This Blog is Moving

As a part of our website redesign we have incorporated our "Random Walk to Wealth" blog into our new website. You will notice some minor changes - the name of the blog will be Alfred Capital Insights, we are using WordPress rather than Blogger - but the content will be the same.

Later this week I will be shifting this blog's feed to point to our new blog: www.alfredcapitalmanagement.com/blog. If you have any questions about the changes please feel free to contact us directly via our website.

Busy Data Week: Case Shiller, GDP, Fed, Employment

Today is the middle of a busy week of economic data.

1. Home Prices: The Case Shiller home price data released on Monday confirmed what many of us have predicted, mainly that the housing market is not showing any signs of stabilization. In fact, the recent trends show an accelerating decline. In the Fed statement released today Bernanke and Co. described the situation as a "deepening housing contraction," hardly comforting words coming from our central bankers. Here in San Diego, home prices are off 24% since their peak:

When you look at the month over month, year to date and year over year numbers you can also tease out some interesting trends. First of all, Charlotte -- the only city posting a year over year in price increases -- is starting to see declines. Second, tract homes in the desert have a hard time holding their value. Just look at Las Vegas and Phoenix over the last 2 months, both are down nearly 10%. Finally, the cities that ran up the most during the upturn are the ones getting hit the hardest now during the downturn. All in all, no surprises here, and certainly no signs of a stabilization:

2. Then we had a dismal consumer confidence report that shows that consumers seem to be well aware of the fragile state of the economy.

I don't put too much weight on the consumer confidence data, but it does give me pause that the people who make up 70% of US GDP and 18% of Global GDP are uncomfortable with their current economic situation.

3. This morning we got the Q1 advance GDP numbers which showed that the economy is still scraping along, helped by stronger than expected inventory numbers and continued growth in net exports. Residential investment still represents an enormous drag (on the order of 1%) on GDP growth and business fixed investment dipped negative for the first time in over a year:


4. Just a few moments ago the Fed decided to lower the Fed Funds Rate and the Discount rate by 25 bps, to 2% and 2.25% respectively. The Fed has moved dramatically this year to address concerns about economic growth. You can see the path of the Fed Funds and Discount Rate in the chart below:


The good news is that the Fed did signal that they have a more balanced approach to its targets of economic growth and price stability going forward. I think it is unlikely that the Fed will aggressively lower rates from where they stand which should put pressure on commodity prices to fall and may further strengthen the nice bottom the dollar is forming.

5. Finally the end of the week is "Labor Market Friday" in which we will get our first glimpse of how weak the employment situation really is. The consensus among economists is for a tick up in the unemployment rate to 5.2% and for the NFP numbers to be negative on the order of 50 or 100 thousand.

Grantham, Recession, Case Shiller, Oh My

1. If you follow the markets and consider yourself a long-term investor, you must read Jeremy Grantham's quarterly newsletters. The most recent one was just posted today, so head on over to www.gmo.com and read it in its entirety. He has some interesting thoughts on the Fed, the Presidential Cycle and Bubbles. He included these great graph de-trended graphs of the S&P 500. Be careful with these graphs though, don't show them to a bull for there is a high likelihood that he/she will laugh in your face and call Grantham a "perma-bear":

2. Is a recession by any other name still a recession?


3. The next round of Case Shiller numbers are due out next week. If February's median price numbers (-5.7% for San Diego single family homes) are any indication, the February Case Shiller numbers aren't going to be pretty. Here are the Case Shiller numbers through January:


The size-adjusted Case Shiller indices reveal a potentially more interesting trend. In San Diego, it is the low end of the market that is bearing the brunt of this real estate bear market. Low Tier homes are off 28% since peak, while high tier homes are only down 14%.


Have a great weekend!

Key Technicals

Thanks to a strong earnings report from Google and some good news out of Citigroup the market rallied today in spite of crude oil rising above $117 for the first time ever. In fact the market broke through some key technical indicators that we have been tracking in the short term:

The Dow closed the day at 12,849.36, well above the 12,750 resistance line we have been watching:

The Nasdaq finished the day at 2,402.97, within 10 points of some minor resistance:



The S&P finished the day at 1,390.33, within 5 points of its resistance:

How the market performs early next week will be very important for the psychology of the market. In fact it is important enough that I am actually writing about this, which should say something because I usually avoid talking about technical analysis on my blog as a matter of principal.

Hat Tip: Bespoke

Is Inflation Here to Stay?

Sometimes pictures are better than words:


Hat Tip: WSJ

How to make $3 billion in a Single Year

So you want to make a couple billion dollars in a single year. It turns out it actually isn't that difficult. You just need to follow this 9 step process:

1. Be Valedictorian of NYU's undergraduate business school (Enrollment: 600 students per class)
2. Be a Baker Scholar (top 5%) at Harvard Business School (Enrollment: 450 students per class)
   
3. Move to Wall Street and become a Managing Director in M&A at a bulge bracket firm (okay, okay it was Bear Stearns but I don't think anyone is reviewing Paulson's resume)
   
4. Get bored and leave to start your own merger arbitrage hedge fund. (note: I don't know if Paulson was actually bored or not, maybe he was just greedy)
   
5. Build it quietly for a couple of years. (by quietly I mean be enormously successful yet under the radar ie. non-rock star status)
   
6. Sniff out the housing decline before anyone else on Wall Street and bet the firm that mortgage backed securities will take a beating.
7. Have your credit opportunities fund finish 2007 up 303%.
   
8. Hire Alan Greenspan as your exclusive (ie. no other hedge funds) advisor.
9. Get ready to be the first person to ever write a billion dollar check to the federal government (I'd love to check out his tax bill).
   

All of these steps are much easier of course if your name is John Paulson. Indeed, it is estimated that Paulson made somewhere north of $3 billion in 2007. This is a guy who started the year with about $7 billion of AUM and finished it with $21 billion. As of April he now sits at nearly $30 billion and runs the 7th largest hedge fund in the world, just behind Jim Simons' Renaissance Technologies.

Click here to read a 2003 interview in which Paulson describes his firm, his investment philosophy and his vision for growth. Nowhere does he mention making $3 billion in a single year, but I can't fault him for that. Here's the background on Paulson's incredible year courtesy of Trader Daily:

City: New York
Firm: Paulson & Co.
Age: 52
Estimated Income: $3 billion+

It’s hard to believe that a sitting Treasury Secretary could come to be known as “the other Paulson” in Wall Street circles, but that’s just how large a shadow John Paulson casts these days, with all due respect to the former CEO of Goldman Sachs. In the wake of Paulson’s pulverizing subprime mortgage-backeds short — which, at this point, is thought to have forced God Himself to sell off liquid assets — Paulson suddenly finds himself elevated to a place that transcends a mere cabinet post.

A Queens native, NYU valedictorian, Harvard MBA and former Bear Stearns investment banker who launched his merger-arbitrage hedge fund in 1994 with a few million dollars, Paulson toiled mostly under the radar for many years. We caught wind of him last year as he secured a spot on the Trader Monthly 100 with an estimated 2006 income of $100–$150 million — or, compared to his 2007 haul, cab fare.

Should he ever expect to rid himself of all that dough, Paulson will require several lifetimes. Indeed, the stash he raked in last year will surely be talked about for generations. Betting that the shakiest section of the mortgage market would buckle and then disintegrate, Paulson set out midway through 2006 to take advantage of his hypothesis, setting up limited partnerships on- and offshore, garnering highnet- worth investors, scouring available MBS information, crunching the numbers and ultimately pouncing, shorting the riskiest CDO tranches and wallpapering his offices with credit default swaps. One of Paulson’s funds, Credit Opportunities II, started the year with $130 million and finished it with $3.2 billion.

As the chief steward of credit strategies, Paulson’s partner in subprime shorting, Paolo Pellegrini, was in line to get a significant taste of the history-making score. Early reports indicated that Paulson, whose firm’s assets are now in the neighborhood of $29 billion, profited between $3 billion and $4 billion in 2007. A spokesman for Paulson refused to confirm the figure for us. Paulson himself similarly declined to comment. We’ve since heard that his total take-home was closer to $3 billion, though the smoke is, of course, still clearing. The result, regardless, is still a payday that eclipses anything we’ve ever come across.

A Per Capita Recession? Japan Growing Faster than the US?

An interesting take on economic growth:

Merrill Lynch North American Chief Economist David Rosenberg points out a simple but overlooked fact about economic growth: The US population is expanding 1.0 - 1.5% per year. Any GDP growth of less than that means that on a per capita basis, we are contracting.

Hence, the per capita Recession already began in Q4 2007, when GDP was 0.6%:

"We are amazed that everyone quibbles about whether real GDP growth will be fractionally positive or negative this quarter. The population is growing in a 1.0-1.5% band annually, so anything less than that on real GDP means that real per capita income is contracting.

That is the way any country’s standard-of-living is determined. And as we saw in the final 4Q revision, real GDP growth may have stayed at +0.6% at an annual rate, but the domestic segments of the economy – strip out foreign trade – actually declined at a 0.4% annual rate. This is roughly the same modestly negative trend in what is referred to as gross domestic purchases that occurred in the first quarter of recession back in 1Q2001 and 3Q1990."

Rosenberg says this means the domestic economy is already in recession.

An interesting comparison to Japan:

A few weeks ago, the Economist noted a similar phenomena about measuring growth globally: Using a per capita measure reveals the changes in a nation's standard of living. If economic growth is slower than population growth, then the living standards in that country are decreasing.

Using a per capita measure works to the benefit of low population growth nations, while using a gross number looks better for faster growing nations:

"Which economy has enjoyed the best economic performance over the past five years: America's or Japan's? Most people will pick America. The popular perception is that America's vibrant economy was sprinting ahead (albeit fuelled by credit and housing bubbles that have now painfully burst), whereas Japan crawled along at a snail's pace. And it is true that America's average annual real GDP growth of 2.9% was much faster than Japan's 2.1%. However, the single best gauge of economic performance is not growth in GDP, but GDP per person, which is a rough guide to average living standards. It tells a completely different story.

GDP growth figures flatter America's relative performance, because its population is rising much faster, by 1% a year, thanks to immigration and a higher birth rate. In contrast, the number of Japanese citizens has been shrinking since 2005. Once you take account of this, Japan's GDP per head increased at an annual rate of 2.1% in the five years to 2007, slightly faster than America's 1.9% and much better than Germany's 1.4%. In other words, contrary to the popular pessimism about Japan's economy, it has actually enjoyed the biggest gain in average income among the big three rich economies. Among all the G7 economies it ranks second only to Britain (see left-hand chart).

Rising PE Ratios in Declining Markets

The Price to Earnings (PE) ratio of the S&P 500 can rise for two reasons:

1. Price increases outweigh earnings increases.
2. Declines in earnings outweigh price declines.

I leave you to figure out which one of these two reasons is causing the PE Ratio of the S&P 500 to rise above 20 this week:


Hat Tip: Bespoke