Tuesday, August 24, 2010

Morning Note...


Surprisingly a lot to say today… Futures are down ~120bps this morning as the bullish M&A spark of the past few days is extinguished and replaced with a bearish wall of worry and U.S. Treasury yields continue to drop to all-time low levels.  In earnings news, retailer Big Lots (BIG) is slightly lower after beating estimates and bookseller Barnes & Noble (BKS) reported a wider than expected loss.  However, fast food retailer Burger King (BKC) is higher after posting its earnings release.  In overseas earnings, European building materials company CRH is down 16%, weighing on the entire global homebuilding sector and also adding to concerns ahead of today’s 10am Existing Home Sales release.  Regarding Europe (down nearly 2% across the board and CDS widening), Amherst grad and Nobel Prize-winning economist Joseph Stiglitz warned of a double-dip recession:  "Cutting back willy-nilly on high-return investments just to make the picture of the deficit look better is really foolish,’’ Stiglitz told Dublin-based RTE Radio.  "Europe is at risk of going into a double-dip.”  Asia was mostly lower overnight.  Oil is down 2% and Gold is down 1% this morning. 

In other news, a key Wall Street Journal article this morning is also adding to market caution.  The article points out that the recent August 10th FOMC meeting was the most fractious since Bernanke took over as Chairman, as 7 of 17 Fed Presidents either outright opposed or expressed reservations at the Fed’s plan to maintain $2.06 trillion of stock, mortgage debt, and Treasury holdings.  This represents a measure of discord and uncertainty among key policy makers, and if there’s anything the market hates, it’s uncertainty.  Elsewhere, a New York Times article speculates that the recent M&A activity is nothing to get too excited about.  Here’s another scary news item:  California will delay $2.9 billion/month of payments to school districts and counties in order to preserve cash and may return to issuing IOU’s.

The USD/JPY (Dollar/Yen) relationship is making headlines today, as the Yen has strengthened against both the USD and the EUR.  This is somewhat counter-intuitive considering the Japanese market has just entered official “-20% off the high level” bear territory, but the Yen – because of long-standing zero-interest-rate-policy (ZIRP) in Japan – does not necessarily trade on fundamentals.  As a result, the Yen is susceptible to “artificial” currents, such as selling of the USD and buying of the JPY by the investment community (representing a “risk off” move, since – according to recent chatter, people have been long the USD and short the Yen).  Of course, the Japanese government – especially entering an official “bear market” – does not want a strong Yen, which would suppress the pricing power of its exports, and may act to intervene, i.e. start selling JPY in the open market, at any time.  (And with that, by the way, I have reached the limit of what I know about USD/JPY currency trading, so if anyone wants to call out any errors, please let me know – my skin is thick enough…)

For the technicians out there, here’s a concerning reminder from Jefferies as it relates to the broad market:

The Russell 2000 will open this morning below the 600 support level. The next stop on the downside looks to be the 585 level. That was the low that was tested in Feb as well as July of this year. Current levels represent a 20% correction from 2010 highs (745). A test of the lows will mean another 2.8% decline. The Russell 2000 is down 3.6% YTD. Keep in mind small caps should underperform on down days as liquidity is the issue.

The market these days reminds me a bit of my favorite John Wooden quote:  Never mistake activity for achievement.  In other words, there are some important economic releases on the horizon and the market will surely react…but given the dearth of decision-makers in front of the screens this time of year, I’m not sure how much exactly to read into any upcoming market moves.  Volumes, as always, are key. 

This may or may not have made the rounds Monday morning (I was on a plane), but in a continued effort to delve into the depths of the internet in order to find value-added market commentary, I stumbled across this piece on famed investor and billionaire Dallas Maverick’s owner Mark Cuban’s (yeah…I know…but don’t shoot the messenger – it’s a good read) blog:

The Stock Market is still for Suckers and why you should put your money in the bank  Aug 20th 2010 11:24PM

I wrote a whole series of articles warning people about the stock market over the years. You can see them here. It’s gotten worse. So I thought i would write some more about why you should probably avoid putting any new money into the stock market…

If you haven’t noticed, individuals are avoiding the stock market in droves.  There has been an enormous exodus from equity based mutual funds. Why? Because people buy stocks for only one reason, they want them to go up in price. If you don’t believe the market is going to go up. If you don’t believe you can find a greater fool to buy your stock, or the stock your funds own, why would you buy either? You wouldn’t and people aren’t.

The amazing thing is that doing nothing in the market is the smartest approach to the market. It is pretty  much impossible for some man or woman or child who devotes a couple of hours per week to the market to outperform the professionals who spend 24×7 doing this for a living and when they are asleep, they have a workforce full of people doing more of the same.  In this day and age, none of us are smarter than the market.

I didn’t always think this way.  I didn’t ever think there was a truly efficient market until just recently.  What changed? The availability of capital changed.  While we can argue about whether or not the market is efficient because everyone has access to the same information, I would always argue that they didn’t efficiently use that information and even if they did, capital was not always allocated correctly  to every market segment.

Capital found its way to where people/funds thought they were smarter than the rest. Some people thought they understood the tech markets better than others. Some thought they understood retail better, etc.  The belief that an individual/fund had an advantage drove where capital was allocated.  People posted good performance or identified macro opportunities and put their own and others money to work.  Others saw the success and followed.  Like the saying goes “first there were the innovators, then the imitators, then the idiots”.    Fortunately for market participants over much of the history of the stock market, if you were the innovator that was  smarter and faster than the other guys, you could make money on the long and / or short side of the market before the imitators and then the idiots flooded the market.

The door was open to opportunity in the past simply because capital was relatively expensive. It was expensive to raise, it was expensive to borrow.  High cost of capital creates scarcity of capital.  The more expensive the scarcer. The scarcer the capital, the more untapped opportunities just waiting for innovators to exploit and the longer it took the imitators and idiots to chase the same opportunities and close them. Which is why you found funds and smart people posting great returns over a long period of time.

But a not so funny thing happened on the way to and through the Great Recession. Capital became progressively cheaper.  It became the opposite of scarce. It became readily available. To anyone.

The innovators had put together unique mortgage programs. The imitators made it a little easier to partake.  Then the idiots took over. Capital was so easy and suckers and idiots so prevalent, everyone believed that there was always going to be a greater fool to buy their house and /or give them refinancing money. Until the idiots couldn’t collect on the mortgages they lent or pay the mortgages they took out.  That de-levered the system and we know what happened next to the banking, mortgage and housing industries and the entire economy.

In response to that great de-levering, the government stepped in and I truly believe they saved us.  Sure, they watched as the idiots dragged us into the mire. Sure they allowed all those mortgages to be guaranteed and that was a key culprit in the Great Recession.  Our government has never been very good at being proactive at anything. Reactive… that’s another matter. That gets the votes.

So the government reacted and poured money into the system. They allowed just about any bank with a pulse to borrow money. To this very minute it is incredibly cheap to borrow short term capital. Particularly if you are in the business of trading/hacking the stock market.  If you are a big fund or investor, money is cheap.  Unfortunately for the stock market, it is cheap for everyone. In other words, capital is not longer expensive and it is no longer scarce.

When capital is so cheap that everyone with a pulse thinks they can make money once they borrow it, the stock market is in trouble.

Remember the rule about first there are the innovators, then the imitators, then the idiots?  It is why the stock market is truly in trouble.

There is SO MUCH CAPITAL available at so little cost to so many that the timeline from innovator to idiot is measured in days, hours and probably even milliseconds.  The guys who are actually smart and uncover new opportunities can’t even get in a position large enough to make it worth their while before the imitators and then idiots pile in right behind them.

Remember the Flash Crash and the discussion about how trades are made in milliseconds, what I called hacking the system? I don’t know for certain, but I’m willing to bet that those innovators that made money by trading in milliseconds, now have so many imitators and idiots that have piled in behind them , putting servers right next to theirs and hiring their algorithm  coders away from them,  that there is no longer any advantage, or not enough of one for any of the players to make any real money.

There is so much capital chasing so little return that big time players are getting out of the business.

So what does this mean for you?

It means that I don’t know if the market will go up or down, or by how much.  My guess is that it stays in a trading range for a while. There isn’t much money coming in, but enough of that easy to come by capital has so  much ego attached to it, that the same people will get in and out of the market over and over again and trade amongst themselves.

Until something happens.  What that will be, I have no idea.

But I do know that I have continued to add to my cash balance or sovereign debt from around the world (that I have owned for a while now and has been profitable and is very, very liquid.) The stocks I still own for the most part pay me a nice cash on cash return, or I have owned them for a long, long time and have more in gains than I want to pay taxes on.  But in total, I have been a net seller of stocks for more than a year. The only investments I am making are small buys into private companies.  I want as much “powder dry” as possible for when something happens.

I’m not saying you should get out of the stock market. What I am saying is that it is not a bad thing to accumulate cash right now.  Retention of capital is a good thing. Don’t go chasing stocks.  Something is going to give in this market. Like I said, I don’t know what it is, but I want to have as much capital available as possible for when it happens.

Baron Rothschild said “the time to buy is when there is blood in the streets”, Warren Buffet said it differently when he said ” you pay a very high price in the stock market  for a cheery consensus”

This is the time to start saving for a “bloody day”.   There will be a time when capital regains its scarcity. When it becomes more expensive. When it does, what do you want to have in as great an amount as possible ? Capital.

So save your money. Pay off your credit cards.  Put your money in the bank where it is insured.   Be patient.  Get a good nights sleep knowing that your money is not going any where  and just wait till your capital is in demand and you get paid for it. When everyone is complaining about the money they lost, you will be ready to step in and buy.

That is how fortunes are made. Having money when no one else does.  And you can take that to the bank!

CITI cuts DUK.  SUSQ cuts COS.  WEFA cuts POM.  BGP CFO resigns.  BP weaker as the Coast Guard’s Deepwater Horizon investigation continues.  DELL may raise PAR offer.  FMCN higher on earnings. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 


Today’s Trivia:  A little business trivia this morning…in 2009, the airline industry collected roughly $5.1 billion from what two fees in particular?

Yesterday’s Question:  What do the letters in “M&M’s” stand for?
                                                                                                                                                             
Yesterday's Answer:  “M&M” stands for the two founders of the company: Mars & Murrie. 

Best Quotes:  From BCAP research…CNN reporting "The Situation" Mike Sorrentino will make $5 mil this year”