Nov 30, 2008

November 30, 2008

This week I eliminated the “funny” subject line since last week’s piece ended up being caught by many of your spam filters. I guess a note entitled “When I grow up I want to be a pirate” isn’t recognized by the spam filter for the economic importance of the subject matter and instead focuses on the bad joke potential.

Weekly percentage performance for the major averages
Based on last Friday's official settlement...

INDU: +9.75%
SPX: +12%
NDX: +9.2%
COMPQ: +10.7%
RUT: +16.3%

The Market
The S&P 500 was up 19% including the prior Friday, the best 5 day rally since 1933. In earlier notes I commented that the market risk is to the upside, and last week we saw exactly how that risky a short position in this market could be. The esteemed Barton Biggs, formerly of Morgan Stanley and now Traxis Partners, agrees that we could see a strong bear market rally, or as he put it “we are setting up for the mother of all bear market rallies.” As I’ve mentioned before, use market strength to take capital off the table, there will be plenty of opportunities to reinvest as the market traces out a bottom. Jeremy Grantham at GMO says that value investors are “paid to buy cheap assets and sell expensive assets” and that he feels the odds are “2:1 the market will be down a lot in ’09.”

If you are adding to stocks, focus on companies with solid balance sheets and self-funding business models. An area of focus might be companies benefitting from falling food and commodity prices. Historically, falling commodity prices have favored consumer related stocks. Although sales have been down at retail, restaurants, and even consumer staple companies, the later two have been benefiting from the downturn in commodity prices, helping to cushion the blow of slower sales.

It’s no surprise that market volatility has been spiking, however, Bespoke Investment group put out a chart last week showing the average daily change of the S&P500 over a 50 day average going back to 1928. You can see the results below, almost a 4% per day movement in the index!

The Economy
Data came in soft across the board, from Durable Goods Orders to home prices. Even so the market went up. Are expectations now so bad that even bad news is now getting a positive reaction? In my view, the answer is probably no. The market was oversold, having dropped a dramatic 49% since the middle of May and 43% since the beginning of September (see chart below), and was due for a rally.

This week we get ISM manufacturing data, domestic and total vehicle sales on Monday; Challenger Job Cuts, ADP Employment Change, nonfarm productivity, the ISM non-manufacturing composite, and unit labor costs on Wednesday; jobless claims, factory orders, and most importantly November same store sales comps on Thursday; and employment and consumer credit data on Friday.

The ECRI put out the chart below which shows their leading economic indicators (green) and coincident indicators (blue). Historically the leading economic indicators will turn positive just before the end of a recession (indicated by the gray shaded areas). We haven’t seen a turn yet, but will keep watching. The coincident indicators typically won’t turn towards a positive reading until the end of the recession.

The Fed
The Fed continued their drunken sailor on shore leave spending habits (no offense meant to you Naval folks), committing an additional $800 billion this week towards the mortgage and consumer debt markets. The first $600 billion is focused on GSE debt ($100 billion for Fannie Mae debt and $500 billion to the mortgage backed security market). The action looks like it had some effect as mortgage rates dropped nearly 50bps to 5.5% this week. The other $200 billion is focused on consumer and small bus loans. The goal of the plan is to encourage banks to begin lending again to both of these markets in an effort to stimulate the economy.

As we have discussed in the past, the Fed is trying to reflate the economy, which will help materials and energy, both of which have bounced hard since November 20th, although behind the returns of both the financial and consumer stocks.

Longer term, I feel the Fed’s actions are inflationary and will be hard on the dollar. Debasement of the dollar over the long term will favor gold. The strategy here is to be short inflation beneficiaries in the short to intermediate term, but long inflation beneficiaries in the longer term.

China just had its biggest rate cut in 11 years in response to their slowing economy. The Chinese PMI fell to 38.8 in November from 44.6 in October, the biggest decline on record. The economy appears to be deteriorating faster than expected by the nation’s top planning agency, a surprise to those who felt this combination of capitalism and a planned economy was a superior model immune to economic downturns. Export orders declined to 29 from 41 month over month (below 50 represents an economic contraction), and before the recent 11% rally, their stock market was down 72% YTD. JP Morgan thinks growth in Q4 may slow to 4%, far below the 11% many were expecting at the beginning of this year. Any way you slice it, China is slowing down right on schedule post their Olympic spending binge.

The New President
President-elect Obama continues to bring in war-tested economic advisors. He announced that Lawrence Summers, formerly the Treasury Secretary under President Clinton, would be returning to 1600 Pennsylvania Avenue as the White House Economic Director. More positively he named former Fed Chairman Paul Volcker as the head of a new White House panel to address the financial crisis-the President’s Economic Recovery Advisory Board. Volcker may be the last living central banker on the planet with a shred of credibility (street cred?), and hopefully his presence will be more than symbolic.

I’m not sure this represents the “change” Obama has been espousing, but, as he said last week “I’ll define what change is”. Sounds eerily similar to that famous quote from the last Democratic President “it depends on what the meaning of “it” is”. You have to love these guys for their ability to manipulate our language.

The Retail Environment
The markets have been anxiously awaiting Black Friday, that magical day after Thanksgiving when the Christmas shopping season officially begins. According to the National Retail Federation’s 2008 Black Friday survey, spending was up 7% over last year, reaching roughly $41 billion. Bargains were the main driver as discounting was very aggressive, which can’t help retail profitability. Somehow it seems like a Pyrrhic victory to announce strong sales, but not be able to profit from them due to the heavy promotional activity. It’s interesting to note that even with the huge discounts being offered by nearly all retailers, the discount stores still had the heaviest traffic. Online sales also look to have been very robust, although again amidst heavy discounting. The bottom line is that shoppers appear willing to spend, but the lure of a deal is more important this year due to the soft economy.

On a sad note, at a Long Island Wal-Mart, a worker was trampled to death as she opened the doors to the store. No discount is worth that tragedy.

The Oil Market
OPEC postponed their meeting on a second output cut, waiting until later in the month to gauge the impact of their first cut of 1.5 million barrels per day, or roughly 5% of their total output. The oil minster of Saudi Arabia feels that $75 is a “fair price” needed to support investment in new fields. While $75 may indeed be a fair price for a barrel of oil, the market doesn’t agree right now since that same barrel of oil fetches $53 (down from $147 in July). Personally, I enjoyed filling up my wife’s grocery getter yesterday for $2 a gallon and not having my credit card max out in the middle of the fill-up. In the last oil downturn, OPEC cut production multiple times, and it took over two years worth of cuts to get prices to stop falling.

The Ridiculous Market
A case of 1961 Chateau Latour sold for $170K over the weekend. My favorite quote from the auction: “you might as well buy something you’ll enjoy”. If they need any help enjoying that Latour, I’m happy to bring over the burgers!

Have a great week. As always, if you’d like to be removed from the list, or have anyone interested in being added, just let me know.


Ned W. Brines

(o) (562) 430-3232

Nov 24, 2008

When I Grow Up I Want To Be A Pirate!

Possibly the easiest money being made this year has been by pirates. I’m not talking about the Pittsburgh type, but the traditional puffy shirted, eye patch wearing, hook handed, sword bearing types roaming the high seas. Last week Somali pirates high jacked a Saudi oil tanker carrying 2 million barrels of oil. As I’ve commented in the past, oil prices are down nearly $100 per barrel since July, but still fetch an impressive $49 per barrel, putting the value of that cargo close to $100 million, not to mention the crew. The pirates are asking for a measly 25% commission, or $25 million, which is akin to the performance fees charged by some hedge funds. Some are now estimating that these pirates have amassed over $100 million in ransom payments since 1990. Now, $100 million over 18 years wouldn’t be enough to get most Harvard MBA’s interested, however, when you consider that the pirates probably pay no income or withholding taxes, have a relatively low overhead, have a great working environment near the ocean, and plenty of available labor with unemployment sky-rocketing around the world, this is a business which should see additional competitors over the next couple of years.

Weekly percentage performance for the major stock market indices
Based on last Friday's official settlement...

INDU: -5.4%
SPX: -8.0%
COMPQ: -8.5%
NDX: -7.9%
RUT: -11.0%

Looking at last week’s horrible performance is even more amazing when you consider the markets bounced 6% on Friday. Some are attributing this bounce to the Obama camp announcing Fed Governor Timothy Geithner as the new Treasury Secretary elect. If this is indeed true, let’s hope the President-elect has about 15 more cabinet candidates which the market deems as worthy as Mr. Geithner. I’m not sure Hilary as Secretary of State is worth 6%, but maybe 2%?

I know I’ll probably be heavily criticized for printing this because it is so obvious, however, for the benefit of some:

P +δ *CDS = R +δ * (100 − R)

I hope that settles that discussion once and for all!

Last week was another crazy week of economic data, with virtually all of it coming in negative. Rail volume, a great leading indicator for economic activity, is down 2% YTD. Coal and grain are up while autos are down 20%, forest (lumber) is down 12%, and metals are down 4%. I’ll keep watching for a turn here to help indicate that economic activity may be picking up.

Speaking of the economic indicators, they (the leading ones) came in at -.8% versus -.6%, and threw the market into more of a tailspin, if that’s possible. The leading indicators are supposed to be just that, and should turn positive (or less negative) some four-six months before the economy turns. Many experts have been suggesting we are at or near the market bottom, and that the market should bounce in anticipation of an economic recovery beginning in the spring of 2009. The LEI report threw some cold water on the timing of that economic recovery.

Other reports during the week included the empire manufacturing index coming in at an all time low, with capital expenditures, one of the drivers of the economy until early 2008, falling significantly. CPI and PPI both registered their largest drops since the 40’s. First-time claims for U.S. unemployment insurance rose to the highest level since September 2001. The total number of people on unemployment benefit rolls jumped to the highest level since 1983. Housing starts fell to 791,000, off 38% from a year ago. That’s the slowest pace of starts since data began being compiled in 1959. Starts are now down 65% from the early 2006 peak — this has become the very worst housing downturn on record.

This week’s scorecard:

Prior Period

Existing Home Sales
5.0 mil

5.2 mil

GDP QoQ (revised)


Consumer Confidence


Durable Goods Orders


Personal Income


Personal Spending


UoM Confidence


Initial Jobless Claims


Michael Donnelly “the good side of a recession is that we get price re-alignment”. Look at prices finally coming in, and the drop in crude (which should keep improving).

The market continued to be pounded this week. The list of new market highs, lows, and extreme readings is so long that I’m becoming numb to them. There were, however, a couple that caught my eye, with two of my favorites from Michael Santoli at Barron’s: 1) this is shaping up to be the markets worst year since 1872, and 2) according to BBH’s Andrew Burkley the current bear market is 284 days old, and down as much as both the 1929-’32 and ’37-‘38 bear markets over the same number of days. The ‘29-‘32 went on to lose 86%, while the ‘37-‘38 bounced 50% over the next six months before rolling over again. That’s comforting.

According to Marketwatch, from the October 2007 high of 1,565 to yesterday’s close of 800, the S&P 500 market capitalization lost $6.69 trillion. That’s almost $1 trillion more than entire 2000-03 bear market losses of $5.76 trillion. That is some real wealth destruction which won’t be coming back soon.

I stole this table from my good friend Scott Chronert at Citigroup in San Francisco. The table shows the performance of the Russell 2000 Small Cap index by sectors for both the ’99-’03 period and the ’07-’08 period. As you can see, the selling has been very thorough, taking down every group significantly. Looking at the energy sector makes me shake my head at the energy converts who were claiming that “this time is different” and that energy wasn’t another “internet bubble because the companies have real earnings and demand behind them”.


Consumer Disc

Consumer Staples









R2 Index

source: RUT, Factset

It seems to me that anyone interested in the market is now spending a lot of time trying to figure out exactly where and when we might see a bottom. I have been maintaining that the market is currently in the process of forming a bottom, but that we will probably find the major indices at comparable levels 12-18 months from now. I also think we will see a very serious rally sometime in the next few months, similar to the 1937 rally of 55% (from 8.50 to 13.40), which then proceeded to give back another 25% before settling into a long downtrend that bottomed at 7.50 in mid 1941. I continue to feel any strong rallies should be opportunities to lighten up on stocks, and weakness should be a time to build positions in strong, reliable companies with strong cash flows and no need for Wall Street capital over the next few years.

Merrill Lynch (aka Bank of America) has created its own matrix for finding a market bottom, and I have reprinted it below. Their conclusion is that we are getting closer, but not quite there.

The chart below shows the Dow this year versus 1929. Not that it matters, but can you guess which is which?

Contrarian Signal of the Week
According to a Merrill survey, 87% of fund managers say a recession is here to stay for the coming year. I agree, but this is the same survey that at June 30 showed only 24% of fund managers thought we would be heading into a recession. If these guys are now agreeing with me, I really need to thoroughly reexamine my positions.

The National Association for Business Economics survey shows 96% of respondents think we are in a recession versus 50% a year ago, when I thought we entered the recession.

Citigroup has taken its share of lumps and criticisms this year, however, the past few weeks have been horrendous for the stock, which was over $30 a year ago and closed Friday at $3.77. Earnings have been collapsing faster than John McCain’s poll ratings in October. Today (Sunday), the government agreed to protect $306 billion of loans and securities on Citigroup’s books against losses. They say that this is primarily to shore up confidence in the bank for their partners and customers. The boys (and girls) at the Treasury and Fed must have been bored after nearly four weeks of not working on a weekend long emergency. I find it interesting that this bailout happened during the weekend with the fewest top 10 college football teams in action this entire season.

Bloomberg has reported that the US government is now on the hook for $7.4 trillion, which is ½ of total production in the US last year. This calculation includes $2.4 trillion in commercial paper and $1.4 trillion from the FDIC for bank-bank loans. For comparison, the S&L bailout in the 1990’s cost $210 billion (inflation adjusted). The good book says that the children will pay for the sins of the parent, and I’m sorry William, Megan and Matthew, you’ll be paying for this your whole lives.

Last week I discussed the weak retail sales environment. According to Bloomberg, average same store sales comps were down 4.2% in October. Department stores were down almost 12%, drug and discount stores were up 2.5%, clothing down 3%, and restaurants up 2% (carried by McDonald’s, up 8%). Retailers are continuing to panic as foot traffic has been running soft and this year’s calendar results in fewer shopping days between Thanksgiving and Christmas versus the prior two years. Anecdotally, I have been surveying foot traffic and speaking to store managers, and all are extremely concerned about the upcoming holiday season (which might mean expectations are getting so low they could be easy to exceed). Today I went to the Long Beach Town Center, a big box retail center featuring a Sam’s Club, Wal-Mart, Lowes, Sports Chalet, movie theaters, and assorted other retailers. The place was absolutely packed, although it seemed the bulk of traffic was headed towards Sam’s and Wal-Mart to prepare for Thanksgiving. I intend to follow up this weekend, and will let you know if I see any changes.

Bear Markets
Not sure I need to add more to this chart.

Last Comment
I can imagine Henry Paulson using this quote in Congressional testimony when asked why he gave away over $7 trillion. “Try to imagine all life as you know it stopping instantaneously and every molecule in your body exploding at the speed of light.” Egon Spengler.

Please have a great Thanksgiving. As always, if you wish to be dropped from this list, just let me know.


Ned W. Brines

0 (562) 430-3232

Nov 16, 2008

We Are All Japanese Now

November 16, 2008

The comparisons to Japan have been rampant over the past few weeks as we continue to bailout banks and potentially other moribund industries. TARP-the government plan to bailout the mortgage business, has spent roughly $290bil of the initial $700bil on presumably helping banks deal with their mortgage portfolio problems. I say presumably because the Fed is refusing to let Congress know exactly where our tax dollars are being spent. One place we know they are going is to AIG, which asked for (and received) an increase in their bailout and much easier terms. Treasury Secretary Paulson now wants to turn TARP into his own vulture fund, investing wherever he sees the need. Stay tuned.

Speaking of Japan, they announced this evening they entered their first recession since 2001, with GDP dropping 0.4%. Japan, the world’s second largest economy, is struggling as a result of the global slowdown. Some Japanese economists are describing this as their worst recession since the early 90’s debacle. Hong Kong also said they have fallen into recession. So much for decoupling.

Weekly performance for the major market indices
Based on last Friday's official settlement...

INDU: -5.0%
SPX: -6.1%
NDX: -7.1%
COMPQ: -7.9%
RUT: -9.6%

Credit Markets

The Libor-OIS spread, which I have discussed numerous times, continues to drop, indicating an improving lending outlook between the banks. The spread is still high by historical standards, 160ps versus a 5 year average of 11bps, and double that of the pre-Lehman Brothers bankruptcy level of 87bps, but well below the peak of 360bps in early October.

While many feel that the stock market is getting “cheap”, it appears that real value is beginning to appear in the credit markets. I have had a number of meetings recently with investors whom I have a lot of respect, and almost all have mentioned the value in moving up the capital structure because of the extraordinary yields secured both by assets and (relatively) safe cash flows coverage. The level of fear can be seen in the chart below, which is the JPM High Yield spread over treasuries. The spread today, 776bps, is near the peak levels we saw in late 2002 and equal to those right after 9/11. High yields alone don’t make an investment a good one, however, the spreads certainly suggest there is plenty of fear priced into the markets, and maybe somewhere some of it is irrational (to borrow a quote from my least favorite former central banker AKA The Bubble King).

The Big Three

Last week we discussed GM coming hat in hand to the government seeking capital assistance. Rick Wagoner, GM’s CEO, is seeking help from the government. He figures that since any financial services company can get help, unless you were Lehman Brothers, then GM and its 200K+ employees deserve the same. The problem is that the current administration doesn’t seem to be interested in bailing out a poorly run manufacturing company burdened with excessive labor costs (see below), especially when those same employees were so instrumental in electing the opposition party. If Wagoner can hold out a few months, he might find a more receptive ear from the President-elect his unions were so helpful in electing. For those who were concerned that the President-elect would be a socialist, rest assured there is no cause for such concern even though he proclaimed this week that we need a “Czar to oversee the auto companies”. I’m sure that’s just more election rhetoric.

The Big Three (Ford, Chrysler and GM) are facing a plethora of problems, but two key problems are that they are making cars that no one seems to want (see SAAR sales below) and their labor costs dwarf those of their competitors (see chart below). I’d be surprised if any bailout occurs without significant concessions by the unions. The SAAR total measures the total sales of autos and trucks manufactured in North America. In October sales dropped 32%, with Toyota and Honda gaining share by posting 20% declines. GM was down 45% in the same period, Ford 30% and Chrysler 35%. This was the 12th straight month of declines, the longest US slide in 17 years.

Ultimate Sacrifice

Cerberus Capital Management, considered very shrewd investors, acquired Chrysler from Daimler Benz for $7 billion and the assumption of at least $13 billion in debt. In a selfless demonstration of patriotism, Cerberus management announced that if Chrysler received a government bailout or if the company was acquired using government money, Cerberus would forgo any profits. What???!!! I find it difficult to believe that there are any profits left for a company whose sales are down by 50% since being acquired. Paraphrasing Rob Reiner’s mother “I’ll have whatever those guys are having”.


Retail sales for October came in at -2.8%, the worst result since this measure began in 1992. Circuit City finally threw in the towel, filing for bankruptcy and Best Buy management said they saw a “seismic” slowdown in spending. It must be exceptionally bad for a management team to use that type of language to describe the current environment. Pre-Christmas sales on all good are pouring in, however, personally I’m waiting until after the holiday to pick the retail carcasses clean (OK, not really, but I thought that sounded good). Christmas expectations are so poor right now that it may not take a lot to give the market a bit of a bump, even though it should be temporary. Heavy discounting now means that post-Christmas sales will be enormous, and in many cases will be liquidation sales. Hold off on buying that new plasma, you may get paid to take it in January.

Unemployment claims hit 516K last week, and we are just starting to see major layoffs. Unemployment is going to continue rising for the foreseeable future.

This week look for the following economic reports: industrial production, capacity utilization, PPI, lots of housing, building and mortgage data, CPI, Philadelphia Fed survey, and the leading economic indicators. Volatility this week should remain high as these key reports are released.


Thanksgiving is coming, and that means tax loss selling. This year should be interesting as retail investors and institutional investors with December 31 tax years try to clear the decks of their 2008 losers. This could add a bit of additional selling pressure through the end of this month, however, we could see a touch of buying into year end if people are trying to reestablish their positions after the requisite 30 day waiting period. This is the time of year when we typically see the tax-loss selling candidate lists from the major brokerages. There aren’t any major brokerages left, and with 482 stocks in the S&P 500 down for the year, any lists that do come out are going to be long. I’ll show you the 18 winners-if you want to recognize some tax losses, sell anything else (just kidding):


It’s notable that the US education system focuses on the three R’s, however, this latest financial crisis should prove that basic finance should be a staple of our education system. We teach kids some basic tools, then throw them out into the world with a bunch of one-liners (such as “buy and hold”) to manage their personal finances. Last week I saw this headline in Opalesque, a hedge fund newsletter: Headline: “Man buys $11 hammer, uses it to break into store to steal $9 bottle of wine”. I think this proves my point.

Last Comments

I have a few final comments for this week:

Cash is king- both consumers and corporations with cash are going to find bargains galore. For companies with cash, acquisitions and market share gains will be their reward for conservative stewardship of shareholder capital. For consumers with cash, the next few years will create opportunities to acquire assets that will create long term value.
This past week we retested the lows on the major indices, and haven’t broken through to new lows. The technicians (those are the guys analyzing the charts) think we could be forming a bottom in the market. I still think the upcoming declines in earnings due to the weakening economy will keep pressure on the market, however, I think there is “risk to the upside”. Risk to the upside means that shorts and people out of the market risk missing a major bear market rally, which could be a 20-40% move. As I’ve mentioned in the past, if we see one of these moves, use the opportunity to lighten up on your exposure.
S&P operating earnings have peaked and should continue to fall. Earnings estimates for 2009 are too high, and will have to come in. The market looks cheap on 2009 estimates, but they are too high because margins are still estimated too high. Margins drop in a recession!
The new administration needs to keep in mind “When banks fall on Wall Street, they stop all traffic on Main Street”.
Last night my wife and I attended the annual HomeWord benefit dinner. I’m not sure how the fundraising went, but the program was phenomenal and I encourage any of you who are married or married with children to utilize the resources on their website ( Like all non-profits, their fundraising is down this year, so if you’re looking for a place to send all those extra dollars, give them some consideration.
I want to give a special thanks to the team at Bloomberg who have been so kind to allow me to use their data feeds to create this letter. Any chart or table you see with a black background is sourced from Bloomberg.

As I close tonight Asian markets are mixed.

As always, if you would like to be removed from the list, please let me know. I appreciate everyone’s feedback and criticisms, and am trying to keep this a relevant and quick read.

Have a great week.


office (562) 430-3232

Nov 10, 2008

Now that the election is over, maybe we can get on with the recession

President-elect Obama just spent $600+ million to win the Presidency, which I believe is a $400K per year job. I’m having a bit of trouble with the math, but that doesn’t look like a good ROI to me.

Weekly performance for the major stock indices
Based on the last Friday, Oct 31st official settlement

INDU: -4.2%
SPX: -3.9%
COMPQ: -4.2%
NDX: -4.8%
RUT: -5.8%

The Market and Earnings
A 4% down week is nothing to sneeze at, but when the week includes the largest gain ever on an election day (up 4%) and then follows that with the worst two day performance since 1987 (down 10%), sneezing could be down right dangerous. The economic releases were dismal, and the earning releases continued to limp in. Quoting the populists, now that the recession has spread from Wall Street to Main Street, corporate earnings are going to be challenging as both consumer and corporate spending hit the skids.

Over 90% of the S&P 500 constituents have reported so far, with 3Q earnings down 10%, especially weak given that at the beginning of 2008 analyst estimates for this quarter were an increase of almost 20%. The weakness is broad and appears to be getting worse. Estimates for the 4th Quarter and 2009 are probably much too high, and will need to come in significantly. Top down strategists have begun lowering their estimates, but the bottoms up numbers are much too high.

As if things weren’t bad enough for retailers, with retail comps negative for October, we are starting to experience significant bankruptcy filings (or companies on the verge). The retailers are starting to look like General Motors, who announced this week that not only would they not be buying Chrysler, but that they would run out of cash this week without an injection of capital.


The economic reports last week were flat out rotten. The ISM data came in weaker than expected, plunging below 40 for the first time since 1974. In an especially dour comment from a government agency, one of the quotes accompanying the release stated “it appears that manufacturing is experiencing significant demand destruction as a result of recent events”. Export orders in the ISM dropped for the first time in 70 months, which coincidently coincided with the great boom in industrial and commodity demand. If this trend has truly turned, it could spell more trouble for the small cap value indices, which was so robust for the bulk of this decade. Unemployment is really starting to hum as we lost 157K jobs a week ago, and the unemployment rate is now 6.5% and rising like an internet stock in 1999.

The upcoming week is a bit light on economic releases. The big one is Thursday’s University of Michigan Consumer Confidence. We highlighted that chart a few weeks ago, but have reproduced it again as this week’s estimate may should take it to a new low over the past 20 years.

Market Prophets

This year’s Elaine Garzarelli award goes to the author of “Black Swan”, Nassim Taleb . Professor Taleb is on a rapid rise to stardom after predicting some of the recent events with precision timing (his book came out just as the financial markets were beginning their demise). Professor Taleb, who is definitely not a fan of quantitative analysis, recently said that “quant models and business school curriculum is all wrong. They must abandon equations and look with the naked eye, emphasizing empirical vs. quantitative analysis”. I imagine that when the bloodletting on Wall Street subsides, there will be fewer PhD’s running those models and Professor Taleb will still be on the talk show circuit. I haven’t read the book yet, but am waiting for the Cliff notes.


Some very interesting comments this week as it relates to Europe. This week the BOE cut rates 150bps to 3%, the lowest rate since 1955, to help shore up their slumping economy. The EC came out last week and said Eurozone is now in a recession. Arcelor Mittal announced they would be cutting production by 35% due to weakness in Europe-quite a change from 12 months ago when they were running full tilt and trying to acquire major producers all over the world.

Europeans have not been shy in their support of President-elect Obama, and their hatred of everything US. Now that they have weighed in on our political system, I wonder how they’ll view the placement of 200 ICBMs in their backyard? Little noticed in the post-election hoopla was a statement by Russian Deputy Foreign Minister Alexander Grushko that they would be deploying missiles in Kaliningrad, a region wedged between Poland and Lithuania, but purely placed there to deter the US from deploying their own missile defense system. This situation should test the resolve of the Euro-support for President Obama, as well as his much bandied about diplomacy skills. The Europeans had better hope their multi-decade free ride on the tails of the US Department of Defense doesn’t end. Building a military is costly, and with the state of the Eurozone economy, they can’t afford to divert resources into building or leasing a military presence. Hopefully the French understand the word “comrade”, they may be hearing it a lot.


I try to keep politics out of this note as much as possible, but this week is a bit of an exception because there is a plethora of great material to carp on. Nancy Pelosi, has a penchant for making statements so outlandish they are often dismissed as the ramblings of a, well, a liberal democrat. Three weeks ago I joked about the new administration solving the budget crisis by confiscating private pensions ala Argentina. I didn’t realize that Speaker Pelosi already had that plan in the works. When the Dems took over Congress in 2006, evidently Speaker Pelosi made some comments about “nationalizing 401K plans” and raising capital gains rates to 80% to “help the 12 million illegal immigrants in this country achieve the standard of living that they wanted” as residents of the US. I can’t even comment here except to say that this is great material that even I couldn’t make up-no one would believe it.


When the market closed on Friday, I anticipated writing about China, where the market is down 70% from its highs, and the impact of the financial crisis on China’s growth is starting to take its toll. The funding drought has slammed the country’s factories as banks have spurned a state plan to lend. Exports are drying up, and GDP is estimated to grow at its lowest level since 1990. However, this evening (Monday morning in China), the government announced a $586 billion spending plan focused on infrastructure. The CSI 300 Index is up 5.2% as I write this, with copper rising 7% and the old regulars (primarily commodities) jumping as well. The Chinese plan to pursue a “moderately loose” monetary policy to goose growth. Personally, I think the world will be facing significant inflation by 2012, but until then let’s party like its 1999 on cheap and plentiful capital. If the Chinese can reinvigorate their economy, I may be forced to move from my negative (and very profitable) position on the IME stocks.

Miscellaneous Comments

1. I saw a report estimating CDS exposure worldwide at over $30 trillion.

2. JP Morgan announced they would be eliminating their proprietary trading desk.

3. I’m hearing the government is considering a bailout of credit card issuer Capital One.

4. Quote heard on Wall Street “This is worse than divorce, I’ve lost half my assets and I still have my wife.”

Miscellaneous Responses

Wow! The counter party risk is still enormous and I’m expecting more skeletons popping out of someone’s closet.
A good idea to get back to the business of banking and let the clients engage in higher risk activities. I’m sure some clients will be attracted to a lower risk business model, one which isn’t in direct competition with the customer.
Why? How is Capital One critical to the survival of the US financial markets and thus deserving of taxpayer money? These are the guys sending credit card applications to my kids and dog, they deserve to be out of business.
I don’t know if that’s a true quote, but it made me smile.

Good luck this week. As always, if you would like to be dropped from the list, please let me know.


Ned W. Brines

Office (562) 430-3232

Nov 2, 2008

Here today, Ghana tomorrow

November 2, 2008

Based on last Friday's official settlement...

INDU: +11.3%
SPX: +10.5%
NDX: +10.8%
COMPQ: +10.8%
RUT: +13.9%

Amazingly, the best performing stock market in the world is Ghana’s, up a whopping 64% YTD. Now, there are questions about liquidity (some days no shares trade), the size of the market, etc, but it is still very impressive. I guess those who were hailing the emerging markets and their ability to continue growing despite the burgeoning recession around the world were right-Ghana has been able to decouple from the rest of the world. I wonder how their less stable neighbors Togo and Ivory Coast are fairing?


Last week was a humdinger, with the markets soaring on Tuesday over 10% and holding those gains through the week to post the best week on the S&P500 since 1974. Not bad for the 79th anniversary of Black Tuesday. There was much speculation about why the market soared that day: the GDP report, the pending Fed meeting, attractive stock valuations, or the end of mutual fund tax loss selling. My favorite came from a rather cantankerous large cap manager who stated that the market “finally had to go up so it could have a higher starting point for its next collapse”. I’m not quite that bearish from these levels, but I found it entertaining and certainly a sign of the times in our business when even fully-invested growth managers are bearish.


The 41st edition of the Stock Trader’s Almanac cites a seasonal phenomenon which begins this week. Historically, the best time to own stocks has been November 1 to April 30, while the worst time has been May 1 to October 31, (an obvious statement this year). Much like Tuesday’s rally, there are many theories as to why this seasonal trade has worked so well. One thing is certain, owning stocks in November has really paid off over the years as it is the #1 performing month for the S&P 500 since 1950 (with similar results for the Dow and the NASDAQ). Keep this in mind as you plan out your asset allocation. Most investors have forgotten about the strength in both November and the subsequent five months as mutual fund redemptions hit a second consecutive monthly record in October, -$17 billion. The pre-2008 record, Oct 2002, preceded an increase in the S&P of 28% over the next 14 months.

As a result of the record redemptions and overall investor caution, money fund assets now represent 25% of the value of the stock market ($3.4 trillion vs. $13.3 trillion). Many of the more cynical in the group will note that the drop in the denominator has pushed this ratio, but there has also been quite a rise in the denominator. According to Ned Davis Research, historically when this ratio hits 11%, the market has rallied an average of 12% over the next year.


Last week I discussed the improvement in the Libor-OIS spread, and Libor continued dropping this week. Libor dropping signals that banks are beginning to trust each other once again, and is a required first step in unthawing the credit markets. Lending remains tight-I have included a chart below which shows that senior credit officers have been very reluctant to lend, comparable to 2001 and 1990. Some chatter coming from the government is that they are very anxious for all the capital they have thrown at the banks to make its way into the private sector instead of being hoarded. This will eventually happen, but will take time.

Junk yields are still very high, some 1200bps above treasuries. The last big peak we saw, also October 2002, preceded the mother of all small cap rallies as the Russell 2000 soared 52% from Nov 1, 2002 until the end of 2003. Now, I don’t know if that was really the mother of all small cap rallies, but it was a big one and I liked the way that sounded.


The FOMC met, and true to form, the Fed cut 50bps from the Fed Funds Rate Target, pushing it down to 1%. I don’t want to get into the criticisms of 1% rates getting us into this mess in the first place, but I do find it interesting that many are viewing the cure to our problem as being the same ill that got us here in the first place-cheap money. Paul Volker, the last true steward of the US dollar, would be rolling over in his grave if he were dead. Instead he is fighting for a regime change. The chart below shows this rate, quarterly, since 1978. Although this weeks’ reduction doesn’t show up yet in this chart, it now equals the low set June 2003 of 1.0% with expectations of another cut in December being priced into the market.

GDP came in at -.3% versus the consensus of -.5%, and the market seemed to take it well, rising roughly 10% on the day. This is a first estimate, and I would expect downward revisions with each subsequent report. The details of the report were not especially attractive, with consumer spending down 3.1%, durable goods orders down a whopping 14%, and exports weak as a result of the slowing global economy. Additionally, the price index was up to 4.2%, which to me seems a bit more in line with the inflation rate the average consumer is facing, at least when compared to the ludicrous rate of 1.1% in the Q2 report. The strength in the GDP report came from government spending, which isn’t a big surprise.

This week a number of key reports hit the tape, including ISM, consumer confidence, factory orders, construction spending, wholesale inventories, and the typical weekly unemployment drabble. For those of you who like to keep score, I have included a scorecard below for your entertainment.

Street Estimate
Actual Result

ISM Manufacturing

ISM Prices Paid

Construction Spending

Factory Orders

ABC Consumer Confidence

ISM Non-manuf

Wholesale Inventories


Earnings continue to limp in, and I can’t help but think about the impact of the market on company’s earnings. How is it that a depressed market impacts earnings per share (EPS)? Through their pension plans. A year ago 90 %(+) of the S&P 500 companies had their pension plans fully funded. I don’t know the recent figure, but you can bet with all asset classes dropping like a rock over the past 12 months, the impact to pension plans is being felt. Remember that any shortfall in a plan now runs through the financial statements, and can hurt reported EPS (I tried to keep that as simple as possible for all the non-accountants on this list). For those of you who found even that explanation too complex, remember this: “market bad, EPS bad; market good, EPS good”. In other words, companies with pension plans are impacted in both directions when the value of the plan rises and falls, and EPS can be impacted accordingly. With the huge fall we have had in the market, it seems obvious to me that companies are going to start taking EPS hits beyond those caused by the slowing economy. Will this be another shoe to drop on the market or is it already priced in? The most recent estimate I have seen is that the impact is over $100 billion for the companies in the S&P. That’s a pile of cash, even though it’s only a fraction of what the new leader of Obama-nation spent on this election.

Speaking of the Election

It’s tomorrow and will be historic which ever way it turns out. I’ll be watching the results crawl in, but will be more focused on the earning reports coming in all week.

As I close this the MSCI Asia Pacific Index is up almost 5% with a loosening of the credit markets receiving credit for the rise.

Have a great week. As always, I’m happy to remove you from the list, just let me know.


new office # (562) 430-3232