August 2007


I feel that I’ve got a little bit more clarity in my understanding of the Fed thinking. My previous post on the Fed policy is here.

I’ve heard a lot of opinions today that the cut of the discount rate today is mostly symbolic and not much helpful. After all, the average daily borrowing at the discount rate was only $190 million this year.

But I think this action demonstrated once more that Feds are very concerned about the dollar franchise in the world as well as the suffocating liquidity problem in the markets. The discount rate cut was not very bearish for the dollar. Yes, the yen carry trade unwound, the oil increased a little bit, but besides that the dollar survived.

But was it really helpful? Yes, I think it was.

First, I think the Fed announcement before the market open at the last day before the options expiration inflicted the big damage on the bears (not me, I was a well-prepared bear). It should be a first indication of the existence of the Bernanke put.

Second, it should help the real problem, i.e. the credit squeeze at Countrywide Financial. Countrywide is the biggest mortgage dealer in US (in the world?). As such, they keep a huge portfolio of the meaningful prime mortgages, to people with solid income, 20%+ down payment and full income verification. Those people are coming to Countrywide for mortgages at around 6.5% rate. Before today this kind of mortgages could not be financed by the discount rate, which was at 6.25%. Today, the rate is 5.75% and suddenly it became possible to finance those deals through the discount window. Countrywide may use those mortgages as collateral, raise many billions of short-term financing and still be cash-flow positive on that deal. I don’t think that the bankruptcy of Countrywide is a possibility anymore.

In conclusion, I see the Feds at work and I think they did the work well

Karl Rove announced that he is resigning. Good buy, evil assh*le, go back boil in your pit

Day one? We have over 18 months of deteriorating RE market, which already pushed few states into recession (like California), how come today is the day one?

Today Countrywide published their new matrix of mortgage quotes. Suppose you are a successful doctor with solid income, huge pension account and almost maximum credit score. You want to buy a new primary residence for, say, $800k (which would be very, very modest 3 bedroom home in may area). You are putting 20% down and can show 2 months worth of payments on your checking account. Obviously you document your income, this is a full-doc loan.

What is your rate? It will be 7.9% for 5/25 ARM loan.

Now the real estate game is over, whatever happened before today was just a preparation for what will happen next

This week was extremely interesting in the sense that I feel that I had a brief glance at the Bernanke hand (in cards term). Let me try to explain.

It all started when Cramer almost collapsed in front of the camera saying that we have liquidity Armageddon. Then it was the Fed meeting and what we got was just usual “we are vigilant on inflation and bla-bla-bla“.

Weird. I thought that if even not-so-well informed Cramer knows that there is an Armageddon (shish, even I know that very well), than how come Bernanke is still playing his old inflation hand?

The answer came Thursday, when few more European hedge funds collapsed (nothing new with that) and European Bank opened unlimited discount window which was tapped for $200 bil in two days. Compare that with U.S. $70-80 bln injection after September 11, it’s almost triple that. Bernanke took a pause and injected “only” $30 bln, quite a lot, but nothing comparing to Europe.

What we got? Euro is dropping against the Dollar.

It all seems to me that Bernanke was playing the blinking game with the rest of the world. Whatever happens – he would not blink first. The world financial markets is the game of confidence, where everyone is bluffing, but the one who drops the cards first will lose. The money injection by European CB provides some liquidity for US as well, so why not make someone else do the job?

My conclusion is that Bernanke is not a political hack, who is getting his instructions from the White House to tune-up the economy before next elections. He is not a Wall Street slave as well, not a person who makes his financial decisions by looking at Dow Jones index.

He is a strict monetarist, whose target is the desired rate of the Treasury bonds of various maturity, which is strictly speaking the cost of money. He has some thought on where the 10-year Treasury bond yield must be and he will drain or inject until it settles in the desired range. Wall Street be damned. There is no Bernanke put

Let get back to this Ken Fisher article from 2/26/2007:

Don’t buy it. For months now the debate has been over whether America will have a hard landing or soft landing, the answer hinging on how big 2007’s housing disaster turns out to be. Well, there won’t be any housing disaster. We won’t have a landing at all, soft or hard. Right now the U.S. and global economies are both accelerating.

When he wrote it back in Q1 the GDP growth was 0.7%.

You can see right through the housing crash story by looking at the prices of housing stocks. The market knows what the economic worrywarts do not, which is that the housing sector is already making a comeback. In the last six months housing stocks are up 24%, well ahead of the overall market. If housing were destined to fall apart in 2007 these stocks wouldn’t be so strong now.

He wrote it two days before the market crashed taking the homebuilders down. Today $HGX, the homebuilder’s index is 26% lower than the day he wrote this nonsense.

Was it not obvious back then? Yes it was. The ABX.HE mortgage credit default swap index was crashing all the late February. Few days before Fisher article I loaded up homebuilders puts that I just unloaded for nice 400% profit. I’m glad I never followed his advices.

The consensus forecast is for single-digit S&P 500 earnings growth tied to a slowing economy. Disbelieve it. Experts’ forecasts have been too low for four years and will be now. First, the accelerating economy will deliver earnings that exceed expectations. Second, the analysts polled for these consensus numbers never factor in the effect of corporate purchases of stock for cash. Whether a company is buying in its own shares or taking over another company, the acquisition of equity stakes (if done cheaply enough) raises earnings per share.

Corporate earnings are in single digits and are trending down.

Home builder Pulte Homes (nyse: PHM news people ) (34, PHM ) is the second-largest U.S. homebuilder and in the top five in three-fourths of the largest markets. But its stock has lagged recently. At 11 times 2007 earnings and 60% of annual sales it’s far too cheap.

If the hysteria over the housing pullback has taken a toll on your courage, try Toll Brothers (nyse: TOL news people ) (34, TOL ). It’s half of Pulte’s size, more expensive (per dollar of earnings) but less risky. It’s the largest vendor serving the affluent end of the housing market, where qualifying for a mortgage is less of a hurdle. It sells at 19 times depressed earnings that will bounce back by 2008.

Yet another builder worth owning is Beazer Homes (nyse: BZH news people ) (44, BZH). At $5.5 billion in sales it’s the same size as Toll but offers both more potential reward and more risk. It focuses on the Southeast and West Coast, which evoke fears of overbuilt condo markets. Beazer shares fell 35% last year, putting them at 30% of annual sales and 18 times depressed earnings. Too cheap for a well-managed company like this one.

All of them are down about 30% since that call.

Conclusion: Ken Fisher is intellectually bankrupt and from now on must be ignored. Go back fishing. Dismissed.

I know most people laugh on Cramer for this video. But I’m here to show my respect to the guy. If I agree or not it’s a different story, but he essentially does the same that I’m doing here in this blog – he expresses the passion. He is not just the guy who got a cool job on TV – he has a passion for it.

Cramer – I respect you

I’ve already mentioned the Kondratieff wave here. Essentially the wave can be simplified to two formulas:

  1. The wave consists of the two legs of inflationary cycle – first part is 30 years of inflationary trend, which ends with absurdly high inflation, then there is another 30 years of disinflation, which ends with absurd deflation
  2. The whole wave is one big credit cycle – it starts with very low outstanding credit levels, when the central bank is forced to increase the monetary base not by credit increase but by printing money. Then the credit grows and the 60-70 year cycle ends with absurd credit levels and then everything collapses with massive defaults

The second rule can be simply illustrated by:

Mortgage debt

When the Kondratieff wave completes, the credit level will fall back to the start, i.e. 10% GDP, and then the next wave will start.

In numbers, it means that from 4 to 7 trillion of mortgage debt will be wiped out by foreclosures. That’s a lot, but in line with previous depressions’ experience.
Obviously it means that the Fourth Great Depression has to happen, but there is nothing we can do about it, it’s a law of nature :-)

Just want to remind you, that according to this chart the employment is a substantially lagging indicator.

The employment is booming when it’s time to heavily short the market, then start deteriorating when the economy is already in recession, and finally the employment collapses when the market is a screaming buy and the economy is strongly in the recovery mode.

Whatever number comes tomorrow – just ignore it. It means absolutely nothing

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