Entries by hb (153)

Thursday
Jan312013

Watson Wilkins & Brown, LLC, presents to students at Xavier University

In connection with the Business Executive Advisory Board of the Finance Department of the Williams School of Business,  alumni J. Hunter Brown presented  A Discussion of Governance & Corporate Control to several undergraduate finance classes. The case study involved an examination of the background issues, conduct & outcome of a recent proxy contest for a publicly traded company.  The case evoked lively discussion of the issues and incorporated various publicly available primary source documents pertaining to the proxy contest.

We hoped they enjoyed it as much as we did.

Wednesday
Oct312012

Sandy forces activation of contingency plans: our evaluation

Hurricane Sandy provided an unwanted, real time test of our contingency plans. Here is the good and bad of our status. Overall we were pleasantly surprised.  

  • significant damage in the local region severely impairing transportation, particularly in wooded areas and completely shutting down all public transportation
  • loss of electricity, heat, hot water, wireline based telephone & primary internet access by cable. Some 80%+ of Connecticut lost power
  • no harm to WWB staff or physical plant 
  • while our primary internet service provider went down, we maintained continuous & adaquate, albeit constrained, access to email & internet thoughout via smart phone 
  • our recent shift of certain applications to the leading internet business platform performed flawlessly thoughout
In face of one of the larger disruptions of the last decade or two, we retained adaquate operational capacity, though limited in some respects. The acid test: we never lost the ability to communicate with our clients, our primary independent custodian, or capacity to execute when the markets were open. 
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Those who followed the news know the magnitude of disruption. Our primary internet provider, a major provider in the region, went down. We heard it was due to a broken internet backbone, not a small issue. We know we had better 'survivability' than some unhappy billion dollar denizens of mid-town who were reliant upon T-1 lines. 
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I can tell you the region is fortunate for the warm weather, and we hope it holds. Things would have been much worse on the population had the temperature been in the 30's.  We watched the opening of the NYSE and see normalcy returning. One suspects the magnitude of damage to the infrastructure below ground in New York City is substantial and for that reason undiscussed in public fora.
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Don't hesitate to call, text or email us if you need assistance. We will respond.  If we can't take your call immediately, we will get back to you asap. 
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Thanks for your support and patience. 

 

Tuesday
Sep182012

pre q3: it's not an empty chair, it's an empty wallet

We’ve run silent for a while with good cause. Those with whom we speak know our distraction with and consternation about some corporate governance issues well away from WWB.  Our homily for last two quarters is, like QE3, ubiquitous: know before you go. More on that later.

The core issue for our silence has been that we've had nothing to say, at least nothing that made any particular sense. We were mesmerized by the magnitude of the geopolitical & macroeconomic frogs in global blenders and by the scale of cynicism marking the political hegemony.  What is it, "if you can't say anything nice, don't say anything"... well, our readers know we missed that bus a long time ago.
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We have accelerated the quarterly review process for our clients because we wanted to be tucked in before the end of this quarter in light of the election and the potentially massive recasting of portfolios driven by tax windows and political outcomes. 
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Talk to your tax advisors now

We suggest all check with their tax advisors to get a grip on their expected marginal tax rates next year; review any embedded long term capital gains and implications of future rates; and make sure you have adequate liquidity to tide over any potential geopolitical stress or untoward political outcomes domestically. 

QE3: Who made the Fed the 4th branch of government? 

The Fed has manipulated the rates for some time and now with the advent of QE3 the price of money will be determined by fiat of the Fed, whether driven by putatively leading economic thought, whimsy, or political objectives... exactly the same way FDR did in 1933. Amity Shlaes wrote a fascinating article in the WSJ on FDR and the notion of confidence, part of which is excerpted below:

Over the summer of 1933 ... Roosevelt launched a novel gold purchase program. The plan was to drive up the general price level by buying gold. Each morning, FDR set the gold price target, personally ... theoretically, Roosevelt's idea of reflating can be defended... but the exposure to investors that Morgenthau was getting through the gold purchase project of 1933 was already teaching him something. Investors didn't like the arbitrariness. It took away their confidence. One day Morgenthau asked FDR why the president had chosen to drive up the price of gold by 21 cents. The president cavalierly said he'd done that because 21 was seven times three, and three was a lucky number.

FDR, Obama and Confidence

That’s Bernanke today, and as we’ve said before “One might then reasonably inquire as to how and on what rational basis ... other than that to be found in a room, dimly lit by burning candles, with chalk pentangles and splatters of chicken blood on the floor ... how do they evaluate risk of this market which funds, essentially, the entire financial system of the known world.” 

The consequence of artificially low rates is a wealth transfer from the investor (you) to borrowers. Crudely put, you get low to no interest income while borrowers get low to no interest expense. Good for borrowers, bad for investors including retirees, your mom & dad, pensions, or anyone who wants to start saving…like young people with or without families. These are big, large scale numbers with generational implications for capital formation. The low yields are only one small part of the silent transfer of wealth & risk that is ongoing. 

Let’s talk about risk, shall we? 

In fixed income risk comes in two forms, duration & credit. Fed policy is attempting to force investors to load up on both. We all know what credit risk is: the weasel is shaky or doesn’t pay you back (Greece or General Motors come to mind, yes? Junk bonds? Your esteemed Uncle?). Duration is a measure of interest rate risk. So, for simple example, if you have duration of 14 as many long term Treasury funds do, and 14 year rates go up 1%, you just lost 14% of the value of your bonds. If the rates go up by 2%, then you lose 28% of your value (kind of a big numbers for purportedly low risk investments, don’t you think?). This is a big deal.

In fixed income there are only two sources of yield: duration or credit risk (let's ignore liquidity premia for the moment). Oh, by the way, these price changes and risk parameters move instantaneously with expectations, so the bond manager (or you the investor) needs to ask if he feels lucky today? Will the center hold? Long enough for me to pick up another coupon payment before expectations collapse? Well … do you?  Or maybe your grandmother shouldn’t own all those long term bond funds?  The Fed is force feeding markets. The investor who stays short forgoes yield, and retail investor who goes long does so by incurring duration risk. It will not end well. 

Inflation risk

Ah, the printing press. Another component of QE3 is the hidden cost of inflation, that part of price changes induced by excess money supply. When you look at the chart below, recall that Jimmy Carter took the title, as it were, with 14.8% inflation in March of 1980. It can & did happen. When you have monetary & fiscal policy created by the belief that $1.00 of government spending creates $1.50 of GDP and that belief continues to drive policy absent supportive data or in fact even in face of contra-indication… you may have a problem, particularly when you’re borrowing $.40 of each $1.00 you spend.

As you look at the graph below imagine it to be 3 sides of cardboard box with two walls and the top cut away. We drape a light blue cloth (a “surface” in math speak) along the upper left hand wall. Go the far upper corner where we start at $100 at time 0 with 0% inflation. You can see the real value stays at $100 where ever you are on the time line at 0% inflation. The front left axis of the floor of the box is the level of inflation running from 0 to 20%, and front right axis is time in years. Go to the rear wall, pick a line on the cloth (the first one is 1% inflation), and slide down the time line across the drape to the front.  Presto! You get something less than $80 in real value at 1% inflation over 25 years. 

 

 

Just so you know, the low points (closest to you, lower center, darker blue shade are the longest timeframes & higher inflation rates) represent about $1 of real value. You get the picture of a pretty severe loss of value over time even with fairly modest inflation: 3% inflation over 25 years kills half your purchasing power. That’s a big deal for individuals planning their retirement or for anyone including insurance companies or banks or corporations trying to fund assets or liabilities in the future. It’s a very difficult box to get out of.


the men would get paid in the morning. they would take pillow cases, put the cash in the pillow cases, walk over to the wall, and throw the bags of money over the wall to the women who would go out shopping, to spend the money before the merchants raised the prices in the afternoon...

source: as told to my friend LG by his grandfather on life in the Weimar Republic

  

Just witness the 25 basis point surge in break evens in the hours following the Fed’s QE3 announcement on Thursday last week, representing a “5-sigma event” for this market-measure of inflationary expectations.

source: Mohamed El Erian in Introducing the “reverse Volcker moment” Sept. 20, 2012

As you look at the graph ask yourself how do I price assets of any kind when I’m looking at a surface of real value that declines like a large water slide at an amusement park? This is how government lowers our standard of living. It is how government levies taxes without the consent or vote of the people. No elected official “votes” for “Quantitative Easing”. Who made these clowns the Fed an unelected 4th branch of government?  … but we digress into outright political control of the broad market economy.

There are very few places to hide, and those are imperfect places. This is not a pleasant time to be either an investor or in the investment management business. The general form of problem is that the Fed has manipulated the “risk free” rate to zero and announced it will print money without limit of time or amount. This causes two tectonic problems. It distorts asset price information and induces inflation risk. 

 

 

Real yields for US Treasuries with maturities less than 20 years are negative. This is the bond bubble. What value could there be in a 20 year bond with a real yield of 0%? We suspect very little positive value and potentially significant negative value. How shall we know? Ask Ben.

The problem of the “bond bubble” does not stop with bonds. The US$ is the global reserve currency, and the US Treasury market sets the benchmark for global asset pricing. As the Fed pushes investors out the “risk curve” the distortion of the Treasury market ripples across the globe and across prices of all asset classes. 

Recall that in response to instability of Euroland we saw investor flight out of the Euro and into the US$ and Treasuries which became too expensive, no yield, then catching its breath, the herd swarms into emerging markets debt & high yield debt which became too expensive, then into US equities generally, and particularly dividend paying stocks, which perhaps have become too expensive, or onto real estate which was previously too expensive and the proximate cause of the initial collapse? Or commodities that reside in bins? Or gold which has no earnings, no P/E ratio? The uroboros eats its own tail.

Add to this the uncertainty of the entire tax code, regulatory framework, the outcome of the US election, clueless Europe, Islamic instability on fire globally, with what appears more & more each day as a failed state on our southern border, not to mention the one in Washington.

Investment strategy

Our view has been that inflation is the primary risk to investors and that view defines portfolio & risk strategy. Of course, the solution is sustainable high real returns but there just isn’t a perfect solution, and there are no risk free solutions. An optimal strategy likely takes a form of ‘least worst’. Our general preference in relative order would include equities, real estate, commodities, short Treasury bills, inflation indexed bonds, and short duration spread product, all defined within prudent diversification and risk parameters.
 
Asset allocation

We do not anticipate significant changes in terms of existing broad asset allocations for most clients. That work has already been done & is embedded in the existing portfolios. We will be inclined to increase our exposures to real assets beyond the positions embedded in existing index product by adding slices of gold or silver, the size of which will vary by client risk tolerance.
On a good day the asset allocation decision already incorporates one’s ability to tolerate risk. We see nothing on a macro basis that would induce us to start adjusting those dials significantly for our clients. Risk tolerance will be the driver.
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Fixed income

As a general comment we’ve had a legacy core bias to short duration investment grade credit augmented by moderate positions of inflation indexed product, emerging markets debt, and domestic high yield. We’re still inclined to avoid duration and favor short Treasury Bills, inflation indexed bonds, short investment grade spread product. We’re not buyers of high yield or emerging markets debt at these levels.  We’re content to hold for now.
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We’re scared to death of municipal credits but suspect there may be value in certain long duration AAA/Aaa floating rate municipals. Ah, wouldn’t we all like to float or drift as the case may be?
 
Solutions to the inflation challenge can be problematic in that many investors simply lack the scale to tolerate the risks associated with the most robust effective classes or lack access to solutions which reside in the capital markets (e.g. interest rate swaps). What can we say, scale counts: “It’s good to be the king.”
  
Why not increase equity exposures?  

By all means if you've got the risk budget and faith in Ben. It has been a significant 3 months for virtually anything: US equities, non-US equities, emerging markets, and gold.  QE3 in connection with a slow grinding economy can do wonders. So do steroids, but there are bad side effects. 

 

While we believe that equities represent the best shot at sustaining higher real returns over time, we also recall the notion of Mr. Bernanke forcing investors out the risk curve. He has made some very large scale bets on a questionable basis. If it ends badly, the equity markets globally may be damaged or radically repriced along with all the guinea pigs herded out the risk curve.

We suspect the Treasury “bubble” has become ubiquitous, spreading to virtually all asset classes globally including equities. Historically, the US equity markets have been characterized by the stability created by a permanent equity market & investor class. Neither Asia, Europe, nor the emerging markets can make that claim credibly. In a heart beat…poof… they can go. Such things happen in panics.  US equities traditionally have stayed, we were open for business after 9-11. 

But things change. We started by saying that we view inflation as the primary risk. But are we not in a growth constrained and credit stressed environment too? The tertiary risk is an untimely, chaotic repricing of the distortions induced into the markets by imprudent fiscal policies & coercive & synchronized monetary policies globally. The risk is that Bernanke, the US Treasury, Congress, and the President, perhaps in conjunction with exogenous forces, unwittingly damage the fabric of the US capital markets and the investor class. We no longer assign a de minimis risk to that outcome. It's already started.

Look at what they did to our bond ratings. 

 

Sunday
Sep022012

What's wrong with the Fed

John Cochrane of University of Chicago provides the best explanation of why & how the Fed is off track in his recent article The Federal Reserve: From Central Bank to Central Planner

 

Thursday
Jun212012

Jim Rickards on the latest Federal Reserve Rate Decision and Operation Twist 2.0

For a lucid view of the recent Fed action in global context watch this:

Jim Rickards on the latest Federal Reserve Rate Decision and Operation Twist 2.0

It's a bit long, but worthwhile. Of particular interest at the back end are his comments on structural rent seeking and the costs it creates for our economy. Rent seeking translates into the political form of your risk, my return.   Moral hazard, the kudzu of our current regulatory framework, is the fountain of rent seeking, and it's everywhere ... 

  • Too Big To Fail whereby the entire loan & swap books of the TBTF institutions are underwritten by the US taxpayer
  • the failure to reform money market funds and the repo market and  the consequent expectation of federal support for funds which have no independent capital or collateral to support trillions of dollars of credit,  counter party & clearing risks
  • Fannie & Freddie which were essentially untouched by Dodd Frank and comprise about 95% of the entire US mortgage market and
  • pick a sector: health carer, automotive, education, pensions, energy etc.

We missed a lot, but you get the picture. We continue to manufacture boatloads of systemic risk by moral hazard. It is not a cost or risk free proposition.  And our politicians monetize for their own benefit their ability to allocate the privilege. No one seems to address the loss of freedom which accompanies the growth of moral hazard, but it is very real.

Lastly, an excerpt from an article on the SEC & money markets in today's WSJ:

Money market mutual funds have been rescued from financial trouble by their parent companies more than 300 times since the 1970s, about 100 more than previously reported, according to a new Securities and Exchange Commission study.

The study, which isn't being released to the public, appears to bolster SEC Chairman Mary Schapiro's contention that the $2.6 trillion industry needs stronger regulation

Wait a minute: "The study... isn't being released to the public"? One might reasonably ask, why not?  How are citizens to make informed decisions about what might be one of the most important regulatory & structural issues of the decade when key information is withheld? 

And if you're considering your freedom you might want to ponder the answer implicitly proffered: you don't need to know... if we wanted your opinion, we would ask.

 

 

Friday
Jun082012

Peter D. Brown joins Watson Wilkins & Brown, LLC, as Chief Portfolio Strategist

Watson Wilkins & Brown, LLC, is pleased to announce that Peter D. Brown has joined the firm as Chief Portfolio Strategist. Mr. Brown will be based in Anchorage, AK, and will handle, among other responsibilities, the firm’s west coast activities. Mr. Brown was formerly an Institutional Portfolio Manager and Director for Victory Capital Management and portfolio manager for Key Trust Company both investment affiliates of KeyCorp, one of the nation's largest bank-based financial services companies. He brings several decades of experience in institutional investment and client management.  

Mr. Brown was graduated from Hamilton College and is a longtime resident and member of the Anchorage community. By avocation he is a member of the Civil Air Patrol, an FAA certificated glider instructor, a Trustee and Treasurer of the Soaring Society of America Foundation, and a board member of the Alaskan Aviation Safety Foundation. 

“We welcome Peter to the firm and look forward to his leadership. We hope to develop a bigger presence in the Pacific Northwest, including the institutional markets” said J. Hunter Brown, Managing Member of Watson Wilkins & Brown. “He brings the highest ethical and professional standards, an acute & disciplined approach to the markets, and a straightforward approach to the client interaction.” 

Visit us at www.wwbllc.com.

 

Wednesday
May022012

A progress report on Dodd-Frank

Davis Polk has done an excellent job of detailing the complexity of process & progress in the Dodd-Frank Progress Report. It's also commendable to see lawyers communicate with pictures.

 

The free citizens of the US need only look at the red stuff (late) and the blue stuff (due date unknown) and ask:"If this were my business and these were my projects, what would I do with these project managers?"

Well, the bad news is that it is your national business, and they are our collective projects.

 

If you have the misfortune to be regulated by the red and blue stuff, well, this is the picture financial oppression and paralysis. It is also how we manufacture systemic risk, how government transfers wealth to politicians & regulators who monetize their ability to dispense economic privilege.

Get your bids in early: it's campaign season.

 

Tuesday
May012012

Choosing the Road to Prosperity: Why We Must End Too Big to Fail –Now

If you haven't seen this you should: Choosing the Road to Prosperity: Why We Must End Too Big to Fail –Now . We commend the Dallas Fed for putting it together.

If we don't fix the issue of moral hazard (Too Big To Fail) we can't have a market oriented economy. It's that simple. Read this in connection with our very own Reforming Money Market Funds: A Response to the Squam Lake Group.

It must change.

Friday
Apr272012

Vanguard crushes costs

Behold Moore's Law at work with scale:

Expense ratio changes announced for a number of Vanguard funds and ETFs.

The diversification of the S&P 500 now costs only .05% pa in fund expenses! On a percentage basis these reductions are huge.  This puts more and more pressure on active managers by increasing the amount of sustainable alpha they need to generate to carry their costs. Conversely, indexing makes more & more sense, but we already knew that, yes?

 

Tuesday
Apr032012

Comments on Q1 2012

Equities got a year's worth of return in the first ninety days of this year, but the glide path that took us there was not encouraging. We take what we can get, however, we have not had a recovery:

The current recovery began in the second half of 2009, but economic growth has been weak. Growth in 2010 was 3% and in 2011 it was 1.7%. Who knows what 2012 will bring, but the current growth rate looks to be about 2%, according to the consensus of economists recently polled by Blue Chip Economic Indicators. Sadly, we have never really recovered from the recession...

Click to read more ...

Friday
Mar302012

FHFA-OIG’s Current Assessment of FHFA’s Conservatorships of Fannie Mae and Freddie Mac

We present a link to and an excerpt from a report by the Federal Housing Finance Agency, Office of the Inspector General. We believe it is important and suspect it will receive limited coverage because it is counter to the currently fashionable narratives. The short story is one we already knew: Fannie & Freddie are big time bust. And don't you know Dodd-Frank is silent on the topic. Well, why not? Both those Senators were essentially parties at interest in Fannie & Freddie.

As to the matter of large scale capital flows & macroeconomic outcomes, our country is slowly awakening to the quaint, old fashioned notion that results & outcomes matter.  They matter very much. 

White Paper: FHA-OIG's Current Assessment of FHFA's Conservatorships of Fannie Mae and Freddie Mac

"As a practical matter, however, the Enterprises’ future solvency – and, thus, emergence from the conservatorships – is unlikely without legislative action. FHFA officials have stated that the PSPAs have made it virtually impossible for the Enterprises to emerge from the conservatorships. For example, the Enterprises currently owe Treasury $183 billion, and are required to pay 10% dividends on Treasury’s outstanding investment. Merely paying the 10% annual dividend (i.e., $18.3 billion, presently) would not reduce Treasury’s outstanding investment. Moreover, the Enterprises have had to borrow from Treasury at least part of their dividend payments to Treasury, thus increasing the value of their outstanding debt. As a result, it would appear highly unlikely – if not mathematically impossible – for the Enterprises to buy themselves out of the conservatorships. FHFA’s Acting Director has stated that:

[T]he Enterprises will not be able to earn their way back to a condition that allows them to emerge from conservatorship. In any event, the model on which they were built is broken beyond repair... "

The magnitude of these losses are huge, the loss of national wealth permanant, and the burden on the US economy and younger generations of American huge... all driven by defective policy and corruption. For insight into the nature of corrupted governance & markets we recommend Reckless Endangerment by Gretchen Morgenson.

Private markets provide mechanics for change of governance in face of failure. That mechanic seems to be lacking in the political arena. The same political class continues to regulate increasing sectors of our economy by the same defective methods. The agency costs of failed political goverance are too high to sustain. Remember the wisdom that brought us here: we see it repeatedly in the regulation of financial markets, health care, and Fed policy.

 "on the basis of historical experience, the risk to the government from a potential default on GSE debt is effectively zero" Implications of the new Fannie Mae and Freddie Mac Risk-Based Capital Standard by Robert & Peter Orszag and Joseph Stiglitz, 2002

 

 

Sunday
Mar182012

Reforming Money Market Funds: A Response to the Squam Lake Group

Updated on Tuesday, March 20, 2012 at 10:00AM by Registered Commenterhb

Updated on Monday, April 16, 2012 at 09:29AM by Registered Commenterhb

Updated on Friday, April 27, 2012 at 10:38AM by Registered Commenterhb

Updated on Friday, June 8, 2012 at 10:44AM by Registered Commenterhb

Updated on Thursday, June 14, 2012 at 01:36PM by Registered Commenterhb

Updated on Friday, June 22, 2012 at 10:06AM by Registered Commenterhb

Updated on Monday, June 25, 2012 at 11:40AM by Registered Commenterhb

Updated on Tuesday, November 27, 2012 at 09:28AM by Registered Commenterhb

The money markets are central to critical issues such as credit creation, systemic risk, and investor confidence. They function on a macro level to allocate globally short term credit, unsecured in the case of commercial paper, and secured in the case of repo.

Money market funds are defined in the Investment Company Act of 1940 Act and influenced by investor preferences as expressed within that regulatory framework. Historically and as a practical, functional necessity the money markets have been geared to the very lowest levels of perceived risk, which is to say very short term exposures (average maturities of 30- 45 days) to the very highest quality credits. Historically, one whiff of trouble … reputational, credit degradation, informational risk or whatever is not clear and simple… and you have investor flight, which is what happened to the TBTF’s (Too Big To Fail) in the Great Unpleasantness.

Today those same problems remain.  Money funds today operate with no capital whatsoever. They are cash repositories and warehouse massive systemic risk: broadly put, short term, rolling AA- credit & liquidity risks ... sovereign, corporate & financial.  And the nature of that risk has qualitatively changed for the worse over the last decade.

Click to read more ...

Tuesday
Mar132012

Observations on tactical asset allocation

We thought we'd share an excerpt from a recent posting from Vanguard regarding the effectiveness of active management, this time with respect to the very fashionable jargon of 'tactical asset allocation'.

Vanguard | 03/08/2012

Tactical allocation mutual funds, which offer portfolio managers the flexibility to shift between asset classes as market conditions change, have proven popular with investors in recent years. But do they deliver?

An article in MorningstarAdvisor looked at the performance of 210 tactical funds to see if they provided a safe harbor during the summer 2011 stock market correction, while also capturing gains during the bull markets that preceded and followed that correction. The goal was to find how many funds provided a better risk-adjusted return than Vanguard Balanced Index Fund.

"Our extended study found scant evidence that these funds delivered on their goal of delivering competitive returns with a smoother ride," according to the article. "Most gained less than the Vanguard fund, were more volatile and prone to downside, or both."

An update to earlier Morningstar research, the report covers only the 17-month period ended December 31, 2011. However, Vanguard has studied similar questions over longer periods and made similar conclusions.

We're not recommending a security here, just providing another datapoint and a suggestion to consider the methodology the next time you're feeling smarter than the market.

Monday
Feb132012

Inflation, deflation & asset classes

A recent article in WSJ referenced a helpful analysis for those interested in the risks of inflation or deflation by asset class. The primary source was the Credit Suisse Global Investment Returns Yearbook 2012

For the short story, go to p.14 of the Yearbook.

Friday
Feb032012

That which is seen and that which is unseen by the Fed

Updated on Monday, February 6, 2012 at 09:01AM by Registered Commenterhb

Updated on Tuesday, February 7, 2012 at 08:22AM by Registered Commenterhb

Updated on Monday, February 13, 2012 at 08:05AM by Registered Commenterhb

The testimony of Ben Bernanke yesterday (2/2/2012) to the Committee on the Budget of the U.S. House of Representatives was marked by an assertion as to the health of the US capital markets, that in response to a question that cited an opinion piece in the WSJ by Kevin Warsh excerpted below:

 "Private investors are crowded out of the market when the Fed shows up as a large and powerful bidder. As a result, the administration and Congress make tax and spending decisions—with huge implications for our standard of living—with heightened risks around future funding costs."

The transcript of the testimony has not yet been published as of this writing, so we quote, sort of, Bernanke's response:

 “The capital markets are all okey dokey. Never better. Next question.”  

We return to that issue because we disagree. We think the narrow context of his response is facially misleading. First, we stipulate

Click to read more ...

Friday
Jan272012

Legal & settlement considerations in various Euroland scenarios

Pillsbury Winthrop Shaw Pittman, LLP, has published an important advisory bulletin Cracks in the Eurozone.

It provides a helpful primer to understand the magnitude and uncertainty of the large scale contractual processes at work in Euroland.

More later.

Monday
Jan022012

Caedite eos! Novit enim Dominus qui sunt eius

Updated on Wednesday, January 4, 2012 at 09:48AM by Registered Commenterhb

Updated on Thursday, January 5, 2012 at 08:20AM by Registered Commenterhb

Updated on Friday, May 4, 2012 at 08:55AM by Registered Commenterhb

We probably should talk about investments, although what I want to do is rant about our domestic policies which are destroying so much of our economy, so much of our national value. We'll get to both, and pictures are a good place to start.

This year's markets were uninspiring at best, frightening at worst. US equites struggled to hold near even while foreign markets, both developed and emerging, suffered. As always we select broad indices for illustrative purposes and note these are graphs of prices, not total returns.

Click to read more ...

Friday
Dec302011

WWB's book of the year award: Currency Wars by James Rickards

Currency Wars by James Rickards  is a well written, understandable & exquisitely logical explication of the economic theory, policy & political economy that currently drives Fed policy. It is stunning in clarity, understandable and reflects the knowledge & perspectives of an obviously seasoned market practitioner who also has a detailed command of current scholarship & theory. The book is not the studiously inaccessible, self-referential work of an academic.

If you have ever had the unpleasant task of telling a sovereign state that… “we regret that in light of current conditions in the market, we have no bid for your paper and do not anticipate a change in that posture in the near to intermediate term. As your staff knows we have no available capacity with respect to our trading lines. We are seeing from time to time your paper trade away from us in the secondary markets at significant discounts and in disorderly manner. We will continue our dialogue and keep you apprised of market conditions as they develop”… you tend to develop a certain sensitive and personal understanding of liquidity.

So, if you’d like to follow how game theory, including war games, foots to the non-linear responses of chaotic systems, give it a go and partake of a very public  & needed sheep dipping of the policies of Bernanke & Timmy Geithner.  A complete reading in one sitting is a rare event, and you might just do it. 

We recommend the book to promote a broader, more accurate understanding of monetary policy & risk management in the context of global dynamics, and that to bring about constructive and timely reform.

Sunday
Oct022011

Kurtosis and systemic risk: policy makers need to get a clue

When we see phenomena we think we intuitively understand, and it's important, we try to kick the tires a bit. Intuition is good, confirmation by fact is better. Here we take the S&P 500 for a broad proxy of the US equity market and further take VFINX, Vanguard's 500 Index Fund, as our guinea pig. We downloaded 10 years of daily data and found some of the pictures of interest, some entertaining, one vitally important. Here we go:

Here is the time series of daily price data from Jan. 3 to Sept 27, 2011 downloaded from Vanguard. You know its ugly, but take a look anyway.

Here is the same data sorted by % size of daily gain or loss. Less ugly, but only due to style of presentation. If we hadn't put the drop down line in, it might have passed for semi normal. But it seems a little longer on the left side, yes? Of the 185 data points, 100 are negative.

Same data displayed differently, or as a matter of conceptual art perhaps a "splatter chart" of someone's viceral reaction hitting the floor.

 

So how does this volatility stack up to a decade of price behavior?  Below we chart the minimum and maximum one day % changes of the past decade (specifically from 9/21/2001 to 9/27/2011). Well, so far it seems there are only three worse years:

 

Interestingly, so far this year's standard deviation in and of itself is about average, but the dispersion seems to be increasing.

 

We took at look at the kurtosis over the last decade. You can see the definition in the picture (bolding courtesy of editor). The trend since mid to late 2007 is not encouraging. Others have found similar results, that is increasing excess kurtosis, in the yields of 90 day T-bills. This is systemic risk.

 

This bears particular import for the operation of global capital markets, and in particular for alternative assets as a class. Most of the literature we've seen indicates that adding alternative assets to portfolios of traditional asset classes can increase kurtosis of the overall portfolio (think pensions & endowments) if unartfully done. We also suspect that the notion of kurtosis induced by alternative assets isn't even examined in by most small institutional & retail investors. And certainly most alternative assets are soldpresented on the basis of mean variance risk/return space which is the quintessential apples to oranges.

Policy implications

At some point the Fed, regulators, and policy makers have to get a clue. They are manufacturing systemic risk and mere repackaging doesn't help. Granted some of this is spillover form Europe, but at the end of the day in the financial sector we still have large scale asymmetry in the treatment of the too big to fail financial sector, that in the form of socialized risk and privatized return. We are still left with increasing aggregates of black box counter-party risk. 

We have utter chaos in the regulation of the non-financial sector, and we have a chaotic tax code that incents the mis-allocation of productive capital. And they continue taking economic water out of one side of the bucket to put in the other side without regard to leakage or fundamental damage to the bucket....We note that free trade bills have languished without action for the last 3 1/2 years; the Senate undertakes consideration of Currency Exchange Rate Oversight Reform Act, our very own modern version of Smoot Hawley; an energy policy designed to throttle exploration & production; and a Rube Goldberg tax code.

But the good news is that the market and the United States has the ability to suffer through the current toxcity of policy and leadership.  No doubt the outcome of the election will impact valuations. Intrade now prices the probability of BHO's re-election at 47%.  Even with a sensible regime change, we're in for a long slog, but we're is not ready to piss on the fire and call in the dogs1

In the context of a seven to ten year time frame equities are not unattractive at these levels, but the meaning of the kurtosis graph is that you better buckle up. The investment premise is simple: you'd better not be investing for near term value. Getting from here to there will be the trick, and adaquate liquidity will be important.  If we get some sensible policies in place and some new leadership, then the values offered today may very well look compelling 7-10 years forward. But as our President is known to say, "let me be very clear": it's going to be a bumpy ride from now to then.

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1  Colliquial expression of cultures in the Appalachian & southwestern regions of the United States.

Tuesday
Sep272011

Observations on foreign bank liquidity

Today's WJS  advises that

For the past three months, European banks have been largely unable to sell debt at affordable prices to investors, who are wary of the banks' vulnerability to risky euro-zone government bonds and other loans.

At $34 billion, the amount of senior unsecured debt issued by the Continent's financial institutions this quarter is on track to be the smallest of any quarter in more than a decade, according to data provider Dealogic. - Europe's Banks Face New Funding Squeeze

Let's see ... from more than $250 billion in QI and QII in 2009 to $34 billion.

We looked at the short end of the curve and see that the foreign financials have racked up a 28% decline in outstandings since the peak in June (see the big red arrow below).

Bloomberg reports

The eight biggest U.S. money-market funds reduced their investments in French banks by 46 percent to $42 billion in the past 12 months, data compiled by Bloomberg and published Sept. 9 in the Bloomberg Risk newsletter shows.

This is particularly precarious for banks, given that liquidity pressures over year end can be stressful even in good years. Saavy liquidity managers are starting now to fund through year end, but there is, evidently, a substantially declining bid for even the shortest of foreign financial paper in our domestic markets.

Where does it go? The Euro commercial paper market is simply too small and, oops, low-to-no bid there anyway.

Below we present outstandings of various segments of the US commercial paper market:

This is the US$ funding crisis everyone's been anticipating. Last we heard France was trading around 1.96% for 5 year credit default swaps, and Italy about 5.03%, so its not clear that sovereign support for the banks will bring much to the party. The Germans need to play.

If there is some good news it is to be found in the blue & green: there is a growing supply and demand for non financial domestic commercial paper. It's good to see some credit creation, however modest and the financial outstandings seem, well, sideways is good enough.

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