The market got a massive rally after a week of pounding – it was as if the investing community was sick of bad news and just drew a line in the sand. Certainly a bailout of one of the world’s largest banks was not the (or should I say should not) be the reason for rejoicing – but it seemed that Citi’s bailout got investors to come out of their treasury hidey holes for another brief euphoric rally. Again – I would point out that a bailout (of yet another failed business) does NOT mean the worst is behind us – regardless of what the talking heads say.
I did get some feedback about the Citi bailout – mostly criticizing my criticizing of the plan. It’s almost as if some people are slowly being convinced that bailing out everything and everyone is the only way. A couple emails I received (from well informed and very smart individuals) read as if they just are giving up – what else is there to do – “As a tax payer, I don't care if the government is using our money to bail out these companies as long as I get good risk-adjusted returns on the bailout. These may be good investment opportunities.” – WHAT, I responded? It would seem that Congress has taken a page from Bush’s Playbook – Lesson 1: Repeat, Repeat, Repeat – (If people hear it over and over again – it MUST be true.) Congress, Hank, Ben, and the rest have been TRYING to convince us that these “bailouts” are GREAT investment opportunities. If you believe that – the brainwashing is working.
Let’s look at it SIMPLY as a investment opportunity (which has been sold to us as a GOOD investment). You be the judge.
First – you have already lost 20 billion – but now you are going to reinvest more.
Second – you are making another investment of 20 billion for an 8% return. On the surface that sounds pretty good – however there is a catch. Not only can you lose ALL of the 20 billion (which is typical with any investment in the markets) – but you are going to be on the hook for 15x that amount as well ($300 billion in additional guarantees). Now – if I was negotiating this deal – I would say – no PROBLEM – but I need 8% on the full $320 billion – not just the 20 billion. No investor in the WORLD would take on 15x risk times capital with no return on risk. Let’s look at it this way – you are really on the hook for $320 billion, but you are getting 8% on $20 billion. So the real return on risk is .5% (only half percent). Remember – this paper is not credit worthy – and it has already been pointed out that 1/3 (100 billion) should have a rating of FAILED.
Third – you are getting warrants for 2x the current stock price. Now warrants are usually a reward to purchase more shares – over a period of time. Most of the times these are at par value of the original investment – sometimes it has a slight premium (if the company tends to be more successful or expectations are for some positive event to happen.) But for a 2x value on the warrants – is pretty much garbage as it pertains to the $20 billion investment vs. $300 billion of risk for a .5% return vs. risk.
Let’s revisit –
Invest $20 billion for $320 billion of risk. Your return on $20 billion is 8% (or .5% on net risk). You are also getting the ability to purchase another 250 million shares at 2x the current stock price (if it ever gets there).
Now let’s look at Buffets investment in Goldman –
Invest $5 billion for 10% return, no additional risk. Warrants to buy $5 billion more in stock at par value to the original investment.
Hopefully you can see the difference. Which investment would you make?
These are NOT great investment opportunities no matter how they spin it – and IF there is any money made from these investments it is because of LUCK not because the strategy was sound. Unfortunate – most investors do not know the difference between luck and sound investment strategies.
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Commodity Risk
So much has been placed on the price of oil and its impact on shipping cost, however supply / demand and the cost of producing/mining is still at hand. Remember – in this nation 2/3rd of the GDP is fueled by consumer spending – which trickles back to the source. If consumers don’t have capital or credit to spend – then it doesn’t trickle back to the mines or farms for the commodity. What does that mean? It means less is produced on the false sense that demand is failing. But is demand really failing? I say false sense because many of these commodities are NOT decreasing in demand – rather their prices are coming off on the assumption that they will. The major commodity that I am talking about is agriculture – FOOD. The world’s population is still growing and true farmers might see some short-fall in the short-term. Many farms have grain storage – the problem with storage is the production-consumption gap. It’s is the same with the SPR (Strategic Petroleum Reserve). The farmer produces less (because cost out strip revenue), the storage makes up for the slack in supply, and then the gap between production-consumption widens. The commodity hits a massive short fall even though demand could remain constant or slight contract – the supply line has run dry.
The military has an impressive logistic operation – which is very interesting – WWII was a massive experiment in managing, supplies, demand, storage, and transportation. Those same logistics SHOULD be applied to current commodity trends – the reason that it is not as simply to measure is that there are several different cogs in the wheel (from the farmer, shipper, seller, and consumer). They make assumptions and decisions based on cost and revenue – the military on the other hand controls the entire flow - from start to finish. I am not advocating military intervention – but I am saying using the military logistic models should give a better picture of commodity prices based on supply and demand channels. WWII was won not on might (no doubt the German’s had the better weapons for the most part) – it was won on managing the logistics and supply chains to keep the man in the field – feed, fueled, rested, and loaded. Getting Sherman’s, M1, Mustangs, ammo, food, etc – to the front on a continual basis was indeed one of the greatest logistical problems in history. A lesson we could learn from and help price commodities based on those logistical models.
Brazil is already seeing growers reduce crops – as revenue dries up. However – does that mean people are going to consume less “NEEDED” commodities? We could very well see a spike in commodity prices in the near future (3 months, 6 months, 1 year) – I believe it WILL come – the time frame and the sharpness of the spike will be based on the credit problems, bailout, and currency rates.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aHwqWQnFqZLE&refer=home
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Fed Pledges $7.7 Trillion
Here is a quote (from Bloomberg) for a little wake-up call if your coffee hasn’t kicked in: “The pledges, amounting to half the value of everything produced in the nation last year..” WOW – that is a massive number by any standards. My concern is not the bailout or if it will work but what do you think is going to happen to the dollar. I mean how much can you print and HOPE to have paid back via the sale of Treasuries.
http://www.bloomberg.com/apps/news?pid=20601109&sid=an3k2rZMNgDw&refer=home
Here is the “hope” model of Congress/Fed/Treasury to sum it up for you.
1. We are going to print a butt ton of money (we have the printing presses so that is easy).
2. We will (hope) to sell enough treasuries to finance the printing of all the money (if we don’t we create inflation – the measure of that inflation will be based on how many treasuries we sell or don’t sell).
3. To keep our payments down – we are going to lower interest rates to as close to zero as possible. We can’t afford to pay higher rates.
4. We expect (hope) that because the USD is the world’s reserve currency – foreign nations will still HAVE to buy it – even at very low rates – so we SHOULD be ok to print a bunch of it.
5. At the end of the day – the TAX payer will be on the hook for it over the next 20+ years.
6. We could raise taxes on some/all of the citizens – or like in WWII issue a NEW tax to pay down the bailout.
There is a lot of assumptions and hope involved in this strategy – mainly the HOPE and ASSUMPTION that the USD will remain strong and the world’s reserve currency. I would argue that confidence in that is seriously eroding fast – true it is still above 50% as a reserve currency – but it is falling fast. Also the implosion of the banking and insurance is not bringing any confidence into the market.
This boils down to one big concern – USD risk. The economist reported that S&P and Moody’s might be lowering the USD treasuries credit rating from AAA. Of course you can bet there is HUGE pressure by the government on those companies not to do so and additionally S&P, Moody’s, and Fitch’s creditability is already in question with their ratings of CDO, SIV, and other structured paper that has failed.
It’s time to hedge dollar back assets - IMHO Jim Rogers and Peter Schiff are right -
Peter Schiff on Fast Money (He called the housing and credit collapse) – you have to suffer through about 45 sec of useless Fast Money garbage before they bring him on as a guest – but it’s worth hearing to what he has to say:
http://www.cnbc.com/id/15840232?video=935047784&play=1
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Futures Pre-Market
The futures are getting a follow-up pop in the pre-market with a new $800 billion of FED money in NEW PROGRAMS – YEAH! Spreads are in play – expect ARB traders to short futures and buy the cash into the opening.
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Support / Resistance
The rally continues – supports are still in play .
INDU 8000 / 9000 (We will probably hit a euphoric wall around 9000 when people realize the worst is not really behind us. )
NDX 1100 / 1200 (Again – may see resistance around 1200)
SPX 800 (850) 900 (850 is the pivot point)
RUT 400 / 450 – 500 (450 would be an interesting level to get through and would show broader strength)
This is a bi-polar market – expect anything.
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Conclusion
Well the numbers are not looking good and recession is certainly on its way. If I had showed you some of the current headlines last year (Lehman fails, AIG bailout, Citi bailout, etc.) would never have believed it. I wonder what future headlines would look like – a forum I read had a thread with a couple of examples – but this one really got a LOL out of me, ”SOMALI PIRATES APPLY TO BECOME BANK, AIM TO ACCESS TARP"
Don’t buy too much into the rally without hedging your long deltas. There is still more to resolve before we can even SEE a light at the end of the tunnel.
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