Stocks and Bonds

Nice, calm post from Zero Hedge titled Are the Bonds Smarter?, comparing the 10-year Treasury bond against the stock market. Here is some accompanying commentary from the post:

When in doubt always go with the bond market. Spreads between riskier bonds and Treasuries begun to notably narrow since December. Even though they widened some by March, they did not widen as much as they did last year. At one point earlier in the year we had narrowing junk bond spreads (the junkier the better) and a falling stock market. This is one of the reasons I did not believe that last leg of the selloff in stocks, although those last 200 SPX points to the downside did come pretty fast. This is what happens when you have to sell and there are not buyers.

Right now the situation seems irrational in the other direction—not complaining, I know markets are irrational by definition—and I believe we are setting up for a nasty disappointment after the inventory rebound in the economy is over. The bonds seem to be suggesting that... I don't think you will be able to rationalize a sub-3% 10-year yield as a green shoot.

DoctoRx here. Things were looking up from the growth-is-here-and-now camp based on Gallup's polling until today's. Unfortunately, self-reported consumer spending has plummeted very recently to $59/day, which is almost the lowest of the entire recession/depression. That metric was close to $120/day in the spring of last year. In addition, there was a brief surge upward in people reporting that their employer was hiring; that has receded; here is the link to the chart. We are back in the hiring/firing range that was first hit in December 2008.

By the above metrics, the stock market may be ahead of itself.

Also, certain market timers ranging from Doug Kass and Robert Prechter have recently tried to ring the bell at the top of this move. These two may deserve some real consideration, as they both got out of the market before the crash and aggressively called to buy around the March low. Past performance is no guarantee of future performance, however. The Kass topping call is a good read and can be accessed by clicking here. Kass and Prechter have very different approaches, it would appear; that they call at least a trading top now is interesting.

What would cause stock prices to decline would be little other than reversion to the mean that the stock market should both have some security of principal and provide income to the owners of the companies the stocks of which are available for public trading. Currently, even a 5-year Treasury note outyields the average S&P 500 stock. The more I think about matters and ponder the disaster that befell owners of a low-yielding stock felt to be safe, AIG, the more I believe that dividendless large, highly profitable companies such as Amgen and Cisco are abominations from the common shareholders standpoint. They are too big to be taken over and instead of keeping all their earnings within their companies, they should go out of their way to share their cash-flow success with their owners. The concept of not rewarding shareholders with current income is a modern contrivance and exemplifies much of what is wrong with modern finance. If at some point Cisco has a bad couple of years, fraud is found, etc., its owners will have had a disastrous multi-year waste of capital, whereas the insiders will have made fortunes via salary, bonuses and cashed-in stock options. In fact, in a statistical success, such an outcome is likely; when is of course unknowable.

If you fear inflation a lot, common stocks are the wrong vehicle to protect purchasing power over a 5-year time horizon. The classic vehicle is gold. Meanwhile, if the stock market is heading down, even if it proves to be a common correction in a cycle of rising prices that accompanies even "False Recoveries", it would appear likely that Treasuries would continue to attract buyers and rise in price (fall in yield). That's at least the trend that is in place now.

Copyright (C) Long Lake LLC 2009

Debt and Defaults

From Zero Hedge comes an interesting post and chart that represents a follow-up to various research that the recent very high risk premia on high yield bonds is likely to be followed by a severe default cycle:

Corporate Leverage At Unsustainable Level
Posted by Tyler Durden
Using the Fed's Flow of Funds (Z.1) report allows readers to calculate overall corporate leverage: a quick and dirty proxy for a top down leverage analysis. Much in the same way that corporate leverage is derived, the Z.1 provides the data needed to calculate the ratio of net debt to LTM internal funds/adjusted after-tax profits. This is a holistic number that does not stratify based on credit quality so IG and HY get commingled in this calculation (thus keeping it simplified and allowing historical apples to apples comparisons).

Q1 corporate leverage was 1.34x, unchanged from Q4 2008, a level higher than at any point over the past quarter of a century. Comparable prior peaks have lead the HY default rate by on average 9 months in 90-91 and 01-02, implying an expected peak of corporate defaults in early 2010. What is a bigger threat is that once all the external benefits from assistance and stimulus programs wears off, the "peak" could end up being merely a blip in an accelerating upward trajectory. As Bank Of America points out: "we remain concerned that we can be witnessing a temporary stabilization in this ratio, similar to the highlighted 1989 episode, which can then take us to the second leg of deterioration to new highs. In this case default cycle is likely to be pushed well into the future, with an uncertain peak levels. Performance of this ratio over the next few quarters would be crucial in answering this question."

The above goes along with the theme repeated over and over at Econblog Review, which is that despite deleveraging by consumers, the massive deficits being run by the Federal Government have kept overall debt levels in the economy at record levels and probably rising a bit. Risk remains very high, given such principles as reversion to the mean.

Copyright (C) Long Lake LLC 2009

Your Lyin' Eyes

The extent of the dichotomy between the ordinary world in which ordinary people make decisions about their financial savings, and the financial world in which current, former or wannabe Masters of the Universe live came home to me today by considering the juxtaposition of some the following blogs I viewed.

First, Mike (Mish) Shedlock's post on mall closures, America's Love Affair With Malls Ends; Toxic Drywall; Halted Projects; and Vacant Dealerships:

Four hundred of the 2,000 largest shopping malls have closed; construction is halted on hi-rise construction projects; and no one knows what to do with the increasing number of vacant auto dealership lots.Let's take a look at each of those commercial real estate disasters starting with The Vanishing Shopping Mall.

For much, much more please go to the source articles hyperlinked above.

Next, from CR, an example or two of commercial real estate halts. First, from Stalled CRE Projects in D.C (which links to a Wash-Post article).:


"Everybody is building these big buildings, and they're empty. It is sad. I live in a ghost town."

Robert Siegel, an advisory neighborhood commissioner;

and CRE Bust: A Hole in the Ground:

From The Oregonian: Construction of downtown Portland high-rise is halted by tight credit (ht Shawn, Justin, Neil)

Tom Moyer, one of Portland's most successful real estate developers, will halt work Monday on his 32-floor tower now under construction in downtown Portland.

Moyer's decision to pull 350 workers off the Park Avenue West is a stunning sign that no city, no person and no block is spared from this recession.

... The building, originally scheduled to open in 2011, already was more than half leased by a law firm and a Nike store.

OK. I get the above. It's easy to summarize. The fact that 20% of the country's largest malls have closed entirely is almost impossible to believe. After all, the 80% that remain are seeing surging vacancies. It is said that from a boom peak to the bust trough in the Great Depression, industrial output dropped 25% in volume and (say) 45% in dollar terms. Given that the U. S. has outsourced a great deal of its production to Asia (much which has seen Great D levels of production and export drop-offs), then is not the closure of 20% of the largest malls a modern
Depression equivalent? What does one think about the cessation of construction of a large office building that is already more than half leased, 2 years before completion?

Then one reads the well-regarded markets blog Zero Hedge and comes across this in today's post, Quantology Revisited: The Negative Convexity Implications of Delta-Hedging:

I thank readers who provided tremendous insights on the market illiquidity post. However, one point that nobody mentioned, which may very well be at the heart of the problem, has to do with the issue of negative convexity from a delta-hedging perspective. Zero Hedge had previously discussed the implications of this very peculiar phenomenon two months ago in the context of CDO trend chasing in the CDS market and how negative convexity (especially in illiquid markets) leads to explosive and self-fulfilling rallies on either side.

I thank an anonymous reader for presenting the missing piece of the puzzle, and taking the convexity argument one step further from merely structured finance to the entire market. I welcome responses and apologize for the thematic wonkiness, however there is only so much simplification that can be presented. But a simplified attempt: we have crossed into territory where the negative convexity consequences of delta hedging will keep on pushing the market in a straight line in whatever direction it is moving until we see a violent reversal and the delta hedge breaks due to lack of vol to "feed it", which will be, in the parlance of our times, the market's epic fail.

Note: The link to the "market illiquidity" post on Zero Hedge is worth a look, in the context of this commentary because of its further opacity.

The bottom line at EBR from Zero Hedge is that individuals cannot/should not be involved with this stock market, because obscure trading strategies dominate what goes where and how long and strong the trend is. If a non-professional market veteran such as I cannot even understand what a blog such as Zero Hedge is talking about with consulting Investopedia, what is going on the financial markets?

Bottom bottom line at EBR involves the following thoughts.

When the Government performs a bogus stress test on large financial institutions and delays announcing the results until these institutions put out carefully massaged earnings releases that are "better than expected" due to refinancings created by massive Government purchases of bonds and generally low interest rates due to the ongoing economic collapse as well as due to understating loan losses; and when the Government will only provide general summaries of the findings; when Paul Volcker is (semi)-officially revealed to have been used only to get Barack Obama nominated and elected; when China "stimulates" more and more fixed construction on top of the unoccupied Beijing real estate recently built which exceeds the entire office space of Manhattan; when our Government keeps asking us to believe its current economic numbers while continually revising numbers downward 1-2 months earlier; but the most accurate analysts on the financial and economic meltdown continue to not like the fundamentals of the economy vs. the official and consensus view:

Who and what do you believe, the Government, or your lyin' eyes?


Copyright (C) Long Lake LLC 2009

More on AIG and Geithner as Scammer-in-Chief

Zero Hedge has posted on its own web site and as a guest post at Naked Capitalism some explosive charges regarding the mechanism by which AIG allegedly raped shareholders, with the approval of Mr. Geithner.

The language is harsh and the conclusions appear reasonable, at least to this non-trader in the securities described.

The simplest way to read this is to go to www.zerohedge.blogspot.com:

SUNDAY, MARCH 29, 2009

Exclusive: AIG Was Responsible For The Banks' January & February Profitability

Posted by Tyler Durden at 6:35 PM

Zero Hedge is rarely speechless, but after receiving this email from a correlation desk trader, we simply had to hold a moment of silence for the phenomenal scam that continues unabated in the financial markets, and now has the full oversight and blessing of the U.S. government, which in turns keeps on duping U.S. taxpayers into believing everything is good.

The above is enough of a teaser.  Non-technical people can skim over what they don't understand.  There is a layman's explanation later after a bunch of technical stuff.

Copyright (C) Long Lake LLC 2009

Merrill, $15 Billion, and BofA

Zero Hedge blog raises the following question:

Was Merrill Casualty #3 of The Basis Trade After DB Prop and Citadel
Posted by Tyler Durden at 9:48 AM

"In a bet gone very bad, that if true would make Jerome Kerviel's $5 billion loss at Soc Gen seem like amateur hour, the WSJ reports ($$$ link with hat tip to portfolio.com) that the main reason for Merrill's massive $15 billion Q4 loss was due to some very large basis trades gone horribly wrong. We wrote briefly about the basis trade here but now with attention turning more firmly to this topic, it is worth revisiting."

If you're a pro, you might find the entire blog interesting and comprehensible. I'm not and don't get most of it. However, here's what I think I do get. Merrill is suspected of gambling on the eve of being sold for $29/share. It had no need to risk scuttling the deal by gambling. Every gamble of this nature has a counterparty taking the other side of the gamble. That counterparty makes an equal profit to the loser, minus transaction costs if any.

In an article titled "BofA had role in Merrill bonuses", The Financial Times reports today that "In the wake of Mr Thain's dismissal last week, sales and trading chief Tom Montag, his top deputy, received a promotion. Mr Montag's department was responsible for at least half of Merrill's $15bn loss in the fourth quarter."

Why promote a loser such as Mr Montag. Did BofA make a profit as a counterparty while Merrill took huge losses?

Even Inspector Clouseau knew that every misdeed needs a motive. The motive here that makes sense is to dump on Merrill to make BofA look good.

Copyright (C) Long Lake LLC 2009