World Markets 101

The Stimulus Plan Will Not Work

It’s unfortunate, but the stimulus plan itself is not going to be enough to revive our broken economy this year.   While the price tag may be staggering, even jaw-dropping, the funds to consumers will merely fill holes and the funds to businesses will not create enough new jobs in the near term.  

 

$145 billion could be funneled back to employed consumers through several payroll cycles.  But as we saw with last year’s rebate checks, consumers did not spend the money as planned.  Consumers that were sent rebate checks merely used them to fill holes, and this was at a time when the economy was in much better shape.  In fact, the rebates that were sent out last year were only 12% effective.  An additional $191 billion will be used for unemployment benefits, earned income credit expansion, COBRA, AMT tax relief and feeding the hungry. 

 

$144 billion is to be spent on infrastructure in areas such as transportation, roads, healthcare and education.  Infrastructure and healthcare companies, such as Caterpillar (CAT), Eagle Materials (EXP), Fluor (FLR), URS Corp. (URS), Stantec (STN), Jacobs Engineering (JEC), Cerner (CERN), McKesson (MCK), Eclipsys (ECLP) will benefit from this part of the bill.   However, the problem with using infrastructure to stimulate a quickly deteriorating economy is that there is a significant lag time between the announced spending and the job creation due to the amount of planning that is required for such large projects.  In the meantime, our economy is suffering from a massive feedback loop, which is causing deflation throughout all sectors. 

 

$91 billion will be used as a “slush fund” to bail out states, which have mismanaged their budgets.  The majority of that $91 billion will be used to help states pay for Medicaid and unemployment benefits. 

 

The stimulus bill does have plenty of spending which will not stimulate the economy.  Here are a few parts of the bill that were singled out by Senator Tom Coburn and former Maryland Governor Bob Ehrlich:

 

·         $2 billion to build a coal plant that produces zero emissions (note: the technology for this project does not currently exist)

·         $88 million to study whether or not the Coast Guard needs another icebreaker

·         $600 million for hybrid vehicles for federal employees

·         $400 million to prevent STD’s

·         $1 billion for the 2010 census (twice the amount the same study cost 10 years ago)

·         $200 million for community college computers (normally state funded)

·         $448 million for a new homeland security building (note: the government already has $1.3 trillion worth of empty buildings)

·         $248 million for the new furniture that is to go in the homeland security building

·         $75 million for smoking cessation

·         $6 billion to turn government buildings into green buildings

·         $88 million to renovate the public health building

·         $200 million to lease alternative energy vehicles to the military

·         $75 million for a security facility (note: four in use already, another is not necessary)

·         $25 million ATV recreation trails

·         $650 million digital TV transition coupons

·         $400 global warming research

·         $150 for the Smithsonian

 

Just a reminder, this bill is supposed to stimulate the economy and create new jobs, not waste money, fill holes, or cover costs that are the state’s responsibilities.  The Wall Street Journal recently conducted an analysis which estimated that approximately 12 cents of every dollar in the stimulus bill is for something that can plausibly be considered a growth stimulus.  According to senator Tom Coburn only two stimulus plans passed by congress have ever worked and unfortunately I do not think this plan will make it as number three.

 

Personally, I think a large portion of the stimulus should be spent on venture capital, funding start-ups and companies that are looking to expand operations.  Companies that would benefit from the plan would most likely spend the capital injections on new assets and additional staff.  While the U.S. would hold an equity stake in each of the companies as well as reap the tax benefits from the growth.  Logistically it may be difficult, but it is a more constructive idea with potentially higher returns than sending a bunch of checks to nearly broke consumers and funding earmarks along with other random projects, many of which are unnecessary. 

 

Satyam Computer Services: India’s Enron?

On January 7^th, Ramalingam Raju, the chairman of Satyam Computer Services, sent a letter to his board and the SEC of India stating that he had been guilty of inflating Satyam’s cash balance by $1 billion, not reporting an additional $253 million in liabilities, and inflating the company’s most recent quarterly sales by 76% and profits by 97%.  In the letter he states “I am now prepared to subject myself to the laws of the land and face the consequences thereof.” Shares dropped 78% on the news adding to recent declines that had been caused by a shady acquisition plan and a scandal at the World Bank.  

In mid-December, the company’s shares fell 55% after an announcement that the company would purchase assets from the chairman’s family for $1.6 billion.  Following an investor protest those plans were scrapped.  In September, the World Bank imposed an eight year ban on the company after it found that Satyam’s employees had hacked into their systems and gained access to sensitive information.  Three directors resigned in late December as a result of the company’s scandals.

PricewaterhouseCoopers was listed as the company’s auditor and had endorsed Satyam’s accounts.  Apparently they didn’t audit the firm and just took the payment.  As an accountant you are taught to balance everything to the penny; these guys fell short by $1 billion, maybe it was rounding?  PwC has said that it is now performing an investigation into what went wrong.  Ironically, the company had recently been awarded the Golden Peacock Global Award for Excellence in Corporate Governance. 

Aberdeen Asset Management manages $45 billion in Singapore and owns a 6.6% stake in Satyam.  In late December, Adrain Lin of Aberdeen Assets Management stated to Bloomberg “quite a few things have made the investment community very skeptical about the intentions of the senior management.”  Gee, ya think?  If you find one roach most likely there are many more that you don’t know about.

 

The World’s 94th Richest Man Adolf Merkle Commits Suicide

Adolf Merkle, who was recently named by Forbes as the 94^th richest man in the world, committed suicide Monday by throwing himself in front of a train.  Merkle owned HeidelbergCement, the fourth largest cement company in the world as well as generic drug maker Ratiopharm. 

HeidelbergCement had been drowning in debt after its purchase of Hanson Plc for $16 billion at the top of the market in May of 2007.  In addition, he shorted Volkswagen shares with company capital in a mistake that helped create the largest short squeeze in history.  You may recall that for one day in late October the market capitalization of Volkswagen actually surpassed that of ExxonMobil, which by market cap is the largest company in the world.  That mistake cost Merkle hundreds of millions of dollars. 

Merkle had petitioned the government for a bailout, but his petition was denied.  He was in the process of negotiating a multi-billion dollar loan deal with several different banks at the time of his death.  According to CNN, his family said that the financial crisis had “broken” Merkle. 

Market Strategists are Talking, but Should You be Listening?

It’s that time of year again, the time when market strategists emerge from the beleaguered investment banks to give you their best guesstimate on how high or how low the indexes will be by the end of the New Year, but should we be listening?  After all they are all too happy to talk to us about the future while sidestepping the results of their previous year end forecasts in the most recent Outlook 2009 article.  In an effort to justify the four foot stack of Barron’s on my living room floor I intend to review the previous years’ prognostications given by the typical group of esteemed market strategists in Barron’s magazine.

Only five of the market strategists that participated in Barron’s Outlook 2009 participated in the Barron’s Outlook 2007 and the Barron’s Outlook 2008 printed in the corresponding December issues.  The five strategists that have participated in each of the Outlooks from the past three years are from Deutsche Bank, Citigroup, JP Morgan, Goldman Sachs and Morgan Stanley.    We will review the calls of only these five strategists since they are the only strategists with a history to evaluate.  We will be looking at their S&P forecasts, sector picks and pans, 10 year treasury rate forecasts and fed fund target rate forecasts.  Let’s start off with their outlook for 2009:

	S&P	10 Yr Treasury	Fed Funds
Deutsche Bank	1025	2.75%	0.13%
Citigroup	1000	3%	0%
JP Morgan	1100	1.65%	0%
Goldman Sachs	1100	3.60%	0.13%
Morgan Stanley	975	3.25%	0.50%

 

	Favored Sectors
Deutsche Bank	Consumer Staples	Health Care	Technology
Citigroup	Semiconductors	Retailers	Diversified Financials	Health care equipment
JP Morgan	Financials	Consumer Discretionary	Health Care
Goldman Sachs	Consumer Staples	Health Care
Morgan Stanley	Health Care	Telecom	Consumer Discretionary	Financials

 

	Avoid
Deutsche Bank	Utilities	Consumer Discretionary
Citigroup	Energy	Utilities	REITS
JP Morgan	Materials	Industrials	Energy
Goldman Sachs	Industrials	Consumer Discretionary
Morgan Stanley	Energy	Materials	Technology	Industrials

 

On average, these five strategists see the S&P up by more than 19% by year end.  Each one is predicting no change in the fed funds rate with the exception of Morgan Stanley, which is targeting a .5% fed funds rate by year end, but there is some disagreement over where the 10 year will trade by year end.  Each one is recommending the health care sector and many are shunning industrials and energy.  Let’s take a look at how their forecasts have fared over the past two years.

	% Delta from S&P Forecast
	2007	2008
Deutsche Bank	4.7%	46.8%
Citigroup	2.1%	47.9%
JP Morgan	-1.9%	45.1%
Goldman Sachs	5.3%	47.9%
Morgan Stanley	3.7%	42.8%

 

	Sector Picks % Gain/Loss
	2007	2008
Deutsche Bank	43.3%	-4.2%
Citigroup	-4.6%	1.6%
JP Morgan	18.8%	-5.2%
Goldman Sachs	-7.6%	16.4%
Morgan Stanley	14.3%	16.4%

 

	10 Yr Treasury Forecast Delta		Fed Funds Forecast Delta
	2007	2008	2007	2008
Deutsche Bank	1.2%	2.6%	0.5%	2.9%
Citigroup	1.1%	2.3%	0.5%	3.4%
JP Morgan	1.2%	2.9%	1.3%	4.4%
Goldman Sachs	0.7%	1.9%	-0.5%	2.9%
Morgan Stanley	0.9%	2.4%	0.5%	3.6%

 

The forecasts that were the closest to hitting their marks by year end are shaded in grey.  There is not really a clear winner based on the strategists S&P forecasts over the past two years, but on average Morgan Stanley’s forecast comes closer than the others.  One thing that I noticed, which I thought was interesting, yet it was probably just a coincidence,  was that the strategist with the worst S&P forecast each year never returns, tough break.

Two judge the sector picks and pans I assumed that the strategist went long the favored sectors and short the panned sectors.  Deutsche Bank hit it out of the park in 2007, which allowed for a 20% average return over the past two years, but Morgan Stanley is the winner when the contest is based on consistent results.  When it comes to forecasting interest rates, Goldman Sachs takes the cake scoring in the top of each category over the past two years.

Judging by the results of the previous Barron’s Outlook articles I would have to side with the rate forecasts of Goldman, and the equity forecasts of Morgan Stanley.  Is two years worth of data enough to make a judgment call on? I’ll leave that part up to you, but one thing is clear; none of these five market strategists saw this financial crisis coming at the end of 2007.  The average S&P forecast of these five analysts was off by over 46%.  With results like that should we expect any one of these strategists to warn us of the danger that lies ahead? Probably not.  Here are some quotes that really drive home just how clueless many of the twelve strategists polled for Outlook 2008 really were:

“…investors are worried that the bull market might end in 2008.  But Wall Street’s top equity strategists are quick to dismiss such fears.”

“Recession likely will be avoided, due to the strength in exports and capital spending by corporations and government.” – Abby Joseph Cohen, Goldman Sachs

“Treasuries may hold less appeal next year, the street’s leading strategists say.”

“The strategists note, as well. That bull markets rarely end when the earnings yield on stocks-now around 6%-is higher than benchmark bond yields.”

“S&P 500 earnings are expected to climb 4%, to an average of $92…”

“While some fear this year’s peak profit margins will wane, Bear Stearns’ Jonathan Golub says margins will prove sticky at a high level after years of cost cutting.”

“Profits conceivably could fall as much as 45% if the U.S. slips into a recession.  But the stock market likely would fall no more than 10% to 15% from current levels even in this worst case scenario.” – Ian Scott, Lehman Brothers

“Stocks screamingly cheap relative to bonds” – Tobias Levkovich, Citigroup

“While the first half may look like death, second-half earnings will improve as the rate cuts take effect” – Thomas Lee, JP Morgan

“Lee expects the sector (financial) to lead markets higher in 2008…”

“…technology has no direct exposure to housing (buy suggestion).”

“Too much credence, Bianco says, has been given to the “domino theory,” under which a wobbly housing market supposedly knocks down the overspent U.S. consumer, who trips up the Asian export market, which triggers a commodity correction that thwarts infrastructure spending.” – David Bianco, UBS

“The consumer is not dead!” - Tobias Levkovich, Citigroup

Sources:

Kopin Tan, “Outlook 2009”, Barron’s, 22 December 2008

Kopin Tan, “Outlook 2008”, Barron’s, 17 December 2007

Michael Santoli, “Outlook 2007”, Barron’s 11 December 2006

Madoff Investor Commits Suicide after Losing $1.4 Billion

Thierry de la Villehuchet, founder of Access International, a hedge fund that raised funds in Europe to be managed by Madoff, was found dead in his New York City Apartment today.  It was reported that he cut his arms and wrists in an apparent suicide.  Access International had been funneling three-quarters of it’s assets into Madoff’s ponzi scheme.  According to the LA Tribune, an associate of Villehuchet had said that he "could not cope with the pressure following the outbreak of the scandal.”  Something tells me that this may not be last suicide that results from this tragedy. 

3x the Fun with New ETFs from Direxion

The markets have experienced record volatility in 2008, but if this roller coaster ride has left you feeling a little bored than maybe you need to get on board with the latest 3x ETFs from Direxion.  In case you were unaware, “ultra” ETFs have been soaring in popularity over the past several years.  An “ultra” fund allows an investor to achieve double the return of the underlying index and they have been very popular with short term traders, that is, until Direxion came along.

Just several months ago Direxion launched a group of ETFs that allow an investor to capture 3x the gain in the underlying index.  The competition between these two firms reminds of the scene from Something About Mary where the hiker discusses his competition for 6 Minute Abs with Ben Stiller.  His idea was to develop 5 Minute Abs and put 6 Minute Abs out of business, but it’s that simple.  In fact I’ll go out on a limb here and predict that in two years we get 4x ETFs, why not?  Unless small investors get burned on these products and start suing the firms for their losses I can’t see why it wouldn’t be a possibility. 

Below is a list of current and just released 3x funds from Direxion.  There is a long version and a short version of each 3x ETF.

On the long side*:

Symbol                             Name                            Index

BGU            Large Cap Bull 3x Shares        Russell 1000

TNA            Small Cap Bull 3x Shares        Russell 2000

ERX             Energy Bull 3x Shares              Russell 1000 Energy

FAS             Financial Bull 3x Shares          Russell 1000 Fin. Services

DZK             Developed Markets Bull 3x   MSCI EAFE Index

EDC             Emerging Markets Bull 3x      MSCI Emerging Markets

TYH             Technology Bull 3x                   Russell 1000 Technology

 

On the short side*:

Symbol                             Name                            Index

BGZ            Large Cap Bear 3x Shares        Russell 1000

TZA            Small Cap Bear 3x Shares        Russell 2000

ERY             Energy Bear 3x Shares             Russell 1000 Energy

FAZ            Financial Bear 3x Shares         Russell 1000 Fin. Services

DPK            Developed Markets Bear 3x MSCI EAFE Index

EDZ            Emerging Markets Bear 3x     MSCI Emerging Markets

TYP            Technology Bear 3x                  Russell 1000 Technology

 

*I do not recommend leveraged funds to clients.  Readers considering investing in any of the funds listed above should first speak with a financial advisor to determine suitability. 

Should Advisors Rebalance into Equities for the New Year?

Many passive money managers rebalance at least annually based on a schedule rather than an analysis of current conditions.  With equities being down so much and government bonds being up so much one would expect that those allocations will be adjusted at the beginning of the year, but Mohammed El-Erian is encouraging advisors to move up the capital structure, rather than reallocate to equities.

 

In a recent address to institutional investors on December 2nd, the PIMCO chief said that “There is no reset button” to cure the credit crisis.  “The dislocation is occurring at the heart of the financial system – not at the periphery – and it follows that the normal circuit breakers will not work.” John Paulson head of top performing hedge fund Paulson & Co. agrees that equities are not the place to be.  Paulson said on December 3rd that the process of de-leveraging is a little more than half complete, but that over the next two years, he sees the “best opportunities ever” in three distressed markets: mortgages, banking and finance, and high-yield debt.

Bernie Madoff on Regulation

This video shows Ponzi King Bernie Madoff discussing the SEC and market regulation with a group of people.  He even mentions the fact that his niece was recently engaged to an SEC regulator, hmm........

Will You Survive the Coming Dollar Flood?

Sometimes economics is simple: how do you stop deflation when you control the printing presses?  Print more money.  Of course the idea of printing money should be used only as a last resort given the inflationary implications down the road.  Today the fed announced it would cut short term rates to a range between 0% and .25% and that it may print money to buy longer term bonds, which would lower longer term rates.  The lowering of longer term rates has a larger impact on the economy than the lowering of short term rates.  They also announced that they may purchase additional mortgage securities to help put a floor under real estate prices.  The markets rallied on the news with most indexes closing above their 50 day moving averages while the dollar broke its short lived uptrend.

Taxpayer Money could be used to Bailout Private Equity

The “big three”, or more fitting the “little three”, are not created equal.  Chrysler is owned by the huge private equity firm Cerberus Capital chaired by former treasury secretary John Snow.  Cerberus has been reluctant to loan the money to Chrysler that would allow the company to “restructure” or even continue their cash burning operations.  However, the idea of taxpayers loaning money to Chrysler is something that would be ideal for Cerberus.  So let me get this straight, loaning money to Chrysler is too risky for Cerberus, but they would like us taxpayers to put up the cash and believe they have a viable plan to profitability?  The private equity firm has gone as far as stating that they would support a merger with GM where they would forego a profit.  GM and Ford have lost over 90% of their value from their highs, yet Cerberus is willing to take one for the team and break even, gee thanks guys!