Helicopter Ben to the Rescue!
Wednesday, March 12, 2008 | Teeka TiwariRating:
In what some will call a final act of desperation, Helicopter Ben has released the hounds and flooded the world with cheap cash. That gnashing and wailing you hear is the sound of the short sellers complaining about “market manipulation”. And you know what - they are right!
The Fed made a momentous decision yesterday to start funding the mortgage market directly by saying that they will swap Treasurys for A-rated mortgage securities. What they are essentially doing is providing liquidity in a market where none currently exists.
Fear is so high right now that no one will touch mortgage debt. Credit liquidity is the gas in the US economic engine, and if the “gas ain’t flowing, the engine ain’t running.” So the fed isn’t giving money away, what they are doing is facilitating the flow of money again. Essentially, they are priming the pump and attempting to restore trust and confidence back to the secondary mortgage market.
Some will see this as a sign of deep fear on the Feds part and, after the first blush of yesterday's run up is over, we may drop again, or this may be the line in the sand that we rally from. I think it’s too early to make that determination. What I can tell you is that the game is rigged, it’s always been rigged, and that’s just the way it is.
Don’t be naive and bemoan an apple for being an apple. As much as you may want an apple to be an orange, it will always be an apple. The world is run by a cadre of very wealthy families and institutions, and they will always bail themselves out - always.
We get to go along for the ride. The problem is that most people sell when the big boys buy and buy when the big boys sell. Always remember that self interest drives the stock market; it will never be allowed to fall into the ocean the way that some pundits would have you believe.
Take a look around - things aren’t as bad as in previous down cycles. In my opinion, 1991 was far, far worse. In 1991, commercial real estate was finished - you couldn’t lease an office building to save your life. Corporate balance sheets were rife with debt from the M&A craze of the 80’s, and the banks were essentially bankrupt from bad real estate loans, bad third world loans, and huge losses on their junk bond portfolios.
In 1991, unemployment was at over 7%, oil was trading at $40 a barrel, and people genuinely thought that the sun had set on American prosperity. In short, investor sentiment was horrible.
Fast forward seventeen years and here we are with a very similar set of circumstances. Investor sentiment is outrageously bearish, we have $100 oil and credit markets are in turmoil.
I’ll tell you what we don’t have - we don’t have weak corporate balance sheets. In fact, America’s corporations have never been better funded with such low debt levels. We don’t have a commercial real estate crisis. Sure, there are regional pockets of commercial real estate weakness, but the market as a whole is very strong. Commercial rents are up and are holding steady.
Oil's over a $100 bucks and that’s a big deal, but also remember that for the last 25 years oil had been ridiculously cheap! Some could argue that all we are seeing is a reversion to the statistical mean on energy prices after almost three decades of near zero inflation in energy costs. In fact, even today at $3.40 a gallon we pay less for our gas than any other western country!
We don’t have high unemployment. At a 5% unemployment rate, we are showing remarkable strength. Sure that can change, but so far it hasn’t.
What is hurting us is that the banks are severely beat up. BUT the banks are holding mostly good quality paper. It’s not like they went out and buried all of their money in pets.com stock. Their CDO portfolios (collateralized debt obligations) are very well diversified portfolios of domestic and international debt securities. Everything from Australian car loans to German credit card loans. Over the life of the CDO security, the default rates are quite low. The problem the banks are having is that they use the CDOs as collateral to finance their lending operations.
Their CDOs must be marked to market every day. The resale market for CDOs has COLLAPSED, so the banks have to write down the value of the CDOs they own based on a reasonable assumption of what they can sell them for. In a thin market like we have now, it is artificially warping the value of the CDOs downward, causing the ripple effect of continued mark downs by the banks. This, in effect, is shrinking their balance sheets and curtailing their loan making operations.
BUT it’s not like someone broke into the banks and set fire to all that money. At maturity, the banks will get virtually all of their money back on their CDO investments. So what will happen is that as the credit markets stabilize, we will begin to see banks start to mark up the value of their CDO assets.
Back in 1991, when the banks lent billions to the third world, they eventually got every cent of that money back. The so-called worthless junk bonds that were on every banks and corporations balance sheet also turned out to be spectacularly successful, as did most of their commercial real estate loans.
You cannot confuse a short crisis of confidence with a long term erosion of capital. Just like the junk bond market collapse of the early 90’s, the issue was a loss of confidence in the market - the underlying securities ended up doing very well. The same is true for today’s current mortgage and CDO market.
All we are seeing is the natural progression of the business cycle. There is nothing “new” or “different” going on.
So what’s the take away?
Don’t bloody panic, stay calm. The US equity market and the US banking system are not falling into the ocean.
Focus on companies that have long-term above-average earnings growth potential, and use this market weakness to buy those securities. If you trade hard assets, take a good long look at buying income producing real estate, classic cars, art, and collectibles. There are some great deals to be had in these non-traditional investment areas.
In economic slowdowns, cash is king. Remember the golden rule: he who has the gold makes the rules. We are in a buyer's market; you, the buyer, have the power. Only buy on terms that make the most sense for you.
The multi millionaires of 2010 and beyond are being made today. Don’t blind yourself to the opportunity that fearful times bring. Be confidant, be bold, and buy on your terms!
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Teeka Tiwari
Chief Investment Officer
ETF Master Trader
