Wipe Out (or Hanging 60 Billion)

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

"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

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

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

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!

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?

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