Tradesense (a.k.a.Horse Sense)

This Blog was launched on 9th October 2008 just after the beginning of the worst financial crises the world is witnessing and fear seems to be reaching its peak.

Sixthsense investing appears to be the need of the time!! The intention is tickle it every week.


Sunday, May 3, 2009

Manipulonomics

The feel good factor is back. Many experts opine that we have indeed put in a bottom and that with due corrections we shall now march upwards. The fact that most were talking about a recovery that would be shaped L, U, W etc., contrary to the expectations as markets usually do, many experts think the market in its wisdom has sought a V shaped recovery. Even the bulls have been taken by surprise at the swiftness and the ease of the up move. What started as a short covering in financials following the leak of Citi’s internal memo stating profitable operations with BOA backing it up and Wells Fargo following it up with a pre-result announcement it appeared a well coordinated effort. And then there was this panic that set in – panic buying. To me this appeared a well prepared script. When you have to move anything heavy say a huge log, the initial efforts are huge and once it rolls, it rolls with slight push thereafter. Once the shorts covered, the institutions which have their hearts in their hands and have been funded by taxpayers’ bonanza needed that the market cut back its negative bias were probably instructed to move it. Sentiment is a great player in how things shape up and to prop it up surely the main focus. Once moved there were others who had their urge to take risk and the scampering started?

This is not to say that some of the macro parameters have not improved. But this sharp move up of the market has has its consequences. The increasing appetite for risk has seen the US 10 year yield move up to 3.2% and the mortgage rates are up from around 4.7% to around 5.2%. And as explained in a previous post sharp up moves in equities is going to make the treasury and the Fed’s trillions of borrowing more expensive pushing up the interest higher which will increase risk for taxpayers and the country dramatically. Hence while printing money the Fed and treasury have to do a fine balancing and that means the interest rates still needs to managed within reasonable levels. This is not going to be easy and is going to be a fine line to tread on, not knowing where the line is.

Prechter explaining his logic for Dow 1000 says:

“The primary reason I believe the Dow is going to fall that far is its Elliott wave structure, which calls for it. But I can also see a monetary reason for this event. The tremendous inflation of the past 76 years has occurred primarily by way of instrument of credit, not banknotes. Credit can implode.

The only monetary outcome that will make sense of the Elliott wave structure is for the market value of dollar-denominated credit to shrink by over 90 percent. Given the eroded state of capital goods in the U.S. and the depletion of manufacturing capacity, it is not hard to see why all these IOUs have a deteriorating basis of repayment. The future has already been fully mortgaged; it's time to pay. But there is no money to pay, only more IOUs, which cannot be paid, either. So the credit supply (after a brief respite) will continue to shrink, which means that wealth, and therefore purchasing power, will disappear along with it. In the broadest sense, this change will constitute a collapse in the "money supply."

Apart from the sentiment angle there seems to be another perspective. The results of the bank stress tests. It was quite clear to the authorities that post these results many of the banks will need to raise more capital. Given the coziness that they have with many of these big banks – (this interesting NYT piece brings it out) and that the lawmakers may not be very inclined to commit more tax payer dollars, the need for market sentiment to improve was a necessity. The postponement of the stress test results is a result of contention between the banks and the treasury/Fed according to reports.

Also Bloomberg reports:

“Miller, a former bank examiner, said his estimate assumes regulators will require banks to maintain tangible common equity, one of the most conservative measures of capital, equal to 4 percent of their risk-weighted assets over the next two years, to withstand losses in case the recession worsens. The tests, originally scheduled for release on May 4, are set to be disclosed after U.S. markets close on May 7, according to a government official who spoke on condition of anonymity.

Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc. and the 16 other banks received preliminary results last week and have been debating the findings with regulators. Officials favor tangible common equity of about 4 percent of a bank’s assets and so-called Tier 1 capital worth about 6 percent, people familiar with the tests say. Tangible common equity, or TCE, is a gauge of financial strength that excludes intangibles such as trademarks that can’t be used to make payments. Tier 1 capital is a broader measure monitored by regulators.

“When you start talking about 4 percent on risk-weighted assets based on the stress test two years out, most banks will be required to raise more capital,” Miller said in an interview yesterday. “I believe it will be as high as 14.” He declined to name them.
Citigroup, which has already taken $45 billion in U.S. taxpayer funds to shore up its finances, may need to raise as much as $10 billion in new capital, the Wall Street Journal reported today, citing people familiar with the matter. Jon Diat, a spokesman for the New York-based bank, declined to comment.”

As one commentator pointed out that we are in the mess that we are due to various models for derivatives/securitization being used and now we are trying sort it out by another modeling exercise!! One has seen the efficacy of these exercises and of course the possibility that they may show what they believe should be, need not surprise.

Respected and well regarded investors also have very sharp points to make. Bloomberg reports:

“Berkshire Hathaway Inc. Vice Chairman Charles Munger, whose company is the largest private shareholder in Goldman Sachs Group Inc. and Wells Fargo & Co., said banks will use their “enormous political power” to prevent changes to the industry that would benefit society.

“This is an enormously influential group of people, and 90 percent of that influence is being spent to gain powers and practices that the world would be better off without,” Munger, 85, said yesterday in an interview with Bloomberg Television. “It will be very hard to accomplish the kind of surgery that would be desirable for the wider civilization.”

Munger said the financial companies spent $500 million on political contributions and lobbying efforts over the last decade. They have a “vested interest” in protecting the system as it exists because of the high levels of pay they were earning, he said. The five biggest U.S. securities firms, only two of which still exist as independent companies, paid their employees about $39 billion in bonuses in 2007.

“They would like to get back as closely as possible to business as usual, and they have enormous political power,” he said.”

There are some other very valid points of view that are difficult to ignore:

1. Since last fall, our financial wizards have promised $12.8 trillion in bailout funds to primarily well connected cronies. The US national debt since the birth of this great nation now stands at a comparable $11 trillion. None of these debts will ever be paid off and it’s hard to fathom how anyone believes to the contrary.

The Fed’s “balance sheet” is supposed to be the substance behind their issuance of money. This balance sheet has been comprised of smoke and mirrors for decades since the total fiat era started in 1973. Those days now look golden compared to the current makeup.

The Fed used to hold almost exclusively Treasury securities with which to perform their various “operations”. Only 24% of their holdings are now in Treasuries. The rest is a toxic soup that they’ve now taken on (mortgage backed securities, commercial paper, money market assets, failed crony paper, etc.) to keep the entire system afloat. The mortgage backed securities, for example, are really worth around 35% on the dollar. The Fed and other banks holding this junk assign pretend values of 100% on them.

The Fed balance sheet had more than doubled to $2.19 trillion since the global meltdown started. It looks like they took the “good bank – bad bank” scenario seriously but made the wrong choice. Watching the world’s most influential bank implode is a rare event.
Most local banks are FDIC insured. These banks also hold just over $200 trillion in obscure derivatives. The reserves to back up these positions are a mere 3.5% as opposed to a more normal 10% backing of solid and traditional loans. Banking gone wild.


More here…

2. The banks are back. Profits are up. Write downs are lower. The government has their back. And the worst is over.

Forget Swiss-based USB. Their huge losses were the exception…

Judging by their latest quarterly reports, big banks have finally figured out how to make money again.

Goldman Sachs, JPMorgan, Bank of America, Wells Fargo and even Citigroup all reported profits for the first quarter.

But a closer look under the hood reveals that many of the big banks reported fake earnings…

-Bank of America arbitrarily increased the value of its Merrill Lynch assets.

-Goldman Sachs bunched much of its losses into the month of December – a month it skipped reporting on this year.

JP Morgan’s bonds fell in price. And that perversely allowed the bank to increase its bottom line. This is how the New York Times explained it: “Theoretically, JP Morgan could retire them and buy them back at a cheaper price; that’s sort of like saying you’re richer because the value of your home has dropped.”

More here

While China is being touted as a savior there is a very interesting point of view on the coming of a China bubble.

“China’s fortunes over the past decade remind me of Lucent Technologies in the 1990s. Lucent (now Alcatel-Lucent (ALU)) was selling equipment to dot-coms. At first, its growth was natural, the result of selling telecom equipment to traditional, cash-generating companies. Thereafter, it was only semi-natural: Dot-coms were able to buy Lucent’s equipment only by raising money through private equity and equity markets, since their business models didn’t factor in the necessity of cash-flow generation.

Funds to buy Lucent’s equipment therefore quickly dried up, and the company’s growth should have decelerated or declined. Instead, Lucent offered its own financing to dot-coms by borrowing and lending money on the cheap to finance the purchase of its own equipment. This worked well enough - until the time came to pay back the loans.

The US, of course, isn’t a dot-com. But a great portion of our growth came from borrowing Chinese money to buy Chinese goods - which means that Chinese growth was dependent on that very same borrowing.

Now the US (and the rest of the world) is retrenching, corporations are slashing their spending, consumers are having moments of sickening recognition - and the consumption of Chinese goods is on the decline. This is where my dot-com analogy breaks down. Unlike Lucent, China has nuclear weapon. It can print money at will, and can simply order its banks to lend; this is a communist-command economy, after all. Lucent is now a $2 stock - but China won’t go down that easily…

…China doesn’t have the kind of social safety net one sees in the developed world, so it needs to keep its economy going at any cost. Millions of people have migrated to its cities, and now they’re hungry and unemployed. People without food or work tend to riot; to keep that from happening, the government is more than willing to artificially stimulate the economy, in the hopes of buying time until the global system restabilizes.

It’s literally forcing banks to lend - which will create a huge pile of horrible loans on top of the ones they’ve originated over the last decade (though of course we can’t see them). Don’t confuse fast growth with sustainable growth. As I’ve discussed in the past, China is suffering from Late Stage Growth Obesity. A not-inconsequential part of the tremendous growth it’s seen over the last 10 years came from lending to the US. Additionally, the quality of late-period growth was, in all likelihood, very poor, and the country now suffers from real overcapacity.

Identifying bubbles is a lot easier that timing their collapse. But as we’ve recently learned, you can defy the laws of financial gravity for only so long. Put simply, mean reversion is a bitch. And the longer inflated prices persist, the harder they fall when financial gravity brings them back to earth.”

While many key indicators may be looking better the fact that the financial system will take a lot of effort and time to straighten out should not be lost sight of. How much ever smoke screen you create at some point the realities will surface with a lot of pain.

Disclosure: No Positions


Copyright © 2008-09 Tradesense

1 comment:

  1. I would like to see more evidence

    1.
    "The US national debt since the birth of this great nation now stands at a comparable $11 trillion. None of these debts will ever be paid off and it’s hard to fathom how anyone believes to the contrary.
    "
    Lets say 5% is the yield 0.55 trillion is the interest payment on the debt of 11 trillion. 13 trillion is the GDP. Lets say tax rate is 25%...which gives government revenue of 3 trillion. So approximately 20% of tax revenue will go to make the interest payment.

    Another fact about US public and private debt...
    Only 15%(8 trillion) of the total 50 trillion US debt(public and private) is held by Rest of world. Rest of it is held internally.

    Another fact is almost all of the US debt is in dollar(hardly any external debt - which can be dangerous as it has exchange rate risk)

    http://sudhee.blogspot.com/2009/02/i-read-below-from-web-site.html

    The big bubble i see is the inflated dollar value against most exporting countries due to the fact $ is reserve currency. This is a bigger issue for US esp if and when dollar stops being used as reserve currency. There is going to be huge inflation and lot of production that is shedding now will need to be taken back..I hope the transition is smooth...

    http://sudhee.blogspot.com/2009/03/reserve-currency.html


    2. you say "The mortgage backed securities, for example, are really worth around 35% on the dollar."
    Where did you get this ?

    ReplyDelete

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