What You See Depends upon where You Sit
In times of great market stress, the investor doing homework needs to know where to look for information. Friday’s trading highlights the problem. The Bear Stearns conference call on fixed income issues is at the center of this question. We shall look at the perspective of different groups before arriving at a conclusion. As usual, "A Dash" is eclectic. We look to each expert to provide information in a specific realm.
Economists are generally citing an improvement in economic conditions in the second quarter versus the first quarter. Consensus predictions suggest that this will continue through the second half of 2007. This has also been the official Fed position. Various pundits predict that factors like credit problems or mortgage refinancings will derail the economy. It is important for the investor to realize that professional economists are well aware of these issues. While there is a range of predictions, one must decide whether to reject the economic consensus. It is interesting to note that many people responding to polls see a recession. This serves to sharpen the question of whether professional economists, traders, or individuals are better forecasters.
The Fed Experts
When attempting to forecast Fed behavior, we think it is wise to look to experts on the Fed. Friday’s Kudlow and Company had a panel including two distinguished experts.
Lawrence Lindsey is a former Fed Governor and top Bush advisor.
Robert McTeer culminated 36 years of experience with the Fed as President of the Dallas Federal Reserve Bank. He is now Chancellor of the Texas A&M system.
In spite of repeated provocation from host Kudlow, they both responded that the Fed was not going to cut rates based upon current conditions and would probably not even change the policy statement. Briefly put, they are looking at general economic conditions, not what is happening to specific hedge funds or investors in mortgage derivatives.
Whether or not this is the correct policy, we should respect these experts concerning the probable Fed direction.
We might also add the comments of Fed Governor Poole, who said that sub-prime investors got what they deserved.
Jim Cramer’s daily segment on CNBC’s program, Stop Trading, is drawing special attention because Cramer went into overdrive in his comments on the interest rate market, the need for a rate cut, Bernanke, and Poole. Cramer’s position is that many hedge funds are about to blow up because they have leveraged positions in mortgages. He cites conversations with companies where they have asked him to tell it as it is. The implication is that this has additional impact for hedge-fund lenders and counter-parties.
Doug Kass had another guest appearance on Fast Money. (Since we think the Kass viewpoint is important, we took the TiVo method to capture his views.) As is often the case, this was not a friendly audience for Doug, making it difficult for him to emphasize his key points. He was on two weeks ago with some accurate predictions about the current environment, but the video connection then seemed to break off. They invited him back.
Kass provides an excellent trader perspective since he had listened to all three of the key elements:
- The Bear Stearns conference call.
- Cramer’s analysis.
- The Kudlow show.
The Fast Money crowd was looking for a buy point in financials, and Kass (reluctantly we thought) said that he would not add to short positions in financials, had not covered, but probably should have. The panel seized upon this to suggest buying financial names and talking about Kass being "early".
When Doug was eventually able to reclaim the floor, he emphasized the following:
A decade or so back, the ability of parties other than the
Fed to increase leverage in the system was limited. You couldn’t put more than 100% on margin
debt, bank loans were restricted by a multiple of capital. In recent years you
have …derivative hedge funds. We do not
know how this is going to end.
and also ….
…we haven’t seen earnings cuts yet. Warnings from every money center bank, every
regional, and every investment bank in the next few weeks. They not only have a mark-to-market problem,
but all of the fee income, that $9.2 B of fees generated in the first half of
2007 are gone.
This is a very dismal outlook on anything in the financial sector. We are not sure about the basis of the dollar estimate, but Kass will probably spell it out in future articles.
The Bear Stearns Conference Call
It would be interesting to see a chart of the market versus comments in the Bear Stearns conference call. At one point, BSC was trading unchanged on the day. Then everything collapsed. The scripted part of the call went very well. Bear said that they were profitable in the current month and quarter, that profits were on track for the range forecast, that they had marked structured products to market, that they had no major exposure to leverage. All was well.
When questioned (we listened to the call) the CFO said that it was a bad environment. It seemed to us that he was trying to excuse the hedge fund blowups, a viewpoint endorsed by some other astute observers — Gary D. Smith and David Merkel.
What hit the tape was something far different. The CFO, in response to questions, was asked how this market compared to those of the past. He said, " I have been in the business for 22 years…."
The market reacted to the headlines.
How is an investor, doing his homework, to navigate through this maze? It is always most difficult at times of stress.
We are particularly concerned that those taking the trading perspective have so little respect for those making policy, a recurring theme on "A Dash." We believe that investors and traders should try to find information from various experts, as shown in this article.
We believe that market pundits too frequently display extreme arrogance, acting as if they are smarter, wiser, and more in touch than those charged with making important decisions. Investors can take a nice contrarian position by discovering the real experts.
A key feature is that the Fed is not going to rescue hedge funds or bad investments.
Meanwhile, if traders or investors are looking for the Fed to rescue hedge funds, the objective interpretation of experts is that this is not about to happen.