Housing and its Future. Friday, Sep 17 2010 

So much has been written about the housing market and its overall effects on the economy so I will not spend much time here.

Without dating myself the S&L crisis was partly solved through the removal of bad loans from the balance sheet of banks, the repackaging of said bad loans, and selling them off in tranches to investors.

The quicker the bad loans are dealt with the quicker credit policy will normalize. At the present time, banks will continue to invest in Treasuries over lending as long as the risk reward matrix favors Treasuries. Attempts to push the banks out of Treasuries and into lending will likely backfire as banks are in a risk averse mode and unwilling to lend in the way which caused the credit bubble.

The aftermath of the housing crisis has dominated headlines across traditional and electronic media yet I am avoiding it for a number of reasons.

Harkening back to my commentary at the beginning and middle of 2010:

“Non-performing loans continue to cause problems in the US banking sector. In fact, financial stocks
remind me of post crash Internet stocks. Some recovered all of their losses 10 years later but ask the
shareholders of stocks like Microsoft, Cisco, Yahoo, and Intel about their 10-year returns. There are values but you should not be buying now for a buy-and-hold strategy.

When a bull market starts the leaders of the new bull market are not the leaders of the previous bull market. Going back almost 20 years to the late 80’s/early 90’s when the high yield debt bubble burst and the S&L crisis consumed headlines the banking sector required years of mergers and healing before returning to normal. It is my opinion that the same will happen with the popping of the housing bubble in 2008.

For the past two years, the US has gone through a process similar to the five stages of grief where we initially denied that there was a problem and everything was under control. Then we had anger at the banks for making these loans regardless of the failure of people to provide proper loan documentation while chasing quick real estate gains. Banks then tried to negotiate and workout the loans so that borrowers can stay in their homes. Finally, people are throwing up their arms and walking away which leads to acceptance by the banks that they have to face up to the problem loans.

It has always been my belief that the faster we work through the problem loans the quicker credit policy can return to a sense of normality.

For the banking industry, the key to getting out from underneath the banking and mortgage problems is loss recognition. Once losses are recognized, the industry will move forward.“

History is not on the side of banks and the housing market with respect to historical trends and market leadership. Looking back into history, previous leaders after the LBO wave of the late 80’s were shunned in the 90’s as the Internet and technology boom took hold. After the popping of the tech bubble in 2000 technology stocks were shunned and stock prices of blue chip technology companies such as Microsoft, Dell, Cisco, and Intel languished. It is true that companies such as Apple, Amazon, and Google have flourished to a certain degree but if one looks at the NASDAQ one sees an index which has come nowhere close to recovering to its previous all-time highs.

I believe that the financial stocks will suffer the same fate as the technology companies and the next bull market, commodities, is beginning to appear on the radar screen of most investors after moving up for the last seven years.

Rather than focus on the problems and the back and forth between global regulators and financial stocks, housing data, and other items I prefer to look for solid values and the beginning of the next bull market which will take hold and drive the equity markets to new highs.

Comment on Tuesday’s article about the dilutive effect of gold producers using their stock as a currency. When a company acquires a zero revenue/loss making company using stock the result is highly dilutive on the acquiring companies stock price as the acquired company does not add to revenues or profits. If the acquired company has revenues and profits then the dilution effect is greatly reduced.

Disclaimer
Communications are intended solely for informational purposes. Statements made should not be construed as an endorsement, either expressed or implied. This article and the author is not responsible for typographic errors or other inaccuracies in the content. This article may not be reproduced without credit or permission from the author. We believe the information contained herein to be accurate and reliable. However, errors may occasionally occur. Therefore, all information and materials are provided “AS IS” without any warranty of any kind. Past results are not indicative of future results.
PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN THE STOCK, BOND, AND DERIVATIVE MARKETS. WHEN CONSIDERING ANY TYPE OF INVESTMENT, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.
Before making any type of investment, one should consult with an investment professional to consider whether the investment is appropriate for the individuals risk profile. This is not intended to be investment advice or a solicitation to purchase any of the securities listed here. I will not be held liable or responsible for any losses or damages, monetary or otherwise that result from the content of this article.

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Why I am Bearish on Financial Stocks Friday, Aug 28 2009 

After seeing quite a large rally from the March lows the market appears to be extended and indicators (stocks above 200 day moving average, market PE, bullish/bearish %’s) are signaling some rough seas ahead. While stock could conceivably move higher there are a few reasons why I am bearish at the present time.

Harkening back to 2007, I would like to give credit and thanks to Credit Suisse for the following graph.

As one can see the initial tsunami of bad loans has receded and financial stocks have been licking their wounds and repairing their balance sheets but we are at the beginning of the second wave. This second wave of option reset mortgages will do more damage because of the already weakened state of banks.

The relaxing of mark to market rules has helped repair balance sheets but there will continue to be problems throughout 2010 and into 2011 until the 2nd wave of resets recede.

As the resets continue, non-performing loans continue to rise, causing additional strain on an already weakened banking sector. It is unlikely that we will see a significant drop off in non-performing loans until the bulk of the option resets are completed.

Bank failures continue on a weekly basis with the problems being felt mainly by small and medium sized institutions. Some larger weakened institutions have succumbed to the pressure as well. Recent comments that the FDIC may need additional capital should sound a warning bell across the financial space.

While the housing data has been bullish due to buyers assistance programs, one needs to keep in mind that the reported figures are month-over-month data, not year-over-year. As we get into the fall and winter months the MoM figures will decrease as seasonal patterns take place.

Housing inventories continue at a high level, with many homes being taken off market and rented until the selling climate improves. As we continue through the resets, it is likely that inventories stay high until the potential overhang from option and agency ARM’s clears. Any spurt in new home construction will slow the housing inventories from being worked off in a timely manner.

Retail sales numbers continue to be disappointing, although we are entering a period where comparisons will be much easier. The year over year data shows a 9.4% decline in June and an 8.3% decline in July. Again the YoY data is more telling than the MoM data.

High levels of unemployment will constrain spending and GDP growth into 2010 and later. Government stimulus programs will provide the necessary counterbalance to weakness in consumer spending helping to guide the economy through this difficult period.

This is not an approval for the governments polices but one needs to note that a similar path is followed in every recession. The authors problem lies in the wasteful programs and high deficit levels that state and federal governments carried coming into the recession which only exacerbates the problem going forward. Spending that is targeted at areas to provide future growth is preferred over the construction of dog parks.

So while global economies are likely to come out of the recession without much problem (Japan will be an exception) GDP growth in the US is likely to be below normal levels.

Inventory restocking will give a bump to GDP growth in the coming quarter as will government stimulus programs. This combination will set the stage for renewed consumer and business confidence in the coming years but first we will need to get through the a possible double dip recession in 2010.

So while the market itself may move higher I see better value and higher upsides in the precious metals and agriculture sectors where there are some very interesting values globally. Quite often the best values are off the beaten path.

Disclaimer
Communications are intended solely for informational purposes. Statements made should not be construed as an endorsement, either expressed or implied. This article and the author is not responsible for typographic errors or other inaccuracies in the content. This article may not be reproduced without credit or permission from the author. We believe the information contained herein to be accurate and reliable. However, errors may occasionally occur. Therefore, all information and materials are provided “AS IS” without any warranty of any kind. Past results are not indicative of future results.
PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN THE STOCK, BOND, AND DERIVATIVE MARKETS. WHEN CONSIDERING ANY TYPE OF INVESTMENT, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.
Before making any type of investment, one should consult with an investment professional to consider whether the investment is appropriate for the individuals risk profile. This is not intended to be investment advice or a solicitation to purchase any of the securities listed here. I will not be held liable or responsible for any losses or damages, monetary or otherwise that result from the content of this article.

Investment Thoughts (August 3rd, 2009): Monday, Aug 3 2009 

Not going to chase the market for a number of reasons, but most of all we should see a retest of the March lows sometime in the distant future, maybe a year or so. The US banking sector is still not healthy and has been propped up by regulatory rule changes.

So while financial stocks may be doing well at the present time they will not be the leaders in the new cycle for a variety of reasons. Among them are the mark-to-market rules, increasing non-performing loans, and difficulty in earning a solid NIM in a 0% cost of funds environment.

In order for a new bull market to begin, a new sector must take up the leadership mantle. The leaders from the previous cycle do not lead in the new cycle.

Technology is unlikely to provide leadership as R&D budgets continue to get cut. Businesses are unlikely to commit to major capital spending programs, despite a 0% interest rate environment, amidst falling revenues and uncertain consumer demand. Consumer uncertainty about the future will translate to a cautious business environment going forward.

It may sound strange to say this but with top line revenue growth falling and earnings estimates being met by cutting employees and R&D budgets, this is not a healthy sign for the future.

Without top line revenue growth earnings momentum will be difficult to maintain. You can only cut so much staff and R&D. At some point revenues need to grow and that will only come through increased consumer confidence.

When you combine an US unemployment rate that has gone from 5% to 9% and 70% of US GDP being made up of personal consumption, it is no surprise that consumer demand is weak and consumers are tightening their budgets. We will need to see strong hiring in order to get consumers feeling better about the future and opening their pocketbooks.

I am not a proponent of massive budget deficits but right now government spending is propping the US economy from falling off a cliff. This happens in every recession so there should be no surprise here.

Government spending is adding a couple of percent to GDP at the current time. A significant portion of the stimulus money is targeted to be spent in the coming years which should help the recovery. The question is how much will it affect hiring which should translate into higher tax collection as well and possibly allowing the government to meet their optimistic projections for the 2011-2012 time frame, although it is not the authors opinion that the overly optimistic projections will not be met.

The biggest question concerning the recovery should come from the balance sheet of the Federal Reserve. It is Mr. Bernanke’s intention to begin shrinking the balance sheet of the Federal Reserve in the coming years bringing it back down to a reasonable level.

The largest problem is how much will the shrinking balance sheet constrain the economic recovery. In order for the Federal Reserve to sell the securities it now holds there needs to be a buyer on the other side of the transaction. It is unlikely that the capital will come from drastically higher leverage levels at hedge funds and banks. This means the capital needs to come from either foreign governments or the private sector. Capital coming from the private sector will mean less capital for investment purposes. Capital coming from foreign governments means competition for Treasury sales.

Any recovery will be slow and grinding which is not what the bull camp wants to hear.

So what am I doing right now? Sitting on the agriculture purchases I have made over the last six months. Farmland, fruit, vegetable, and sugar production has provided a nice hedge and decent returns. There is tremendous value in the sector with some stocks already surpassing pre-crash highs.

Gold and silver should begin moving to the upside in the next few months but I am content to wait for a washout correction. This should occur about the time we get either a peak in the US Dollar, the US equity market, or both. We have yet to see a 50% retracement from last years lows which is giving me pause, although there are some interesting trades in the large cap sector.

Disclaimer
Communications are intended solely for informational purposes. Statements made should not be construed as an endorsement, either expressed or implied. This article and the author is not responsible for typographic errors or other inaccuracies in the content. This article may not be reproduced without credit or permission from the author. We believe the information contained herein to be accurate and reliable. However, errors may occasionally occur. Therefore, all information and materials are provided “AS IS” without any warranty of any kind. Past results are not indicative of future results.
PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN THE STOCK, BOND, AND DERIVATIVE MARKETS. WHEN CONSIDERING ANY TYPE OF INVESTMENT, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.
Before making any type of investment, one should consult with an investment professional to consider whether the investment is appropriate for the individuals risk profile. This is not intended to be investment advice or a solicitation to purchase any of the securities listed here. I will not be held liable or responsible for any losses or damages, monetary or otherwise that result from the content of this article.

It is what it Is Wednesday, May 13 2009 

When one looks at the stress tests recently completed by the US government one has to properly filter the noise. The government has released the results and metrics used in the ‘stress tests’ which have been picked apart by many people. You can crunch the numbers and manipulate the statistics all you want but in the end it comes down to loss recognition on bad assets.

Right now there is a tug of war going on between the private sector and the government. On one hand, we have the government looking for greater oversight of the financial sector. On the other hand, we have a banking industry looking to get out from underneath the government’s umbrella believing that they can fix the problems on their own. In this case, both sides are wrong.

The financial sector can be self-policing with a greater emphasis on risk management as is the case in Canada. But the participants in the sector must accept a greater responsibility for their actions and that includes the potential for failure. Capitalism is not about bailouts it is about letting market forces dictate winners and losers.

The government cannot expect to go the route of pay regulation as it will contribute to a brain drain in the financial sector. Just ask anyone working for a Big 4 auditing firm if they are having problems recruiting talent after the Arthur Andersen debacle. This should be a warning to those who seek to regulate items like executive pay.

Sarbanes-Oxley did more harm to the US financial markets by forcing small to medium sized businesses to go private and chased away IPO dollars to markets such as Toronto, London, and Hong Kong.

For those who wish to pursue further regulation in the financial markets, it should be done in a way similar to the regulations which came into effect after the 1987 market crash. In other words, capital formation should not be inhibited in any manner.

Everything is Getting Better Tuesday, May 12 2009 

Back in the middle of the financial meltdown last October I penned a quick article entitled [url=”http://www.financialsense.com/fsu/editorials/urban/2008/1016.html“]Everything will be All Right in the End[/url]. At the time the world seemed to be falling apart but it is important to understand that although the skies seemed dark at the time, there is a light on the horizon.

Since then the banking industry has undergone stress tests, the creation of various governmental funding mechanisms, and the thinning of the herd in terms of smaller weaker banks being acquired by larger organizations. A sense of normalcy is slowly returning to the industry and as banks spend the appropriate time in recovery.

We are currently at the point where lending standards have tightened and banks feel that the risk/reward ratio is tilted in favor of holding government and corporate bonds rather than making loans. Good people with good credit can get loans in this environment however people who have no income and no job will have no access to credit as it should have been over the past five years. This has been lost in the noise about banks writing off mortgage balances and foreclosures.

We are in the same position today in terms of lending standards as we were at the bottom of every credit cycle going back as long as records are kept. What makes this cycle different from the rest was the movement of mortgages on the edge of the lending bell curve to the mean. Because these mortgages were securitized into illiquid MBS and then chopped and diced into even more illiquid securities the healing process in the banking system will take longer than normal.

So where do we go from here? The healing process will take a number of years as banks continue to deal with problem loans and rebuild their capital structures. The key is loss recognition. The quicker losses are recognized and put behind the bank the quicker they can move forward in terms of rebuilding the capital structures.

Once the capital structures are rebuilt, banks will continue to choose to hold bonds over making loans to less than creditworthy clients until the risk/reward ratio favors making loans to those clients. Any efforts by the government or private sector to return to the lending practices in the middle of this decade should be looked at as a worrisome sign. Even more worrisome would be a return to these lending practices by banks of their own accord.

One recommendation would be to allow Canadian banks, who have very strong capital bases, to acquire weaker banks in the United States. TD Bank made a sizable acquisition in acquiring Commerce Bank but other Canadian banks should be allowed to make acquisitions as well. After speaking with a number of professionals in Canada, they are showing a keen interest in expansion south of the border. Given the strong capital base and risk management practices employed in Canada, where the banking sector was recently rated the strongest in the world, the US government should be opening doors for our neighbors to the north. This would only strengthen the US banking system as a whole and strengthen any economic recovery.