Harry Newton's In Search of The Perfect Investment
Technology Investor. Auction Rate Securities. Auction Rate Preferreds.
9:00 AM EST Monday, April 14, 2008: Is
blood flowing in the streets? Has the market reached bottom? Is now the time
to jump back in?
investors dumping their shares irrespective? One theory on picking a stockmarket
bottom is that investors have to be panicking, throwing stocks out the window...
blood flowing in the streets. Personally I don't believe we're there yet. In
my opinion the fall in stockmarkets this year -- Dow is down 7.1%, NASDAQ 14%
this year. Russell 2000 10% -- is not sufficient to allow for the economy's
weakness -- yet. Bearish sentiment is not big enough. When everybody is a bear,
that's when your know it's the bottom.
everyone else's attempts to pick market bottoms recently have failed. Check
out all the millions lost on pumping money into saving the financials.
big "problem" is that many of us have a little money we'd like to
see earn more than the miserable 2% it's getting in banks and money market
funds. We're getting itchy. Resist the itchiness. 2% and 100% capital preservation
is far better than the alternative -- further capital losses. When in doubt,
stay out and play tennis (or golf, if you must).
And then there's
the economy. How bad is it? I refer you to this piece from the weekend's Economist
economy is in recession. Don't expect a quick recovery
IT MAY not be
official but it is increasingly obvious: America's economy has slipped into
recession. The latest labour-market figuresa jump in the unemployment
rate to 5.1% and the loss of 98,000 private-sector jobs in March, the fourth
consecutive month of declinepoint to a shrinking economy. So do surveys
of manufacturing and services. So does Ben Bernanke, chairman of the Federal
Reserve. On April 2nd he told a congressional committee that output was unlikely
to grow much, if at all, over the first half of 2008 and could even
judges of American downturnsa group of academics at the National Bureau
of Economic Research (NBER)define a recession as a significant
decline in economic activity spread across the economy, lasting more than
a few months, normally visible in real GDP, real income, employment, industrial
production and wholesale-retail sales. (Contrary to popular belief,
recession does not require two consecutive quarters of falling output.) Though
the NBER's wonks will not pronounce for many months, their criteria look increasingly
likely to be met.
now is: what kind of recession will this be? Shallow or deep; short or long?
So far, it seems remarkably gentle, given that many think America is suffering
its worst financial shock since the Great Depression. Since December the
economy has shed an average of almost 80,000 jobs a month. In most recessions
a rate of 150,000-200,000 is normal.
To be sure,
this downturn has only just started. The labour market will surely worsen
as firms cut back in the face of weaker consumer spending. But a buoyant world
economy is still boosting American exports; a fiscal stimulus is on the way;
real interest rates are around zero and likely to fall further; and, with
the rescue of Bear Stearns, the Fed has given an implicit guarantee to Wall
Street. So few forecasters expect outright slump. A liberal enough loosening
of fiscal and monetary policy can stop recession turning into depression,
and American policymakers have left little doubt that they will use their
recession-fighting weaponry freely.
is the question of how long the weakness will last. Not very, Mr. Bernanke
told Congress. Growth will strengthen in the second half of the year, nourished
by lower interest rates and the fiscal package. In 2009, he suggested, the
economy would be growing at or a little above its trend rate,
which the Fed is thought to put at around 2.5%. Many investors seem to agree
that the downturn will be short as well as shallow. Share prices have recovered
since the Bear Stearns rescue, even as economic statistics have been gloomy.
The S&P 500 stockmarket index is around 5% higher than it was a couple
of weeks ago and is still only 13% below its all-time high.
Others are more
pessimistic. In its latest World Economic Outlook, published on April 9th,
the IMF slashed its forecasts for America's economy both this year and next.
It now expects GDP to shrink in every quarter of this year. By the
fourth quarter the economy will be 0.7% smaller than a year before. (Only
three months ago the fund expected a rise of 0.9%.) Nor does the IMF expect
2009 to be much better: GDP will grow, but at well below its trend rate.
Such a dramatic
divergence of official economic opinion is rare. And it matters. Recent recessions,
as defined by the NBER, have been both short and shallow: those of 1990-91
and 2001 each lasted eight months, below the postwar average of ten. If the
Fed is right, the 2008 recession may be shorter and shallower still. That
would be remarkable, given the extent of the housing bust and credit turmoil.
If the IMF is
right, weakness will last longer this time. America's new president will be
elected against the backdrop of a shrinking economy and on taking office will
face months of economic malaise. That in turn will imply bigger budget deficits,
and redefine next year's big domestic policy debates: whether to roll back
George Bush's tax cuts for the wealthy, for instance, and how ambitiously
to reform health care. It could fuel protectionist and populist sentiment,
particularly since Americans are already unusually fed up. A new CBS/New York
Times poll finds that eight out of ten people think the country is on
the wrong track, the most since the question was first asked in
duration will depend on many things, from the strength of foreign economies
to the degree to which American firms cut jobs and investment. But top of
the list, given the recession's origins in the property bust and the
credit crunch, are the fate of the housing market and the resilience of
consumer spending. On both counts, the odds are against catastrophe but on
a lasting headache.
By many measures
the news from housing is still getting grimmer. Housing starts are at less
than half their peak, and builders are continuing to cut back. Although
this has begun to reduce the stock of unsold new homes, the frailty of demand
means that supply still vastly outweighs sales. At 9.8 months' worth of
sales, the stock is at a 26-year high. The official overhang of existing
homes (which excludes those repossessed) is not much lower. The excess of
supply over demand means that the fall in house prices is accelerating. According
to the S&P/Case-Shiller index, house prices are 13% off their peak. They
fell at an annual rate of 25% in the three months to January.
The drop in
house prices so far has left some 9 million people, or 10% of all those
with mortgages, owing more than their houses are worth. Among all mortgage
borrowers, 6% are behind on their payments; among subprime borrowers, 17%
are in arrears. Lenders are already foreclosing on more than 1m homes.
The pessimists expect these figures to climb much higher, adding to supply
and further depressing prices.
In the short
term that is likely. But there are some signs of hope. Demand seems to have
stabilised: since November total home sales have been running at an annualised
rate of 5m or so (see chart 1). Lower prices have made houses a bit more affordable.
And government action may help to ease the drought of mortgage finance stemming
from the collapse of the subprime market and the contraction of the market
for large (jumbo) mortgages, and to limit foreclosures.
At the height of the housing boom in 2006, non-traditional loans, such as
subprime and jumbo mortgages, backed nearly 40% of home sales. Some
$750 billion of financing disappeared as they shrank. Fannie Mae and Freddie
Mac, America's government-backed mortgage behemoths, will fill part of that
hole. The Bush administration recently announced changes to these institutions'
capital rules, to let them buy up to an extra $200 billion of mortgages. Political
momentum is also building to prevent a surge of foreclosures. For now Congress
is debating some modest tax incentives. But a more ambitious idea is gaining
support: to allow the Federal Housing Administration to refinance troubled
mortgages at a discount.
hopeful signs, house prices will continue to fall until the excess inventory
is worked off. Even the cheeriest analysts expect that average house prices
will continue to fall this year. Worse, house-price deflation is only the
first element of a quadruple whammy that is thumping American consumers. The
other three elements are tougher credit conditions; a deteriorating labour
market (with unemployment on the way up and wages slowing); and high
commodity prices pushing up the cost of fuel and food.
wages rose by 3.6% in the year to March, the slowest pace since mid-2003.
Headline consumer-price inflation is likely to have topped 4% in the same
period, so for many real pay is falling. Economists at Goldman Sachs reckon
that consumers' real discretionary cashflowtheir income plus any new
credit minus debt service and spending on essentialshas been shrinking
since late last year.
Faced with all
this, no wonder Americans are glum. The forward-looking bit of the Conference
Board's measure of consumer confidence is at depths not seen since the recession
of 1973. Indicators of financial stress outside housing, such as delinquencies
on car loans and credit cards, are rising. And consumer spending, after years
of resilience, has finally cracked. Not all economists share the IMF's view
that spending is actually falling, but none doubts that it is at best barely
growing. Because it makes up 70% of total demand, its feebleness does much
to explain why the economy has tipped into recession.
On all four
countshouse prices, credit, the labour market, and fuel and food pricesthe
consumer's position is likely to worsen in coming months. Granted, the imminent
fiscal stimulus should help. Between early May and mid-July $117 billion will
be paid out in tax rebates. The average American household with two children
will get a cheque from Uncle Sam for up to $1,800 and will spend at least
some of it.
most of the forces dragging down consumer spending are likely to persist long
after the cheques have been banked. Even with stronger exports, growth is
likely to be too sluggish to raise incomes by a lot or offer much support
to employment. Looser monetary policy will cushion but not avert financial
deleveraging. Lending standards are usually tight for years after credit busts,
not months. And by most estimates less than half the likely losses in America's
financial sector have been written down. Meanwhile, lower house prices
will reduce both homeowners' wealth and their potential collateral.
Even when house
prices eventually stop falling, they will not suddenly soar. After years of
tapping rising housing wealth to finance their consumption, Americans will
need to build wealth the old fashioned way, by saving more. At 0.3%, the household
saving rate is above its all-time nadir, but not by a lot (see chart 2).
No one knows
by how much, or for how long, America's economy will be weighed down. The
IMF's gloom is based in part on its reading of history. An analysis by the
fund of post-war housing busts in rich countries, written in 2003, suggests
that crashes typically last about four years and are often accompanied by
banking crises. Economies end up 8% smaller, on average, than they would have
been had they carried on growing at pre-crunch rates. Perhaps this time will
be different, and the hangover will soon be gone. But given the scale of America's
housing binge and of the financial crisis the bust has spawned, that seems
your customers and potential customers: Running
your own business? Afraid of the downturn? Don't be. There is good news: First,
your competitors are cutting back -- firing staff, reducing inventory, etc.
Second, there are still customers but you need to become more aggressive --
find them. Don't wait for them to find you. Get on the phone. I have several
vendors whom I've contacted for stuff - windows, carpentry, etc. None have called
me to close the sale! And then there's the Internet. I have a bunch of friends
who -- believe it or not -- are still resisting putting up a web site. I say
to them, "But you'll sell more." They resist. Meantime, I hear the
head of Niemann Marcus on CNBC this morning saying that his Internet business
is booming and half of it "comes from outside our core trading area."
your April 15 tax bill: Most brokers will now lend against your locked
auction rate securities. But you need to check the terms: Some will lend you
money but they have the right to call the loan in full at any time or
perhaps in six months, e.g. before your securities are redeemed. Others
will lend but demand repayment only when the securities are redeemed. You don't
want your broker demanding his money back before you get yours. If he does,
he'll sell your securities at a loss and you'll be screwed. I understand that
UBS will now lend 100% of the par value of your ARPS. They'll lend a libor +50bps.
non recourse. According to one reader, UBS was able to collateralize the other
50% with Treasurys from their FDIC bank in Utah. Previously they would only
lend 50%. For more, see www.AuctionRatePreferreds.org.
is king. Where is your cash? Increasingly
I don't like many money market and bond funds.
I increasingly fear what they contain. As I've harped on a thousand times, before
you trust your broker and his fund, CHECK, CHECK, CHECK. I was reminded of this
with a piece in Friday Wall Street Street which began:
Pitched Safety, Courted Danger
YieldPlus Turns Toxic After Move to Embrace Mortgage-Backed Paper
The mortgage rout has laid waste one of discount broker Charles Schwab Corp.'s
star mutual funds, with returns falling deep into negative double digits and
once the company's most popular bond fund, had pitched itself as a safe alternative
to cash. But it stuffed mortgage-backed securities into its portfolio to pump
up performance, and they have turned toxic. YieldPlus has lost 24% so far
this year, while the average so-called ultra-short bond fund is down just
are suing, alleging that they were misled. The imbroglio is a setback for
Schwab's effort to diversify itself beyond collecting volatile trading fees.
Started in 1999,
the fund used to routinely beat bond indexes and peers. YieldPlus aimed to
offer juicier yields than investors could find in alternatives such as money-market
funds. One of its latest strategies was to focus on mortgage-backed securities,
which made up half of its assets through February. Some of that paper was
underpinned by subprime loans, a tactic that went awry when they started going
bad last summer.
very disappointed in the fund" and "in the losses a small percentage
of our clients have incurred," Charles Schwab President Walt Bettinger
its problems on the credit crunch and says they affect a small part of the
company, which is generally performing well. Schwab spokeswoman Sondra Harris
said the firm continues to "manage the fund in the best interests of
clients." She also said the "allegations of the lawsuit are without
The firm has
declined to make the fund's lead manager, Kimon Daifotis, available for interviews
for several months, saying he is focused on running the funds. It also cites
the lawsuit and a quiet period as its earnings release approaches next week
as limiting its ability to comment more fully about the situation.
began under Mr. Daifotis, and Schwab brokers often advised clients with short-term
certificates of deposit to switch in, saying YieldPlus aimed to provide generally
steady monthly income with limited interest rate and credit risk.
It was one of
the best sellers in the highly competitive fund industry during much of 2007.
"Meet with one of the best bond fund managers," said a pitch from
a press firm about Mr. Daifotis's visit to New York last August.
Then the credit
crunch devastated mortgage-backed paper. YieldPlus took one blow in November
when Interactive Data Corp. repriced some of the portfolio's debt downward.
The fund's situation has "jaws dropping" among "veteran guys"
in the industry, said Don Phillips, a managing director at fund tracker Morningstar
compounded Schwab's problems by pulling their money out. The fund's asset
base, which peaked at $13.5 billion last year, had by last month dropped to
$2.5 billion and by last week, to about $1.5 billion.
best BlueTooth cellphone headset is cheaper: It's now only $69.99
From 93-year old reader and friend in Florida, Bob
These three Nuns die and when they arrived at the Pearlly Gates St.
Peter met them and said before I can let You into Heaven, each of You must answer
one question, so for the first Nun He asked "Who was the First Man, and
She said Adam, so the Trumpets blared and the Angels sang and the gates opened,
then He asked the second Nun,"who was the first woman", and She said
Eve, and the Trumpets blared and the Angels sang, and the gates opend, then
He asked the third Nun, "what was the first words Eve spoke to Adam",
and She said, "Oh, that's a Hard One" and as St Peter was starting
to explain, the Trumpets blared and the Angels Sang and the gates opened!!!!!.
- Your 93 year old Friend in Florida, Bob Bailey
news of note.
Archbishop of Canterbury has finally got his way: British weather has been declared
It's either Sunni
A very loud, unattractive, mean-acting woman walked into Wal-Mart with her two
kids, yelling obscenities at them all the way through the entrance.
The Wal-Mart Greeter
said pleasantly, "Good morning, and welcome to Wal-Mart. Nice children
you have there. Are they twins?"
The woman stopped
yelling long enough to say, "Hell no they ain't! The oldest one's 9 and
the other one's 7. Why the hell would you think they're twins? Are you blind,
or just stupid?"
blind nor stupid, Ma'am," replied the greeter. "I just couldn't believe
someone would sleep with you twice. Have a good day and thank you for shopping
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
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