Stonehouse Asset Management, Inc

Dr. Copper

2011-12-08T15:40:00.002-05:00

For generations the market for copper has been one of the best bellwethers of the direction of the global economy. More recently other indicators, such as silicon chip sales have become popular, but copper remains important. It presages construction plans, auto manufacturing expectations and capital equipment demand. Lately Mr. Copper has been looking a little tired. In fact more contracts are being bought in anticipation of a decline in copper pricing than rising.

For all the babble over massaged retail sales figures on Black Friday and the firehose liquidity injections to European Banks the 30,000 ft view is flashing warning. Forewarned is forearmed.

A Whopper

2011-12-02T16:14:00.002-05:00

End of day headline....Dow gains whopping 7% for the week!!

pssst...we're still 150 dow points below where we were three fridays ago. It seems nano technology has come to attention spans now.

Headlines etc

2011-12-02T09:18:00.005-05:00

There has been no post on the blog for more than a year and as I reflect on 2011 it almost looks like I didn't miss a thing. 2011 opened with the S&P index at 1257. As I write this the S&P index, approaching the end of the year is at.....1257. Rip Van Winkle wouldn't have missed a thing but had lots of crazy dreams in the interim. A lot like the investment year in equities has been.

Of course if you didn't sleep through it you didn't miss the breathless voices on CNBC alternating between orgasmic glee and catatonic despondency. In other words much of the year could have been spent in an alcohol induced coma both in celebratory cork popping and bleary eyed single malt sipping.

It has been a traders year with breathtaking volatility and profits for the quick opportunist. For the fundamental long term position a plodding marathon. When the headline news is set against a back of reality it makes me despair of the disingenuous nature of investment market reporting. Seemingly everyday the banner headline is one not merely of hope but of gleeful cheerleading. Without an awareness of both underlying expectation and the details behind the news the reportage is less than worthless.

Today is no exception. Jobless Rate Falls to 8.6% reads the headline. The lowest level in two and a half years, spouts the Labor Department. A lower jobless rate is good, right? 120,000 jobs created. What's not to like?

The labor force participation rate is falling at an unprecedented rate. For those who pine for the good old days when June Cleaver had perfect hair, a martini waiting for her dutiful husband and a roast in the oven, be patient. We're getting there. Statistics show that it is increasingly likely it won't be June fixing dinner and waiting for the breadwinner to come home, but husband, Ward

The participation rate began a long advance following the 1970's when women entered the work force in substantial numbers. The social changes of those years meant that women who were burning their bras were also beginning to collect a paycheck.

Behind the headline number of 120,000 new jobs is another number. 315,000 people stopped looking for work or otherwise fell off the labor force rolls. If you actually work the numbers reported backwards, it looks like about 3 million people have statistically disappeared.

The graphic below charts the average period of unemployment for those in the labor force and looking for work. Clearly there is a striking structural change. For the first time since the 1930's the U.S. labor picture is of significant long term, even permanent unemployment. Left unchanged the social implications are major both in terms of average standard of living and social polarization.

Our client portfolios remain decidedly cautious and hedged which means experiencing contrarian emotions. Earlier this week when every central bank in the world announced it was opening the spigots of liquidity to banks still wider I was not a happy camper. But in a market driven by headlines there will always be times when fundamentals will be overwhelmed by fleeting events. Surfing the tsunami is not for the meek; or even for those who hang on every word that comes across the wires. So much information, so little wisdom.

Outrunning the Bear

2010-04-28T16:00:00.002-04:00

When confronted by a hungry bear you don’t need to be faster than the bear, just faster than kid that ate all the Twinkies. Increasingly the global economy is looking similar with Europe being the bloated glutton. For all the problems in the United States the friends across the pond are looking more and more like bear food.

The problems in Greece, which in the recent past I wrote were not going to go gently into the night, rose up this week with a massive downgrade of their sovereign debt by S&P to junk status. There was political posturing to try to hold down the panic as a large piece of Greek debt was due to be rolled forward in May. It looks like that posture is unlikely to be upright as two-year interest rates on Greek bonds moved to 15% this week. The PIGS (Portugal, Ireland, Greece and Spain) are looking like crispy bacon.

In Club Med, Barclay’s analysts believe Greece needs 90 Billion Euros to get through the current crisis, Portugal, 40 Billion and Spain 350 Billion. The IMF runs dry at 200 Billion which would mean heating up the printing presses. If the other rating agencies follow S&P’s lead, the European Central Bank will not be able to hold Greek debt on its balance sheet. Or they will destroy the sanctity of the ECB, much as the Fed has done.

The crisis in Greece puts a stake in the heart of discussions of the Euro supplanting the dollar as the world’s reserve currency. The lack of a cohesive national government in time of crisis has been shown to be the weak underbelly of the European monetary union. The inability to enact independent monetary policy because of treaty obligations and mandates may well be the emperor has no clothes moment for the Euro.

If this lit fuse reaches Spain where there is serious German and British investment fireworks could ensue. The expectation of an imminent Fed rate hike is deflating by the day. If one looks back to 1997 a crisis in Thailand started the Asian crisis and quickly derailed plans for interest rate hikes.

Vampire Squid

2010-04-19T17:50:00.003-04:00

A recent podcast by the radio program This American Life does an excellent job of describing the complexities of Collateral Debt Obligations in the episode ">The Inside Job.

Vampire Squid

2010-04-19T17:50:00.000-04:00

Inside Job

http://feeds.thisamericanlife.org/talpodcast

Playing the Odds - to no avail

2010-04-14T11:01:00.007-04:00

As a manager of clients whose primary focus is on long term gains and security, I have focused on risk before growth. In the past year, that was an uncomfortable focus as the stock market went on an almost unparalleled tear. Looking at historical precedent and market valuations has been off the mark this time.

Looking back to the pre-depression 1920's and analyzing markets shows just how unusual this past year has been. Using rolling time periods of just over a year, there have been 4,237 different outcomes in the market. The current gain places this period ahead of ALL market performance periods except during the Great Depression. This fact does not imply that the next period will be either positive or negative but a regression to the mean will certainly occur. Trees don't grow to heaven.

(click on image to enlarge)

This market rally was exceeded only in periods during 1933, 1934 and 1936.

John Barnyak

Pension Tsunami

2010-04-12T13:33:00.002-04:00

When we look in practically any newspaper that reports municipal issues we find an ongoing friction between unionized public sector workers and management. Recently teachers in a local school district went on strike for improved contractual salary benefits and continued modest health care contributions that frankly make the rest of us glaze over with envy.

Behind the daily jostling for continuing generous retirement and health care benefits, on the not too distant horizon is a wall of trouble. In typical fashion we are kicking the issue down the road until the current embers turn into a fiscal inferno.

How voters and taxpayers will confront the coming crisis will be interesting to say the least because we sure aren't dealing with it adequately now. Public services we take for granted will clearly be jeopardized in years to come. In my activities on a local library board I am alarmed at the sanguine attitude that local municipal contributions for the operating expenses will continue to be available. When public pension contributions have to be increased dramatically through taxes to fund future obligations how deep will taxpayers dig for libraries, swimming pools, cultural events, fire and police protection, road maintenance etc. etc. etc?

Nationally, the municipal, state and local pension plans are currently underfunded by and estimated $2 to $2 TRILLION. Future pension plans will have to be terminated and defined contribution plans put in their place. Future benefits will become a battle royale when private sector neighbor eyes public sector neighbor with envy and anger. Let's get ready to rumblllllle.

The interactive chart below shows various pension plans in each state and their level of funding.

John Barnyak

Jim Grant Takes on the Maestro

2010-04-09T11:25:00.001-04:00

'''

Flesh eating fish and a dolphin

2010-03-31T13:06:00.004-04:00

As I read about the developments in the national residential real estate market I am struck the images. First is the return of the flipper. Whereas five years ago every cab driver and school teacher in Florida and Nevada was playing the home edition of Monopoly and lining up houses on Baltic Avenue, today it is a more sophisticated and serious investor. Some might say vulture. They do their homework, look at distressed houses with a dispassionate eye and a full checkbook. Scores of investors with hearts of stone are nibbling like Chinchin Yu (the Chinese dead skin munching pedicure fish)on the housing market and cleaning up the dead skin.

From an economic perspective this is a good thing. Whereas the banks and government have played a game of extend and pretend with the financial side of housing, until prices reach a level for existing housing stock to clear, the pain will be prolonged.
The price of a house is that at which buyer and seller agree. It is not the price that the bank holding the amalgam of sub-prime mortgages wants it to be.

The foreclosure process forces banks to recognize an asset as worth much less than the balance sheet would like. Like the Japanese banks of the past twenty years, pretending that the underlying collateral of loans is worth as much as the debt outstanding when the market says it is not is the only thing that keeps the bank solvent and unable to lend in the interest of economic growth. There have been serious and workable solutions to the housing overhang, but they would require banks recognizing the pain and creating a "housing appreciation note." Such a vehicle would mean the possibility of the bank being made whole at some point in the future, but also of recognizing the diminished current value while trying to clear the logjam.

Rather like my wife saying to me, "you are never sick BECAUSE you never go to the doctor!" It is a system that has focused more on emergency triage than well banking care.

Emerged Markets

2010-03-31T11:07:00.004-04:00

For the past decade the emerging market investment theme has been the most compelling long term. Traditionally the lesser developed nations have depended on export of raw materials and labor cost arbitrage. You can still build a computer more cheaply in India than in San Francisco and South African chrome, indonesian rubber jamaican bauxite still live or die with the general state of global industrial demand. Other things have changed however.

The less established political and legal framework of these erstwhile backwaters has long been an impediment to structural stability of the likes of the U.S., Europe and Japan. But now the history of IMF life support to nations in fiscal and monetary disarray is no longer the standard. It is now the developed nations which are looking like banana republics with unfunded spending and economic policies that seem set upon shifting sand.

The compelling demographics have been clearly visible for many years. The populations of the underdeveloped nations are younger and growing richer even if only by living standards much lower than our own. But the man who buys one refrigerator after a life of none or increases his caloric intake from subsistence levels to a healthier diet is of increasing global impact.

The financial data coming out of the IMF regarding the emerging markets is compelling, particularly when put next to that of the developed economy.

While we in the "industrial" economies groan under current account deficits the IMF reports the emerging markets had a current account surplus of $355 billion, forecast to grow to $550 billion this year. The developed markets have a deficit of $262 billion forecast to decline to $161 billion in 2010.

Emerging markets had GDP growth of 1.7% in 2009 and forecast to increase to 5.1% in 2010. Advanced economies had GDP contraction of 3.4% in 2009 forecast to grow 1.3% in 2010.

Emerging nations had gross national savings rates of 33% in 2009 while developed nations had aggregate savings of 17% in 2009.

The combination of cyclical and secular factors indicate a comfort with an increased allocation to emerging market is warranted including fixed income instruments. The inflation rates of emerging markets have long been where the wheels fell off. While forecast inflation in the aggregate emerging markets is higher than in the developed nations where deflation has taken hold, higher but declining inflation as forecast would not threaten bondholders excessively.

John Barnyak

Bob Farrell on the Mountain

2010-03-30T20:05:00.004-04:00

Bob Farrell's Top Ten Market Rules

Bob Farrell was the Chief Stock Market Analyst at Merrill Lynch for 25 years and retired in 1992. The list below has been reprinted and repeated so often because it captures the human element of investing.

1. Markets tend to return to the mean over time.

2. Excesses in one direction will lead to an opposite excess in the other direction.

3. There are no new eras -- excesses are never permanent. (This time it's different)

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways. (The market can remain irrational longer than you can remain solvent)

5. The public buys the most at the top and the least at the bottom. (buying sizzle, not steak)

6. Fear and greed are stronger than long-term resolve.

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.

8. Bear markets have three stages -- sharp down, reflexive rebound and a drawn-out fundamental downtrend.

9. When all the experts and forecasts agree -- something else is going to happen.

10. Bull markets are more fun than bear markets.

The Last Real Estate Boom

2010-03-30T15:42:00.004-04:00

A generation ago there was a real estate boom and bust on the other side of the globe not so different than the one we have just experienced. On the last business day of 1989 the Nikkei reached 38,957. Today it sits at 11,097, less than one third the level of that day twenty years ago. Does that mean that U.S. markets will follow? According to Mark Twain, history doesn't repeat itself, but it rhymes.

The wildly excessive speculation in real estate was the catalyst to a still deeply ingrained deflationary economy and slow growth in Japan which is now entering the third decade. Unlike the typical US post WWII recession, Japan's lingering state of affairs was a credit and banking crisis. Rather than deal with the destruction of capital loaned, the bank instead kept assets on the books which were badly impaired and never to return. To confront the crisis honestly and accurately would have brought about the recognizable insolvency of the banking system. Instead it was papered over. It is at that time that we were introduced to the term "zombie banks."

(click on image to expand)

The unwillingness to treat the banks according to market rules rather than political expedience will prolong the pain, not remove the dysfunctional.

The chart above is intended not to predict the future of our own market, but to serve as an illustration of what CAN happen. The similarities are too many and the performance too similar to ignore.

“Before I draw nearer to that stone to which you point,” said Scrooge, “answer me one question. Are these the shadows of the things that Will be, or are they shadows of things that May be, only?”

Still the Ghost pointed downward to the grave by which it stood.

“Men’s courses will foreshadow certain ends, to which, if persevered in, they must lead,” said Scrooge. “But if the courses be departed from, the ends will change. Say it is thus with what you show me!”

John Barnyak

The Trend Is Your Friend.....sorta

2010-03-30T14:10:00.006-04:00

For many the investment experience which sticks in our minds as the "norm" is the 1980's and 90's when people were checking their IRA accounts twice a day and celebrating their investment skills. The fact that the broad market was up 1000% during the period was apparently incidental to our brilliance.

One of my favorite pictures for a 30,000 ft look at the markets has long been the Rydex Historical Trend chart. For a good perspective of stock market behavior, 113 years ought to give us something usable. Regardless of the alternating cheerleading and lamentations of Money Magazine, Bloomberg and dozens of other pundits, historical precedent is not found between station breaks.

Secular markets, that is, long term markets, are born of fundamental change. This could be a change in interest rates, changes in inflation expectations or demographics or valuation. Secular markets are not overnight sensations but rather long plodding affairs both upward and down.

Back in the late 90's I doubt there was not a retail adviser who didn't tell a client, "it's not timing the market, it's time IN the market." Since about the time that aphorism was hitting its high water mark, market buy and holders have lost just a bit less than 5% in the past decade.

When the investment advertising budgets reach fever pitch listen for those idioms, they are a canary in the coal mine.

(Click on image to increase size)

Given the current valuations on longer term historical averages and the challenges still confronting global economies I wouldn't be looking for the next upward glide path to start anytime too soon. And if you weren't IN the market last year be patient, and if you WERE in the market, moving to more a defensive stance would be prudent.

John Barnyak

Mortgage Modification Program - Audio

2010-03-30T05:57:00.003-04:00

Barry Ritholtz has been ahead of the curve over recent years. Hear what he thinks about the new mortgage modification program.

The Fox and the Price of a Chicken Dinner

2010-03-29T12:03:00.016-04:00

In looking at markets and economies there are really a number of subjects which although interconnected are not moving in lockstep. The fear of two years ago that the financial system was on the precipice of Armageddon has abated. Whether that sanguine attitude is justified is another issue.

The palpable fear of the autumn of 2008 was clearly lessened. The eyes fixed on the coming tsunami have adjusted their gaze. Although the impending violence of the imminent implosion has passed, have the deep and stiller waters receded? I think not. The underlying issues of nonfeasance still exist. There is no more oversight into the activities financial institutions and risk assets than before.

Derivatives, what Warren Buffet called the “financial weapons of mass destruction” are still without serious oversight. The Commodity Futures Modernization Act of 2000 (CFMA), mandated that derivatives were completely exempt from ALL regulation. Whether it was Collateralized Debt Obligations (CDOs) or Credit Default Swaps (CDSs) that single act required that the fox run the chicken coop. How? The CFMA mandated it. No supervision was allowed, no reserve requirements for potential future payouts were mandated, no exchange listing requirements were put into effect, all capital minimums were legally ignored, there was no required disclosures of counter-parties. Derivatives were treated differently from every other financial asset — stocks, bonds, options, futures. They were uniquely unregulated. (And we rail about welfare to the poor?!) Our grade for dealing with the systemic problems that was the Petri dish of the breakdown is a “D.”

The second stool leg would be the investment markets. Clearly the blast off from a year ago to the current stock market levels has been impressive. It has fueled a collective sigh of relief while 75% of the public missed it. While the gnomes of Wall Street enjoyed trillions of dollars of investment liquidity, bailout funding and friendly accounting standards those on Main Street continued to focus on unemployment, diminished retirement funding by employers and fiscal panic in local economies.

This has been a trader’s market with the mantra, “the trend is your friend,” leading the charge. Our grade for market evolution over the past year is clearly a resounding “A”. The market is telling us that the economy is right behind and ready to swing into action creating jobs and profits in a typical post war recession recovery.

The final issue is value. Separating the idea of price from that of value is difficult. Ask those in the hot housing markets of the early part of the last decade. Real estate was priced at the last sale plus a profit. In most markets it delinked from such value parameters as the rental market or the cost of materials. The sky was the limit and living (and lending) was easy.

Today the stock market is again delinking from traditional historical valuation measures. With the exception of the period from 1997 and 2007 the cost of “the market” is back in bubble territory. But it is hard to be analytically cold blooded when the streets are running with soup instead of blood.

Economists are forecasting modest growth of the next several years. Although corporate earnings generally grow more quickly than the economy coming out of a recession, the aggressive forecasted earnings growth is utterly detached from historical precedent. Equity analysts are expecting earnings to grow 25% in 2010, 20% in 2011 and 14% in 2012.

Corporate sales are forecast to 5.5% this year and 7% next year which will mean record profit margins. If we assume that corporate profit margins reach unprecedented levels, the market is already at a valuation far above the norm. If profit margins revert to more historical average levels of slightly above 6% instead of the projected 10% the market would be VERY overvalued at the current level.

Regardless of mood and sentiment and trend, this is not a time to underestimate risk in investment markets.

John Barnyak
Stonehouse Asset Management

Over Bought

2010-03-25T14:11:00.003-04:00

After the debacle of 2008 the rebound in 2009 of the stock market feels to many like a resumption of business as usual on the inexorable path upward. Unfortunately once the human feel-better psychology and sentiment is peeled back we are again in on of the most over bought, over valued markets ever.

In 2007, prior to the market collapse, stocks were an extreme valuation with rich valuation multiples measured with inflated, abnormal profit margins. With investor belief that 2007 represented a norm forecasting a decline to more historically attractive levels presents a significant challenge. However for the true investor (as opposed to speculator/trader) the market risk is not worth taking when measured against a reasonable sustainable outcome. The combination of valuation, market psychology and action should not entice fresh money off of the sidelines and currently invested money should remain defensive.

We have lived from bubble to bubble for quite some time and are conditioned to expect the next bubble to be profitable and benign. Much like the tech and housing bubbles before?

The challenge for investors now is to have patience to an extent anathema to our CNBC conditioned primitive brains.

John Barnyak
Stonehouse Asset Management

Duct Tape and String

2010-03-25T10:02:00.004-04:00

Sometimes things hold together for the damnedest reasons. I had a silver Rambler that continued running because of a piece of rusty wire I found on the New York Thruway. I was not just relieved, I was proud. Broken down in the middle of nowhere and in a McGiver moment I had us back up and running. Sounds rather like Ben Bernanke and the economy. It's running, but won't pass inspection, but damn weren't we clever to avert catastrophe?

Like Silver Cloud, that Rambler's unlikely name, eventually that rusty wire will give up the ghost but hopefully we'll limp to a safe destination and really fix it. Unlike Silver Cloud we can't scrap the economy for a new one, although god knows, it seems like we could get more easily get financing for a trillion than a new clunker.

FASB, the accounting standards board continues to allow banks "substantial discretion" in valuing their assets. But a financial system without a clear standard for valuing assets if impaired. Currently unless a debt is in foreclosure, it appears banks are reluctant to modify mortgages or restate delinquencies in order to obscure valuations.

This development is exactly how Japan became a stagnant economy for the past twenty years with constrained lending activity and business growth. The unusual and growing gap between delinquencies and foreclosures indicates an increasing need for resolution. As we are progressing now, zombie banks will continue to operate at public expense while performing their function as lenders to private endeavors suboptimally.

The accounting industry needs to force greater disclosure discipline on the banks, however following the recent revelations about Ernst & Young and Lehman Brothers that may be too much to expect. Until things are fixed right, it's anyone's guess when we will again grind to a halt.

John Barnyak
Stonehouse Asset Management

Recognition Phase

2010-03-16T11:13:00.003-04:00

The most significant damage done in markets often happens in the recognition phase. That moment when reality and optimism diverge. As I see the reality I can't help thinking of the apocryphal tale of General George Custer shouting above the din of battle, "Take no prisoners!" Looking across the spectrum of the economy Ben Bernanke might feel similar.

Using fundamental measures of market value, from 1929 until the late 1990's, the market has carried a higher valuation only twice. In late 1972 prior to a two year 50% decline and in summer of 1987 before the market plummeted in the autumn.

Anyone who has read Bringing Down the House, the story of the MIT blackjack "team", knows when the odds are good you pull up a seat at the table and when they are not, you walk away. If the fundamentals of valuation look iffy, what could drive the speculative values higher? The monetary stimulus of the Obama package can hardly be replicated in 2010. The consumer driven economy will be lackluster at best with high levels of unemployment and constrained consumer credit. The outsized gains in the market during 2009 have already discounted a normal recovery a couple years into the future. This is not a normal recovery and a couple years in the future, is just that, somewhere over the horizon.

The chart above shows what more than a decade of buy and hold has down for investors. What was it good for? Absolutely nothin'.

John Barnyak
Stonehouse Asset Management

"Custer,was a man of boundless confidence in himself and great faith in his lucky star."

The Wizard of Wall Street

2010-03-15T15:18:00.003-04:00

Much like in Oz, the closer one gets to the seat of power the more bombastic the dialogue becomes and the more smoke filled the room. "Pay no attention to the man behind the curtain!" Do not pull back the drapes lest the origin of the booming voice and stentorian tones is discovered to be a charlatan at worst or more likely hopeful and biased.

My continued skepticism about the economic recovery and remarkable market drive of the past twelve months is grounded in the fact that the United States is an economy based on consumer spending. Approximately 70% of our economy is consumer driven and based on income, dissaving and debt. All of these factors have been, and continue to be severely constrained. Unemployment and underemployment is about 16%. Saving rates are rising back toward historical levels up from negative numbers. Finally, credit has fallen at dramatic rates as banks seek to repair their balance sheets and become solvent. This is a view. Let's look at the raw data that brought the financial writers to their collective feet last week to cheer.

The headline is that retail sales rose by a surprising, seasonally adjusted, 0.3% in February. One of the wizard's wands is the seasonal adjustment. It is a useful tool but can also be an obscuring one. To compare apples with apples let's look at how February normally behaves using the raw data. Eliminating the seasonal adjustment, sales actually declined by 1.6% from the previous month, rather than rose by 0.3%. This in and of itself is not meaningful. However the unadjusted sales when compared with each February over the past decade is not very promising. On average February unadjusted retail sales are down by 0.4% month to month. So compared with the past ten years of Februaries, sales were down 4x normal.

Pulling the numbers apart yet further, retail sales are equal to January 2006. The population is higher by 4.3% and sales are not. If we throw inflation into the mix, sales on a per capita basis are down to 1996 levels. Don't get me wrong. I don't see anything wrong with steady inflation adjusted per capita spending and I expect it to fall longer term as we move back to a sustainable spending level. But it does tell us that productivity gains have been illusion.

Stay cautious.

John Barnyak
Stonehouse Asset Management

Creative Accountants

2010-03-12T13:04:00.003-05:00

For years a famous line from Shakespeare's historical play King Henry VI has been usefully been taken out of context. I confess I have enjoyed twisting its original meaning to support an argument. The intent of that line was to state that without guardians of independent thinking chaos would ensue and the speaker, Jack Cade, pretender to the throne would like just that. But, "the first thing we do, let's kill all the lawyers".

Today's reading of the independent review of the Lehman Brothers bankruptcy brought those words to mind with a small twist. "Let's kill all the accountants!" The report on the event and the factors leading up to it does not put their accountants, Ernst and Young in a very favorable light. In fact it seems to me that E&Y is in danger of following Arthur Anderson into the sunset as they did post Enron.

E&Y was culpable of non disclosure of material information about the balance sheet. They were aware of and chose to remain silent on creative accounting by Lehman. If Enron was enough to take AA down, Lehman is much bigger. With E&Y's knowledge Lehman was moving tens of billions of assets off the balance sheet in a overnight cash transaction intended solely to give the appearance of greater liquidity than existed at quarter end. "Repo 105" was intended to do one thing, deceive shareholders and creditors into keeping faith in Lehman's solvency. Ernst and Young signed off on the financials as true and accurate representations of the state of Lehman's financial state. They knew that to be untrue as billions of dollars assets left and billions in cash came in overnight to tart up the books.

From Enron to Parmalat to Lehman it appears when push comes to shove outside accountants provide no value. Management generally dislikes the cost of outside audits running into the millions of dollars and investors receive no value in terms of adequate and honest disclosure of the state of a company. Let the vested interests outside of the company provide the audit function because those on the inside are sitting at the table with the dealer they have chosen. The rest of us? If you can't tell who the sucker is at the table, it's you.

John Barnyak
President

Poof it's gone!

What's in Your Wallet?

2010-03-11T15:39:00.010-05:00

Based on surveys by the American Association of Individual Investors (AAII) and the Investment Company Institute (ICI) the answer to the above question is either, still a little, or not much. The AAII surveys individual investors who have been less convinced that the coast is clear or are still licking their wounds from 2008. That group is currently sitting with a liquidity stash that is just about in the middle of the range as far as % allocation to cash. In other words neither dramatically excessively liquid or illiquid. As each uptick pains the remaining cash off the sidelines the upside is limited as is the downside risk at the moment. My concern with the data is that the time frame is again limited to the period beginning only with the 1980's when a new secular bull market was evolving

(click to expand)

On the institutional side of things, as surveyed by the ICI tells a slightly different story, but consistent with the theme of the past year of institutions in the market and individuals out. Portfolio managers have been so worried about missing up moves in the market and thereby lagging their benchmarks they have decreased cash holdings to less than 4% from nearly 6% last year. This is the largest decline in 19 years. It does beg the question of how much the thumb of government was on the scale in 2009. This cash level ties for the lowest level of cash in twenty years, matching the levels of 2007 before the markets turned southward. Conversely corporate bond fund managers are holding cash positions at the high end of the range of the past two decades.

Government liquidity goosed the market last year in 2009. Where will liquidity come from this year as the government faces strong resistance to further deficit spending?

John Barnyak
President

No Harm No Foul...no gain

2010-03-11T14:42:00.004-05:00

While the 80's and 90's were "mainlining" stock market investments, the 00's have been mid-lining those indexes. A period of at best, consolidation is in the stars.

John Barnyak
President

Much ado about nothing

2010-03-11T11:08:00.003-05:00

If we look back twelve years to the first financial industry bailout, Long Term Capital Management (LTCM), it really is quite like Disney's Magic Mountain. Full of swoops and climbs but getting out pretty much exactly where we started.

Dave Rosenberg of Gluskin Sheff makes the following points with a 30,000 ft perspective on the markets. When we look at the last 12 years, dating back to LTCM and the bailout that ensued, we have endured a 60% rally, followed by a 50% selloff, followed by a 100% rally, followed by a 60% selloff, followed by a 70% rally. Over 12 years the Dow is up about 10 percent, or less than one percent per year. But wasn't it fun to celebrate and commiserate and pontificate for the last decade?

The equity market is basically flat for a buy-and-hold investor. The really important lesson though is that this is a great case for active portfolio management, also a lesson that investors will not lose out by going long after a 50% collapse from the high; nor are they likely to feel much pain from selling into a 70% rally from the low. Chasing performance at this juncture is probably unwise.

John Barnyak
President

All the Way Baby!

2010-03-10T15:28:00.003-05:00

One of the things I noted early in my career, at the time with a large natural resources company, was that graphs tended to go in one direction. If the market was poor it was forecast to go down continually, if it was good it went to heaven. Being optimists with billion dollar investments, when it was beginning to turn down, it was forecast to bounce back shortly.

Investment professionals are no different. There is a habit of expectations based on the extrapolation of the short term past. The fact that those extrapolations are at odds with historical relationships often is dismissed.

Over the past thirteen years, the S&P 500 has underperformed Treasury bills. "Investors" ignored valuations in the late 90's and let them again rise to unsustainable levels in 2004-2007. Unfortunately we are again at a high valuation.

As the accounting standards has gotten more stringent, we should begin to see with greater clarity the true state of corporate affairs in the banking sector. This greater clarity should make investment decisions more rational.

Stay tuned the next couple months are critical although I expect policymakers to continue to kick the can down the road to avoid dealing with the issues.

John Barnyak

A Sacred Cow

2010-03-08T11:09:00.011-05:00

I confess I have been waiting for the first mainstream rumblings to arise about the issue of home ownership in the U.S. Certainly for as long as we can remember the home as castle has permeated the psyche of Americans. I think Professor Shiller's editorial in yesterday's NY Times may be the edge of the wedge for a future national debate. I personally doubt that the mortgage deduction, long taken for granted will survive. The subsidization of home purchases provided through taxes has been a trickle up affair from renters to more affluent homeowners. It should be a long and heated battle.

What say the readers?

John Barnyak
Stonehouse Asset Management

Mom, Apple Pie and Mortgages

By ROBERT J. SHILLER

Published: March 5, 2010

FOR decades, the federal government has subsidized housing — particularly owner-occupied housing. This has been especially true during the continuing financial crisis, with Fannie Mae, Freddie Mac and the Federal Housing Administration propping up the housing market by issuing guarantees for investors on most new mortgages.

But what is the long-term justification for putting taxpayers on the line to subsidize homeownership? Is this nothing more than a sacred cow in American society — a political necessity because so many voters own homes and are mindful of their resale value?

In fact, there is much more to the history of subsidizing housing. While the crisis in the housing market shows that our current approach is far from perfect, there is a certain wisdom behind it, related not only to economic stimulus but also to the preservation of a sense of national identity. It’s important to remember this as we consider re-engineering our institutions as the crisis ebbs.

Federal subsidies for housing essentially began in the Great Depression with, among other things, the creation of the F.H.A. in 1934 and Fannie Mae in 1938. It all started for a simple reason: more than a third of all the unemployed were identified, directly or indirectly, with the building trades. At the time, there seemed to be no way to reduce unemployment without stimulating housing, and much the same is true today.

But consider what will happen once the economy is again operating at full capacity. Basic economics tells us that when Americans, over all, spend more on housing, they must ultimately spend less on something else. Why should housing consumption be better than other consumption, or investments that people might choose?

This time, the best answer isn’t found in traditional economics but rather in American culture: a long-standing feeling that owning homes in healthy communities is connected to individual liberties that embody our national identity. Historically, homeownership has been associated with freedom, while renting — often in tenements or mill villages — has been linked to the oppression of a landlord.

In his classic 1985 book, “Crabgrass Frontier,” Kenneth T. Jackson of Columbia University delineated the complex train of thought that over the last two centuries has produced the American belief that homeownership encourages pride and good citizenship and, ultimately, preservation of liberty. These attitudes are enduring.

Back in 1899, in “The Theory of the Leisure Class,” Thorstein Veblen described homeownership, particularly of large and expensive dwellings, as “conspicuous consumption.” By that, he meant that it was undertaken substantially for the purpose of impressing others by showing the amount of money one can afford to waste on space one doesn’t need.

What is specifically American here — though it’s increasingly seen in other countries, too — may be the modern sense of equal citizenship, engendered by the illusion that we can sustain conspicuous housing consumption even among a majority of the people.

In short, this all has a great deal to do with culture, and little to do with financial wisdom. After all, financial theory suggests that people should not own their own homes, at least not in the way that many do today. A cardinal tenet is that people should diversify — meaning they shouldn’t put nearly all of their financial eggs in one basket, which is what homeownership now means for so many people.

American mortgage institutions encourage people to take a leveraged position in the real estate market, which is quite risky because home prices can and do decline, as we have learned so painfully. Leverage a risky investment 10 to 1 and you can expect trouble — and we have plenty of it today. More than 16 million homeowners owe more on their mortgages than their homes are worth, according to Mark Zandi of Economy.com.

If we choose to keep subsidizing individual homeownership, we must also commit to adding safeguards so that homeowners are less financially vulnerable. Of course, that will require some creative finance.

But first, we should rethink the idea of renting, which could be a viable option for many more Americans and needn’t endanger the traditional values of individual liberty and good citizenship.

Switzerland, for example, is a country with strong patriotism, a fighting spirit of national defense, a commitment to freedom and tolerance, and a low crime rate. Yet its homeownership rate is just 34.6 percent, versus 66.2 percent for the United States, according to the two countries’ 2000 censuses.

Swiss national identity doesn’t depend on homeownership. Instead, Riccarda Torriani, a historian at the Swiss Federal Department of Foreign Affairs, links the country’s sense of identity to such things as its system of direct democracy, which enforces popular participation in government; the idea that its citizens are frontier people (living in or near the rugged Alps); and a history of collective courage in defense of freedom, even when outnumbered.

BUT America isn’t Switzerland. Our values and habits of thought are very different. Moreover, our homes are largely scattered in vast suburbs, often with distinct features. If many of these homes needed to be converted to rental units, home prices might well drop.

A stock of apartment buildings in central cities, of course, makes rental management much easier. This is true in Switzerland, as well as in American cities like New York, which aren’t typical of the rest of the United States. We need to consider a gradual transition toward new kinds of housing finance institutions — entities that may lead us to a different kind of housing, yet preserve our core values. Although such innovation isn’t likely to end subsidies, it should refocus them on enhancing the qualities of life that we really value.

We need to invent financial institutions that take into account the kinds of communities we want to build. And we need to base this innovation on an approach to economics that captures the richness of human experience — and not on efficient-market economics, which disregards human psychology and assumes that our basic institutions are already perfect.

Robert J. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC.

From GARP to SIRP

2010-03-04T12:05:00.003-05:00

With so much of the economy's health and direction dependent on people actually working, buying and paying taxes, it remains difficult to get too excited about our prospects.

This morning the headline was that layoff data for February reached a four year low. According to the Challenger analysis layoff announcements fell to 42,090 for the month. The ADP report showed job losses of 20,000 but government numbers released on Friday will likely be somewhat worse because of the methodology. ADP counts employees who worked no hours during the survey week as employed while the Bureau of Labor Statistics counts non-working employees as unemployed. The flattening of the slope of decline is certainly encouraging but what awaits across the recessionary valley remains very challenging.

Assuming employment cannot logically go to zero, the stabilizing is a modest light at the end of the tunnel. During the tepid economic recovery we have continued to lose jobs with over 1 million lost during the recovery period. Since the recession began the loss of jobs has reached 8.4 million. The workforce today is the same as in 1999 with both a larger economy and population. Depending on one's perspective, we are either wonderfully productive or woefully underemployed.

Total unemployment and underemployment is close to 17% and 40% of the unemployed have been without work for over six months. These are depression like figures. The U.S. economy is 12 million jobs below full employment. Estimates of time until we reach previous levels of full employment range from 5 to 10 years. Against that backdrop we would continue to expect to see a deflationary investment theme. The threats to that view would be from the public sector debt should policy begin to monetize debt, significantly weaken the dollar and become less attractive to foreign buyers of US treasury debt. All of those are possible.

The investment theme will continue to be safety and income at a reasonable price (SIRP), a far cry from the growth at a reasonable price (GARP) investment tune of not so long ago.

John Barnyak
Stonehouse Asset Management
(412) 849-3723

Natural Gas Outlook ala Credit Suisse

2010-02-24T19:11:00.003-05:00

With such focus in our region of SW Pennsylvania on the Marcellus Shale I include here a brief blurb about the investment bank, Credit Suisse view on natural gas over the next year.

Oil & Gas, Exploration and Production J. Wolff

Q4'09 U.S. Gas Production Showing Up 0.4% Qtr/Qtr

Supply Stabilizes in Q4'09. With 90%+ of our quarterly gas survey now complete, we find that U.S. gas production rose 0.4% qtr/qtr and 1.7% yr/yr.

Recent supply numbers continue to surprise the market in their resiliency given shut-ins in
October and a rig count that was down 51% yr/yr in November. Clearly, we have an incomplete data set that excludes private producers. However, we think our survey is a fairly close proxy. In fact, recent 914 data for November (which is a more exhaustive data set) shows that Lower 48 supply is less than 1% off its peak in February 2009.

Look for Muted Gas Prices. With supply now stabilizing, LNG imports likely to move higher in Q2'10 and drilling activity on the rise, we would look for fairly muted gas prices through 2010. Front-month gas now trades below $5.00 per MMBtu but may find some stability given that coal price parity is close to $5.00 per MMBtu. Our NYMEX outlook remains $5.25 per
MMBtu for 2010 and $6.50 per MMBtu for 2011.

Drilling Activity on the Rise, E&Ps Set to Grow 7% in 2010. The theme from year-end conference calls continues to be rising drilling activity focused on horizontal shale/tight gas plays. In fact, since the July trough the natural gas rig count has risen 34% to 893 from 665. Perhaps more importantly, the horizontal rig count has reached a new high, surging 77% from a
372 rig trough in June to 658 currently. We estimate that independent E&P natural gas production for our coverage universe (16.8 Bcf/d in 2010) is set to grow 6.6% in 2010.

John Barnyak
Stonehouse Asset Management

Parsing the Unemployment Headlines

2010-02-22T12:26:00.003-05:00

Each month, even each week, the financial markets focus on the release of unemployment numbers. Lately each week we again see the nascent green shoots of recovery--don't we? There is no denying that fear had abated in the past year. Corporate earning by the standards of last year are improved. But how much of the breathless optimism is real and how much overblown?

The focus on weekly statistics is largely misplaced. Of course weekly improvement is a precursor to monthly and annual improvements, but the statistical noise and revisions make the number misguiding and volatile. Currently the 4 week moving average of new claims for unemployment is 468,000 which normally means about 80,000 in new monthly job losses. Better, but more indicative of an economy in stabilization than recovery. The temporary surge in census bureau employment should also be considered as less than sustainable employment gains.

What concerns me about the employment outlook is how the various pieces of the puzzle fit (or don't fit) together.

Recently the unemployment percentage fell back below 10%. However the employment number fell more indicating that the participation rate has fallen to the lowest level in a quarter century.
The exodus of discouraged workers from the labor force is unprecedented. The growth of the number employed is lagging the population growth badly. To use this statistical legerdemain to present an improving employment outlook is beyond suspect. If the participation rate were the same as it was in 2000, the unemployment rate would be closer to 13% instead of 10%. Additionally, the share of employed persons who are working full time has also dropped 3% which would accurately reflect an unemployment rate in the mid-teens, not slightly below 10%.

At a time when the economy is weak and government policies are subject to intense scrutiny and discussion, obvious diddling of the numbers does not increase one's faith in the leadership.

John Barnyak
Stonehouse Asset Management

Things I Have Learned

2010-02-09T10:47:00.002-05:00

When powerful forces have vested interests take advice with a grain of salt (if it hasn't all been used on roads around the eastern US this week.)

About six years ago, a client asked what I thought about General Motors bonds. I recall saying they weren't trading very well, but why ask me when others, like Moody's was spending millions on the answer. The bond rating agencies were telling the world things weren't as bad as they appeared.

A year ago, a friend told me she was thinking of buying National City Bank stock. The branch manager and senior management of the bank said the price was far too low and they were one of the best capitalized banks in the country. About a month later, they ceased to exist as PNC bought them before they had to declare bankruptcy.

Whenever we begin a discussion with, "people a lot smarter than I am...." it's a fair bet that those smart people are wrong. The graph above has to put your teeth in edge as words and the market diverged. In the words of Deep Throat in All the President's Men during the Nixon debacle said repeatedly, "follow the money."

When oil was at $150 dollars a barrel, the more Goldman Sachs publicly said it was going to $200 the more convinced I was that we would see $80 before $200.

The Attorney General is suing Bank of America for fraud in the purchase of Merrill Lynch as the state of Merrill was withheld from shareholders.

So trust common sense in your investment dealings. If you can't pay attention, hire someone to pay attention for you, but never give up a healthy portion of skepticism. Even if you're talking to yourself.

John Barnyak
Stonehouse Asset Management

Snow is Falling!!, Sell Snow!!

2010-02-05T12:46:00.001-05:00

Years ago a New Yorker magazine cartoon showed a trader with a phone in each ear looking out the window and yelling, "Snow is falling, sell, sell, sell!"

This is the same urgency one is fed by the likes of CNBC where entertainment is the product, not investing. The markets have fallen a little more than 7% in the past two weeks. That is hardly spirit crushing in a market that rose more than 60% during last year. Or seen another way, a market that is exactly where it was sixteen months ago.....or where it was ten years ago. A year ago, the stock market was where it was thirteen years before. In other words, in the legendary words of Foghorn Leghorn, "Two nothings is nothing! That's mathematics, son! ... Two half nothings is a whole nothing!"

I continue to be of the belief that 2009 was a bear market rally. That view has not been without pain as a too conservative position for clients faded the previous outperformance of portfolios. But our style is risk averse and steady as clients look for long term security more than fleeting short term gains.

The principal caveat that keeps at the forefront of our thinking is the unprecedented employment picture. While in a typical post WWII recession, 24 months after the recession began the economy would be showing +100k monthly gains in employment. This morning the Bureau of Labor Statistics printed a -20k for January.

What particularly keeps me on edge is that in the face of fewer employed, the unemployment rate fell from 10% to 9.7. This fact means yet again the denominator has dropped. The work force continues to contract as longer term unemployed fall of the statistical radar screen and those discouraged and not looking are also not included.

To be sure there is good news in the employment report. The index of aggregate hours worked rose to 33.3hrs per week from 33.2, modest but positive. Backing up to look at the larger demographic picture we find that the number of employed at 129.5 million is exactly where it was in 1999, while the working age population has grown 29 million. 29 million more people competing for the same number of jobs as a decade ago.

Put this in the context of a government policy that held interest rates at zero, injected $2.2 trillion into the economy and incurred deficit fiscal stimulus of 10% of GDP. All that and employment fell nearly 5 million. Mind numbing.

The 2009 Jolt Cola technical rally is about to meet the 2010 technical reality check. The rebound of 50% of the 2007-2009 slide could well see a 50% retrenchment of that rally which would take the dow easily down another 1000 points. At that point the market will have shaken off some of its overvaluation and we would begin to get constructive again.

John Barnyak
Stonehouse Asset Management

Weak Technicals

2010-02-04T14:38:00.003-05:00

Equity indices are losing a technical battle as the S&P has substantially dropped below its 50 day moving average and out of the upward channel established since last March lows. The market has reached an oversold daily condition, but weekly and monthly indicators are still elevated making me suspect short term choppiness at best with a resolution downward.

The past 10 months have been government quadruple espresso as liquidity was created out of thin air in the public and quasi public sector. They are running out of Red Bull the market could give back some more of that binge.

Fundamentally until the employment conditions improve I don't know how to get excited about the market at high valuations. In an economy that is largely consumer dominated the chart below is no all-clear signal.

Click on image to increase size.

Neither employment nor average hourly wages lead one to believe inflation is just around the corner or that the Fed will raise interest rates soon.

John Barnyak
Stonehouse Asset Management

Yet Another Indicator

2010-02-04T14:01:00.002-05:00

We all tend to pontificate a bit more than we need to, but who can resist? But this morning's industry data release from the Distilled Spirits Council of the United States, seems to sum it up perfectly. Americans are drinking more but spending less. Quantity is trumping quality in today's economy. Who says you can't have it both ways?!

John Barnyak
Stonehouse Asset Management

Happy Groundhog Day

2010-02-02T13:11:00.011-05:00

Punxutawny Phil knows its not different. Same thing, different year, and yet the masses are hopeful.

"Our immersion in the details of crises that have arisen over the past eight centuries and in data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that 'this time is different.' That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy."

- This Time is Different (Carmen M. Reinhart and Kenneth Rogoff)

The Reinhart/Rogoff book is one of the stars of the financial books published in 2009 and for students of markets and history it is a good, if at times weighty, read. Much of what we presume to be conventional wisdom is in fact thinking constrained by our relatively short term experience. Reinhart and Rogoff looked back over hundreds of years to find parallels and the McKinsey Group found 32 examples of financial crisis followed by sustained deleveraging such as we are experiencing now. At a time of such uncertainty we are well advised to look at events from 30,000 feet and not from within the maelstrom.

Looking at centuries of debt cycles the Reinhart/Rogoff book reports that on average a country's outstanding debt nearly doubles within three years of the crisis. Unemployment rates on average increase seven percentage points and remain elevated for five years. Finally, once a nation's public debt exceed 90% of GDP economic growth slows by 1%.

Many of the historic models and forecasts being touted this year are based on post WW-II experience which may turn out to be less than useless, even harmful. Trillions of dollars of financial espresso can get the consumer pretty jacked. It doesn't mean necessary that it is sustaining.

Instead of econometric models of the past 40 years an analysis must look for examples, sometimes centuries old for relevant examples of deleveraging economies. Ironically the assets that look less risky now are in the developing nations. That is also where the growth is likely to be found, where the consumer sector is still very young, where national debt levels are low, where reserves are high and trade surpluses abound. The developed world has lost its position as drivers of the global economy.

Each of the developed markets presents its own challenges for investors in both equities and bonds. Japan has its aging population and need for external financing. The U.S. has large deficits and exploding entitlements on the horizon, and Europe faces such disparate members one wonders how it will remain united. Germany the extreme saver and producer while at the other end Spain and Greece are awash with debt.

It's never different, but you may need to be the better part of 100 years old to remember when it looked like this.

John Barnyak
Stonehouse Asset Managment

All Engine No Transmission

2010-01-29T14:56:00.004-05:00

Taken with a grain of salt, this morning the headline read:

WASHINGTON (MarketWatch) -- Coming out of the worst recession in generations, the U.S. economy grew at the fastest pace in six years during the fourth quarter of 2009.

Uh huh. Out the blocks the Dow rose more than 100 points and then reason drifted in. If one assumes the report today to be good news and we are still at this moment trading at a 30 point loss for the day, it is very troubling indeed. Bull markets rise on bad news and bear markets tend to fall on good news. Misleading news? I'm not sure, except that such things eventually come home to roost.

The headline 5.7% quarter on quarter annualized GDP growth looks halfway decent unless one is a economics wonk. Removing the adjustment of inventories to sales to more accurately look at true demand, we get to a lackluster 2.2% annual rate of growth. If we take out the foreign trade sector we find domestic growth of 1.7%.

The massive amounts of monetary and fiscal stimulus would, in a "normal" recession be creating growth over 10% and begs the question, what happens if public debt stimulus fades this year? Aggregate hours worked in the private sector FELL in the fourth quarter, so equating to a 5.7% growth rate stretches credulity. Domestic demand is little more than flat in the end analysis. Is it any wonder that President Obama singled out export growth an economic driver in the future in his State of the Union address? Domestic economic demand for the next few years looks tepid at best. We HAVE to look elsewhere.

What are the investment implications of this call to export arms? (Excuse the unintended pun) In domestic equity investments those companies with substantial export capabilities likely offer better prospects. Secondly, the likely driver of increased exports will be a weaker dollar to enhance international competitiveness. In that vein a longer term perspective on commodities and precious metals should also prove useful. Shorter term the asset bubble that we are once again experiencing, including commodities, may may take a breather in this still substantial deflationary environment.

It will be years before this economic python swallows this debt pig.

John Barnyak
Stonehouse Asset Management

That's another fine mess.....

2010-01-28T16:47:00.004-05:00

Lately, well, more than just lately, I’ve been trying to find value somewhere in any market. Stocks, bonds, commodities, and I don’t see much at all. But I am not alone.

After the Fed has created over a trillion dollars out of thin air, and all asset classes have ramped up, there’s not much left. In a recovery that is almost entirely government based it still doesn’t look like a self sustaining recovery. Much like 2005 to 2007, institutional investors are looking for ways to project earnings adequate to fund pensions at statutory levels.

The State of Wisconsin investment board, responsible for $78 Billion has found their new holy grail. Borrow. Use leverage to pump up returns to keep the wolf away from the door. Wisconsin is adopting a strategy of borrowing from 4% to 20% of the portfolio value to buy fixed income investments.

After becoming disillusioned with the use of hedge funds and illiquid private equity investments pension managers are scurrying to find higher returns in a disturbingly familiar way. This is how bubbles are created. And as we have heard, there is no predicting when they have run their course. The yields available in safe fixed income are too low to provide sufficient returns. So we move back up the risk ladder to find the target return.

Why these managers weren’t leveraging early last year when bonds were priced for value is a mystery. The problem is that the bond market is so vast that this bubble could continue to inflate for a couple more years in a deflationary market. So for yield, corporate bonds provide some of the answer, but with much more risk than a year ago.

Much like 2005/6 when the real estate bubble was about to blow up, global asset allocation is piling into fixed income at the end of a very long secular bull bond market. The allocation of bonds to equities remains underweight. In a deflationary environment for the next couple years bonds are still reasonable and apt to benefit from such activities as Wisconsin’s strategy which will work until it doesn’t. Then it will pop.

Stay balanced and don’t expect any free lunches in this market.

John Barnyak
Stonehouse Asset Management

Tipping Point?

2010-01-26T12:04:00.002-05:00

Sadly it would seem that financial analysis has become so entangled in political analysis it is impossible to do one without the other.

Ten years ago Malcolm Gladwell wrote the popular book, The Tipping Point. A tipping point is an otherwise small event that precipitates a massive social change. I would suggest we may be near such a point.

Over the past eighteen months the world has endured the deepest and most prolonged recession since the 1930’s. The unemployment rate is the highest in a generation, the debt of the country and its citizens is at unprecedented levels and the obligations for the future are being swept under the rug. Yet the market rebounded fabulously last year. All the while the fundamental reasons for the meltdown remained intact and borrowing trillions from the public to give to the private sector was the best that could be come up with.

The item which has galvanized me to again write here is the Supreme Court ruling of last week which clears the way for corporations to exercise their constitutional rights as citizens. Corporations now have the same rights to contribute millions (or billions) to political candidates as you and I. With an election process that continues to see ever increasing cost (price) while seemingly moving further away from coherent debate this seems like a holly stake to the heart of government by the people.

According to Senator Mitch McConnell (R) from Kentucky, "For too long, some in this country have been deprived of full participation in the political process." The statement alone makes me cringe as if by limiting campaign contributions from Exxon or Pfizer or Citibank somehow disenfranchised the individuals managing them. In a nation that increasingly seems to be a ‘one dollar, one vote’ democracy, this court ruling seems to underline all the more emphatically the entwining of politics and our current style of capitalism. Having given countless banks a free pass on insolvency by loosening FASB accounting rules or given sufficient taxpayer capital to them to avoid or delay the impact of horrific business management decisions, we have seemingly moved from Wall Street to Every Street.

Normally in a Supreme Court ruling I find disagreeable, I can see both sides of the argument and play devil’s advocate on either side. However this ruling opens a path for the disenfranchisement of us all. Not since the Court ruled in favor of slavery in the Dred-Scott case has a ruling been so detrimental to the common good and public policy.

I wonder, could this be a tipping point, one way or another? As one client said, just how much more will the people accept?

John Barnyak
Stonehouse Asset Management

Color Me Puzzled

2009-11-18T14:39:00.003-05:00

Never before have I seen and heard such a disparity of opinion and certainty as in the current economic and investment arena. The economists are generally glum and fact based. The sell side investment wags are buoyant and perky. The Chief Investment Officer of one investment house stated, "we feel like this market still has some room to move higher. We're still at levels that are lower than we were before Lehman Brothers. We are vastly better off than we were then."

God help us if this gentleman should ever think we are not doing vastly better. Since the time of the Lehman collapse things have improved as follows:

We have lost 6.2 million jobs

The unemployment rate is 10.2% versus 6.2%

Real GDP is down 3%

Housing starts are down 30%

Auto sales are down 23%

Bank Credit has contracted 8% or $500 billion

Household net worth has declined $7 Trillion

Home Prices are down an average of 10%

Office vacancy rates are up 3.5% to 17.2%

Apartment vacancy rates are up to 11.1%

Consumer confidence is down 11 points to 47.7.

The U.S. budget deficit has tripled on the back of a government engineered "recovery".

Never has a market recovery been so powerfully driven by deflating employment, credit, wages and rents.

The macroeconomic challenges of our country are daunting and fundamentals are out the window as ad hoc solutions are pulled out one after another. Seems like a shell game of trying to buy time for the great and powerful Oz behind the curtain.

John Barnyak

Hats on, Hats off

2009-10-22T11:20:00.003-04:00

With apologies to the Karate Kid, last week the CNBC the staff dusted off their Dow 10000 caps and donned them in celebratory hurrahs. For the 27th time since 1999, the Dow crossed 10,000. Pretty special moment obviously.

I had an aunt who crossed her thirty-fifth birthday almost as often. Some celebrations are more about rolling eyes and making wishes than reality.

(oops, just crossed again, hats off)

(click on image for clearer image)

John Barnyak
Stonehouse Asset Management

Back in the Saddle

2009-10-22T11:02:00.004-04:00

As my wife said to the doctor, "he's says he's never sick. It's because he never goes to the doctor." Sure enough I went, and got sick. I liked my way better. Now I am back to following the markets stressfully and doing all those ridiculous things I've heard rumors of, like eat better, lose weight, get some sleep. Silly things really, but I'm giving them a try.

With that out of the way, let's kick off with the Financial Times takes on banks with a bit of tongue in cheek.

http://www.ft.com/cms/4fe40d1a-07b4-11dd-a922-0000779fd2ac.html?_i_referralObject=10664514&fromSearch=n

The Financial Times video cannot be embedded into the blog, but past the above link in your browser to view.

Cash on the Sidelines

2009-09-08T11:59:00.002-04:00

As in all of the debate about investing and economics, conventional wisdom is the most intriguing to me. Repeat something often enough and it can become self fulfilling. Frankly I see nothing wrong with self fulfillment and if I thought it worked I would be repeating all sorts of things until they became true.

This week Liz Ann Sonders, Schwab's Chief Market strategist, who has been quietly one of the better economists in recent years, noted in her commentary that there is plenty of "money on the sidelines." Last week a friend off mine said the same thing. And CNBC seems to ALWAYS think there is a lot of money on the sidelines.

Last month Merrill Lynch did a survey of 204 fund managers in 80 countries who manage more than half a trillion dollars in assets. The average cash balance is 3.5%, the lowest since July 2007. Equity allocations are the highest since October 2007 and bond allocations the lowest since April 2007.

What will the source of funding be to push the stock market still higher? The big money seems all in already. There seems only one source lately, federal debt with the Fed lending to banks at 0 - 0.25% who then in turn buy treasuries at higher returns. A much safer bet than actually lending to debt ridden citizens without the power of the printing press.

So maybe there IS cash on the sidelines. But it isn't from the usual investment sources.

John Barnyak

Billy Bernanke

2009-08-24T14:27:00.003-04:00

Saint Bill of the grotto of the greenback has been beatified last week. That he performed the canonization on his own in Jackson Hole, Wyoming surrounded by some of the greatest scenery ever created gave it a certain holy gravitas. Herewith, the words of the rites.

“Our forecast is for moderate but positive growth going into next year. We think that by the spring, early next year, that as these credit problems resolve and, as we hope, the housing market begins to find a bottom, that the broader resiliency of the economy, which we are seeing in other areas outside of housing, will take control and will help the economy recover to a more reasonable growth pace.”

Ben Bernanke, Federal Reserve Chairman

The market cheered, the holders of short positions cringed, and the sun shone a little brighter. Wait, there must be a mistake. The keeper of the trillions said those words in 2007. Hmmm.....could it be he is plagiarizing himself. Considering those 2007 sentiments have to be among the least prescient ever uttered by a Fed Chairman maybe we should defer our accolades just a little longer.

I hope like everyone that he is right this time. But maybe first a prayer to Saint Anthony of Padua, the patron saint of lost items, soon to be declared patron saint of 401k's.

The consensus of economists now expect no recession next year. Unfortunately, the consensus has never accurately predicted a recession. So much for that comfort.

Given all the euphoria of last week, I have a feeling the animal spirits are nearing a neutering. It is always dangerous to reach a conclusion in the waning days of summer when junior traders practice and seasoned investors are on Martha's Vineyard or in the Hamptons, but things feel "toppy" and fundamentals no longer support broad valuations as they did in March.

John Barnyak

Watch This!

2009-08-24T13:20:00.002-04:00

Any testosterone enhanced male knows that, "watch this!" are often the last words spoken before a trip to the emergency room. Last week central bankers across the globe were declaring the recession in retreat with the chest thumping certainty reminiscent of the last time I ever stood on a diving board. (yes it ended badly).

Level of consumer spending that gave us giddy investment returns is not likely to return anytime soon, if in our lifetimes. So we should expect sub par growth as personal balance sheets are repaired over the coming years.

The talking head debate now is about the shape of the recovery. "W"? "V"? or my favorite recent description "square root symbol", which is a quick rebound and then a long period of flat activity. One could argue that we are already in the long flat period as the market has gone nowhere (if a rollercoaster can be said to go nowhere) for ten years. Throwing up your hands and squealing with delight and just plain throwing up notwithstanding.

Historically, secular markets, those acting on major underlying economics last a generation. I would argue we are about half way through the current secular bear market and another decade of stumbling is very likely. Japan's Nikkei average last saw its historical high in 1990 at which point wild exuberance and real estate speculation brought market fun to an end. At the time Japan's broad market average was nearing 40,000. Today it is flirting with 10,000 after twenty years. Closer to home, from 1964 to 1981, the Dow Industrials rose an eye popping one point. Seventeen years with no return, excluding dividend yield.

Relative valuations matter. Alternative returns in other assets matter. We live in a different world of volatility encouraged by crazed derivative activity but the long term reality is the same. We remain in a time when giving up opportunity will have less negative impact than giving up capital.

This is an extraordinarily warped market as government intervention plays the tune. The fundamentals come out of Washington now, and as Keynes once said, "the market can remain irrational, longer than I can remain solvent."

John Barnyak

Eeek! Economics!

2009-08-24T10:37:00.002-04:00

The biggest impediment to being right for an economist is the lack of fixation on time. Gary Shilling, Noriel Roubini and Nasem Taleb are all prescient economists who predicted the current deflation.....for years. In other words they were wrong until they were right. That is one of the advantages of being an academic. One can work in relative obscurity apart from occasional snickers during presentations of papers for years until reality turns to agree. Then you are a rock star....until you're not.

My economic based view has been tested the past several months. While being quite confident that March represented a buying opportunity, I have been much less assured since mid year while the market keeps moving higher. While the massive asset price lifting power of billions of public dollars has been demonstrated clearly the hangover that policy will produce has been largely ignored.

What has not changed is the massively important credit and debt aspects of the global economy and the U.S. economy specifically. The US debt to GDP ratio continues to rise with the public debt portion taking over an additional and substantial portion of total debt. Until debt declines we
are simply adding gasoline to the fire and eventually we will burn.

Those who see green shoots assume a typical "V" shaped recovery from a production/consumption recession. This is a credit and debt induced collapse and adding additional debt will not solve the problem. The public injection of capital allowing the banking system to continue to not recognize its insolvency and allow a market clearing event to take place rests on a misguided combination of fear and hope.

Schumpeter's creative destruction has been thwarted allowing zombie institutions to ultimately keep private investment to in check while ironically encouraging, once again, riskier speculation with the knowledge that public money would be made available to bail out failure.

If there is any rationale to the current public policy it is to buy time, keep the population placated and HOPE that a demographic tailwind rights the boat.

The US economy has been +70% driven by consumer spending and negative savings rates over the past 20 years. The is reasonable behaviour that will rekindle that irrationality in the near future.

The baby boom generation has seen its retirement savings decimated. Credit is no longer easily available. Unemployment appears to be structurally elevated for the foreseeable future.

Let's look at the green shoots. Housing. The good news is that there is some activity in housing. The vast majority of that activity is in foreclosure sales. That is in and of itself positive. It clears inventory, and inventory remains very high. Like the Cash for Clunkers program the government tax credit program may pull demand forward into 2009 from 2010.
This is another example of a buying time policy. Which in a normal recession would work well as spending returned. The housing stats reported last week are strong only if listening to spinmeisters. A suspicious increase in Northeast Condo sales was the only data that turned the numbers positive. Single family homes were still weaker.

The growth this past quarter seem largely limited to inventory rebuilding and cost cutting. Again, both positives for economic recovery, but with unemployment high and credit limited is it sustainable? Retail analysts continue to see very low store traffic and increasing pressure on rents by storeowners to landlords. Conversely real estate owners, i.e. landlords are facing severe financing problems of their own. Commercial real estate loans are the 1000 pound gorilla unless we begin to see a re-emergent consumer.

Think of a number and double it

2009-07-10T17:24:00.003-04:00

The below paper written on the mortgage, housing and credit crisis gives one continuing pause. It is why it is very difficult to accept time horizons longer than our experience and why we are emotionally disposed to see recovery around each corner.

T2 July 3

Green Shoot Fatigue

2009-07-10T13:29:00.002-04:00

It's tough fighting against the tide. For several months the popular (i.e. loudest) media spoke of the signs of the rebound. Truthfully, having a more defensive portfolio position started to look a little spooky. The chief strategist for Schwab called being out of the market now, "a career killer." Yeah, I grimaced as she seemed to be looking directly at me.

Anyone who says they know exactly what happens next is either lying or too old to be considered anything but suffering dementia. We have not seen this set of circumstances in our lifetime. It is not a recession in the usual sense of the word. Since World War II, the time period for most historical comparison there has never been a credit based recession. They have been manufacturing recessions for which inventory adjustment and interest rate policy would soon put the ship of state back on course.

This is driven by a lack of available credit. As I see some perfectly reasonably qualified individuals be rejected time and time again for credit one has to consider looking more deeply at the reasons. Based on the anecdotal information it would seem less a question of risk analysis by the banks an inability to lend within the regulatory capital requirements of the lenders.

Anticipation of commercial loan impairment is the fly in the ointment. The $3.5 trillion commercial real estate market could dwarf the residential real estate problems of the recent past. In the next year, about $700 billion will need to be refinanced or significant bankruptcies of shopping centers, hotels and other real estate holdings loom with the subsequent losses and effect on banks.

The argument for end of the recession in a traditional inventory readjustment shows signs of approaching---if only that were the problem. In a cyclical economic environment, we are near a bottom. Currently North American automobile sales are running at a rate of 7.0 million units per year. Production is at a 3.9 million units per year pace. Obviously production of automobiles will have to increase simply to slow the destocking process. The knock on effect to the manufacturing economy should bring some benefit.

The sea anchor to this positive cyclical process is credit system impairment. As long as severe credit headwinds exist, the traditional recession ebb and flow will not play out as we are used to. Despite the popular refusal to say it, we are in an economic depression not a mere recession. It is not the severity that defines this, it is the process of deflationary pressure unseen since the 1930's.

John Barnyak

Our view of CRE exposure has not changed at all, namely that the loss rates in that asset class will be multiples of the record loss rates on residential or RES exposures. Why on earth is the Obama Administration still listening to Tim Geithner and Ben Bernanke on the latest PPIP proposal to buy CMBS at current prices when the cash flows are falling every month? If you look at the yields on bank CRE and then extrapolate to the securitization market where much of the CRE exposure resides, there is no way that the pricing assumptions in the PPIP make sense. Guess we have to wait for T-Day for Obama & Co to wake up and smell the bird burning.

One of the questions I ask my clients is this: How do you think prices for exisiting homes and commercial both will react when the RES and CRE properties now in foreclosure work their way through the courts and come popping out onto the secondary market around Thanksgiving? My firm entered a JV with a very experienced asset management and disposal group earlier this year. The view from the disposal channel is ugly.

Excerpt of article below:

Commercial Real Estate Is a ‘Time Bomb,’ Maloney Says (Update2)

(Adds comments on rebound in third, fifth paragraphs.)

By Dawn Kopecki

July 9 (Bloomberg) — The $3.5 trillion commercial real estate market is a ticking ”time bomb” that may lead to a second wave of losses at large U.S. banks, congressional Joint Economic Committee Chairwoman Carolyn Maloney said.

About $700 billion in commercial mortgages will need to be refinanced before the end of 2010 and ”doing nothing is not an option,” Maloney, a New York Democrat, said at a committee hearing today. This ”looming crisis” may lead to significant losses for banks, force shopping center and hotel owners into bankruptcy, and impede economic recovery, she said.

The response by banks to this ”growing threat has been slow and inadequate,” said James Helsel, a partner at RSR Realtors in Harrisburg, Pennsylvania, and treasurer for the National Association of Realtors. ”The lack of liquidity and banks’ reluctance to extend lending are also becoming apparent in the increasing level of delinquent properties.”

Click the Boob Tube

2009-06-09T09:44:00.002-04:00

I've long ago dismissed the financial talking heads of CNBC and other quasi financial programs as tripe. Now Barry Ritholz one of my favorite analysts has put together a list of shortcomings which all could take to heart.

I personally think it's way to late to fix it and the damage is done. By the time anything serious would be done, technology will probably sending financial news direct to our cerebral cortex.

Barry's List

1. Stop Yelling. Stop interrupting. Stop Talking Over Each Other: This is not Jerry Springer, its serious business. People’s retirement and investments are at stake. Please treat it that way.

2. Bring us People We Don’t Have Access to. What various FinTV channels do really well is when they bring us long, thoughtful interviews with the likes of Warren Buffett, William Ackman, David Einhorn, and others. People we wouldn’t ordinarily have access to. Example: This morning, CNBC had on James Rickard. More of this please.

3. S - L - O - W D - O - W - N

4. Risk: All traders must appreciate the potential downside of trades. So too, must FinTV. Explain stop losses. Understand Risk/Reward. Recognize there are periods when Buy & Hold is a jumbo loser.

5. Lose the Octobox. Fire whoever came up with the Decabox. ‘Nuff said.

6. Separate the Signal from the Noise. Understand that most of the day-to-day action is simply noise. Look at a long term chart, you can barely see 1987 or 9/11. If those major events get lost in the long term trend, what does the intraday jags, kinks and reversals mean? Very little. Recognize that not every data release, slice of news, or rumor is at all significant. Stop treating them as if they were.

7. Fact Check: An awful lot of things on air get stated with authority and confidence. Much of them are little more than junk or pop myths. Why is it that the more dubious a proposition is, the greater the confidence the speaker seems to muster? Consider fact checking as much of the statements that are made on air as possible, and making frequent corrections.

8. Accountability is important: I am astounded at some of the money losing hacks that are various shows again and again. These are the “articulate incompetents” to use Bennett Goodspeed’s phrase. Why not keep track of the records of guests — and let the viewers know how their past few calls have been. Are they Perma-bulls or bears? Are their stock picks awful? Are they reliable money makers? If not, let us know. (Of course, the better question is, if not, why even have them on?)

9. Bring Back Louis Rukeyser: Not the man, but rather, his style. Wall $treet Week — Rukeyser hosted it from 1970 to 2005 — was plain-spoken, thoughtful and accessible. Quiet, contemplative, discussions, with intelligent market participants, revealing helpful information. The investing public would appreciate something of that sort — again.

10. Sound FX: What is with all the bizarre sound effects every time a screen changes? Its financial news, not a video game. Kill ‘em.

11. Embed your video (on your own website or YouTube) instead of using WMP. At long last, thank you.

12. Investigative Pieces: David Faber seems to have a monopoly on deep, long thoughtful analyses. Be they on Wal-Mart, the credit crisis, whatever, his long format work is a highlight of CNBC. More of these, please.

13. Most stock picks are losers. That’s normal, but the audience does not realize this. A big part of the challenge is informing the viewer that finding the biog winners is a low probability, high outcome event. As in a baseball, a 350 hitter is a star. Explain this to your audience.

14. Stop the Bull/Bear Debate: This is a vast over-simplification of the market, and often does not serve the audience well. There are nuances and variables that get lost when you reduce everything to black and white.

15. Partisanship: Leave your personal politics at home. Viewers don’t care what most of you think.

16. Respect the Audience: We are adults. Treat us that way.

Mortgage Chaos

2009-05-29T11:50:00.003-04:00

The government is buying Fannie Mae and Freddie Mac debt to force down yields and stabilize home prices. Could it reach still lower? 3.50%? Perhaps. But if it does it will likely be of extremely short duration as suddenly every mortgage in America will benefit from refinancing. If you haven't done your homework you will likely miss it. So do your homework, be prudent and conservative. If you plan in remaining in your home for more than a few years, this could be a windfall moment when you look back.

That was my view on April 10th and I am sticking with it. Particularly since it turned out to be right. Less than 1/10% from the bottom, I think we won't be seeing those rates again in our lifetimes. C'est la vie.

Unless the fed begins to increase purchase of mortgage backed securities massively that ship has sailed. Mortgage originators have frozen all new applications until they work through the backlog of committed but not closed loans on their books. Below is a letter being sent out by one mortgage originator.

John Barnyak
President
www.stonehouseasset.com

Mixed Messages

2009-05-29T11:31:00.002-04:00

Today the Wall Street Journal reported the fed believes (how's that for second derivative thinking) that the rising interest rates are a function of improvement of the economy. I'm all for that if it's true.

However the falling dollar and rising gold prices indicate fewer "green shoots" and more a reluctance to own dollars, lend to the US at such low returns and a belief that inflation is lurking out there. The green shoot and wilting dollar aren't mutually exclusive, but prompt caution.

John Barnyak
President
www.stonehouseasset.com

Gold in a Deflationary Environment

2009-05-28T18:10:00.002-04:00

One of the more interesting developments on the web is Scribd. A means to publish online documents, even books. The paper below is one I've had in my files for years and dust off now for your perusal.

The Behaviour of Gold Under Deflation

Publish at Scribd or explore others: Finance Business & Law investment Deflation

John Barnyak
President
www.stonehouseasset.com

Gazing at Charts

2009-05-28T13:05:00.005-04:00

Anyone involved in the investment industry knows that technical analysts are the pariahs of the business. My son who in ten days will take his first Chartered Financial Analyst exam already scoffs that technical analysis cannot predict the market future. Jeremy, well duh!

What charts do is describe, in a distilled fashion, the market response to all of the fundamental aspects of the economy. It does not predict, it shows. When in the midst of a maelstrom of information, opinion and pontification stepping back and looking at what a market is doing as it absorbs the information is invaluable.

We have had nearly three months of revisionist aftercasting as the pundits fall over themselves to celebrate "green shoots" and second derivative improvements. I am not privy to the machiavellian cabals of Wall Street and the White House. Interpreting the data which is at best statistically meaningless and at worst massaged ceaselessly for policy reasons is no better than a guess. (click on image to enlarge)

What I see in the S&P 500 market is a bear market doing a cowboy death kick. Not pretty, not quick but inevitable. It isn't unlike the high school horror film where the psychopathic killer is vanquished, everyone hugs and cries in relief, and then the camera pans to the spot where he died. The body is gone. He's still out there!

The recent bounce was powerful and feel good, but when we zoom out it is evident that all trends are not repaired. The market is above the 50 day moving average which was my initial buy indicator in early march, but like any wounded animal, this is when it when it is most dangerous. As this rebound has matured, the volume has dried up and it looks like late comers to the party.

The market short term cycle ebb and flow still shows lower highs and lower lows. Until I see a higher high and high low I will be cautious. In March the oversold chart combined with reasonable market valuations. In May we are now at an overbought condition and no longer attractive value. We went from an A/B market grade (oversold, reasonable value) to now a D/C market (overbought/neutral value). I do not expect to see significant valuation improvement but absent a market breakdown I will be taking a more positive equity position in portfolios on the next oversold condition.

I am hedging modestly to hold recent gains, and formulating the thematic guidelines of the next secular market forces. Following my daily thoughts will give a reader a good idea of those themes.

John Barnyak
President
www.stonehouseasset.com

Woodshed Time For Treasuries

2009-05-27T16:35:00.004-04:00

Wow, in a benign world credit demand pushes interest rates up. This is not a benign world and it looks like lenders to the USA are voting with their feet.
The mortgage refinance market just had the knife put in. It's doubtful THAT will be driving the drivel of second quarter bank reports.

In the past we've seen both stocks and bonds in a bull market. I looks like that linkage may remain but in less favorable fashion. Investors will need to think more broadly to protect and grow capital.

The ten year treasury rate just hit 3.70%. Borrowers tied to variable rates could conceivably be seeing interest costs up nearly 70% since the first of the year. As commercial real estate loans begin to come due to roll over this can't be good. IF credit is available it is likely to be at onerous rates and inflict severe pain on all but the most credit worthy.

John Barnyak
President
www.stonehouseasset.com

Half Full, Half Empty or totally Full of it?

2009-05-27T16:30:00.002-04:00

Yesterday CNBC shrieked all day "Markets Surging!" when the Dow rose 198 Points. Today the Dow retreated 173 points. Silence.

Bond Tsunami

2009-05-27T10:45:00.005-04:00

Worms turn. They don't spin, but they do turn. Something seismic is happening in the bond market and while the world focuses on the equity rebound, bonds are collapsing. Having said that I have become very cautious short term on selling bonds in a hurry. But longer term, this goose is cooked.

The change in the 20+yr US Treasure ETF has had parabolic moves in the past nine months. With the time honored premise that trees don't grow to heaven have things gotten ahead of themselves? While I am a believer still that inflation is ahead of us in a few years the short bond trade is looking crowded.

When it hit the fan last November the Long Bond ETF (TLT) went from 93 to 123 in a month as the market went completely risk averse. Now, TLT is back to 93 as market participants have become less risk averse as well as concerned for the US debt policy.

The short Thirty Year ETF (TBT)is up over 5% in the past month and the Rydex inverse Long Government Bond Fund is up nearly 10%.

Whereas a month ago I was commenting on the Ten Year yield bumping up against 3.00% in my April 29th post, "Dog off the Leash" TNX broke through the yield is now decisively above 3.50%.

The spread between 2 year treasuries and 30 treasuries has never been greater. In normal times this would be a call to profit for the banks as they do what banks do, borrow short and lend long and make money on the difference. But this spread is telling us more.

The recent treasury auctions show foreign central banks buying the two year note, but as one goes further out there is very little interest. The world is giving a mighty thumbs down to the US long term fiscal and monetary policy.

Pay attention, its getting way too interesting.

Next posting - Treasury Inflation Protected Securities

John Barnyak
President
www.stonehouseasset.com

We only owe to ourselves

2009-05-26T14:30:00.002-04:00

The monetization of private debt by the Fed is reaching epic proportions. But as someone said to me recently, we only owe it to ourselves. Indeed. Last week one of the candidates for Japanese prime minister announced, if he is elected he will not buy anymore US$ denominated debt. The Chinese continue to calmly extricate themselves quietly from the US tar baby by buying hard assets and productive manufacturing capacity worldwide and by reaching swap arrangements with Asian trading partners to have debt denominated in remembi. Quite possibly we only owe to ourselves because we are the last suckers left.

Since we only owe it to ourselves, just exactly how do we pay it back? By raising taxes? By devaluing the debt via inflation? By simply canceling it? Ironically growing out of it, which seems to be the current whistling past the graveyard approach, will be much harder as more and more assets focus on debt service and not productive economic activity.

(click to enlarge)

John Barnyak
President

We're here because we're here

2009-05-26T14:00:00.005-04:00

Back in the early 1980's one saturday morning in London I stood in the underground waiting for a train. Up drew a rather time worn carriage, when all others were newer and frankly looked safer. In any event, it stopped, I got on and quickly discovered why it was looking a little long in the tooth. This was one of the saturday football fan cars. The Transport Authority fully expected them to be beaten up, pissed in, graffitied and left for dead when the fans got to Wembley Stadium and I worried the same fate might be mine. Lovely bunch of fans they are. I was in it amidst the relentless singing of the Yobs (backward boys) "we're here because we're here because we're here" to the tune of Auld Lang Syne.

Blame it on whoever you wish, but the chart below seems to be singing the yobo song. We are here because we're here, and it shouldn't come as a great surprise. The whole country acted like a bunch of drunken louts, in suits and with credit.

I expect we may be riding the beat up cars for a while until we've paid for not only for some new ones, but for some beaten up junkers still unpaid.

John Barnyak
President
www.stonehouseasset.com

Case Shiller Quarterly88

2009-05-26T12:36:00.004-04:00

The Case-Shiller house data were released to today. Not a lot of green shoots to be seen. As mentioned previously, investors (the entire country) really need to recalibrate their realities. It isn't easy when one's total experience does not prepare one for the current situation.

It is said to be bright is to learn from one's mistakes, to be genius is to learn from the mistakes of others. How many geniuses are among us since only history can teach us about this economic event. We haven't made these mistakes before.

In the first quarter, annual national housing prices fell 19.1%), quarterly (-7.5%) and monthly (-2.2%) data continue to show prices reverting back towards levels not seen for years.

One of the truths revealed in housing collapse is that a house is not an investment, it is a consumption expense. If one is fortunate enough to have no mortgage and not on the edge of downsizing, trading one abode for another is neither pain nor gain. However in a debt burdened nation of mortgages, the debt on a value of declining value is a huge problem.

It is not always easy to have perspective, particularly in housing. Housing is a cost/price that has generally only gone up in our life times. Unlike most people I have the benefit of living in a house that is more than two hundred years old. In researching the deed and changes in ownership over those years I have seen this very house decline dramatically in price twice in its history. Now perhaps a third time. It doesn't take a genius to see history repeats.

John Barnyak
President
www.stonehouseasset.com

Firmly Fixed on the Past

2009-05-22T15:38:00.008-04:00

Investing is a pursuit fraught with emotion. Euphoria, despair, hope and fear all play a role and much of that is the result of not where we are, but where have been. Unfortunately that is largely irrelevant but the comfort of familiarity has a strong draw.

At my son's graduation last weekend I had a "discussion" of some investment precepts with an extended family member. (why do I let myself go that way!) This individual holds General Motors Bonds and was fixated on the fact that the bond has continued to pay its 6.75% coupon. The fact that the price has fallen from $100 to $5 seemed incidental. Thank god she didn't understand that the current yield is 121% or she'd have bought more. Her rational for buying and then holding the investment eludes me but the sun was shining and it was a beautiful day.

Likewise the investor who has the "$20" stock worth $5 now. "I don't want to sell it at a loss, but I'm out at $20 so I'll break even." WTF? Happily watching it lose 75% of its value, when (if pigs fly) the company finally turns itself around, the stars realign and business is growing THEN you sell it. That piece of paper that says "100 shares" on it has absolutely no memory of the day you bought it. Doesn't know, doesn't care. Get over it.

Lets look at some other stocks that seem to have gotten amnesia even if the holder is still dreaming of what was and must yet come again. (Click on the image to expand)

Microsoft

Intel

Cisco

and the mother of all hope-springs-eternal investors.....JDS Uniphase

Investors holding on to financial and housing stocks should emotionally move on. You can't reblow a bubble and you miss the opportunities elsewhere trying.

John Barnyak
President
www.stonehouseasset.com

Headline - (small print)

2009-05-21T22:26:00.003-04:00

U.S. initial jobless claims fall in latest week

(continuing unemployment claims reach highest level since records have been kept.)

Widen Your Perspectives

2009-05-21T15:57:00.003-04:00

As we flail around in the midst of the most troubled US economy in more than seventy years the focal point of most investors is the stock market. Fed by the likes of CNBC, and hourly updates on the Dow Industrial Average and our equity heavy brokerage statements the stock market is everything. If it goes up things are better. Right? Maybe not, as I watch the US debt burgeon to solve problems created by high risk in the financial backbone of the economy my mind wandered to the Weimar Republic.

In the face of global deflation pressure, the German republic created money at a pace never before seen. As in Weimar Germany, money creation in the U.S. is now being undertaken by a privately-owned central bank, the Federal Reserve; and it is largely being done to settle speculative bets on the books of private banks, without producing anything of value to the economy.

The $12.9 billion in bailout funds funneled through AIG to pay Goldman Sachs for its highly speculative credit default swaps is just one egregious example.To the extent that the money generated by “quantitative easing” is being sucked into the black hole of paying off these speculative derivative bets, we could indeed be on the Weimar road. We have been led to believe that we must prop up a zombie Wall Street banking behemoth because without it we would have no credit system.

Insofar as the word Credit comes from the Latin word for trust, I would suggest that the bailout does the precise opposite of create trust. The lack of credit offered by the banking system seem to verify that we have created money, not credo.

During the money creation of the Weimar republic, the stock market soared. Hundreds and thousands of percent gains showed up in portfolios. But obviously inflation made the gains irrelevant and less.

I am not positing that the U.S. is about to enter into hyperinflation. It is a "Black Swan Event." That is, an unpredictable outcome unexpected by historical knowledge.

In January two Morgan Stanley economist first uttered the word in a report.Could it happen to Europe or the US? Morgan Stanley says possibly yes, under certain conditions.

Firstly, the rapid expansion of the monetary base by the Fed, ECB and BoE would have to continue and feed into a more rapid and sustained expansion of money in the hands of the general public. This we currently do not see

Secondly, Morgan Stanley says governments would have to face difficulties financing their bailout packages and funding their debt. Given the actions of treasury auctions which seem to find bids primarily from the Federal Reserve this would be a yes.

Lastly, public confidence in the government’s ability to service debt without resorting to the printing press would have to disappear, as well as the government’s actual ability to withstand the pressure to do so in the first place. This would seem to me to be the tipping point. If analysis inside the government were to come to the same conclusion, it would be no wonder the "green shoots of recovery" would be trumpeted from the ramparts. Two months ago I noted that the positive spin began as if someone had turned the feel good spigot on.

And while all of the above is an extreme scenario, the Morgan Stanley analysts say:

"…given the size of the current and prospective economic and financial problems, and given the size of the monetary and fiscal stimulus that central banks and governments are throwing at these problems, investors would be well advised not to ignore this tail risk, especially as markets are priced for the opposite outcome of lasting deflation in the next several years. Put differently, we believe that buying some insurance against the black swan event of high inflation or even hyperinflation makes sense and is relatively cheap "

Don't just watch the market, watch your wealth.

John Barnyak
President
www.stonehouseasset.com

Tea Leave Follow Up

2009-05-21T14:08:00.002-04:00

Today we woke to a very interesting bit of news. Now it was the headline that initial jobless claims declined (yawn). It was that S&P was about to lower the rating on UK sovereign debt. Could the US be next? In keeping with this theme and my commentary yesterday the only green on my screen is, short dollar, gold, commodities and short treasury bonds. The macro environment is changing investors must as well.

With the UK Credit outlook lowered to negative from stable looking at the commensurate data for the U.S. is in order.

The premise for the change: debt/GDP will soon pass 100%. In that case the US should be afraid with some estimates for the comparable ratio in the United States at over 370%.

S&P's statment:

The negative outlook reflects Standard & Poor's view that, in light of the challenges to strengthen the tax base and contain public expenditures, the U.K. government debt burden could approach 100% of GDP by 2013 and remain near that level thereafter. The rating could be lowered if we conclude that, following the election, the next government's fiscal consolidation plans are unlikely to put the U.K. debt burden on a secure downward trajectory over the medium term. Conversely, the outlook could be revised back to stable if comprehensive measures are implemented to place the public finances on a sustainable footing, or if fiscal outturns are more benign than we currently anticipate.

First Japan, now the U.K., the pattern is pretty obvious.

John Barnyak
President
www.stonehouseasset.com

Housing Green Shoots, er, Shots?

2009-05-20T16:15:00.004-04:00

Now that we're all sick to death of hearing about "green shoots" of economic recovery I think the truth is actually out. It was Green Shots! Not economic recovery, Lime Jello Shots. I have no other explanation for finding the excitement of recovery in this chart of US housing starts. Sucking down wiggly vodka can be the only reason to find glee here.

Don't worry, a month from now, you'll know you really didn't miss a thing

John Barnyak
President
www.stonehouseasset.com

Listen to the Market

2009-05-20T14:31:00.002-04:00

Although the stock market has had an extraordinary rebound, what are the thematic tendencies we see. The last two months have been an exercise in return to risk and practically anything has been a profitable buy, but some areas are the tea leaves of the future.

We have seen the strongest move in our gold holdings. In the past twenty trading days, the S&P 500 index has risen approximately 4.5% while our gold investments have risen approximately 25%.

Our commodity stock fund and emerging market holding have advanced in the area of 15% over the same period. The other sector above 10% growth has been developed international markets.

At first blush one could reach the conclusion that money is flowing out of the US equity markets on a relative basis. The treasury bond market has sold off modestly in the past month and our negative US dollar investment has been moderately higher. Deeper analysis agrees with the first impression.

On balance I believe the guidance of the market leads one to be more wary of US Dollar denominated assets. The strength of the US dollar has been substantial over the past year but principally because of its position as the continuing global reserve currency and more importantly by the fact that as bad as the US economy has been, other economies, in Europe in particular have been worse.

As global recovery takes place over the next years, the green shoots of globalization will benefit other less debt burdened economies and the US dollar decline, higher interest rates and higher inflation are on the other side of the current deflationary environment.

John Barnyak
President
www.stonehouseasset.com

Now Back to Regularly Scheduled Programming

2009-05-20T12:44:00.006-04:00

Just how high can a dead cat bounce? That is the question most investment managers are asking. The historical strong bounce since the March 6th market low has so many attributes that make caution the theme of the hour.

On a per-share basis, first-quarter earnings on the index came in a tad over $10. With forecasters looking for $40 or a bit higher for the full year, which means the S&P 500 is selling for over 20 times 2009 earnings. That is by no means a bargain or near historical market lows in recessions. The market which was at a reasonable value in early March is no longer so.

Despite the appearance of improving credit conditions, lending is still not flowing. Consumer credit is shrinking rapidly. Commercial Real Estate continues to collapse. Today Saks attempted to raise capital to pay down existing debt. Morgan Stanley floated a bond proposal of approximately $190 Million secured by owned real estate. The market's response was to require 15%. That is hardly a ringing endorsement for loosening credit.

Historically, new bull markets do not begin with the leadership of the sectors which led the bear market down. This rally has been largely the result of a bounce of the trash equity that collapsed, particularly banks and financial firms. It would be unusual that a new bull market would find leadership from the likes of Bank of America and Citigroup such as we have thus far seen.

The rebound of the market has had extraordinary and unusual aspects brought about by the enormous influx of government liquidity and curious market manipulation through futures markets. It has the look of a heavy thumb on the scale. While I expected liquidity would lead the market to regain its footing, I certainly underestimated its extent and effect.

As market bottoms go this one is still quite young, particularly considering the uniquely bad condition of the economy. The dotcom market collapse took more than one year to settle down. We appear to be in about the ninth month of a must more serious credit collapse. I think it reasonable to expect this will take at least as long to stabilize. The press and governmental positive spin has been remarkable and I doubt sustainable without pause.

John Barnyak
President
www.stonehouseasset.com

Passing the Torch

2009-05-20T12:24:00.003-04:00

I spent the past few days blissfully seeing my elder son graduate from college. Walking through the town with him as he moved from person to person, hugging so many friends we'd never met, hearing adulation from teachers and staff I had to keep reminding myself that this WAS the same person who lay on the couch unmoving for days it seemed. The same young man who told me he had joined the army and was to report for basic training in three days after he kept it a secret for months from us. The same son who made it back from Iraq safe and sound. No, this is not the same son I moved into a freshman dormitory. This is a calmer, more mature, self reliant young man. I look forward to getting to know him.

The challenges ahead will be many and different, but he has already faced many and Sunday afternoon was the proof that he could handle them. To paraphrase Yogi Berra, he came to a fork in the road and he took it.

Congratulations son,

Dad

Elizabeth Warren and TARP

2009-05-14T14:56:00.001-04:00

Elizabeth Warren overseer of TARP plan interview on Charlie Rose.

Make an offer he can't refuse

2009-05-14T14:07:00.004-04:00

"I'd hoped that we could come here and reason together. And as a reasonable man I'm willing to do whatever is necessary to find a peaceful solution to this problem." Vito Corleone

This from Bloomberg today:

"The big news from Goldman and Massachusetts Attorney General Martha Coakley this week was a $60 million settlement, under which the investment bank resolved her office’s investigation into its packaging of mortgage securities backed by subprime home loans. Per the usual custom in such accords, Goldman didn’t admit any wrongdoing.

The odd part is that Coakley’s office didn’t accuse Goldman of any wrongdoing, either. It filed no lawsuit. And it made no allegations that Goldman had violated any statutes or rules."

It seems to me there are two possibilities here. Either the state of Massachusetts is shaking down Goldman in a protection money racket. Or the state of Massachusetts is taking hush money. The third, Goldman Sachs is just charitable didn't pass the sniff test.

John Barnyak
President
www.stonehouseasset.com

More Moral Hazard

2009-05-14T13:28:00.004-04:00

All of us have heard the tale of woe from borrowers who find themselves underwater on loans that they probably shouldn't have qualified for in the first place. The rallying cry of libertarians is that they shouldn't have taken on obligations they couldn't handle. While there is truth to that its not that clear cut. Who among us has not said at some point, "well lets give it a shot and see what happens"? Sure its kool-aid, but that's why they make it taste so good.

Today we see a rather extreme example of the misplaced incentive to throw money down a hole. The Yellowstone Club is/was a playground of the ultrawealthy which came unraveled in the financial meltdown and is now in bankruptcy. In a very unusual ruling by the judge a secured loan made by Credit Suisse has been downgraded to true junk. The $375 million first lien loan has been put behind ALL other creditors, included unsecured.

The judges rationale is the utter haphazard lending practice and disregard for risk assessment. CS asked for NO financials or verifications. The judges ruling:

"The only plausible explanation for Credit Suisse's actions is that it was simply driven by the fees it was extracting from the loans it was selling, and letting the chips fall where they may. The only equitable remedy to compensate for Credit Suisse's overreaching and predatory lending practices in this instance is to subordinate Credit Suisse's first lien position to that of CrossHarbor's super-priority debtor-in-possession financing and to subordinate such lien to that of the allowed claims of unsecured creditors."

As long as they could slice and dice and sell the loan through securitization and pocket a nice $7.5 million fee go for it! The judge's ruling speaks volumes of the decreasing tolerance for such behaviour regardless of the contractual aspects. Could common sense be about to devour legal precedent?

John Barnyak
President
www.stonehouseasset.com

Tales of the Unexpected

2009-05-13T16:37:00.003-04:00

With apologies to Roahl Dahl and his collections of short stories titled Tales of the Unexpected, I doubt some of recent financial surprises would have risen to the level of "unexpected", although maybe spooky. Today Bloomberg reported consumers' retail spending unexpectedly dropped in April, "indicating that rising unemployment is prompting consumers to conserve cash."

Another half million people lose their jobs and then, bless their souls, they spend less money. I suspect some out of work real estate writers, (charming fixer upper; cozy eat in kitchen) have been picked up by the financial press. Who wants to buy a bank handyman special? Nothing a lick of paint and some air freshener can't make right.

John Barnyak
President
www.stonehouseasset.com

Don't Be a Yield Hog

2009-05-13T16:06:00.003-04:00

One of the things many investors, particularly older, income oriented ones do is look first at the yield of investments. It is natural to see 8% as better than 4% and count those chickens long before hatching. The piece of the puzzle not on the page is risk. All those synthetic Merrill Lynch preferred shares looked pretty good once. Even the Lehman Brothers money market funds paid a little more than the average. Today we have an extreme example of why 8% is not 4% and why sometimes less is more.

General Motors. I have a friend who accumulated GM bonds for retirement and despite my groans and cautionary nudges held them. Today those 9.4% bonds due in 2021 are paying (excuse me, calculating) 196% yield to maturity. I could eat caviar everyday of retirement on that! I can only wince at her decision.

You have to buy a lot of bonds at 8 cents on the dollar to get much beluga. Of course that 196% is completely illusory and that 8 cents will shortly be 0 cents. The same thing happened in the latter part of last year (though not so dramatically) when a scan of stocks paying dividends over 5% produced a slew of well know companies. Alcoa, Citigroup, PNC, all have cut dividends to reflect cash constraints and market realities. A lot of chickens have crossed the road in the past months and more than a few didn't make it across.

High yield is as much a yellow flag as a semi-annual check so choose carefully.

John Barnyak
President
www.stonehouseasset.com

Pundit Love

2009-05-11T15:48:00.005-04:00

I admit, I've hated this historic rebound in the stock market. Historical events are never exactly predictable and they have a siren's call to join in at just about the wrong time. For better or worse Stonehouse portfolio discipline makes emotion driven action more difficult. A remarkable similarity is found in the in commentary in 2001 by that successful self promoter and motor mouth Jim Cramer and some of the statements of the past week.

A Bull Is Born

By James J. Cramer
Published Nov 19, 2001

Professionals hate this stock market. They think it's overvalued on earnings and going up solely because of the lack of other alternatives. They think it's a roller coaster poised atop a downhill drop, an accident waiting to happen. And they hate that there are no alternatives: Cash brings you next to no return and bonds seem downright dangerous given their skimpy return and monster run.

Individuals hate this stock market, too. They've had it with losses, they're fed up with bad advice from crummy mutual-fund managers, and they're tired of the blue-chip tech stocks they paid hundreds of dollars for that are now worth a fraction of that. Either they've sold everything and turned their back on the market or just decided it isn't worth throwing in good money after bad and started hoping to one day get back within a few dollars of where they got in.

Which is precisely why I think the market is poised to go higher -- perhaps dramatically so. Look how easily it's shrugging off bad news. Last week, after an American Airlines flight crashed in Queens, it barely blinked; traders paused to sell off the usual suspects -- travel and leisure -- and then kept buying. This market might well be a baby bull, conceived in the despair of September 11 and born on September 21, 2001, after the worst sell-off since the Great Depression.

The main reason is simple: Interest rates are lower than they've been in 40 years. And those lower interest rates that allow buyers to finance new cars for nothing,

But for the date, it would not be out of place in today's punditocracy.

May 11, 2009
Published in Marketwatch.com

Gray Emerson Cardiff of Sound Advice has been mulling a major market move for some time. He wrote in his most recent issue, published in April: "As noted in the March issue, we are approaching the cusp of a new SuperCycle,

So what happened to Mr. Cramer's bull? It flirted with the forty week moving average then expired, sending the S&P to a new low, 30% lower, a year later which eventually was tested and retested before proving to be the base from which a bull market could begin. (click on image to enlarge)

Plan your trade, and trade your plan.

John Barnyak
President
www.stonehouseasset.com

Green Shoots or Soylent Green

2009-05-11T11:58:00.003-04:00

One of the all time film cult classics was the futuristic Soylent Green in which a world beset by overpopulation and food shortages depended on the government for nutritional supplement. Without giving away the ending, let is only be said that the government solved both issues in one policy. Who knows how many problems are being solved today with similar sweeping efficiency!

In early march there was a palpable acceleration of feel good data and market action. Two months later we've experienced the sharpest stock market rebound in history on the back of short covering of investments in the worst companies in the economy and Tim Geithner's loose change. The power of sentiment is great and it is important. But some perspective is helpful.

The point of the chart is to illustrate where we were and where we are. Bear market rallies are the most powerful rallies and like when we stop hitting our finger with a hammer, it feels so good.

The leading sector in the rally has been financials. That beleaguered collection of insolvent and powerful companies rode up higher on the fact that the hammering stopped. Given the trillions of loans, guarantees and bailout funds for short sellers it was a good bet the juice was no longer worth the squeeze. For example the short sale of Citigroup at 46 when it fell below its 200 day moving average looked pretty good at $1. The incremental added profit betting on the move to zero wouldn't add much to the game. At about $3/share, the technical analysis indicated a shift in risk to the upside.

What about the economic evidence to support an end to the recession. It remains in the realm of second derivatives. Less bad is the new good. The headline employment data looked good-ish. Here's the good news:

* 539,000 jobs were lost in total vs. 663,00 jobs last month.
* 110,00 construction jobs were lost vs. 126,000 last month.
* 149,000 manufacturing jobs were lost vs. 161,000 last month.
* 269,000 service providing jobs were lost vs. 358,000 last month.
* 47,000 retail trade jobs were lost vs. 48,000 last month.
* 122,000 professional and business services jobs were lost vs. 133,000 last month.
* 15,000 education and health services jobs were added vs. 8,000 added last month.
* 44,000 leisure and hospitality jobs were lost vs. 40,000 last month.
* 72,000 government jobs were added vs. 5,000 lost.

Don't misunderstand, things must get less bad before they are good, but several items give me pause.

The automotive plant closures haven't hit these data yet.

There are approximately 2 million college graduates about to hit the job market.

The Bureau of Labor Statistics has been particularly aggressive in downward revisions a month after initial release. Each month the revision has been greater job loss by between 30,000 and 100,000. So the green shoots are delicate indeed.

The statistical adjustments, which are statistically justifiable, still create obscurity. The Birth/Death adjustment calculates a projected gain or loss of jobs from failing businesses and new businesses. The BLS is assuming the net creation of 226,000 new jobs from new businesses in April.

The government creation of jobs was principally the hiring of census workers for the upcoming census, temporary workers.

I am keeping the vintage champagne corked and chilled still.

John Barnyak
President
www.stonehouseasset.com

More Marcellus Analysis

2009-05-07T18:18:00.002-04:00

For those following the local gas bonanza or bust, depending on your perspective below is an report from Toby Shute of Motley Fool put out this week.

By Toby Shute
updated 4:56 a.m. ET, Fri., May 1, 2009

Range Resources (NYSE: RRC) and Cabot Oil & Gas (NYSE: COG) may call Texas home, but don't let the zip codes fool you. These independent oil and gas shops have deep roots in Appalachia and are feeling right at home in the race to unlock the mighty Marcellus shale.

Range Resources' first operations in the area date back to the 1970s, when predecessor Lomak Petroleum got its start. Cabot, as a spinoff of the eponymous chemical company, goes back over 100 years, to the days when the firm drilled gas wells in order to produce carbon black. Now, what's old is new again, with horizontal drilling and multi-stage fracturing technology breathing new life into the birthplace of the American oil and gas industry.

In case you're still wondering why you should care about the Marcellus, check out these rate of return estimates by Range:

Flat NYMEX Price (per Million BTU) Rate of Return

$7 75%

$6 60%

$5 46%

$4 34%

$3.25 20%

Figures from Range Resources' April 8, 2009 Hart Energy presentation and 2008 Annual Report. Assumed reserves of three to four billion cubic feet equivalent per well, and $3 to $4 million cost per well.

Those are simply killer economics, so long as you've got the right acreage. Considering their quality positions in the play, plus the solid hedges that both firms have in place, Range and Cabot are the envy of many a gas producer today.

Both firms just reported first-quarter earnings this week, so let's see what kind of headway these E&Ps are making, despite the headwinds of low commodity prices. So long as we're looking under the hood, let's also check out the firms' cost structures to make sure they're built for this environment.

Home on the Range
Range, a very technically savvy shop, got an early jump on the Marcellus play, drilling its first well into the formation in 2004. The management addition of Mark Whitley in 2006 really set Range's various horizontal drilling programs in motion. Whitley helped Mitchell Energy (acquired by Devon Energy (NYSE: DVN) earlier this decade) unlock the Godfather of Shale: the Fort Worth Barnett. Range just announced what it believes to be the highest 30-day initial production rate for any Barnett well. Considering that the competition there includes Chesapeake Energy (NYSE: CHK), XTO Energy (NYSE: XTO), and EOG Resources (NYSE: EOG), Whitley is clearly some kind of shale whisperer.

Range exited 2008 with 30 million cubic feet equivalent of daily gas production (Mmcfe/d) from the Marcellus and is looking to roughly triple that rate in 2009. The firm has been punching holes into the Marcellus at a pretty rapid pace -- so much so that the regional infrastructure buildout is hardly keeping pace. Fortunately, Range has found MarkWest Energy Partners (NYSE: MWE) to help it add gas processing and pipeline infrastructure to support this busy program. Cryogenic plants, for example, will help Range to extract more high-valued natural gas liquids from its hydrocarbon stream.

For the first quarter, Range cranked out 416 Mmcfe/d in total, with 82% of that production attributable to natural gas. Price realizations after hedges, which cover 83% of gas production for the balance of the year, came in at $6.62 per thousand cubic feet equivalent (mcfe).

As for cost structure, Range provided, in convenient form, all of the metrics that we need to calculate this. Note that some people prefer to exclude interest or corporate overhead (G&A), but let's be inclusive today. Combine the direct operating expense and production tax figures provided, and you've got $1.15/mcfe. Layer on G&A and interest, and you're looking at $2.36/mcfe. After depletion (DD&A) charges, Range's all-in costs roll in at $4.61, allowing it to net right around two bucks per mcfe of production, pre-tax. Not too shabby!

Cabot crackles
With a foothold in each of the two hottest resource plays in the country right now -- the other being the Haynesville -- Cabot's riding pretty high these days. Despite the hype potential, I do find this firm to be pretty conservatively run. The fact that last year's capital raise was the first since 2001 really grabbed my attention. Excessive equity raises have really turned me off of some of Cabot's competitors.

As far as Marcellus development goes, Cabot is at a slightly earlier stage than Range. The firm's got four horizontal completions under its belt now, with the most recent setting a new high. Having identified the Marcellus as its "most economic program," and with new rigs ordered for the region, Cabot is definitely committed to pushing this play forward.

In the first quarter, Cabot's high-priced hedges helped it achieve significantly higher price realizations than Range, at $7.51/mcf for gas production alone. Liquids appear to bump the overall take to $7.76/mcfe. This higher price allowed Cabot to realize a fatter pre-tax margin than Range, despite what I calculate to be a 10% higher cost structure for the quarter.

Of course, these figures bounce around from quarter to quarter, so keep monitoring these cost trends and hedge positions going forward. While I'm a bit more comfortable with Range as an operator, both of these shale players appear positioned to deliver strong economic returns in a lousy environment for natural gas.

John Barnyak
President
www.stonehouseasset.com

Dickensian World

2009-05-07T10:03:00.002-04:00

"It was the best of times, it was the worst of times." Such timeless words can find fertile soil in the investment world of today. The system will endure. Like it or not, the changes will be incremental, protect the whales and occasionally toss a sprat into the pan. The SEC filing suit against the managers of the Reserve Fund for misleading investors is not a bad thing, if you like your sacrificial lambs small. Reserve was the money market fund that broke the buck and brought the short term commercial paper market to a stand still.

Actually it was Lehman that was the big fish behind that debacle, but tant pis as the french would say. That whale has left the building.

As an advisor of client portfolio's I have to say, this extraordinary run up has been very schizophrenic. My gloating at moving (or trying to move) clients to raise beta on portfolios has turned slightly bitter as my cautious entries were obviously far too modest. (Beta is the sensitivity to the market. An S&P index fund has a beta of one, more aggressive holding have higher betas as they move with greater force than the broad market. Long term positive? Increase beta. Have a negative outlook, decrease portfolio beta)

Investors would do well to memorize cliche's. They come in handy when you need a good dope slap.
1. Don't fight the Fed. When out to dinner with a guy with a trillion dollar line of credit, let him buy. Don't argue, just enjoy. If you think he's gauche and ordering the wrong things, swallow and smile.

2. The market can remain irrational longer than you can remain solvent. Lord Keynes comment still rings true. If your trillion dollar buddy is slipping 100's into g-strings, let him. Starting a fight will only get you bounced out of the club. Wait until he passes out and then drive him home. Until then you use $1's, and smile.

3. Don't fight the tape One thousand years ago King Canute sat upon the strand in England and ordered the sea to stop rising and the waves to still. He had no luck either. Go with the flow there may be more powerful forces at work than can be seen.

The money flow and source of trading indicates two things still. First, the weakest stocks and companies have done the best recently. This would suggest a strong short covering rally. Second, online trade activity has increased much more than institutional activity. This leads me to believe that this bottom still has some work to do, but the definite bias is to the long side.

John Barnyak
President
www.stonehouseasset.com

Light at the end of .....

2009-05-06T12:36:00.004-04:00

Ok, I confess, I don't get it. The Treasury finally offers its assessment of the very weak stress test for BAC and the light shines brightly. The hard hitting stress test assumes a worse case of 8.5% unemployment when we are already at 8.6 among other soft pitches down the middle of the plate and then guess what? Bank of America is fundamentally insolvent to the tune of $34 Billion and the stock goes up like a rocket.

I once used to sell metals and alloys to a manufacturing company in Wisconsin and recall a conversation one day with the purchasing agent. This fellow dabbled in commodity trading for himself and was focused like a laser on the silver market. The day in question he said to me, "John, it makes no sense. The silver market makes no sense. Something is going on. It's being manipulated." I being the wise and youthful know it all smirked. Not long afterwards the Hunt brothers were arrested, silver plummeted from $40/oz to single digits.

This time its different. You don't have to look hard but what the outcome will be, I can only guess, change my mind and guess again.

Goldman Sachs is incredible. No, not incredible, god-like. In trading, being right slightly more often than wrong is the stuff of legends. A trader is going to be wrong, a lot. But the concept of cutting losses and letting profits run is what separates good from gone. That being said, GS was right in predicting the market 87.5% of the time in the first quarter! They generated over $100 million in trading profit 34 trading days, was profitable 56 days and lost money on 8 days. The days they lost over $100mm? Zero.

The NYSE's Supplemental Liquidity Program is designed to promote aggressive quoting activity and liquidity to the market. In return the NYSE will pay providers a 15 cent rebate per 100 shares traded. Additionally, it is designed to lead to tighter spreads between the bid and ask price. One of the reasons given for GS profits is very wide spreads in a program for which they seem to be the sole beneficiary. GS is currently the dominant trader on the NYSE, trading about 6x the trades as principalof the nearest competitor, Credit Suisse.

Look at the US Fed and Treasury activity, trillions of dollars in guarantees, purchases and loans. This administration clearly has a rocket in its pocket and Goldman is the fuse. But I can't help but hear in the back of my head the saying, "when the Fed taps on the brakes, somebody goes through the windshield."

Tread very very carefully people.

John Barnyak
President
www.stonehouseasset.com

Savings Bonds Stop Paying

2009-05-06T10:47:00.001-04:00

'I Bond' Payments Get Wiped Out - When Inflation Goes Negative, Investors in These Savings Products Suffer

Wall Street Journal, May 2, 2009

Rates on government securities, certificates of deposit and savings accounts all have plummeted in recent months. Now, yields on another safe haven -- Series I Savings Bonds, or I bonds -- are dropping to nothing.

Friday, the Treasury Department said these inflation-linked bonds that are purchased between May and October will earn 0% for their first six months, the first time rates have hit 0% since the bonds were issued in 1998. The announcement also affects current I-bond owners, whose interest rate drops to 0% the next time their rates reset.

Blame the financial crisis. Normally, yields on inflation-linked investments gradually rise as prices rise. But amid the sharp drop in consumer-price inflation last fall, returns on many inflation-linked products were hammered.

Rates on I bonds, whose maturities are all 30 years, have two parts: a fixed rate, now set by the Treasury at 0.10% for new issues and which lasts for the bond's life, and the inflation adjustment, which reflects the change in the Consumer Price Index over a six-month period. Since that inflation adjustment worked out to a negative 5.56% annualized rate for the September-to-March period, the fixed-rate portion of every I bond will be wiped out during its next six-month rate period. The Treasury announces the rates each May 1 and Nov. 1.

The silver lining is that rates can't fall below 0%, so I-bond holders won't lose their principal. What's more, "prices tend to go up in the first half of the year, so because of that, we'd definitely expect there to be a positive inflation component" the next time the rate resets, said Tom Adams, editor of www.savings-bond-advisor.com.

Over the long term, inflation-linked investments are still a good bet, experts say. "In the short term, inflation will be hard to detect because of the weak economy and lack of pricing power," says Greg McBride, senior financial analyst at Bankrate.com. "But over the longer term, the substantial debt issuance by the government and large ongoing deficits bode for higher inflation than what we've experienced in recent years."

Until rates pick up, the best option might be to "suck it up" while the bonds pay 0%, Mr. Adams says. I bonds typically lag behind returns on other investments, so its investors are coming off returns of 4.92%, while stock-market indexes fell around 40%, he says. Returns on Treasury Inflation-Protected Securities, by contrast, fell last year, but have started to inch higher as signs of inflation emerged in recent months.

For those thinking about cashing in I bonds after the one-year minimum holding period, be sure to find out what your bonds are earning now and when their rates will reset, says Mr. Adams. The Treasury has an online calculator at http://www.treasurydirect.gov/indiv/tools/tools_savingsbondcalc.htm.

Wipe Out (or Hanging 60 Billion)

2009-05-06T09:56:00.002-04:00

Well it finally happened GM stockholders had the fork stuck in and the juice ran clear. Turkeys do that. Last night it was announced that GM will do a 100 to 1 reverse split. Own 100 shares? Now you're going to own 1 share.

"If the restructuring as currently contemplated occurs, there will be very substantial dilution to existing holders of GM common stock." I love a good understatement as found in the SEC filing.
Existing shareholders will have 1% of the company. The other 60 Billion new shares will be issued to pay off the debt of the U.S. Government, Bond holders and the United Auto Workers Union.

Whether this approach will be allowed to broach the banking system which is effectively insolvent remains to my mind the largest question facing the economy. The insolvency and question of toxic asset pricing could largely be answered with the conversion of debt to equity in the banks.

A leaked result of the bank stress test (which hasn't been particularly stressing) for Bank of America indicates a need for $34 billion in equity capital to be raised. I question whether the private sector will put up the $34 billion without restructuring and I am sure congress is not ready to foot the bill (dear God I hope not.) Expect some move toward ultimately diluting existing shareholder and removing debt similarly to GM. Otherwise the hole will devour the Fed and taxpayers with it.

John Barnyak
President
www.stonehouseasset.com

Public Pension Pinch

2009-05-05T16:45:00.004-04:00

"The market has changed and has caught up with the rest of the world, but raising taxes is really the last thing we want to do," said Jon Rupert, business manger of the Highlands School District In Natrona Heights.

No Mr. Rupert, the tide went out as it does and you got caught naked. The Pennsylvania school districts, and therefore the taxpayers, are about to get their private parts burned. It is one thing to raise an eyebrow and tsk, tsk a private pension plan when the company clearly ran it into the ground, but a public pension plan has broader ramifications.

Ironically one of the worst things that could have happened to us was the unrelenting bullish attitude and market of the 1980's and 1990's. Mutual Fund Wholesalers and pushers drew lines that went up and to the right infinitely. Insurance salesmen made assumptive illustrations that used 12% and more as sales pitches. Brokers explained 10% average returns over the years and created financial plans that never faltered and left legacies for children and charities. And school districts failed to make pension contributions because the charts showed they were fully funded forever.

No one explained that those 10% average returns over many years included decades long periods of zero return.

Much like the corner we are painting ourselves into nationally, local taxing authorities have a problem that won't simply go away.

Pittsburgh Public Schools, the largest district in western pennsylvnia, has 2,700 teachers and full-time professionals. Chris Berdnik, chief financial officer and chief operations officer, estimates that contributions to the pension fund will rise from $10.08 million this year to $33.18 million in the 2012 school year. So sometime in the next three years between the city and state another $20 million a year needs to be found. Property tax relief? Right.

In 2002, after the state raised pension benefits for public school teachers by 25%, contributions from school districts in the state were $539,000, and the state contributed $662 million. Say what?! As school districts and board members jockeyed for no tax hike platforms, Rome smoldered. The high returns of pension plan assets allowed school districts to glibly take a pass on funding. We seem to be a country that does love to let infrastructure and deferred liabilities slide to the next administration or next generation.

Much like the stories one hears of elaborate ice fishing houses left too long on the lake, the school districts acted as if the 8 inches of financial ice beneath their feet would never melt. The districts and tax payers all over the states are about to find the water deep and cold. Expect active school district bond floats and taxes hikes to cover the debt service. Another reason to hope interest rates down, hoping public financing costs stay lower?

As the effects of poor planning slip into every corner, public and private, thinking as if it is business as usual will not cut it for investors. New challenges will provide new risks and opportunities.

John Barnyak
President
www.stonehouseasset.com

Tea Leaves and Crystal Balls

2009-05-05T11:56:00.007-04:00

The market is in the midst of one of the more powerful up thrusts we've seen in many years. It should not be terribly surprising as we are in one of the worst collapses in even more years. What do we see inside the magic 8-ball?

1. Everyone in the investment world and economic world is delving deep into data and anecdotes for positive news. And with the idea that dropping a five pound sledge hammer on one's foot is so much better than an eight pound sledge, we agree. Feels great.

2. The stocks up the most are the stocks that were down the most. These were the most heavily shorted stocks in the world and the covering of short positions can make very powerful rebounds. If Citigroup was shorted near 45 when moving averages began to fall, buying to cover at 2 or 3 or even 4 is still a pretty good trade. With so much political uncertainly, take the money and run seems prudent.

3. Volume has been quite low. There is no indication that institutional money is doing more than edging in.

4. The internal technical issues are frankly strange. In a once in a lifetime decline that is hardly surprising but data going back seventy years is not so readily available as going back twenty. There is a lot of flying blind going on. The Supplementary Liquidity Providers (SLP) program of the New York Stock exchange has the appearance of making Goldman Sachs the spigot for the Fed. When it gets turned off and for how long is unknowable and makes this a follow the money market. The fundamental reasons for the market to rise or fall will be plugged in later.

5. The equity market is not the story here. Its the feel good part right now, but the real market is the credit markets. This is not Adam Smith's invisible hand. This is Timothy Geithner & Co's. dutch boy and the dike gambit. The question is how many fingers does the Fed have?

6. If you are looking back two years or ten you won't think straight. It is a new market. With perfect hindsight, what would you be doing in the 1930's?

As one can see from 1930 to 1940 the S&P Index began dramatically badly but created dramatic opportunity as well. The high of 1929 was not regained until 1946. To look backward and embrace the despair was very easy but not productive for anyone who had investment capital. There are similarities currently I believe.

Investors need to take a deep breath and look forward now. Take a breath, be patient, be prudent, be selective, be strategic, be positive.

As my sons begin their adult lives for the first time outside of the embrace of academia I hope they are not poisoned by the fear that is now so pervasive. They are looking forward and frankly don't care about 1990 or 2000 or 2007. That's ancient history now. The time for fear was two years ago. Now it is the time to make changes and move forward.

John Barnyak
President
www.stonehouseasset.com

First the Good News

2009-05-05T11:53:00.002-04:00

Today a client brought us a bag of morel mushrooms. Now THAT is a client who knows how to negotiate fees. :)

John Barnyak
President
www.stonehouseasset.com

Comic Relief

2009-05-04T15:22:00.003-04:00

Once again comedy provides the best synopsis of current conditions. The Onion has long had a tradition of cutting through the noise by bellowing it yet louder.

At the moment there seems to be almost total correlation amongst asset classes. In a "don't just sit there, buy something!" mood if you buy anything you buy everything. There seems to be no fundamental reason other than releveraging, and as I look at my screen I see bonds up, stocks up, gold up, real estate up, commodities up. It has the feel of a sugar high before a crash. I learned long ago, when it makes no sense, step back. The quantitative methodology of investments has come unglued. My only conclusion is that policy and a Black American Express card with Timothy Geithner's name on it trumps all else. As my wife used to say when the boys were particularly filthy and happy, "all fun ends in tears." I am getting a bad feeling about this market.

John Barnyak
President
www.stonehouseasset.com

Dog off the leash!

2009-04-29T21:47:00.002-04:00

As mentioned earlier, if the 10 yr treasury yield breaks 3.00% decisively the treasury bond has broken down. Today it did. Act accordingly.

John Barnyak
President
www.stonehouseasset.com

Where's the Debt?

2009-04-29T10:44:00.003-04:00

This recession (call it what you will) is predicated on debt. Too much debt. I'm indebted, you're indebted, wouldn't you like to be indebted too?

The world is surely more interconnected than it was and as the makers of Tamiflu will tell you, when one of us sneezes we all get sick. But they will also tell you to stay away from sick people. It's not easy to isolate oneself, but we can try. So too is it with United States as a borrower. It's impossible to isolate us, but the rest of the world will try to stay out of sneeze distance if possible.

The U.S. currently has $3 Trillion of its debt in the form of Treasury securities around the world. The biggest as we all know is China, but there is plenty to go around. Given the state of the US economy, future liabilities and government policies it is a certainty that the rest of the world is trying to figure out how to let loose of the United States tarbaby. It likely will not happen quickly as such disruptions create problems globally, but it will happen. It IS happening.

The Chinese proposal of substituting the US Dollar with IMF Special Drawing Rights is a non-starter but it IS a warning. The world is looking. There is no alternative, yet. What keeps the US dollar up is every other currency being worse.
The Chinese have been hard at work to diversify a bit from the US dollar. They increased gold holdings significantly in the past year. They have been buying copper and hard asset productions. Whether with equity positions in mining companies or long term contracts for oil they've been on a shopping spree with a $3 trillion dollar line of credit.

What I have been watching is the action of the yields on treasuries and the policy moves. On March 18, the ten year bond was yielding 3.09% when trading opened. The Fed then announced it would buy $1.2 Trillion in treasuries. This tidal wave of impending demand pushed yields down immediately to under 2.50%. Today, the 10 year treasury yield is 3.02%. In other words the prospect of over a trillion dollars of buying has brought interest rates down, not at all. What happens when the Fed stops?

In the UK they experienced a failed auction of government debt. Not enough bidders showed up for the amount offered. In the US it is unlikely we would ever experience that as the Fed has taken it upon themselves to "monetize" the debt by being the buyer of last resort. Something has to give. The dollar? Inflation? Taxes?

Everyone seems to agree that shorting the treasury bond makes sense in this bubble. Usually I would think too many on the same side of the trade, but this might just be the mother of all bubbles, so be patient, but pay attention. The top of the 10 year rate has bounced off 3.00% repeatedly this year. When it doesn't bounce, the hound may have broken its leash. If you have all of your retirement money in bonds, pay CLOSE attention.

The quadrillion dollar question is which, what, and when.

John Barnyak
President
www.stonehouseasset.com

Bennie and the Feds

2009-04-28T15:28:00.001-04:00

Amazing to think jazz pianists knew even before the recession was officially declared but not those running the ship of state. Enjoy.

Almost Midnight for Ken Lewis

2009-04-28T14:07:00.003-04:00

Something is up. The trading cliche is that low volatility leads to high volatility. Well the market has been comatose since the beginning of April leaving us crystal ball gazers to shake it repeatedly just to make sure its working.

Since the equity markets seem to be, ahem, acting oddly, we look deeper to the Credit Default Swap market. The price of CDS for BOA/Merrill is way up today so bets are being placed on fireworks at tomorrows annual shareholder's meeting.

I for one am hoping he is escorted to the door and don't really care if it hits him in the ass. There are so many hands on the levers of power these days I'm just hoping, not betting.

Update: The powerful pension fund, CALPERS just stated they will be voting for his ouster. Wasn't one Kenny Boy enough?

John Barnyak
President
www.stonehouseasset.com

If you Squint you can see the light at the end of the tunnel

2009-04-28T12:04:00.005-04:00

Good news folks! Monthly housing prices fell for less than a record amount for the first time since October 2007. Talk about your second derivative celebration! I concede it is better than a sharp stick in the eye but the chart below isn't exactly cause for exuberance. News like this makes short sellers slightly less aggressive but hardly reverse investment positions.

Maybe if a few thousand more homes are bulldozed prices will stablize and head north once again.

John Barnyak
President
www.stonehouseasset.com

Theater of the Absurd in Detroit

2009-04-28T11:41:00.003-04:00

The Government proposal for General Motors may just be a watershed event. It is not that hard to understand and reveals who gains and loses fairly clearly. For American taxpayers, its not that good and when looking at the winners, joe sixpack might not be that happy.

If the deal goes through as currently proposed....

US taxpayers) would get stuck with 50% of GM's equity (currently worth $625 million) in exchange for forgiving about $10 billion in federal loans.

The UAW would get 39% of GM's equity (currently worth $488 million) in exchange for giving up $10 billion in health care benefits.

Corporate bondholders would get 10% equity (currently worth $125 million) in exchange for giving up $27 billion in bonds.

Under the above agreement there is still a missing $10 billion piece of the puzzle: "The government wants the union to accept company stock to finance half of G.M.’s $20 billion obligation for retiree health care as noted above."

What happens to the other $10 billion? Either it goes to the retired worker or to taxpayers via the Pension Benefit Guarantee Corporation.

Everybody loses but the credit default swap holders. Now who might that be? JPMorgan, Goldman Sachs, and/or Citigroup by any chance?

The decision to allow CDS to be an opaque, unregulated, casino might end up staining Bill Clinton's legacy even in the eyes of admirers.

The idea that Wall Street runs the country and not the elected or the electorate becoming clearer by the day.

As we saw with the Goldman Sachs/AIG counterparty party in which rolled the dice with AIG and taxpayers paid up, there seems no limit to our collective generosity.

John Barnyak
President
www.stonehouseasset.com

Starving Private Beasts Too

2009-04-28T10:59:00.006-04:00

The rallying cry of the conservative movement in the 1990's was to, "starve the beast." As Grover Norquist said, "My goal is to cut government in half in twenty-five years, to get it down to the size where we can drown it in the bathtub." Well run the bath honey, GM is ready for a dip.

Following yesterday's announcements of additional plant closings, the demise of Pontiac and another 21,000 job eliminations, GM will be of a size even Mr. Norquist can handle. Employment will be 38,000, down from 395,000 in 1970. The company that once touted, "what's good for General Motors is good for the USA," seems on its way to irrelevance. Times, they are a changin.'

John Barnyak
President
www.stonehouseasset.com

Green Shoots of Recovery?

2009-04-28T10:46:00.004-04:00

Over a year ago I listened to an interview with a real estate analyst from a major firm. His worst case scenario was the bulldozing of houses to bring supply and demand back into balance. This video indicates that in southern california at least, we're there.

The value of the houses to the banks that foreclosed has become negative with local zoning ordinances imposing fines on houses that are still unlivable but brand new.

I live near a big box strip mall that is now largely abandoned because of development problems followed by the developer's bankruptcy. I wonder how long before the municipality takes a similar route.

John Barnyak
President
www.stonehouseasset.com

Out of the box

2009-04-28T10:09:00.002-04:00

I believe I have mentioned before the statement made by a speaker at a conference I attended that we cannot, “think outside the box. We are the box.” The current apparent thrashing about in search of the solution to the current banking crisis brings that statement to mind. Depending on the same people who created the environment that allowed the systemic problems to take root and then flourish to provide the solution has become part of the problem.

It is understandable to seek out expertise in a subject to provide guidance in all matters pertaining to that subject. Unfortunately it is also understandable that self preservation becomes the default mode. How can we expect the very people who insisted on repealing Glass-Steagall to now lead us back to similar regulation. How can we expect that those who wrote the legislation allowing banks to police their own capital levels to throw themselves on their swords or find the solution that is not within their view of the universe?

The problems hatched by financial engineering and complexity beyond the understanding of even those who created it cannot be solved by adding yet more complexity engineered by the same persons. The response that a problem is so complex that it can only be addressed by those who created it is common. The problem needs to be deconstructed to a level at which mere mortals can provide simple coherent solutions.

Each time I hear a CEO of a failed, insolvent bank lament that compensation limits will mean they lose their best people I am surprised that the questioner does not follow up with, “and you don’t think that would be a good start?”

The solution to the banking problem would be fairly simple those without vested interests were not the ones looking for the perfect solution that supports the status quo. The holders of Citigroup and Bank of America bonds are not preponderantly widows and orphans. They are credit default swap wielding, monolithic investment banks. It is time that the private sector step up to the risk they took as sophisticated investors and lenders. The taxpayer is NOT the counterparty on poor judgment insurance.

If Mr. Geithner and Mr. Bernanke believe they are the protectors of the banks that has bought them lunches for the past decade they should be replaced. Since they can’t think out of the box they are in, we need a different box and they should move theirs from K street back to Wall St .

Stiglitz Fora.tv Lecture

2009-04-28T02:24:00.003-04:00

Nobel Prize winner Joseph Stiglitz discussing the financial crisis and outlook. Nearly hour long discussion, slightly academic assessment of the current policy failures.

Charlie Rose Interview..state of the banking system

2009-04-27T20:04:00.001-04:00

Sitzfleisch

2009-04-27T18:44:00.005-04:00

One of the most frustrating aspects of a secular bear market is the number of bear market rallies seemingly designed to pull in investors then swat them down just when hope begins to renew. The graph below shows the seven bear market rallies following 1929 and the accompanying seven failures to sustain them. From 1929 until 1933 there were ample opportunities to hope and croak.

Since the market high in October 2007 the S&P has paused three times for a bounce before resuming its downward path. In early spring of 2008 the S&P gained nearly 15% before collapsing again. The year end rally of last year saw a relief gain of over 27% and now again, the springtime sprigs have put on over 30% since the March low. None of the rebounds have been able to regain the level of the previous one. The pattern of lower highs and lower lows remains intact despite the green shoots of recovery the Washington policy makers wax poetic about.

Make no mistake, I know the siren call of a rally. No manager wants to miss a 30% move and I find myself taking very small scout positions just in case. The covered call strategy begins to look ugly when a minor time premium is exchanged for strike price that goes deeper into the money.

I once had an old jewish attorney whisper to me as I headed up to the witness stand in court, "sitzfleisch." What he was saying was, sit, shut up and be patient.

John Barnyak
President
www.stonehouseasset.com

Natural Gas Update

2009-04-27T15:01:00.004-04:00

For all the Marcellus Shale aficionados in the area we offer this natural gas update. Today the price of the NYMEX continuous gas contract touched $3.37 and I confess to being sorely tempted. But there is more to the supply question than meets the eye of those of us who see drill rigs in the neighborhood.

While the analysis of rig count and demand gives me some confidence of higher prices later this year, an analysis of LNG availability presented by The Barricade blog puts an additional spin that many in this region don't consider. I think it best to let the money flow of natural gas show us when to put on a trade.

Commodities move with the underlying economy. My oil price call last year was dictated by macroeconomic conditions on the horizon and I expect despite the bleak outlook in the Barricade analysis, macroeconomic revival will provide some greater light for Natural gas prices in the coming year, but no need to catch a falling knife.

John Barnyak
President
www.stonehouseasset.com

The other side of the street

2009-04-27T12:56:00.008-04:00

One of the challenges to investing is the matter of asymmetrical knowledge. What makes the concept fascinating to me is the continual pitchmen who talk their book to all of us. In a world in which salesmanship moves faster than accuracy, it is very easy to be caught up and caught out. Every grade school kid knows that when offered something in the cafeteria by a questionable friend the first question asked is, "what did you do to it?" Unfortunately it also seems the first question to ask years later when the tasty investment morsel may have longer term and less benign consequences.

Remember last summer when Goldman Sachs came out and clearly stated its view that oil was heading for $200/bbl? When an investor remembers that Goldman Sachs trades on behalf of itself the vast majority of the time, such advice might be taken with a grain of salt. Just because she knows the street, doesn't mean she's not about to give you more than you bargained for.

In the week before last, GS traded 84% of its program trades on the NSYE on behalf of Goldman Sachs. They also traded over half of the volume on the exchange. So how do we invest in a world that is working the other side of the street? Follow the money, not the advice of those with opposite interests.

The politicians would do well to also pay attention to the source of advice. Bank holding companies continue to put one hand out and another in the taxpayer's pocket but I am beginning to feel the complexity of the problems will not be tolerated for much longer. The simple solutions may well be finally allowed to rise to the surface and bank debt to equity swaps will be allowed to provide the elegant systemic answer to bank undercapitalization. The banking firms would rather keep hands in the deepest pockets in the world but its time to step up and create healthy banks from reluctant bondholders. Sorry Bill Gross, you're smart, you'll adapt.

John Barnyak
President
www.stonehouseasset.com

Fixed Income Strategy

2009-04-27T11:10:00.003-04:00

Each year when I would attend annual metal commodity conferences part of ceremony was handing out the awards to those who had made the best predictions. Out of the several hundred guesses about the price development of several metals such a gold, aluminum and nickel, it was usual that the outliers were the ones that won. The distribution was the vast majority within several percentage points of the current price and a few nuts miles away. The winners were almost always the nuts.

Right now, the informed opinion is that long term bond prices are going to begin to fall any day. History has a way of making conventional wisdom look foolish. So slowly slowly and the more confident one is, the more slowly should be the entries.

\

John Barnyak
President
www.stonehouseasset.com

News so fast you'll freak!

2009-04-24T16:19:00.003-04:00

Both my sons have at some time worked for a sandwich shop with the advertising, "sandwiches so fast you'll freak." Lately the news, and I mean BIG news just keeps coming. Often it is old before it is even released and reverses thinking on a dime.

This week as pundits spoke of the "green shoots" of economic recovery everyone seemed to grasp for positive spin on news, even selective spin.

Today March's durable good report was released and was just such a green shoot. While by no means great, orders fell by only half what was expected. But..uh, what about the news yesterday that General Motors will completely shut down for the balance of the second quarter? I think it might put a crimp in the next couple months' durable goods reports. Including parts suppliers this could be a reduction of payrolls of about 140,000 workers.

The U.S. economy needs approximately 100,000 new jobs per month to move the unemployment rate lower. By May we can expect to see 9% and 10% by June or July.

In other news, the Bernanke, Paulson, Bank of America saga looks about to get deeper, wider and more despairing. That laws were broken seems clear. That there will be consequences to any of them is less clear. But we're getting used to that.

The issue in question is that Mr. Lewis, BOA's CEO, wanted to step out of the deal to purchase Merrill Lynch as details came to light that the company was crumbling fast. Secretary of the Treasury Paulsen and Fed Chairman Bernanke threatened to remove Lewis and the board of BOA if the deal were not completed.

The bank had a fiduciary responsibility to alert shareholders of material events, such as the mounting losses at Merrill Lynch which would have given them the opportunity to stop the deal. Lewis told investigators, "it wasn't up to me."

It sure is up to you buddy. You don't work for the regulators you work for the shareholders. If your actions result in your removal from office by a regulator, tough. You followed the law.

Until consequences are felt at the HIGHEST levels, our system will grind ahead very slowly at best. With no clarity of policy or even law to guide commerce we are dead in the water. It's time to take a deep breath cut out the rot.

John Barnyak
President
www.stonehouseasset.com

Natural Gas

2009-04-24T14:42:00.006-04:00

If there is one thing to learn about commodities, it is a phrase one hears often in energy trading. The answer to high prices is high prices. A cyclical industry, commodities are driven by supply and demand with greater speed and clarity than economic products higher up the food chain.

In our geographic area of southwestern Pennsylvania, last year there was group hysteria as every property owner I know was scurrying to confirm they owned the gas rights beneath their feet. Drilling lease rates went from little more than single digits per acre to thousands of dollars over the course of several years. It was marcellus shale fever! You could almost see their lips moving as they figured, "200 acres times $3000 equals...whoa. A really nice new pickup truck!" And that didn't even consider the gas price over $10/mcf, 20% royalty rates and well over a million cubic feet per day production on wells.

Combine a slowing economy with a massive new production supply and Adam Smith's invisible hand of capitalism comes into view. Today the price of natural gas is below $4/mcf and lease rates back to earth. Back to old pick-up, smaller crowds at meetings and life in the slow lane once more.

But for investors, the answer to low prices is low prices. The Natural gas prices show no sign yet of returning to last years lofty levels but the decreasing rig count is the seed of the next cycle. Investors may want to consider taking exploratory small positions in natural gas if they have a time horizon of beyond the next weeks or months. Looking at the ETF chart for natural gas tells the story.

A decline (collapse) of more than 80% in less than a year to levels below production costs in some cases begins to look interesting for the patient. As the graphic below shows trees don't grow to heaven, but they resprout in time.

John Barnyak
President
www.stonehouseasset.com

Curiouser and Curiouser

2009-04-23T14:04:00.007-04:00

Let me say first that this entry is not about the economy. The economic backdrop remains quite abysmal at every turn. Unemployment continues to rise, real estate foreclosures are soaring, states and local municipalities are starved for tax revenue. The policy makers have successfully shown great confusion and poor communication.

Having said all that, markets are discounting mechanisms which judge the future not the past or even the present. To make things even more difficult, one of the major market participants is now the US government. If that is true for the equity markets, as we know it is for the fixed income markets, US strategic activity may diverge completely from fundamental value in the markets.

The news flow is stunningly bad yet the market shrugs it off. The question is whether this is a matter of the market judging that valuation is reasonable or something more nefarious. Earlier this week traders seeking to short the S&P discovered they could not borrow shares as needed to sell short. This is unheard of. In an efficient market, the index of the 500 largest public companies in the country surely could not be cornered. Inconceivable, but for a short while true? Could someone's finger be on the scale? The conspiratorial thoughts run wild.

Technically the market is working off its overbought condition benignly. It appears that a few more days of flat trading days would poise the market again to move higher. If only news wasn't so damn bad.

In a market that is fundamentally unknowable, the only strategy is to follow the money.

John Barnyak
President
www.stonehouseasset.com

Freddie Mac Tragedy

2009-04-22T12:04:00.005-04:00

Everyone knows that the stories of brokers throwing themselves from tall buildings in the Crash of 1929 are apocryphal urban legends. I think. While not yet clear why Mr. Kellermann, CFO of Freddie Mac, apparently chose to take his own life late last night, it is not hard to imagine. The despair that can overtake one in the midst of a personal and professional maelstrom can strip even the brightest and most outwardly successful of logic as well as hope.

No one else can be blamed for Mr. Kellermann's decision. We all make decisions daily under the guise professional responsibility, shareholder interest, orders from the top or even personal gain. We would all do well to remind ourselves that somewhere behind the paperwork, the policy and the profit, there are people.

The list of individuals who have taken their own lives because of reversals of fortune or because of shame grows as the current crisis continues. The asset manager in London, the real estate attorney in New York, the industrialist in Germany, the foreclosed widow in Toledo, all saw no way better way out.

Each of these is another reason to clean the system of the moral hazard that creates undue risky behaviour. Too often the consequence of ill considered actions is shifted. In some cases, it cannot be reversed. Even in death Mr. Kellermann left a wife and daughter to deal with them.

John Barnyak
President
www.stonehouseasset.com