New Records are Not Good

This year has been a year of records. Here are some of the benchmarks we have hit in the three short months of 2008.

1) Gold rises above $1,000 an ounce:

Most-active April gold futures reached a new high of $1,001.50 on the Comex division on the New York Mercantile Exchange Thursday.

The metal has climbed steadily since 2001 after falling as far as $250s a number of times during the period from 1999 to 2001.

The several-year bull market accelerated rapidly since August after the Federal Reserve signaled it was easing monetary policy to shore up the economy amid worries about the credit markets due to sub-prime problems. In fact, to hit $1,000, April gold futures soared 50% since the Aug. 16 low of $666.40.

Hat Tip: WSJ

2) Oil first rises above $100, and now sits at a record $111:

Crude oil for April delivery rose more than $1 to hit $111 a barrel on the New York Mercantile Exchange in mid-morning trading. It was last up 85 cents, or 0.8%, to $110.77 a barrel. Crude has gained nearly $6 since Monday.

Crude prices, denominated in dollars, tend to rise when the greenback falls, as a weaker U.S. currency makes crude less expensive to buyers holding other currencies. It also eats into oil producers' dollar revenue and forces them to raise prices. The weak dollar is also pushing up prices of other commodities.

Hat Tip: Marketwatch

3) The Dollar falls to record lows against the Euro.

The euro has been on an upward trajectory since late 2001, but its rally has intensified since the credit crisis shocked financial markets last August and aggressive U.S. interest rate cuts sent dollar to record lows.

The latest, some say third, wave of the credit crunch in recent weeks has seen the dollar's broad decline accelerate and on Thursday the euro surged to records above $1.56 and the dollar broke to 12-year lows under 100 Japanese yen.

Policymaker protests are well underway.

Hat Tip: Guardian, Bespoke

4) The Dollar falls below ¥100 for the first time since 1995:

``Dollar-yen is going lower,'' said Ray Farris, head of foreign-exchange strategy at Credit Suisse in London. ``It will definitely overshoot our 98 forecast in the very near term. Our forecast was for the dollar to reach 98 in three months. The big question now is whether there will be intervention.''

Japanese officials are unlikely to intervene now in the foreign-exchange market because the yen is ``cheap'' compared with other currencies, Sakakibara said. The U.S. and Japan may intervene to weaken the yen should it break through 90 and head toward 80 per dollar, he said.

The yen's real effective exchange rate, measured against 15 currencies of major trading partners including China, Europe and Canada, is 99.5, according to Bank of Japan figures. The rate averaged 121.9 in the first quarter of 2004, when the bank last intervened on behalf of the Ministry of Finance.

Hat Tip: Bloomberg

5) Carlyle Capital becomes the next hedge fund implosion:

The credit crisis has claimed another victim.

Carlyle Capital Corp. said late Wednesday it expects its lenders will seize its assets, causing the likely liquidation of the fund, which until recently owned $21.7 billion in mortgage securities.

"Although it has been working diligently with its lenders, the Company has not been able to reach a mutually beneficial agreement to stabilize its financing," the fund said in a statement.

Hat Tip: WSJ

What Happens When Everyone gets a Margin Call at the Same Time?

Paul Krugman had a great op-ed piece today in the NYT appropriately named the "Face-Slap Theory." Here's a taste:

One consequence of the crisis is that while the Fed has been cutting the interest rate it controls — the so-called Fed funds rate — the rates that matter most directly to the economy, including rates on mortgages and corporate bonds, have been rising. And that’s sure to worsen the economic downturn.

What’s going on? Mr. Geithner described a vicious circle in which banks and other market players who took on too much risk are all trying to get out of unsafe investments at the same time, causing “significant collateral damage to market functioning.”

A report released last Friday by JPMorgan Chase was even blunter. It described what’s happening as a “systemic margin call,” in which the whole financial system is facing demands to come up with cash it doesn’t have. (A financial joke making the rounds, via the blog Calculated Risk: “Who is this guy Margin that keeps calling me?”)

You'll have to check out the article for yourself to read on.

Historical Corrections

Every now and then Bespoke Investment Group puts together a graph that really helps put current market events in historical perspective. The graph below is such a graph. It shows all market corrections in the S&P 500 dating back to 1927. You can see that this current correction is already longer than the typical correction, though it isn't as deep:


There have only been 4 corrections that have lasted longer than a year and roughly 6 that have led to declines over 35%. One final note, this current "correction" will only turn into a "bear market" if the S&P 500 falls below 1260.87, which is roughly 6% below the current level of the market.

Hat Tip: Bespoke

Only Funny Because it's True

Hat Tip: Barry Ritholtz

Obama, Medvedev, iPhone, TrimTabs

Here is the week in Preview:

1. Will Barack punch his ticket on this second version of "Super Tuesday" in which Texas, Ohio, Vermont and Rhode Island hit the polls? Barack and Clinton square off in what should be the deciding battle of the race for the Democratic candidacy.

If Barack Obama defeats Hillary Clinton in Texas or Ohio tomorrow, he will take control of a unified Democratic Party and enter the race against John McCain with an already-established reputation as a political giant- killer.

Hat Tip: Bloomberg

2. Putin's hand-picked successor Dmitry Medvedev wins the election:

Dmitry Medvedev won Russia's presidential election, giving him a mandate to succeed Vladimir Putin. Russian monitors complained of election-law violations. Medvedev had 70.2 percent of the vote with 98.1 percent of returns counted at 7:30 a.m. in Moscow today, according to the Central Election Commission. The Commission will announce the result at 10 a.m.

Medvedev, 42, became the favorite after Putin named him as his chosen successor on Dec. 10. Putin then enjoyed approval ratings of more than 80 percent. A week later, Putin agreed to serve as Medvedev's prime minister, keeping a pledge to retain influence and setting the stage for a dual leadership that's unprecedented in modern Russian history.

Hat Tip: Bloomberg

3. Is Apple opening up the iPhone on Thursday?

Apple has invited the media to an event Thursday at the company's Cupertino, Calif., headquarters, where it plans to present an "iPhone software roadmap." One of the event's highlights will be a software-development kit that will let independent programmers build iPhone applications, according to Apple's invitation.

Hat Tip: WSJ

4. Labor Market Friday - The first Friday of the month should give us a taste of how many jobs we gained in February. But, thanks to Barry Ritholtz we've learned to not trust these numbers. After all the NFP data did overstate job growth by 14.4% in 2007. The more accurate data point is probably from TrimTabs:

TRIMTABS, which estimates employment growth using data from an online job index and an analysis of income tax withheld versus job creation rates, has been far more accurate than the Bureau of Labor Statistics. For example, in 2006, the government’s initial estimates of employment growth came in at 1.52 million jobs. But the bureau revised that data upward in February 2007, for a total of 2.24 million.
By comparison, TrimTabs’ estimates of 2006 employment growth, using real-time data, totaled 2.39 million jobs. The firm reported those figures to clients contemporaneously.

Last week, TrimTabs told clients it estimated that 77,000 jobs would be lost in February; Wall Street economists are calling for a gain of 30,000 for the month.

Since October 2007, TrimTabs estimates, the economy has lost about 175,000 jobs, the first sustained employment drop since early 2003.

Hat Tip: CR

Goldman's Call: CRE is Next

I have been speculating for some time that commercial real estate might be the next US asset class to take a hit. In fact I first wrote about this issue in May of 2007 in a post titled "Froth in Commercial Real Estate." We've been seeing turmoil in that marketplace for quite some time, but it looks like 2008 might be the first major leg down. Obviously any pronounced downturn will hurt businesses and commercial real estate. But, the longer and more pronounced the recession, the worse CRE could get.


Of all the Wall Street firms, Goldman has been perhaps the best at identifying major structural issues in the US economy over the past 2 years. They hedged against subprime better than any other firm, they have been correctly bullish on agricultural commodities, they saw the major bank writedowns coming and now they are calling for a major (20%+) CRE correction.

You can read the full article here. Or you can just read this ubiq-cerpt:

After suffering a beating from their exposure to home loans, banks and securities firms are about to take their lumps from office towers, hotels and other commercial real estate. And the losses could last longer than those from the subprime shakeout.

As the economy wobbles and financing costs rise because of the credit crunch, commercial-real-estate values are starting to slide, with analysts at Goldman Sachs Group Inc. projecting a decline of 21% to 26% in the next two years. That means misery for securities firms with exposure to commercial-real-estate loans and commercial- mortgage-backed securities.

William Tanona, a Goldman analyst, expects total write-downs of $7.2 billion by Bear Stearns Cos., Citigroup Inc., J.P. Morgan Chase & Co., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Morgan Stanley in the first quarter. Those firms had combined commercial-real-estate exposure of $141 billion at the end of the fourth quarter.

Goldman analysts predicts the financial damage from commercial real estate could last as long as two years, which would mean "a significantly longer tail than subprime." That is because only 28% of commercial-real-estate loans have been packaged into securities since 1995, while about 80% of subprime loans have been securitized; the higher level of securitization subjects the subprime assets to more-immediate mark-to-market accounting, which is playing out in the form of the write-downs that are dominating headlines.

I hate to say this, but I hope Goldman is wrong about the long tail effects of the CRE slodown. Hopefully the decline will be swift so that we can start putting this major real estate asset bubble behind us. For more on this issue check out this CNBC video.

In one final note I want to draw attention to the Markit CMBX indices. The particular index of note is the one that I first posted about back in July of 2008. At that point the CMBXNA-BB 3 index had a spread of 600 bps. As of today that same index has a spread of nearly 2000 bps:
Hat Tip: WSJ

Warren Buffett's Annual Shareholder Letter

It's that time of the year again. Warren Buffett released his annual letter to shareholders. I encourage everyone to go read it here.

Here are my favorite quotes in no particular order.

1. Buffett is great at managing shareholder expectations:

It’s a certainty that insurance-industry profit margins, including ours, will fall significantly in 2008. Prices are down, and exposures inexorably rise. Even if the U.S. has its third consecutive catastrophe-light year, industry profit margins will probably shrink by four percentage points or so. If the winds roar or the earth trembles, results could be far worse. So be prepared for lower insurance earnings during the next few years. (Page 3)

Berkshire’s past record can’t be duplicated or even approached. Our base of assets and earnings is now far too large for us to make outsized gains in the future. (Page 4)

2. Buffett's ability to buy a company quickly and with cash makes him the acquirer of choice:

This deal was done in the way Jay would have liked. We arrived at a price using only Marmon’s financial statements, employing no advisors and engaging in no nit-picking. I knew that the business would be exactly as the Pritzkers represented, and they knew that we would close on the dot, however chaotic financial markets might be. During the past year, many large deals have been renegotiated or killed entirely. With the Pritzkers, as with Berkshire, a deal is a deal.

I think this is hilarious because what Warren calls "nit-picking" most people would just call "due diligence."

3. Buffett consistently praises his CEO's and recognizes the competitive advantage they give him:

A second, somewhat related, point about these managers is that they have exactly the job they want for the rest of their working years. At almost any other company, key managers below the top aspire to keep climbing the pyramid. For them, the subsidiary or division they manage today is a way station – or so they hope. Indeed, if they are in their present positions five years from now, they may well feel like failures.

Conversely, our CEOs’ scorecards for success are not whether they obtain my job but instead are the long-term performances of their businesses. Their decisions flow from a here-today, here-forever mindset. I think our rare and hard-to-replicate managerial structure gives Berkshire a real advantage.

4. Buffett's "simple" investment philosophy:

Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stock market purchases. It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.

A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the lowcost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with “Roman Candles,” companies whose moats proved illusory and were soon crossed.

5. The first time Buffett ever agreed to increase his offer for a company:

We agreed to purchase 35,464,337 shares of MidAmerican at $35.05 per share in 1999, a year in which its per-share earnings were $2.59. Why the odd figure of $35.05? I originally decided the business was worth $35.00 per share to Berkshire. Now, I’m a “one-price” guy (remember See’s?) and for several days the investment bankers representing MidAmerican had no luck in getting me to increase Berkshire’s offer. But, finally, they caught me in a moment of weakness, and I caved, telling them I would go to $35.05. With that, I explained, they could tell their client they had wrung the last nickel out of me. At the time, it hurt.

6. Buffett isn't joking when he says he likes to buy enduring franchises with strong brands:

In 2007, American Express, Coca-Cola and Procter & Gamble, three of our four largest holdings, increased per-share earnings by 12%, 14% and 14%. The fourth, Wells Fargo, had a small decline in earnings because of the popping of the real estate bubble. Nevertheless, I believe its intrinsic value increased, even if only by a minor amount.

In the strange world department, note that American Express and Wells Fargo were both organized by Henry Wells and William Fargo, Amex in 1850 and Wells in 1852. P&G and Coke began business in 1837 and 1886 respectively. Start-ups are not our game.

Note that this quote contrasts with Buffett's early comments regarding Lebron James:

"If Lebron were an IPO, I'd buy it." - Buffett

7. Would Buffett buy Google stock? Well, its probably not seasoned enough, but he does like the cash flow:

A company that needs large increases in capital to engender its growth may well prove to be a satisfactory investment. There is, to follow through on our example, nothing shabby about earning $82 million pre-tax on $400 million of net tangible assets. But that equation for the owner is vastly different from the See’s situation. It’s far better to have an ever-increasing stream of earnings with virtually no major capital requirements. Ask Microsoft or Google.

8. Buffett on sovereign wealth funds:

There’s been much talk recently of sovereign wealth funds and how they are buying large pieces of American businesses. This is our doing, not some nefarious plot by foreign governments. Our trade equation guarantees massive foreign investment in the U.S. When we force-feed $2 billion daily to the rest of the world, they must invest in something here. Why should we complain when they choose stocks over bonds?

9. Buffett is bullish on America:

At Berkshire, we will attempt to further increase our stream of direct and indirect foreign earnings. Even if we are successful, however, our assets and earnings will always be concentrated in the U.S. Despite our country’s many imperfections and unrelenting problems of one sort or another, America’s rule of law, market-responsive economic system, and belief in meritocracy are almost certain to produce evergrowing prosperity for its citizens.

10. Quotes:

Wells Fargo CEO John Stumpf on the Banking Industry- “It is interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine.”

Mitt Romney asked his wife, Ann, "When we were young, did you ever in your wildest dreams think I might be president?" To which she replied, "Honey, you weren't in my wildest dreams."

Former Senator Alan Simpson: "Those who travel the high road in Washington need to fear heavy traffic."

Barry's Imaginary Fed Statement

Opening statement of the FOMC Chair, Senate Testimony
February 27, 2008:

Senators, we find ourselves in a very challenging situation.

Following the dot com implosion, my predecessor at the Fed slashed rates to a generational low of 1%; the FOMC then kept rates at 1% for over a year.

While that re-inflated the economy, it also set off a shock wave of inflation unseen since the 1970s. Houses doubled in price, Oil is up 5 fold, food stuffs have tripled, and the dollar has collapsed. Gold is at multi-decade highs.

As always happens, these price increases in hard assets attracted speculators, and that made the situation -- especially in housing -- much more complex. Even worse, the housing speculation contributed to a debacle, while these other assets are actually accelerating in price.

Further, as was the political fashion, deregulation and a lack of interest in the oversight role of the banking system allowed an unprecedented expansion of credit, including to the least credit worthy consumers. Additionally, derivative selling -- at is heart, an unregulated form of insurance -- expanded from a few billion dollars to $46 trillion dollars.

The credit crunch is unprecedented, far worse than the S&L collapse and Long Term Capital Management -- combined.

All of these factors have combined to create our present situation. Inflation remains very elevated and worse, quite sticky. Growth continues to slide towards zero -- and possibly beyond.

Like many others, our forecasts in these areas have been wrong. We expected the slowing economy to moderate inflation, and so far, that has not happened. Demand for commodities from China and India is keeping prices elevated. The weakening dollar -- now at levels last seen in the 1960s -- is forcing all dollar denominated commodities higher. I don't necessarily believe in "Peak Oil," but the fact that the Saudis are one of the world's biggest investors in alternative energy research might tell you something.

The last time a slowing economy failed to moderate prices was the 1970s. Even as the economy slid into recession, we had major spikes in the prices of energy, food, clothing.

What is particularly worrisome to me is that as we have slashed interest rates 225 basis points, consumer loans -- mortgages and revolving credit -- have actually moved higher.

Gentleman, this is a major problem. And our internal, non-public projections forecast it is only going to get worse for the next 4 quarters . . .

I think we can all agree that Barry imaginary central banker would make a horrible Fed Chairman, he's just too honest. I think even the worst central banker have been given basic training on words to avoid, among which "implosion" is probably up near the top next to "explosion", "meltdown"and "contagion." But, Barry makes his point: in public conversations the Fed Chairman must sugar-coat everything in order to maintain confidence in the US financial system.

That being said I think that increasing concern over the Fed's "independence" is warranted. There is no reason for the largest economy in the world to fear the lower part of the business cycle. Most sane economists agree that recessions are a healthy and necessary part of longer term economic growth. When faced with a recession, the policy of devaluing the currency and fueling inflation is not a sound long-term strategy for the United States. Bernanke is risking a repeat of the 1970's stagflation nightmare. From everything we've learned, inflation is a pernicious, resilient foe. It seeps in and is tough to fight back. Let us hope that Bernanke doesn't forget about inflation this year. But, in the meantime lets buy all the non-dollar denominated real assets we can get our hands on -- asian currencies, agricultural commodities, base metals and emerging market materials stocks.