Sentient Money

It’s been a while since I posted, which doesn’t mean there wasn’t anything interesting going on.  I just got lazy…these things happen.

Anyway, we are heading into the bulk of the earnings reports, which should either solidify the recent run up or start to pound it back into its dank little hole.  I’m voting for the pounding.  Why?

Banks are making numbers up again.  Goldman Sachs switched reporting years, which effectively allows them to hide December 2008.  Guess what month they took their huge hits?  DECEMBER!  BoA and many others are now freed of mark to market and are suddenly finding their assets “appeared” to be undervalued.  Nice to see we are back to short-term thinking from our vaunted corporate leaders (See Bank Profits Appear Out of Thin Air - NYT, for more info).  How often does Lucy have to pull the football from Charlie Brown before he learns?

S&P 500 earnings have had their largest percentage drop EVER (Chart at Big Picture)!  The drop is larger than the Great Depression and far faster and steeper.  The line is so steep it is bending back in on itself.  This does not seem to have EVER happened in the past, though it is a little hard to be sure due to the clutter on the graph.  Black swans within black swans?  Scary.

Also, foreclosures are still increasing and have moved into the higher end market (Foreclosures: Mov’n On Up - Calculated Risk).  Along with the accompanying link, I have seen a significant number of comments, on various blogs, from other areas of the country, noting the difficulty in the upper end market.

Ok, that’s enough bad news for now, anymore and I might have to get closer to 80% or 90% cash.

Finally, the government is doing the right thing.  First, it was Wagner being fired and now either GM makes real changes, or proposes real changes over the next 60 days, or they will be forced into bankruptcy. 

Hopefully, this will wake up all the banks and Wall Street firms who have been taking advantage of government bailouts for far too long.  The need for real change in the finance industry still exits.

By the way, don’t pay attention to the gloom and doom about GM’s potential bankruptcy (CNN Money article, “Auto Bankruptcy:  What it means”).  It’s not that the article is incorrect, but that the bad things it lists are also good things:

• Remove excess capacity from the market
• Make not only our auto manufacturer’s more efficient, but our auto industry (dealers, parts suppliers, etc.) more efficient
• Make our auto industry stable for the long haul, which will really help the economy
• Eliminate welfare jobs provided by the auto unions
• Reduce the wages for jobs that require little skill

If none of this happens, all of the people who say we don’t make anything will actually be correct.  And, none of this happens without giving GM the chance to succeed or fail.  This will be rocky over the short-term, but it is nice someone is waking up and looking further ahead than the next quarterly report or the next election.

Per Bloomberg, this is the biggest 10 day rally since 1938.  The relief is visible on the faces of our “vaunted” CNBC hosts and in the voices of the many financial pundits from the WSJ and other financial papers.  They are all acting like everything is fine, well, it’s not. 

On the outside, the recent gains suggest the market may have turned the corner.  However, if you look back through the history of the market this is more likely a bounce from lows and not a recovery.    

Along with historical data suggesting it is just a bounce, the economic and market data does not suggest a recovery:

• Housing is still declining, though at a slower rate. This is good news, but not great news. (Yes, you have seen headlines stating housing saw an “unexpected rebound” in February. This is incorrect. Housing sales did go up from January to February, but they always steadily go up from January and peak in mid/late summer. This happens in good times and bad. If you compare February ‘08 with February ‘09 you will see that housing stats are still declining)
• “As to the overall economy bottoming, not only is there no evidence of that, but the leading indicators (ECRI, LEI, etc) all suggest the opposite: The economy is likely to get worse before it gets better.” - The Big Picture (Mr. Ritholtz has been very accurate during this downturn)
• “A large portion of the recent buying was from investors and institutions covering their short positions. This is especially true concerning financial stocks.” (CNN Money) Overall, this is slightly positive for the long-term, but probably means the rally won’t have legs over the short-term once the bulk of the shorts have covered.

Based on this information, I plan on selling at least 15-20% of my portfolio this week, as long as the market stays fairly positive.  I see no reason the market will stay at this level long-term, and I expect we will retest the lows at some point.  Thus, I will take a modest profit on some of my investments and wait for another buying opportunity.

This is what Andrew Ross Sorkin of the New York Times advocates (you know he is cool because he uses his middle name).  We should just go ahead and pay the AIG bonuses and count ourselves lucky. 

“So here is a sobering thought: Maybe we have to swallow hard and pay up, partly for our own good. I can hear the howls already, so let me explain.” -  NYT

Bullshit!

Mr. Sorkin provides a couple “great” explanations for paying these bonuses.  These reasons look valid on the surface, but fail miserably when you look closely.

“On that last issue, lawyers, Wall Street types and compensation consultants agree with the president. But from their point of view, the “fundamental value” in question here is the sanctity of contracts.

That may strike many people as a bit of convenient legalese, but maybe there is something to it. If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

As much as we might want to void those A.I.G. pay contracts, Pearl Meyer, a compensation consultant at Steven Hall & Partners, says it would put American business on a worse slippery slope than it already is. Business agreements of other companies that have taken taxpayer money might fall into question. Even companies that have not turned to Washington might seize the opportunity to break inconvenient contracts. ” - NYT

This is his best argument, but is ultimately a failure.  It’s not a failure because the idea is incorrect.  It’s a failure because the government has already forced auto unions to tear up their contracts.  This hasn’t caused the government to abrogate contracts willy-nilly, nor has it caused any great contract catastrophe amongst businesses, as the “vaunted” compensation consultant advocates.

This isn’t even a real business contract, it’s really just welfare.  It isn’t like the government wants to own AIG.  They had to take a chunk to even have a chance of getting anything back.  If you are getting something for free, which is AIG, you lose some of your rights.

Now for Mr. Sorkin’s second point:

“A.I.G. employees concocted complex derivatives that then wormed their way through the global financial system. If they leave - the buzz on Wall Street is that some have, and more are ready to - they might simply turn around and trade against A.I.G.’s book. Why not? They know how bad it is. They built it.

So as unpalatable as it seems, taxpayers need to keep some of these brainiacs in their seats, if only to prevent them from turning against the company. In the end, we may actually be better off if they can figure out how to unwind these tricky investments.” - NYT

With rivers of blood flowing on Wall Street, only the very heavy hitters are getting scooped up by firms.  None of these heavy hitters are still at AIG, as they would be long gone knowing the dire situation at AIG.  These guys don’t stick around to watch their company be moved to the minors.

Even if these supposed “brainiacs” never left, why would you want to keep them?  They are the same guys who got you into this mess.  They shouldn’t have a job anyway.  Considering how much of a mess these idiots made, letting them trade against AIG’s book might be a good thing, as it’s almost impossible to imagine them not screwing it up.

The last point about unwinding these investments sounds good, but it’s been 16 months already, and no solution.  There is no magical financial formula or genius Ivy League financial vehicle that will get us out of this mess.  The solution is not brain power.  The only solution is time and none of these idiots at AIG can make it go faster or gives us more.

“The word on the street is that A.I.G. employees are being heavily recruited,” Ms. Meyer says. -  NYT

Of course, this is the word on the street.  AIG is part of the street and fanning these rumors.  What do you think everyone of these guys who got the bonus is telling anyone who will listen?  They are telling them they have tons of offers.

Instead of trying to save these guys’ and gals’ jobs we should be marching them in front of a judge and finding a place for them in Leavanworth.

The International Energy Agency (IEA) released a report in November 2008 detailing future energy production.  The report focuses on oil, of course.  Guess what?  We are entering a period of declining energy production:

The world’s energy system is at a crossroads. Current global trends in energy supply and consumption are patently unsustainable - environmentally, economically, socially. But that can - and must - be altered; there’s still time to change the road we’re on.[1] It is not an exaggeration to claim that the future of human prosperity depends on how successfully we tackle the two central energy challenges facing us today: securing the supply of reliable and affordable energy; - World Energy Outlook

The IEA estimates oil field production to fall 5.1% for every field with the top 3 falling 3.4%, 6.5% and 10.4% respectively.  This would be an issue if world energy use was stagnate, but it has been rising.  Admittedly, the economic downturn will reduce the percentage increase, but it is unlikely to completely stop increasing energy demands.

Along with a reduction in potential oil field output, major oil producers are starting to reduce production.  The producers are looking to drive prices back-up, as most see anything below $50 per barrel to be far too cheap. 

It said that Saudi Arabia had committed to trimming its crude output to around eight million bpd by January compared with more than nine million bpd in September. The Kingdom, the world’s top crude exporter, is also planning to reduce production by an additional 300,000 bpd this month. - Business 24/7

Saudi Arabia’s reduction in oil also means they are reducing their natural gas production.  As a result, Saudi Arabia is now a net importer of natural gas.  They knew a reduction in oil would force them to import natural gas, but to them it is worth a little extra cost in natural gas to force oil prices up.

All of this suggests oil prices will be heading far north of the mid $40’s where they are currently residing.  This makes oil and quality alternative energy companies valid opportunities over the next few years.

Is this the ultimate use of Buffett’s “be fearful when others are greedy, and greedy when others are fearful” rule?

Billionaire Warren Buffett, whose Berkshire Hathaway Inc. posted its worst results ever in 2008, said the economy “has fallen off a cliff” and that efforts to stimulate recovery may lead to inflation higher than the 1970s.

The American public is fearful, confused and changing their buying habits, which is showing up at Berkshire’s operating units, Buffett said during an appearance on the CNBC television network today. While the recession will end and future generations will live better than their parents, the economy “can’t turn around on a dime,” Buffett said, adding that some inflation is appropriate right now.

“We are doing things now that are potentially very inflationary,” he said. Buffett called on Congress to unite behind President Barack Obama, comparing the economic crisis to a military conflict that needs a commander-in-chief. “Patriotic Americans will realize this is a war,” he said. - Bloomberg

When Buffett is fearful, or at least as fearful as someone of his stature can ever be, is the bottom in sight?

I have one word, and it’s a word you have heard over and over again…China. I know…I know, I’m not coming up with anything new and earth shattering, but it still needs to be said with conviction. Why? Because, even though everyone talks about China there always seems to be an air of non-committal or slight disbelief that China, Inc. will actually happen.

Here are some key reasons China, Inc. will happen and create the best market in the first 25 years, or more, of this century:

· China is completely committed to expanding its economy and political influence.

o It is making energy deals with any country regardless of politics.

o They spent over $40 billion on the Olympics (the British are projected to only spend half that when they host the summer games).

o China is investing $6.9 billion; the port of Shanghai now has almost as much container capacity as all U.S. ports combined (Source: Brookings Institute).

o The U.S. is currently investing less on infrastructure as a percentage of gross domestic product (GDP) than Europe, China and many emerging countries (Source: Progressive Policy Institute).

o By 2020 China plans to build 55,000 miles of highways, more than the total length of the U.S. interstate system (Source: Atlanta Fed).

· Coke is investing $2 billion dollars in China over the next 3 years. This is during the worst economic downturn since the Great Depression. It demonstrates that Coke sees enormous growth in China and refuses to let anything stop them from being part of it.

· China saw venture capitalists invest a record $4.2bn in 245 deals in 2008, up from $2.8bn in 290 deals in 2007. Again, this was during the worst downturn since the great depression.

· China expects their economy to grow roughly 8% in 2009. This number is probably inflated, but even if it is inflated 8% and their growth is flat, their economy will still be better than the US or Europe.

· “Ace commodities investor and global investment guru Jim Rogers says he hates British pound and is putting all future hope and investments only on China.” – Jim Rogers. He is not investing in a lot of Chinese companies, but he is investing in commodities he expects China to use.

I’m not advocating we all go “Jim Rogers” on our lives and move to Singapore and push all of our cash into investments connected to China. What I am saying is if you are an active investor, and EVERYONE should be, you need to keep an eye on China, Chinese companies, and commodities connected to China, as this is a great buying opportunity.

Along with actively researching, we need to allocate a decent portion of our capital to make Chinese investments a large part of our portfolios. You don’t want to miss the creation of a new America…do you?

“Saying that China is a fascinating place to invest in, Rogers said China is on the rise, like America 100 years ago, and the problems the Asian giant is encountering right now in certain, mainly export-driven, sectors of its economy will not alter the country’s long-term trajectory. “ – Jim Rogers

Concerning the end of the week beer recommendation, I am focusing on a beer that can be the mainstay of your fridge. It will win over everyone who actually likes beer. Yes, even some people who drink Bud/Coors/Miller like beer. They are just misguided and need our help. The beer is from New Belgium Brewing and is called Fat Tire. It tastes like beer, which means it actually has taste unlike the three stooges I mentioned above. However, it is not overpowering and will not scare off those beer drinkers who are unfamiliar with real beer.

The one real problem with Fat Tire is its availability. It is very rare east of the Mississippi, which is unfortunate. So, if you stumble on to it somewhere…BUY IT!

That appears to be what all the markets are hoping for, as there is no other good news.

Chinese Premier Wen Jiabao is considering new stimulus measures, adding to a 4 trillion yuan ($585 billion) spending plan as the government tries to revive growth in the world’s third-biggest economy.  -Bloomberg

I must admit I’m more than a little skeptical this will be enough to spike growth throughout the world.  China’s people have never been big consumers, so stimulating an export economy seems unlikely to be a huge benefit to the global economy. 

On top of that, how does this stimulus pull the U.S. and the U.K. out of this housing debacle, or the rest of the modern world out of what some are calling the Great Recession?  It doesn’t.  I may help, but it’s not the answer.

This does not mean the “good” news won’t create a nice run up in the market.  Everyone is literally begging for a positive sign (just watch CNBC) and this might be positive enough to cause a rally.  Well, at least a sucker’s rally based on current data. 

If a rally does appear I will shed some of the investments I have purchased over the last week to free up cash for the next drop, as volatility is far from over.  How can it be when GE is on the verge of losing it’s AAA rating. 

China’s day as a co-world leader or outright world leader may come, but right now they are only part of the solution…not the entire solution.

The silver lining amongst all this pain is the exposure of fraudulent money managers.  People like Madoff, Stanford, and the two most recent potential prison inductees, Paul Greenwood and Stephen Walsh are being revealed, as the downturn does not allow them to hide their criminal behavior.

For two decades, Paul Greenwood and Stephen Walsh looked like Wall Street wizards.

But on Wednesday morning, federal agents arrested the two money managers on accusations filed by the United States attorney for the Southern District of New York in what has become all too familiar on Wall Street: Their investment fund was in fact a $667 million fraud - a small-scale version of the $50 billion fraud that Bernard L. Madoff is suspected of orchestrating.

But unlike Mr. Madoff, who is accused of masterminding a global Ponzi scheme, Mr. Greenwood and Mr. Walsh simply stole their investors’ money, the authorities said. Their two firms, the WG Trading Company and Westridge Capital, misappropriated funds from a host of deep-pocketed investors, including state and city pension funds, Carnegie Mellon University and the University of Pittsburgh.

-NYT

Hopefully, this will help clean-up Wall Street, by removing a good portion of the completely immoral money wizards.  With these men gone and publicly punished, it may nudge the Wall Street attitude a bit more towards the ethical side.  Just maybe, our financial distract will emerge from this debacle, as a leaner and more capable industry.

No.  Feel free to read the rest, but I have no doubt this analysis is dead on.

This bill will not even come close to stabilizing housing prices.  Oh, it may cause prices to plateau for a month or two, or make declines over the next few months very minor, but this is a band-aid for the housing market…nothing more.

Let’s take a look at the ration of house prices to rents (see chart above):

A first grader can see the massive disparity that still exists.  Until we are closer to historical norms, it will still be cheaper to rent in many places.  This will make it difficult to sell any houses.

Now, let’s take a look at the ratio of home prices and median income (see chart above):

Again, anyone with eye sight and a grasp of grade school math can see this chart is out of whack.  Maybe if the population of U.S. had suddenly increased by 30 million people, who had average to above average jobs, there might be a chance this chart was correct.  By the way, if you haven’t checked lately, people are losing jobs, not getting them. 

Sure, this tax credit for first time buyers will help in the short-term, but what happens when people who bought houses in March ‘09 or April ‘09 have lost money by the Fall of ‘09?  The housing market will dry up again.  I can’t say this enough…we are just prolonging the pain.  If we would just let the market correct and rid us of these high housing prices and these shit banks, we would be a lot better off. 

As this is part of the weekend edition and I haven’t covered a quality beer yet…here it is.

Flying Dog has a sweet seasonal out right now called Garde Dog.  It’s a great tasting beer to snag on a slightly warmer day, as we head towards spring.  The aftertaste is light for the warm day, but it has a good solid lead in that let’s you know you are drinking a real beer.  I must say, that Flying Dog rarely disappoints.