Editor’s Note: In this series of articles, we include important or interesting videoclips with our comments. This
is an article that expresses our personal opinions about comments made
on Television and in Print. It is NOT intended to provide any investment
advice of any type whatsoever. No one should base any investing
decisions or conclusions based on anything written in or inferred from
this article. Investing is a serious matter and all investment decisions
should only be taken after a detailed discussion with your investment
advisor and should be subject to your objectives, suitability
requirements and risk tolerances.
QME & the Energizer Bunny!
This Fed just cannot stop. Their Operation Torque (Twist as others call it) is barely a month old. Already the Feds have begun a verbal campaign to pump more liquidity. In a speech at Columbia University on Thursday, October 20, Fed Governor Daniel Tarullo publicly called for a new program to make large-scale purchases of additional mortgage-backed securities, or Quantitative Mortgage Easing (QME). The idea is to provide support to mortgage lending and housing markets.
This Energizer Bunny Fed just can’t stop. We are so fed up with this Fed that we won’t waste any effort, web-ink or space to discuss the failure of the previous Fed purchases.
Except to say, the S&P broke out of its trading range the day after the speech by Governor Tarullo. The Australian Dollar spiked, the Euro spiked and 30-Year Treasuries fell. Looks like the Risk On march followed the drum beat of the Energizer Fed.
Back to the Future in Europe?
Europe is back to a France-Germany conflict. This time over recapitalization of French Banks. Germany, so far, refuses to bail out French Banks with German money. If Germany does not and France recapitalizes its Banks, France is certain to be downgraded. Actually, France might be downgraded anyway. And then EFSF, the European Stability Fund might not work as a solution. And the EFSF might fail anyway.
We are really fed up with Europe. Just downgrade them, we say. Downgrade France and Germany to AA. Why
would that be so bad? At least, the pretense would end. And if
everybody is AA, then c’est la vie, the markets might say and look
Larry Fink of BlackRock seems fed up with Europe as well. He warned this week that markets may be disappointed with what is being discussed about EFSF. Then he made the same points that Josef Ackermann of Deutsche Bank made last week – that European Sovereign Credits have to be stabilized before Banks (see clip 2 below).
The S&P Breakout
The US stock market is clearly looking ahead. It also seems fed up with Europe. As long as there is no actual bad news from Europe, it is prepared to ignore Europe. A postponement with a positive outlook is all it demands. The earnings have come in OK. The economic data is surprising a bit to the upside. The S&P broke out of the 1220 level on Tuesday. But that proved false as it closed below that level on Wednesday and Thursday.
But on Friday, perhaps due to the QME possibility, S&P broke decisively above 1230 to close at 1238. So far, October 2011 has been the best month for stocks since 1982.
The US stock market seems under-owned. It does go down on bad European news but it bounces fiercely on even the faintest of positive European rumors. It helps that we are in a seasonally strong period.
Mary Ann Bartels of BAC-Merrill said the S&P can go to 1260, 1270. Heck, that is just another day like Friday. She does not expect to test the lows this year (see clip 1 below). She thinks the lows might be tested next year. But that is an investment lifetime away, meaning after this year’s performance fees are calculated.
Currencies & Fund Flows
Well, the US Dollar “secular” move lasted just a little bit. This week, the Australian Dollar acted well and the Euro looks as if it might get to 1.40 fast. The Fund flows also point to resumption of risk appetite according to Michael Hartnett of BAC-Merrill Lynch. In his words on Thursday:
- Huge $3.2 billion weekly inflows to High Yield funds = largest since 2003 as % AUM;
- biggest redemptions from US Treasury funds since Oct’2008, only 2nd weekly outflow in past 27 weeks,
- 1st inflows to EM equities in 12 weeks & 1st inflows to EM debt in 5 weeks,
- 4th straight week of inflows to Financial funds, longest winning streak since Feb’11.
So what should we do? According to Mr. Hartnett:
- If next GDP revision is up, go long stocks, if next GDP revision is down, go short stocks.
He points out that US GDP revisions and US Bond yields have been correlated this year and both edging higher.
Treasuries, High Yield Bonds, US Economy
Edging higher is a good way to describe the action in yields of long maturity Treasuries. The Treasury market is still the beneficiary of the “insurance value” as Steven Walsh of Western Asset Management put it this week (see clip 3 below). How much insurance does Mr. Walsh need? He is at 2/3rds weighting in Treasuries, he said.
Clearly risk is on and clearly there is no recession according to many Pandits. So money has to be invested in High Yield Bonds. Last week, Jeffrey Gundlach threw cold water on this idea arguing that default risk is rising and that mitigates the cheap valuation. This week, Steven Walsh only admits to “nibbling” in high yield.
But Larry Fink of BlackRock seems more interested in High Yield Bonds than Gundlach and Walsh (see clip 2 below). Mr. Fink was semi-prophetic in 2007 and any one who listened to him in 2007 saved a lot of money. This year has been very different for Mr. Fink. Anybody who listened to Mr. Fink in June-July 2011 got burned. On June 29, 2011, Mr. Fink said he would rather be 100% in stocks. Then on Wednesday, July 20, Mr. Fink told investors to Stop Being Chicken. He told Maria Bartiromo “ Equities are relatively cheap vs. almost any other asset class“ (see clip 2 of Videoclips of July 16 – July 22, 2011). Then the stock market fell apart in August 2011.
Since Financial TV has begun dismissing recession fears, we gently remind readers that Rosenberg & Company have spoken about a slowdown beginning in Q1 2012 or Q2 2012, not in Q4 2011. So it may be too soon to dismiss fears of a recession in 2012. Those who concur should welcome a sell off in US Treasuries in October and hopefully in November. A good buying opportunity is worth the wait.
- Mary Ann Bartels on CNBC Closing Bell on Wednesday, October 19
- Laurence Fink on CNBC Closing Bell on Wednesday, October 19
- Steven Walsh on CNBC Squawk on the Street on Wednesday, October 19
1. Lows of the Year in – S&P can go to 1260, 1270 – Mary Ann Bartels on CNBC Closing Bell – Wednesday, October 19
Actually this clip features two expert guests, Mary Ann Bartels of BAC-Merrill Lynch and Kathy Jones of Charles Schwab. The interviewers are Maria Bartiromo & Bill Griffeth.
- Griffeth – You think we have hit the lows for the year?
- Bartels – It is possible we have hit the lows of the year. And I expect the markets to remain very volatile depending on what we hear out of Europe. But we haven’t ruled out that we would test the lows or make marginally new lows possibly next year.
- Griffeth – Do you think given the uncertainty in Europe, the Treasury markets are reacting accordingly or are they still artificially low because of the Fed right now?
- Jones – I think they are really reacting to the ne
ws but the Fed is certainly helping us out.
- Griffeth – Don’t you think yields would go higher necessarily, I mean lower if they were really concerned about the markets?
- Jones – yeah absolutely. We have a big safe harbor bid in the long end of the Treasury curve and I think that will remain the case for awhile. We also have the Fed just beginning Operation Twist and they have only done about $15 billion out of the $400 billion. So even when the yields pop up, I think they won’t go very far.
- Bartiromo – Mary Ann, you say we may have hit the lows of the year. What are you looking at to make you believe we are bumping along the bottom and we’ve seen the worst?
- Bartels – I‘m sure you remember that day when the markets went straight down to 1074. In the last 20 minutes, we kind off rallied very sharply and now we are above that 1100 mark. So there is some support. Yes, at 1074 but even like 1100, 1150 there’s some support. But we do have a seasonal positive bias. Just looking at the seasonals, generally November, December are a good seasonal period for the market. And the markets did get very oversold. But I still think the markets are hostage to Europe... Really technically what we’re doing is we can’t get above 1230 on the S&P. If you get above 1230, you can go to 1260, 1270. If we don’t get above 1230, we can drift down to 1150, 1100. But I am not sure we are going to 1074 this year.
- Bartiromo – Now we are at 1208. I was reading your research yesterday and it was about volume. You said, even when we’re looking at a rally, the volume does not confirm that it is a rally. Even if we have seen the worst of the year here, you’re not necessarily predicting a rally?
- Bartels – Not a huge rally. Really the rally that we saw really came from the short covering. The evidence points to the Shorts covering. You really need buyers to step up and then follow through. You always have the shorts come in first. but if those buyers don’t come in, the market can’t keep a bid.
- Bartiromo – … given what we know in Europe and the U.S. economic landscape, are higher interest rates a 2012 affair or 2013?
- Jones – I would say probably 2013. I would not say very soon. The Fed is going to keep them where they said they would. Zero into 2013, barring a big surprise on the upside. And I think long-term rates will continue to stay low, maybe even drift a little lower.
We did get above 1230 on Friday, October 21. The S&P closed at 1238.
2. BlackRock’s Fink One-on-One – BlackRock’s Laurence Fink with CNBC’s Maria Bartiromo (11:51 minute clip) – Wednesday, October 19
Larry Fink is the Chairman & CEO of BlackRock, a firm that manages about $3 trillion of investor assets.
- Fink – I think the marketplace is quite confused. We’re seeing governments worldwide focus on incrementalism and not long-term planning. That’s putting a deep chill into the marketplace. We’re seeing that in Europe and as a result of that deep chill, we’ve seen outflows in Europe in our mutual fund area but not as much as the industry.
- Fink – … But in terms of the pension funds, they’re witnessing a decline in their interest rates, which reassesses their liabilities to be more expensive. At the same time, the equity market has fallen around 20%. So our pension clients worldwide are struggling, what to do here. They’re certainly not in denial but they’re taking a step backwards now and saying, how do we think about asset allocation?
- Fink – I think as a stabilizer views, they’re probably going to move a great sum of money out of bonds into equities because at 2.5%, you cannot meet your liability. It is impossible to meet your liabilities. Most pension fund liabilities, they promise to their schoolteachers or firemen about a 7.5% rate to meet that liability, and earning 2.5%, you’re just not going to get there.
- Fink – Bonds are a great investment if you think the world is going to be terribly unsettled and if you think that will persist. So it’s really a tactical decision. When do you think the marketplace can be stable enough to start dipping your toes back into equities and do it in a substantial way because bonds will not achieve your needs.
- Bartiromo – right. and of course we just had someone on earlier in the last hour saying that higher interest rates, anything that’s really competitive wit
h the stock market, not really happening until at least 2013, 2014. So you have this volatility and uncertainty keeping people hunkered down. You’ve been meeting with institutional clients the last couple of days. tell us what they’re telling you given the fact that combined you’re talking about $3 trillion under management, more than $3 trillion. You say the theme is finding the high hanging fruit. tell us about it.
- Fink – well, high hanging fruit, I don’t think there’s anything totally obvious that’s low hanging. So we use this high hanging fruit as our theme in this conference. And it takes more long-term views to make any real strategic decisions. But some of the high-hanging fruit in my mind is Credit, is High Yield. We are going to be enjoying higher coupons. But also we believe moving into alternatives is going to play a large role as the pension funds start rebalancing. So it’s going to mean moving some of the money that they’re sitting in bonds and cash into more credit decisions, into more Preferreds. If you could earn a 7.5% to 8% return on some of the Preferreds, that’s going to look really good versus your liability. And then you’re going to have to make a judgment on emerging markets and the rest of the world. Emerging markets and the rest of the world are down quite a bit more in the third quarter than the U.S. So all those mavericks, including members of BlackRock, saying diversify. Actually in the third quarter, diversification did not work. but I think over a long cycle, you want to follow where GDP is. You want to go where the countries of growth are to get the returns above 7%. And so what we’re suggesting is diversifying worldwide into multi markets, diversify into more alternatives. diversify into more credit strategies.
- Fink – and importantly, as we talk about Europe, the European banks are going to have to sell hundreds of billions of dollars of assets. there’s huge shortfalls in their equity accounts to achieve their Basel III requirements. and one way of achieving the necessary capital requirements is to reduce your balance sheet. and so you’re going to see huge amounts of assets being liquidated by European banks. that may present a very good opportunity for investors as these securities and assets are sold by the Europeans.
- Bartiromo – Larry, the regulatory framework here in the U.S. as well as in Europe, what are you expecting to come out of Sunday? You’re speaking to these government officials all the time. A lot of talk that the market is going to be disappointed with the recapitalization plan around European Banks.
- Fink – well, it appears that Europe cannot hold a secret, so you’re seeing and hearing all these different types of opinions. From our view, they’re going to have to use the EFSF as a mechanism to create a firewall around the core of Europe to find ways to liquefy Sovereign Credits. Right now, it’s very difficult for Spain and Italy, to name two countries, to come into the marketplace and issue more debt. And both of them have about another $75 billion of issuance between now and year end. It’s the ECB who’s been — or the EFSF that has been a big buyer of these bonds. And so they need to find a way to unlock private capital and go back into the marketplace. So the rumors are that the EFSF, which is the stability fund of Europe, is going to subordinate their interest up to 20%. So if you buy a an Italian bond, if you had a loss the first 20% of the loss would be borne by the Stability fund of Europe. It does not address existing Italian and Spanish debt. and so we are worried that it will disappoint in Europe. but there’s other things that they could announce
- Bartiromo – What’s a number that they need? $2 trillion? What do they need, the Banks?
- Fink – This is not for the banks, Maria. The money that they’re talking about is to purchase Sovereign Credit. None of that money was done for stabilization of the banks yet.
- Bartiromo – but what does — what do the banks need? The banks keep trading down because they don’t have enough capital as a perception. What do you think it’s going to take to make people feel comfortable? How much money for the European banks?
- Fink – My worry is not the banks. You cannot stabilize the banks until you stabilize the countries. The Banks’ problems are related to the falling prices of the Sovereign Debt. We don’t stabilize the Sovereign Debt, it’s obvious the Banks are going to need more and more and more capital. As we stabilize the Sovereign Credits of Europe and if those Sovereign Credits then rally,
the capital shortfall of the banking system would be reduced. So first and foremost, the Europeans have to stabilize the Sovereign Credits. Then they can focus on the banking system. And I think in the banking system, what I have been told, there’s as much as $300 billion of new equity that is needed. They could shrink your balance sheets and sell a lot of assets so they don’t have to dilute their shareholders. Another way to do that is getting their regulators to allow Preferreds to be a tier one capital. So this is something that we would be interested in. We’d be a buyer of bank Preferreds. But the problem in Europe is much more severe than the Banks. It’s really a Sovereign Credit issue. Then we stabilize the Banks. and then we fix Greece. So you can’t stabilize the Banks alone without stabilizing the Sovereign Credits.
3. Hunting For High Yield Bonds – Steven Walsh with CNBC’s David Faber – Wednesday, October 19
Mr. Walsh is the CIO of Western Asset Management. He manages about $447 Billion of Fixed Income Assets.
- Walsh – surely Greece is an issue…. Europe is a big issue. How they maneuver through this sovereign crisis is critical to financial markets everywhere.…we started out with policy makers hoping the restructuring might be 10% and then 20% and now we’re talking about 30 to 50% hair cuts. Remember, five-year Greek debt in the marketplace today trades at 40 cents on the dollar. that gives you some idea of where the markets believe the ultimate value in Greek debt is.…..we do need to see some restructuring of Greek debt, we do need see to see a bank recapitalization and some sort of leveraging of the EFSF fund.…
- Walsh – From our perspective, we look at the markets and see some pretty attractive valuations in some of the credit sectors of the marketplace. On one hand you have attractive valuations, on the other you have this enormous elephant in the room…. What it’s meant for us is that we are far more cautious in introducing credit risk into our portfolios. at 800 off for high yield bonds over Treasuries, 9% yields, normally if we were talking about the U.S. economy and where is it, I think they would be very compelling values, but you have this unknowable which I think has to make you more cautious about taking risk in the market. So we have put our toes in the water.
- Faber – do you nibble and not move as aggressively or just stay away entirely?
- Walsh – We’ve nibbled. We’ve added about a percent to high yield in our broadly diversified portfolios That’s a small and modest allocation. We’ll continue to look to add to that should spreads widen out, but no heroic moves by piling in at this point in time into these sectors. But we do find high yield attractive and think modest allocations makes some sense.
- Faber – You and I have been talking for a year and a half during which we’ve watched Treasuries go down. What do you do in terms of treasuries as a huge fixed income manager, just stay away entirely?
- Walsh – I don’t think you stay away entirely. What do Treasuries represent? They don’t represent good long-term value but they are an insurance policy. To not have them in your portfolio doesn’t make a lot of sense…. We have begun a program as we’ve gotten below 2.25% and certainly below 2% to ease away from interest rate risk in the U.S.,…We probably have about a two-thirds weighting to the Treasury market and again only maintaining the allocation we have primarily because of insurance to an unknowable outcome out of Europe. I do think you need to step away from interest rate risk in the U.S Treasury market.
- Walsh – Yeah, I don’t want anybody think we’re big bears on U.S. Treasuries. We do think they can back off a little bit.
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