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.
1. Two Bunts & a Home Run
Both Bernanke & Draghi were at bat this week. They were both expected to hit home runs or at least doubles. But both chose to bunt instead, Bernanke with greater success. Bernanke gave the markets nothing but still managed to move the batter, himself, to the Jackson Hole base. Draghi’s bunt looked like a disaster until Thursday afternoon when, according to CNBC, Larry Fink moved him to the next base by telling traders that Draghi’s plan to buy the Spanish-Italian short term bonds was a big deal.
The Dow went down on each of the first four days of the week. It was down about 190 points on Thursday until the afternoon rally cut the loss to about 92 points. The McClellan Oscillator closed on Thursday at minus 89. The stage was now set for Friday.
Europe was already in a rally mode on Friday morning because of buzz about Spanish Prime Minister Rajoy getting up his courage to ask for a bailout. Then the Non-Farm Payroll number hit a home run with a 163,000 number. The rally was one to behold especially in European stocks and Oil. Just look at European Banks – BBVA up 9%, Deutsche Bank up nearly 10%, Santander up 7%.
Yes, the internals of the Payroll report were far from superb. But nobody cared on Friday. The Dow closed at a 3-month high with 4th straight week of gains. The S&P is now up over 10% ytd and only 29 points from new 2012 high.
2. US Treasuries
You would have expected US Treasuries to get shot after a +163,000 jobs number and a 200+ point Dow rally. Yes, the 30-year T-Bond did fall by 2 points on Friday and the 30-year, 10-year yields both went up by about 9 basis points. But we did not see furious selling the way we saw on the previous Friday, when the 30-year bond was down over 3 points intra-day. The sell-off this Friday was more from individual investors, as Jeff Kilburg said to Scott “Judge” Wapner on CNBC FM-1/2 on Friday:
- “honestly I don’t think we’re seeing the euphoria in the equity markets being translated to the bond market. We’re seeing a bigger selloff in the retail side. The TLT, if you look at last Friday’s Judge , the low in the ten-year note, the price was 133-26.5. the TLT low price was 128.50. Right now, you’re seeing the price come down to 126.77. the arbitrage…playing the TLT for the long, as long as we have not seen anything substantial out of Europe.”
- “….there is no panic selling noticed in bond market today yet…we just tested the low on the ten-year price, not to settle, the price action, which technicians like to look at. we bounced off of that. Therefore, I think you can get into the TLT under 127.”
- “Due to the fact if Germany does buckle, if they concede and we get something substantial, unlimited firepower out of there, we will see Treasury yields go up and prices sell. That’s the knee-jerk reaction. The next reaction is what happens to Germany and the debt downgrade? Where do you go in that downgrade happens? Just like the counter-intuitive trade we saw last August, in our own u.s. debt ceiling debacle. counter-intuitive trade, they come back into the U.S. Treasuries, the U.S. dollar. That’s why I think the ten-year is tethered to 1.5% through the election, Judge.”
Mr. Kilburg’s target for the 10-year yield is 1.19%. But he added the caveat that if the 10-year yield gets above 1.67%, then you can’t fight the tape.
3. The Cult of Equity is Dead!
This phrase will now be associated with Pimco’s Bill Gross forever. But the concept and the phrase was first used by David Rosenberg of Gluskin Sheff, according to an article on CNBC.com on Monday, July 30. Reportedly David Rosenberg wrote the following in his note to Gluskin Sheff clients:
- “equity cult is clearly over,….The secular shift in investor behavior towards income-generation continues apace.”
Then Bill Gross wrote a detailed case of why both stock and bond markets are likely to provide far lower returns than they did for the past 30 years. In other words, Gross said the cult of equity and the cult of bonds are both dead while the cult of inflation may have begun. Mr. Gross’ article Cult Figures is a must-read for all investors. A few excerpts are below:
- “The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of “stocks for the long run” or any run have mellowed as well.“
- “Boomers can’t take risk. Gen X and Y believe in Facebook but not its stock. Gen Z has no money.”
- “Yet the 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes – a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)?“
- “Together then, a presumed 2% return for bonds and an historically low percentage nominal return for stocks – call it 4%, when combined in a diversified portfolio produce a nominal return of 3% and an expected inflation adjusted return near zero.”
- “The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned.”
Professor Jeremy Siegel took this article rather personally. He made some injudicious comments on BTV which were answered by Bill Gross in his interview with BTV’s Betty Liu (see clip 3 below).
4. The U.S. Stock Market
Last week, Lawrence McMillan of Option Strategist wrote, “A return to the top of the uptrending $SPX channel would take prices to about 1400 or slightly higher in the short term.” Well that’s just another morning like Friday. So what does he say now? He is not as positive as he has been since June.
- “However, this time around, we are starting to see some more deterioration in some other technical indicators. In particular, the equity-only put-call ratios are beginning to seriously weaken. Moreover breadth indicators are on sell signals…. volatility paints a more bullish picture. As long as $VIX stays below 21, it is conducive to higher stock prices.” (emphasis ours)
- “Overall, we are retaining our bullish posture — mainly because $SPX remains in its upward-trending channel.”
This caution is shared by Michael Hartnett of BAC-Merill Lynch in his Draghi Racing vs. Le Mans report:
- Draghi induced inflows to risk assets, with US and EM equities notable weekly beneficiaries. But bond investors unfazed, strong bond inflows continued and positioning remains significantly tilted toward fixed income ($644bn inflows since 2007 versus $552bn outflows from long-only equities).
- On June 1st, BofAML Global Breadth Rule flashed “buy” when 42 out of 45 markets became oversold. Equities troughed a day later and thereafter rallied 9% trough-to-peak. But today rule back in neutral territory…indicating technicals less favorable for equities.
- Big picture reality unchanged. Big, fat trading range in place. Upside limited until fiscal mess sorted and growth resumes. Downside limited until monetary policy fails to boost credit markets. Bull market in equities requires a “good” rise in interest rates. Assets with “growth”, “yield”, “quality” remain in bull markets, with probable bubbles in coming years. Creditors to continue outperforming debtors…Other working themes in 2012/13: US real estate, EU distressed, EM consumer.
We all realize that the US stock market at least in the short term is linked to Europe, especially to the Spanish bond market. So the comments below from Rick Santelli are worth a listen. He takes exception to the euphoria expressed about the flattening of the Spanish yield curve:
- “10-year minus 2-year spread in Spain. Look at it. You will see it has come out like a bat out of Hades in terms of upside, flattening central bankers don’t like, steepening they are in love with. So does that mean everything is working? That isn’t my assumption.”
- “Look at what really moved. … the 2 year, it closed last week at 5.30%, it is 4% this week. Look at the ten-year. Its basically unchanged – 6.85% last week, 6.75% today. The hedgies, they had huge positions…along the curve. The short maturities are associated with ….buying programs. They are not going to go there. But they are certainly not running away from their shorts on the long end. That’s significant. Be careful how you look at this curve. It is not a virgin curve anymore. It has been attacked and it is going to behave differently.”
The notion of a “virgin curve” is new to us but Santelli’s caution against euphoria about Spain we understand. But we understand irony too. It would indeed be ironic if risk assets explode next week in response to the caution expressed above by Hartnett, McMillan, and Santelli.
5. China & Japan
Last week, we wrote about the increasing tensions between China and the ASEAN about the South China Sea. Frankly, China is not too worried about Vietnam, Philippines or any other ASEAN country. What would trouble China, what would make the Chinese leadership stay awake at night is the prospect of Japan becoming a nuclear adversary. And it is an open secret that Japan has the ability to become a nuclear power within a week.
What is not that well known is that pacifist Japan has quietly built the second best navy in the world. And the South China Sea is Japan’s lifeline just as it is China’s. To get a glimpse into the increasing military tension between China and Japan, watch the 3-minute Stratfor video below.
In clip 1 below, Dinakar Singh of TPG-Axon argues that today, Japan is a much better story than China. If Stratfor is correct, then it may also be true about naval capabilities.
6. US Model for future war between USA and China
The Washington Post has written a detailed article about the controversial Air-Sea battle strategy developed by Pentagon’s ever-young futurist, Andrew Marshall. Mr. Marshall, now 91 years old, has been running Pentagon’s office of new assessment for the past 40 years. We urge readers to at least go through this 4-page article. The following graphic is a good visual of the strategy.
(What is the Air-Sea Battle? – src – Washington Post)
7. Remember ChIndia?
Just a year or two ago, India was considered on semi-par with China as a vibrant growth story. Then came India’s
currency crash, the slowdown in its industrial production. This was followed by a series of articles, the most direct of which was a British article calling India’s Prime Minister Manmohan Singh a ‘poodle‘ of his party President Sonia Gandhi.
This week came the unkindest cut to India’s reputation, the dubious record of the World’s Largest Power Outage. Over 600 million people went without power in India’s north, northwest and northeast states. India’s media went to town against Prime Minister Singh’s government. But India’s political class showed it is above such criticism.
The Prime Minister, clearly on Sonia Gandhi’s instructions, promoted the failed Power Minister to Home Minister, traditionally the 2nd most important position in India’s cabinet. Singh also advised the new Power Minister to “urgently look into the matter” of the power outage. Such ‘Britlish‘ lingo is unique to ‘educated’ Indians. Perhaps CNBC’s Simon Hobbs can tell us whether such expressions are still used in today’s Britain.
With this series of events, you don’t hear much of the Chindia stuff. Because India’s image is now in tatters while China looks so well-managed by contrast. This, we think, will look just as ridiculous in a few years as the term “Chindia” looks now. Historically, India is to be shorted when it looks great. That is why we wrote about India’s credit bubble in June 2011. But historically India is to be bought when it looks really hopeless. Despite all the outrage and abuse, India has yet to fall to that hopeless stage but it is on its way there.
Getting back to the power outage, you would have expected the Indian stock market to be down big. Instead, it rallied on both days of the blackout. Because the market knew this blackout wasn’t that big a deal economically. Read what HBS professor Krishna Palepu said in the Harvard Business Review on Tuesday:
- What hasn’t been pointed out, however, is the massive amount of private
power generation that goes on India every day. Every single business,
every single organization, every single middle class apartment complex,
has a backup-generator of some kind
Of course, you don’t need a HBS professor for such common sense. You could read the personal experience of NPR’s Elliot Hannon, who “was on the streets of New Delhi when the power went out.” In his words:
- “When I arrived at my place, there were no signs of a blackout. The
generator in the corner of the room was buzzing, so the lights switched
on and the Internet still existed. It wasn’t until I read the news
online that I realized that half the country — or about 10 percent of
the world’s population — had no electrical power. When
I turned on the TV, Indian reporters were in a tizzy, reporting from
darkened subway stations and jammed street corners. I got emails from
the U.S. asking if I was safe and calls from editors asking what was
going on. But everything else felt about the same.”
- I spoke with a small grocery store owner, thinking maybe he would be
irate with freezers full of rotting imported food. He seemed amused that
I was so interested in whether his coolers of French cheese were safe.
- The grocer told me that if you wanted to run a business in India, you
had to take care of your own power. And while he hadn’t anticipated the
massive power failure, he was prepared for it.
This reminds us of a paper by a leading Chinese Strategist who visited India in 2007 for the first time. He wrote that while Chinese business is supported by the Chinese Government, Indian businesses have to succeed in spite of the Indian Government. This is why Elliot Hannon described the huge blackout as An Annoyance Not a Crisis. Read his article.
By the way, as soon as the previous Power Minister became the Home Minister, 5 bombs exploded in Pune, the historical city of the Maratha Confederacy and now an emerging Technology and manufacturing center. Perhaps now, he can “urgently look into the matter” of Islamic terrorism. Unfortunately or fortunately, India does not have Cossacks to repel Muslim Migrants, the way the Governor of Russia’s Krasnodar region plans to.
The core Indian is utterly disgusted with the rampant corruption in India’s electocracy and the complete mess it has left in India’s administration. This is why Anna Hazare, the Gandhian anti-corruption activist, has decided to launch a new political party. The crowd below celebrates that decision.
This is a very tall order. Contesting elections requires tremendous financial resources which traditionally come from industries and businesses, such favors being repaid after the election with licenses and favors. How would the new anti-corruption party be able to compete in this corrupt electocracy? No one knows. But the mere prospect of a political challenge from Anna Hazare and his party is likely to change the political calculus of all other parties.
(crowd at India Gate in New Delhi – src – Associated Press/NYT)
- Dinakar Singh on BTV Market Makers on Friday, August 3
- Tom Hoenig on CNBC Squawk Box on Thursday, August 2
- Bill Gross on BTV’s InTheLoop on Thursday, August 2
- Meredith Whitney on BTV Surveillance on Tuesday, July 31
- Robert Shiller on FBN Markets Now on Tuesday, July 31
Dinakar Singh is the founder of the $4 billion TPG-Axon hedge Fund. He used to head the proprietary desk at Goldman Sachs. This is the first interview we have seen of Mr. Singh. We expected him to make our day, as his name (Kar = maker & Din = day; Dinakar = maker of day = a synonym for Sun) promises. He kept the promise of his name in the interview, in our opinion. Of course, he was amply aided by the terrific anchor duo of Stephanie Ruhle and Erik Schatzker.
The excellent summary below of his two videoclips is courtesy of Bloomberg Television PR.
On the current environment:
- “For us, we pick stocks. That is how we make money. More and more, everyone has become more emotional in markets. We get scared by headlines and we all start acting the same way whether you are a CEO or a consumer. Jobs do matter. I think when you look at the U.S. in the last number of months, our view coming in this year is that people got too excited. There was a bounce back from last year and some good weather but it was going to be a slow gradual sloppy messy restructuring without a big recovery. Things have reversed. I think people are getting too pessimistic…I think ultimately consumers and CEOs are reading the same headlines and scared. I think you are seeing a cyclical or temporary step down. We do not think there one should expect a big bounce, but there won’t be much of a plunge either. It feels like the numbers are crummy but they will probably stay this way for a while. The fiscal cliff is a real issue. I think you’re seeing an impact right now.”
On how to play this market:
- “People have gotten scared and they’re paying a lot for safety. On the safety side, people like dividends in safe industries. So Verizon is trading 18 times earnings because people want safety and a good dividend. There are companies like Time Warner Cable that we think are just as defensive but they did not happen to pay a dividend, they have even better cash flow, but they traded as a result much less well last year. For us, big opportunity. So media and cable that’s very cash flow rich and where we think management is going to turn that spigot on and turn it into a dividend or buy back machine that makes sense. Sirius, Time Warner Cable, companies like that. On the cyclical side, not everything is terrible. There are some sectors where we think there is good structural growth and balance sheets will be put to work. Some chemical companies are very good restructuring candidates. Aerospace suppliers. Aerospace is in the middle innings of a very long term upgrade cycle.”
On whether financials are a good buy:
- “We are bearish on some financials, U.S. regional b
anks especially. Not because they are bad but because they are not going to make a lot of money. I don’t think people have factored through how much their earnings will get hit with rates being so low. We see earnings going down sharply for regional banks. For the global money center banks and securities firms, they are going to be volatile, but the bad news is out there right now and there are some good things to look forward to. The old way of making money used to be mergers, advisory, underwriting. Markets are going up and down every 13 seconds. None of those happened, but they settle down and they happen again. If the market settles down, you will see a big wave of mergers pop up and that will help. I think people are overstating things right now on the bad side.”
- “If you look at China specifically, multiples had really collapsed…You have two general types of companies. Big, state-owned companies that people don’t trust and private companies that people really don’t trust. There isn’t a lot that trades at big multiples anymore. I think if you can find cases where there is real growth and they can pay cash back to you, you’ll make money.”
On whether Japan is a better buy:
- “Some of my favorite stock stories are in Japan. The Japan-China comparison is pretty interesting. The place where you have seen the best profit improvement in the world is Japan. China is the only index that has gone down. Profit margins are falling because costs are going up…In Japan, they’ve had a brutal headwind from the yen and yet they have restructured pretty aggressively so profit margins for the Nikkei have gone up and are now about there with the S&P. People do not expect that… Japan Inc. was a disaster 15 years ago. Today, there are stocks we like with low multiples that are paying out cash and growing.”
On what stocks he’s buying and selling:
- “People are paying a lot for dividends in defensive sectors, but if the dividends are not there, they were not paying a lot before. There opportunity is to find a stock in a company where there is a lot of cash flow, people aren’t paying for it, but they will tomorrow. Sirius is an example of a stock that we love. The company nearly went bust a few years back, merged with a competitor and changed the dynamic of the industry. Take it as an example against Verizon. Verizon is a good company but trades 18 times earnings. They are paying out almost all their cash in the dividend. Sirius has double digit free cash flow yield. It is restructuring. It is going to grow its earnings because it is still recovering from a few years ago…This is a case where you are getting a much, much better deal for something that is growing and where the cash is going to turn from being in the company today and in your pocket tomorrow.”
- “Health care was a terrible sector until a few months ago. Pharma stocks have been some of the best performers in the market. And suddenly they have gone into the safety category because if you want to buy dividends, there are not that many options for large cap big dividend stocks that are very cyclical…The best thing you want in this environment is a company that not only has value, but where management that will work with you to deliver value over time.”
On telecom services:
- “In a hedge fund, this is called a funding short. It is not that you think it is terrible and going straight to 0, but it is priced fully and not going up much so not a very good risk reward. Within telecom services there are two categories. There are the Verizons, we get it, they trade here for a reason, but they are pretty fully priced. On the other side, there are other companies that are legacy telecom companies where the dividend is a very high, but business really is eroding. It is priced well today because of a high dividend, but it is not sustainable. When you look around the world, a lot of high dividend stocks in Europe are not trading well because people are looking at them and saying I get it. I have a dividend today but it might not be there tomorrow.”
On M&A activity:
- “I think it is picking up. It’s better than 2008 and 2009. I think you are going to see waves of M&A. I think if you are a CEO right now, you do not make a big move because you do not know what the landscape is going to look like in six months. Europe headlines on one side—U.S. politics on the other. Six months from now, 100 days from now, we will know who is going to win the election. I think you will see some level of activity come back in. We are clearly seeing companies start to sniff around for small acquisitions and over time i think you will see bigger ones. Take the chemical sector. We are not fans of the cyclical cycle overall, there are several companies, W.R. Grace is one, Rockwood is another–where you have very low multiples and good businesses. The key is to make sure they are businesses that people want to buy. So the large strategics have good balance sheets. It is not just a cheap multiple. You’re going to get paid for it.”
On where the hedge fund industry will get its human capital:
- “I think when you look at where most people have joined, most joined from a couple of areas. They’ve worked in investment banking for a couple of years and then come on over with analytical skills set and then you train them. Or they work in research and come over as well. Those are usually the two places where people join hedge funds from. Ironically on the prop side, I think prop desks being shut down means fewer people will be going and raising money as you start up traders. I don’t think it is going to change the supply of capital or labor that much because ironically in some ways, if Goldman or Morgan Stanley and others are aggressively prop trading, they are competing for good young guys with us. So now, if you want to do investing and you are a good young person at pick a firm, there is only one place to go. So not so bad for us.”
On whether there is still real talent left on the sell-side:
- “I think so. When I look at firms like Goldman Sachs, Morgan Stanley, CS, etc., the people there are still terrific. The prop trade business has always had their own complexity but these firms make a lot of money doing their old job and they still need some very good people doing it. When you are treading stocks every day, futures and currencies every day, you need very good people who know what they are doing and frankly I think the business is going to look like it did ten years ago.”
2. Bank Break Up – Function Matters Not Size – Tom Hoenig on CNBC Squawk Box – Thursday, August 2
Mr. Hoenig was formerly the President of the Kansas City Fed. He is highly regarded for his knowledge and acumen. This is a very good interview, the kind Squawk Box used to be famous for. Watch this clip or simply read the comments we include below. You will see a first-class mind with the ability to form succinct opinions and with the courage to express them without passion or prejudice.
- Quick – You were out talking about this before Sandy Weill said this. You had an op-ed in June in the Wall Street Journal back in June. Why do you think the banks should be broken up? It’s different from Sandy’s line of reasoning.
- Hoenig – Yes. I have the perspective of the FDIC. You need to break this up by lines of business and the effects will be greater competition. For example. greater accountability of the institutions and, very importantly, I think it will begin to rationalize the use of Federal Deposit insurance and the government’s guarantee behind these institutions so that we can fine it to what it was originally intended for and that’s protection of the safety net and the intermediation process that goes on in commercial banks. I think our proposal that I put out also importantly issues of the shadow banking industry. The proposal is forward-looking and I think the effects will be beneficial. In an important sense, I think, will spur new activity in Wall Street and in the United States. So I’m very strongly supportive of not cutting them by size but by function and making them more competitive again and more accountable.
- Quick – We should point out a couple of points, the first of which the FDIC funds are paid from the banks and the big banks pay the lion’s share of the fees. These aren’t taxpayer dollars that we are talking about with the FDIC.
- Hoenig – There are two safety nets. The FDIC is the first line. Let’s be candid. Behind it is the Federal Government’s guarantee. That’s reflected in things such as TARP and other forms of bailout…. It is the federal backstop that came into play in this last crisis. I can assure you it will come into play in the next crisis should the largest institutions again find themselves threatened.
- Quick – ..big banks exist around the globe. What you’re talking about would be action that would only stop banks based in the United States. Can you really make massive changes if you are only making changes here in the United States?
- Hoenig – I think you can. I think you should. The United States is the leader. I would point out a couple of things. I have had many people tell me the United States wouldn’t be competitive, that corporations want one company to go to and borrow. My experience over 20 years is I have talked to CEOs. They know that they have to have multiple access to credit. If they had to rely on just one or two major lenders it would be a very foolish thing for them to do. This will actually open up, I think, the markets, the capital markets. I think it will invigorate the industry and be beneficial to U.S. corporations. I would very importantly point out that right now we have a very concentrated — increasingly concentrated industry. I think it does mean that there is a certain lack luster element to our financial system since they have been able to form rather than before when our capital markets were the most vigorous in the world as we competed globally, even then and very successfully, I might add.
- Sorkin – I want to talk about the international banking system which is to say that in most other countries, if you look at the G-7, for example. We actually aren’t nearly as concentrated as many other developed countries. So the question becomes is this not only — I understand the safety and soundness issue, but I do wonder about the competitiveness issue, perhaps even more broadly, our ability so use and leverage the financial world to be a power engine of the economy.
- Hoenig – well, I think, frankly, that the United States — first of all, if you look at the rest of the world, I’m not envious of that model. They are in deep difficulty now. The
y are not as competitive as you would like to believe. It’s obvious. I would also point out that in our 200 years of history and in the last 56 years of history where we have had a less concentrated financial system with many banks across the country, we have been the most competitive, the most innovative. We are the entrepreneurial center of the globe and we have benefited from that. I don’t know why I would give that up for a model that I respected very much but is not as dynamic as ours has been and I think our wills not be as dynamic in the future if we go the way of other countries where they have allowed themselves to be highly concentrated and, I think, very lax in the sense of their competitive vigor. I think we should not buy that model. We should not buy the story at all.
- Sorkin – If you’re right, why are so many leaders on Wall Street against doing what you say in the context also that your argument suggests that actually there could be more profits in the future if broken up.
- Hoenig – I think the subsidy has a lot to do with that. People are reluctant to give up subsidies, this too big to fail subsidy, this safety net, the government guarantee behind them gives them important funding advantages that they don’t want to give up very easily. I think that’s the impediment. For heaven’s sakes i don’t know where Sandy Weill was on this, but if you are trading at 60% of book, I don’t think you necessarily can offer that model as the way of the future for success.
- Sorkin – Let’s go back to too big to fail. I want to go to moral hazard. This is a big issue. you just suggested, I think in one of your answer there was some moral hazard in all of this. Do you believe when executives and bankers make trades, make real risk decisions they sit around and say, you know what, I will shoot for the moon because ultimately if I fail I’m going to get saved?
- Hoenig – I think what they do is they say, I’m smart, smarter than everyone else. This is the exactly thing to do and by the way, I have access to incredible amounts of funds because there is a safety net out there. I can raise money below what I would otherwise raise it. I can hold capital levels that are significantly lower than they would otherwise be. So I leverage up, we make high returns for the risk I’m taking on but the risk is shared by the Federal–
- Sorkin – why is the solution not higher capital requirements?
- Hoenig – that would be a part of the solution. it’s not all. You have the incentives. Remember this. The real capital levels of the largest institutions when you look at tangible capital, take all the deferred credits out of it. it’s 5% to 6% at the highest level, less than 5 at the lowest level. Before you had the safety net in the modern 20th and now 21st century, the capital levels would be more than double that. We’re in the process but that’s getting as much resistance in terms of raising real capital levels as the breaking up proposal I have.
- Kernen – am I wrong that the U.S. government has a subsidy and the Fed enables the U.S. government to have a subsidy and because it’s too big to fail we are also in danger of generating the same type of issue as a country as you’re talking about with banks that are too big to fail. I mean, the U.S. government has an incredible subsidy from what the Fed is doing allowing it to do all this stuff.
- Hoenig – I think the ability to be a reserve global currency as we are gives us a great advantage. and in a sense a subsidy relative to the rest of the world. There is no question about that. If I could though, Andrew, back on the capital question, one of the things that’s complicating our ability is Basle 3. Basel one didn’t work, Basel two didn’t work. Now it’s Basle three which allows you to assign weights which don’t shift as risk shift and so the industry is following those incentives and I think going back to the very clear fundamental tangible capital level would be a great improvement for the banking industry. And as long you are a reserve currency, you can print this money. You have a longer period of time than the other countries to either make things worse or correct them. I hope we choose the path of correcting them. as soon as possible.
- Sorkin – Is the Fed too close to the banks today in terms of how they are regulated?
- Hoenig – I think all the regulatory agencies have a pretty questionable track record historically. It is now time that our job is to be first of all knowledgeable, second of all willing to be confrontatio
nal when it is necessary and that’s where we have to step up our pace, all of us including the Fed.
3. “pushing at wind mills & belongs in ivory tower” – Bill Gross with BTV’s Betty Liu – Thursday, August 2
Wow! We have watched Bill Gross give interviews for over a decade and we have never seen him lose decorum or get personal. Kudos, mucho Kudos to Betty Liu for provoking Mr. Gross into showing his own nasty. Ex-BTV & now CNBC anchor Brian Sullivan tried to goad Bill Gross the day before on his CNBC show. He failed. In the CNBC segment, Bill Gross was effusively complimentary of Jeremy Siegel.
Is Sully too nice a guy and is Betty Liu a provocateur? Or did Ms. Liu plan a better show? She played soundbites of Jeremy Siegel that were uncomplimentary of Bill Gross. Whatever the reason, BTV & Betty Liu won this round over CNBC & Brian Sullivan. The other factor could be CNBC’s penchant for packing 6-8 people into a segment which diminishes all participants. In contrast, BTV featured a one-on-one with Bill Gross and won this contest going away.
The excellent summary below is courtesy of Bloomberg TV PR.
Gross on whether he is disappointed by the lack of details coming from Mario Draghi:
- “Yes, it is less powerful than we had hoped for. To this point, the ECB and other policy makers have been all about promises and inviting others to take the first step and it appears that we are seeing much of the same thing this morning. Draghi is saying Spain and Italy should take the first step, make a request, and then something might happen. He is not exactly sure how much he would buy or the ECB would buy, whether it would be sterilized or unsterilized. This is a game of promises, a kick the can type of moment and yes, we’re disappointed.”
On what happens in Europe from here:
- “It’s fair to say that risk markets have built in an uncertainty level of anticipation. U.S. stocks have gone up, whether by 2% or 3% in anticipation of this moment, of this money printing moment is hard to say. I would think that today in terms of risk markets, we are seeing a selloff because that is what the markets have been anticipating, some type of monetization from the ECB which in concert with the Fed, perhaps in August in Jackson Hole, would be a one-two punch.”
On what he was hoping for:
- “We were hoping for, at least temporarily, some type of specific effort on the part of the central banks and ultimately of course on the part of fiscal agents, which is the combination that Ben Bernanke has been pleading for in the United States. To rectify the situation in part, we have never been a believer in total that both combinations, monetary and fiscal, could solve the problems because there are negative aspects of any of these solutions going forward. Zero-based money produces very negative aspects in terms of business models, money market funds and bank loans etc.This isn’t just a one-way street in terms of printing money and things will get better again. We have been skeptical but at least at the moment in terms of kicking the can, and placating the waters, we’ve been hopeful that something would be done without the expectation that it’s a permanent solution.”
On how patient the market will really be:
- “I think it’s perhaps passed the point of patience. I speak to the scarlet 7% on the market’s chest so to speak and that refers to interest rates in Spain and Italy, towards which and above which, their countries have gone in terms of their ten-year securities. Once you get to that level, once ratings services begin to downgrade your sovereign instruments, once the market fails to trust what’s going forward in terms of returning yields to 3% and 4% that might promote a semblance of economic growth going forward, then the story is pretty much over. Absent something significant over the next week in terms of a follow-through on the part of the ECB that the market in part, and certainly PIMCO will never trust Italian bonds and will never trust Spanish bonds because the yields are too high and the technical deterioration is too significant and the ratings services are on their heels in terms of downgrading.”
On Jeremy Siegel saying earlier today that it’s usually the start of a huge bull market when the media pronounces equities dead:
- “Professor Siegel is getting a little nasty here. Yesterday I was praiseworthy but it seems like gloves are off. When I said that the cult of equity was dying, what I meant was that those investors and those liabilities structures such as pension funds and insurance companies that have depended on a 6.5% constant real return from stocks such as we’ve have had over the past century are bound to be disappointed. In individual terms, those that are looking for double digit returns of stocks to pay for education and retirement are bound to be disappointed and that’s why the cult of equity is dead. It sounds like Prof. Siegel hasn’t even read my piece, let alone understood it. I said as well the cult of bonds is dead. When bonds yield
1.75% for investment-grade bonds, then it’s difficult to turn that into
a 5-10% return going forward. What we have really seen over the past
several years, in terms of the appreciation of markets and the decline of interest rates based on what the Fed has been doing is a result which has eliminated the possibility of investors in bonds and stocks to earn an adequate return relative to their expected liabilities. If he wants to argue against that, and talk about Dow 5000 and bear and bull markets then he’s welcome to but he’s pushing at wind mills in my opinion and he belongs back in his Ivory tower. There, backatcha!”
On Siegel’s retort that “the real U.S. economy is growing at 3.5% per year so how could stocks give 6.5% per year?”
- “Prof. Siegel’s ivory tower again lacks common sense. If wealth is created at 3% a year based on GDP, and that wealth is divided as it always is by government, by labor, and by business in the form of corporate profits, then it’s hard to see how one element like corporations and stocks can continue to earn 3% more than real GDP going forward. That’s only common sense.”
There is only one winner here, in our opinion. And it is not the talker, it is the doer. You can get away talking rubbish in front of students who want a good grade from you. You can’t get away from the stinging rebuke of markets as Mr. Gross himself experienced last year.
4. Banking Industry to lose another 50,000 jobs – Meredith Whitney on BTV Surveillance – Tuesday, July 31
BTV shows tend to have longer conversations with their guests while CNBC keeps a faster pace by keeping each conversation short. This tends to benefit BTV’s viewers because the guests are more relaxed and impart more insight. The conversation below with Meredith Whitney shows this BTV advantage.
Again, the detailed summary below is courtesy of Bloomberg TV PR.
Whitney on how many more jobs will be lost:
- “I think the industry goes for another 50,000. We’re already close to 200 deep…Across the board. London is as miserable as New York.”
On whether we’ve seen the end of the overhiring and overfiring spree on Wall Street:
- “Everything goes in extremes and particularly in financial services. I hope I am around when the over hiring phase comes back to this market. But I would argue the banks have not over fired and are really middle of the way through firing. As I said, shareholders are demanding increased profitability. These banks are not earning their cost of capital and it’s being reflected in their stock prices.”
On the state of big banks:
- “It’s bad. If you look at the European banks reporting earnings today, it’s a reflection of the same that the old way of making money for Wall Street for so many of the banks that became real Wall Street driven revenue machines is gone. That was driven by the unsexy world of housing and leverage. The world is deleveraging—at least the post-modern world is deleveraging. It puts real sustained pressure on revenues and the business models just have to shrink.”
On whether Citigroup needs to cut the most:
- “Citi certainly needs to cut, but they have reduced their mortgage portfolio dramatically. I would say Citi, Bank of America has made good progress. JPMorgan certainly. A lot of the traditional banks. Any of the regional banks have got to downsize dramatically. All of the European banks have to downsize dramatically. There has been no mortgage industry for the investment banking to ride of the shoulders of any more. So it is really the investment banking side that has to shrink dramatically.”
On where those who are laid off will find jobs:
- “The problem to date has been that those that have been laid off have been sitting on their couches because they do not want to take a downgrade in pay. They are not going back to work and the longer you are out of work, the more difficult it is to get a new job. My advice to them is take what you can get. It is very hard to transfer skills from a high-paying job…so recalibrate your expectations. “
On Sandy Weill’s call last week to break up the big banks:
- “I thought the reaction to that was surprisingly big. I appreciate the fact that it was a big turn for him, but he’s been out of the industry for a long time. And most of the guys who are coming out—Dick Kovacevich, who was against breaking up the big banks—have really been out of the loop for a long period of time.”
On whether Jamie Dimon wants to break up the banks:
- “Of course he doesn’t. Bigger is better for all of the guys who are in their seats. But it is very expensive. It takes a long time to integrate the banks. It will take a long time to break up the banks.”
On whether Washington should get involved:
- “I think shareholders are already getting in the way and demanding higher profitability. The big banks are effectively on their backs. Many big banks are trading at half of tangible book value. Shareholders are voting with their feet and saying get profitable or soon we’re not going to buy your stock.”
On whether there’s a case for buying b
ank stocks right now:
- “I think the case is valuation. I think that financials, for me anyway, it is a relative investment and it’s a momentum investment. And the momentum is going against the fundamentals of these names. I would stay away. All that said, there are some great names. Some of the smaller names are chugging ahead…Like a PNC, a USB, even a Wells. If you look at these banks that look very expensive compared to the big banks—some investors are solely designated towards financials. They have to go somewhere. And these are the safe names, so just like U.S. treasuries, they will pay a premium for safety.”
On what she’d like to see out Washington:
- “I would like to see the government streamline regulation and actually back off of some of the capital requirements. The market is telling you how the banks should access capital. The market is pricing access to capital for the banks and the government is really adding insult to injury in the financial industry by layering on so much increased capital pressures and so much increased regulation. Dick Kovacevich said it better than anyone—it was not a lack of regulation that got us into this mess. It was a lack of enforcement of regulation that got us into this mess.”
On whether she would take the position of Bob Diamond if Barclays were to call:
- “No. I think that’s a really scary position. But I think there’s going to be a surprisingly excellent candidate that will take that position.”
5. New housing bubble in San Francisco, Phoenix – Robert Shiller with FBN’s Connell McShane – Tuesday, July 31
Fox Business interviews Robert Shiller every month after the release of the Case-Shiller housing numbers are released.
- McShane – How about this talk of a housing bottom? These home prices look pretty good today in your index.
- Shiller – They do look good and one thing that I believe in home pricing forecasting is momentum. We do have some upward momentum. Part of its just seasonal, though…If you look at a plot of the data, it doesn’t look like a pretty big rebound yet. It is mostly seasonal. So I am not confident. I think it is possible that this is the bottom but I am not at all confident; I tend to worry more than most people about the longer run downtrend resuming.
- McShane – We know that from talking to you over how many years, really….When will we know that we should take these numbers a bit more seriously, sometime in the fall or….
- Shiller – Well, we never know for sure….it is a speculative market. The real question is on my mind is are we possibly off to the races again? You know the real estate market has become more volatile by the decade over the last few decades and people are, you know,… in cities like Phoenix or San Francisco we might be seeing something pretty big developing..people there are very speculative minded…
- McShane – Are you saying there is another bubble forming in some areas?
- Shiller – It could be; there could be. these things take me by surprise. Bubbles occur sometimes in the least optimal times because people think you want to buy before the news. So in the midst of a recession, you could start a bubble. Europe, northern Europe, has a housing boom going on right now…. It is kind of surprising there would be such a boom going on there.
- McShane – What areas in particular are you looking at and you would continue to look at? And how much data do you need before you draw some cort of a conclusion?
- Shiller – There are a lot of things that matter. Fannie Mae, Freddie Mac still unresolved. What’s Congress gonna do with reining in the mortgage deduction? All sorts of uncertainties right now. The thing is momentum does matter and I am very much noticing the strong performance we had in the last month = 2.2% in 1-month. If it kept that up, it would be like over 24% in the year. It won’t because this is partly seasonal.
- McShane – Just give me the areas you are thinking about with bubble-like behavior in the country.
- Shiller – I think notably, it would be San Francisco and Phoenix. Other cities look like bubble cities but I am not sure they are, like Chicago was up a lot this month, Atlanta was up a lot this month. But part of this is just the decline in foreclosure activity. We just had a report .. that foreclosure activity is down a quarter from a year ago. So that’s gonna boost the index. Could be that’s the kind of stimulus we are getting, stimulus being people see home prices going up because there aren’t as many foreclosures and they are starting to get optimistic and reinforcing that. That could be what’s happening.
Send your feedback to [email protected] Or @MacroViewpoints on Twitter