David Fuller and Eoin Treacy's Free (Abbreviated) Comment of the Day.
Wednesday 3rd December 2008
Tim Price: Considering the snow - This issue from PFP Wealth Management discusses 'The Snowball: Warren Buffett and the business of life', by Alice Schroeder. Here is a section:
Aspirant financiers and entrepreneurs seeking the Value Way to Riches will be well served by the shareholders? letters alone. "The Snowball? fills in both the private and public history of America's greatest investor. What strikes the reader of today is the extent to which the current deep crisis has its roots in the behaviour of bankers ten and twenty years ago - the Credit Crunch and Banking Fiasco of 2008 did not come out of a clear blue sky. The full dress rehearsal for the bankruptcy of Lehman Brothers in 2008 - probably the worst decision made by the US Treasury and Federal Reserve so far, in an environment where the swirl of poor decisions has been as thick as autumn leaves - came in 1991 when Salomon Brothers was hours away from bankruptcy following a hushed-up fraud involving rigged auctions for US Treasury bonds. Buffett was parachuted in as chairman to save the firm, and perhaps even the integrity of the US financial system. So "too big to fail" is hardly a contemporary coinage. And the festival of moral hazard that is the current Anglo-Saxon banking culture has its origins in the 1998 collapse of Long-Term Capital Management and its vilely hubristic executives. Buffett was invited to rescue the fund. But its management, in what might be seen as an eerie presentiment of the downfall of Lehman's CEO Dick Fuld, were determined to retain ownership and control of the business. Alice Schroeder asks the pertinent question of the Fed-orchestrated LTCM bailout:
"It is hard to overstate the significance of a central-bank-led rescue of a private money manager. If a hedge fund, however large, was too big to fail, then what large financial institution would ever be allowed to collapse? The government risked becoming the margin of safety. No serious consequences had come about in the end from the derivatives near-meltdown. The market afterward seemed to behave as if no serious consequences ever could. This threat, the so-called "moral hazard," was a chronic worry of regulators."
Buffett himself candidly explained the second- and third-order impact of failing derivative structures, which again carries huge resonance in our dislocated modern financial arena:
"Derivatives are like sex. It's not who we're sleeping with, it's who they're sleeping with that's the problem."
Much of "The Snowball? has a grim relevance to current events:
"Terrorists have a huge advantage. They pick the time, the place, and the means. It's very difficult to defend against fanatics.. This [the terrorist attacks of September 11, 2001] is just the start of things. We don't know who our enemy is. Now, it's us versus a shadow. There could be many shadows."
And like the shareholders? letters, "The Snowball? is a repository of fine quotations, about business and investment success, and much else. But as we crouch in the aftermath of the Crash of 2008, amidst the rubble of the equity and credit markets, there is specific cause to see optimism and a sense of opportunity in Warren Buffett's words describing a previous panic (in this case, the crisis of confidence in the financial markets post-Enron). As Alice Schroeder puts it,
"Berkshire's best opportunities always came at times of uncertainty, when others lacked the insight, resources, and fortitude to make the right judgments and commit."
But Buffett tells it best, and the advice resonates for our time as well as in relation to his previous market coups:
"Cash combined with courage in a crisis is priceless."
My view - This quote immediately above, selected by Tim Price, is particularly apt. When a crisis appears all but insurmountable, it is usually well discounted.
'The Snowball' should make a good present for the forthcoming holiday season.
"It is always pleasure to get to read insightful independent thoughts from our community on our site. Pl note I call it as our site...
"I am from India and have spent close to 17 years in equities. I just want to bring to notice two crucial facts:
a. all bear markets bottom with a mishap
"I am sensing that the current situation in Mumbai is giving us similar signals and we might just be fishing the bottom at this stage...
"I am attaching herewith a good piece from Stratfor which highlights possibilities of the scenario as it sets to develop over the next few days, weeks or months...
"What is your take on the situation...as always would keen to get your words of wisdom..."
My comment - Absolutely we think of Fullermoney as your site (as in the Collectives'). Eoin and I know that the service would be much diminished without the insightful comments, articles and reports that we receive from Subscriber's. Long may this last.
On your point (a), I do think some economic situations become sufficiently worrying to provoke an even more dramatic policy response, and expect it to happen this time.
On point (b), there are precedents, but I suggest that the 2003-2006 bull-run was delayed until the invasion of Iraq had commenced and met minimal opposition, initially. I have great sympathy with the citizens of Mumbai and obviously emotions there run high. However as you will know, the president of Pakistan, Asif Ali Zardari, is also a victim of terrorism following the assassination of his wife, Benazir Bhutto, last December. Even though his ability to control the terrorists and eliminate their bases must be limited, India may have more success if the current government is on their side. I sincerely hope there is no likelihood of another war, although the problem of Kashmir is far from resolved. Assuming there is no serious conflict between India and Pakistan, I expect your country to be among the leaders of the next upturn.
No one is calling for Pollyannaish stories in an economic crisis or cheerleading from those with vested interests. However there is an old adage: 'Fear sells.' Readers will have their own views as to whether there is sometimes an element of gratuitous gloom in headlines or a surfeit of articles focusing on everything that might possibly go bump in the night.
Journalists can be as emotional as the rest of us, and one of their functions is to be a mirror of our fears and expectations. My own view is that the serious press is responsible and that we are generally well served.
Here I go again! Gosh it was only six years ago that I cemented my place in stock market history by predicting that the Dow would fall from 8,500 to 5,000, instead of going up to 14,000 where it peaked in October of 2007. Well, I could use the standard set of excuses: 1) No one else saw it coming, 2) I was misinterpreted, and taken out of context, 3) I was tired, overworked, and had family problems, or 4) I had just come out of rehab. But these days what really works is a full confession. I mean, like, uh, it was totally my fault and I take full responsibility. The fact is I was only off by 9,000 points. That's my story, and I'm stickin' to it.
My view - The Q Ratio is certainly at an interesting level but what of Bill Gross' concluding four points?
Corporate profits - I assume that the outlook is diabolical through at least 2Q 2009, and that a great deal of this is factored into today's share prices. The longer-term points cited by Bill Gross are a concern for US equities but policies in a Democratically-dominated Washington will not necessarily be repeated in Asian-led emerging markets.
Globalization's salutary growth rate - These are interesting points and we can only guess as to how it will play out. Protectionism is always a risk, especially in an economic downturn, but I think the attractions of globalisation are well understood by most governments. I have often wondered if Asia would be less willing to fund the USA's deficits, but their holdings in US Treasuries have done extremely well recently, due to falling yields and a stronger dollar.
Animal spirits - These are part of human nature and I am optimistic that they will return, although hopefully on a healthier basis, meaning less cowboy capitalism.
The benevolent fist of government - Usually, this is less onerous in developing economies, which I expect to outperform OECD countries once again.
"I refer to the e-mail of the day on 27 November on the above subject. I trust you will advise us further, once you are able to ascertain the compensation available, if the spread betting company was to go bust."
My comment - I promised that I would follow up, particularly regarding IG Index, which has recently reported potential bad debts of £15 million due to clients unable to meet margin calls.
I spoke to Chris De La Vega (email@example.com) of IG, who is my account manager, although I deal online. He has always been helpful and provided two links to their website. This first link will tell you about the firm. This second link confirms compensation limits.
Incidentally, I was offered 10% of all commissions generated by any clients whom I introduced to the firm. I thanked them for the offer but explained that by longstanding policy agreement, neither Fullermoney nor any of our associates ever receives any commissions or other forms of remuneration for services mentioned on this site. To do so, would in our view, compromise our objectivity and potentially create a conflict of interests in terms of our relationships with our subscribers.
However, subscribers should be aware that revenue sharing has always been commonplace in the financial sector. Therefore, when any financial service is recommended to you, it may not be a bad idea to enquire if that person or their firm has a financial incentive in making the recommendation.
Asia ex Japan: The Valuation Inquisition - The MSCI Asia Pacific ex-Japan Index soared from its 2001 lows to the highs posted late last year, in what had been a very consistent uptrend that accelerated towards the peak. The Index lost 67% of its peak value before finding at least short-term support near 200 in late October. When we compare the Index's Price / Book ratio with the price chart, we see that extreme lows for the ratio correspond with important market lows.
In the past, periods which have seen such enormous sell-offs are generally good buying opportunities if one is willing to look past the short term. Given the size and speed of the decline, base formation development is needed before the market can sustain more than a technical rally. The question now is whether this already taking place; with the downtrend having lost momentum and a sustained move below 200 needed to question scope for further higher to lateral ranging.
There are two ways of looking at the market for 30-year Gilts, mentioned in another part of the above piece: One can't but identify the obvious acceleration and be wary that this trend is quite overextended. The flight to quality has been remarkably swift and investors are experiencing unusually high levels of fear. Being objective about the chart action, the accelerations are eyebrow raising but there is no sign yet that they are over. However, considering the extent of the move, a trailing stop might be advisable. .
The other view is that UK interest rates are expected to come significantly lower over the coming months and on a commonality basis US, European and Canadian 30yr yields have all already broken to new lows. The UK 30yr yield has been relatively steady by comparison, but could now be partaking in a catch-up move. An upward dynamic would be needed to check downward momentum beyond a brief pause.
"I see, interestingly, bonds yields continue to decline due I suppose to huge risk aversion, safe haven flows, a guarantee that you will get your money back, deflationary fears, de-leveraging, capital flight from emerging markets, CDS levels on corporate debt and now the prospect that the fed will buy the Treasuries own bonds.
"However one would have thought yields would rise with the excessive supply coming on the market in 2009. Not so obviously looking at the charts.. What gives...
"What will China and other emerging countries with current account surpluses make of this game? Will they look for higher yields on new bonds or be happy the value of the existing bonds they are holding is appreciating."
My comment - Thank you for these interesting questions which I'm sure other subscribers are also asking. Of all the valid reasons you mention above we can also add the prospect of lower interest rates, not least in the UK and Europe.
The fear for fixed income investors is that the current recession turns into a damaging deflationary spiral such as that experienced by Japan in the 1990s. Japanese 10yr yields fell to a low near 0.77% in 1998 and while they posted even more extreme levels in 2003, they have ranged between 1 and 2% for a decade. Japan continues to experience anaemic growth and little or no inflation. Could the USA, UK and Europe follow a similar pattern?
Bond markets are certainly being re-priced to allow for this possibility and the word 'depression' is being thrown around willy nilly as if it were a certainty. The power of this contention is that its proponents can point to Japan as an example and rationalise that government bonds are cheap even at these elevated levels.
They might be right in predicting that government bond prices can still go higher in the short to medium-term. However, the Japanese example is different from the current situation because the policy response has been implemented much quicker and is far more wide ranging than any initial move to prevent the Japanese deflation. Policy makers can also look to the Japanese example and learn from past mistakes. However, there is no short-term solution. It could be a number of years before Western central banks can declare victory in their efforts to stem the deflationary threat. Considering, the quantity of cash been printed, it is hard to imagine that the seeds of the next inflationary cycle, which is some years away, are not now being sown.
Asian governments have been buying Treasuries over the last decade as a safe haven for their national savings and in the process, have helped to fund consumption in the USA. Net Foreign Transactions into the USA are still considerable but are declining; suggesting foreigners are buying less US securities. It is too early to say whether this will turn into a more prolonged trend but anecdotally, we also hear that China and other Asian economies are spending more money at home in order to support their domestic economies. There will still be a need for AAA rated government securities but at such low yields, better long-term returns are likely to be found in other assets.
Shanghai A-Share Index - this market continues to show more evidence of base development than others and would need to sustain a move below 1750 to question potential for some additional support building around current levels.
South Africa - continues to range above 18,000 and would need to sustain a move below that level to reaffirm the downtrend.
Oil - remains in a consistent, albeit increasingly overextended downtrend and a clear upward dynamic is needed to question scope for some additional downside.
"At your earliest convenience, please add the following to the chart library:
"Please add Impax Environmental Markets plc (IEM) to your chart library (it is a "fund", actually a closed end investment company), thanks."
"Could you please add the Mortgage Finance index (MFX) to the library?"
My comment - Thank you for these interesting suggestions which have now been added to the Chart Library.