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.

The Economists

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.

The Traders

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:

  1. The Bear Stearns conference call.
  2. Cramer’s analysis.
  3. 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.

Conclusion

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.

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9 comments

  • RB August 5, 2007  

    Although the Fed doesn’t consider headline inflation, it is unlikely they will lower rates given their preference for core falling under 2% and with a headline inflation number poised to hit 4% in a few months. I know the long-term bullish posture advocated here is based on the Fed model — on the basis of a track record and justified by managers deciding to allocate between stocks and bonds. In that regard, here is a perspective of a portfolio manager describing his asset allocation in real time.
    http://www.minyanville.com/articles/Stocks-GNMA-Treasuries-S%26P/index/a/13074
    He is not impressed by the argument of stocks being cheap in comparison with Treasuries because for him Ginnie Mae’s at 6% are the appropriate comparison.

  • James Tellier August 6, 2007  

    Cramer’s video almost captures the hilarity of his Microsoft recommendations in summer 06 – http://www.stocktagger.com/2007/07/jim-cramer-microsoft-corporation-msft.html

  • Jeff August 6, 2007  

    RB – Thanks for (yet another) interesting pointer. I respect the approach taken, but I have reasons for preferring the method I selected.
    When one compares any two assets, the risk-adjusted return should be the same. There is a reason that GNMA’s have a higher yield. (David Merkel had a recent piece using other bond yields and making additional adjustments in the Fed Model).
    Second, as Sedacca notes in the article you cite, it is useful to have a history of meaningful length to do your analysis.
    Finally, I am very uncomfortable with the “average” or “median” stock analyses that are making the rounds. In each one I have reviewed, the measures are very loosely defined and lack historical comparisons. I have looked at a basket of stocks from the median range. They have a higher P/E but also a higher growth rate.
    Jeff

  • muckdog August 6, 2007  

    Dr. Jeff, I think from a retail investor POV, every pullback in a bull market provides an opportunity to get long.
    It’s interesting that the under invested folks on the sidelines always say that they’re waiting for the dip to get in. Then, when the dip happens, these folks say that they are now waiting for a bounce so that they can go short. Meanwhile, they underperform the SP500 year after year.
    I think the Fed does have room to cut rates. Inflation is really small at the core (year over year). Even with employment tight and wages growing, the economy is growing at a moderate and sustainable pace around 3%. Plus productivity is growing.

  • Bill aka NO DooDahs! August 6, 2007  

    There are two assumptions with the dip waiters: First, they assume they’ll be able to tell when the dip has bottomed, and Second, they assume they’ll have the balls to buy at that point.
    Those assumptions are somewhat “less than robust” (scientific jargon there). Hard for retail joe to buy when Barry and the other fear-mongerers have turned up the volume on their screed.

  • muckdog August 6, 2007  

    True, Bill. But usually anything over 5-7% on a dip is a decent play to ratchet up the beta and/or put cash to work (IMHO)…

  • Bill aka NO DooDahs! August 6, 2007  

    I agree. But tell that to the Joe who jumps in on a 5% decline that continues to 10% … and then sells.
    Or the guy who is too scared to buy at 5% down, waits for 10% down, too scared, and then buys on the way up … at 5% down.
    Without large huevos of steel and a method that works (statistically speaking), the dip waiter is better off being 100% in the market 100% of the time. IMHO.

  • Joe August 7, 2007  

    OK, now we’ve got the FED decision today which is exactly as expected by DoI. Good job, also in general with this blog!
    Joe

  • Quincy October 17, 2008  

    Well, a year later, it seems Cramer is right and the Fed is DEAD WRONG. They waited 7 months until they had no choice but to do what Cramer implored them to do– Open the fed window to the investment banks and cut rates. But by then, it’s too late and Bear collapsed. And now we have armageddon.
    It is true. Bernanke and Poole– THEY KNOW NOTHING!