7/29/08 (Soap Box, Merrill Needs Money, Inflation?)

Traders,

I guess last week’s was as expected, one big fat dead cat bounce – ending in a splat. The euphoric rally was based on government intervention, rule changes by the SEC, and the world’s largest bailout – rather than the kind of legs a traditional rally is built on – SOLID FUNDAMENTALS. The economic landscape in this country remains poor at best and every day brings new revelation as to how far these credit problems extend. But if we just keep the big picture simple – it so easy to see. This country is built on credit, massive credit. It is just not individuals that have borrowed beyond their means – it is corporations as well. Banks carrying 5:1, 10:1, even 20:1 leveraged positions/debt against actual deposits. Congress giving the green light to Freddie and Fannie to increase their debt leverage to 100:1.

The psychology of this country is the fundamental problem that needs to be changed. It’s the “keeping up with the Jones” and the need for materialistic wealth that has taken this country and its citizens to debt hemorrhaging levels. And while all these people have leased expensive cars, credit spend their high-end fashion, and mortgaged their way to prosperity – they NOW do not want to pay (or cannot pay) and it is NOW time for Mommy Government to bail us out.

The citizens in this country also have a serious problem with accountability and responsibility. In corporate America the employees are never given latitude to make decisions – and thus there is no accountability or responsibility. Students are giving free passes in school when they screw up – public schools are lowering their curve to make sure EVERYONE passes – for they cannot have kids fail – because of the way the system is built. For an early age we are subject to societies ways of judging a person by their materialistic wealth and taught early how to “pass the buck”.

Our public school systems are breeding grounds for socialist behavior, and through no fault of the teachers - but rather the system as a whole. Competition is frowned upon and teaching kids how to accept failure, take accountability and responsibility to pick themselves back up is no longer acceptable. Either get them out of the system (drop out) so they are NOT counted as a failure or pass them by lowering the grading curve. The most valuable resource in this country is EDUCATION – our teachers need to be incentivized, they need to allow children to compete, they need to be allowed to FAIL students, they need to be allowed to grade their students respectively (not forced to grade on a ever lowering curve), they need to be able to teach without fear from the administration, government or unions dictating policies that breeds mediocrity. It’s ironic that I come from a family of public school teachers – but I even hear the same from them.

This generation and the generation before and future generations in this country are becoming complacent. And complacency is not what America is about. We need to stop pointing fingers at the speculators, at the short sellers, at the Democrats, at the Republicans, at anyone but ourselves. We need to stand up and take accountability and responsibility. We also need to hold our elected officials to even a higher standard.

We also need to stop giving everyone a free pass – and blame others. Corporations that made bad lending decisions need to fail, borrowers that borrowed to much need to take the losses. A massive bailout does nothing but breed socialism, more government control, massive inflation, and more taxes. A loss is a loss, passing it to the government does NOT eliminate that loss!

I’ll get off the soap box now….sorry. Just was a little fired up this morning.

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Merrill to sell shares?

Companies have a multitude of ways to raise money, the last resort is to sell your own shares into the market. Just like with anyone – buying or selling securities is about a value judgment. Whenever I see companies selling shares to raise money, I ask myself why? Mainly because when a company is selling shares – they are diluting their ownership in the company. Giving up equity ownership is never a good thing, unless you are getting well paid for it. And getting well paid is a value judgment, obviously you think the price is high enough that it should be sold. Thus you think the price is over the value to where you would buy it.

When companies sell stock, it usually means that traditional methods of borrowing are either not attractive, they can’t get any, or they already have so much on the books that more debt and interest payments will just further put them behind an eight-ball. No matter how you slice it – people, companies, investors, anyone never sells their equity ownership if they think things are great an going higher! So don’t read into it for anything more that it is – the Company needs money, bad enough that they can’t borrow or will not borrow because rates are too high (when rates are too high – it’s for a reason, which equals RISK) – plain and simple. Remember – keep it simple, stupid (KISS) – will usually get you the answer you are looking for.

So let’s get to the numbers, Merrill (3rd largest securities firm) is selling $8.5 billion shares to raise money and liquidating $30.6 billion of their bonds (at 20% of their face value – that’s a 80% lower) to shore up their credit exposure. Of course they have found a buyer for a big slice of those new shares (of course a Sovereign Wealth Fund). Additionally – more write downs are to come – it looks to be $5.7 billion in the 3rd quarter.

What gets me is that the new CEO Thain, has been saying (like others) “The worst is behind us!” – that slogan/speech is getting old fast. He is now back-tracking on all these promises and assurances that Merrill has weathered the storm and now a new fresh load of write-downs are around the corner.

I keep saying this – until they write-down to ZERO – it is simply a game of Mark-to-Myth. These are illiquid positions, which most are defaulted, and while Thain and others say they want to sell it – there are just no buyers. It’s like owning a house in this market, you may want to sell it for $1 million dollars, your appraiser might even tell you it’s $1 million dollars – the reality – it isn’t worth a THING unless you find a buyer!

Regardless – while the stock is not seeing too much stress in the pre-market. It is NOT a good sign that the worst is behind us. Expect more write downs and continued more stress in the financial sectors.

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Inflation = exchanging one fiat currency for another?

In Zimbabwe they are printing higher denominations daily it seems. They even have a 10,000 million bill now. Of course it is all worth nothing – but such is the twilight years of a fiat currency. At some point you have to stop printing money, because in the end it is just paper. I find it humorous watching BBC World News – seeing videos of these Black Market Zimbabwe exchanges. These people show up with billions of dollars (stacks of 1 million dollar bills) to exchange them for another fiat currency the US dollar.

As of yesterday the exchange rate for $1 US dollar was $54,209,000,000 – and is inflation is rocketing so fast that it is impossible to measure. Now Zimbabwe is printing the billion dollar bill. That’s right the billion dollar bill (I am going to try to get one – just to hang on my wall).

Let me explain why this is so important to understand. The US dollar is a fiat currency and we NEED to monitor M3 (money levels) because it keeps track of the total money in circulation. Unfortunately the FED, Congress, and the Government do not feel it is important to monitor this anymore. Sure they can give you all kinds of reasons and they might sound good – but the reality – we NEED to know how much money we are printing. Because at the fundamental level – printing more money is a core function of inflation.

The only reason the dollar holds any value is because we BELIEVE it has value. I like to call FIAT currencies Faith Backed currencies, once you lose the faith – well you end up with Confederate Dollars very quickly. Now there is nothing wrong with using this Fiat currency – as long as the Treasury, Fed, Congress, and the Government are forthright about inflation and the printing of money. However, recently (under both Democrats and Republicans) we have changed the method of measuring inflation (CPI methodologies) as well as stop measuring the printing of money (or amount of money) also known as M3. Remember – let’s keep it simple, stupid (KISS).

So where am I going with this – well Fannie and Freddie, as well as these banks are getting access to borrow money at the Discount Window (not part of the rules – but those rules are changing daily it would seem) – by not allowing companies to citizens to fail – the government bailout requires the printing of billions if not trillions of more money (without the selling of more treasuries) – thus the money in circulation increases (M3). This is not a good thing – because it “Cheapens” our money and creates more inflation.

My concern is not the recession as much as it is the fast track road to hyper-inflation, like the 70s. We are heading fast down that road – with this massive bailout and while we might not be printing any billion dollar bills soon. We need to focus on investing and protecting from the standpoint of BUYING POWER, rather than FACE VALUE.

It’s never about how much money you have, it’s about how much buying power you have.

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Futures Pre-Market

The futures are getting a good boost in the pre-market – part of the “worst of behind us” news from Merrill is bringing back some confidence (while skeptical at best). Additionally the British Airways merger talks is also giving some pre-market upside jolts. However the spreads are fairly narrow and after yesterday’s drop, I don’t think you will see too many Arb traders take the risk of legging into the opening. Expect a small pop at the opening.

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Support / Resistances

Well we are getting back down to those support areas pretty quickly – this back-n-forth between the supports and resistances have been driving investors crazy, but traders (market makers) are having a good old time.

INDU 11,000 / 11,500 (I guess that 11,250 area was just butter – is 11k in the cards? Certainly – but don’t start getting long again and hoping for a rally. This is trader country and investors should be paying attention to beating the rate of inflation – not trying to pick a bottom.)

NDX 1800 / 1850 (We are right there – at support – it looks like we are getting some pre-market upside for now. Watch the close)

SPX 1200-1225 / 1250-1275 (It is a little hard to call it – other than to say we are in the volatile middle. Hedge those hard deltas – a move either way is possible.)

RUT 700 (Yikes! We are below 700 – I guess the rush back to treasuries was in the cards. We need to close above 700 to show any support in the broader market.)

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Conclusion

Sorry about my diatribe today, I had 3 conversations this last weekend – mostly that got my anti-socialism hackles up – so I needed to vent a little. These are pressing times and trying to find a scape goat is not what we should be doing. It is also easy to run to mommy (government) to have them solve the problem, but if we judge their ability to manage anything by the likes of Freddie and Fannie (well I don’t want them balancing my check book or making investment decisions). The government is in the process of bailing out its own bailout. Not a good thing.

It’s time we step up to the plate as individuals, take some accountability and responsibility, and roll up our sleeves. Those that took the risk, have to eat the losses – that is the way it has to be. Stop blaming the rich, Wall Street, Short Sellers, Speculators, etc. Those people that borrowed money interest only to buy their McMansion, used credit cards to buy this or that, leased a car, etc. Have no one to blame but themselves. Passing the buck doesn’t solve the problem. Same is true for those companies that lent to high risk borrowers – stop passing the losses and step up to the plate and eat them.

This massive government bailout will force this country into a Socialist State very fast that will be married with hyper-inflation!

Socialism is having no accountability or responsiblity and trusting the government knows what is best for you.

You roll the dice, now pay the piper! End of story.