Reggie's Blog & Proprietary Research

Reggie's Blog & Proprietary Research (1277)


In continuing the rant on the possibility of the US entering a stagflationary environment, as was hinted by Alcoa's quarterly  report (see "Is My Warning of the Risks of a Stagflationary Environment Coming to Fore?"), I have decided to graphically illustrate the historically most successful inflation hedges. Click graphic below to enlarge.

inflation_correlation.png

For those "gold bugs" who have never ran the numbers, gold offers less inflation protection than your house does. The same goes for WTI crude and probably most other categories of oil.

 

 Last year, as the debate between the inflationists and the deflationist was raging, I stepped in with a little empirical research. I try not to make predictions and prognostications, but rather stick to being prepared for the most likely events. I stated that if I had to pick a scenario, the most likely as I was would be stagflation wherein high input costs would co-exist with a deflationary drop in asset values, creating a "worst of both worlds" style environment. Well, Alcoa has given us some anecdotal evidence of the likelihood of such an occurrence approaching.

Alcoa's Quarterly Profit Trails Estimates on Higher Energy, Currency Costs

 Jan. 11 (Bloomberg) -- Alcoa Inc., the largest U.S. aluminum producer, reported fourth-quarter profit that trailed analysts’ estimates as the company faced higher energy and currency costs...

Profit was hurt by higher energy prices and the dollar’s decline against the euro and the Brazilian real, Deutsche Bank AG analyst Jorge Beristain said...

“This quarter was disappointing, especially with the energy costs, and having to buy primary aluminum on the open market,” said John Stephenson, who helps manage C$1.5 billion ($1.45 billion) including Alcoa shares at First Asset Investment Management in Toronto. The miss on earnings was “significant,” he said.

I have been looking for banks that have the potential to fold under the weight of under-appreciated European sovereign risk (that is, those banks that haven't already imploded or bailed out). It was an interesting study and I will try to have the bank to subscribers by tomorrow or the day after. In the meantime, let's look at the sectors that I have examined.

 

 

 

Following the empirical evidence that banks share price moves are outstripping their fundamental performance, I have decided to run the same analysis with REITs that have beat the S&P 500. In the chart below, General Growth Properties had to be stripped out since it had a 3,000% return, it made the rest of graph participants illegible. Click to enlarge.

 reit_over_broad_market.png

The metrics used to segregate the companies were:
  1. TTM NOI / Current EV               
  2. Y-o-Y Growth in Rental Income               
  3. Q-o-Q growth in Rental Income           
  4. Y-o-Y Growth in NOI
  5. Q-o-Q growth in NOI
  6. Y-o-Y Growth in FFO
  7. Q-o-Q growth in FFO
  8. EBITDA/Interest expenses
  9. Total debt-to-Gross real estate investments
  10. Total Debt-to-Current EV
  11. Trailing 12 months EBITDA
  12. Trailing 12 months interest expenses
  13. Trailing 12 months NOI               
  14. Plus a whole host of other performance related criteria. All in all, very rich and informative model for those interested in the space.

A heat map was created to visualize the trend in fundamentals for those companies whose performance bested that of the broad market. As one may have guessed, the heat map is throwing off a lot of red, with implied cap rates (NOI/EV) going up as quarter over quarter net operating income declines in the face of both rising share prices and drastically falling rents and land values. Below is a snapshot of the heat map. Although this is a subscriber download, there is definitely something to be gleaned from trends highlighted below. Twilight zone, here we come...

From Bloomberg: Bank Profits Tripling Leaves Stocks Cheapest With 15% Discount to S&P 500

Jan. 11 (Bloomberg) -- No U.S. industry has faster profit growth than banks and brokers, and no group is more hated by investors.

Analysts say earnings at financial companies rose 120 percent in the fourth quarter, accounting for all of the income increase in the Standard & Poor’s 500 Index, and will triple by 2011, climbing four times as fast as the market. Should the estimates prove correct, the shares are trading at a 15 percent discount to the index, data compiled by Bloomberg show.

That’s not enough for money managers burned by the 84 percent drop in the stocks from February 2007 through March and more than 160 U.S. bank failures in the past two years. Financial companies are the least-favored equities, according to a Bank of America Corp. survey of investors with $617 billion in assets that showed 38 percent of 123 money managers are holding fewer shares than are in benchmark indexes.

“The stocks are clearly too cheap,” said Mark Giambrone, a fund manager who bought PNC Financial Services Group Inc. and Bank of America stock for USAA Investment Management Co., which oversees about $74 billion in San Antonio. “There may be some bumps in the road ahead, but for the most part those are reflected in the valuations.”

So far the analysts have proven right after the S&P 500 Financials Index gained 15 percent in 2009. Now, Jennifer Thompson, whose ratings for New York-based research firm Portales Partners LLC returned 31 percent in the past two years, eight times the gain for all the companies she follows, said PNC and Fifth Third Bancorp are poised to rally.

Most Bullish

Analysts are more bullish on bank stocks in the S&P 500 than any other industry based on their average share-price forecasts, which call for a 14 percent rally, according to data compiled by Bloomberg. That would extend the group’s 145 percent rally since March that was spurred by better economic data and government rescues of companies from New York-based Citigroup Inc. to American International Group Inc.

The industry has risen the most of 10 in the S&P 500 during the past 10 months. The benchmark index itself gained 2.7 percent last week and closed at 1,144.98 on Jan. 8. Futures on the gauge added 0.4 percent to 1,146.10 as of 12:56 p.m. in New York.

The S&P 500 Financials Index of 78 banks, brokerages and insurers remains down 60 percent since peaking in February 2007. The slump is twice the drop of the S&P 500, which has lost 27 percent from its October 2007 record, after the subprime mortgage market collapse caused $1.71 trillion in losses and writedowns for financial firms worldwide and led to the demise of New York-based Lehman Brothers Holdings Inc. and Bear Stearns Cos., data compiled by Bloomberg show.

 

In order to guard against a continued rally against the fundamentals for the new year, I will be releasing updated market neutral strategies using market based pricing. I will also release data driven models of the hot sectors that have beat the S&P 500 for 2009 that compare the trends of share price growth against the trend of the fundamentals for each company in that sector over a certain market cap so readers can see for themselves how safe and realistic this rally is.
Wednesday, 06 January 2010 19:00

Methinks It May Be Time for Mr. Geithner to Go

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It's going to be pretty hard extracting your metatarsus from your anus this time around. I mean, everyone makes mistakes with taxes, but the multi-billion dollar back door bailout that you tried to hide via EMAIL???!!! Come on, guys. If you're not smarter than that then you definitely won't be able to solve this financial situation thingy... Unless he knew absolutely nothing about the biggest bailout in the history of his country - under his watch, that is...

Jan. 7 (Bloomberg) -- The Federal Reserve Bank of New York, then led by Timothy Geithner, told American International Group Inc. to withhold details from the public about the bailed-out insurer’s payments to banks during the depths of the financial crisis, e-mails between the company and its regulator show. And I must ask, Why???!!! If it was to be secret, why use email. If it wasn't to be a secret, why'd you do it anyway! Did you assume that there would be de minimus blowback in the form of repercussions?

Just the other day I stated "Why does everyone confuse a bubble with economic progress" in a post about a very probable bubble in China (see "It Doesn't Take a Genius to Figure Out How This Will End" then get your chuckles on with "Goldman Seems to Trust the Chinese Economic Reporting a Tad Bit More Than I Do!"). Well, as if on cue,  Stocks, Metals Decline Around World After China Curbs Lending; Yen Weakens:

Jan. 7 (Bloomberg) -- Stocks fell around the world, driving the MSCI Emerging Markets Index down the most in three weeks, and metals declined after China moved to curb lending. The yen dropped after Japan’s new finance minister said he would welcome a weaker currency.

The MSCI emerging markets gauge slipped 0.7 percent at 9:45 a.m. in London, led by China as the Shanghai Composite Index plunged 1.9 percent, the biggest decline among benchmark indexes tracked by Bloomberg. Futures on the Standard & Poor’s 500 Index lost 0.3 percent. Copper retreated from a 16-month high and oil snapped an 11-day rally. The yen weakened against all 16 most- traded currencies.

Central bankers in China, the engine of the global economic bubble recovery, sold three-month bills at a higher interest rate for the first time in 19 weeks after saying their 2010 focus is controlling record loan growth. The Federal Reserve said in the minutes of its latest meeting that the U.S. economic recovery might require additional stimulus measures to be sustained.

Bubble Blowing Growth will probably reverse slow this year as tight credit will damp the artificially derived and probably outright lied about demand side,” said Zhang Ling, who helps oversee $7.2 billion at ICBC Credit Suisse Asset Management Co. in Beijing. “That will dash investors’ hope of another year of fast bubble blowing growth.”

Wednesday, 06 January 2010 19:00

Someone Is Paying a Lot for High Priced Doo Doo

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In reviewing the banks that were originally included in the Doo Doo 32 (a list of likely doomed banks created in the spring of 2008), I decided to have a team take the devil's advocate perspective (an exercise that we normally pursue) and attempt to build a bullish case for the sectors that I viewed bearishly yet have outperformed the S&P and escaped profitable shorting during the last three quarters. The results are illuminating.

Below is a list of shortlisted banks that have reported higher returns relative to S&P 500 between the period March 9, 2009 and January 5, 2010 - the bear market rally of 2009. The methodology that we followed for this short listing is as follows:

·         We took out a list of banks that are domiciled in the US and have market capital of more than $500 million and current share price of more than $10.

·         Next we calculated returns for each bank and S&P 500 between period March 9, 2009 and January 5, 2010.

Monday, 04 January 2010 19:00

Common Sense Bits From the News Bytes

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 U.S. Consumer Credit Shrinks by $17.5 Billion, Biggest Decline on Record

Jan. 8 (Bloomberg) -- Consumer credit in the U.S. dropped a record $17.5 billion in November as unemployment close to a 26- year high discouraged borrowing and banks limited access to loans.

The slump in credit to $2.46 trillion was more than anticipated and followed a revised $4.2 billion drop in October, Federal Reserve figures showed today in Washington. The median estimate of economists surveyed by Bloomberg News projected a decrease of $5 billion. The series of 10 straight declines was the longest since record-keeping began in 1943.

A labor market that’s shed 7.2 million jobs since the recession started in December 2007 is restraining consumer spending that accounts for about 70 percent of the economy. Fed policy makers have said tighter bank lending standards and reductions in credit lines are hampering the recovery.

“The consumer is battling some pretty fierce headwinds right now with double-digit unemployment rates, an inability to obtain credit, and looming tax hikes for wealthier Americans,” Chris Rupkey, chief financial economist at Bank of Tokyo- Mitsubishi UFJ Ltd. in New York, said before the report. “Consumers are trying to wean themselves off of credit cards, and if they don’t, banks will help them.”

Consumer credit in October was revised from a previously reported $3.5 billion decline, and the forecast for November was based on the median of 32 estimates in a Bloomberg News survey. Projections ranged from decreases of $2 billion to $10 billion. Credit dropped at an 8.5 percent annual rate in November.

Fitch: U.S. Credit Card Delinquencies Reach Record Levels ...

NEW YORK--(BUSINESS WIRE)--Delinquent balances on U.S. credit cards reached record levels and defaults surged higher in December 2009, according to the latest Credit Card Index results from Fitch Ratings.

Chargeoffs are poised to trend even higher in the coming months as consumers struggle with debt burdens in the still challenging employment environment, according to Managing Director Michael Dean.

'U.S. consumer credit quality remains under considerable stress due to persistently weak labor market conditions,' said Dean. 'As a result, chargeoffs will retest their recent highs throughout the first half of 2010.'

The 60+ day delinquency rate reached an all time high of 4.54% for the December 2009 index, which is based on performance data through November month end. This surpassed the previous high of 4.45% set in June 2009. Chargeoffs crept up to 10.68% from 10.09% in the prior month but remained inside of the record high of 11.52% set in September 2009.

Despite the unfavorable trends, Fitch continues to expect current ratings of senior credit card ABS tranches to remain stable given available credit enhancement, loss coverage multiples, and structural protections afforded investors. The outlook for subordinate tranches remains negative. Fitch expects U.S. unemployment will peak at 10.4% in second quarter-2010 (2Q'10) and remain above the 10% threshold throughout 2010.

From 4Q'08 through 2Q'09, Fitch's delinquency index rose 42% as the economic environment and employment situation worsened. Chargeoffs subsequently peaked in 3Q'09 with Fitch's index reaching 11.52% in September 2009 before receding in recent months. While recent trends point to higher chargeoffs, future deterioration is not anticipated to be as severe given that unemployment is expected to plateau near current levels.

'The recent acceleration in delinquencies has not yet approached levels experienced last year,' said Senior Director Cynthia Ullrich. 'With that said, seasonal patterns dictate further delinquency increases and higher chargeoffs in the coming months.'

 

Stocks in U.S. Decline, Two-Year Treasuries Rally on Unexpected Job Losses

The Labor Department said the U.S. lost 85,000 jobs in December, compared with the median economist estimate in a Bloomberg survey that called for no change in payrolls. The decrease in employment wiped out November’s gain. Global equities rose before the report on speculation the labor market improved in the world’s largest economy.

“People are still losing some jobs here, even in the fourth quarter,” said Jason Cooper, who manages $2.5 billion at 1st Source Investment Advisors in South Bend, Indiana. “The economy, it’s not as good as what people were anticipating. And I think that’s reflected in what the markets are doing.”

Benchmark U.S. equity indexes trimmed losses after inventories at wholesalers unexpectedly jumped in November by the most in five years. That signaled companies are picking up the pace of orders as sales climbed 3.3 percent, the biggest gain since January 2008.

 Morgan Stanley, Goldman, JPMorgan Earnings Estimates Are Cut at Citigroup

Geithner Asked to Testify in House on AIG E-Mails Over Payment Disclosures

 Pimco's Gross Says U.S. Economy Too Fragile for Fed to Withdraw Stimulus

Schwarzenegger Seeks Worker Pay Cuts, U.S. Help to Reduce Budget Shortfall

Seenmy forecast of this a year and a half ago in the Asset Securitization Crisis series installment on muni debt. State governments haven't started firing yet, but when they do it will add significantly to the unemployment rolls. 

IPOs May Triple in Europe as Private Equity Firms, Governments Plan Sales

 

Pending Home Sales Drop, Factory Orders Climb as Plants Lead U.S. Rebound

My how quickly we have forgotten how we got into this mess. This is a balance sheet recession, not a manufacturing recession. Going into the recession there was no problem with Factory Orders either. Look at home prices, home sales, foreclosures and delinquency rates - all trending towards the negative. This is what led us into the economic hard times and we will not get out of the hard times until this imbalance is corrected. The other stuff is fodder for the news feeds.

Bernanke Says Low Rates Didn't Cause US Housing Bubble: Video Jan. ... 

This is a joke, one almost as funny as when Bernanke said he didn't see any evidence of a bubble in asset prices.

 Taylor Disputes Bernanke on Housing Bubble, Says Low Rates `Were a Factor'

Insurer Regulators May Ease Capital Rules by $6 Billion After Pimco Review 

Is PIMCO a disinterested party? After all, they do invest in this stuff, and prices are likely to increase as liquidity increases. Will liquidity increase as insurers are released from RMBS lockdown? If anything, now is the time to rely more on the rating agencies assessments since they are being threatened with litigation. After all, now that they feel they may actually be responsible for the opinion they put out, they may actually do some due diligence. As you read this article you will see that PIMCO's reserve estimations are about 60% of what the agencies recommend. Somebody is very wrong here, and if the life insurance industry is supposed to be staid and safe, one would think the higher number to be most prudent. Excerpts from the article:

Jan. 5 (Bloomberg) -- U.S. life insurers may gain a benefit of almost $6 billion after regulators began using analysis from Pacific Investment Management Co. to review the amount of funds the companies need to back claims.

The industry will need about $8.75 billion in capital to cover potential losses tied to residential mortgage-backed securities based on Pimco’s assessment, according to the New York Insurance Department. The figure would have been about $14.5 billion based on a review by ratings firms, said Andy Mais, spokesman for the department.

The National Association of Insurance Commissioners, a group of state regulators, monitors investments to make sure carriers have enough money to pay claims. The group last year selected Pimco, manager of the world’s largest bond fund, to assess companies’ RMBS portfolios as regulators reduced reliance on ratings firms such as Moody’s Investors Service.

The $8.75 billion sum is a “fair and adequate amount,” said Michael Monahan, director of accounting policy at the American Council of Life Insurers, an industry group that pushed for regulators to change capital requirements. Pimco’s models, which consider home prices and unemployment, are more accurate than credit ratings in determining bond performance, he said.

Grades from ratings companies are “too volatile” to be used as the sole source for regulating capital, said Michael Moriarty, New York Insurance Department deputy superintendent. Either the rating agencies got it “dead wrong” at yearend 2008 and their ratings were too high, or at the end of 2009 with ratings that were too low, he said.

Why Use Ratings?

“It does beg the question, if the rating agencies were wrong, why should regulators reaffirm the explicit use of ratings for regulatory purposes?” Moriarty said.

Life insurers owned more than $145 billion of RMBS without government guarantees in 2008, according to the ACLI. The industry lost $76.8 billion in surplus in 2008 on investment declines and costs guaranteeing retirement products, according to a study by Conning & Co.

The $8.75 billion figure is an estimate based on modeling of about 20,000 RMBS, and a more precise figure may be available in March after 2009 financial statements are filed and more securities are included in calculations, Moriarty said. The Wall Street Journal reported the estimates yesterday.

The Pimco plan was opposed by the Center for Economic Justice, a consumer group, which said fewer funds may be available for policyholders.

Financial Crisis

“You don’t pick a financial crisis as a time to say, ‘OK let’s relax the capital requirements,’” said Birny Birnbaum, executive director of the center. “That is the time when consumers are most in need of that level of protection that surplus and reserves represent.”

 

Silicon Valley ‘Bloodbath’ Leaves Entire Office Buildings Empty