tag:blogger.com,1999:blog-1939360515087790152024-03-05T05:38:26.405-05:00Market Passion - Macros.Fundamentals.This blog attempts to help share information about the financial markets to all investors. Primary focus of discussion would be US stocks, Emerging market stocks, Fixed Income market, Commodities & macro economic fundamentals in general.Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.comBlogger51125tag:blogger.com,1999:blog-193936051508779015.post-57170510035306656622010-09-11T12:30:00.001-04:002010-09-11T12:32:19.100-04:00Fishing for value - some good picks in retailSince hitting their highs in March-April, the retail sector has taken a strong beating over the past several months. A significant correction was bound to happen since the uptick in the first 3 quarters in stocks in this sector was way too steep to be sustainable! However, by any stretch of logic, the current valuation levels are too low, unless you are a firm believer of a clear double-dip recession. <br /><br />Let's start with the economy - as i opined in my last article, there are simply no clear indicators of a double dip - despite the fact that employment stats would remain depressing for quite some time. Recent indicators on home sales, manufacturing and retail have been very mixed too, indicating a slow but choppy recovery. Neither the government nor the private sector can afford a double dip at this point, and given the speed with which stakeholders have acted to quell any fears of a slip-back in to recession, there is little reason to worry about a double-dip actuyally happening. More over, many real indicators are so depressed that there is not too much room to move down from here. Given this, I would put my bets on at least a minor-to-moderate rally in the retail sector over the next quarter, especially with back-to-school and holiday seasons perking up sales.<br /><br />In fact, August numbers from several retailers beat analyst expectations, helped by increased promotions, and a pickup in back-to-school sales. Overall same-store sales (Retail Metrics index culled from 30 retailers) rose 3.5% as against an analyst expectation of 2.8% - this is the first time since Q1 that there has been a positive surprise. Several retaliers had positive same-store sales suprises - from Costco (7%) to Nordstrom (6.3%) to Zumiez and Wet Seal, numbers were good pretty much across the board, though not for all names.September results will be critical to guage overall trend, as the back-to-school season is the next biggest period after the holiday season, and is often a good barometer of Q4 peformance. Just looking at the lines in front of retailers like ANF, M, JCP, it is hard to doubt the fact that it is going to be a better Q3 and probably an even better Q4. My wife went in for the Macy's one-day sales today here at Boston, and from her words, it feels like it's Thanksgiving weekend already - clearly there is enough steam left in consumer spending to present positive surprises on currently depressed expectations!<br /><br />Some names are interesting in specific:American Eagle (AEO), Aeropostale (ARO) are decent picks to ride this season, given current valuation levels. However, among all the good picks, i would put my money on JCP and KIRK.<br /><br />JCP is trading close to its 52-week low at about 21, and not too far from its 5 year low. At a P/E of ~16+, with its value-for-money merchandise positioning, i do not see much of a downside. If initial back-to-school trends are an indication (August sales up 2.3% as against an analyst estimate of 1.6%), it should see reasonably healthy Q3 numbers and a good Q4. Given the choppiness of the market and the high stock beta (1.7), i would not bet on near-term options though...would either go long on the stock or Jan '11 options. From a timing perspective, note that Q3 results will be out in mid-November.<br /><br />KIRK is trading at 12+, close to its 52-week low of ~10 and far below its high of 25.3! Given the spread and uniqueness of the merchandise they carry, i would jump on this stock at its current P/E of sub-7! The stock has been hammerred badly ever since May primarily because same-store and overall numbers failed to keep the abnormal growth trend shown over the previous year. Q2 2010 revenue numbers were only 2% higher Y-o-Y and same-store numbers were only 1% higher...it was a case of expectations going way above normal, and a correction to reflect reality - however, the downward correction has been clearly overdone, and i would bet on a level of atleast 16-17 by Q4. As mentioned earlier, i would rather go long on the stock or longer-term options as against near-term options. Again, from a timing perspective, note that Q3 results will be out in mid-November.Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-55768943496244036802010-07-02T15:51:00.004-04:002010-07-02T18:30:06.647-04:00Volatility still rules - but do we need to necessarily be on cash?Ever since Q1 '10 calm was broken by the Greek crisis, markets have struggled to remain steady. VIX, VSTOXX and other volatility indices around the world are near 52-week highs and there is a very heavy sense of uncertainty across markets globally. The DJIA has already fallen close to 9% from the 10,500 levels in early January to 9600 levels as of today. Emerging market indices have also been as badly affected - the MSCI emerging market index for example is down over 8% YTD and the Shanghai index is down over 27%! It is perhaps safest to be in cash during this period of high volatility; but there might be an attractive risk-return play at current market levels.<br /><br />It is important to understand macro trends at this point:<br /><br />Europe<br />Budget tightening prompted by high deficits will cause restrained growth/slow down across Italy, Greece, Spain, UK; and this would mean subdued growth in the near term for the Euro region as a whole. However, valuations across Europe are at one of the most attractive levels in the last decade [STOXX (P/E - 12.1), FTSE (P/E - 13.2), DAX (P/E - 14.5) etc], and hence there is little room for heavy downward correction in the short-term. Also, the quickness of response from Euro region countries during the Greek crisis earlier this year showed that there is enough governmental support to prevent any drastic fall out.<br /><br />China<br />Property price pressures will continue to affect China. However, the correction in the market YTD have dragged valuations on the Shanghai index to less than 17 times reported earnings, compared with 37 times in July 2009. This is while economic growth is still expected to be 10.2 percent in 2010 and over 9 percent in 2011! Thus, there is not enough fundamental pressure to push stocks downward - and an upward correction in this quarter is highly likely. In fact, many investment banks including Morgan Stanley, BNP Paribas SA and Nomura Holdings have predicted that stocks will rally - especially since China’s recent decision to end the yuan’s two-year 6.83/dollar peg to the dollar will help curb inflation and asset bubbles.<br /><br />Other emerging markets<br />Most other emerging markets have dropped heavily YTD too, except India (BSE Sensex) which has stayed closed to<br />neutral). Brazil’s Bovespa index dropped over 10 percent YTD and Russia’s Micex slipped over 8.5%. However, economic growth projections are still strong across most emerging markets, ranging from 3% in Russia to 9%+ in India. And its<br />important to note that most of these (except perhaps Russia) are cases where growth is driven by domestic demand and not necessarily deeply tied to global trade flows.<br /><br />US<br />Job growth in the US is still constrained with unemployment rate projected to stay in the high 9% range till end of 2010 and probably well in to 2011. Partly due to the same, the housing market would continue to face pressures - the recent bill (to extend the date for the 8K rebate to Sep) not withstanding. However, projected economic growth across Asian and Latin American markets should continue to drive manufacturing exports. Banking balance sheets are much cleaner too - though regulatory pressures to add capital would continue, increased trading revenue due to high volatility, gradual pick up in consumer and corporate credit, and a moderate revival in the wealth management space, would help earnings. Retail stocks should also look up after the heavy sell off during last 2 months, which have left valuations at very attractive levels.<br /><br />Thus, there clearly are enough factors to sustain market volatility - risk of further sovereign downgrades in Europe, potential of aggravated property price corrections in China, speed of US economic growth and job creation, sustainability of growth in other emerging markets etc. Any balanced investment strategy should hence favor heavier weightage towards cash. However, there are more valuation and macro economic factors pointing to a market reversal than a continued downturn. It is definitely not an easy call considering the continued volatility, but a thought-out riks-reward play should favor going long on emerging markets and the US. Index bets are safer than individual stock bets due to aggravated volatility though.Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-55402082397191804592010-05-16T06:47:00.011-04:002010-05-16T07:52:05.652-04:00Financial stocks - Trouble is not over yet!After a couple of weeks where every one was more focused on the VIX and the VSTOXX than any thing else, it is interesting to sit back and try predict where the markets are going to move for the rest of the year. We can be sure about a few things - the European debt crisis is far from over, property (and hence stock) price correction in China still has quite some way to go and the banking sector in US and Europe hasn't seen the last of regulatory changes! Considering the above, any long-term directional strategies are prone to extreme volatility...it's much safer to sit on cash and watch from the sidelines! But, if you have the appetite and energy to track and play index funds, there is more money to be made than any other time - provided one doesn't get greedy enough to try and catch the rock bottom or time the peaks!<br /><br />If there is one sector to avoid jumping in to invest at this point, it is financials. A combination of factors would make good returns on equity extremely difficult to achieve in this sector. A simplistic way to look at how ROE can be impacted for this sector is the way Dupont model looks at it:<br />Return on Equity = Net Income/Equity = Net Income/Sales * Sales/Assets * Assets/Equity<br /><br />Factor 1 - Corporate and investment banks would be forced to move out of more and more of their propreitary trading functions out of the banking entity if not stop some forms of propreitary trading altogether. The recent news on Goldman stopping prop trading on CLOs should come as no surprise. Though the regulation to carve out swap desks from FDIC-covered entities would probably not see the light of the day (and would be a shame if implemented!), there is still the looming possibility of regulatory restrictions forcing banks to curtail some of their most lucrative revenue streams. If not regulatory changes, the very fact that the more complex, and hence in most cases more profitable, instruments would face higher capital charges would force banks to be much more selective in the new product area than they ever have been. Winning banks would however find a way to manage capital risk and liquidity risk well while still forging ahead with products that provide greater-than-normal returns. That's why GS and JPM are still good bets in the medium term despite any negative publicity and legal risk that stares in their face!<br /><br />Factor 2 - Key drivers for this factor goes hand in hand with some of the drivers from factor 1. The ability to increase sales on assets is severely constrained if banks are forced to depend more on revenue streams from traditional net interest and fee income streams. Trading shops get an unfair advantage in this area - though covering settlement risk and liquidity risk are more important than ever, banks with strong trading desks would continue to exploit volatility to generate maximum spread revenue from trading across different asset classses, while locking up poportionately lower capital than traditional banking functions. Though the last couple of quarters saw low volatility and hence lower spread income than the same period in 2009, the spike in volatility (which i bet is going to sustain itself for some time) would boost trading revenues again for the best trading desks in the industry. Traditional financial entities focused on retail and commercial lending, asset management or for that matter trust and custody, would on the other hand face severe challenges to increase sales on assets. Asset managers would especially see more and more end customers preferring less-lucrative passive strategies instead of higher-spread active strategies. Again, GS, JPM and maybe even MS has an advantage.<br /><br />Factor 3 - This is an area where every one from the best to the worst in the industry would be hard hit. There simply is no more appetite for abnormal leverage - Tier 1 capital as a proportion of total capital would need to increase significantly from current levels. This combined with the fact that Tier 1 would be defined much more striclty - no hybrid instruments, netting of minority interest components etc for example - would force several banks to raise more capital. The recent directive from the Swiss government to UBS and CS for curtailing risk taking and increasing capital (<a href="http://www.bloomberg.com/apps/news?pid=20601110&sid=aCGxFLs8FV64">www.bloomberg.com/apps/news?pid=20601110&sid=aCGxFLs8FV64</a>) is a sign of things to come in this area. There are some analysts who have predicted that US and European banks would have to raise over USD 250 bn in additional capital over the next 12-18 months to meet more stringent rules on risk weighting assets and Tier 1 capital as a proportion of total capital.<br /><br />A combination of these factors would make it extremely difficult for most, if not all banks, to maintain and increase ROE at or above the pre-crisis 15%+ levels. This, combined with lower options for fueling top line growth, would mean that there is not much room for share prices to go up! I would still bet on GS in specific since it is going to be new product ingenuity and smart strategies that are going to be even more important for driving shareholder value in the immediate future.<br /><br />But, if governments and regulators go ballistic and blame banks for all the ills in the world (the Greek PM blaming US and European banks for 'misleading them' for example!!), God help even Goldman! It is difficult to find any logic in any kind of mob-mentality driven regulatory action though - blaming Goldman or Citi or JPM for making some propreitary profits on shorting MBS while some clients lost money on it is like blaming your stock broker for increase in value of his personal portfolio while you suffered losses on yours!! It's you who got to take care of your own money! Just to make it clear, i am not talking about asset managers here, but the traditional sell-side part of the industry.<br /><br />Having said that, GS at 140 or even C at sub-4 is still defintely worth putting your money in!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-91193667357871697052010-04-10T12:14:00.004-04:002010-04-10T12:32:03.766-04:00High-risk (yield) debt markets - Swing back to irrational exuberance?Leveraged/high-yield market prices have risen up drastically over the last 6 months, prompting questions on whether the industry is again building up some of the toxicity that caused the previous melt-down. Reports show that leveraged loan prices rose to as high as 92 cents on the dollar per the S&P U.S. Leveraged Loan 100 index, the highest level since late 2008. Global high-yield debt sales has touched over USD 90 bn this year while US issuances have crossed USD 70+ bn, over 5 times 2009 levels for the same period. In line with high demand for leveraged loan issues, spreads have dropped to record lows, with below-CCC categories trading at just over 9 percent - as compared to the long term average of 12+ percent. Also, the trend has not been limited to issuers from specific sectors, but pretty much across the manufacturing and services spectrum.<br /><br />Though the economy is definitely better placed now as compared to 2009, it is difficult to imagine that risks associated with the most risky borrowers have dropped that low, especially at this stage in the economic cycle...assuming there in fact is a correlation the market is placing between risk and return!<br /><br />Just to prove a point, let's take a look at a another activity that is not directly tied, but driven by some of the same growth fundamentals - Leveraged Buy Outs (LBOs). LBO funds have raised the least capital over the latest period since 2004 and large funds including those from Caryle and Madison Dearborne have struggled to close LBO funds. Average fund raising length for buyout funds seeking more than $1 billion is as high as 19 months now as compared to 16 months in 2009 and less than 5 months in 2004, per Bloomberg reports...deal closures have been even slower, resulting in firms sitting on massive piles of uncommitted capital. It is safe to argue that there is greater investor sophistication and 'better' due diligence that happens as part of LBO fund raising and deal closure as compared to traditional credit market activity. Also, given the fact that LBO deals arguably involve better reference credit as compared to that associated with high-yield issuers in the primary market, indicators from a tepid LBO market do not augur well for the high-yield credit market. Unless there is a perverse logic that issuers with the highest risk will see faster pick-up in activity during a period of weak economic growth! Just to clarify, I agree there is no direct correlation in the reference entities for credit in both cases (high-yield credit markets and LBO deals), but it should be the same fundamentals - economic growth and recovery prospects - that logically should underpin both markets.<br /><br />Perhaps, capital market participants have extremely short memory spans - as this article on a recent BCG study points out,<br />(<a href="http://www.businessspectator.com.au/bs.nsf/Article/Boston-Consulting-Group-investment-banks-revenue-G-pd20100325-3V3FW?OpenDocument">http://www.businessspectator.com.au/bs.nsf/Article/Boston-Consulting-Group-investment-banks-revenue-G-pd20100325-3V3FW?OpenDocument</a>),<br />sliding revenues are possibly making profit-driven firms focus on the next stop for immediate super-profits...despite all the talk on risk-aligned performance measurement and deferred bonuses!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-47336752434894721162010-04-01T17:10:00.003-04:002010-04-01T17:25:46.329-04:00View on April earnings calls - FinancialsQuite unlike what many (myself included) expected, markets have continued to rally over the<br />past couple of weeks. Though not unidirectional through the period, the DJIA has inched almost close to the 11K mark and emerging market indices have continued to rise...the MSCI emerging markets index in fact shot up 1.3%+ yesterday! I still hold on to the view that there has been too much-too fast in terms of market rebound and a short-term correction is imminent.<br /><br />Having said that, there are some interesting picks worth looking among financial stocks -<br />with a bunch of earnings announcements expected the weeks of April 12 and 19. Let's take a quick look:<br /><br /><ul><li>JPM/JPMC - Earnings expected 14th April. Trading at 45 levels, close to the 52-week high of 47.5 and 5-year high of 52.6. P/E at 20. Though Jamie Dimon's shop weathered the crash better than most others, most of the upside has been factored in and i don't think there is still enough upside left medium-term. However, trading and asset management revenues should look up though credit card losses may moderate profits. Neutral/no directional view.</li><li>BAC/Bank Am - Earnings expected 16th April. Trading at 17-18 levels, close to the 52-week high of 19.1; 5 year number not relevant due to equity dilution post bail-out. P/E NA. Bank Am should show significant gains due to trading and investment banking revenues and loan loss provisions should be tempered enough to beat street estimates. Bullish - can touch 20 post-earnings - watch May strike 17 call options.</li><li>BK/BNY Mellon - Earnings expected 19th April. Trading at 30-31 levels, close to the 52-week high of 33.6, 37% below 5-year high of 49. P/E NA. Custody segment should show growth while international revenues will gain from Mellon's share of business. BNY also has lower loan loass provisions as compared to some of its peers. Bullish - watch May strike 30 call options.</li><li>C/Citi - Earnings expected 19th April. Trading at 4 levels, away from the 52-week high of<br />5.4; 5 year number not relevant due to equity dilution post bail-out. P/E NA. Though the US Treasury has announced its intent to sell of its Citi stake (27 and odd %) this year, 7.7<br />billion shares on a daily volume of 500 million+ shouldn't cause undue pressure on shares.<br />It is reasonable to expect loan loss provisions to moderate & investment banking revenues to climb...though credit card losses can still renmain at high levels. Citi might show good<br />margin improvements due to cost rationalization too. Bullish - May strike 4 call options at<br />~0.25 is a good bet.</li><li>GS/Goldman - Earnings expected 20th April. Trading at 170 levels, down from its 52-week high of 193, 25% below 5-year high of 229. P/E of 8.5. Higher fixed income revenues, higher trading revenues in general, stronger M&A and advisory revenues etc should continue to propel growth - though it's difficult to replicate '09 numbers due to lower market volatility/lower spreads. Bullish - May strike 175 call options at ~5.1 is a good bet</li><li>SS/State Street - Earnings expected 20th April. Trading at 45 levels, down from its 52-week high of 56, 43% below 5-year high of 78. P/E of 13. Custody and outsourced securities services should show strong growth while asset management should see gains due to a market trend favoring exchange traded funds. Loss provisions associated with conduits should taper down. Bullish long-term - May strike 44 call options at ~2.7 is a good bet.</li><li>WFC/Wells Fargo - Earnings expected 20th April. Trading at 31 levels, close to its 52-week high of 32 and 21% below 5-year high of 39. P/E of 18. Wells does not have a strong trading desk, and on the other hand has a loan portfolio heavy in optional ARMs and commercial mortgages. This doesn't provide enough reason for any optimism in the short-medium term, and considering current levels, there is a very strong chance of downward movement in the stock price. Bearish - May strike 31 put options at ~1.2 is a good bet.</li><li>CS/Credit Suisse - Earnings expected 20th April. Trading at 51 levels, down from its 52-week high of 60, 32% below 5-year high of 75. P/E of 10. Apart from gains due to significantly reduced exposure to leveraged finance, commercial & residential mortgages, CS should see gains in wealth management, clearly an area which continues to show long-term growth. Neutral-to-bullish - watch May strike 50 call options.</li></ul><p>Having said that, it is safer to take bullish bets closer to the earnings dates since a downward market correction (long over-due) might put overall selling pressure interim. </p>Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-69466395127344769022010-03-21T16:48:00.004-04:002010-03-21T17:49:02.403-04:00Unsustainable rally and valuations - a correction on the way?<span style="font-family:trebuchet ms;">A look at how some of the retail picks from my last blog performed clearly indicates the rally that this sector has seen in the past month or so.</span><br /><span style="font-family:trebuchet ms;">Walmart from 52.90 to 55.34; March 52.5 options - from 1.4 to 2.9 </span><br /><span style="font-family:trebuchet ms;">JCP from 24.89 to 31.42; March 26.0 options from 0.7 to 5.4.</span><br /><span style="font-family:trebuchet ms;">ROST from 46.43 to 54.07; March 45 options - from 2.2 to 8.8.</span><br /><span style="font-family:trebuchet ms;">KIRK from 16.67 to 20.07; March 17.5 options - from 0.5 to 2.5.</span><br /><span style="font-family:Trebuchet MS;"></span><br /><span style="font-family:Trebuchet MS;">Though some of the above are longer-term value plays too, i believe the sector in general has seen too much of a rally considering how fundamentals driving the sector has moved - (un)employment levels, wages...and consumer confidence as a leading indicator. The same probably applies from a broader market perspective too - we have seen a steep rally from early year lows and the DJIA has already touched close to 10,800, a massive rebound from the 6500 levels touched at its worst point. Fundamental indicators on the other hand have yet to show sustained improvement:</span><br /><ul><li><span style="font-family:Trebuchet MS;">Job losses have significantly reduced from 300K per month levels 6 months back to sub-100K per month levels; however that's only arresting the decline and not really driving positive growth</span></li><li><span style="font-family:Trebuchet MS;">Manufacturing & supply side indices have not budged a lot over the past 6 months - the ISM PMI index for example has only inched up from 52.5 levels 6 months back to around 56. More importantly, there has been some deterioration over the past 2 months</span></li><li><span style="font-family:Trebuchet MS;">Housing market inventory remain reasonably high at 7-8 months of sales nationally and hasn't budged from that levels for the past 6-9 months. This is despite continuation of the tax credit in to 2010.</span></li><li><span style="font-family:Trebuchet MS;">Personal consumption expenditure has improved, but consumer confidence indices are not showing sustained improvement</span></li><li><span style="font-family:Trebuchet MS;">Bank lending/credit has still not improved significantly over the past 6 months</span></li></ul><p><span style="font-family:Trebuchet MS;">Having said that about the US market, emerging market stocks have seen an even larger share of action, leading to valuations almost near unsustainable levels - especially considering risks associated with price bubbles (China), inflation (India), commodity prices/demand (Brazil, Russia) etc. Friday's move by the Indian central bank to raise repo and reverse repo rates show clearly that rate tightening and hence tempering of growth can be expected over the next 12 months...analysts in fact predict an over 200 basis point increase in bank rates in India over this period. </span></p><p><span style="font-family:Trebuchet MS;">Considering this backdrop at this point in the economic cycle, there probably is more down side than upside from a short-term (3 month) perspective - except for financial sector stocks, there could be little positive news over and above what has been factored in to the recent rally. Prudence would demand pruning investments in emerging market picks, retail, real estate holding companies to name a few - all of which are slated for a correction.</span></p><span style="font-family:Trebuchet MS;">Having said that, there still are some medium and large-cap picks in technology (ADBE is an interesting pick) , Consumer staples (GIS, CPB, DLM etc), Financials (like C) which can continue to deliver - but except for staples, its safer to wait than to jump in yet.</span><br /><span style="font-family:Trebuchet MS;"></span><br /><span style="font-family:Trebuchet MS;"></span><br /><span style="font-size:85%;"></span>Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-82844736392247389282010-02-15T13:27:00.002-05:002010-02-15T13:30:17.340-05:00Some interesting retail option picks for Feb/MarchThough the market's still catching up with New Year blues and the Dubai-Greece debt story, there has been little to change the belief that a fundamental improvement in business and consumer sentiment is still underway. Except for a few aberrations, statistics related to Industrial supply, inventory, home sales and retail spending has been showing clear signs of improvement. Though employment numbers are not picking up as fast as one would wish for, consumer confidence has clearly reversed the downward trend - I would hence see the recent DJIA fall to 10K levels as an opportunity to increase exposure to some retail stock plays.<br /><br />Having said that, there's little reason to hurry and increase/build exposure to high-end retail...that is, I would still not bet on abercrombie or American Eagle or Saks at this point! In line with the notion of a new normal for the economy, i am willing to bet on a continued trend of increased spending on discount stores and value-for-money plays as against higher-end retail.<br /><br />Some interesting picks in value-for-money retail players in the current market scenario:<br /><br />Walmart @ 52.90 - 25% below 52 week high, P/E of 15.29 (PEG 5-year of 1.24) is interesting. Even after we move back to sustained positive economic growth, consumers would stick to their new found buying pattern. With quarterly results expected on Feb 18, March options at 52.5 are attractive at ~1.40. COSTCO is also attractive, but i am not as upbeat considerable its near its 52 week high and trades at a PE of 24 (PEG of over 1.5).<br /><br />JCP @ 24.89 - 48% below 52 week high, P/E of 21.54 (High PEG though of 2.5+) might be worth a look. In line with its recent drop from the 35-levels, Godlman moved JCP to the buy list as of early January. Though it might not be a long-term bet, recent weakness means there's enough upside potential short-to-medium term. With quarterly results expected on Feb 19, feb options at 25.0 are attractive at 0.5 levels and March options at 26.0 are attractive at ~0.70.<br /><br />I am even more bullish on two other niche plays - Ross Stores and Kirkland:<br /><br />ROST @ 46.43 - 19% below 52-week high, P/E of 14.75 (PEG of 0.89!) is a strong pick. Their strong value-for-money positioning has led to an increasing base of loyal clientele, and i would bet on richer valuations. With quarterly results expected on Mar 18, March 45 options at 2.2 and March 47.5 options at 1.05 are attractive.<br /><br />KIRK @ 16.67 - 16% below 52-week high, P/E of 11.89 (PEG of 1.01) is a very strong pick. With quarterly results expected on March 12, March 15 options at 2.2 (though they have doubled in the last week) and March 17.5 options at 0.50-levels are attarctive.Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-45590868344325248252009-12-06T11:31:00.004-05:002009-12-06T11:41:20.221-05:00A view - The new normal & impact on Retail over the next 12 monthsAs compared to earlier expectations, the main indices saw a remarkable rally over the last 2 months, fuelled by arguably good third quarter results from a majority of companies across sectors. Now that the DJIA hovers around the 10,400 mark and emerging markets have mostly recovered from the Dubai World impact, the rest of the year and early 2010 does look rosy for the optimists. Especially given the reasonably welcoming statistics on unemployment released last Friday, which saw unemployment dropping to 10% (the first ever drop in the last several quarters i guess) and employers cutting fewer jobs than in prior months.<br /><br />I do personally believe and agree to the fact that a recovery is very well underway - but still stick to the view point that we are going to continue to see a new normal with lower consumer spending, greater savings & investments and a more tempered retail and construction growth. WIth unemployment still set to stay above 9% at least for the next 12 months & the impact that the down turn has had on consumer psyche, i will bet on a few trends continuing to hold momentum [as compared to averages over the 5 years pre-recession]. Just to highlight a few:<br /><ul><li>A higher proportion will continue to shop for perishables and consumer durables from lower-prices department chains (read Walmart, Costco, BJ, Aldi etc). But niche health-oriented stores like Whole Foods should continue to draw new customers though.</li><li>Given the significant price differentials, online retailers like Amazon and to a lower extent ebay will continue to build their consumer base across segments - but, especially on consumer electronics and even some high-value retail items like perfumes!</li><li>In the broadline retail segment, low-price should still continue to draw customers - JC Penney should hold ground against a Macys for example</li><li>Though the teen segment still has some strength in higher-priced apparel, i still would bet on an Aeropostale (P/E of below-10!) as against Abercrombie & Fitch or American Eagle for example</li><li>On the Food sector, food-at-home players like General Mills, Campbell should see increased growth (globally in this case) as compared to restaurant chains.<br /></li></ul><p>Having said that, there still is enough steam in the very high end to perk up valuations further - Tiffany's, Saks for example. It's the higher-priced mass-market retailers that should underperform if a new normal is indeed the reality. With the same view, housing prices in the low-to-mid and extremely high end should see a higher uptick over the next year as against the upper middle segment - the incentive expiring by April 2010 will create a big 'non-seasonal' fluctuation though.</p><p><br />On a more-macro angle, discretion is probably the better option. Like Dubai World was an eye opener to bulls in the high-yield/high-risk bond market, there are probably several skeletons to come out in many sectors, especially commercial real estate for example. To sum up, it's still better to bet on price-value plays and fundamentals as against exuberant growth in higher-end sectors which rely on a rapid uptick in consumer spending.</p>Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-43342856528915159682009-10-16T18:56:00.002-04:002009-10-16T19:17:30.113-04:00Need for a balanced and practical approach - Regulating the OTC Derivatives marketAs legislators prepare to move ahead in debating the recently introduced draft bill on regulating OTC derivatives, several observers have questioned the need for the bill to be diluted, both in terms of coverage and in terms of regulatory oversight mandated. With over USD 600 trillion in notional amount & the stigma attached to CDS instruments (thanks to AIG) due to the current financial crisis, it is easy for one to be led astray and push for a total clamp-down on the market. However, we need to ensure this is looked at from the right perspective.<br /><br />Regulation is very much needed and so is enhanced reporting and disclosure - without going in to an argument on Value at Risk Vs notional amounts, the very fact that US financial firms make over USD 30-40 billion+ in annual profits from such instruments gives an idea of the level of implied risk in this segment of the financial market. However, it is to be noted that not all of the volume is driven by speculative positions. To put this in perspective, a majority (65%+) of the USD 600 trillion notional pertains to Interest Rate Swaps (IRS) and close to 10% pertains to Currency swaps; and only about USD 60 trillion pertains to the much-vilified CDS bucket. And this is not to say that CDS as an instrument has any inherent flaws - it is as much necessary to create a vibrant credit market as is oil futures and options for a vibrant crude oil market.<br /><br />More over, close to USD 60 trillion of the USD 600 trillion notional pertains to positions by non-financial firms, where they are hedging real risk associated with variables like interest rates, foreign exchange rates and commodity prices to reduce profit volatility related to factors not linked to their core business. Also, a significant portion of the IRS market would be covered swaps with hedged counter-positions on the books of financial services firms (banks using a pay floating-receive fixed swap to hedge interest rate risk on their floating rate loan pools for example).<br /><br />To put it in a nut shell, the OTC derivatives market plays a significant role in maintaining a well-oiled financial services world. Over-regulation without understanding the true nature of the market kills the industry and reduces liquidity from the financial services market as a whole. The very nature of customization associated with loan tenures, currency positions etc is what makes the market so difficult to be managed through a pure exchange-driven mechanism. This is the very reason for large delays between trade execution and settlement, and hence accumulation of settlement risk. A regulatory push towards enhanced disclosure and reporting, and hence supervisory review of systemic risk, is a good idea - but draconian rules related to reporting or margining will add disproportionate costs and hence eventually strangles the industry.<br /><br />Having said this, the directive towards moving a larger portion of the OTC Derivatives volume to central clearing houses is laudable. This is as much a solution to industry woes as for regulators' woes - the positive industry response to DTCC's Trade Information Warehouse a few years back & success of other service providers like Markit and TriOptima clearly shows that there is proven business value attached to central parties which can facilitate information exchange and drive information accuracy. However, a few points need to be noted:<br /><ul><li>Centralized clearing houses do create systematic risk due to aggregation of risk to a single counterparty. So, unless strict norms around capitalization of these clearing houses is part of the mandate, the move could be counter-productive in the longer term.</li><li>What is more important than centralized information is how regulators and industry uses this information. Unless there is a good mechanism to roll up exposures across related parties and highlight areas of risk concentration, along with a clear mechanism of regualting the same by supervisory oversight, the central clearing house solution doesn't provide any real relief. For example, several large US firms had exposures to multiple Lehman entities (collateral pledged with Lehman US and Lehman UK separately for example) and since analysis of rolled-up exposures to Lehman group as a whole was not done or acted upon, realization of the overall exposure happenned only post-event.</li><li>Margining requirements have to be as tight on non-financial firms as on financial services firms. I do not personally agree with the opinion that stricter margining requirements dilutes business value for firms using it as a true hedge. I agree that it does entail added costs to doing business, but if the regulation is lax towards non-financial firms in this area, it leaves a big loop hole. Nothing stops rogue financial arms of oil companies or any others from creating Enron-like situations due to unregulated open exposures in derivative positions. </li></ul><p>To summarize, we do need fresh regulations on facilitating centralized counterparty driven clearing, enhanced reporting and stricter margin requirements; however, regulators need to work closely with industry leaders and industry SROs to ensure that we create an environment for controlled growth and not lead to total market constriction. On the same note, we have to be careful on diluting rules for select areas of the market - since loop holes almost always are exploited by smart players in the market!</p>Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-27529778930179973442009-10-10T17:22:00.010-04:002009-10-10T18:22:39.339-04:00Do we have a sustainable economic recovery yet?Forecasts and projections galore over the past 3-4 months as the DJIA (read market indicators) gradually worked its way almost inching up to the 10,000 mark. Thankfully, unlike the all-pervading gloominess in early March, the biggest question currently in the minds of market pundits and investors is whether the rally is sustainable. Led from the front by Roubini, there are several economists forecasting a double dip recession and the market reverting back to pre-rally levels. Though I personally agree more with Summers than Roubini, it's difficult to stretch the optimism at this point to say that the market is completely on track to a V-shaped reversal.<br /><br /><p>A quick look a factors which support the sustained rally camp:</p><ul><li>Job losses are stabilizing - by labor department statistics, total nonfarm payroll employment declined by 263,000 in September. From May through September, job losses averaged 307,000 per month, compared with lossses averaging 645,000 per month from November 2008 to April 2009.</li><li>Manufacturing supplier and purchaser indexes are up - for example, the Institute of Supply Management PMI index has gradually increased from 40.1 in April 2009 to 52.6 in Sep 2009, showing an uptick in 4 out of 5 month-to-month instances.</li><li>Home price decline has been stopped across all major regions, with month-on-month price ncreases reported for Sep 09. Also, both new and existing home inventory are down to the 7-8 month levels as compared to the 11+ months inventory in Q4 2008 and Q1 2009.</li></ul><p>On the other hand, those forecasting a double dip recession point to lack of fundamental strength in key indicators:<br /></p><ul><li>Corporate budgets are generally flat and employers have not started hiring. This is supported by continued increase in unemployment, reduction in hours worked and lack of strong private sector new employment generation</li><li>Manufacturing stats are just showing a blip to shore up inventories back to minimum levels</li><li>Home foreclosure rates have not slowed down and home prices have not yet shown a consistent upward trend</li></ul><p>Let's take a look at some of the key numbers from April to Sep 09 (wherever data is available):</p><p>Apr May Jun Jul Aug Sep</p><p>Personal consumption expenditure (USD trillion) 9.18 9.19 9.20 9.22 9.31<br />Unemployment rate (%) 8.90 9.40 9.50 9.40 9.70 9.80<br />ISM index 40.10 42.80 44.80 48.90 52.90 52.60<br />Bank lending (USD btrillion) 9.25 9.34 9.33 9.26 9.20 9.11<br />New home sales (annualized in '000s) 352 346 384 429 426 </p><p>(sorry for the mess up on the table - could not get it in neatly!)</p><p>As can be seen clearly, while new home sales and manufacturing indicators (using PMI as a proxy) has shown notable progress over the past 6 months, bank lending has yet to show any progress of improvement and so is the unemployment rate. This probably confirms the view that there is still quite some way to move forward for a sustainable recovery. Also, considering near-flat trends for personal consumption expenditure and hence fundamental demand drivers in general, it is perhaps easier to agree with the view that manufacturing stats are up primarily due to re-stocking pressure - due to drastic production cuts and abnormally low inventory levels during the past few quarters as against demand-driven growth. </p><p>Unless increased bank lending and government driven spending initiatives create enough employment, personal consumption expenditure would not pick up sufficiently to drive back demand for products and services. This, along with a sustained uptick in both personal and business confidence indices, is required to pave the way to recovery over the next few quarters. </p><p>Finally, i personally think that we are more on the way to a 'New normal' as against the pre-crisis economy - as I opined in the previous article too. The impact created due to the crisis is significant enough to affect long-term trends in spending and saving patterns, if not financial services lending patterns too! This will prevent a drastic v-shaped reversal hoped by early-mover market bulls. However, there is enough initial momentum to continue a path to recovery and hence there is no reason to expect a decline of market indicators back to the Q1 2009 levels. From a numbers perspective, assuming continued Fed and government support, I would rather bet on a slow, but volatile climb of the DJIA to 11,000 levels by Q3 2010 as against a move to 7000 or a 14000! </p><p>Due to the same reality, there is not enough fundamental strength for the drastic surge in retail stocks. Manufacturing stocks should see a tempered rise while home builder stocks, especially luxury builders, have quite a way to go before high multipliers are justified. I would personally bet on financial services picks with healthier balance sheets or consumer non-durables, and not retail at this point! </p>Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-85316298513516712342009-08-16T18:12:00.003-04:002009-08-16T18:15:25.988-04:00The case for a new normalMarket movements and direction of key economic indicators over the last 2-3 months clearly points to a tempering of the current down-turn and possibly a quick uptick in activity across most sectors. THough the market's overexuberance is not supported by any facts pointing to a drastic return to growth and profits, there are many economists who support this view. Last week, James Glassman at JP Morgan opined that 'Whenever we have plunged off a cliff and fallen into a deep hole in the past, for a while the economy has a tendency to bounce back very quickly' - a view supported by some others including Lauirence Meyer, formal Fed governor. And contradicted by several others who predict a slower, uptick, and that too to a 'new normal' where we would see higher savings rates, reduced consumer spending and tempered growth. I would sincerely hope the latter is true, despite all the immediate benefits and gains from the former trajectory!<br /><br />As compared to what has been traditionally decade long recession-boom cycles, we are probably seeing a series of heightened, but faster cycles during this decade. Without too much of doubt, we can say that the US central government responses to both the 2000-'01 downturn and the 2008-'09 downturn has been led/driven by monetary policy. Not often have we seen Fed rates fall, rise and then fall so drastically in a span of 8-9 years - this coupled with a consistently loose fiscal policy has perhaps exacerbated the speed of economc cycles. I am not saying that one should find fault with the Fed's rapid response to the current down-turn - in fact, i agree with the view that nothing short of such a reponse would have helped push the economy out of a recession spiral faster this time around. To understand this, we have to compare the Fed's response to the Japanese central bank's response to their down-turn which started in January 1990. Bank of Japan took 17 months to make its first interest rate cut, and even after that, it relied more on fiscal policy and government funded projects rather than use monetary policy as a tool to steer the economy. The success/failure of such a strategy is known to all of us - it created a prolonged period of stagnation, though it did manage to avoid a recession. Having said that, should we say the current direction of US monetary and fiscal policy would take the economy in the right direction long-term - it's doubtful to say the least.<br /><br />In the Fed's last rate-setting meeting, the board of governors almost unanimously supported a dove-ish monetary policy - this essentially means an unwritten commitment from the Fed to keep rates near sub-zero levels, helping a rapid pick up in the credit cycle - that assuming inflation stays within 'acceptable limits'. On the fiscal policy front, though there has been quite a lot of lip-service to fiscal discipline from the current government, we haven't yet seen any concerete action/plan yet. The latest in a series of 'government-funded' initiatives, the health care plan, sees an additional 2 trillion USD of spend over the next 10 years - and apart from either a possible drop in service/care levels or a rise in taxes, the only 'funding' mechanism we have seen is a piddly USD 80 billion deal that the White House supposedly has ironed out with the big pharma manfacturers! If we combine the above stands on monetary and fiscal policy, we have the stage set for another cycle of unreasonable growth backed by high fiscal deficits and loose credit standards. Based on advances in distressed bonds, corporate bonds and munis over the last quarter, it already seems that the financial sector has picked on the thread. Add to that an agonisingly slow pace of regulatory reform - and there is a significant risk of a too-rapid turn around before we fix some of the fundamentals.<br /><br />Why can the Fed not set an internal target for economic and market activity (economic growth, market indicators etc) and rigidly follow a monetary policy which can control expansionary cycles and curtail market booms? Instead of using inflation as the sole leading indicator for monetary policy, the Fed should play a more active role in tracking key indicators and not restrain itself from pulling the trigger if it sees unreasonable moves. Pure free market advocates would loath such a Fed avatar, but we have already seen what happens if the Fed stays in its Greenspan mode. It's amply clear that the current market culture driven by quarterly results, bloated profits and huge bonuses can never be self-correcting or self-regulated. Uni-directional Fed policies targeted at avoiding recessions and fueling growth cycles can only lead to unbridled activity in one or more of the asset markets. We probably need a more 'range'bound', directional fed policy for the next many years to help temper cycles and avoid asset bubbles.<br /><br />On the fiscal front, an ever-expanding government reach is definitely not the solution to all ills. When comparing government-run programs in other countries, we often forget the size and nature of the beast here - most markets are too big in size and volume for the government to play an active role without compromising fiscal reponsibility. Government-run programs are fine provided it is targeted only at tha wekest links in soceity and provided there are clear stakeholders who fund the plan. Else, rising deficits would soon push external debt to over half of the national GDP and threaten the credibility of US treasuries. Many would point to an intermediate uptick in interest in treasuries and opine that foreign economies would continue pumping back money in to the US given clear signs of economic revival. However, we cannot<br />expect this to be sustainable if central authorities continue with a loose monetary policy and a fiscal policy which promotes deficit spending without a clear plan of future curtailment. This can only yield one result long-term - a gradual move away from the dollar as the reserve currency and subsequent struggle in funding deficts through foreign money. Its difficult to ever assume that consumer savings would rise to a level that can fund such gargantuan deficits!<br /><br />Regulatory reform is the third pillar which needs utmost attention. Among the broad outline of financial services regulatory reform moves that the Treasury Secretary announced months back, very few have seen implementation yet. A few of these are critical to be implemented befoire any serious market/economic uptick occurs:<br /><ul><li>Disclosure and regulatory guidelines for credit rating agencies</li><li>Market governance framework for OTC instruments, especially credit default swaps</li><li>Increased disclosure norms for non-bank financial services entities like hedge funds and private equity funds</li><li>Continued monitoring and regulation of financial services firm practices as related to consumer products/services (the only area we have seen some conceret action so far)</li><li>Policy outlining broad principles and limits for compensation policies at financial services firms (going beyond Ken Feinstein!)</li></ul><p>Among the above, the last one would see the highest amount of debate and opposition. But unless there is either a central regulatory or self-regulatory control of compensation principles, top management & trader (key profit-driving) compensations would continue to be driven by immediate profits, which would in turn forec minimal alignment between risk management principles and corporate reward/compensation norms. Because irrespective of the nature and volume of regulatory overhaul and international guidelines like Basel II, there is enough ingenuity in the financial system to unearth loopholes and drive short-term profit and compensation maximization. And that combined with loose federal monetary/fiscal oversight would prevent any sustainability of economic growth long-term.</p>Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-81351760908926147532009-06-20T14:47:00.005-04:002009-06-20T15:03:41.205-04:00Early exuberance - are we getting ahead of ourselves?It's suprising that merely two months after the PPIP was announced, with foul play cries from critics on 'too much of government/tax payer support', there is already indications of a lack of interest in the program from larger banks. The treasury secretary himself referred to this in a recent interview. This is primarily due to a rapid 30-45 day surge in stock market indicators, with early talks of the recession slowing down.<br /><br />It's indeed glad to see early-stage trend changes in unemployment, housing stats (new & existing), consumer spending, industrial spending - a possible early signal that the steepness of the downturn has been arrested. But that's just about it at this point - the economy as a whole is still showing negative growth, housing prices are still showing no signs of any significant bounce & overall consumer sentiment is still negative. Given this background, it would be suprising if banks bask in the short term uptick in stock market indicators and show lax interest in participation in the PPIP program. None of the basic drivers - house prices, unemployment rate - have shown a marked movement towards positive territory, and hence its too early to expect quick reduction in credit card delinquencies, loan write-offs or foreclosures. Also, the credit market as a whole has been next-to-inaccessible for a larger part of the population due to extremely stringent lending norms and a sudden uptick in lending (especially mortgage) rates. This is dangerous - it increases the risk of at-the-brink consumers stepping in to delinquency due to insufficient means for availing short-term increases in credit, and thus flexibly manage their debt.<br /><br />Another reason for the early exuberance, and hence perceived lack of interest in PPIP, might be the result of the bank stress tests that was announced in early May. However, one needs to understand that the 'stress' parameter values used were pretty mild by current standards - looks at this:<br /><em>The stress test’s “more adverse” scenario, factored in ONLY the following worst case scenarios for GDP, unemployment and housing prices (as described in detail in The Supervisory Capital Assessment Program, Design and Implementation released by the Fed on April 24, 2009):</em><br /><em><br /><strong>GDP:</strong></em><br /><em>- a decline of -3.3% in 2009</em><br /><em>- increase of 0.5% in 2010<br /><strong></strong></em><br /><em><strong>Unemployment:</strong> </em><br /><em>- civilian unemployment of 8.9% in 2009 </em><br /><em>- civilian unemployment of 10.3% in 2010</em><br /><br /><strong><em>House prices:</em></strong><br /><em>- declines of -22% during 2009 </em><br /><em>-7% in 2010<br /></em><br />Given the nature of the downturn and the depth of the crisis, the worstcase values used for GDP are pretty mild - especially 2010 numbers. Also, unemployment numbers assumed in worstcase are way too mild - we are already close to 8.5% in Q2 2009! House price decline numbers are probably realistic even in worst case scenario considering the decline that this parameter<br />has already seen over the past 30 months! On top of this, only a 2-year stress scenario was used as against a more stringment 5 or 10 year scenario - we are talking of 'stress testing' and hence scenarios need to assume worst case numbers/assumptions.<br /><br />The fact that the Fed/Treasury allowed many large TARP recipients to repay the money in light of the above stress test results does park serious concern. I agree that some of these institutions are fundamentally sound even in this environment, but not all. Letting banks with pass marks after a mild stress test and then allowing them to ease out of regulatory control (especially on executive compensation) by allowing TARP money repayments show serious laxness on the regulators.<br /><br />Just to sum it up, we should all be happy to see an uptick in indicators and see the economy reviving. I also believe in the government needing to support this economy and market in ways that are mandated by the current environment. But its not common sense to let go of this opportunity to clean up bank/financial company balance sheets and forge a stronger culture of risk management. This can only lead to future peril and a possible relapse of recessionary trends. The current situation was clearly caused by lax risk management and poor regulatory and governance framework - and unless this fundamental issue is corrected, we are never going to come out of the rut clean.<br /><br />Also, the situation has to be seen in an even larger context - treasury funding itself might be constrained due to a drastic increase in federal debt. Several of the large sovereign investors in treasuries (notably the BRIC countries) have already expressed serious concerns of the high-level of treasury debt floated these days, lack of focus on reigning in deficits longer term, and hence the risk posed due to an over-reliance on the US dollar as the reserve currency! This limits future treasury/governmant ability to fund and support the market, and hence it is all the more imperative to do it right this time!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-58254285367042394702009-04-26T22:09:00.000-04:002009-04-26T22:10:17.129-04:00PPIP moves in to execution mode...With Blackrock, TCW and most probably PIMCO submitting bids as Asset Managers for the legacy securities program, the PPIP program has definitely gotten the kick start it needed!<br /><br />There is definitely still a lot of skepticism in the program - however some provisions that have become clearer as the program reaches execution phase should give some comfort to skeptics.<br />Again, to reiterate fundamentals, this US program is far better than similar programs - unlike the UK Asset protection Program (see: <a href="http://www.hm-treasury.gov.uk/press_07_09.htm" target="_blank" _extended="true">http://www.hm-treasury...</a>) for bad assets where exposure is not clearly ring-fenced, the US program has definite quantifiable upside and downside. Also, executive compensation restrictions for entities which invest money and avail government funding/debt for the same ensure asset managers clearly segregate agency functions and principal functions.<br /><br />However, the complex structure (of both the legacy loan and securities programs) and other parallel government initiatives in the credit markets make program administration tricky if not tough.<br /><br />For example, the Home Mortgage Modification program under which the Treasury has earmarked money for mortgage servicers (see article: <a href="http://online.wsj.com/article/SB123983952090823017.html" target="_blank" _extended="true">http://online.wsj.com/...</a>) will pose questions on applicability of the subsidy to investors in the PPIP program - since the subsidy is targeted at servicers and not loan/asset owners. Similar programs would potentially increase book value of the loan pools and raise acquisition price for PPIP investors, but the actual subsidy is tied to servicers and would be lost to investors unless the servicing contract with the same servicer is retained durign period of ownership.<br /><br />Another example of uncertaintly/complexity is the extent to which ongoing asset management strategies for the pool (as employed by selected asset managers), and management of the program in general would be subject to Treasury oversight, is not known yet. Some or all of these will become clearer as the program unfolds, but some amount of fluidity is unfortunately bound to prevail.<br /><br />There's a lot of money and time invested in this program - and enough and more stakes for all parties to ensure it helps revive the distressed securities market and hence credit markets in general! The onus is on the Treasury to continue effective articulation of program logistics/operating model and also interlinkages with other credit market initiatives!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-60024993132587410022009-04-12T08:53:00.003-04:002009-04-12T13:03:03.467-04:00Government intervention - do we really have alternatives at this point?My last post on the PPIP drew strong opinions - on the government's strategy behind the plan.<br /><br />The key reasons for the opposition are:<br />1) How can the government 'waste' tax payer money on helping unfreeze MBS/ABS/CMO and other securities and asset markets, and hence proppping up the same set of institutions that has caused the market crash in the first place?<br />2) How will the government ensure its not taken for a ride - through participants in the plan colluding and creating flawed price discovery?<br />3) It's a better long-term option to let the situation play out i.e. let weaker banks fall, let asset prices find their true values etc - isn't that a more balanced long-term strategy?<br /><br />Let's take the points in the inverse order above - first looking at the option of letting the crisis play out in its 'normal course'. Apart from the agony associated with prolonged recession and persistently high unemployment, i would question the very premise between this argument.<br /><br />Take a look at the Japanese economic crisis of the 90's - Bank of Japan took 7-9 years to meaningfully relax interest rates, and close to 8 years to meaningfully inject public money to help banks; while there were changes in rules and regulations in the interim. Thus, BoJ basically played 'prudent and waited/allowed the crisis to play its course. Though many observers quote the Japanese and US crisis to show case the evils of deregulation, the parallels hopefully stop there. Because apart from what's commonly known as 'the lost decade', we didn't see any medium term gains from BoJ's wait-and-watch plan. On the other hand, if we can have a counter-balancing force of strong regulatory supervision and revival of corporate governance and risk monitoring, a government-facilitated resuscitation can help the economy revive short-term while laying the foundation for more meaningful growth longer-term.<br /><br />In a different kind of comparison, some including Roubini have been advocating a repeat of the bank nationalization that happenned in Sweden in the early 90's. However, the size of the Swedish economy (less than 3% of the US economy) and the relative size of the banking institutions clearly means we are not comparing apples to apples. As an example, our mortgage debt book size itself is 12 trillion plus - as compared to the Treasury balance sheet of USD 9 trillion. This is only a part (if not tip) of the iceberg - if we add notionals on derivative instruments, it reaches gargantuan proportions. To presume that the US government has the appetite to nationalize and turn around at such scale is being naive.<br /><br />As for flawed price discovery and the government being taken for a ride, i don't think there is more at stake compared to what has been already done - or forced to be done rather. <br /><br />A realistic assessment would tell us that the worst case downside is probably USD 200-250 bn (asset and securitiy prices falling a further 50% from current levels, and the government losing its equity investments apart from losses on guarantees/debt). The amount is not trivial; but not as large if we compare current stake that the government has already assumed, the impact that the lack of a forceful plan would have on (continued) depletion in asset prices, further bank delinguencies (and hence FDIC money-on-the-table), continued slump in the economy and a long period of depleted tax revenues.<br /><br />Taking a look at the dynamics of price collusion and flawed price discovery, there are enough reasons why this should/would not happen in a rampant fashion. To presume that institutions which have already taken a severe jolt would further collude to take more risk is basically assuming there's a total lack of regulatory oversight, share holder vigilance and corporate governance. More over, if the treasury can get the right financial expertise (we are already seeing increased recruitment of such kind from all govt agencies including the SEC), its common sense to assume that it can have a fairer estimate of the valuation to prevent participants from playing foul!<br /><br />Lastly, on the point that tax payer money is lost, the counter argument is - who else bears the brunt of the crisis if it is prolonged? Are we saying we can live with a 5-year recessionary cycle, 10%+ unemployment and every thing else that comes with it? I hope not - unless there's a meaningful (&practical) alternate option where frozen markets can be resuscitated without heavy government intervention. Also, to look at it from another angle, the government has majority equity stakes in AIG, Freddie & Fannie, a significant stake (with inbuilt clauses for expanded stake) in institutions like Citi and several such. So, tax payers are assured of a similar share in the upside. Going back to the Swedish example, this is similar to what the Swedish governmant did too - resulting in a net total (tax payer) cost of less than 1-2% of GDP at steady state.<br /><br />Having said the above, I cannot agree more with the opinion that any revival not built on a stronger strategic/long-term foundation of risk monitoring, regulatory oversight and fiscal prudence is unsustainable. Though we haven't seen a lot of details on this front yet from the government, we did see an outline of upcoming changes - strong monitoring of systemic risk, stronger liquidity monitoring for bigger banks, increased capital cushions for the bigger banks, mandatory stress tests for bailout package recipient banks, increased regulatory oversight and reporting norms for alternative investments etc.<br /><br />There might be some who say we need the above first and every thing else later i.e. effect stronger regulations, let the market play out its course and then think about fiscally-prudent long-term growth. But considering the impact that the crisis had on institions like AIG and Citi, and hence the larger US and global economy, this approach is very text-book by nature. Nor are other stakeholders (EU, Japan, China) going to abide by such a long-drawn out plan.<br /><br />To put it in simple terms, unless we have key large participants in the system functioning normally, we cannot either talk about revival or sustainable growth. Because we need to first stand up before we can run or even walk!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-59908020805052199542009-03-29T00:52:00.003-04:002009-03-29T01:44:25.049-04:00Making sense of the Public-Private Investment ProgramTim Geithner unveiled a good amount of detail on the much-awaited financial sector resuscitation package over the last week. Apart from addressing the core issue of unfreezing the credit market and hence imrpoving liquidity, the Treasury also clearly articulated the broad guidelines of new financial sector regulation.<br /><br />Let's try to make sense of the PPIP - the plan basically envisages the government putting its skin-in-the-game to push/incentivize private sector participants (read money managers) to take that elusive step forward - buy distressed assets and securities. The government's share of risk is through a mix of FDIC guarantees, direct Fed loans and Equity participation. To make sense of the program, let's look at the Legacy Assets and Legacy Securities program separately.<br /><br />Legacy Assets PPIP program - This envisages private parties (meeting certain eligibility criteria) to bid for defined pools of troubled assets as made available by banks. Once the best bidder is decided for each pool, the government would match equity contribution. But the bigger piece of the puzzle here is the FDIC guarantee - FDIC would employ consultants to value each pool and provide debt guarantees up to 85% of the total bid value of the pool. The actual guarantee percentage for each pool (85% or lesser) would eventually determine total credit risk assumed by the government. Assume a USD 100 million RMBS pool with a bid value of USD 80 million (to account for potential losses in the portfolio), if the FDIC provides a debt guarantee up to 85% of bid value, it basically means the government is taking a risk of USD 6.0 mn in Equity + additional losses if the actual realizable value of the asset pool is lesser than 68 million. This is fine in case the overall PPIP plan does turn back the market to normalcy; but its a significant risk to the Treasury's balance sheet otherwise...another 12 million (15%) value drop on the portfolio is not beyond practicality! In a nut shell, there is enough risk sharing from the government to bring in private investment - but on the same note, an ineffective execution can expose the treasury balance sheet signficantly. Considering the vary nature of the base asset (loans as against negotiable securities), initial participation is bound to be tepid, unless the securties PPIP program picks up speed and loosens the secondary market.<br /><br />Legacy Securities PPIP program - The basic premise of the plan is similar to the assets program described above, but the modus operandi is a bit different. It starts with the treasury inviting bids from large assets managers (again, defined eligibility criteria) to select up to 5 asset managers to run the program. These managers would form distressed securities funds with disclosure on fund amount, investor mix, asset selection strategy, asset management strategy, fees etc. The treasury would commit an equal share of equity and on top of that, provide a matching share or in some cases (based on analysis of target investment pool, strategy etc) even twice the matching share in the form of senior debt. Assuming the maximum share of senior debt from the treasury/FDIC, this basically means, there's an open risk beyond a value depletion of 25% on the base assesses value of the securities pool. Given the fact that several large global funds have already raised significant money targeted at distressed securities, this plan should drive active participation and free up liquidity in the market.<br /><br />From the above, its clear that its a well-thought out plan from the Treasury, but its no magic wand. As in any other solution, it does assume rational markets (and market participants) and hence does imply significant balance sheet risks to the treasury - up to 800+ billion, a large number considering the 9 trillion + balance sheet size. But, given the already-distressed value of the base assets and latent investor appetite for such assets, i would bet my money on the plan gradually unleashing liquidity over the next few quarters. The dark horse here is the impact that freshly unveiled regulatory changes (read registration, increased disclosures and hence constariend investment strategies) will have on the existence and volumes associated with critical participants like hedge funds, venture capital funds and private equity funds.Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-13443586168706076262009-03-21T15:04:00.005-04:002009-03-21T15:23:25.278-04:00Why are we wasting our energy - and getting so pseudo-moralistic?Last week saw an unprecendented amount of corporate CXO-bashing from politicians, public and the media in general. A sudden surge of moral anger seem to have been generated by the AIG bonus news. I don't personally support the AIG bonuses, but none the less, i cannot fathom the logic behind doing a witch hunt for the bonus recipients. We are living in a capitalistic economy and hence there's little merit in arguing on the lines of rich-getting-richer/ poor-getting- poorer.<br /><br />Let's try to look at it from another angle. The past few decades saw unprecendented growth and as a result, an accumulation of personal wealth and a consistent increase in personal spending across most classes in society. This unfortunately came at the cost of lax supervisory oversight and poor market discipline. Every one shared the gains, but leaders in the financial services space which drove or at least facilitated most of the economic expansion reaped the largest gains through windfall corporate profits and hence astronomical bonuses. We are seeing a drastic correction, which is forcing us to look at the value of fiscal prudence, savings and long-term sustainability. So, all of a sudden the same media and public voices which ga-ga-ed at Bill Clinton's talk of 'we do it large because we can afford it' turns around and moves to a position of extreme fiscal prudence and conservatism.<br /><br />I am not saying the correction's not warranted - but whole heartedly agree with the 'back-to-the-basics' move towards increased savings, financial prudence and controlled markets. However, it has to stop being a witch hunt - if we go over board with governmental oversight and regulations, we would be committing a big mistake. What gain will come out of revealing the names of individual bonus recipients at Merril Lynch or for that matter AIG? Even worser, you have state AGs investigating why tax payer money went to honor counter-party obligations of AIG related to its CDS portfolios!! The government can and should use more subtle means to discipline firms who received tax payer funds - but stop at being moralistic. Do we REALLY expect businesses to stop honoring legal commitments, contractual norms and focus on reviving the economy and ensuring money flow? I hope not...there's a lot else that's left to be done before we spend our collective energies on discussions around economic philosophy.<br /><br />- By now, we know that no stimulus/bail out package can succeed unless flow of money is restored in the larger economy - but we haven't YET seen anything substantial/serious from Tim Geithner and team to revive the financial services sector. While we saw individual firms like Citi forming 'bad money' banks and trying to separate out the wheat from the chaff, we still haven't seen any further light on the ambiguously termed larger 'public-private' partnership that was announced many weeks back. This is imperative to re-energize bank balance sheets and enable them to work 'normally'and do what they are supposed to do - lend money and facilitate money flow.<br />- We haven't seen any details on revised accounting norms for mark-to-market valuation.<br />- Nor have we seen any serious/informed discussion on the nature and form of regulations for the Securities and Investments industry that can prevent what happenned.<br /><br />As a result, we have a financial services sector that's still stuck in a quagmire, with out either the ability or the willigness to circulate government and tax-payer funded money that's flowing in! While the government, media and many others have litle time but to debate whether CXOs deserve to earn their million dollar bonuses!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-61610748513993463172009-02-22T18:39:00.011-05:002009-02-22T20:28:38.170-05:00Devil lies in the details - the importance of financial sector resuscitationDespite the House passing the Recovery and Reinvestment act over the past week, there's been a persistent sense of doom and gloom in the US and global markets. Though it is a fallacy to predict the effectiveness of such an initiative using a short-term stock market reaction, we cannot ignore the natue of the stick market reaction and the sector which bore all the brunt - financials. Let's take a quick look at the numbers.<br /><br />The recovery and reinvestment act, in terms of size, looks quite dwarfed in context of overall macro economic numbers (all numbers as of end Q3 2008):<br />Domestic financial sector debt: USD 16.9 trillion<br />Domestic home mortgage debt: USD 10.5 trillion<br />Domestic consumer credit: USD 2.6 trillion<br />Domestic Federal debt: USD 5.8 trillion<br />In comparison, the act would add to budgetary deficits by USD 185 billion in 2009, USD 399 billion in 2010 and USD 787 billion cumulatively over the next few years. So, despite all the hoopla over the size of the package and the fiscal profligacy tag imposed by fiscal conservatives (if there is such a class at all!), the size of the package is quite moderate! Let's look at it another way: Federal debt increased by over USD 770 billion over Q3 2007 to Q3 2008 (15.2% increase). In comparison, the stimulus act would add over USD 584 billion (9.9% increase) over 2009-'10.<br /><br />From the above, its clear that the stimulus act by itself does not pose a fatal threat to the fiscal state of the US economy. As long as there's a foundation of fiscal discipline (read avoidance of unfettered tax cuts and freebies), the economy will be able to absorb the fiscal bump to reach a mangeable steady state.<br /><br />However, as can be easily seen from the above macro-economic numbers, there's little that the stimulus act can achieve unless there is a very focused and directed effort to 'unfreeze' the money flow in the financial sector, with special emphasis on 'directed' mortgage lending.<br /><br />TARP Phase 1 obviously didn't achieve it, neither did any efforts from the Federal Reserve for driving additional liquidity. During the past few months, while Federal Reserve lending to banks increased by over USD 800 billion, deposits from banks with the Fed increased by almost the same amount - what a sheer fallacy! The basic problem with the above efforts was the same - as long as the mortgage freeze persists and banks continue to face the risk of further write-offs on newer assets, no amount of additional money in the system wil help ensure free flow of credit!<br /><br />Phase 2 of the financial and mortgage sector revitalization act has to do all of the below to be effective (as highlighted in some of my write-ups earlier too):<br /><br />1) Until the credit market freeze is significantly overcome, its difficult to ensure free credit flow without altering the rules of the game. In some form or fashion, there need to be a dilution of the mark-to-market rule - i hate to advocate a core principle behind conservative/realistic accounting, but a temporary 2-year moratorium on mark-to-market provisions related to assets in high-priority sectors would not be too bad. For the sake of argument, lets say we enforce a 2-year moratorium on mark-to-market provisions for new mortgage-related assets, including mortgage loans, MBS, CDOs and CMOs with residential and commercial real estate assets as collateral for the base reference credit. Considering the potential danger associated with rule-interpretation, derivatives (CDS) should be kept out of this moratorium and continue to be subject to mark-to-market norms. This has to be complimented by a mechanism to rid the bank balance sheets of existing written down/troubled assets, through some federal participation, as has been already discussed.<br /><br />2) Even if the above is done, money flow to sectors deserving the highest priority cannot be ensured without a new dose of targeted/priority lending norms. This can be either through carved out priority lending funds or clear provisions to channel a specified percentage of government funding to new loans in targeted sectors (including obviously residential and commercial mortgage)!<br /><br />3) A thorough revamp of the regulatory and compliance scenario. Tim Geithner already referred to mandatory stress testing for banks receiving (above a certain threshold limit of) TARP funds, but we probably need to go much deeper and broader beyond that. The US has been unfortunately lagging in implementation of Basel II as compared to Europe and Asia - some would question the efficacy of these norms by pointing out the failure of several banks in Europe, but as in many other cases, the mode and manner of implementing such norms/guidelines is even more important that the risk/regulatory oversight that it mandates. Even if banks compute capital norms per Basel II norms and practice market disclosure, true risk assessment often lies in some areas where rules are not as explicit - risk aggregation, stress testing and scenario analysis. Also, goal alignment between business groups and risk management groups through risk-aligned performance measurements and the like is equally critical.<br /><br />More over, central and regulatory oversight would not be complete without a fresh complementary dose of self-regulatory guidelines, principles and institutions focusing on oversight of equity and credit rating agencies, enhanced market disclosures and fostering market discipline.<br /><br />A lot depends of the finer print of the financial sector package that Tim Geithner would hopefully announce over this week and next - what it addresses and how! I am personally sure there would be enough meat in the proposal, given how the current administration has conducted itself so far.Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-68586886343601847392009-02-08T13:06:00.004-05:002009-02-08T14:03:14.509-05:00Stimulus package - ensuring efficiency and sustainabilityThe Senate is closer to signing of the stimulus bill, after a short hiatus of introspection and wrangling. Though one does feel that the package is spread out a bit too thin - in terms of areas it tries to cover - it never the less provides a much-need lever for trying to stem the current economic decline. Sceptics would question the relevance of another 850-odd billion 'stimulus package' when the earlier 700 billion kitty (TARP) did little to either ease money supply or contain fincnail sector turmoil! This could very well be true unless administration and execution of the package is done in a business-like fashion. Adding the money remaining from the TARP package, the government has a ~USD 1 trillion pool now to spark economic activity.<br /><br />Despite all the goodwill and long term benefits that green energy spending and healthcare spending would bring, we probably cannot pull ourselves out of the rut unless there is targeted efforts at improving money supply. Government spending in infrastructure would drive some downstream activity in construction and ancilliary sectors; but this cannot result in sustainable business acticity unless the core issue of liquidity and money supply is addressed. We need to address the root problem for this - ongoing mark-to-market impairment on the balance sheets of fincancial services firms and resulting squeeze for meeting regulatory and economic capital norms. This cannot be achieved without both of the following:<br />1) I would absolutely hate to advocate scrapping of the mark-to-market rule, but a temporary 2-year moratorium on mark-to-market provisions related to assets in high-priority sectors would not be too bad. For the sake of argument, lets say we enforce a 2-year moratorium on mark-to-market provisions for new mortgage-related assets, including mortgage loans, MBS, CDOs and CMOs with residential and commercial real estate assets as collateral for the base reference credit. Considering the potential danger associated with rule-interpretation, derivatives (CDS) should be kept out of this moratorium and continue to be subject to mark-to-market norms.<br />2) There should be explicit provisions for emergency priority lending provisions targeted at residential/commercial mortgage and commercial lending. This can be either through carved out priority lending funds or clear provisions to channel a specified percentage of government funding to new loans in targeted sectors.<br />With steps like the above, banks can continue to build core-sector assets without undue downside risk, and also beef up interest income since base treasury funding rates would be low enough to provide decent margins even at low lending rates.<br /><br />None of the above would ensure sutainability unless backed by strong regulatory changes as advocated in some of my earlier notes - oversight on credit rating agencies, enhancement of supervisory oversight on risk management, stronger corporate governance norms...among other things.Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-73222167172425246082009-01-11T10:01:00.007-05:002009-01-11T11:04:31.761-05:00Retail spending, bleak statistics - but is it a good forecast for 2009?Economic statistics have been pointing only one way since the past 3-4 quarters - down! Though the NBER announced a few months back that we 'technically' entered recession some time in Q4 2007, we really didn't feel the intensity of the slow down till Q3 2008, especially after the Lehman-Merrill day in September '08. Almost all indicators are very bleak by now - retail sales fell by 1.8 and 1.2 percent respectively in November and December, with same store sales falling close to 2.2 percent on the average as compared to the same period in 2007. This, along with an exteremly depressing unemployment rate of 7.2%, paints the picture of a deep, gloomy slow down period. The big question in every one's mind is - is this the start of a deeper recession or is the worst behind us?<br /><br />WIthout doubt, the slow down has deeply impacted consumer sentiment and thus damaged the trend of the single largest factor which drives over 2/3rd of this nations GDP - consumer spending. However, I would personally argue this is more of a reversal of the exuberant trends seen from '05-'07 rather than point to anything that's inherently unhealthy in this sector. The consumer hasn't stopped spending - just to illustrate this point, let me mention an interesting experience i had when i was at an outlet mall south of Boston recently along with my spouse. We saw a long line of 15+ people waiting outside the door of an Uggs store and was curious as to why - apparently, Uggs was offering some good deals, and there were more than enough people interested...to make the folks who run the store 'control' intake of customers to prevent over crowding! We saw pretty much the same at a nearby Coach outlet...they were offering 50%+ discounts (which still doesn't make the purchase price reasonable for many!) and there were throngs of women pouring over their handbags, clutches and other accessories on sale. I have heard the same from many of my colleagues and friends across the region - which all points to the fact that the consumer is still willing to spend money, provided the deals are 'right'. So, what's happening is more of a change in the way consumers approach spending than any doomsday no-spending behavior as many would expect us to believe. If people prefer buying at Walmart and pay less dollar for exactly the same merchandise as compared to the fancy department store locally, or if they switch from Saks to Gap for a larger percentage of their clothing purchases, it's probably for the good. We saw a long period of (close to) reckless spending, depleted savings rates and bloated same-store retail numbers...a period where 'value' took a backseat and the consumer stretched savings and on-paper home equity values to splurge on not-so-necessities. We are just seeing a 'good' reversal of these trends - this is exactly the same psyche that led consumers to (hopefully) permenently alter their outlook on fuel-related spending when oil touched 147 a barrel in Q3 '08...despite prices crashing down to 40 a barrel levels, consumers have continued to stay more 'conscious' of the money that are spending on running their cars and heating up their homes. As i had said earlier, this was probably one of the best things to happen from the oil price shock in late '08. And probably this retail spending 'pattern change' is a better thing for the consumer in the long run too!<br /><br />My basic argument is that there is still some 'sentiment' around and consumers are not sitting at their homes and looking out of their windows altogether - which means good for the economy. As i had mentioned in one of my blogs in late '08, the only way to step up from this slow down is to loosen fiscal prudence for a brief while and indulge in drastic government spending. Don't get me wrong - i am not typically a demand-side economics supporter, but the current unprecendented situation warrants unusual strength in fiscal and monetary actions. We don't have much of a leverage in monetary policy, with fed rates already close to zero - thus there's no option but to use the fiscal lever! If Obama does succeed, even moderately in targeting fresh money in to areas like construction, healthcare, green energy and education, the very impact of this in down stream sectors and resulting gains in employment would be more than enough to crank the engine back. From what he's said so far, it looks very much like it's going to be a very common-sensical approach - every one cannot expect taxes to be cut and sops to be given , but still expect the economy to be revived...sops can only be targetd at the right sectors (high-employment industry areas and low-income population). Once we see early signals in the US, there would be downstream impact across global markets and a synchronized global recession can probably be turned around! There are many who opine that history points to a longer period of slow-down, but when we compare this slow down to earlier slowdowns, what we should note is that everything's been played in pretty much fast forward so far - and a pickup in trends would be quite quick too, given the right stimulus. Advances in economic theory and fiscal and monetary tools and policies have just made economic cycles more drastic! But hopefully we should see some thing even better - if policy makers can use this opportunity to drive permanent shifts in trends towards increased savings, tempered leverage and fiscal prudence (long-term), we should see a more stable growth trend once a turn-around happens!<br /><br />Even by risking the probability of being wrong, i would stick out my neck and say that we should be back to near-sanity conditions by mid-to-late Q3 2009. We shoud see unemployment trends slowly reverting, housing and real estate stabilizing, and manufacturing looking up from it's trough. So, we are still looking at another 2 quarters of bad statistics and sad news on the unemployment and consumer spending fronts, but there's light at the end of the tunnel. That is assuming Obama and his team does not flounder completely - the chances of which look pretty grim. Here's promising and hoping a more cheerful look-back blog for late 2009!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-1939742255448489982008-11-27T17:51:00.006-05:002008-11-27T18:30:39.834-05:00Mumbai terror strike, global economy and more...This has been an year not to remember so far - not from a personal view point, but from what's transpiring globally.<br /><br />What started off as a weak year with clear hints of a slowing global economy is winding down as one of the worst ever years in a life time (I sincerely hope this is the case!). The sub-prime lending fallout in US drastically led the global economy to a grinding halt - strung by a global credit crunch, gargantuan write-offs at financial firms, massive lay-offs, depressed consumer sentiment, a drastic fall in consumer spending and almost surely a global recessionary scenario...Japan, China, the US (by 4th quarter, even by technical definition) and many to come in the Euro region. What started off in the US has probably to be fixed here too - with firm central/federal steps, be it demand side or supply side! In the current scenario, it probably takes some strong demand-side measures by the new government post Jan 2009 (similar to the 30's when government-led infrastructure spending helped escape the rut)...there has been enough supply-side measures without much avail. Though quite uncommon in the free-market era, we would probably/surely see a strong switch to central regulation and state-led measures to pump-prime the economy back in to shape, but in a measured manner. The industry has little option, but to comply...but every one sincerely hopes this doesn't throw us back to a pre-free market state regime!<br /><br />We didn't need anything more to spread further gloom to the year - but the terror attack which unreeled in Mumbai on Nov 26 did exactly the same. Its suprising to see 7-8 terror attacks in India over the course of 12 months (almost surely unprecedented due to nature of the attacks) pass by without any firm counter-steps. 9/11 in the US was replied by a strong counter-lash - though the direction and intent of the measures ever since then might be debatable, the nature and tone of the response delivered an equivocal message. Nov 26 probably delivers a repeated warning without any doubt...the world cannot sit and wait for more attacks to respond. India (and the world) needs a very pro-active and firm approach to tackle terrorism - we probably need a multi-pronged approach involving political means, economic means, advanced global warning systems and last but not least brute force! The right approach has to a) identify the funding means of terrorist groups and stifle funding sources (we can do this at least partly by strongly promoting green energy for what you know!) b) orchestrate political and diplomatic forces globally to isolate and target such forces and c) enforce counter-terrorism measures with complete conviction and force. This again calls for an approach which is unique to the times, driven centrally, but towards the right direction.Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-31651724321621903262008-09-17T20:31:00.002-04:002008-09-17T20:34:25.352-04:00Regulations, Risk Management & financial sector ails...Its difficult to write anything on the economy or the market in the midst of such a horrendous week! However the very fact that 3 of the top 5 stand-alone investment banks cease to exist independently (and probably one more in the offing) - all with in a span of 3 months - shows how ridiculously leveraged and reckless most of these shops would have been. And seeing an insurer the stature of AIG in such massive trouble makes it even more dreadful.<br /><br />Every one's now talking about regulation and the need for supervisory oversight - including the 2 presidential candidates - though more in populist terms! When the credit crisis unravelled (the early Citi and Merill write-offs), I had written about the need to regulate the credit rating agencies, to avoid conflict of interest situations and also to ensure a robust methodology for ensuring forward-looking ratings. This week proves beyond doubt that we need this and much more to lend some credibility back to the financial services sector.<br /><br />I completely agree with experts who blame the Alan Greenspan era of deregulation and laissez-fare culture for creating this mess. Free market culture breeds unbridled capitalism, which in turn creates a business culture driven by short-term profit-taking...which leads to corporate decision-making power completely skewed to favor profit-generating functions. This is against the basic principle of risk management - a strong independent risk organization which mandates a firm-wide risk management policy, monitors and controls risk limits and promotes risk management-aligned business and compensation practices. It is apparent that none of this was happenning in most (if not all) of the broker dealers and investment banks. Financial innovation driven by exotic structured products and complex derivatives fueled an artificial boom whereby firms resorted to excessive leverage and focused on generating maximum returns on capital and thus maximum bonuses for revenue generating functions.<br /><br />What is needed for financial services firms, especially investment banks, to win back the credibility that they have lost? Advanced modeling skills to price and value exotic products (like the so-called Level-3 'classified' assets)?? Even more efficient straight-through processing engines to avoid settlement risk and operational risk?? Multi-factor risk models to churn tons of data and help facilitate stress testing and scenario analysis? All of the above would probably help - but the root of the malaise is some thing more fundamental. Lack of corporate accountability and supervisory regulation are two very important factors; however the absence of a culture driven by risk-management principles is even more important. Look at some basic tenets - a) Independent and powerful risk management reporting to senior management, b) complete separation of duties between say, traders and back office folks, c) Defined risk exposure limits for lines of business and enforcement of the same. All of these were probably followed in letter, but not in spirit. There's absolutely no use having a compensation structure driven by risk-adjusted profits or for that matter trading policies controlled by VaR/Conditional VaR-driven exposure limits if fundamental principles on classifying assets by risk weights, defining sectoral or instrument-level exposure limits etc are not followed. For once, the focus has to shift away from unbridled financial 'innovation' to enforcement of basic risk management principles. But, having said all that, its difficult to blame the investment banks completely for the same - since a regulatory environment which promotes extreme free-market culture does not incentivize executive management to take any long-term decisions sacrificing short-term profits. The very fact that regulatory authorities gave a short-shrift to the level of enforcement/coverage and deadlines associated with applying Basel II norms shows how callous they have been!<br /><br />As Basel II norms clearly stipulate, one pillar (capital adequacy norms - driven partly/wholly by internal risk models and subsequent capital allocation) cannot hold on its own without the other two - supervisory review and market discipline. There's a lot to be done - solve the issue of overlapping supervisory roles (SEC, FDIC, OCC etc), creation of regulatory bodies to monitor systemic risk and excessive risk concentration, formation of a regulatory body/SRO to supervise the risk monitoring and rating agencies etc. However, none of these would solve the problem in itself - we probably need strong compliance mandates for corporate accountability and oversight to ensure that internal management of firms are driven with a balanced risk-reward mindset. Because, with out it, we have enough ingenuity and brilliance in the system to thwart any regulatory oversight and exploit compliance loopholes!!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com1tag:blogger.com,1999:blog-193936051508779015.post-35175145866567088302008-07-13T21:41:00.006-04:002008-07-13T23:00:24.958-04:00Paulson's rescue act & the need for better risk management regulationsThe Treasury Secretary did what every one expected - step in and propose a unfettered vote of confidence on Fannie Mae and Freddie Mac. If the Fed could react with such promptness to save Bear Stearns (which i feel was right anyway), there's no way any one could expect the Fed/govt reaction to be muted for these behemoths which together buy/package almost 50% of the 12 trillion+ mortgage loans outstanding. Any delay would further depress already low markets and cause more trouble for the already-shattered housing market.<br /><br />Having said that, I personally don't agree with the whole trend that such moves set - though given such a situation, there's pretty much nothing else that the Fed/govt could have done. The real trouble lies in the market mechanism which let things come to such a state. Of course, many questions remain on the role that risk management groups play in even mid and large tier investment banks - however in a quarterly-result driven market, little different could be expected in terms of market dynamics that force firms to sacrifice prudent risk managemenmt for profit-maxmimizing strategies backed by hollow VaR-backed 'risk management policies'. The real blame lies elsewhere though - as I probably have written multiple times over the past 6 months (!), one of the primary reasons has to be the lack of self regulatory (SRO-driven) or central regulatory supervision on credit rating agencies.<br /><br />Moody's latest faux-pas related to rating errors on European constant proportion debt obligations is probably only the tip of the ice berg. In a scenario where rating agencies rate debt for the same investment banks which form their key client base for fee revenues, conflict of interest is the (only) name of the game. The other driving factor could lack of senior rating analysts to cover the vast volume of debt that gets issued in today's market. A small bunch of analysts using basic senior management interviews and review of the entity's internal VaR/other risk management limits cannot do justice given the ingenuity that exists in ths system. For example, as long as regulations allow hidden buckets like 'Level 3 assets' to park illiquid assets (no rule book can ANY WAY be fool proof), its very difficult to look at a balance sheet, conduct interviews, review adherence to firm-level exposure limits and decide on current solvency or credit worthiness. Forced adherence to stronger risk management policies leveraging tougher measures like Condition VaR or extreme scenario-based stress testing and modeling need to be made an industry norm - with penalties proposed for non-adhering members through higher capital requirements. The SEC should show some urgency to forge a strong SRO culture that would do multiple things:<br />a) define best practices w.r.t rating methodology for rating agencies, especially with respect to exotic and structured instruments,<br />b) code of busines guidelines for addressing the conflict of interest inherent in the model,<br />c) define guidelines address extreme/tail-end risks in internal risk managemnet frameworks<br />being some of the key.<br /><br />We already have seen a good amount of laxness in interpreting and implementing capital allocation rules per Basel II rules in the US for example - unless this trend is reversed and a stronger SRO-driven risk management focus emerges, we would continue to see more systemic market crashes!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-34598471864366770582008-06-28T22:53:00.003-04:002008-06-28T23:02:55.227-04:00Technically in Bear territory...Market volatility could not be stressed more - after a brief positive upsurge to the 13K levels by early May, the markets swung back to sub-12K levels as early as June mid. With the Dow currently at 11,300+, we are technically close to bear territory, about 20% below the last high. As in the early year fall, Financials were the worst affected...you can rarely see C at 17, WB at 16! Some of the big names are now trading at close to 1/3rd of their highs! Though I am tempted to say these are buys, would resist doing so considering what happpenned after the last such prediction. However, like the housing market, we are probably closer to the bottom.<br /><br />The same cannot probably be said about the US equity market as a whole - Q3 and Q4 should see tough results too, especially retail, industrials and feeder service industries which bear the brunt of depressed consumer spending & unemployment highs. Drastic down turn in global stock markets like in India and China (The Mumbai Sensex is at 13,000 levels as against 20,000+ levels early this year!), fall in consumer confidence in Germany, UK and the rest of the Euro territory all means there is not a global growth story to counter domestic ails either!<br /><br />Summer should see some positive news on increased consumer spending though, in line with seasonal cycles. Housing stats should see some relief too, aided by the seasonal pattern - though an upturn is probably still a way off, a perk in activity this summer should bring us closer to the bottom. The biggest spoiler could be Oil...any rise above the current stratospheric levels would make it next to impossible for the Fed not to further tighten monetary policy, which would further squeeze the housing and consumer markets. We should hopefully see some concerted action by the G-30 and OPEC in order to bring some sanity to spot and future crude prices. It's difficult to imagine busines and political powers not acting together to prevent any thing that could seriously affect economies globally.<br /><br />I would rather not jump in to any contra-investments at this point, and take a wait and watch approach. Near-month call options on Financials might look pretty attractive, but not without associated downside risks. A normal turn of events should see oil prices cooling down, Fed keeping interest rates flat and summer activity giving the needed positive dose to this drab market.Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com1tag:blogger.com,1999:blog-193936051508779015.post-31511537579698444992008-05-25T06:00:00.002-04:002008-05-25T06:23:22.361-04:00The self-defeating oil surgeAfter a brief spell of (unwarranted) upward bounce, last week saw the market erase most of its gains and swing back down to 12,600 levels. Though this is still significantly above the low touched on March 10, during the Fed-JPM-Bear Stearns drama.<br /><br />OIl continued it's non chalant upward climb, touching as high as USD 133/barrell. It's difficult not to say that OPEC and the other supply side players are strethching their luck. Though there is no refuting the fact that industrial/consumer growth results in increased demand for several gas-guzzling 'instruments' across both the developed and developing worlds, an unreasonable spurt in prices raise red alarms. It's like a fore-warning of future danger due to over-reliance on oil - this in turn shifts tremendous amount of attention on alternative energy - solar being the flavor of the day. The spike in interest in solar shares has been over an year old (at least) by now, but this is probably the turning point for co-ordinated industry-led investments in solar. An example of the latest news on JPM & Wells Fargo funding large banks of solar thermal fields in the west coast and large players like Google and Chevron funding research for the same. If any thing positive is to come by the recent spike in oil prices (apart from bloated tressuries in the Middle East!), its this increased attention and serious focus on alternative energy.<br /><br />Apart from the above trend, continued upward pressure will feed inflationary pressures which has already shown from the US to Europe to Asia. Inflationary pressures amidst a cooling global economy causes unwanted strain and would further slow growth, especially consumer growth. As has been pointed by almost every one from now, this will eventually create a drop in demand for oil and downward pressure in prices.<br /><br />So, while the oil economies reap immediate gains, this spike is in a sense the worst thing they could ahve done to themselves longer term. Prices are bound to come back to saner sub-100 levels at least in the next 6-9 months and the longer term focus on alternative anergy gets a tremendous boost. To every one's benefit, reducing over-dependence on one single source of energy!<br /><br />As for the stock picks to cash in on this wave, i frankly haven't done enough research. My brother's (he does private equity research for an India-based shop) favourite pick has been First Solar...i ignored the pick way back in its 180's! Now that its up in high 200's, i am still wary due to my P/E-driven view of this stock world. He's probably correct since every one from Citi to Jm Cramer has upped their targets on FSLR! And we have another star on the horizon with Evergreen solar - last week saw news of this player winning 2 contracts (from Germany & US) worth almost USD 1 billion - and the shares spiking over 20%!<br /><br />The next 5-10 years is definitely the time for GREEN. Thanks to OPEC and their greed for helping every one realize that without doubt!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0tag:blogger.com,1999:blog-193936051508779015.post-80493497752214779392008-05-11T08:16:00.002-04:002008-05-11T08:22:18.921-04:00Shift in focus away from FinancialsThe last 4 weeks saw a significant upward correction, with the market touching the 13K levels, albeit for a short while. Technology and Oil & gas led sectoral gains, with names like GOOG and AAPL recovering most of 2008 losses. Financials gained too - MER, LEH, GS etc have all recouped enough to say that there's not enough immediate upside left in them now, till the economy as a whole is back on the growth track. Citi (C) stands out though - it has been one of my perennial favourities in this recession cycle...Vikram Pandit's aggressive trim-down startegy across lines of business and asset segments should give it enough steam to demand far better valuations.<br /><br />A quick look at S&P 500 sectoral swings the last 30 days:<br />- Technology up 10% [GOOG, AAPL up 25%; Intel, Cisco, HP, IBM up around 7-10%]<br />- Oil and gas up 8% [CHK up 20%; SLB up 15%]<br />- Industrials up 5% [CMI up 40%; BA, CAT up 10%]<br />- Consumer up 5% [DIS up 14%; TWX up 12%; MCD up 7%; WMT up 5%]<br />- Financials up 4% [GS, JPM, LEH, FRE, FNM up over 10%]<br />- Health care down [UNI, LLI down 8%; MRK, PFE down 5%]<br />...and a look at 3 month trends show an obvious trend - Oil & Gas and Commodities have gained the most [big ticket names like HAL, HLB, CVX, X, NUE, FCX have gained over 25%].<br /><br />It is however very early in the economic cycle to be bullish on the whole market - we need to take a quick look at the macro picture to interpret the overall trend:<br />1)Real estate market hits peak in late 2006 and shows signs of buckling by mid 2007<br />2)#1 results in a bubble burst in the CDO/MBS market, with Bear's hedge funds leading the pack.<br />3) #2 in turn resulted in sustained panic on Financials...with higher foreclosures, more stress assets, depressed MBS/CDO values, failed auction rate markets, massive write-downs and tighter credit in general<br />4) Fed/govt responds to #3 with massive rate cuts (325 bps in 6+ months), fiscal stimulus packages and some dare-devil acts like the Bear Stearns rescue.<br />5) #4 results in some regaining of lost confidence in Financials and realization of the fact that its not the end of the world for any of the big financial firms. Also, Q1 results across most sectors did not show the level of weakness that analysts factored in. This is what probably played out the last few weeks.<br /><br />However, while the above played out, there are a couple of core trends which stayed negative, to say the least:<br />- Housing market remains depressed (both new and resale)<br />- Oil pricess continue maddenning upward trend (125+/barrel as of last)<br /><br />The above two has enough power to pull down consumer spending for quite some time...and considering that consumer spending accounts for 2/3rds of the economy, we should see sustained slowdown in most sectors as a result. It is just that the market focus will shift from Financials to Manufacturing and Service sectors. Depressed consumer spending would reduce demand for goods and services and this would reflect in earnings for these sectors over the next 2 quarters. What we have seen in Q1 earnings deceleration is probably just the start - in fact Q1 suprised many since probably the lag effect has not started kicking in to reflect in actual earnings for these sectors. Except for Healthcare, I am bearish on most sectors over the next 3 months...save some names in consumer and financials.<br /><br />BULLISH: UNH, WLP, MRK, PFE, KO, PEP, PG, C<br />BEARISH: HAL, SLB, CVX, X, NUE, FCX, AA, AAPl, IBM, CSCO, ORCL, MER<br />NEUTRAL: JPM, GS, LEH<br /><br />* I do not have positions in any of the stocks mentioned above.<br /><br />The market as a whole will probably lose volatility in the coming months. Financials will remain flat to positive while heavy equipment, automobile, IT/networking will trend downwards. I would rather bet on a 12-12.5K range for the Dow than anything upwards of 13K!Pro @ marketshttp://www.blogger.com/profile/06331827673394095252noreply@blogger.com0