Wednesday, July 30, 2008

Market Update

Yesterday's rally appears to have been fueled by an extension of the "no short sale" rule another 30 days. The implementation of the initial rule two weeks ago led to a sharp rally in many financials and I'd expect this extension to add at least 5-10% to many of these names.

However, the bigger game in town right now is collapse of oil prices. Let's see if I can walk you through what has happened in the past few weeks. The demand destruction caused by $4+ gas has actually changed some driving habits in the US slightly. That has had a small effect on the price of oil. The biggest contributor to this recent sell-off however, appears to be the strengthening dollar. So why is the dollar gaining strength in the face of a very weak US economy?

Well, investors are always trying to see ten moves ahead and this is how the equation works - Inflation is getting out of hand, so the Federal Reserve is likely to start raising rates (probably after the election), so the US dollar will strengthen when rates go up, so oil will fall when the US $ goes up. Hedge funds (that have been the fast money behind the latest move from $80 to $140) are looking to lock in their gains in oil - if you got to keep 20% of the profits that you delivered to investors you would want to lock in gains as well. Thus, the trade right now is unload oil and buy equities for the next little bump up. I've said for sometime that $70-$80/barrel is the right price for oil given demand, OPEC issued a similar statement yesterday.

I'd expect this to play out through mid-August (all of Wall Street goes to Nantucket on 8/15). By mid-September look for everyone to get nervous about earnings again (and the no-short rule will have expired by then) and you can be comfortable being short again at that time.

Cheers.

Tuesday, July 29, 2008

Re-post - Wall Street's Woes to Impact NY State

A couple of weeks ago I covered the impact Wall Street's troubles will have on New York State. Today's news that Gov. Paterson and Mayor Bloomberg are sounding the alarm that budget deficits are growing beyond expectations are a further signal that services and jobs are likely to be cut and taxes raised in the near future as result of the NYC's economic troubles.

Friday, July 11, 2008

Wall Street's Woes Will Impact Upstate NY
It's hard to sympathize with the Bankers and Analysts on Wall Street as their jobs and bonuses evaporate faster than the $80 you just put in your F-150, but the impact of lower profits and smaller salaries on Upstate will be real in the very near-term.

The numbers thus far are staggering - nearly 60,000 positions eliminated and perhaps over 100,000 by the end of the year (NY Times - 5/08). I think that might even be conservative. The average salary in Manhattan (this includes everyone - Wall Street, Ad execs, chefs, etc) was over $146k in 2006 pre-bonus and on Wall Street bonuses of 100-200% were not uncommon in recent years.

If we assume a conservative 40,000 positions eliminated in 2008 (with more likely in 2009) with an average total comp package of $200,000 - You could see a $600 million drop in state tax receipts just from positions eliminated. It takes a lot of jobs at Texas Roadhouse to make up that kind of tax revenue.

Recently the NYS Budget office put out the following outlook which highlights the problems facing NYS if Wall Street continues to struggle."New York State receives about 20 percent of its tax revenues from Wall Street in the form of taxes on bonuses, income, capital gains and large real estate transactions."

"Financial giants such as Morgan Stanley, Merrill Lynch, Bank of America, Citigroup, Lehman Brothers and others have reported disappointing earnings and are preparing for potential layoffs."

My real concern is with the tax collection in future years as Wall Street dramatically shifts it's bonus structure. *** Update - I think today's news on Merrill Lynch further emphasizes that payroll at the big firms are going to fall sharply in coming years ***.

So when you read tonight another story about the struggles at Lehman Brothers or Merrill Lynch or Fannie Mae or Freddie Mac, don't think we live in vacuum here in Upstate NY for all the complaining local politicians do about "Downstate" that's where the money comes from to support our statewide economy. Their struggles are our struggles.

There is one very large domino (lower tax revenue) that could start a chain of events that will lead to lower spending, reduced services and possibly one higher taxes at the local level as state aid is reduced for schools.

Cheers.

Monday, July 28, 2008

Student Lender in MA Stops Lending

There are a number of topics to discuss as it relates to this story in today's Boston Globe.

Student Lender Won't Have Loan Money This Season

The nonprofit lending authority said it was unable to secure funding to provide private student loans. It is contacting more than 40,000 students and families to whom it has made loans in the past, to urge them to seek other options.

"As a result of our problems and the continued dislocation of the capital markets, we have been unable to raise funds for the coming academic year,'' said Thomas M. Graf, executive director of the group."

With about a month to the start of the fall semester this news is clearly going to be a painful blow to the hopes of many college bound students and I understand the anxiety this is going to cause.

I think this a trend that is going to continue across numerous state and federal agencies as the credit crisis rolls through different markets.

This is clearly the cloud - here's the silver lining. College costs have been spiralling out of control for the better part of the past 20 years. A major contributing factor to this growth in the cost of education is the easy access to relatively cheap credit. Colleges have felt no need to innovate or control costs b/c every bump in tuition has been met by a 20% increase in applications. If the days of cheap credit are truly over, then perhaps the cost of tuition will eventually start to ease as the number of applicants fall.

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On a related subject - There's a good business model to be had here. Continue to lend to students, but base the interest rate on the applicant's future prospects. For example, someone with a 2350 SAT that is going to MIT gets a rate of X%, while a D student with an undeclared major at Arizona State gets a rate of 2X%. The quality of the loan portfolio would be easily broken into tranches. Someone at Goldman should get to work on this model.

NYS Governor Reading Grindstone Financial?

About two weeks ago I posted that the current financial crisis on Wall Street coupled with smaller and fewer real estate transactions was likely to have a dramatic impact on the NYS Budget process.

"There is one very large domino (lower tax revenue) that could start a chain of events that will lead to lower spending, reduced services and possibly one higher taxes at the local level as state aid is reduced for schools."

Now comes word that Gov. David Patterson will host a news conference tomorrow where he will outline the fiscal difficulties facing NYS.

“He will say that plunging state revenues will force painful cuts in state services, necessitate a reduction in the state work force, possibly through layoffs, and require other difficult economic measures, a source said.”

Better to be lucky than good sometimes....

Sunday, July 27, 2008

Best of the Weekend on the Web....

I found some interesting posts around the web this weekend. Enjoy.

From a well known banker - "Don't buy a house today if you aren't going to stay there at least 7 years." It's funny that this is now seen as some kind of ancient mythology, but for many years this has been the threshold of the buy/sell decision. In fact, I'd argue that 10 years is a nice round number and a better number if you are a bit more conservative. Why 7-10yrs? Well, assuming prices fall 5%-20% further from here, after fees (agent fees, bank fees, attorney fees) you are probably looking at 7-10+ years of normal appreciation (2-3%/year) to get back to break-even. I'm more skeptical on housing than the author of this posting but I found it interesting that someone whose livelihood is tied to mortgage transactions would be honest about breaking even in real estate.

Let Look at the Durable Goods number on Friday. Yes, it was ahead of expectations, but consider 2 things.
1) The stimulus package has a depreciation tax credit that expires this year that is designed to spur spending and it may have contributed.

2) It's a month. Month-to-month data is basically meaningless. Look for long-term trends, including revisions - don't overlook the revisions - year over year changes, etc.

Soros buying the dips in India, should you?
Despite the screaming headlines about the roaring economies in India and China, India's primary stock index is off 35% this year and everyone is rightfully down on India's near-term prospects (violence in Gujarat this weekend doesn't help). Inflation is up to 12% and all measures of growth seem to be slowing. So why is the one of the smartest traders in modern times buying in India?

I suppose the theory is that India is able to operate independent of the rest of world, but I respectfully disagree with that theory.

The bigger risk to this style of investing is currency risk. Maybe the stock market in India might rebound, but you could have your gain wiped out by gains in the $/Rupee exchange rate.

Steer clear of India for now and instead invest in Randy Pausch's book.

Friday, July 25, 2008

Dr. Pausch, 47

Dr. Randy Pausch, the inspiration professor behind the famous Carnegie Mellon "Last Lecture" hit on Youtube, passed away today.

Dr. Pausch's message of hard work, trial and error, and learning from dissapointment continues to live on in his speech and his book.

If you have kids, do yourself a favor and spend an hour tonight watching his Last Lecture.

Saving the US Economy 1 Check at a Time

The NY Times has a fairly comprehensive piece on the new housing bill that was rushed through Congress in an effort to "save" Fannie Mae and Freddie Mac. I could go into a long discussion on the risks of this maneuver and why we should be questioning a US taxpayer bailout of two private companies that benefits foreign investors (China/Japan) as much as it does US homeowners, but I'll focus on the pork in this bill.

In fact the pork is so clear that the Times calls it for what it is:

"Whether larding up the bill with all these benefits is good for taxpayers is a debate for another part of the newspaper. But there is no shame in taking advantage of what is offered. In fact, you would be foolish not to."

1. New 30 yr mortgages - In theory this seems like a good plan assuming people can keep up with the new payments. Unfortunately, this plan is destined to fail from the start because it limits the loan size to 90% of the current market value (which is falling like a stone every day). A home bought in 2005 in California for $650k with no money down is now worth $420k and the mortgage is over $600k. Unless the banks agree to more writedowns, this plan is DOA. Oh and how about this:

"Finally, you have to hand over no less than 50 percent of any appreciation on the home to the government once you sell. Sell the house in less than five years, and you will have to turn over as much as all of the gain." What's that?!?!?! I sell my house and the government wants my gain b/c they helped renegotiate the loan? Who wrote this legislation?

2. Tax Credit for new buyers - this one smells of the Real Estate Agent lobby. If you qualify and buy a home you get a $7,500 tax credit this year. Again, this sounds good on the surface, but the devil is in the details. This "credit" isn't a credit at all. In fact, you have to repay the $7,500 over 15 back to the government. So now, you owe your bank and the Federal government - great. Welcome to home ownership!!!

3. Standard deduction kicker - For those prudent individuals that actually paid off their home (I heard there was some guy in Omaha that did this once) there will be another $500-$1000 deduction for these people next year. This is another handout for the baby boomers that can't stop stealing from my kids to put gas in their RV's. The baby boomers better enjoy it while it lasts, b/c the time is coming when we are going to have to take off their training wheels and they are going to actually have to survive without all these handouts.

4. A Break for Veterans - This is perhaps the most offensive part of the bill. The old GI Bills really helped Veterans kick start our economy after WWII. Despite all the flag waving, lapel pins, support our troops stickers - this is what the housing bill does to support Veterans:

"Lenders will have to wait nine months, instead of 90 days, before beginning foreclosure proceedings on homes owned by someone returning from the military. Lenders must also wait a year before raising interest rates on a mortgage held by someone returning from military service."

Wow. Thanks for risking your life and spending the last 4 years away from your family. Now, thanks to your friends in Washington, the bank won't be able to foreclose on you for another 180 days. Care to re-enlist?

This legislation is such an embarrassment. Our economy is on the verge of tipping into a very dark place and if this is the leadership provided by our legislative and executive branches rest assured that US debt will be facing a downgrade in the next 2-3 yrs and if/when that happens, it's all over.

Cheers :(

Thursday, July 24, 2008

Hmmm, Housing bottoming? Not so much....

Homes are safe investments, right? Well, the problem with that theory is that the law of supply and demand applies to homes as well and right now supply is exploding and demand continues to weaken.

"The National Association of Realtors reported that sales dropped by 2.6 percent last month to a seasonally adjusted annual rate of 4.86 million units. That was more than double the decline that had been expected and left sales 15.5 percent below where they were a year ago.

The downward slide in sales depressed prices, too. The median price for a home sold in June dropped to $215,100, down by 6.1 percent from a year ago. That was the fifth largest year-over-year price drop on record."

I always distrust data from the National Association of Realtors because they have a vested self-interest in promoting how good the housing market is. Given how ugly this data is, I'd suggest that in reality the real estate market is actually a good deal worse than this data shows.

The inventory of unsold homes sits at 11 mths supply which is a level we haven't seen since you were rocking out to Quiet Riot on your new boombox. Some others have noted that this inventory doesn't include homes listed for sale outside the Multiple Listing Service (Bank owned, foreclosures, etc), which is a growing number as well, and means inventory is even higher than reported.

Locally, the real estate market continues to defy logic but inventory in Jefferson-Lewis stands at 2,400+ listings and just a few years ago it rarely exceeded 1,000 listings. I think as long as government spending stays strong the local market will remain relatively healthy, but I think you can see a day 2-3 yrs down the road when state, local and Federal spending is cut and that will directly impact local home prices.

I think the upper end of the local market (waterfront properties, large new construction) is likely to be impacted first. The days of someone selling their overpriced split ranch in Long Island and moving up to the St. Lawrence seem to be over because that split ranch in Long Island is now one of 700 properties sitting with a 12 mth old "For Sale" sign in the front lawn. This demand destruction is coupled with a sharp increase in supply of $300k+ homes for sale. Four years ago there were fewer than 25 homes for sale priced over $300k. Today in Jefferson-Lewis counties that number is................ 219!!! That's nearly a ten-fold increase in high-end inventory in 5 yrs.

Cheers!

WSJ - States Slammed by Tax Shortfalls

As I noted last week, Wall Street's woes are going to have a serious impact on NY State's budget. The result will be either reduced services or higher taxes (despite what your favorite candidate will tell you).

Yesterday's Wall Street Journal had a good article on the tax shortfalls around the US.

"Sales-tax collections, for example, have been hurt by the housing slump and high gasoline prices, which are prompting cutbacks in consumer spending."

Click for an interactive map on the budget shortfalls. In particular, note the shortfalls in big states like NY, NJ, and CA.

Tuesday, July 22, 2008

Truthiness invades Employment Data.

For some time many bloggers with far greater reach have accurately railed against the fiction coming out of the Bureau of Labor Statistics (BLS) regarding employment data.

The complexity of the US economy makes it necessary for statisticians to employ some formulas in their models to allow for new business formations that haven't been captured by any other Federal agency. In theory, this seems harmless enough.

However, the media and (unfortunately) many intellectually challenged money managers have latched onto the headline number - Jobs gained or lost.

The most dangerous component of these models is the Birth/Death Adjustment which is little more than a guess at the new jobs created by newly formed companies.

In June, this estimate accounted for 177,000 new jobs and without these "jobs" the net loss of jobs in June would have been north of 230,000 (rather than 60,000 as reported).

Included in the 177,000 new jobs created was an estimate of 29,000 new construction jobs and over 80,000 jobs in leisure/hospitality. Anyone that has read the horror stories on construction activity around the country knows that the construction number is ridiculous.

Prior to 2001 the Birth Death adjustment averaged less than 20,000 jobs per month. Over the past 5 months the Birth Death adjustment added 922,000 jobs or almost 185,000/month.

Commercial Bankruptcies have spiked as of late and this is an indication that the reality is far from the truthiness put forth by the BLS.

The real danger comes in the first week of August when the BLS adjusts for Birth Death errors in the previous six months. If they are honest the revisions could be historic, but honesty is not a strength of the B(L)S.

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Current market conditions - This short covering rally has a little more legs, but once we get past earnings season I expect the professionals to get short again in big way. A number of favorite short names are up 30-60% in a week and they will be the first to be targeted when the real money comes back to play.

Monday, July 21, 2008

Debtor Nation

The NY Times is running a series of articles focused on the unbearable weight of consumer debt that the average American is carrying.


Unfortunately, debt and it's long-lost cousin savings, are among the most taboo subjects in our culture. We avoid talking about it with our kids and then send them to counseling when they are shopaholics at 18 (see MTV's True Life I'm a Compulsive Shopper). I don't know what the answer is to this current crisis of consumerism, but more coverage of the problem is a start.

Given a Shovel, Americans Dig Deeper into Debt

"Today, Americans carry $2.56 trillion in consumer debt, up 22 percent since 2000 alone, according to the Federal Reserve Board. The average household’s credit card debt is $8,565, up almost 15 percent from 2000."

"By contrast, the nation’s savings rate, which exceeded 8 percent of disposable income in 1968, stood at 0.4 percent at the end of the first quarter of this year, according to the Bureau of Economic Analysis."

Wednesday, July 16, 2008

Surprise, Surprise, Things are Getting More Expensive

Today's CPI report showed inflation jumped 5% from 2007 which is the biggest jump since 1991. The core rate of inflation jumped 2.4% (ex-food and energy) also ahead of expectations. Frankly, even these numbers feel low to anyone that has had the joy of shopping for consumer staples lately.

Perhaps more troubling is that average hourly earnings slipped in June by 0.9%.

So while the cost of everything is rising, the average household income is slipping. This is particularly difficult situation to address for policymakers. If prices AND wages rise, the recipe is simple - raise interest rates. If prices and wages are falling, cut rates. Unfortunately, the Federal Reserve has lost sight of these guiding principals and instead focuses on the daily swings in the stock market.

An important note was raised by UBS (the large Swiss Banking firm):

"Whilst Bernanke took centre stage, macro data showed the increasing problems we face. Producer prices rose by 9.2% y/y, the highest by quite a margin since July 1981 when U.S. interest rates were still at 15.5%. " Note that - The last time producer prices rose this fast (ie, we had high inflation), interest rates were 15.5%!!! Today rates stand at 2%. Clearly the lack of wage pressure is the key difference, but if the Fed is wrong we are in for a world of hurt.

However, there is one factor that could change everything. Oil. It's down about $10 in recent days as a result of concerns about slowing global growth, but I also suspect that some big traders have started to unwind the oil trade over fears that the Gov't is going to increase regulation to limit trading in oil futures. That's just my guess, though.

Tuesday, July 15, 2008

GM - $9 and falling...

Wow, GM just can't find a floor. Today they announced a plan to cut their dividend, cut salaries by 20% and selling assets in an attempt to raise $15 billion.

Included in this move are some cuts to health care benefits to retirees. This has long been one of my biggest complaints with the US automakers (aside from the fact they can't make a decent car). They have so many retirees living longer and longer while their base business erodes that GM and Ford have basically become large, poorly managed health care insurers that happen to make mediocre cars on the side.

If GM can bring a 40 mpg sedan to the US market in the next 3 years they have a shot at survival. If not, they seem destined to head to junk heap of past US powers like Woolworth's, Zenith and Gateway.

Bernake, Bush and Boom goes your 401k...

All of Washington seems to be buzzing trying to figure out what they can do to counter the current crisis of confidence in the markets right now. Bernake is speaking in front of Congress right now. Unfortunately, Big Ben has shown no ability to calm the markets in his short tenure at the Fed.

President Bush will speak at 10:20 but that is not expected to materially move the markets.

Frankly, I'm surprised by the latest moves in the market. Clearly there is increased tightening in the credit markets that is seizing up the financial markets. This can change in a minute if a big fund decides to get long (the sheep are chomping at the bit to buy this market), but we have broken through a number of technical supports that might cause further drops - I'm not a believer in technical analysis, but a ton of money is managed via charts and if you chose to ignore it, you do so at your own risk.

Fun times....

Sunday, July 13, 2008

Congrats! You (and the rest of the taxpaying public) just bought some FNM and FRE...

Fannie Mae and Freddie Mac have struggled recently as a result of weakening credit around the country. Real estate markets from CA to Florida are in steep decline and the increasing defaults has weakened the status of mortgage finance companies including Fannie and Freddie.

Their equities have been a disaster over the past 12 months but the real fear was coming tomorrow morning. Freddie has a $3 billion offering set that was meeting with lukewarm response on Wall Street. The thinking was that if the offering failed it could trigger a series of financial dominoes that might create a widespread financial panic.

In steps the US Treasury to extend a special line of credit to Fannie and Freddie, no big deal. Then the US Treasury announces a plan to purchase equity in the two companies if need be, that's a big deal. It's unclear how much the Treasury is willing to buy, but the fact that they US Government is effectively acting as a backstop to equity investors (AGAIN - SEE Bear Stearns 4 mths ago) is a big deal.

Separately, the White House asked Congress to boost the National Debt Limit again.

Borrowing from foreign investors to support over-leveraged financial firms holding assets that are declining in value is not a prudent long-term fiscal strategy IMHO.

The next time you fill up your car and gas hits $5/gallon remember it's not because of rising oil demand, but rather the weakening US Dollar. Actions like this move by the US Treasury continue to weaken the US Dollar.

Cheers.

Friday, July 11, 2008

Wall Street's Woes Will Impact Upstate NY

It's hard to sympathize with the Bankers and Analysts on Wall Street as their jobs and bonuses evaporate faster than the $80 you just put in your F-150, but the impact of lower profits and smaller salaries on Upstate will be real in the very near-term.

The numbers thus far are staggering - nearly 60,000 positions eliminated and perhaps over 100,000 by the end of the year (NY Times - 5/08). I think that might even be conservative. The average salary in Manhattan (this includes everyone - Wall Street, Ad execs, chefs, etc) was over $146k in 2006 pre-bonus and on Wall Street bonuses of 100-200% were not uncommon in recent years.

If we assume a conservative 40,000 positions eliminated in 2008 (with more likely in 2009) with an average total comp package of $200,000 - You could see a $600 million drop in state tax receipts just from positions eliminated. It takes a lot of jobs at Texas Roadhouse to make up that kind of tax revenue.

Recently the NYS Budget office put out the following outlook which highlights the problems facing NYS if Wall Street continues to struggle.

"New York State receives about 20 percent of its tax revenues from Wall Street in the form of taxes on bonuses, income, capital gains and large real estate transactions."

"Financial giants such as Morgan Stanley, Merrill Lynch, Bank of America, Citigroup, Lehman Brothers and others have reported disappointing earnings and are preparing for potential layoffs."


My real concern is with the tax collection in future years as Wall Street dramatically shifts it's bonus structure.

So when you read tonight another story about the struggles at Lehman Brothers or Fannie Mae or Freddie Mac, don't think we live in vacuum here in Upstate NY.

There is one very large domino (lower tax revenue) that could start a chain of events that will lead to lower spending, reduced services and possibly one higher taxes at the local level as state aid is reduced for schools.

Cheerfully yours,

Grindstone Financial

PS - Sorry for the long delay in posting. I've been very active in the markets lately and thought it best to avoid posting during this period.

Disclosure - I worked for Lehman Brothers in the late 90's and I am deeply upset by the recent turn of events there.