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.


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