Joined: 28 Dec 2005
|Posted: Sun Aug 26, 2007 11:04 pm Post subject: Professional Commentaries
|Lou, if you look at the potential and actual output
chart in middle of page in that link I sent, the
implication is U.S. economic growth will accelerate
over the next few years and inflation will remain low.
Higher U.S. household debt was caused mostly by cheap
goods and low interest rates (or easy access to
capital, which was plentiful). The capital or credit
boom came from foreign capital inflows and
productivity, along with improving terms of trade more
than a higher money supply or greater domestic growth.
Americans maximized their living standards and will
have to work longer to at least maintain autonomous
consumption, while paying-down debt and building-up
saving, which will add to economic growth. Also,
you're right, some only look at debt and ignore or
underestimate assets, similar to focusing on lost
purchasing power, while ignoring gains in living
Thanks for your comments Art.
I wouldn't have enough $ to pay for your quality of analysis.
After studying Ken Fisher's latest book I'm starting to come around to your line of thinking with
I don't want to dog guys like Rogers and Faber, because they have much more training and
experience than I have.
However, correct me if I'm wrong but these guys seem like a bunch of "merchantilist".
If you analyze the statistics correctly, you'll find it puts a lot of what these guys and many gold bugs say on its head.
E.g. If the U.S. is in Debt 5 trillion dollars it sounds like it will go to hell in handbasket soon.
However, if you look to see that U.S. is worth 111 trillion in assets, you'll find the U.S. may be quite underleveraged relative to optimization.
E.g. Stock markets of countries with deficits have actually outperformed countries with surplus. Lou
Lou, I found Jim Rogers comments most interesting. The
fact that he's short banks, and been short for a
while, helps show he's a long-run business cycle
investor. However, shorting banks is dangerous.
Financial institutions helped raise economic growth.
So, the Fed is helping financial institutions. Buffett
has shown interest in buying Wells Fargo. Bank stock
P/Es are around 10, etc. So, Rogers is betting against
the Fed, Buffett, and low P/Es, although bank stocks
have above average betas. Also, Rogers seems to
believe the U.S. money supply is too high. However,
the U.S. economy has generally been expanding below
potential output for seven years, because foreigners
have been buying dollars and selling their currencies.
Rogers stated: "The Federal Reserve was not founded to
bail out Bear Stearns or a few hedge funds. It was
founded to keep a stable currency and maintain its
value." However, the dollar has lost over 90% of its
purchasing power, while the dollar has fluctuated in a
wide range. So, obviously, the Fed hasn't kept a
stable currency and maintained its value. Sustainable
economic growth is the Fed's goal, through price
stability. Moreover, Rogers is bullish on China.
However, what may cause a global stock market crash is
the collapse of China's economy (perhaps, through
political upheaval, because for every one Chinese
reaping large benefits, there are 100 Chinese being
exploited). Rogers may be waiting for a big stock
market decline, which should eventually take place.
The link below shows U.S. money supply growth and a
chart of actual and potential output. Art Click Published
Warren Buffett Chairman and CEO, Berkshire Hathaway:
Because many institutions are highly leveraged, the difference between "model" and "market" could deliver a huge whack to shareholders' equity. Indeed, for a few institutions, the difference in valuations is the difference between what purports to be robust health and insolvency. For these institutions, pinning down market values would not be difficult: They should simply sell 5% of all the large positions they hold. That kind of sale would establish a true value, though one still higher, no doubt, than would be realized for 100% of an oversized and illiquid holding.
In one way, I'm sympathetic to the institutional reluctance to face the music. I'd give a lot to mark my weight to "model" rather than to "market."
Wilbur Ross, Chairman and CEO, W.L. Ross & Co:
Liquidity is not about physical cash; it is mainly a psychological state. Subprime problems have consumed only trivial amounts of global cash but already have burst bubbles by shocking lenders. Clever financial engineering effectively had convinced lenders to ignore risk, and not just in subprime. A major hedge fund participated in a loan to one of our companies, but sent no one to a due diligence meeting. So I called the senior partner to thank him and tell him about the non-attendance. He responded, "I know. For a $10 million commitment, it wasn't worth going to a meeting."
The present $200 billion of delinquencies will grow to $400 billion or $500 billion next year because $570 billion more low, teaser-rate mortgages will reset to market and consume more than 50% of the borrowers' income. Therefore most of the loans will be foreclosed or restructured. Probably 1.5 million to two million families will lose their homes. Meanwhile, few lenders will put mortgages on the foreclosed houses, so the prices will plummet. Despite these tragedies, total losses will probably be less than 1% of household wealth and only 2% to 3% of one year's GDP, so this is not Armageddon. However, even prime jumbo mortgages will be more expensive and more difficult to obtain.
John Mack, Chairman and CEO, Morgan Stanley:
I was around in 1987, and that crisis was more disruptive and much more alarming than this is. So was the 1998 foreign-debt crisis. It's not all bad news now. There's still liquidity in the markets. There's plenty of investor money in China, Russia, the Middle East, as well as the U.S. The rest of the world has developed to the point that, if the U.S. goes into a recession, I don't think we'll have a global recession. I don't think a recession is going to happen, but it's what our central banks have to worry about.
Bill Miller, Chairman and chief investment officer, Legg Mason Capital Management:
These sorts of things are what's known to the academics as "endogenous to the system"--that is to say, they're normal. They happen usually every three to five years. So we had a freezing up of the market for corporate credit in the summer of '02. We had an equity bubble just before that. In '98 we had Long-Term Capital. In '94 we had a mortgage collapse like we're having right now. In 1990 we had an S&L collapse. In '87 we had a stock market collapse. These things flow through the system, and they're part of the system. I saw one quant quoted over the weekend saying, "Stuff that's not supposed to happen once in 10,000 years happened three days in a row in August." Well, I would think that you would learn in Quant 101 that the market is not what's known as normally distributed. I'm not sure where he was when all these things happened every three or five years. I think these quant models are structurally flawed and tend to exacerbate this stuff.
But these events represent opportunities. When markets get locked up like this, it's virtually always the case that you'll have opportunities if you have liquidity. Instead of worrying how bad it's going to get, I think people should be thinking about where the opportunities might be.
The NYSE financial index is probably the best barometer of what's to come. The financials tend to be a very good indicator of where the market's going. They tend to lead the market because they're the lubrication for the economy. So I think the financial index will tell you if this thing is over, and so far it's telling you it's not over. It's still falling. But just as financials lead on the downside, they will lead on the upside.
Jim Rogers, Founder of the Rogers Raw Materials Index:
Historically, when an industry goes through a retrenchment like this, you have two or three big companies going bankrupt and most of the companies in the industry losing money for a year or two or three. Well, we haven't gotten anywhere near that in the homebuilding business, so I think that bottom is a long way off. As far as the credit bubble, we have another several months, if not more, of mortgages that are going to reset and people who are going to find themselves with even higher monthly payments. There are many, many more losses to come, most of which we won't know about for weeks or months.
Normally you have markets go down 10% or so every couple of years. We haven't had a 10% correction in the stock market in nearly five years. I don't know if this is the beginning of it, but we've got a lot of corrections coming. It wouldn't surprise me to see a little bounce--say if a central bank cuts rates. But that will just lead to the markets falling further late this year or next year. It would be better for the market, it would be better for investors, and it would be better for the world if we went ahead and cleaned out the system. If they do cut rates in the U.S., it would be pure madness. Because the market's down 7% or 8% from an all-time high? My gosh, what's that going to say about the dollar? What's that going to say to foreign creditors? What's that going to say about inflation? The Federal Reserve was not founded to bail out Bear Stearns or a few hedge funds. It was founded to keep a stable currency and maintain its value.
I have been and continue to be short the investment banks and the commercial banks. If they bounce up, I'll probably short more. I'm certainly not buying anything. The market's only down 8%. I don't consider that a buying opportunity. The things that I'm short, some people probably think are buying opportunities, but I don't. I've been short the banks for close to a year, and for a while it was not fun. But I added to my positions, and now it's a lot of fun.
Jeremy Grantham, Chairman, GMO:
There is a lot of pain still to be had in the equity markets, particularly aimed at the risky end of the spectrum. We think the fair value on the market is about a third lower in the U.S and EAFE from today and about a quarter less in emerging markets.
Most of that is not because P/E's are high. The great weakness in equities is that profit margins are off the scale globally. They're off the scale for the same reason that the risk premium got so low--that we've had wonderful global conditions, wonderful global growth, wonderful global liquidity, wonderfully low inflation. That will do it every time, without fail. So the profit margins went steadily up under a constant series of pleasant surprises: Global growth was always a little better than expected, consumption in the U.S. was always a little stronger than expected.
Pleasant surprises are the key to profit margins. If you can put together three years of constant pleasant surprises, you will have fabulous profit margins. It isn't to do with productivity, it isn't to do with China or India. It's to do with pleasant surprises. And of course, the longer the pleasant surprises, the higher the hurdle. The hurdle is now desperately high. It is virtually impossible to pleasantly surprise the world now. And profit margins will of course drift or drop down to normal and below. That's the pressure on the markets. That is what causes the market value to be a third less than it is today.
And people don't get that. People always look at P/E and take great comfort. Often it's perfectly fine to do that. But today it's horribly misleading because the main pain is in profit margins.
In five years, I expect that at least one major bank (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private equity firms in existence today will have simply ceased to exist.
Lou, I believe, Shakespeare said it's better to love
and lost than to never loved. Some who bought homes
shouldn't have been able to buy them in the first
place. They should be thankful, they had the
opportunity. Some will be able to keep their homes,
because homeownership made them more responsible.
First time homebuyers, e.g. young people, now have the
opportunity to afford homes. Gross has some crazy
> Pimco's Gross Urges Bush to Bail Out U.S. Homeowners
> By Patricia Kuo
> Aug. 23 (Bloomberg) -- Bill Gross, manager of the
> world's biggest bond fund at Pacific Investment
> Management Co., urged the Bush administration,
> rather than the Federal Reserve, to bail out U.S.
> homeowners to avoid ``destructive housing
> ``Fiscal, not monetary policy should be the
> preferred remedy,'' said Gross, who manages the $103
> billion Pimco Total Return Fund. ``This rescue,
> which admittedly might bail out speculators who
> deserve much worse, would support millions of hard
> working Americans whose recent hours have become
> ones of frantic desperation.''
> Fed interest-rate cuts won't lighten the extra
> mortgage payments for homeowners as lenders may not
> follow with cheaper rates, he said. Lower Fed rates
> would likely weaken the dollar, Gross wrote in his
> monthly commentary on Pimco's Web site. The
> unexpected 0.5 percentage point cut last week on the
> rate the Fed charges banks and the addition of cash
> to ease access to capital may provide short-term
> relief to markets, he said.
> The Fed left its benchmark overnight interest rate
> at 5.25 percent at its last meeting Aug. 7.
> ``The fed funds rate at 5 1/4 percent is
> restrictive,'' Gross said the same day. ``The
> economy is slowing. They're going to have to'' cut
> rates in the next several months. He also said his
> firm has been buying high-yield assets.
Gross has been predicting for about a year that the
> Fed will lower rates in 2007. As of June 30, Gross
> had most of his fund's cash in securities maturing
> in one year to three years. Such bets benefit more
> from rate cuts than longer-maturity debt.
> Home Foreclosures
> U.S. homes facing foreclosure almost doubled in July
> to 179,599 notices as property owners with
> adjustable-rate mortgages saw payments rise and were
> unable to refinance because of the subprime crisis,
> RealtyTrac Inc. said. Analysts expect defaults to
> rise to more than 2 million, which would likely dent
> housing prices by 10 percent, Gross wrote.
> There are precedents from previous crises in the
> 1990s, Gross said. The U.S. government created the
> Resolution Trust Corp. to rescue the insolvent
> savings and loan industry and the Fed organized a
> bailout to prevent billions in losses from rippling
> through Wall Street after the collapse of Long-Term
> Capital Management LP hedge fund in 1998.
> ``Why is it possible to rescue corrupt S&L
> buccaneers in the early 1990s and provide guidance
> to levered Wall Street investment bankers during the
> 1998 LTCM crisis, yet throw 2 million homeowners to
> the wolves in 2007?'' Gross wrote. ``If we can bail
> out Chrysler, why can't we support the American
> Gross advised President George W. Bush to set up a
> ``Reconstruction Mortgage Corporation'' and ``write
> some checks'' to bail out homeowners.
> `Additional Avenues'
> The U.S. government can also make adjustments to the
> existing Federal Housing Administration's program,
> which long ago was ``discarded as ineffective,''
> said Gross. The FHA insures loans made to
> lower-income homebuyers. U.S. Senate Banking
> Committee Chairman Christopher Dodd plans to move
> legislation next month that would expand the role of
> FHA to ``provide additional avenues for people to
> get cheaper, reasonable, safer credit'' without
> relying on subprime loans, he said in an interview
> with CNBC.
> Lehman Brothers Holdings Inc., the biggest U.S.
> underwriter of mortgage-backed securities, expects
> the Fed to lower the federal funds rate by between
> 50 and 75 basis points from the current 5.25 percent
> by the end of March.
> Traders see a 58 percent chance the Fed will cut its
> target for overnight bank lending by half a
> percentage point to 4.75 percent at its next meeting
> Sept. 18, based on futures contracts.
> No Automatic Adjustments
> ``Even cuts of 200-300 basis points by the Fed would
> not avert a built-in upward adjustment of
> adjustable-rate-mortgage interest rates,'' Gross
> said. ``Nor would it guarantee that the private
> mortgage market, flush with fears of depreciating
> collateral, would follow the Fed down in terms of
> 15-30 year mortgage yields and relaxed lending
> If U.S. home prices fall by 10 percent, it would be
> the worst asset deflation in the U.S. since the
> Great Depression, according to Gross.
> ``Now many of those that bought homes in 2005-2007
> stand a good chance of resembling passengers on the
> Poseidon -- upside down with negative equity,'' he
> said. Seventy percent of American households own
> As no one really knows where the defaulting
> mortgages will arise and how many rest in
> institutional portfolios, the investments can
> hibernate for many months before investors get to
> find its true value, Gross said.
> `Trust Breaks Down'
> ``When no one knows where and how many Waldos there
> are, the trust breaks down, and money is
> figuratively stuffed in Wall Street and London
> mattresses as opposed to extended into the
> increasingly desperate hands of hedge funds and
> similarly levered financial conduits,'' he wrote.
> Newport Beach, California-based Pimco, which
> oversees about $687 billion, is a unit of
> Munich-based insurer Allianz SE.
> Almost half of all collateralized debt obligations
> sold in the U.S. in 2006 contained subprime debt,
> according to a March report by Moody's Investors
> Service. CDOs are packages of bonds and loans.
> ``The inherent leverage that accompanies derivative
> creation may foster systemic risk when information
> is unavailable or delayed in its release,'' said
> Gross. ``Nothing within the current marketplace
> allows for the hedging of liquidity risk and that's
> the problem at the moment.''
> To contact the reporter for this story: Patricia Kuo
> in Hong Kong at email@example.com