Monthly Archives: March 2009

First Quarter 2009 – Is The Worst Behind Us?

Posted on March 31, 2009 by | Leave a comment

Now that the first quarter of the year has come to an end it is time to take stock of where we are in the equity markets, where we’ve been, and consider where we’re going.  The following is a recap of the quarter courtesy of Bespoke Investment Group LLC:

First Quarter Sector Performance and Top Stocks

As shown in the chart below, the S&P 500 was down 11.7% in the first quarter of 2009.  Six sectors outperformed the index, while four underperformed.  The Financial sector was by far the worst performer with a decline of 29.5%.  Industrials, Energy, and Utilities were the three other sectors that underperformed the market as a whole.  Only one sector finished the quarter in positive territory — Technology (4%).  Consumer Staples, Consumer Discretionary, Health Care, Telecom, and Materials are the other five sectors that outperformed the market.

Sectorperf331

Below we highlight the 25 best performing stocks (>$3/share) in the Russell 3,000 for the first quarter.  Just 28% of stocks in the index were up for the quarter, while 2% were up more than 50%.  The stocks below were all up more than 65%.  Providence Service (PRSC) was up the most with a gain of 374%, followed by DuPont Fabros (DFT), Palm (PALM), and gun-maker Smith & Wesson.  Other notables on the list of winners include Sprint, Whole Foods, Western Digital, and Coinstar.

Ray331

Just imagine how horrible the quarter would have been but for the recent rally.  What seems to be behind the wild swings is uncertainty.  When the market is dropping like a rock, it is because there is uncertainty as to whether the economy will ever improve.  But just the same, when the market bounces higher, it is because there is uncertainty as to whether an economic recovery is right around the corner.  Thus, the rapid declines and breathtaking rallies of the past year or so are the result of investors wanting to get out of the way (or being forced to sell because of margin calls) or desiring to get in before missing out on the final bottom.

As this author has stated repeatedly, there can be no visibility in the economy until the crisis in the banking system is resolved.  Although the government appears to be inching closer to dealing directly with the bank’s toxic assets and recapitalizing banks to get them healthy enough to begin lending normally again, there has been little action on that front.  Further, this is a process that may take years to complete, so wild aspirations of a quick economic recovery and restoration of the stock market to its pre-crisis highs are misplaced.

There are opportunities in equities, as there are in any market.  This can be seen from the list above.  But finding those opportunities requires heavy research and discipline.  Simply shoving one’s 401(k) in an equity index fund is likely to be a mistake.  Investors will need good advice to get through these difficult times.

Speaking of investment advice, there was an excellent article in The Wall Street Journal recently, educating investors about obtaining such advice.  An excerpt of the article follows with a link to the full story:

Need a Real Sponsor here

The Fight Over Who Will Guard Your Nest Egg

  • By JASON ZWEIG

A power struggle in Washington will shape how investors get the advice they need.

On one side are stockbrokers and other securities salespeople who work for Wall Street firms, banks and insurance companies. On the other are financial planners or investment advisers who often work for themselves or smaller firms.

[Intelligent Investor image] Heath Hinegardner

Brokers are largely regulated by the Financial Industry Regulatory Authority, which is funded by the brokerage business itself and inspects firms every one or two years. Under Finra’s rules, brokers must recommend only investments that are “suitable” for clients.

Advisers are regulated by the states or the Securities and Exchange Commission, which examines firms every six to 10 years on average. Advisers act out of “fiduciary duty,” or the obligation to put their clients’ interests first.

Most investors don’t understand this key distinction. A report by Rand Corp. last year found that 63% of investors think brokers are legally required to act in the best interest of the client; 70% believe that brokers must disclose any conflicts of interest. Advisers always have those duties, but brokers often don’t. The confusion is understandable, because a lot of stock brokers these days call themselves financial planners.

Read the rest here.

→ Leave a comment

Posted in Economy, Investing, Market Commentary, Personal Finance, Stocks

Tagged , , ,

U.S. Fixed Income Investors Offer Bleak View of 2009: Fitch Ratings

Posted on March 25, 2009 by | Leave a comment

The recent stock market rally has been impressive, as are most bear market rallies.  In a way, the violent upswings of the market are almost as sickening as the downward slides—hence, the oft-used roller coaster analogy.  When the market lurches up, as it has over the past two weeks, investors must not get too euphoric, just as they should not get too depressed when it seems like the market can only go down.  Controlling emotions is very difficult during times like these (which, in many ways, are unprecedented), but it must be done for prudent investing.

This author has recommended investors looking for some stability and income streams for their portfolios to consider fixed income.  One suggestion has been investment in investment-grade corporate bonds rated AA or higher.  In light of a recent report from Fitch Ratings, which surveyed senior fixed income investors, I want to revisit this area.

Below, a press release from Fitch Ratings is reproduced, and it includes a link to the full report on the 2009 economic and credit outlook from senior fixed income investors (login required).  Notably, the survey found that the sector most expected to improve this year is financials.  This explains, in part, the stock market rally—while the S&P 500 is up over 20 percent, financials have rallied almost 60 percent!  This is most likely due to the Treasury’s announced programs, such as the Private-Public Investment Program, designed to tackle some of the so-called “toxic assets” on banks’ balance sheets.  Although it is tempting to jump into financials stocks or a sector exchange traded fund, equity investors are subject to market risk (known officially as systemic risk).  One way to avoid such risk, but still participate in improvement in the financial sector is to invest in corporate bonds of certain financials, such as Goldman Sachs or General Electric (GE is not a financial per se, but its GE Capital Corp. is a major lender and has dragged GE into the middle of the credit crisis).

Here is the Fitch Ratings release:

Fitch Ratings-New York-05 March 2009: A deep or very deep recession will grip the U.S., Europe and emerging markets over the coming year, and the economic downturn is likely to last one to two years across all regions, according to the most recent Fitch Ratings/Fixed Income Forum Survey of Senior Fixed Income Investors.The bi-annual survey, designed to provide insight into the opinions of professional money managers on the state of the U.S. credit markets, includes a wide range of questions targeting views on the economy, fundamental credit conditions across various asset classes and sectors, corporate strategies, and other market developments.

In the recent survey, conducted in January, expectations for stability in the housing market were pushed further back, with 57% of respondents not expecting normal conditions to return before 2010. However, most investors believe that credit market stability will return sometime in 2009 (77% expressed this view).

In a notable reversal from the mid 2008 survey, and clearly a consequence of the speed and severity of the economic downturn, the recent survey showed greater receptivity on the part of investors to the expanded role of government in the credit markets.

Banks’ reluctance to lend received the most votes as a high risk to the credit markets over the next 12 months and nearly 40% of respondents believe that banks’ willingness to lend will not stabilize this year.

Interestingly, the corporate area with the most votes (40%) for some improvement over the coming year was financials. However, 44% of investors also expected improvement among financials in the June 2008 survey. In fact, responses on the outlook for financials continued to be among the most diverse. Views were also notably divided on whether the bigger risk going forward is inflation or deflation.

The full survey is titled ‘Grim 2009 Economic and Credit Market Outlook From Senior U.S. Fixed Income Investors’ and is available on Fitch’s web site at www.fitchratings.com under Credit Market Research.

If you have trouble viewing the report, please follow this link
http://www.fitchratings.com/corporate/reports/report_frame.cfm?rpt_id=428086

Contact: James Batterman +1-212-908-0385or Mariarosa Verde +1-212-908-0791, New York.

Media Relations: Cindy Stoller, New York, Tel: +1 212 908 0526, Email: cindy.stoller@fitchratings.com.

Fitch’s rating definitions and the terms of use of such ratings are available on the agency’s public site, ‘www.fitchratings.com’. Published ratings, criteria and methodologies are available from this site, at all times. Fitch’s code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the ‘Code of Conduct‘ section of this site.

Corporate Headquarters101 Finsbury Pavement | London | UK | EC2A 1RS
One State Street Plaza | New York | NY | 10004

→ Leave a comment

Posted in Corporate Bonds, Corporate Defaults, Economy, Fixed-Income, Investing, Personal Finance

Tagged , , , ,

Treasury Attempts to Separate Toxic Assets From Banks: Public-Private Investment Program

Posted on March 23, 2009 by | Leave a comment

The U.S. Department of the Treasury is taking direct aim at the troubled assets the Troubled Asset Relief Program was originally designed to ameliorate.  Residential mortgages and the multitude of securities that have been created using them as a base have clogged the balance sheets of banks, insurance companies, investment companies and many others since the beginning of the credit crisis in August 2007.  That was when high default-rates began to appear in subprime loans as the housing bubble popped.  As the credit crisis worsened, the market for mortgage securities (and derivates, such as credit default swaps) dried up completely as investors and banks lost confidence in such investments. With no market, there has been no reasonable method to assess the value of the mortgage securities and derivatives, which has frustrated certain efforts like evaluating the relative health of banks, implementing programs designed to get credit markets flowing again (TARP, TALF, etc.), and the general functioning of credit markets (high credit spreads are the result of uncertainty over banks’ balance sheets).  The Treasury’s Public Private Partnership Investment Program seeks to reestablish a market for mortgage loans, securities, and derivatives, which the programs refers to as “legacy assets” by providing up to $500 billion, with the potential to expand to $1 trillion.

According to the Treasury, the program will operate under three basic principles:

  1. Maximizing the impact of each taxpayer dollar
  2. Shared risk and profits with private sector participants
  3. Private sector price discovery

Funding for the program will consist of $75 to $100 billion from TARP capital and capital from private investors, with additional funding provided by the FDIC and the Federal Reserve.  By using funds from TARP and the Fed’s balance sheet, no new legislation or Congressional approval is necessary.

The Public-Private Investment Program is split into two parts: purchase of legacy loans and legacy securities.

The process for purchasing legacy loans:

  • Banks identify the assets they wish to sell
  • Loan pools auctioned off to highest bidder
  • Financing provided through FDIC guarantee
  • Private section fund managers manages the assets until final liquidation

Sample Investment Under the Legacy Loans Program

Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis – using asset managers approved and subject to oversight by the FDIC.

The mortgage loans of course are easier to deal with than the securities.  After all, the loans are collateralized by real property, and even though house prices have dropped significantly, a price, or value, of the collateral can still be determined.  Thus, while holding the loan still carries credit risk (the ability of the borrower to repay the loan on a timely basis), the value of the loan is, at the very least, the value of the collateral.  Securities are an interest in the repayment streams of a pool of mortgage loans.  Thus, securities have maximum credit risk, and the holder of a security has no collateral.  Derivatives carry the same problem, and generally they are bets on the risk, like credit default swaps.  It is exponentially more difficult to put a price on securities and derivatives than on the loans themselves.

And so, the legacy securities side of the Public-Private Investment Program is much more complex. First, the Term Asset-Backed Securities Loan Facility (TALF) is expanded to legacy securities.  The Program Fact Sheet explains it like this:

Providing Investors Greater Confidence to Purchase Legacy Assets:As with securitizations backed by new originations of consumer and business credit already included in the TALF, we expect that the provision of leverage through this program will give investors greater confidence to purchase these assets, thus increasing market liquidity.
Funding Purchase of Legacy Securities: Through this new program, non-recourse loans will be made available to investors to fund purchases of legacy securitization assets. Eligible assets are expected to include certain non-agency residential mortgage backed securities (RMBS) that were originally rated AAA and outstanding commercial mortgage-backed securities (CMBS) and asset-backed securities (ABS) that are rated AAA.
Working with Market Participants: Borrowers will need to meet eligibility criteria. Haircuts will be determined at a later date and will reflect the riskiness of the assets provided as collateral. Lending rates, minimum loan sizes, and loan durations have not been determined. These and other terms of the programs will be informed by discussions with market participants. However, the Federal Reserve is working to ensure that the duration of these loans takes into account the duration of the underlying assets.

The Treasury will then partner with experienced asset managers who will raise private capital to purchase, with matching Treasury funds, designated asset classes.

Sample Investment Under the Legacy Securities Program

Step 1: Treasury will launch the application process for managers interested in the Legacy Securities Program.
Step 2: A fund manager submits a proposal and is pre-qualified to raise private capital to participate in joint investment programs with Treasury.
Step 3: The Government agrees to provide a one-for-one match for every dollar of private capital that the fund manager raises and to provide fund-level leverage for the proposed Public-Private Investment Fund.
Step 4: The fund manager commences the sales process for the investment fund and is able to raise $100 of private capital for the fund. Treasury provides $100 equity co-investment on a side-by-side basis with private capital and will provide a $100 loan to the Public-Private Investment Fund. Treasury will also consider requests from the fund manager for an additional loan of up to $100 to the fund.
Step 5: As a result, the fund manager has $300 (or, in some cases, up to $400) in total capital and commences a purchase program for targeted securities.
Step 6: The fund manager has full discretion in investment decisions, although it will predominately follow a long-term buy-and-hold strategy. The Public-Private Investment Fund, if the fund manager so determines, would also be eligible to take advantage of the expanded TALF program for legacy securities when it is launched.

A fact sheet on the Program may be viewed here.

→ Leave a comment

Posted in Banking, Credit Crisis, Economy, Public-Private Investment Program

Tagged , , ,

Inflation Still Around, But in Check; Fed to Buy Treasuries

Posted on March 19, 2009 by | Leave a comment

The Consumer Price Index (CPI) increased in February slightly more than expected.  While this shows that inflation is still hanging around despite the economic decline, it is being held in check by the lack of economic activity.

From the U.S. Department of Labor, Bureau of Labor Statistics:

 

On a seasonally adjusted basis, the CPI-U increased 0.4 percent in February after rising 0.3 percent in January. The energy index rose 3.3 percent in February following a 1.7 percent increase in January as the gasoline index rose 8.3 percent in February after a 6.0 percent increase in January. In contrast, the indexes for fuel oil and natural gas both declined in February. About two-thirds of the all items increase was due to the rise in the gasoline index. Compared to the July 2008 peak, the energy index was 29.2 percent lower and the gasoline index was down 44.0 percent. The food index turned down slightly in February, falling 0.1 percent.

The food at home index fell 0.4 percent with five of the six major grocery store food group indexes posting declines in February. The index for all items less food and energy rose 0.2 percent in February, the same increase as in January. The indexes for new vehicles and apparel increased substantially in February, and the indexes for rent and owners’ equivalent rent increased slightly. Partly offsetting these increases were continuing declines in the indexes for lodging away from home and airline fares.

The food and beverages index declined 0.1 percent in February after rising 0.1 percent in January. The food at home index, which declined 0.1 percent in January, fell 0.4 percent in February. Within food at home, the dairy and related products index fell 2.4 percent in February, with the milk index declining 5.7 percent. The milk index has declined 10.0 percent over the past year. The fruits and vegetables index was the only major grocery store food group to post an increase, rising 0.4 percent in February after declining in each of the past five months. The other four groups posted modest declines, from 0.1 percent for the meats, poultry, fish and eggs index to 0.5 percent for the cereals and bakery products index. Over the last year the food at home index has risen 4.8 percent. Among the major grocery store food groups, the cereals and bakery products index had the largest increase over the past year at 8.9 percent, while dairy and related products was the only index to decline, falling 1.7 percent. Among the other indexes within the food and beverages major group, the food away from home index rose 0.3 percent in February, while the index for alcoholic beverages declined 0.2 percent, the first decline since December 2005.

The housing index was virtually unchanged in February for the third straight month. The shelter index, which rose 0.2 percent in January, was virtually unchanged in February. The indexes for rent and owners’ equivalent rent both rose 0.1 percent in February after increasing 0.3 percent in January. The lodging away from home index fell 1.8 percent in February, the fifth straight monthly decline. It has declined 5.7 percent over the past year. The index for household energy fell 0.2 percent in February and was down 8.1 percent from its July peak. Within household energy, the index for fuel oil fell 3.8 percent and the index for natural gas declined 1.6 percent, while the electricity index rose 0.5 percent. The index for household furnishings and operations rose 0.2 percent in February after declining 0.1 percent in January. Over the past year, the housing index increased 1.9 percent, with the shelter index up 1.7 percent.

The index for transportation rose 1.9 percent in February after a 1.3 percent increase in January. The new and used motor vehicles index rose 0.5 percent in February. The new vehicles index increased 0.8 percent in February, while the index for used cars and trucks declined 1.7 percent. The motor fuel index rose 7.6 percent in February but was down 35.4 percent over the past year. The airline fare index fell in February for the sixth straight month, declining 2.6 percent, and has fallen 14.0 percent since August 2008. The transportation index has declined 11.0 percent over the past year.

The apparel index rose 1.3 percent in February after increasing 0.3 percent in January. The index for men’s and boys’ apparel rose 2.8 percent and the index for women’s and girls’ apparel advanced 0.8 percent.

(Before seasonal adjustment, apparel prices rose 3.5 percent in February and were up 0.8 percent over the past year.)

Among other CPI groups, the medical care index rose 0.3 percent with the prescription drug index rising 0.6 percent. The index for recreation rose 0.4 percent as the indexes for toys, for sporting goods, and for pets, pet products and services all increased. The education and communication index rose 0.2 percent, with the education index rising 0.4 percent and the communication index virtually unchanged. The index for other goods and services advanced 0.2 percent with the tobacco and smoking products index posting a 0.7 percent increase.

Federal Reserve to Buy Treasuries

Also, the Federal Reserve announced that it will buy back long-term Treasury bonds.  This is a monetary policy move known as  ”quantitative easing.”  The Fed buys government debt, that has the effect of pumping more money into the capital markets, because the private money that was in Treasuries will now go elsewhere to find a better yield (buying Treasuries increases the price of the bonds and, inversely, drives down the yield).

Here are some analytical observations put together by the team at RGE Monitor:

Overview: The Fed announced in December 2008 that it will buy up to $500bn in agency MBS and up to $100bn in agency debt by the end of Q2 2009. On March 18, 2009 the Fed decided to purchase “up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of agency MBS to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.” In addition, the Fed decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

March 18: Upon Fed intervention, the mortgage rate drops from 5.16% to 4.68% and the 10-year Treasury yield drops to below 2.5% (CNN, FT)

Feb 9, Calculated Risk: Based on historical data, the Fed would have to push the Ten Year yield down to around 2.3% for the 30 year conforming mortgage rate to fall to 4.5%. 

March 18 economists react: if the Fed brings 30-yr fixed rate mortgages down to 4.50% and all homeowners are able refi, the aggregate permanent cash flow savings would be on the order of $200 billion per year (Greenlaw, MorganStanley)

cont.: ForwardCapital: With the declines in house prices already in the books and the probability that house prices will register further significant declines, the number of current homeowners who will be able to successfully refinance will be pared down accordingly as greater numbers find themselves treading water if not under water.–> see Congress and Treasury Scale Up Measures to Reduce Foreclosures

This is a very positive move for the economy and should put some more support under the recent stock market rally in the short-term.  There are still plenty of economic problems, however, so enjoy the rally, but be sure to take profits where possible.  For instance, General Mills missed earnings expectations and lost 10 percent of its value in one day.  If consumers aren’t buying Cheerios like they used to, then nothing is safe.

 

   

→ Leave a comment

Posted in Economy, Indicators, Market Commentary, U.S. Treasury Bonds

Tagged , , , , ,

Credit Spreads (3-18-09): Still Reflecting a Reluctance to Lend

Posted on March 19, 2009 by | Leave a comment

The LIBOR-OIS spread remains frustratingly high, signalling continued apprehension in the credit markets.

The LIBOR-OIS spread is used by economists and financial analysts as a measure of the availability of cash among banks.  The higher the spread, the fewer available dollars. The London Inter-Bank Offered Rate (LIBOR) is the interest rate that banks charge each other for three-month loans in U.S. dollars.  The rate is set by a panel of banks in a survey by the British Bankers’ Association each day around noon in London.  LIBOR is also used as a benchmark for approximately $360 trillion of financial products across the globe.  The overnight indexed swap (OIS) rate is an interest rate swap transaction in which the overnight rate is exchanged for a certain fixed rate.

The spread currently stands at 1.01, and it has remained above one percentage point since Feb. 19, after falling below that threshold on Jan. 12 and staying there for almost six weeks. The chart below shows the history of the spread over the last year.

 

 

 TED Spread

The TED Spread, which is the difference between what the government and companies pay for three-month loans, also remains elevated after recently showing signs of improvement.  It rose to 103 basis points (1.03 percent), compared with 94 basis points (.94 percent) on Feb. 13, 2009, and a record high of 464  basis points (4.64 percent) on Oct. 10, 2008.  The gap averaged 27 basis points (0.27 percent) from 2002 through 2006, before the credit crisis began in 2007.

The chart below reflects movement in the TED Spread over the last year.

→ Leave a comment

Posted in Credit Spreads, Economy

Tagged , ,