The REAL Global Threat No One Seems to Be Talking About

November 16th, 2011

The WSJ ran a great editorial called
“The Phony Success of China’s Stimulus”

To summarize:
• China’s stimulus plan has been quite dangerous
• Instead of Western style stimulus where you increase transfer payments, China forced its banks to extend more credit
• The credit boom was supposed to last 6 months but now continues on – potentially fueling inflation and a dangerous asset bubble
• The amount of credit as a proportion of the economy is huge. Imagine $6 trillion in new credit to the US economy – that’s the relative size of China’s stimulus – 40% of GDP!
• The “punch” of the stimulus is rapidly diminishing, with increases in lending is having a lower and lower effect on GDP

Expect many loans to go bad and Chinese bank disclosure is poor, so this may be already well underway. 

If the US got into such trouble by “fine tuning” the mortgage market to facilitate home ownership (via Freddie and Fannie and sub-prime loans) what happens when China mis-allocates a huge swath of its entire economy in the name of  a social agenda?

Click for the link below for the full WSJ editorial (log-in requried)

http://online.wsj.com/article/SB10001424052970204644504576650983229842402.html?mod=WSJ_topics_obama

Roller Coaster Rally!

August 9th, 2011

We again want to keep our clients and friends up to date during these periods of uncertainty.

There was extreme volatility again today, but stocks ended up sharply higher. The Dow touched a low of 10,600 but closed up 460 points to 11,240 an intra-day swing of 640 points.

The S&P 500 followed a similar path. At one point it was down 17 points but closed up a whopping 53 points to close at 1173 – an increase of 4.73% which erased a good chunk of yesterday’s wipe out.

Financials rocketed higher leading the rally.
Gold was up again, but down sharply from its intra-day high.

Did we learn anything new today? Have we really learned anything new in the last week? Not really. Today we learned the Fed is going to keep rates low for a long time, but in this release they actually quantified “an extended period of time” which they identified as 2013. The Fed can always pull this back if the economy does better than expected. There were no new “gimmicks” announced like a QE3. I think stocks sold off after they realized there was to be no additional ‘monetary sugar highs’ but then stabilized and moved much higher.

I’ve said for some time now that trying to micro manage every turn of the cycle lends itself to policy errors and unintended consequences. So perhaps letting the economy stand on its own and not reacting to every single data point will promote genuine recovery.

Interest rates fell sharply again today. The 10 year treasury now yields only 2.50%. This is amazing as a few months ago almost EVERYONE (except us) argued for much higher interest rates. We’ve had a deflationary bias in our equity and bond portfolios for some time now. Many high quality dividend paying stocks now have dividend yields nicely higher than treasuries, which is usually a good time to buy them.

So once again we see a market trading on high emotion and really very little new fundamental data – which is an environment an opportunistic investor with any reasonable horizon should try to exploit.

I can be reached with questions at 570 825 2600
Gerry Mihalick, CFA

 

Important Disclosure: Berkshire equity portfolios and Berkshire employee accounts have long positions in the stocks and sectors mentioned in this post. 

The views expressed in this commentary reflect those of Berkshire Asset Management, LLC (Berkshire) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Berkshire disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. The information contained herein has been prepared from sources believed to be reliable, but is not guaranteed by Berkshire as to its accuracy or completeness.

References to particular securities are intended only to explain the rationale for the portfolio manager’s action with respect to such securities. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities.

An Important Note About Recent Market Volatility

August 8th, 2011

We are writing to you to update you on recent market volatility. We are keenly aware how unsettling it can be witnessing losses, even if they are temporary. As professional investors, we have a ring side seat to what’s happening in the market. In no way are we trying to call an absolute bottom, but to try to lend the proper perspective and let you know we understand what you are going through. We’re investors in the same strategy you are. We sympathize.

What happened?
On Friday a major rating agency, Standard and Poors, downgraded the LONG TERM creditworthiness of the United States to AA+ from AAA. This has sent tremors throughout many world stock markets. HOWEVER it is important to keep in mind a few very important points:

1. The actual downgrade by S&P really took no one by surprise.
2. The report revealed absolutely no new insights into the fiscal condition of the United States.
3. Importantly the technical downgrade does not “trigger” any financial event. There is not going to be forced selling of US treasuries because they are “not AAA anymore”, banks are not going to have to raise more capital, or the Chinese are not going to be forced to sell as a result of the downgrade.
4. S&P is the same company who rated exotic securities based on sub-prime mortgages AAA. Our personal opinion is that S&P is trying to build image of a “tough cop on the beat.” After the reputational hit they took in 2008, they are not immune to biases in their opinion to serve a particular business aim.
5. The White House correctly challenged S&P’s math and found a $2 TRILLION dollar mistake.
6. Many have called this a “Sputnik-type” moment, or a clarion call to our country to taking the real steps to recovery. Perhaps now our country will be willing to take meaningful long term steps.
7. While stocks have gotten slammed today, investors have POURED MONEY INTO TREASURIES. The market categorically rejects S&P’s assessment. Interest rates went sharply LOWER today which in many ways does the Fed’s job for it.
8. What is real is that it spreads and amplifies the gloom that is surrounding our economy. Today’s market action is more emotional than technical. The negative emotion driving down stock prices today IS REAL, but it can be exploited.
9. Unlike parts of Europe, the US has PLENTY of financial ability to “fix this”. Rates are low, and is plenty of “low hanging fruit” expense wise be made without affecting the very attractive long term growth profile of this country.

What is The Appropriate Response?
Stocks were not expensive a month ago and are still attractive even as some of the indicators have turned weaker. Could the economy slip back into a period where GDP growth turns negative again? Of course but does not need to be a catastrophe. Capital ratios at banks are much higher and unlike 2008, everyone is on high alert.

Bonds are substantially less attractive today and offer little in the way of current return, standard of living increases or inflation fighting protection. Can we call a bottom? Of course not. But today sure feels like a selling climax where many investors have totally thrown in the towel after a couple of brutal weeks.

Selling into the panic rarely is an effective strategy and isn’t likely to be a good choice today. Whether its lack of nerve or lack of funds, there are many who HAVE to sell today. So where risk tolerance and financial circumstances allow, we believe that investors should be adding to stocks at these levels.

Call us with questions

Thoughts On Bank Stocks – July

July 15th, 2011

Quick thoughts on Citi, JP Morgan….

Clearly banks are the most hated sector right now but perhaps good operating results and some progress on the debt ceiling helps will help this sector catch a bid.

Consider: JPM cranked out a 17% return on tangible equity, and showed decent top line growth. Book value is just north of $32 so it trades at only 1.2 times tangible book – and unlike 2008, book value is now growing at a healthy clip. Historical regressions show that banks with ROE’s in the high teens should trade closer to 2.3 times book. With all the new capital requirements and restrictions ROE’s could fall to the lower teens, but even in that scenario multiples should be 1.5 to 1.8 times book value, which would still drive much higher valuations for most bank stocks including JPM and CITI

Citi, has more problems but the direction is the same and shares are MUCH cheaper. Tangible book value is around $49 dollars, so now it trades at about 80% of tangible book value. That literally means you could buy the stock at $39, liquidate all the assets pay off the liabilities and still put $10 dollars in your pocket. Citi’s Tier 1 capital ratios already exceed the proposed Basel 3 standards as does JPM.

In both cases the operating metrics, particularly loan losses are on the upswing.

Bonus: Cramer did a 10 minute rant on last night’s show on how much he hates the banks.

Important Disclosure: Berkshire equity portfolios and Berkshire employee accounts have long positions in the stocks and sectors mentioned in this post. 

The views expressed in this commentary reflect those of Berkshire Asset Management, LLC (Berkshire) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Berkshire disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. The information contained herein has been prepared from sources believed to be reliable, but is not guaranteed by Berkshire as to its accuracy or completeness.

References to particular securities are intended only to explain the rationale for the portfolio manager’s action with respect to such securities. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities.

Possible Impact of Greek Default

June 17th, 2011

Greece: Total outstanding debt is about $400 billion and its now trading at 40-60 cents on the dollar. That’s a very manageable number relative to the world’s total debt outstanding. German banks are the largest holders of this debt with about $26 billion in exposure. To put that in context, Deutche Banks balance sheet alone is over $2.5 trillion.

Is this, as many say “ A Lehman Style Moment?”. Probably not. First, Lehman’s balance sheet dwarfed the size of Greece’s. But what did in the system with Lehman’s default was not so much the debt default (although painful), but how the default triggered the credit default swap payments/collateral postings from the counter parties.

And in the subprime mess, the amount of outstanding swaps throughout the system was much greater than the value of the outstanding bonds. So there was rampant, “naked” swap trading by entities that had no insurable interest or legitimate hedges in the underlying debt. That’s part of the reason why it was so hard to predict ‘who would fall next.’ According to a Citigroup analyst, there is only $10 billion in outstanding CDS on Greek debt so that part of the contagion many fear would also have limited impact.

Where the system would run into problems is if a Greek default triggers sky rocketing interest costs to other larger sovereign countries like Portugal, Spain and Ireland. Spain and Ireland at least have been more successful in recent bond auctions and have economies that are much more vibrant, and better political systems. Another risk is if the entire European Union falls apart and the uncertainty that would bring.

Low Interest Rates Mask Real US Debt Burden

December 22nd, 2010

Below is a chart on the interest burden on US Government debt (courtesy of the Hussman Funds)

The blue line represents the debt burden at an average of 10 and 3 month rates.

The red line is what the interest burden for the United states would be if interest rates were at their long term average of 5.2%.

 

Implication?

While the budget deficit and interest burden looks terrible now, it will look even worse if rates rise back to historical norms. As we have seen in recent weeks, near zero interest rates can’t last forever. The rise can be swift and sharp. One could argue rising rates would likely be accompanied by  growth and rising tax revenues. The unthinkable of course is that if the rate rise was from credit spreads on US debt blowing out (a la Euro zone). I still think this is a wild card as Japan, with 200% debt to GDP still has access to debt markets at reasonable rates. (That can’t last forever either and they are even more susceptible to rising rates)

It is also important to keep in mind that the average maturity on US debt is among the lowest in the developed world – around 60 months. With rates this low, one would think that the government would lengthening its debt duration. As we saw with the likes of Lehman brothers and Bear Stearns, reliance on short term financing against long term obligations is a toxic combination.

Value Trumps Fundamentals

December 3rd, 2010

The market so far today is shrugging off a jobs number that missed expectations by a mile.  You can rationalize a poor jobs number if average hourly earnings hours worked is increasing, but this is not the case with today’s report. It is weak.

 Banks, homebuilders, and industrials have lead to a strong advance in US stocks of late.  The S&P 500 is now approaching double digit percentage gains for the year.

 The appreciation potential of banks remains strong, as most investors are still highly skeptical given all the headline risk. The “once burned twice shy” attitude presents opportunity for this sector in my opinion. It’s rare you get to buy high quality banking franchises at or below tangible book value.

A broader view of recent economic data is more encouraging:

  • Initial jobless claims receding
  • Retail sales rising sharply
  • US productivity improving
  • Private sector hiring (ADP report) encouraging
  • Auto sales brisk
  • Corporate profits increasing
  • Export economies like Germany and China are performing nicely
  • Spreads on PIIG debt coming in (although the European issue remains a wild card)
  • ISM Manufacturing reading of 56+ is consistent with US GDP growth around 3.5%

 3.5% GDP growth  is still below average growth compared with other early stage recoveries. It is tough for a world economy to grow briskly as the world deleverages and takes credit out of the system at rapid rates. That’s just a fact.

 However, the fundamental scenario need not be perfect with prices at these very reasonable levels. Even muted, plodding growth  can still provide attractive equity market returns when P/E’s  are as low as they are and dividend yields are at near or above than 10 year bond rates.

Important Disclosure: Berkshire equity portfolios and Berkshire employee accounts have long positions in the stocks and sectors mentioned in this post. 

The views expressed in this commentary reflect those of Berkshire Asset Management, LLC (Berkshire) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Berkshire disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. The information contained herein has been prepared from sources believed to be reliable, but is not guaranteed by Berkshire as to its accuracy or completeness.

References to particular securities are intended only to explain the rationale for the portfolio manager’s action with respect to such securities. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities.

Views To Open November

November 2nd, 2010

Friday’s GDP Report:

GDP took center stage last week, and generally the report  met expectations.

Remember this was only an advance number and the trend has been for some pretty noteworthy downward revisions down the road. 

Emerging Markets Euphoria?

This is the chart of the week for sure. The chart is pretty self explanatory – there is a lot of enthusiasm for this asset class as investors pour money into this asset class. 

In some ways, it is perfectly understandable. The ultra loose monetary ZIRP (“ZERO INTEREST RATE POLICY”) and fiscal largesse at large developed sovereigns has investors seeking stronger currencies and better sovereign balance sheets. Most of the emerging markets balance sheets are in much better shape. Some weeks ago, I put forth comparative debt to GDP levels which demonstrated this.

What no one seems to be asking how these balance sheets in the emerging world got so good. In much of South East Asia you could make the case that the successful austerity measures following the Asian Debt Crisis are behind the improvement. But it is also quite possible the improved fortunes are a direct result of the US credit boom.  Loose policies in the United States helped fuel a global boom and high commodity prices creating a very large wind fall for many emerging markets tied to the commodity cycle. And yes, that includes China (and countries whose economies depend on it) where the major commodity is labor.

 The problem of course is that investors are potentially yield chasing as spreads compress. Historically, this is a toxic combination. Balance sheets are much better, but spreads have gotten much, coming in from nearly 1100 over Treasuries during the credit crisis to inside 300 basis points. They are not back to their bubble lows of 2007 however.   

Recommended Commentary:

Here is a Halloween Special compliments of Jeremy Grantham: “Night of the Living Fed” it is available at the following link. As usual, Mr. Grantham is highly insightful. Registration required. www.gmo.com

 The Effects of Extreme Monetary Policy:

Here are some thoughts about the ultra low rate policy we are pursuing.  As the financial system was melting down, aggressive action was required. But now the system is indeed much more stable. Credit markets are obviously functioning again – maybe too well – There is more than adequate issuance of emerging market debt, performance of high yield bonds etc, even some LBO’s are coming to market.

Sure US GDP growth is not where most would like it and unemployment is stubbornly high. But how much more accommodating do we need to be? We’ve gone beyond “ZIRP” and into “QE 2” and the dollar has gotten crushed. So what this is now amounting to is a big tax on savers.  The Fed of course is trying to help, but exactly who is this policy helping? The millions of Americans who live off the interest of their accumulated assets? The scores of pensions who are making assumptions based on 8% returns? Meanwhile the dollar is getting torched and all of the real stuff that these individuals need to live on (you know like gas, food, clothes) are skyrocketing because commodities are purchased in dollars. Below is a chart of the Jeffries CRB Index.

 

 

 

 

 

 

 

 

  Election Week:

I am frequently asked how I think the elections will affect the markets. By now it is generally expected the Republicans will win the House and the Democrats will retain the Senate. You can look at www.intrade.com to see the odds of each win. This site has been pretty uncanny at predicting outcomes of events like this. Bettors have surmised a 95% chance of a Republican victory for the House and a 55% chance that the Democrats retain control of the Senate. My take, I think the market would be surprised by a Republican Senate Victory (market probably rallies) or Democrats holding the House (market probably sells off). The outcome I can guarantee? Vitriol and rancor will stay abundant!

Important Disclosure: Berkshire equity portfolios and Berkshire employee accounts have long positions in the stocks and sectors mentioned in this post. 

The views expressed in this commentary reflect those of Berkshire Asset Management, LLC (Berkshire) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Berkshire disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. The information contained herein has been prepared from sources believed to be reliable, but is not guaranteed by Berkshire as to its accuracy or completeness.

References to particular securities are intended only to explain the rationale for the portfolio manager’s action with respect to such securities. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities.

Stocks Finish Strong September

October 1st, 2010

US equities posted strong results in September. Values are within a few percentage points of their April highs.

We are working on 3rd quarter commentary.

Meanwhile, here are a few charts we showed in a recent presentation.

Chart 1 The outperformance of bonds vs. stocks over the last ten years has been one of the most dramatic in history.

Chart 2:

What’s to make of the tension between developed world’s over levered balance sheets and the emerging markets under levered balance sheets? To what extent did the credit binge fuel emerging markets largely commodity based economies? As the developed world “delevers” or enacts “austerity measures” will the developed world become savers and the emerging world become consumers? What will these balance sheets look like in ten years?

Chart 3: Trends in Sovereign Debt

Canada has been a model of fiscal restraint of late

Chart 4:  Canadian equities are  trading at a multi year premium (on a price to sales basis) vs. the US

Chart 5:

Emerging Markets appear expensive on a price to book basis relative to Developed

Important Disclosure: Berkshire equity portfolios and Berkshire employee accounts have long positions in the stocks and sectors mentioned in this post. 

The views expressed in this commentary reflect those of Berkshire Asset Management, LLC (Berkshire) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Berkshire disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. The information contained herein has been prepared from sources believed to be reliable, but is not guaranteed by Berkshire as to its accuracy or completeness.

References to particular securities are intended only to explain the rationale for the portfolio manager’s action with respect to such securities. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities

September Strength Continues

September 9th, 2010

While pessimism was palpable in late August, stocks are now up six out of the last 7 days and have risen approximately 6%.  Better than expected economic reports, indicating  a (slightly) improving labor market and housing led the advance. 

European bond auctions, which were successful were also another important hurdle the market successfully cleared (at least for now).

After another 1% advance stocks have pulled back intraday (September 9) as a major German bank is announcing it MAY raise capital. Stocks tied to global risk and recovery  (aka the “risk trade”) sold off noticeably.  We are not of the opinion this decision has negative investment implications for other financial institutions.  The bank in question had rather thin capital ratios to begin with and has made numerous acquisitions. In contrast many US banks are already already sitting on high capital ratios relative to their foreign counterparts.

    Dow 10,427.95 +40.94 +0.39%
    Nasdaq 2,238.89 +10.02 +0.45%
    S&P 500 1,105.72 +6.85 +0.62%

Prices 9/9 at 3:00 pm est.

Important Disclosure: Berkshire equity portfolios and Berkshire employee accounts have long positions in the stocks and sectors mentioned in this post. 

The views expressed in this commentary reflect those of Berkshire Asset Management, LLC (Berkshire) as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Berkshire disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. The information contained herein has been prepared from sources believed to be reliable, but is not guaranteed by Berkshire as to its accuracy or completeness.

References to particular securities are intended only to explain the rationale for the portfolio manager’s action with respect to such securities. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities.