Tuesday, March 31, 2009

Saving for the Future South Park Style

For all the convoluted explanations sometimes the basic facts are clearest when explained by those outside of the mysterious ways of high finance! We could use a lot more "emperor has no clothes" humor. So when you hear something that doesn't make sense, it very well might not. Ask, probe, question. Black boxes are for magicians who make things disappear, so no black box investments for us.


Monday, March 30, 2009

Three Ring Circus

A friend of mine used to work for Ringling Brothers Circus. When he would come to town his father would collect a gang of us to go meet the clowns and the other marvelous bits of the crazy circus world. Josh played saxophone in the circus band and the stories he gathered in those years should keep him supplied with entertaining tales forever. That circus was a lot more fun.

The three rings going on now have more clowns than Ringling ever had with nowhere near as many laughs. (How many investment bankers COULD fit in that little car I wonder?) With so much going on at once it is difficult to focus on each aspect that we are mentally juggling without getting them mixed up. The three are, the investment markets, the banking crisis, and the economy. While inextricably bound, they do not march in lock step. Let's first look at the banking crisis.

With all the discussion of toxic assets and the Public Private Investment Program (PPIP), rescue plans and the FDIC, I find people generally have at most a smattering of knowledge of the problem, let alone the solutions. It is complex, but seemingly more so with the explanations coming from Washington.

First let's look at the fundamental financial structure of a bank. The balance sheet looks something like this.

Good Assets $90
Questionable Assets $10
Total Assets $100

Liabilities to Customers $65 (bank depositors)
Debt to Bondholders $30
Shareholder Equity $5
Total Liabilities and Shareholder Equity $100

Those $10 of legacy/toxic assets have turned out to be pretty lousy investments for the banks. They have been written down to reflect reality, let's say from $10 to $4. So now the balance sheet looks like this:

Good Assets: $90
Questionable Assets $4
Total Assets $94

Liabilities to Customers: $65
Debt to Bondholders: $30
Shareholder Equity: $-1
Total Liabilities and Shareholder Equity: $94

This is by definition an insolvent bank. Now the question is, what to do? If this were 1st National Bank of Anytown, USA the FDIC would walk on on Friday afternoon, take the bank over, wipe out the shareholders, make sure the depositors are safe with the $90 of good assets, pay the bondholders $25 of the $30 owed and reopen on Monday morning as a new bank. Equity holders would lose all, bond holders part, depositors nothing.

This is how depositors of banks are protected with sufficient capital in the system.

The owners are first on the line for losses, the bondholders are next, and the customers are kept intact.

Except now. Except for a few big banks. There have been 46 bank failures since the beginning of 2008. In most cases, the failed bank was acquired immediately by another bank. In several cases where an acquiring bank was not found, the depositors simply had checks sent to them from the FDIC for covered deposits. Obviously we are dealing with banks too big to fail, i.e. too big to exist.

How can a bank be rescued from insolvency? The first option is to provide additional capital through the sale of stock. This is what the Treasury did when it purchased preferred stock of banks making us the largest shareholder of some. This is a solution for immediate and temporary threat of insolvency. We can hope some of the money will be loaned but without restriction, bonuses, new desks are also on the list of uses. If the bank fails, the taxpayer, as an equity holder loses everything since we are down the priority list. There is no provision for placing taxpayers ahead of bondholders. That hole keeps growing and it is highly unlikely that there is the political will for additional congressional approval for more cash infusion.

So what now??

Enter the Treasury plan of a Public/Private partnership. Obviously if the bank can make the toxic asset go away that would help....almost. If the toxic asset, valued at $4, is bought by the taxpayer for $4, there is no balance sheet improvement, only a transformation from $4 in an asset to $4 in cash. Only by paying $6 in cash for $4 in asset value, do things improve. So the question becomes how do we get buyers to overpay?

We start with the FDIC agreeing to lend the money to a buying "manager", guarantee the FDIC will absorb any loss over 3-7%, juice it up with 6x leverage and finally have the failing bank begin buying toxic assets in the market before the plan launches at above market prices to at least create the illusion of higher prices at which the bank will then sell. And best of all, Congress didn't have to approve it. What happens when FDIC fails? Then congress will pony up rather than leave bank depositors uninsured.

All of this convoluted structure is in place for the sole reason of protecting the bondholders of the major money center banks. Why?

Why should the taxpayer have a lower security position than the lenders to Citibank? How is the American public responsible for the losses? Why are the bondholders of Citi not being "encouraged" to swap debt for equity avoiding insolvency and allowing the bank to recover by its own business.

If that doesn't work, the banks should be taken in to receivership, the customers defended, the management changed, the shareholders wiped out and bond holders contributing. The bank can be immediately reprivatized as an operating and profitable entity. The only impediment to solvency is the bondholder debt.

To big to fail or too big to save is really the question.

John Barnyak

Friday, March 27, 2009

Hey Watch This! Technical Analysis

Talking to myself a bit today...anyone out there?

Needed a bit of humor, with a triple flip.

John Barnyak

Ponzi Palooza!

If we've learned nothing else this year, surely we must be looking at the fabulously knowledgeable with less star struck eyes. When hushed tones prevail for the rich and famous its probably time for someone to burst our laughing just for balance.

Bernard Madoff...philanthropist, investor, head of the NASDAQ, largest market maker on Wall Street, scion of the community, thief, cheat, incorrigible crook.

Myron Scholes....Nobel Prize winner, inventor of pricing models for derivatives, expert on risk analysis, founder of Long Term Capital, Managing Director of Soloman Brothers, Stanford Professor emeritus, loser of $4 Billion at Long Term Capital, founder of Platinum Grove Asset Management, with new opportunity to lose 29% of $4 Billion in first two weeks of October 2008.

Sir Allen Stanford...manager of $40 Billion, first american to be knighted in british commonwealth nation of antigua, cricketeer extrodinaire, political who's who, liar, cheat, thief, weaver of $8 Billion dollar ponzi scheme.

I admit to wondering now about the next class of puffins. Those who were right about the market meltdown and have become this years rock stars. Noriel Roubini and Taleb Nasem come first to mind. Both brilliant academicians who got it right and now must endure fame and the likely fortune coming their way. I keep thinking maybe the Andy Warhol comment about everyone having their fifteen minutes of fame should serve a warning against enduring too much more than that.

Opinions are a dime a dozen. Reputations might be worth about a quarter these days.

John Barnyak

The cure is not worse than the illness

Today the Bureau of Economic Analysis released last months personal savings rate for the nation. 4.2% is the figure after 4.4% in January. The last time we saw back to back months over 4% was in 1998. In the post WWII years until the early 1980's the national savings rate remained steady near 10%. It then declined steadily until reaching negative levels earlier this decade. A decrease in savings is the corollary of an increase in spending and drove the portion of GDP fueled by consumption to above 70%. Increased saving (decreased consumption) will provide a steady headwind on GDP growth powered by consumption and will account for a long term decrease in growth rates in the United States.

It is what needs to be done, but no one says it is going to be easy.

The financial background of investing is shifting and will continue to do so.

John Barnyak

Thursday, March 26, 2009

Magoo, you've done it again.

I am honestly not sure if this is a good thing or a bad thing. Several days ago I mentioned the rather disingenuous reporting of housing figures in the news. They've done it again. On one hand it is nice to hear good news. Maybe we need it more than accurate news. Maybe it is better to feel good than to think straight.

WSJ: Sales of new homes rose in February for the first time in seven months, the Commerce Department reported Wednesday, another sign that the housing market is thawing

Bloomberg: Purchases of new homes in the U.S. unexpectedly rose in February from a record low as plummeting prices and cheaper mortgage rates lured some buyers. Sales increased 4.7 percent to an annual pace of 337,000 . . .

Marketwatch: The U.S. housing sector continues to see signs of improvement. The latest government data showed new home sales climbed in February for the first time in seven months, sending shares of home-building companies soaring.


Not only did the New Home Sales data NOT improve, but it was terrible. Not only was the 4.7% gain statistically insignificant as the Census Bureau report gives it a +/- 18.3% margin of error. Year over year change?, down 41%. Sales down nearly by half, woohoo!

I'm not saying you can go up before you stop going down. But this is just noise!

John Barnyak

Wednesday, March 25, 2009

Ten Trillion and Counting

The Frontline program this week is worth watching. If you missed it because American Idol was just too exciting, here's a chance to watch it at your leisure.

Yesterday the UK held a debt auction of 40 yr gilts, much like our treasury bonds; and it failed. Not enough bidders showed up to buy the british bonds to fulfill the funding. A hint of things to come?

Frontline Report on the National Debt

John Barnyak

We Never Saw it Coming!

It seems to me, that there is very little in life that we never saw coming, if we paid attention and gave it some thought. We live in a world of endless, ceaseless information. So much infomation, so little thought. Below is an editorial by the venerable columnist William Safire. Written in 1998 when Citibank and Travelers Group were on the cusp of merging. It reads like something someone actually thought about. Enjoy.

Essay; Don't Bank On It
Published: Thursday, April 16, 1998

''Mere size is no sin,'' William Howard Taft is supposed to have said, refuting the trustbusting philosophy of his predecessor, Theodore Roosevelt. (At the time of the apocryphal remark, Taft weighed 300 pounds.)

When a big bank on the West Coast decides to merge with a big East Coast bank, that doesn't bother me. All the stuff about synergies and cost-saving layoffs and global reach will be meaningless soon enough; future banking will be done on the Internet, every home a branch, and today's giants will be undercut by speedy cyberbankers unencumbered by overhead.

Far more troubling is the kind of marriage proposed by Citibank and the Travelers Group of insurance companies and stock brokerage. That would require changing the law that keeps banks -- where individual deposits are insured up to $100,000 by the Federal Government -- separate from other enterprises.

With remarkable chutzpah, these companies have embarked on a course that blithely assumes that change in law.

They think they can count on Republicans in Congress who say that the 1933 Glass-Steagall Act is a Depression-era relic. Fears that a market collapse could affect banks are old hat, these descendants of Dr. Pangloss insist. Break down the fire wall and let the Federal Reserve keep a benign eye on everything financial; we don't even have to fear fear itself.

Not so fast. Suppose the Big Quake afflicts California. Or maybe a Category 5 hurricane, which comes every decade or so, rips along the expensive expanses of a place like Long Island. That would put a lot of pressure on even the most reinsured insurance company.

If you heard such news, and you could switch your money out of the bank affiliated with that insurer with a keyboard stroke, wouldn't you be inclined to play it safe? And wouldn't that Internetted panic cause a run on the superbank?

That's being alarmist, of course. Such disasters are just as unlikely as a market crash (which we all assure each other can never happen again). But before the cash cow of Chase Manhattan starts making cow-eyes at the thundering herd of bulls of Merrill Lynch, Congress had better take a close look at the downside of upsizing across the old boundaries.

1. No private enterprise should be allowed to think of itself as ''too big to fail.'' Federal deposit insurance, protecting a bank's depositors, should not become a subsidy protecting the risks taken by non-banking affiliates. If a huge ''group'' runs into trouble, it should take the bank down with it; no taxpayer bailouts should allow executives or stockholders to relax.

2. What about privacy? Our bank already knows the details of our buying habits. Won't the affiliated stockbroker and insurance salesman have access to the superbank's records? Do we want a bank that handles our credit cards to be calling us at dinner time as a financial-service telemarketer?

3. Let's not be in such a big rush to knock down barriers. The Government's biggest financial mistake of the past generation was to raise deposit insurance to $100,000 while allowing housing S.& L.'s to plunge into commercial lending. That all but removed the element of risk from foolish or corrupt loans and helped bring on the S.& L. debacle. Good fences make good banks.

4. Beware the slippery slope to crony capitalism. Paul Volcker, former Fed chairman, is less troubled than I am about an amalgam of financial services, provided the Fed is the supervisor. ''But there is an Anglo-Saxon tradition separating banking and commerce,'' he says. ''I'd continue to draw the line between finance and business.''

There's the rub. If commercial banks invade mutual funds, stock brokerage, investment banking, insurance sales and the like -- or get invaded by them -- that ''finance'' is likely to spill over into ''commerce and industry.'' That's the seamlessly interconnected philosophy. And that's the path of Japanese keiretsu, the cozy network of insider financial dealings that crushes competition and breeds inefficiency.

''Mere size'' can be a virtue when it reduces prices. But the fewer the competitors, the more collusive the pricing.

Our financial institutions can go global without going gaga. I've never knocked greed, but this spreadeagled ''universality'' is getting out of hand. Let bankers be bankers.

John Barnyak

Tuesday, March 24, 2009

Emerging Market Commentary

Mark Mobius has been a sane and pragmatic investor in the emerging markets for decades. One might take exception with his optimism based on the "re-linkage" of the weak U.S. economy with the export sensitive emerging markets. His comment in the video beneath focus on the internal improvements in the EM while the less optimistic might look more critically at the dramatic slowdown in global trade.

Analysis of Geithner Plan on Charlie Rose

Dr Doom - Marc Faber

Marc is always worth listening to him. His analysis shifts with change in evidence so it pays to keep in touch.

Stop Listening

Yesterday in a fit of multitasking I was reading economic analysis on the computer screen while listening to the news on the radio. "Existing home sales unexpectedly rebounded 5.1% in February it was reported today...," I heard.

At precisely the same moment I was reading, "Existing home sales fell 4.6% it was reported today." That is about as close as one can get to the spin cycle in full force.

The National Association of Realtors has been among the most egregious of distorters in the past year. Mark Twain spoke long ago of liars, damned liars and statistics. The NAR makes his hundred year old commentary more useful now than ever.

Real Estate is a seasonal industry. Each year home sales reach lows in winter months and begin to regain ground throughout spring and summer. To compare February sales to January is meaningless, to report it as anything else is dishonest. The country could use some positive economic news without a doubt, but to continue to erode trust with misleading information is maddening.

This is precisely the sort of nonsense and doublespeak that we do not need. We've heard it from politicians, bankers, investment pundits. Citibank is "making" money says the CEO of Citibank. Real Estate is moving higher, says the President of the NAR. "Toxic Assets" yesterday have been rechristianed, "Legacy Assets." This is called "talking your book" in trading speak. Lately talking one's book is standard operating procedure in a CYA society. Maybe P.T. Barnum was right. You can fool some of the people all of the time.

February existing home sales FELL in February from the PREVIOUS February. I did not notice in the NAR press release that foreclosures soared in February and sales prices plummeted.

Is it any wonder people find it increasingly difficult to trust sources of information that should provide objective reporting? I expect next year we'll see, "toy sales soar in December from lower November!" "Lawn mowers showed strong signs of renewed growth in March following lackluster February." We will likely drown in this sea of worthless misleading drivel. So much for the information age.

John Barnyak

Monday, March 23, 2009


I admit to having some real reservations about the trillion dollar ante made today by Mr. Geithner. But in the spirit of "It's not what I think, it's what I see" I have to say today was a nice day. It was the first day with a close above the 50 day moving average in a number of areas. The S&P, the Nasdaq, EAFE, Emerging Market and commodity indexes all closed above what has been a brick wall. We've begun taking partial allocations in number of positions.

For all the positives of today, the markets are now overbought and can remain so indefinitely. The trend of lower lows and lower highs is still intact, but the positive internals along with the unprecedented treasury stimulus makes us more constructive than we have been in many many months. We are moving clients back toward long term strategic allocations while reducing some of the more defensive positions.

One day does not a bottom make but who can deny that fighting the tape rarely makes sense. The market finished strong without the profit taking I had expected to see late in the day which bodes well.

The S&P 500 has not had a 5% advancing month since December 2003 but month to date the S&P is up 13%. Clients should be coming back in from the cold and unwrapping.

John Barnyak

Sunday, March 22, 2009

United Hedgefund of America

It appears from leaked reports of Secretary Geithner's plan to be released this coming week that the official policy of the Treasury Department has become, if you can beat 'em, join 'em. The United States will buy risky and distressed assets in the hope they are substantially undervalued. One trillion will make us all partners in the worlds larges hedge fund.

$150 Billion comes from the TARP in the form of equity, $820 Billion will come from the FDIC in the form of debt and $30 billion from hedge fund and pension fund managers hired to run the program. The funds will be leveraged up providing adequate incentive to keep the private managers interested. The typical hedge fund operates on a 2 and 20 principal with fees of 2% of capital and 20% of profits. In this program, Treasury will be paying 0% of capital and 17% of profits.

The purpose of the structure to be announced will be to remove $1 trillion of risky, information impaired assets. This presumably will enhance the ability of banks to lend and raise the prices of the risk assets.

Based on the trillions destroyed in the private sector this could well be inadequate to fill the hole, but staunching the bloodletting of asset values while adding public trillions may cauterize the financial wound.

The market effects of this plan I expect will positive. The economy will require much longer recovery time but stabilizing the banking system is needed first. I admit to misgivings of the plan and the phrase, "if one lays down with dogs....," comes to mind.

It is still unclear to me how the various assets will be wrested from the banks which hold them unless either a price is mutually agreed upon or the assets are part of a reorganization plan. I look forward to hearing the plan first hand in a few days.

John Barnyak

Friday, March 20, 2009

Throw the Frog In!

GM Chief Executive Officer Rick Wagoner and Chrysler’s Robert Nardelli have been “exceptionally cooperative,” “thoughtful,” and “energetic,” Rattner said.

“They’re good guys really trying hard to run those companies,” Rattner said. “I have nothing bad to say about them.”

Steven Rattner is the Obama "car czar" called upon to sort out the nation's automakers.

This may be a good example of a significant problem not simply at the automakers, but in the dealing with the financial crisis as a whole. The Orwellian "nicespeak" and back slapping seen in congressional testimony is obscene.

Our current problem is the result of errors of judgement and ethics by people. No amount of massaging sensitivities will right that macro misjudgement.

The foot dragging has to end. The financial balance sheets must be cleaned up and blood will be spilt......and then we will get on with the job of rebuilding.

We as taxpayers own 80% of AIG, and very significant interests in the largest banks in the country. Throw the frog in the the pot and he'll jump out. Cook him slowly and it's, "pass the garlic butter."

John Barnyak

What's Good for the Goose

General Motors bond holders are unhappy, and little wonder. GM has been negotiating a complicated debt exchange that would cut the automaker's unsecured debt by two-thirds to $9.2 billion. To get there, bondholders would have to accept about 30 cents on the dollar, which is a requirement of the automaker's $13.4 billion federal loan package.

How is it GM bond holders take a hair cut and those of the troubled banks get a free pass? Bond holders of Citi should expect the same and will get a debt for equity outcome. With Citigroup stock at current levels dilution seems less a problem than survival. The next bailout should come from bond holders and I suspect it will.

Lending to insolvent borrowers is a risk proposition and bond holders should prepare to swallow some of that risk.

John Barnyak

Whither China?

This weeks announcement that the Fed will push interest rates yet lower raises a number of trillion dollar questions. Among them is what will the Chinese do with current holding in US Treasury Bonds and Mortgage backed securities and what will they do with new reserves?

The Fed announcement will push interest rates to unnaturally low levels which in time will snap back, unless the financial system is so broken there is no normal anymore. Leaving aside that possibility for the moment what about the trillions of dollars in china's hands?

Firstly for the treasury bonds they hold, this move is a gift. There asset value has risen remarkably and now they must consider whether moving some of those bonds out of the portfolio wouldn't make sense. It would be very "un-chinese" to move rashly so I do not expect we will see sales of any magnitude prompted by a policy change. However, going forward locking in unnaturally low rates of interest likely is not in chinese interest.

How will china use and protect its huge asset? Part of that question is being answered already as we have witnessed massive hard asset investment in the past two months. Mining operations, energy resources and domestic infrastructure stimulus have all stepped forward.

Years ago when trading physical commodities, when China entered (or stepped out of) a market whether steel, copper or nickel the effects were powerful. We will be watching china's steps for clues of direction, duration of their money flow.

John Barnyak

Thursday, March 19, 2009

What's Working?

Having scanned at least a hundred various funds for signs of life, the pickings are still very slim on the long side. Precious metals are in a reasonable uptrend. The injection of massive public stimulus, the prospect of inflation down the road and questions about the dollar all are constructive for precious metals.

Otherwise only technology seems to be working its way higher creeping along either side of the 50 day moving average. Other sectors are quite mired on the underside of the 50dma line. Although still below the moving average, I am beginning to see clear signs of flattening. Sellers exhaustion? Better valuations? Whichever it is, there is a distinct bottoming process beginning.

I have some concerns that first quarter earnings and continued rising unemployment claims are going to be a nasty jolt of reality in the next month. The question will be, how much of that reality is already baked in the cake? If we see terrible numbers and a modest reaction that will be a positive sign. I haven't heard ANY positive spin lately on corporate earning so we will be looking for lessening of declines. At some point we will hit a lower water mark before beginning a slow recovery. Same hole, slower digging.

Apart from equities investors should be watching for continuing weakness in the dollar or rising inflation expections. The dollar looks terrible, but everything else looks worse, so that remains a watch more than a strong position.

John Barnyak


After the breathtaking announcement of the Fed yesterday that Chairman Bernanke has pulled out the heavy artillery, today the market did more of the same. The S&P went to the fifty day moving average, lingered and rolled over. Apparently inertia is more powerful than a promise.

I do think that ultimately the trillions of dollars of stimulus will move the needle off deflation and start to move us higher. However, the injection of public funds is not keeping pace with the destruction of private debt. It is still hard to imagine the word "trillion" with any number higher than "one" in front of it, but I think we're going to have to go there.

From the trading standpoint, today I bought only gold and resisted entering equity or fixed income trades. Technically we have another lower high and will wait to see how it resolves. A move in the next week below S&P of 666 will indicate the downtrend is still intact. A close above the 50 day average for several days would be constructive as would be holding above 740 on a pullback.

John Barnyak

Spring is in the Air

For all the wailing I heard yesterday in the congressional finance committee hearing there is one theme that is growing stronger. In the press, the blogosphere and now Capital Hill, I hear the increasing comfort with cutting bait. We rushed to war first in Iraq and then on Wall Street. Over the weekend, tone deafness seems to be the malady of choice with the masters of the universe.

There is a certain Keystone Cop quality to the daily sound bites and press briefings as each political party plays "gotcha." There is so much blame to go around one hopes that a adult will show up and sort out the kids.

I expect that eventually, as unemployment crests ten percent political pressure should mount to the point where members of congress will feel the risk of taking strong action will finally be less than passivity. Zombie banks on life support should end and I hear increasing calls to do just that. It feels increasingly like domestic blackmail. If you leave me, you'll be sorry. It's time to pull the plug and walk out the door.

John Barnyak

Wednesday, March 18, 2009

Blowing another bubble?

The minutes of the Federal Open Market Committee meeting were just released. The effect was quick and meaningful.

The Federal Reserve Bank has run out of room in monetary policy. It's hard to lower interest rates below zero. But wait! We have a rabbit in our hat! Quantitative Easing to the rescue!

The Federal Reserve has presented a plan to purchase billions and billions of mortgage backed securities, long term treasury bonds. Below is the language of the minutes.

To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve's balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of evolving financial and economic developments.

The Fed has promised to add dramatically to money supply by purchasing these bonds. This should help create the inflation impetus the economy needs to increase the flow of money. It is in line with Bernanke's monniker of Helicopter Ben after he stated some years ago that he would, "drop money from helicopters," to avoid deflation.

What was the immediate market response? Stocks up, Bonds up, gold up, dollar down.
Will that initial reaction hold? That is impossible to say in a dramatic economic environment with daily cross currents.

It is said that when the Fed taps on the brakes, somebody is going through the windshield. Conversely when it slams the accelerator to the floor we might want to buckle up.

John Barnyak

Phantom Market

This morning I listened to a fascinating piece on National Public Radio that gives some additional insight into our investing primal instincts. After years of learned reality, a neurosurgeon explained that a patient cannot mentally decipher a new reality, such an amputated limb. The result was excruciating pain in a limb that was no longer there. As I listened to this report I thought of a generation of learned investment market behavior. Could they be be analogous?

After years of the Greenspan Put, whereby any stutter in markets and the economy was immediately met with lowered interest rates, could we too have a mental impediment to rational behavior? For two decades mutual fund sales forces and brokers trotted out proof of average 10% annual gains in the equity markets and retirement illustrations assured us of everlasting financial security. Now we are facing a serious case of cognitive dissonance. The limb (20 year bull market) is no longer there but we still feel it, even to the point of disbelief. Listen to the interview at the NPR site.

As an investment advisor the challenge is twofold now. Find the investments that will perform well in a changed economic environment and then helping clients accept that changing behavior will provide positive performance. Simply saying the limb is gone meets remarkable learned resistance. If the human brain cannot accept that an amputated limb is no longer there, what chance does our brain have of letting go of General Electric shares that served us well for years?

For example, having been taught the advantages of tax deferral in 401-k's and traditional IRA's, facing higher tax rates in the future, clients may find that deferring taxes is no longer the best approach. Realizing gains and income sooner rather than later should be considered.

While equities reflect underlying economic growth, seeking out non-equity investments should undertaken. As economic growth slows for the foreseeable future, there will be opportunities but the glide path will be flatter. Expectations for the stock market alone should be reexamined.

We all profited in a world in easily available credit, declining interest rates, high employment, high asset valuations and increasing leverage. Does it make sense to invest as if none of that has changed when all of it has changed. Investors need new limbs, and they are available for those who look.

John Barnyak

Tuesday, March 17, 2009


Each year since 1984 in Long Beach California, a gathering is held called the TED Conference. Originally it stood for Technology, Entertainment and Design. Meant to be an eclectic collection of short talks on a variety of subject it has grown in popularity over the years and never fails to provide food for thought.

One of the eighteen minute talks this year was on cheating given by behavioral finance guru Dan Ariely. Entertaining but also illuminating as one contemplates the behavior of investment bankers and derivative creators in recent years.

John Barnyak

Monday, March 16, 2009

Taking the corner on two wheels?

The chart below gives a bird's eye view of the broad market. Each colored section was an oversold correction, a bottom that failed. Buying the bottom of a market is an exercise in ego. We all like to bag the big one. Prudence suggests awaiting the turn will be a more reasonable entrance, although valuations support small purchases now for investment, not speculation.

Already this market has seen more bottoms than a nudist colony. At last count there have been five moments when the market had "found a bottom," only to cascade once more on another wave of selling.

The news last week was insipid but interpreted as positive. When bad news is met with buying that MAY be a bottom. When the averages move above the moving average for longer than a few days, then we can begin to look again to constructive buying.

There most assuredly will be an end and the valuations of today portend better long term returns than any time in years. I question those who bought greedily forty percent ago and now refuse to put a toe in the water. We will continue to be judicious and cautious, but most of the harm has been done. Now is the time to engage in strategy, not fear, nor greed.

Unlike Warren Buffet, we'd rather make late entrance to this party. But an entrance is not unwarranted.

John Barnyak

Dead Cat Bounce or Turning a Corner?

Last week was the best market week we've seen in many months. What changed, if anything, to produce the buoyancy? There are a number of reasonable explanations, and a few popular explanations.

1. The chairman of Citibank declared they were making money. That pronouncement from an internal memo, conveniently leaked, strikes me a blantant effort to inject "confidence" where none has been warranted. Citibank has always made money on an operating basis. Borrowing at 1% and lending at 5% is profitable. There is the "minor" issue of losing value in the collateral by the billions that was not addressed.

2. Technical oversold conditions. Each day tens of millions of shares change hands for non fundamental reasons. For the past year, it has been a profitable trade to be short. Sell on the bounce, cover on the dip, rinse and repeat. Last week the market reached a very oversold condition. Shorts covered, whether true buyers emerged is still questionable.

3. Bernanke made noises that the recession was going to end, as one headline stated, "shortly." Another trumpeted that the Fed chairman feared the political will was lacking. You decide.

Watch CBS Videos Online

Wednesday, March 11, 2009

His Lips Are Moving?

This seems like it could be the Jeopardy Show answer to, "how do you know a banker is lying?"

The 300+ dow bounce yesterday was certainly appreciated, even overdue after the relentless reality of the past weeks. I lament however the reasons the talking heads give for this gasp as if it were an all clear signal. Citibank CEO Vikram Pandit yesterday said his bank is doing swimmingly. They even made money in the first two months of the year, which as far as I can tell from the details he gave, he may have found a twenty dollar bill in the parking garage which went straight to the bottom line.

That the chairman of the erstwhile largest money center bank would state, "we are making money," without disclosure of how much the balance sheet was impaired in the same time period is a travesty. Putting that twenty in your pocket and ignoring the detail that you lost your wallet with five hundred dollars in it is hardly full disclosure.

Bushido, the samurai code of conduct, The Way of the Warrior had seven virtues: Rectitude, Courage, Benevolence, Respect, Honesty, Honor, and Loyalty. Might I suggest the next congressional hearing begin there?

John Barnyak

Tuesday, March 10, 2009

It's not the end of the world, but you can see it from here

I've been crunching numbers since last October. In another time and culture it might be throwing the I Ching or divining entrails, but here, it's formulae. Warren Buffet warns against kids with calculators, but I'm old and have a pencil, so maybe this will work.

Personally I think we still haven't seen the bottom of the market for a few reasons. Perhaps the major one being that CNBC is still on the air. Today, Nouriel Roubini opined that the S&P will see 600 by October. After a nine hundred point drop in the past eighteen months, another seventy in seven months seems like child's play. Another ten percent? Bring it on!

Considering how prescient Mr. Roubini has been in this economic debacle finding our projections relatively close seems a comforting confirmation of my own work. Below are my reasons for throwing my dart at 600.

1. I project earnings next year near $50 for the S&P 500. Goldman Sachs suggests $40 so I am not the most pessimistic.

2. Currently inflation is essentially zero.

3. Typically in a deep recession the PE ratio troughs in the high single digits however inflation impacts future earnings present value so I expect the market PE to more likely settle in the area of 12x earnings.

4. 12 times 50 is....600. Voila

It is so critical for the policy makers to get the banking system sorted out. Without that, it will remain difficult to move ahead.

What will be difficult is that bear market rallys will give hope before it is time, then despair when they fail. Buying judiciously now will likely end well over time, but there is no hurry.

John Barnyak

Friday, March 6, 2009

Mohammed El-Erian Video

Mohammed El-Erian describes our current challenges and a way forward. No easy answers but a good discussion.

Thursday, March 5, 2009

Things that can't happen already have

We must be near a bottom. Comedy is closer to truth than news.


Laugh or weep...the choice is not clear.

Today the financial foundations of the U.S. economy look a little frayed.

Here’s a short list of only the highest quality, bluest of blue chip, penny stocks:

AIG (39 cents)
Citigroup (98 cents)
E*Trade (66 cents)
Fannie Mae (39 cents)
Freddie (39 cents)
Unisys (37 cents)
Given the trading volumes, you might think these were real firms or something!

Now, for the not-quite-penny stocks:

Ford ($1.83)
GM ($1.83)
Las Vegas Sands ($1.97)
MGM ($1.99)
CIT ($2)
Kodak ($2.50)
Bank of America ($3.15)
New York Times ($4.00)
News Corp ($6.15)
Xerox ($4.36)
International Paper ($4.22)
Alcoa ($5.55)
GE ($6.75)
Dow Chemical ($6.56)
Wells Fargo ($7.95)
Dell ($8.50)
It looks like American Express ($10.83) is one of the few double digit stocks . . .

John Barnyak

Tectonic Shift

The world is constantly changing. Mercifully we don't feel most of the changes. They are the incremental progressions that effect us subtly. Life changing for some, but not most. A new treatment for shingles, a breakthrough in silicon chips, a more efficient and cleaner engine. Tiny steps, quiet huge leaps that enter our lives but generally do not collide with them.

Economic and financial shifts tend to impact us more dramatically and immediately. Can we afford education, healthcare, shelter, retirement? These are in our face everyday and changes are felt quickly. Losing a job, winning the lottery, getting the tuition bill, getting ill. The global economic shifts taking place now are significant, will effect us directly and one ignores them at ones peril.

Mohamed El-Erian sees the world changing. El-Erian has been active in global finance for the past three decades. Born in New York City to an Egyptian father and French mother, he grew up both in the U.S. and abroad. He worked for the International Monetary Fund for 15 years, then did stints with Salomon Smith Barney and Pimco before running Harvard's endowment fund. He returned to Pimco, the bond powerhouse, in 2008. El-Erian is chief executive of Pimco as well as its co-chief investment officer (a title he shares with bond guru Bill Gross).

The shift is not necessarily bad for you, but it will require some adaptation. A tectonic shift is occurring. No longer will the world simply march to the U.S. rhythm. We will have to share leadership with emerging giants, such as China and India. If the US remains flexible and educated we will provide the world with goods and services easing our trade deficit and stimulating growth and jobs over time.

But stability is easy only once we get there. Transitions are hard. Vested interests struggle to keep their advantages. Just as blacksmiths and longshoremen, scribes and pick and axe coal miners pushed back against the tide so will we. Eventually the typewriter ribbon cannot be replaced, the rotary dial telephone cannot be repaired and the cassette tapes will have no place to load in the car. Imbedded thoughts do not go easily either.

Many of us are investing and saving based on rotary telephone thinking. Some of the truths that worked for a generation are now only half truths. Judging by the past several years in which so many assets we invested in moved in lockstep, diversification no longer means 60% stocks and 40% bonds. To continue in that vein will be mean having good times and bad times, but volatile times. Diversification is not dead, but the simple 60/40, buy and hold strategy will not decrease risk any longer nor will it find the dynamic opportunities.

Because of all these changes, El-Erian suggests that investors spread their money over a wider array of assets than was once thought necessary. That means shrinking U.S. stocks to smaller portion. Just 15% of your total portfolio in his view.

The world's financial landscape is being re-defined without a master plan. This has become a crisis-management phenomenon. As individuals, to attach our personal well being to global crisis management is not a strategy.

In El-Erian's world the traditional approach to diversification, "which served us very well, went like this: Adopt a diversified portfolio, be disciplined about rebalancing the asset mix, own very well-defined types of asset classes and favor the home team because the minute you invest outside the U.S., you take on additional risk. A typical mix would then be 60% stocks and 40% bonds, and most of the stocks would be part of Standard & Poor's 500-stock index.

This approach is fatigued for several reasons. First of all, diversification
alone is no longer sufficient to temper risk. In the past year, we saw virtually
every asset class hammered. You need something more to manage risk well. Second,it matters a great deal how you implement the asset allocation, because when the world gets bumpy, different investment types really do behave differently. Third, consider where we're headed. We are going toward a world where the U.S. will no longer be the most dynamic part of the global economy. Because of the debt excesses of the past few years, it will be a while before the U.S. economy returns to 3% or 4% annual growth. Therefore, the wise investor asks, "Where else can I tap into sustainable growth?" To do that, you need a more global approach. And one more thing. Don't become hostage to historical definitions of asset classes. Be flexible, because there will be opportunities that don't fit easily into those categories."

Now is the time to dig deeper, spread wings wider. We've seen what happens to the financial Icarus when soaring too close to the sun, but the wiser will still keep their wings.

John Barnyak

Tuesday, March 3, 2009

What is it Doctor?!

It always seemed in the sci-fi movies I watched as a kid, at some point a small group of scientists would be staring at some creature and the buxom blonde assistant would say, "what is it doctor?!" He would reply, "I don't know, I've never seen anything like it before." Not long afterwards you knew someone was going to be eaten. This grown up economic horror film is not dissimilar.

Reading the fixed income research from one of the largest investment banks today I saw that phrase again. "I've never seen anything like it." The behavior of the policy makers in Washington indicate they are also among the group peering at the creature. So the reasonable question is, who gets eaten next?

The only positive I can find is that I can find no one who is being positive. Only the VIX index show some sign of moderate complacency, which is in itself, not a good sign.

In a "normal" market condition, (i.e. those starting in 1981) the VIX showed periods of irrational fear to be "buy" signals. However those signals existed in a background of secular economic growth, but more importantly, in a period of secular bull market. Last autumn's extreme spike would normally be an all clear signal to pick up the pieces after irrational fear. However this time, the global deleveraging and credit contraction represents a very different backdrop. The economic inertia of a body in motion is proving very powerful.

The constellation of financial stars that came together to drive equities and bonds to a generation long bull market are no longer in place.

In 1980/81 the Fed Funds rate target was 18 to 20% to fight inflation. Today the target is 0 to 1/2%. The falling in interst rates made buying future earning and stocks attractive. Where do we go from zero?

There will be market dynamics in the coming years, but they will not be the same as the previous bull market. The 1000% 17 year bull market was a once in more than a century event. It may be a stretch to expect it to occur twice in a generation. Be flexible, be ready to change. Think.

John Barnyak

Sunday, March 1, 2009

Pandora's Box

Let it never be said I am not a contrarian at heart. I have the most annoying habit of responding to most statements with, "why?" This market and economy is presenting me with a quandry. When all are abandoning ship I am looking for hope. Afterall in mythology when Pandora opened the box letting loose upon the world all the ills to come, one item remained in the box, hope. So the contrarian in me is looking for hope and the harder I search the more elusive it seems.

We are in a new secular market that will alter behaviour not just of investment but also of personal behaviour of years to come. The investment strategies and tactics that worked for years, need to be dismantled, cleaned and set aside. I feel the danger in saying, "this time it's different." I have never said it before. Not in the asian meltdown of the late nineties, not in the dot com bubble, but now, I relent.

Hope springs eternal, but I don't like the data. Cyclical aspects of our economy that have been predictable are out of sync and the relationships of cause and effect that held for more than a half century are breaking. Let me explain.

In each of the recessions of the past sixty years certain truths held firm. Increases in inflation brought about accompanying decreases in real personal consumption and vice versa. The connection held true since 1950, until now. Last year as CPI fell dramatically, consumption fell even faster.

In a period of falling prices, by definition, purchasing power increases. But real consumption fell at a pace unseen in post war United States. The one-two punch of job losses and credit curtailment came together in a perfect storm.

Recovery in past recessions came on the back of consumer spending. Unfortunately the american consumer is tapped out.

By two separate measurements, the tail wind of consumer spending looks like it is shifting to a headwind as needed savings comes at the expense of spending. Historically consumer spending has run in the low to mid 60%'s. In recent years, however, consumer spending rose to above 70% of GDP. By far the highest in the world. Perhaps even starker evidence is found in that consumption on a national level rose to over 95% of personal disposable income. The reversion to more sustainable levels of consumption will result in higher savings and a significant drag on returning the economy to its previous path of annual increase.

This secular shift in aggregate economic behavior will have an effect for years. Investors and savers will find that opportunity and safety will exist in new strategies.

John Barnyak