orderly decline.

There is a major difference for investors from losing 30% of the stock portfolio and home equity overnight versus an orderly decline over a 1-2 year period as happened after the tech bubble. The economy is really straining under an insolvency crisis at this point as the amount of leverage at play in the financial system as well at the micro level in the residential housing market shows just how sensitive the economy is to declines in asset prices.

So what kind of conclusions or hypothesis can we make for testing at this point. I will put forth the following:

1) The major rally in the financials that began today and likely will continue for a bit should be shorted.

2) Gold should be treated with skepticism. There is a temptation to buy gold hand over fist here as the money printing bailout has begun, but this is only Step 1 in probably a 100 step process. Even before the year is over we should see major bailout packages from Congress including an increase in the Conforming loan limit so that mortgages as high as $600K are now government insured vis a vis Fannie Mae and Freddie Mac as well as multiple Fed Funds cuts. The way to know the correct point is just to let the market prices guide us. Watch how the US dollar trades relative to Euros and Yen as well as gold. Once the psychology gets behind it, the train will be difficult to stop.

3) We are just beginning the BUST for real estate and leveraged finance in this country. The unwinding is going to take YEARS not days. The takeaway is to raise cash and SAVINGS not "equity" in imaginary asset price increases. Well we may not have an overnight route in asset prices I expect an orderly decline to occur slowly and painfully as many more hedge funds, banks, and lenders fail.

4) This is not a great opportunity to "buy the dip" in real estate. Sure if you want to be a homeowner - and you have the means to do it - go for it. There is no need to time the market for your first home purchase and place of lodging. But any real estate investment in residential or commercial for speculative or even investment purposes should be deferred until cap rates return to a sane level above 10% and asset prices have declined by at least 50%. We are getting there in residential at least in San Diego with prices probably down about 20% in many areas, but the Commercial has not budged yet.

-BG

Tuesday, August 07, 2007

Well just call these the ones that got away






I was not short any of the above stocks last week to my great dismay. I have been watching these among many others for the past couple years though. The pure fear that shines through these charts surprised me. It was not slowing earnings or a recession that caused these abrupt declines in the mortgage lenders shares and the mortgage insurers it was fears of a credit crunch and the obvious implications.
Im leaving on vacation to Nebraska for one week, so I will check back in about a week from now.
-Ben