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

No comments:

Post a Comment