Sunday, March 16, 2008


Another Round?

Bear Stearns collapsing following the US$200bn injection by the Fed scared many investors. Below was the conference call held by the company:

12:30 P.M. ET: While the bulk of the investment community is listening to classical music in anticipation of the call’s beginning, here’s an update of where the world stands. Bear Stearns shares are down 36.7% on more than 100 million shares traded, making it easily the most actively traded stock on the Big Board today. The options market shows a ballooning in interest in put options at the US$20 strike price – more than 29,000 contracts have traded, and headed into today there was no open interest at this strike.

12:37 p.m.: Finally, the call is beginning. Elizabeth Ventura of Bear’s corporate communications department is starting the call with the usual boilerplate about forward-looking statements.

12:38 p.m.: Sam Molinaro, CFO notes that the firm is moving up its earnings relase to Monday, and also to share some information on the shared loan facility.

12:39 p.m.: Mr. Molinaro turns it over to Alan Schwartz, CEO, who immediately sets about blaming rumors. “Bear Stearns has been subject to a significant amount of rumor and innuendo over the past week. We attempted to try to provide some facts to the situation but in the market environment we’re in, the rumors intensified and given the nervousness in the market a lot of people it seemed wanted to act to protect themselves from the possibility of rumors being true and didn’t want to wait to see the facts.” MarketBeat is having a hard time remembering what “facts” the firm put out other than to say the rumors weren’t true.

12:42 p.m.: Mr. Schwartz drops this fact — that the firm has been talking to Lazard about “alternatives.” He doesn’t elaborate on this, and quickly opens the floor for questions.

12:46 p.m.: Guy Moszkowski of Merrill Lynch wants to know where the liquidity problems came from — prime brokerage, repo markets, or what. Mr. Molinaro notes that both he and Mr. Schwartz said earlier in the week that liquidity issues were not a problem at the beginning of the week, but “I would would say on Thursday we experienced pretty broad cash outflows from a number of different sources,” including prime brokerage and repo, and also saw “mark-to-market calls on open derivatives contracts. It was from a lot of places and there was a lot of concern in the market, and we had a significant level of outflows.”

Bear

12:49 p.m.: Mr. Schwartz, in response to a question, notes that the reason the firm went to J.P. Morgan was because the firm “is the clearing agent for our collateral. It’s easy for them to see the kind and quality of the collateral we had available and therefore could move very very quickly.”

12:52 p.m: Mr. Molinaro is asked about the firm’s view on its liquidity ratios in terms of coverage of unsecured debt. He says this ratio has actually increased because the firm’s short-term unsecured debt has “rolled off,” or declined. But then he goes again after market rumors. “The difficulty we found ourselves in was, counterparties that were providing secured financing against assets that were well liquid and routinely financed, they were no longer willing to provide financing,” he says. This was a result of a market being “fanned by rumors that were not true,” he adds.

12:54 p.m.: Glenn Schorr, analyst at UBS, wants to know if the facility being provided through J.P. Morgan (the size is not known) is large enough to “fill the gaps of all the pulled lines” from those who pulled credit lines from the company. He also wants to know if the 28-day lending facility from J.P. Morgan was given that length because the Fed’s Term Lending Facility comes into play during that time period. Mr. Schwartz says Bear Stearns has “been able to convince customers and counterparites that we have the abillity to fund ourselves every day and do business as usual and there is overlap where liquidity does become available to us and other dealers on some other very high quality collateral.”

12:55 p.m.: Mr. Schwartz continues, calling the facility a “bridge to a more permanent solution.” He then goes back to talking about fact vs. fiction (although the firm’s statements earlier in the week, about not having any liquidity problems, are clearly no longer operative, and the firm did not provide any detail, either. He says the facility is a “bridge to look at strategic alternatives which could run the gamut, but put us in the position where… investors will be able to see the facts instead of the fiction.”

12:56 p.m.: The brief call ends. Shares are down 39%, having not received any kind of boost from the call. The company’s credit default swaps, which measure protection against default on debt, are in a range of 690 basis points to 720 basis points, which is slightly better than the 730 level quoted earlier in the day, but still worse than 685 yesterday, according to Phoenix Partners Group, a derivatives broker.

Comments:

a) This panic is largely unwarranted. You are not going to have US$250-350bn write downs with no companies collapsing. BS is the weakest of the lot. Citic from China showed that not all Asian sovereign wealth funds or linked companies investing in troubled international invest banks are that savvy, or are just picking on the cheap. Their investments can backfire just as well.

b) BS troubles was amplified because it came almost immediately after Fed's silly move. The markets interpreted that as extreme pessimism, and wondering aloud which banks were the Fed trying to save.

c) To lend weight to the above opinion, shares of Lehman Brothers lost 15% and even Citigroup dropped another 10% as shorts betted on the next to follow BS. To me, that showed extreme pessimism - which shows that the reversal is probably very near.

d) Still sticking to 11,500-11,750 as the level where smart investors such as Buffett and the like will start buying large stakes in depressed companies. This is still largely a banks issue. Yes, the employment data has softened and retail sales in the US have tapered off, but that is understandable in light of the sharply correcting property markets there. The bulk of the global economy is still fighting inflationary pressures ( from sustained growth) and not part of this liquidity problem (with the exception of parts of Europe: or more specifically the European investment banks).

e) The Carlye situation also exacerbated matter as troubled hedge funds may be forced to sell other "good stocks" in other markets to cover their asses. However, Carlye's problems was due to extreme leverage - they geared up 1,200% on their positions to lock in certain credit risk papers to magnify returns which did not pan out as they hoped. There is good leverage and silly leverage.

f) Hence this does not look like "another round" but rather darkest before dawn scenario.


4 comments:

Encik Wan said...

I agree bearish sentiment is at extreme, e.g. 12/3/08 aaii.com survey. However I am not sure about the strength of this rebound. Whether you are bull or bear, read 516 trillion ticking bomb. Different opinions are a sign of healthy market :) Otherwise price will move in one direction.

ikanair said...

Hi Dali,

Your blog is informative and entertaining.

But your earlier call that "subprime is not a problem" have proven otherwise.

So have your call "to keep chinese linked call warrant till expire for the biggest bang for the buck" have really literally blown up.

Like S&P, Moddy's and Fitch, nobody expect them or you to be right all the time, but it is not right or wrong, but the magnitude of error.

To have so many "AAA" rated debt turned to become no better than junk. Or saying subprime is not an issue to being an issue, or keeping chinese linked call warrant till expiring till worthless.

Well, i'm sticking with my call of the unholy trinity
1) US subprime
2) US consumer
3) Shanghai bubble

The first one have come, second is on the way, i'm waiting for the end of the third then only i'm buying.

Cheers

Salvatore_Dali said...

ikan air,

I hope I dont have to do this again. Investment opinions changes with new information. It is not fair to take something I said 6 or 9 months ago, and screw me for this. If the USD gains 100% in value next, would you go and screw Buffett for being bearish on it for the last 5 years?? Be fair. If u r a reader of my blog, u would be able to see how my opinions change and evolve. Yes, subprime was not a prob to me 9 months ago, but new information and collateral effects of know the scale of exposure within investment banks changed that for me-things which I didnt know then. I was bullish for the past 2 years on stocks, who nothing from you then... didnt u get my posts on GET OUT... what does get out mean to you??

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Monday, January 28, 2008


Bull To Bear

Blogger Edmund said...

Hi dali

I am a staunch follower of your blog and I must say you are one of the better ones around.

I'd like to be the devil here and bring you back several weeks on the outset of the infancy of the subprime crisis.

Together with most other analysts, you have been quick to brush off the subprime being an insignificant % of the total loans in the US system and that it will only cause a blip.

Fast forward now, like the others, you are pressing the panic button frantically and calling for a total stampede out of equities.

I know the financial markets are fluid and far from blaming you for making such calls, would you hold a contrarian view now ala Marc Faber in bull markets or when Warren Buffet took short positions in the USD (which has proven to be correct and his net worth would have multiplied had he continued to rollover those positions) in the think of a wall street boom.

What is your argument on China and India being a potential saviour for the rest of the world?

And why is it that even when the subprime loans were identified to be an insignificant % of the financial system (and thus, confidently brushed aside by all and sundry), never did i hear of one analyst then predicting it to be the ultimate downturn of the wall street and global equities?

I mean, what changed?
Edmund,
Fair comment. I think I have been a strong bull since I started writing this blog, and thats for the past 2.5 years. Everyone can be a long time bull or a long time bear, and they will eventually be right. Marc Faber has been a bear for so long its not funny, now that he is right, is that wonderful, did that help you? Same with Buffett, he has been bearish on USD since late 90s and has had shorts on USD since then, he did lose some money for a years but now proven right, is that great? If you are bearish or bullish long enough, you will be right eventually because the market goes up and down. Hence I always argue that if you are a bear or bull, it is also important to get the timing as close as possible. If not, you are just a good economist (i.e. great at explaining cause-effect) not a good market reader. To be a good market reader or stock picker, one must locate the catalysts and and see them in front of them, not when they are miles away. William Cheng in 2000, in deep trouble with his Lion Group, said in an interview that he saw the 97 financial implosion could happen way back in 1994, but still wasn't able to plan and strategise properly for his conglomerate. So, is that brilliant or brilliantly stupid? Brilliant as a market economist, poor as a market reader. If you ask me, Faber is a market economist, full stop. Cramer is neither.

What made me change can be traced to the postings history below, highlighted in red. Yes, back in October 2007 I did think that subprime was only a fraction of total real estate market. As in anything , its the CATALYSTS for any substantive change. If there are no catalysts, its hard for markets to change direction properly. Same like the way I call stocks, there have to be catalysts or else a good stock will be just a good stock, not a performing stock. The build up of catalysts to me was the way Countrywide fell from US$22 when BOA bought in August 2007 (when they think subprime has fallen enough). When BOA bought the rest around US$5, you know the subprime mess is a lot messier. The second catalyst was when Citigroup wrote down an additional US$4bn for "future consumer debt" - hinting at how the bubble may have burst and now be spreading. The third was the realisation that the subprime is only a subset of a big credit bubble imploding. Without the catalysts, the down trend would not have happened. Hence, I think its not fair when you said that I joined the crowd. I did try to warn as fast as I could cause the news were happening quickly around me. But I will also be quick to post when I think its OK to get back in.

There is no point to blow your own horn because readers will know I have gotten things wrong before. To me, if you get 7 out 10 calls correct, you are golden. What's important is to be passionate about a call. Its a big advantage when you are a reader of a blog, you can even question my thought processes and I have to justify my views and no one pays me a cent. No one will be able to do that to Faber or Buffett that freely. But thats a blog I guess. Portions in red below are important.


2 Jan 2008: Macro Predictions For 2008

Lukewarm - Rest of Asia will have to come to terms with inflationary pressures as local currencies may not rise enough to counter imported inflation, thus hurting outlook for local equities.

US - Will still have to deal with fallouts from subprime and property correction. Jobs the only factor sustaining the overall economic picture as many US companies still rely more on global growth for their bottom line. US rates will not have much room to fall as defending the dollar will be more of a priority - still we are likely to see the dollar weakening by 3%-5% in 2008.

US Stocks - A lot will be riding on the recovery of financials for index to perform. Pain before pleasure, probably things will improve from 2Q onwards. Depressed dollar will see more foreign M&A buying US companies. That will be creating a lot of pressure on the Fed and related units to stem the slide in the dollar. Corporate profits growth may not be as positive as 2007 and will cap the markets for 1H2008.

Japan - Economic recovery is failing as people still refuse to spend. Carry trade to continue.

2008 will be tougher than 2007.

7 Jan 2008: Market Mutterings

US Jobs Data - Well, it looks like the final pillar standing has finally crumbled. That has caused players to factor in even a total of 1.25% in rate cuts by the Fed by March/April. The knee jerk reaction to sell down the Dow should be just that. The Dow should regain lost ground from here on because the jobs data would definitely force the hand of Fed to lower rates by at least 1.0% in total (in two strikes) by end March/April. That will give stocks a better footing going forward.

Globalisation - The US can still stand because many of its companies now derive almost 50% of their revenue from the rest of the world. As long as growth from overseas is strong, it can cover their dependence on US domestic economy.

Stock Prices & Liquidity - At present levels, markets pushing higher are more likely to be due to liquidity forces rather than company fundamentals. Hence one can say its bubblish area going higher. If there is a further contraction in liquidity, it could be messy. Thus investing now may bring more volatility.

12 Jan: BOA Averaging Down

To me, averaging down means you totally ignore the fact that you were terribly wrong in the first instance, and went in with fuller gusto the second time around at lower prices. That's Bank of America. Bank of America offered an all-stock deal valued at $4 billion for Countrywide - a fraction of the company's US$24 billion market value a year ago.

The deal is a landmark in the housing crisis, given Countrywide's prominence as the nation's largest mortgage lender, at least until recently. Bank of America's move is a gamble that the U.S. is nearing a housing bottom and crystallizes the divide on Wall Street over whether now is the time to buy housing-related assets on the cheap - or flee from them to avoid further losses.

Or is it a gamble. BOA did invest back in the middle of last year when trouble first hit Countrywide. A loan which is convertible into Countrywide shares at an effective US$18 or so. The share price has since fallen to US$5. BOA is buying a deeply troubled company, and it faces the risk that Countrywide's assets could continue deteriorating.

As of Sept. 30, Countrywide's savings bank held about US$79.5 billion of loans as investments. Three-quarters of these loans were second-lien home-equity loans - where Countrywide doesn't have first crack at the collateral in case of default - or option adjustable-rate mortgages, which let borrowers make minimal initial payments and face sharply higher ones later. Overdue payments by Countrywide borrowers are surging as house prices drop and loans reset to higher payments.
BOA was one of the least affected among the big banks with sub prime write downs. The company should have stayed the course and not try to be too smart. Well, they have dug a hole for themselves already, might as well continue digging.

13 Jan 2008: Relative Returns By Asset Class

Inflation - The one big danger which could rein in equity returns win 2008 will be inflation. Food prices are 18% higher in China from a year ago, and Beijing fears that runaway inflation could ignite social unrest. The price of pork, which forms the core of most Chinese diets, was up a staggering 56%. China has become a victim of its own phenomenal success. China’s economy expanded at a blistering 11.5% last year, but was plagued with a 7% inflation rate, largely linked to the country’s voracious appetite for global commodities. Even with a more subdued growth rate in 2008 of around 10%, the inflationary pressures will take a lot longer to work off.
In the U.S, producer prices were 7.7% higher in November from a year ago, the highest in 34-years. Consumer prices rose at an annual rate of 4.2% through the first 11-months of 2007, the most in 17-years, thanks to soaring food and energy prices. The same scene can be replayed in almost all countries, especially in emerging markets. Having said that, that factor will actually fuel the commodities upcycle.

US Factor - The sub prime fallout has started a more widespread correction in real estate, and may crimp consumption in the US. In the UK, a similar pattern, albeit less severe, is evolving. The danger is clear as many emerging markets still rely on the US to export to. A pullback will keep most emerging markets' run up in check in 2008.
The Pendulum - The pendulum has swung, now emerging markets will have to contend with strong local currency, enlarged capacities, inflationary pressures, higher prices, plus a weakening US economy. The US economy have settled for low growth, some inflation, weak USD (to make their assets more attractive): thus shielding themselves somewhat from excessive money supply growth repercussions, now unwinding in our face. Its going to be a difficult 2008.

14 Jan 2008: Warning

Readers should reread my postings on "Macro Predictions 2008" and "Assessing Bursa's Run-Up". The rally looks temporary. Any sign of wobbling, one should get out. This looks like it. I have submitted a detail article for this weekend's column in BizWeekly, which is a bit more bearish on all equities. I cannot publish it on the blog before it makes the paper. Just a warning note.

yj said...

what is this ???..JPM taking over BS for only $2 a share ???..what the heck is going on here? i thought the closing price after tumbling more than 40% still $36....imagine the how much did citic paid!!!this share sold for almost $200 a yr ago if i'm not wrong....