Posted on 08/22/2007 8:33:20 PM PDT by bruinbirdman
Wall Street shot itself in the foot, and Ben Bernanke came on, sirens wailing.
There are dozens of money managers in both the fixed-income and equities sectors who've self-destructed. Not conventional money managers, who grew up as practicing security analysts, analyzing companies and industries, performing sharp-penciled credit analysis of corporate debt instruments.
The guys with burnt fingers are quants who go long and short stocks but leverage up to 10 times their base equity. Players in the debt markets also leverage up 10 times or more using low-cost Eurodollars as security for positions in all kinds of collateralized debt paper. Obviously, they didn't know or care what they owned. The quants got into trouble buying stocks with low earnings valuations. Ergo, the forced selling of airlines and commodity plays in copper, steel, even oil.
The most significant part of the Fed's rescue package is its willingness to accept mortgage paper as collateral for loans at the discount rate window. Lowering rates 50 basis points helps, but taking in mortgages liquifies the housing sector and prevents a total implosion.
Computer-driven trading on the Big Board frequently accounts for half the day's volume as operators seek to exploit tiny anomalies in prices. Most quants end up looking like a single quant in that their computer-driven strategies are basically undifferentiated. A sell or buy signal for one is for all, and then the crowds pile up at the doors and piss on themselves (the feedback loop).
Today, there are hundreds of quants and other long-short managers who each control tens of billions in buying power. For a few, it's hundreds of billions. Goldman Sachs (nyse: GS) had to shore up its quantitative funds because of the leverage employed, needing to avoid forced liquidations of portfolio positions.
All this mufti-pufti roils markets, saps public confidence and then lowers valuation for Big Board securities. Stocks and market sectors that are highly volatile now sell at lower valuations of earning power. Not good for the country. This inhibits risk taking by the entrepreneurial and capital spending in well-heeled boardrooms like Caterpillar Tractor and IBM (nyse: IBM).
Economic prosperity over the past 25 years was propelled by steadily rising home prices and a stock market that returned 14% compounded annually. Nobody but cockeyed optimists expects this trend to perpetuate itself. The market in 1982 stood grossly undervalued. For the past decade, the S&P 500 returned 7%, which is as much as I can see looking forward.
Despite the Fed's action, a turnaround in home prices is pushed out to at least 2009. There's too much inventory in new and existing properties for sale. If the home construction market doesn't turn up in 2009, major home builders will face bankruptcy unless the banks forgo loan covenants on debt to net worth ratios.
At current gross margins, under 15% for almost all home builders, nobody covers his overhead. Airlines anybody? Home builders did it to themselves. Many bought back stock in the good times. You don't do this in a capital-intensive business. They abetted starter home buyers to find no-money-down mortgages too. Why shouldn't they be punished?
Our gross domestic product probably contracts for several quarters as consumer disposable income peaks, considering all the adjustable mortgages resetting. I'm more worried about Wal-Mart's (nyse: WMT) same-store sales stalling out. That's the real world. I thought that this Fed was stalwart enough not to cut fed funds rates until job growth peters out and unemployment rises, and that any action was three months away. But now it seems imminent.
I stand by my previous column's market call. Fair value is 1,425 on the S&P 500 Index (less than 20 points below where we are right now). The earnings consensus still must adjust downward from the high 90s per share to low 90s, what we have today. It reflects slowing GDP momentum. The Treasury bond market should rally, allowing the market to sell at 15 times forward earning power.
I see contraction in the financial sector and in energy, which account for 30% of the S&P 500 Index. Hedge funds will change their spots and look more like conventional money managers in the next cycle. We are going back to the days of stock picking and less quantitative mumbo jumbo. All this is to the good, but the financial community has a lot more to work out regarding what's an optimum capital structure going forward. It suggests rates of return for Wall Street houses work lower.
It will take the financial community the rest of this year to clear hundreds of billions in bridge loans and collateralized debt obligators off their books. The markdown could reach 5% to 10% of face value. The large institutions--banks, brokerage houses and some insurance underwriters--will take modest hits to their net worth, but big dents in quarterly earnings are coming. Lehman Brothers (nyse: LEH) already is at 1.5 times book value, but Goldman Sachs still is almost double book.
I expect health care to find new buying interest. The technology sector is reasonably priced and could outperform the market, barring a recession.
We're seeing the peak in cash flow going to the alternative investment houses. Harvard, Princeton and Yale better find some conventional money managers for their capital. I can't promise them 1% a month in appreciation, but who can these days?
I just marked down my New York co-op from four times original cost to twice book. Layoffs at hedge funds spell diminished bonuses on Wall Street. The Big Apple apartment cycle peaks coincidentally along with contemporary art prices at the November auctions at Sotheby's and Christie's.
It's worth repeating: "Nobody on Wall Street has a monopoly on brains."
Meaningless to me, but the YouTube video of the “Mad Money” guy going crazy was pretty funny. Would you seriously consider investing your savings on the recommendations of such a nut? That’s pretty much my feelings about the stock market in general.
So what’s your point?
Hope you aren’t leveraged. That’s the point.
Also, everything will look scary and crazy to you until you learn that there is method in the seeming madness. Read up a little about finance in general and markets in particular.
Too many technical terms for me.
Best analysis on this mess I’ve seen yet...
This is a shoot-from-the-lip writer (and I enjoyed reading this piece). In my view, Bernanke had no business lowering any rate at this time. But, above all, he had no business lowering rates simply because the market was trying to correct an overbought condition. That’s ridiculous. Is this like the crooked referee deal?
How about the construction guys focus on roads and bridges, if the private lease idea gets moving, that could spark a boom that would benefit many.
ping
It must be remembered that the ECB injected about $130 billion into the EU 8 hours before Bernanke opened the window for about only $13 billion.
Odd? What did the ECB know?
Turns out some EU state banks were going belly up (in the US they were credit institutions) because they were prime targets of the credit scam.
I think it was the ECB that actually plugged the hole. Bernanke just gave a token pep talk.
The Koreans took a big hit too.
Hmmm. Wonder if the Albanians got suckered again by a ponzi scheme.
yitbos
In this particular case, recent threads here noted that Cramer's stock picks have consistently underperformed the major indices over virtually any time period of the past two years.
Cramer’s picks have been analyzed and shown to be below market average. You need a new hero. maybe it’s you who should “read up”.
Sosnoff, admits that the Fed will cut rates yet he's still negative on financials? Very odd.... Regional banks should thrive in this new environment, iow a steeper yield curve. Just be careful not to buy one with a lot of subprime exposure.
Where did you see me speaking for or against Cramer?
Please. Pretending to confuse the general and the specific in order to invent an offense is particularly transparent sophistry.
The “shoot from the lip” writer has 7 bill, as in billion, invested in the market and is expressing his opinion. Are you suggesting he is going to risk this type of $ to look flashy?
Nope. I’m suggesting he has a dashing, daring, candid writing style, and I enjoyed it very much.
BOC shares plunge after U.S. subprime revelation ( Hong Kong bank holds 10 B..subprime paper..)
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.