What we need…

Below I will lay out what, in my opinion, would help our market and economy recover in a timely manner. Some of the parts are more critical than others.

We need…
1. The government to buy mortgages- The bill that failed in congress today actually had a decent plan for this. They were giving an unprecedented amount of money to the Secretary of the Treasury, Hank Paulson, with which he was to buy mortgages. The government would then be in a position renegotiate terms with the borrowers, keeping more people in their homes. By buying the mortgages, banks would be able to lend again because they’re already paid back for these loans that they thought were going to go bad, be it at some amount of cents on the dollar.

2. Congress to wake up! The size of this problem should have put politicing at the very, very, very back of anyone’s mind… but it didn’t. The bill, even though it was far from perfect, would have done a lot to help banks be able to lend again, housing prices to slow their fall, and our economy to begin a recovery. Think of anything you need a loan to buy: car, home, tuition, you name it. And do it again for businesses. Right now BANKS CANNOT LEND MONEY, they do not have it, they are just trying to stay afloat and meet their reserve requirements. How much is your house worth if you try to sell it and someone who wants to buy it cannot take out a loan? It’s worth whatever someone can pay in cash. No help will result in real estate values being cut in half, to start with. How many people are going to show up and offer a couple hundred grand in cash for your house? Welcome to a deflationary environment. Seriously, this is the environment we are in RIGHT NOW, and will continue to be in for 4-7 years without some help from the government. Not to mention, with out any help, many of our banks will go under in the next 6-12 months. I hate government intervention as much as anyone. The government being involved with Fannie and Freddie worked out great. But right now, they’re the only friendly balance sheet big enough to help.

3. People to listen to Paulson. Hank is the smartest financial mind in the federal government. He made himself hundreds of millions of dollars, a lot of it off the buildup of this problem. Now let’s let him help us fix it.

4. Minimize moral hazard. This is part of what congress has been complaining about, CEOs getting big severance packages. They think the whole bill was a bailout of financial firms that took on way too much risk. It is, but the people who took on the risk have already been punished, any net worth they accumulated through options is gone. The government can reposses executive shares as part of the deal, I don’t care how we do it, but making sure no current executives walk away with posh deals is important. However, this is not a reason to not pass the bill. The bill is not for the Wall St firms, it’s for every American who owns, or wants to own an asset of significant value. This is closer to an investment than a bailout, and the more our government is willing to invest, the quicker the housing market will turn around, the quicker the economy will turn around and the more money the government will make off their investment.

5. Europe to watch us. They’re next, about 12 months behind. A British lender and a Dutch bank both had to have government rescues over the weekend…

6. People with a backbone in regulatory positions. Fire Christopher Cox. “Naked shorting” is, and has always been illegal. To short you first have to borrow the stock you want to sell. In the past it’s been ok to sell short if you say you’re “in the process” of borrowing the shares. Check the filings, the vast majority of short positions, including ones that have been on for weeks, are still in the process of borrowing the shares. They’re naked shorting (shorting without borrowing the shares) because they know the SEC under Cox’s astute leadership won’t do jack! Pull Elliot Spitzer out of jail and make his sentence house arrest at the SEC for a few years, he’ll slap hundreds of millions of dollars of fines on firms playing games like the one above before they turn around. McCain says he’ll appoint Cuomo, current NY Attorney general, but why not go for the ultimate white collar crime fighter in Spitzer and save the penitentiary system a few bucks, just a thought.

7. People to forget it’s an election year. The most frustrating thing about the bill not passing is because a big reason it didn’t pass was politicing between congressmen. It’s an election year and these guys are going home soon to campaign. Sometimes it’s the role of an elected official to do what’s right even if their constituents don’t immediately agree. In an election year, politicians aren’t willing to do this because they want to be reelected.

What? We can be funny?

Scott Green is the man. Read this article from the DI. Now. That is of course, if you haven't already read it between sudokus while you weren't paying attention in class.

Afterward, check this out. The irony to Scott's story is how much money Nintendo's employees (not even including the Brothers) actually do make for their company. It's even more per capita than Goldman, apparently.

Where are we now?

So what's going on right now? Paulson will be doing his best to fight back the swarms of angry Congressmen, and broker deals with banks left and right... for the moment, the dust is starting to settle, and now we're seeing politicians squabble over power.

Maybe people have a right to be mad. Apparantly, these fallen titans doled out $39 billion in bonuses to their employees in 2007. Talk about a job well done!

If there is any type of article you should be reading, it is this one. Without a doubt, this entire problem occured because people didn't understand risk and statistics, and because of that:

"The banking system (betting AGAINST rare events) just lost > 1 Trillion dollars (so far) on a single error, more than was ever earned in the history of banking. Yet bankers kept their previous bonuses and it looks like citizens have to foot the bills."

You read that correctly. While banks certainly handled more than $1trillion over their collective history, the money they made by handling that money has just been eclipsed by the staggering loss they are now responsible for.

Or are they responsible for it? Could this have been the government's fault? This article insinuates that mark-to-market, or the act of valuing a difficult-to-value asset by matching it to the price it would fetch on the market. An accounting rule called FAS157 was responsible for implementing it, and beyond financial instruments, it is actually a very useful, fair value approach to accounting. I disagree largely with this arguement, because the implementation of FAS157 is a step forward to more accurate accounting.

Whether or not you think this was all the government's fault, it's clear that the government still has a golden opportunity to make a mess of things at this point. I agree with Mean Street, who thinks congress should back off and let Paulson do his thing. However, this is largely becuase I think a speedy solution at this point is more important than a more thought-out one. Waiting too long might do even worse damage around the world to an already broken system. This article does a good job at describing the motivations of the actors in this Greek tragedy. I think their arguement is persuasive as to why Hank needs as much bargaining power as he can get, and why the liberal solution to this problem is nonsensical.

But what can go wrong? Freakenomics, backed with a letter to congress from, literally, hundreds of prestigious economists has this to say: it looks really unfair, we have no idea how this bailout (the government buying up a staggering amount of toxic debt) will be structured (implying that it probably will be structured really poorly), and the effects of this bailout will be felt for ages, as the government's balance sheet tries to accomodate the incredible loss it will most likely incur.

So it is a race against time, and everyone knows it.

Will this solution probably be unfair? Yes. Are we basically forcing the innocent tax-payer to bail out these greedy bankers, who are largely responsible for this whole mess to begin with? Yes. But if we wait too long, then we may be dealing with far too many defaults for society, let alone the capital markets, to sustain.

Greed

We are in a very complex and dire situation. By we, I mean Americans, and I also mean just about ever other developed country. We are growing closer to having a truly global economy, which is great when everything is going well, but it also raises the pain level when we hit rough seas.

How did we get into this mess? That’s a long story. In two words: we’re greedy. I’m not trying to be condescending, I’m a greedy person too. And not everyone is greedy, there are a lot of people living in developed economies that don’t care about material possessions and money, but by and large, we’re greedy people.

Mortgages
In the late ‘80’s “genius” investment bankers started packaging mortgages and reselling them. These investments, called mortgage-backed securities, were fixed income investments very similar to bonds. They were very profitable for the investment banks, but their real benefit was enabling banks to make more loans. For example, after the bank lent someone a mortgage, they would give them the cash and keep a piece of paper that was a promise to pay. In the old days, the bank would have to wait for the mortgage to be paid back before making another loan. Now, as soon as the borrower walked out, the bank would call the investment bank sell them the mortgage for 90 some cents on the dollar. The bank got their money back right away so it could make another mortgage loan and repeat the whole process over again.

The process described above had several effects. It increased leverage (the level of debt) in our society, banks we’re able to lend more, increasing the level of debt in our economy. It also made lending mortgages much more profitable. The increased profitability of mortgage lending led to many more mortgage brokers popping up, and growing much larger. The mortgage brokers were not banks, who relied on customer relationships, they just lent the mortgage, sold it to the investment bank (who sold it to investors) and moved to the next person in line waiting for a mortgage. These brokers (Countrywide e.g.), in many cases, skirted the due diligence they should have done on the person asking the mortgage, such as asking if they had a job, how much money they make, do they have other homes, etc. This is what led to the boom in subprime mortgages, mortgages lent to people in a not-solid financial position.

Why didn’t these brokers care that much about a lenders’ financial position? Well this is in the 2004 - 2006 time frame when it seemed that real estate value went up every single year. Therefore, if someone did not pay, they could foreclose and resell the house for more than the value of the mortgage. In order to entice more people to take out a mortgage, they offered mortgages that started with a very low interest rate for the first 2-5 years, the interest rate would then reset much, much higher, but that was in small print, after all, it was a few years off. Now not only could someone that wasn’t fit to have a mortgage get one, they could afford a really nice house too!

Now, it is unfair to blame the whole mess on the brokers. Many banks did their fair share of this practice too. Overall, however, banks (especially smaller and local ones) did a much better job of sticking to lending standards than mortgage brokers did. All you have to do right now to get a good approximation of how well someone stuck to lending standards and making good loans is to look at a stock chart. Compare U.S. Bank (USB) to Thornburg Mortgage (TMA) since January 2007.

Who helped make sure the whole securitization process ran smoothly? Well that is the job of Fannie Mae and Freddie Mac. Fannie and Freddie were government-sponsored entities that were created to help more people be able to buy a home. Then even Fannie and Freddie got greedy and started keeping some of these mortgages on their balance sheet to boost returns. It’s funny how the ones that didn’t fly off the shelves turned out to be some of the worst loans.

As you can see, our housing market saw quite the bubble form over the prior few years. As more and more people could get loans, they could pay more for housing, making the value of real estate inflate. These increased real estate values were really driven almost entirely by leverage. Leverage was not only at work with people and their homes, it was also at work with corporations.

Investment Banks
In addition to starting the mortgage securitization process and seeing a boon in that business, investment banks were also seeing pressure on their main business model. Investment banks are strategic advisors to companies. They get paid fees for things like: helping a company buy another company, issue stock, buy back their stock, etc. Many of the big banks also have a balance sheet (money to lend to companies). These banks would also make loans to companies to help them achieve their goals. The banks historically made a little by lending, but it was nothing compared to a M&A (buying another company) or IPO (issuing new stock to take a company public) fee.

The investment banking model is entirely dependent on relationships. All the investment banks have basically the same capabilities, with some variation, but that makes the bank getting hired almost entirely dependent on whether the company’s management likes it. Companies and banks acknowledge the give and take relationship. Companies need to borrow money, but banks don’t make a lot on lending money. However, the banks willing to lend money to the company when they need it coincidentally have the best chance to get the big fee engagements when the time is right for the company.

Over the last few years, up through July 2007, debt was readily available. Interest rates were relatively low, banks had lots of cash and companies knew it. If a company needed a loan, it would go to their main bank and say how much they wanted. If the bank said “no”, the company would go down the street to the next bank, the next bank would lend to them no questions asked and in the process put themselves front and center as the main bank ready to reap the big fees when they came along. Therefore, the main bank couldn’t say no. It would lose it’s customer before the “o” in no came out. Banks, like Citi, like JP Morgan, made lots of loans to companies knowing that they were going to lose money on the loan, but that was ok because they would make back way more then they were losing with the next big fee engagement.

Again, this business model, like lending mortgages to anybody works great as long as the economy is going strong. But, when the economy slows down, those big fee engagements don’t come along. This way of conducting business and the mortgage mess drove leverage to unprecedented levels in the history of mankind. Leverage, the level of debt, increases the risk of a firm going bankrupt. Purely looking at leverage, the risk of a going concern going bankrupt had never been higher than it was in summer 2007.

Credit default swaps
Credit default swaps (CDS) are a specialty financial product the essentially provides insurance on an asset defaulting. For example, if you bought a corporate bond you could buy credit default swaps and lock-in a return, albeit a smaller one. Credit default swaps have been used on all types of fixed-income assets, including many mortgage backed securities.

As our economy has levered up for the past several years, more and more companies, including insurance companies like AIG began issuing credit default swaps. It was, after all, a very profitable business. So we have increasing leverage, meaning and increasing risk of bankruptcy, or default, and some of the biggest financial firms are taking positions worth hundreds and hundreds of billions insuring against default.

Credit default swaps have become a favorite gauge of how likely it is that a certain bank will go under in these trying times. As the spread (the premium) on a given bank’s credit default swaps rises, so does the market’s perceived risk that the firm will go under.

Out of bounds
One of the major issues leading to this crisis is firms stepping out of their normal area of business in order to boost profits. AIG, unlike most insurance companies, began doing credit default swaps. Many bond insurers, like MBIA (ticker: MBI) who used to insure municipal bonds, started insuring mortgage-backed securities. The list goes on and on. Why did these firms enter new markets? Simple, there was a lot of money to be made. There is nothing wrong with that, this is capitalism after all. But in true capitalism it’s a live or die world, and if the firms that stepped over their bounds went bankrupt or almost went bankrupt, the next time new opportunities presented themselves, there would be a hell of a lot more due diligence done before those markets were entered.

But we now live in a world where firms can grow to be “too big to fail”. I agree, AIG was too big to fail. There were too many counterparties all over the world who had contracts with AIG, our financial world would be in chaos had the firm gone out of business. How have we not had a problem with this in the past? Is anti-trust growing more and more lax? Probably a little, but that is not the problem, AIG had lots of competition. How do companies like Citi and AIG operate in so many geographies, markets and products yet remain organized, focused and profitable and why wasn’t anyone ever able to do it before? Some would say they don’t, but if you give them the benefit of the doubt, the only answer is technology. We’ve never had a problem this big before because we’ve never had the technology to allow firms to grow as big as they are now. Our own advances in technology gave corporations enough rope to hang themselves, and many of them succeeded. Firms had the capacity to expand product offerings across more markets fast and more efficiently than ever before and handsomely increase profits. Stocks, bonds, all forms of money are not transferred in hard form anymore, they are ones and zeros going from computer to computer.

Firms took full advantage of technology and market conditions (low interest rates and a strong housing market) fill their greedy desires and maximize profits. There is nothing wrong with using technology to get bigger, taking advantage of market conditions or being greedy. This is capitalism.

The hammer
The sledgehammer that broke the proverbial camel’s back was the housing market. When the housing market turned downward in summer 2007, the value of mortgage backed securities went down because the value of mortgages went down. Some people’s mortgages were now worth more than the underlying home. Why pay it off? The economy was starting to weaken. At the same time, lots of those adjustable rate mortgages discussed above were re-setting to higher interest rates, making the interest payment unaffordable to many homeowners, driving more of them closer to defaulting.

As more of the mortgage backed securities weakened, first the mortgage brokers were hit hard, then the insurers. Now, with the credit default swaps through the roof, all the issuers of the credit default swaps are being forced to post cash collateral, driving them to insolvency (they don’t have any more cash)

What needs to happen?
We went through a multi-decade levering process that needs to be at least partially unwound. What does that mean? Profits will go down because businesses can’t finance expansion as regularly. This will drive stock prices down. Academically, as leverage increases, returns on equity increase and with it the firms’ stock price. That unwinding will take equities lower as well.

Am I saying the Dow goes to 8,000? No. But will the recovery be as quick as the drop? Not in my opinion. However, there are, and will continue to be tons for great buying in the stock market.

What will start the turn back towards a more normal state will be when the housing market begins to turn. That will ease some of the stress in the system. However, by that time we may be in a recession. Stay tuned.

...and then there were two

Of the five big stand-alone investment banks, only Goldman Sachs and Morgan Stanley remain. Even these folks have been hit, though. Goldman has shown a 70% drop in third quarter net income. Morgan is looking at Wachovia for a merger, who, interestingly enough, has hired Goldman to look for potential merger partners. How has Goldman done so well? A commentator noted how Goldman mentioned last year that they were net short, effectively shorting indexes of all of the bonds which they were selling. I had mentioned this concept only a few weeks ago, but cited it only as a general business strategy. The commentator in fact saw it as a "predatory" action, due to the fact that Goldman is selling to customers (the bond purchasers) products which they personally don't have faith in.

If we are going to see Morgan and Wachovia merging, and perhaps Goldman at some point down the road, this brief article does a good job at describing the nature of combining investment and commercial banks, as it pertains to risk and loans.

“There’s a prevailing sense that the business model of the free-standing, highly leveraged investment bank that funds itself in the wholesale financial markets is virtually kaput,” Willem H. Buiter, a professor at the London School of Economics, told the New York Times this week.

“The pure investment bank was an American specialty,” he added. “But we’ve now seen three major American investment banks go down, so this model looks like a weakness, not a strength in a down market.”

What is the advantage of a merger with a commercial bank? To cite this article, the large pools of capital that come from retail banking deposits - your and my money. Because there is so much stable money in retail banking, made safe by the FDIC's insurance, retail banks receive greater credit ratings, which makes it easier for them to raise capital. 

Goldman doesn't necessarily need these deposits:

That’s because a large amount of what Goldman Sachs invests in is considered riskier than the bread-and-butter loans that commercial banks make with deposits. If Goldman were to become part of a commercial bank, those deposits couldn’t be used to support the vast majority of its investments.

Meredith Whitney, an analyst from Oppenheimer, was quick to respond on the conference call, telling Mr. Viniar, “Obviously, you can’t fund capital market activities with deposits, but your overall credit rating as seen by the rating agencies would improve because of diversification. So there would be a benefit.”

Whether or not Goldman's shareholders will agree to this when a good purchase offer comes around is a different story.

And finally, this comment comes from Judey, and one which I'm sure we'll be hearing a lot more of, as the fallout of this market tends to lead towards more conservatism.

The Glass Stiegal was put in place during the Depression for a reason. Having banks which have access to low cost federally insured deposit funds is just another way to have a government subsidy for investment banking.Its repeal was dangerous. Merging with banks is another even more insidious way to to subsidize risk taking.We need to learn from history. We must stop and investigate and regulate market manipulation. We must put the brakes on short sellers. The bear raids must be stopped. The uptick rule must be restored in addition to stopping naked shorts. And the uptick should be at least .05.

Most people expect this crisis to take ages to finally erode away, but I have more faith than Judey in the after-shock. People will be looking for a solution, and I'm sure that is going to come from strict regulation changes. Most likely, as the US continues to switch to IFRS accounting standards (a topic that has obviously taken a back seat to the credit crunch and sub-prime write downs), I believe will see a more international standard of regulation as well.

Musings

This is one of the most historic weeks in US financial history. That was a period. And I'm not excluding black monday, the great depression, the S&L crisis, or any of the other monumental events that shaped our financial history. If you're not reading every possible thing you can get your hands on, if you're not reading the Journal and soaking it up, you're an idiot. That was a period.

I'm not going to reiterate everything that's happened over the last few days, if you don't know go read the news paper.

-The housing starts number sucked today. Guess what? That's great news. Housing starts will be the last part of the housing market to recover. Right now the biggest problem in housing is the inventory (the amount of houses on the market). If more homes are being built, that number goes up by more. Starts going down let's us rip through the inventory and go through the price discovery process. Let's not forget what started this shit show, housing. What's going to lead us out? Housing.

-The journal had a phenomenal article on the AIG mess front and center on pg 1. Go steal a journal from the front of an apartment building or go to this thing they call the library. Read the article, study the chart at the top of the second page of the article, it's a great simplification of how AIG got in trouble. AIG got killed by the credit default swaps they helped create, which are basically insurance on banks' debt, or in other words: insurance against a firm going bankrupt. Think about how the value of that has changed over the last few months.

-Barclays got the deal of the century yesterday. They bought the good parts of Lehman for $1.75bn. Included in this is Lehman's main office building which the Journal reported valued at $600-900 million. Essentially, Barclays bought one of America's best financial services institutions and investment bank for $1.15BN max. And they didn't have to tke any of the toxic paper with them because LEH was already in bankruptcy. For comparison purposes, Bank of America paid in the neighborhood of $50BN for Merrill Lynch. In my opinion Barclay's got a much better deal than even JP Morgan did when they were wed with Bear Stearns.

Those are some of my quick musings. I will write another post about the underlying theme of this whole mess, greed, shortly.

What in the world...

I hope you're all turning your attention to the news.

Lehman's finished. Merrill has been bought by BofA. AIG is looking for more capital.

It's recruiting season over here at school, but don't expect to find many finance jobs, considering how many thousands of former Lehman workers are now going to be pushing out new hires for cheap banking jobs.

This was a historic weekend, following a previous historic weekend. I'll be sure to slap something together soon.

Google blows up UAL

Let's avoid the giant elephants in the room for a moment (Fannie Freddie Lehman Merrill), so I can point out another technical folly that has come out of the woodworks.

On Monday, UAL's stock price was essentially wiped out this week by an error in the systems that track news stories on the internet.

Here's a breakdown I'm citing form the LA Times:

Back in 2002, United was verging on bankruptcy, and South-Florida Sun Sentinel newspaper, a subsidiary of Tribune group, published an article about it. The Google News search algorithms came across the article early Sunday, and by opening it, probably pushed it to the "most viewed" section of the webpage. From there, other news aggregators that just search over "most viewed" lists picked up the article and, due to a mis-dating on the original article, presented it as current news to Income Securities Adivsors, inc. Bloomberg news picked up the "story" from there, and automatic trading algorithms that are programmed to respond immediately to certain news events, like bankruptcies, dumped shares, cutting away 75% of UAL's market cap before trading was manually frozen.

Things are back to normal now, but this brings to light some pretty interesting considerations, as the effects that automated information system processes have on our lives increase.

These systems work fine, as long as they are designed perfectly, but when you incorporate human error, like mis-dating an old news article from a tiny newspaper, the shock waves that can be made are staggering. This is especially true in capital markets, due to the affect information has on liquidity. In spite of all of it's value in maintaining fair value, liquidity also has the adverse effect of draining a security of value, whether the information causing the change is accurate or not. 

How will we solve these issues? Insurance first comes to my mind as a "solution," but it exists more to treat the symptoms, not the cause. I imagine that more and more adaptable circuit breakers will need to be put in place. We will need to find innovative new solutions that fight to maintain a fair market value that still has a solid, auditable foundation of value. Perhaps we can use historic data to statistically model past market responses to news items like bankruptcies, and design a circuit breaker that prevents a stock's price from swinging too far past that average?

Maybe such intervention sounds too manipulative, even for these times. Speaking of market manipulation, I'll try to throw something together about the big news stories soon.

The Economics of Crowded Markets

I read a great article on O'Riley Radar about how the big players (read: Google and the New York Times online) on the Internet are behaving like the big banks, who, when facing a turn in the tide against ridiculous growth, used subversive tactics to try to maintain that growth.

What atrocity could golden Google possibly commit? Well, as a high-flying public company with several years of growth, Google started to slow down late last year. That slow down was occurring as the "product life cycle" signaled that web search may have been beginning to mature. Tim O'Reiley, in his infinite wisdom, was able to notice their actions as early as then, and cited another clever clogs called Bill Janeway, who drew parallels to Google with the banks' actions a few years ago.

As Bill explains:

"The price of a trade a generation ago was regulated by the exchanges: it cost approximately 22 cents per share to trade an institutional-size block of stocks on the New York Stock Exchange. The ability to fix commissions reflected the historical fact that the brokers had long been large, relative to their customers. Unable to compete on price, some firms competed on the quality of their investment research, and brokers’ relations to clients were based on the information and insights they could provide (others competed in less respectable ways).

As pension funds, mutual funds, and other institutional investors grew to dominate trading, they successfully broke the NYSE cartel. Once the exchanges no longer regulated the price of a trade, prices fell over time to current levels of a fraction of a cent per share: for large trades, effectively zero. As a result, some sell-side firms tried to charge directly for research and found that their buy-side clients were unwilling to pay. Instead, they were investing money saved from commissions to build their own research staffs. Two other things happened. Seeking an alternative subsidy for sell-side research, most firms repositioned their research staffs as marketing arms of their corporate finance firms, a strategy that blew up spectacularly with the Bubble in 2000–2002. More important, firms began to trade against their clients for their own account, such that now, the direct investment activities of a firm like Goldman Sachs dwarfs its activities on behalf of outside customers."

One thing innovation does is drive out older inefficiencies, and charging someone $.22 to transfer information from one party to the other is the definition of waste. And when a company's means of subsistence proves to be inefficient, and starts to get squeezed, it is only natural for that company to fight back. There are two solutions: fight to maintain the status-quo, or wriggle free through innovation and invention. The latter is of course the harder of the two, and is the reason why entrepreneurs are so successful at being "destructive creators."

Google is responding to their pinch releasing more and more products that maintain focus - and web traffic - on their products:

Google's announcement of Knol shows that they understand some of their key business drivers very well; With as much as 5% of the search result links for popular terms going to Wikipedia pages, a solution to capturing some of that traffic in an environment that Google can control and display ads on makes good business sense...

Now the last thing I want to do is imply that Google doesn't innovate - I think Google is our generation's proudest example for innovation. In fact, I believe that this issue has largely been resolved, thanks to Google's new browser, Chrome. The potential Chrome will realize in freeing up system resources for more advanced web applications is a discussion for a different time.

We can't say the same f0r the New York Times online, which people are complaining about sacrificing their journalistic quality by keeping all of the links in their articles internal. This practice redirects readers to other related articles, which increases web traffic, however at the cost of relevance to the story.

However, I'm more optimistic than O'Reiley. Switching costs are as low on the Internet as they possibly could be - the only thing keeping people looking at the New York Times is the New York Times' brand power. If this practice continues to dilute that brand, then we should see consumers shift to a different service. The same goes for O'Reiley's complaints about other web services that attempt to lock people into their brand - the very nature of search should allow them to seek quality elsewhere.

The web is the most meritocratic economy man has ever developed. This only means good news for us.

Ballad of a Thin Man

For all those Bob Dylan fans, here's Mr. Jones' take on the economy

Back from London

Well I'm back from my 1 month work rotation in London, so I'll be posting again and trying to get out of this summertime slump.

In the mean time, here is a really short op piece about Mr. Bernanke's situation. It's a pretty insightful commentary on the behavioral side of economic predictions and the market movements that happen in result.

There's no need to describe the article, as it is only a few paragraphs long to begin with. I think this only shows how erratic and unfounded so much of this market analysis really is. It's already difficult enough to analyze objectively the condition of an economy, due to the bluntness of our models, and the limits of data penetration. But when one incorporates simple psychology, and how Wall Street and Bernanke are, on one level, playing mind games with each other, I wonder how anyone can say with any confidence that the market is reacting to reality.

These past two years makes me think Wall Street lives in its own convoluted universe, which skips blindly like a spinning stone over the real world, occasionally changing direction when the natural laws of reality pull it back to Earth.

Market Summary: Fri. July 11, 2008

DJIA 11,100.54 -128.48 (-1.16%)
Nasdaq 2,239.08 -18.77 (-0.84%)
S&P 500 1,239.49 -13.90 (-1.12%)
NYSE Composite Volume 1.73 bln

2-Yr Note 2.59% +0.15
10-Yr Note 3.96% +0.13
30-Yr Bond 4.52% +0.10

Dollar Index 72.096 -0.397
Crude Oil (Aug) 145.08 +3.43
Nat Gas (Aug) 11.904 -0.396
Gold (Aug) 960.60 +18.60

Market Summary: Thurs. July 10, 2008

DJIA 11,229.02 +81.58 (+0.73%)
Nasdaq 2,257.85 +22.96 (+1.02%)
S&P 500 1,253.39 +8.70 (+0.69%)
NYSE Composite Volume 1.53 bln

2-Yr Note 2.44% +0.03
10-Yr Note 3.83% -0.02
30-Yr Bond 4.42% unch

Dollar Index 72.493 -0.087
Crude Oil (Aug) 141.65 +5.60
Nat Gas (Aug) 12.300 +0.294
Gold (Aug) 942.00 +13.40

Market Summary: Wed. July 9, 2008

DJIA 11,147.44 -236.77 (-2.12%)
Nasdaq 2,234.89 -59.55 (-2.66%)
S&P 500 1,244.69 -29.01 (-2.33%)
NYSE Composite Volume 1.49 bln

2-Yr Note 2.41% -0.06
10-Yr Note 3.85% -0.06
30-Yr Bond 4.42% -0.04

Dollar Index 72.580 -0.432
Crude Oil (Aug) 136.05 +0.01
Nat Gas (Aug) 12.006 -0.362
Gold (Aug) 928.60 +5.30

Market Summary: Tues. July 8, 2008

DJIA 11,384.21 +153.25 (+1.68%)
Nasdaq 2,294.42 +51.10 (+2.23%)
S&P 500 1,273.70 +21.39 (+1.68%)
NYSE Composite Volume 1.72 bln

2-Yr Note 2.47% unch
10-Yr Note 3.91% -0.04
30-Yr Bond 4.46% -0.05

Dollar Index 73.012 +0.342
Crude Oil (Aug) 136.04 -5.33
Nat Gas (Aug) 12.368 -0.609
Gold (Aug) 923.30 -5.50

Market Summary: Mon. July 7, 2008

DJIA 11,231.96 -56.58 (-0.50%)
Nasdaq 2,243.32 -2.06 (-0.09%)
S&P 500 1,252.31 -10.59 (-0.84%)
NYSE Composite Volume 1.52 bln

2-Yr Note 2.47% -0.07
10-Yr Note 3.95% -0.04
30-Yr Bond 4.51% -0.02

Dollar Index 72.670 -0.061
Crude Oil (Aug) 141.37 -3.92
Nat Gas (Aug) 12.977 -0.600
Gold 927.30 -4.60

Market Summary: Fri. July 4, 2008

I became a little less negative on the stock market following the ECB statement Thursday morning. Everyone has been hoping for a dollar rebound to help stabilize the economy and stock market. So far, no luck. The Fed was ‘talking up’ the dollar because they could not raise rates and this tactic worked until two weeks ago when Trichet (ECB President) announced he would raise rates in the Eurozone. Foreign rates going higher make the dollar less attractive to investors.

As expected, Trichet and the ECB raised rates a quarter point to 4.25% Thursday morning, but it was the rhetoric that was positive for the dollar. Trichet commented that he has “no bias” for further rate hikes and he expects inflation to stabilize because of this one rate increase. The dollar index rallied 1% Thursday because of Trichet’s bullish commentary.

I was very worried about what Trichet might say. His goal is to combat inflation, but I was concerned that his rate hike would be counter-productive. The rate hike, and possible further rate hikes, would make the dollar relatively weaker, and seeing that commodities are denominated in dollars, he would be fueling inflation. However, my concerns were eased when he mentioned that no more rate hikes are on the horizon.

Market Summary: Thurs. July 3, 2008

DJIA 11,288.54 +73.03 (+0.65%)
Nasdaq 2,245.38 -6.08 (-0.27%)
S&P 500 1,262.90 +1.38 (+0.11%)
NYSE Composite Volume 931 mln

2-Yr Note 2.54% -0.06
10-Yr Note 3.99% unch
30-Yr Bond 4.53% +0.02

Dollar Index 72.742 +0.713
Crude Oil (Aug) 145.29 +1.72
Nat Gas (Aug) 13.577 +0.188
Gold (Aug) 931.90 -12.90

Market Summary: Wed. July 2, 2008

DJIA 11,215.51 -166.75 (-1.46%)
Nasdaq 2,251.46 -53.51 (-2.32%)
S&P 500 1,261.52 -23.39 (-1.82%)
NYSE Composite Volume 1.52 bln

2-Yr Note 2.60% -0.03
10-Yr Note 3.99% -0.02
30-Yr Bond 4.51% -0.04

Dollar Index 72.029 -0.340
Crude Oil (Aug) 143.57 +2.60
Nat Gas (Aug) 13.389 -0.116
Gold (Aug) 944.80 +2.30

Bulls vs. Bears: Beginning of the quarter repositioning

The bulls on Wall Street were glad to see the second quarter come to an end yesterday. The bulls that have been talking up stocks in the face of tremendous economic headwinds are way too optimistic. The market will continue to trend lower as more and more companies either miss earnings expectations or give sub par guidance.

The VIX, a measure of volatility (aka fear), is no where near its March 17^th level when Bear Stearns was bailed out by the Federal Reserve. The sellers have not all been washed out of the market yet because we have not seen a heavy volume down day.

Also, all the market pundits that appear on CNBC say the market will turn later this year or sometime next year. For the market (and economy) to get back on track there needs to be a catalyst to cause this reversal to occur. Unfortunately, there are so many areas of our economy that are struggling I do not think one catalyst will suffice. The one area that could turn things around is a rebound (or at least no more declines) in housing, but this is a slow process that I do not see occurring anytime soon.

Today, why did we see stocks like U.S. Steel and Potash, two big winners from the first half of the year, significantly underperform the major averages on no big news reports?

The money managers want to show their investors they knew what they were doing by owning these stocks. When the quarter ends, they either take profits or dump the stock. Then with the extra cash, they buy up the losers from the previous quarter, e.g. financials. This explains why we saw Lehman Brothers up 6% today. Nothing about this company changed from yesterday when we saw it decline 11%. Look at CIT, another financial company. This stock was up about 30% today.

Do not expect the rally in these ‘loser’ stocks to last more than a few days. We saw this same pattern at the end of the first quarter/start of the second quarter when the financials rallied (this rally lasted about a month and a half until the bad news resurfaced. By the end of the second quarter, the financials were still toxic and should not have been touched.

Market Summary: Tues. July 1, 2008

DJIA 11,382.26 +32.25 (+0.28%)
Nasdaq 2,304.97 +11.99 (+0.52%)
S&P 500 1,284.91 +4.91 (+0.38%)
NYSE Composite Volume 1.64 bln

2-Yr Note 2.63% unch
10-Yr Note 4.01% +0.02
30-Yr Bond 4.55% +0.02

Dollar Index 72.369 -0.094
Crude Oil (Aug) 140.97 +0.97
Nat Gas (Aug) 13.505 +0.152
Gold (Aug) 942.50 +16.30

Why is the Dow the underperformer?

The U.S. recession talk has been going on since last October, so this topic should be nothing new if you have been keeping up with the markets. Really, it is just a matter of when not if anymore. During this same time, everyone was advising to put money overseas in the stronger emerging markets (China, Russia, Brazil, and India) and avoid the frail American economy. Recently however, there are now talks that the U.S. slowdown will spill over into the global market.

The rise in commodity prices, especially crude oil, has crimped the American economy – consumer and corporation. The analysts are now expecting the emerging markets to slow with the American economy.

The Dow Jones Industrial Average contains 30 stocks which have enormous overseas exposure. The S&P 500 contains many of the same stocks, but there are also smaller, more domestically based companies that will not be as affected by slowing global demand. So relatively, the S&P 500 components are not as dependent on the global markets as the Dow components are.

For instance, Alcoa, Boeing, Hewlett-Packard, IBM, Intel, Coca-Cola, McDonald’s, and Proctor & Gamble (just to name a few) are all Dow components that rely heavily on international sales (and the weak U.S. dollar). These companies almost rely more on their international sales than their domestic sales (some actually do more business overseas).

This change in the global growth forecast has negatively affected American companies, especially ones that sell goods to these once-growing, now thought to be slowing, emerging economies.

Also, you can look at the Russell 2000 Index which tracks small cap stocks (minimal international exposure). This index has outpaced the S&P 500 by 4% over the last month and a half.

Market Summary: Mon. June 30, 2008

DJIA 11,350.01 +3.50 (+0.03%)
Nasdaq 2,292.98 -22.65 (-0.98%)
S&P 500 1,280.00 +1.62 (+0.13%)
NYSE Composite Volume 1.61 bln

2-Yr Note 2.63% -0.02
10-Yr Note 3.99% unch
30-Yr Bond 4.53% unch

Dollar Index 72.463 +0.103
Crude Oil (Aug) 140.00 -0.21
Nat Gas (Aug) 13.353 +0.155
Gold (Aug) 926.20 -3.10

Market Summary: Fri. June 27, 2008

DJIA 11,346.51 -106.91 (-0.94%)
Nasdaq 2,315.63 -5.74 (-0.25%)
S&P 500 1,278.38 -4.77 (-0.37%)
NYSE Volume 2.24 bln

2-Yr Bond 2.65% -0.03
10-Yr Bond 3.99% -0.08
30-Yr Bond 4.53% -0.09

Dollar Index 72.360 -0.127
Crude Oil (Aug) 140.21 +0.57
Nat Gas (Aug) 13.198 -0.050
Gold (Aug) 931.30 +16.20

Market Summary: Thurs. June 26, 2008

DJIA 11,453.42 -358.41 (-3.13%)
Nasdaq 2,321.37 -79.89 (-3.44%)
S&P 500 1,283.15 -38.82 (-3.03%)
NYSE Volume 1.54 bln

2-Yr Bond 2.68% -0.14
10-Yr Bond 4.07% -0.05
30-Yr Bond 4.62% -0.03

Dollar Index 72.487 -0.446
Crude Oil (Aug) 139.64 +5.09
Nat Gas (Aug) 13.248 +0.382
Gold (Aug) 915.10 +32.80

Cool Numbers: Tech

"Worldwide, people sent 1.9 trillion text messages last year" <- That's a lot of money spent. That stat comes from this article, written in last month's Technology Review, a fantastic magazine put out by MIT (I guess it's like their Harvard Business Review, my all-time favorite publication).

Another cool article in the same magazine talks about the founder of modern venture capital, a Frenchman by the name of Georges Doriot. He earned his stripes in the US in the 20s-40s. They mention a biography in the article that I might pick up. I recently read Faust In Copenhagen: A Struggle for the Soul of Physics, that discusses the lives and discoveries made in the community of theoretical physicists at the beginning of the 1920 and 30s, when quantum mechanics were pioneering a new understanding of our universe. The first half of the century must have been incredibly exciting for developments in science and business, but it is nothing like we're seeing now... especially in areas where they merge so closely, like the web. Here's one last fantastic (huge) article about concerns over monetizing Web 2.0.

The biggest issue? Advertising, which these types of websites are depending on for income, is being ignored by users. Basically, the best model is Google's Adwords Auction.

"Advertising on Google works because visitors come to Google looking for specific information. If a user who types "scooter" in the site's search field is hoping to buy a scooter, the keyword ads that appear at the right of the search results can be more useful than the results themselves. In social networks, on the other hand, users show up to find friends; ads are, at best, irrele­vant to that goal. The click-through rates on social-­networking sites bear this out. While around 2 percent of Google users actually click on a given ad (and the number is much higher when users are conducting searches for purchasing reasons), fewer than .04 percent of Facebook users do, according to a media buyer's report obtained last year by the Silicon Valley blog Valleywag."

THIS is intelligent advertising, because Google is taking advantage of people who are actively looking for something, while the Web 2.0 companies have to depend simply on a large user base. The only difference between advertising on Facebook and advertising on CNN is Facebook can better target people with specific ads - but the nature of the advertising remains the same.

The article is long, and talks about some of the interesting failures to address this issue, like Facebook's ill-fated Beacon program, and MySpace's HyperTargeting system. I'll leave it to you to read it.

Market Summary: Wed. June 25, 2008

DJIA 11,811.83 +4.40 (+0.04%)
Nasdaq 2,401.26 +32.98 (+1.37%)
S&P 500 1,321.97 +7.68 (+0.58%)
NYSE Volume 1.40 bln

2-Yr Bond 2.82% -0.05
10-Yr Bond 4.12% +0.02
30-Yr Bond 4.65% unch

Dollar Index 72.933 -0.308
Crude Oil (Aug) 134.55 -2.45
Nat Gas (Aug) 12.866 -0.260
Gold (Aug) 882.30 -9.30

Market Summary: Tues. June 24, 2008

DJIA 11,807.43 -34.93 (-0.30%)
Nasdaq 2,368.28 -17.46 (-0.74%)
S&P 500 1,314.29 -3.71 (-0.28%)
NYSE Volume 1.34 bln

2-Yr Bond 2.87% -0.11
10-Yr Bond 4.10% -0.09
30-Yr Bond 4.65% -0.06

Dollar Index 73.241 -0.193
Crude Oil (Aug) 137.00 +0.26
Nat Gas (Aug) 13.126 -0.196
Gold (Aug) 891.60 +4.40

Those Hedge Fund Guys

American icon Tom Wolfe (think Electric Cool-Aid Acid Test, Ken Kesey, 1969) put out an awesome article for Conde Nast about the characters of the uber-rich titans who manage hedge funds, lambasting them for their coarse attempts at high-culture, and their towering hubris. "These people" are, to Mr. Wolfe, the American Pirates, burning and raiding companies

It's long, but it's a classic read.

So do yourself a favor and read it.

Here's an excerpt:

"The freebooters have only contempt for other types of money managers, who always play it safe. They reserve a special scorn for mutual fund managers, a breed they call “pure vanilla.” Corporate C.E.O.’s don’t come off much better, not even “superstars” such as Lee Iacocca and Jack Welch...C.E.O.’s are people who expend their energies in binges of insincerity, holding the hands of shareholders and board members, constantly “negotiating” with government, with labor, and with God knows who else, constantly temporizing, compromising—resorting to flattery and “charm,” both of which are unmanly—striving to look dignified, clad in the obligatory dark suit, white shirt, and red or Arctic-blue necktie. That goes for C.E.O.’s and everybody else who works in investment banking, for the Merrill Lynches and Morgan Stanleys, with one exception: the traders.

THE TRADERS ARE ON THE FRONT LINES moment by moment, pulling the trigger with only seconds to think about it. They are our kind! They are aggressive—real men! Their plain vanilla C.E.O.’s know it too. They will pay a daring, battle-hardened trader $50 million and up per year to keep him from defecting to our pirate fleet. They pay them more than they pay themselves, because they are worth more, because they are real men, because they are willing to fight."

Market Summary: Mon. June 23, 2008

DJIA 11,824.36 -0.33 (-0.00%)
Nasdaq 2,385.74 -20.35 (-0.85%)
S&P 500 1,318.00 +0.07 (+0.01%)
NYSE Composite Volume 1.09 bln

2-Yr Note 2.98% +0.10
10-Yr Note 4.19% +0.03
30-Yr Bond 4.71% unch

Dollar Index 73.434 +0.404
Crude Oil (Aug) 136.74 +1.38
Nat Gas (July) 13.203 +0.209
Gold (Aug) 887.20 -16.50

Cool Numbers: Giving

Remember these? I barely do either... But either way, here is another cool number!

According to GivingUSA, charitable giving in 2006 reached a record $295.02 billion, which Slate's Moneybox noted was something like 2.2% of our nation's GDP. Excluding disaster gifts from the year previously, (remember 2005?), that's a yoy increase of 6.6%. Pretty cool, yeah? Now, part of that 2006 record comes from Warren Buffet's 1.9billion donation (which will amount to $30 billion over the next 20 years).

The Moneybox article's focus is actually less uplifting - the author suggests that our economic turmoil has recently, and will continue to hurt charitable giving in the near future. This is because, not surprisingly, "...philanthropy is tethered directly to the health of the overall economy, and in particular to the health of the upper-middle-class consumer."

Gone Bananas!

There was a pretty cool Op-Ed in the Times recently about bananas. Not surprisingly, rising fuel costs have hurt banana distribution, and is affecting the value of publicly traded companies, like Cincinatti-based Chiquita. The Wall Street Journal attributes Chiquita's 29% dip in stock price to recent bad weather and a spike in demand for milk and meat (my guess due to the rising disposable income of people in developing countries).

Bananas, traditionally the cheapest of America's popular fruits, actually have a pretty interesting economic history.

From the NYT:

"That bananas have long been the cheapest fruit at the grocery store is astonishing. They’re grown thousands of miles away, they must be transported in cooled containers and even then they survive no more than two weeks after they’re cut off the tree. Apples, in contrast, are typically grown within a few hundred miles of the store and keep for months in a basket out in the garage. Yet apples traditionally have cost at least twice as much per pound as bananas...

They became a staple only after the men who in the late 19th century founded the United Fruit Company (today’s Chiquita) figured out how to get bananas to American tables quickly — by clearing rainforest in Latin America, building railroads and communication networks and inventing refrigeration techniques to control ripening. The banana barons also marketed their product in ways that had never occurred to farmers or grocers before, by offering discount coupons, writing jingles and placing bananas in schoolbooks and on picture postcards. They even hired doctors to convince mothers that bananas were good for children."

The article also briefly describes the terrifying control the United Banana had over the many "banana republics" in Latin America, which kept costs low by denying many human rights to the citizens of the countries they grew bananas in. One startling example was the 1954 overthrowing of the democratically elected government of Guatemala by United Fruit. And apparantly "labor is still cheap in these countries, and growers still resort to heavy-handed tactics."

Banana companies are also able to optimize economies of scale (most notably by controlling ripening rates) by only selling one species of banana, the Cavendish. Prior to that, the only thing you could get was the Gros Michel, but a blight known as the Panama disease wiped them all out. I've written previously about the growing concern over massive food loss due to disease, and it look's like the Cavendish banana's goose is cooked. The disease, which is killing off plantations of Cavendish crops as we speak, is expected to reach Latin America (where the US gets its bananas) in the next 5-20 years.

The only thing that can probably be done is to start growing a different kind of banana - but to do that, genetic engineers must research other under-used strains of banana (of which there are many), to find a more resistant cousin. This will undoubtedly be of incredible importance to the banana industry in the coming years, although some say the big companies are not moving fast enough.

A side note, ff you're really interested, the book Banana: The Fruit That Changed The World is supposed to be pretty interesting. How silly it is the titles publishers and media-makers dream up to grab our attention. And just to seal the deal on how ridiculous this article is...here's some mildly interesting banana trivia

Market Summary: Fri. June 20, 2008

DJIA 11,842.69 -220.40 (-1.86%)
Nasdaq 2,406.09 -55.97 (-2.33%)
S&P 500 1,317.93 -24.90 (-1.89%)
NYSE Composite Volume 2.01 bln

2-Yr Note 2.88% -0.11
10-Yr Note 4.16% -0.06
30-Yr Bond 4.71% -0.05

Dollar Index 73.030 -0.453
Crude Oil (July) 134.62 +2.69
Nat Gas (July) 12.994 +0.133
Gold (Aug) 903.70 -0.50

Market Summary: Thurs. June 19 2008

DJIA 12,063.09 +34.03 (+0.28%)
Nasdaq 2,462.07 +32.36 (+1.31%)
S&P 500 1,342.83 +5.02 (+0.37%)
NYSE Composite Volume 1.29 bln

2-Yr Note 2.99% +0.10
10-Yr Note 4.22% +0.06
30-Yr Bond 4.76% +0.04

Dollar Index 73.483 +0.043
Crude Oil (July) 131.93 -4.75
Nat Gas (July) 12.861 -0.349
Gold (Aug) 904.20 +10.70

Market Summary: Wed. June 18, 2008

DJIA 12,029.06 -131.24 (-1.09%)
Nasdaq 2,429.71 -28.02 (-1.15%)
S&P 500 1,337.81 -13.12 (-0.98%)
NYSE Composite Volume 1.28 bln

2-Yr Note 2.89% -0.05
10-Yr Note 4.16% -0.07
30-Yr Bond 4.72% -0.06

Dollar Index 73.440 -0.074
Crude Oil (July) 136.68 +2.67
Nat Gas (July) 13.210 +0.258
Gold (Aug) 893.50 +6.60

Market Summary: Tues. June 17, 2008

DJIA 12,160.30 -108.79 (-0.89%)
Nasdaq 2,457.73 -17.05 (-0.69%)
S&P 500 1,350.93 -9.21 (-0.68%)
NYSE Composite Volume 1.09 bln

2-Yr Note 2.94% -0.08
10-Yr Note 4.23% -0.02
30-Yr Bond 4.78% +0.01

Dollar Index 73.514 -0.096
Crude Oil (July) 134.01 -0.60
Nat Gas (July) 12.952 +0.019
Gold (Aug) 886.90 +0.60

Market Summary: Mon. June 16, 2008

DJIA 12,269.08 -38.27 (-0.31%)
Nasdaq 2,474.78 +20.28 (+0.83%)
S&P 500 1,360.14 +0.11 (+0.01%)
NYSE Composite Volume 1.16 bln

2-Yr Note 3.02% -0.03
10-Yr Note 4.25% -0.02
30-Yr Bond 4.77% -0.02

Dollar Index 73.610 -0.536
Crude Oil (July) 134.61 -0.25
Nat Gas (July) 12.933 +0.308
Gold (Aug) 886.30 +13.20

Market Summary: Fri. June 13, 2008

DJIA 12,307.35 +165.77 (+1.37%)
Nasdaq 2,454.50 +50.15 (+2.09%)
S&P 500 1,360.03 +20.16 (+1.50%)
NYSE Composite Volume 1.22 bln

2-Yr Note 3.05% +0.02
10-Yr Note 4.27% +0.04
30-Yr Bond 4.79% +0.02

Dollar Index 74.146 +0.287
Crude Oil (July) 134.86 -1.88
Nat Gas (July) 12.625 -0.173
Gold (Aug) 873.10 +1.10

Market Summary: Thurs. June 12, 2008

DJIA 12,141.58 +57.81 (+0.48%)
Nasdaq 2,404.35 +10.34 (+0.43%)
S&P 500 1,339.87 +4.38 (+0.33%)
NYSE Composite Volume 1.33 bln

2-Yr Note 3.03% +0.20
10-Yr Note 4.23% +0.13
30-Yr Bond 4.77% +0.05

Dollar Index 73.859 +0.650
Crude Oil (July) 136.74 +0.36
Nat Gas (July) 12.798 +0.138
Gold (Aug) 872.00 -10.90

Market Summary: Wed. June 11, 2008

DJIA 12,083.77 -205.99 (-1.68%)
Nasdaq 2,394.01 -54.93 (-2.24%)
S&P 500 1,335.49 -22.95 (-1.69%)
NYSE Composite Volume 1.39 bln

2-Yr Note 2.83% -0.08
10-Yr Note 4.10% -0.01
30-Yr Bond 4.72% +0.02

Dollar Index 73.209 -0.487
Crude Oil (July) 136.38 +5.07
Nat Gas (July) 12.660 +0.225
Gold (Aug) 882.90 +11.70

The Fed & Interest Rates

In the last few trading days, expectations about Federal Reserve policy have changed drastically. When the Fed cut its target rate to 2%, Bernanke mentioned that the risks to inflation and growth were about equal. Most people took his comments as meaning that there would be no more rate cuts and rates would remain at 2% for some time (at least until the health of the economy looked a little more promising).

On Friday, the European Central Bank (ECB) President Jean-Claude Trichet made a statement hinting that the ECB will be raising rates at its next meeting. This news, coupled with the poor employment number, equaled trouble for the dollar at the end of last week. However, over the weekend Bernanke and his colleagues at the Federal Reserve stepped in and made comments that supported the dollar. Bernanke also hinted that rates could go higher to combat inflationary pressures. In a matter of three days, the dollar went from free-fall to near bull mode. All the interest rate futures are now pricing in multiple rate hikes by the end of the year. The Fed is expected to keep its target rate at 2% at its meeting later this month, but by the end of the year traders are betting on a 75 basis point increase. In my view, I think the traders are getting ahead of themselves.

As of right now, the Fed needs to keep its target rate at 2% for the following reasons:

1) Five consecutive months of contraction in the job market. The only statistic that remains strong is the initial jobless claims number which is holding steady and still above typical recessionary levels.

2) Continued weakness in the housing market. Mortgage rates are resetting and if the Fed raises rates, the delinquency rate on sub-prime loans will surely increase.

3) GDP at a standstill and a struggling consumer. With record commodity prices, the consumer has begun to shift its spending habits and many businesses are expected to slow because of this adjustment.

4) A broken financial system. When the Fed cuts rates (and the yield curve becomes steeper) banks can make more money in their lending businesses. However, if the Fed raises rates, the fragile banks will face another unneeded headwind.

5) Finally, in my opinion, if the Fed raises rates 75 basis points by the end of the year (which is very wishful thinking barring no extraordinary events) it will just look bad. What’s the point of raising rates when we just finished lowering them 325 basis points? Typically, everyone says rate cuts take about 9 months to take effect so the economy is just beginning to feel these rates cuts. It is too early for the Fed to tighten its monetary policy.

The market has been extremely choppy and volatile of late, mostly due to uncertainty about the economy, surging energy prices, continued weakness in the housing market, and renewed concerns among the financials.

Market Summary: Tues. June 10, 2008

DJIA 12,289.76 +9.44 (+0.08%)
Nasdaq 2,448.94 -10.52 (-0.43%)
S&P 500 1,358.44 -3.32 (-0.24%)
NYSE Composite Volume 1.39 bln

2-Yr Note 2.91% +0.18
10-Yr Note 4.11% +0.09
30-Yr Bond 4.70% +0.06

Dollar Index 73.696 +0.842
Crude Oil (July) 131.31 -3.04
Nat Gas (July) 12.435 -0.169
Gold (Aug) 871.20 -26.90

Market Summary: Mon. June 9, 2008

DJIA 12,280.32 +70.51 (+0.57%)
Nasdaq 2,459.46 -15.10 (-0.61%)
S&P 500 1,361.76 +1.08 (+0.08%)
NYSE Composite Volume 1.36 bln

2-Yr Note 2.73% +0.33
10-Yr Note 4.02% +0.08
30-Yr Bond 4.64% -0.01

Dollar Index 72.854 +0.464
Crude Oil (July) 134.35 -4.19
Nat Gas (July) 12.604 -0.089
Gold (Aug) 898.10 -0.90

Unbelievable...

I'm averse to making short posts, but this is just too unreal, and really needs no amount of introduction, nor any kind of "analysis."

Check. This. Out.

Market Summary: Fri. June 6, 2008

All I can say is ‘wow!’ Thursday morning crude oil was just below $122 per barrel and Friday it touched $139 per barrel. That is a 14% move in less than two days! The Commodity Futures Trade Commission (CFTC) has mentioned price manipulation in certain markets and I am becoming more and more convinced with this recent move in crude oil prices. To put this move in perspective, just ten years ago crude oil was at $11 per barrel. On Friday the price of one barrel increased by $11. Off of this ridiculous move in crude oil prices, the national average for a gallon of gas surpassed $4 for the first time.

Thursday, the markets got a nice boost from Wal-Mart and CostCo after the companies posted better-than-expected same store sales for May. Oil did manage to gain $5 on the day thanks to comments from the European Central Bank President Jean-Claude Trichet. Trichet said the ECB might raise rates to combat inflation. This statement put downward pressure on the dollar because the Euro will become relatively stronger and consequently, commodity prices rallied. I was a little surprised the markets did not sell off in the afternoon after the release of this statement. Also, S&P finally lowered its ratings on Ambac and MBIA, but it was not too much of a market moving event because S&P and the other credit rating agencies have been so far behind the curve.

Friday was a completely different story for the markets as they finished down about 3%. The unemployment number came in at 5.5%, much higher than the expected 5.0%. This unexpected news caused the markets to open significantly lower and the selling pressures increased when Morgan Stanley said it expects oil prices to be at $150 by July 4^th. Off of this news, the dollar and stocks tanked while crude oil surged to another new record.

Financials were also very weak the entire week. There have been concerns regarding Lehman Brother’s liquidity and speculation that the company will be raising capital. Washington Mutual and Wachovia both gave their CEOs the ax. Right now, the markets are on edge waiting for the next shoe to drop in the financial sector. Adding to the uncertainty is surging crude oil and gas prices which are significantly pinching the consumer.

Obama vs. McCain: Economics

The first of many posts, no doubt, here is a quick breakdown of some important economic differences between John McCain and Barack Obama.

This WSJ article has done a good job of laying out the differences, although I am sure positions will change as we approach November.

Concerning taxes, Obama is following the traditional Dem policy: lower taxes for middle class, and raise for the wealthy. In terms of business, Obama wants to support a capital gains tax on private equity and hedge funds, and an overall raise for capital gains and dividend tax rates from 15% to somewhere between 20% and 25%.

Now hedge funds and PE shops are pretty easy targets for politicking liberals. They have gotten some bad press (I remember reading a lot of griping over the winter) about the meager taxes they pay, relative to other financial companies. However, as David Rubenstein, co-founder of Carlyle Group, noted, private equity has grown to be an incredibly important part of the US economy, and is one of the last bastions of US business dominance. Furthermore, private equity has largely been financed by investments from pension funds, who have grown dependent on PE's high returns; so taxation would inadvertently hurt retirees dependent on their pensions.

McCain wants to lower the corporate tax from 35% to 25%, and require a 3/5 majority in Congress to raise taxes in the future. McCain cap gains and dividends tax the same as it is. This would (probably) do a lot of good to foster growth in our near-recessionary economy (although the verdict is still out on whether or not this "recession" is limited to housing and finance).

In terms of trade, the Journal suggests that this is a matter of pro- and anti-globalization, although that may be putting words in Obama's mouth, who is arguably anti-globalization. Trade hasn't been much of an issue recently, as exports are up 15.5% this year (probably due to our weak dollar more than anything else).

Obama said in Pennsylvania in April that “trade should work not just for some Americans, but for all Americans, not just for Wall Street, but for Main Street,” and is a proponent of including labor and environmental provisions in trade agreements with other countries. Elsewhere, Obama has promised that he “will fight for a trade policy that opens up foreign markets to support good American jobs,” although I have no idea how he expects that to happen, as opening up foreign markets would do anything but support costly American jobs.

McCain expresses a much less isolationist rhetoric, stating that "the U.S. should engage in multilateral, regional and bilateral efforts to reduce barriers to trade, level the global playing field and build effective enforcement of global trading rules." The result of this rhetoric is theoretically healthier and more competitive multinational corporations (many of which are based in the US), as well as raising the standard of living in developing countries through increased foreign direct investment (a good thing).

Now as a good college student, I am naturally leaning towards Obama, and look forward to seeing how his rhetoric (hopefully) shifts towards the center as debate heats up between the two. It is worth mentioning as well that McCain is notoriously ignorant of economics, which is also pretty disappointing.

And something of a surprise, guess who Mr. Murdoch is leaning towards....

The January Effect

I learned this at work the other day and thought I would share. Turns out taxes do more than just take your money away. The January effect is a bounce in stock prices in January due to the absence of abnormal selling pressure taxes create. This does not happen in all stocks; you see the most results from small cap stocks that have gotten beaten down during the previous year, although mid to larger cap stocks are affected also, just not as much. There are a couple reasons for this phenomena. First is because of window dressing from professional investors that manage large funds. They eliminate their losses from their portfolio and add winners to improve their perceived performance. This is because professional investors are evaluated on both their investment results and consistency of their investment philosophy. This also occurs at the end of each quarter because of professional investors; however, it does not result in the same increase in stock prices. The second reason is because of abnormal selling pressure prior to the end of the year. This pressure is a result of taxes. People/investors want to sell their stocks that have lost them money during the year to obtain the tax losses. Thus, towards the end of the year everyone sells their losers which causes them to go down more. When the New Year begins there is no abnormal selling pressure from taxes. This lack of selling pressure results in increased prices of stocks that were affected from the abnormal selling pressure. The bounce usually occurs within the first 10 – 14 days of the year. If no bounce occurs within the first two weeks, there usually will not be a bounce. Here is a good example of the January Effect on Las Vegas Sands Corp (LVS). Back In 2005 LVS hit a high of $49.05 in Feb; hit its low of $31.37 in Oct.; rebounded to 45.51 on Nov 25 and closed two weeks later at $38.73. This decrease could have resulted from the abnormal selling pressure. The last trading day of the year, Dec 30, the stock was at $39.47. By January 6, ’06 the stock price was at $41.61, by Jan 13 it was at $48.35, and by Jan 20, $49.66. After looking at past predictions for possible Jan. Effect stocks, the best way to win by using this theory is to use a basket of stocks that you have researched and that you believe could bounce in Jan. Some of our own Professors and alumni at U of I have written on the topic as well.

Market Summary: Thurs. June 5, 2008

DJIA 12,604.45 +213.97 (+1.70%)
Nasdaq 2,549.94 +46.80 (+1.84%)
S&P 500 1,404.05 +26.85 (+1.91%)
NYSE Composite Volume 1.31 bln

2-Yr Note 2.52% +0.05
10-Yr Note 4.06% +0.08
30-Yr Bond 4.75% +0.04

Dollar Index 73.038 -0.386
Crude Oil (July) 127.79 +5.49
Nat Gas (July) 12.519 +0.140
Gold (Aug) 875.50 -8.30

Market Summary: Wed. June 4, 2008

DJIA 12,390.48 -12.37 (-0.10%)
Nasdaq 2,503.14 +22.66 (+0.91%)
S&P 500 1,377.20 -0.45 (-0.03%)
NYSE Composite Volume 1.29 bln

2-Yr Bond 2.47% +0.02
10-Yr Bond 3.98% +0.08
30-Yr Bond 4.71% +0.04

Dollar Index 73.424 +0.184
Crude Oil (July) 122.30 -2.01
Nat Gas (July) 12.379 +0.158
Gold (Aug) 883.80 -1.70