Thursday, May 24, 2012

It’s not like you’d think

Last week I was in New York City for a conference put on by S&P.  Everyone that heard where I had been said something along the lines of “Oh I LOVE New York! “ or perhaps “That’s my favorite place to go.”  While I too love going to NYC, I got a very quick reminder that things there don’t always work like you’d think.  As a country we watch a lot of TV and movies.  Many of those movies and shows take place in New York City, which means you see a lot of the quintessential “actor hails a cab” type scenes.  It’s the way to get around and it’s easy.  The city is chock full of cabs…when you need one you just walk to the street, throw out your hand, and one pulls over to whisk you away to your destination.

That’s how the movies have trained us to think of cabs.  With that in mind I’d like you to picture our recent trip to NYC.  We stayed at a hotel in lower Manhattan and I was absolutely shocked at how much horn-honking goes on in the city.  The horns were so constant that at first I thought Godzilla might be attacking the Island. Then I realized that it’s just how New Yorkers communicate with each other in traffic…I think they use horns instead of turn signals.  Whatever the case…the system works for them.  Around midnight the horn-honking marathon was still going strong, and as I lay wide-awake in bed I began to wonder if this is why NYC is also called “the city that never sleeps”.

On “Day 1” in the city we had to catch a cab to the S&P building which was just a few miles away.  Mr. Brian Hey and I walked down to Delancey Avenue, crossed the street, and quickly took up a spot where we could hail a cab.  I could see perhaps 20 cabs in the immediate vicinity.  I threw my hand out just like in the movies…and the cab blew right by me.  “Hmmm.  Must have someone in the back” I thought.  The next cab approaches and I throw my hand out and he too blows by me without a glance.  “Geez…strike two”. 

After the third cab passed us like we were invisible I looked at my watch.  We planned to be at the S&P building 15 minutes early…if these cabs keep it up we might only have 5 minutes to spare.   Now we decided to switch to the other side of the intersection…maybe our luck would be better over there.  No dice.  I hold my hand out and the driver just looks at me shaking his head in a “No” gesture.  Time is getting tight…we decide to split up.  Brian went back to our original destination and I stayed on the north side of the intersection.  Surely if we split up we’d increase our odds of getting a cab.  Cabs are going by faster than the second-hand on my watch.  It’s unbelievable that in a city bursting with cabs we can’t get one to stop.  

Eventually we decide that it’s time to initiate “Plan B”.  “Plan B” isn’t so much a “plan” as it is a last resort…we have to start walking…and fast.  I broke out my iPhone and used it to navigate us on our hike.  The plan was to hike through Little Italy, skirt the edge of China Town and then push into the heart of the financial district.  If we were lucky we’d get there just as they shut the conference room door. 

Little Italy was a ghost town at that time of day so we blew right through it.  After a few blocks we entered China Town, which was a much different story.  Now in addition to navigating with the GPS we had to move in and around a fairly thick crowd that included pedestrians, bicyclists, skateboards, delivery trucks, workers unloading the delivery trucks, along with construction workers and their machinery.  The only method of transportation I didn’t see was someone on a pogo stick.  We even saw a basketball court with one half being used for basketball and the other side full of people doing Tai-Chi amid the hustle and bustle.  Crates of raw seafood and boxes of strange vegetables lined our way along an impossibly small and cluttered sidewalk…it was a labyrinth of chaos with a very unique blend of sights and smells… we were strangers in a strange land…and we still had no cab.

We popped out the far side of China Town with a shot-clock that was running really low.  In the distance I could see the edge of the financial district.  It was a few blocks away which meant that we had to cross another three or four intersections just to get to the next big group of cabs.

The conference was scheduled to start at 9:00 AM.  When that hour struck we were again standing on a street corner with a hand out in the air.  Finally we got a cab.  Once you’re in the cab it’s a pretty easy gig…he got us there right away.  You just have to remember not to open the door on the street-side of the cab or you could get killed by a passing cab that I suspect still wouldn’t stop even if he hit you.  Always get out on the sidewalk side…here you might get hit by a bicycle but it’s the lesser of two evils.

Ultimately we walked into the conference about 20 minutes late.  The morning commute had gone nothing like we expected.  It was longer and more difficult than we could have possibly imagined when we drew up our “Plan A” the night before.

The economy hails a cab

The NBER told us that the recession ended in June of 2009.  The average yield on the 10-year Treasury in June of 2009 was a 3.72%.  After almost three years in “recovery mode” the 10-year is at a 1.71%, the unemployment rate is still north of 8.00%, the Fed is still on hold at 0-25 bps, economic problems are still raging in Europe, and there is a whole menu of other problems you could pick from if you really wanted to go further in the analysis.

Like trying to catch a cab in NYC, gaining economic momentum in this “recovery” may not be as easy as we might have thought.  By all accounts our “recovery” has been a modest one.  What makes matters worse is that the very modest gains we’ve made here at home have been offset by a worsening global picture.


The story that won’t go away is Europe.  It won’t go away because they keep kicking the can down the road…and no matter how fast or slow you are travelling…you’re eventually going to get to the can again and have to deal with it.  Perhaps my favorite headline of the day is from the Wall Street Journal who wrote: “In Europe, Time for Plan B, Only There’s No Plan, and No Time”. 

Worries about the future of the Euro are dominating market activity today as a key EU summit is held to discuss growth in Europe.  The short story here is that it’s causing a flight to safety in US Treasuries.  The 5-year Treasury auction just went off and it posted a new record low…it came off at 0.74%...the prior record was in the mid 80 bps range. 

As we move into the summer of 2012 we appear to be on same pattern we had in 2010 and 2011 where predictions of growth gave way to problems and lower yields that started in the second quarter and got worse as we moved deeper into the summer.  If you want a refresher on how this pattern has worked over the past few years just pull up the Market Update piece titled “It’s like Déjà vu all over again” that I sent out on 5/8/12.  It provides a nice recap of how this cycle has developed over the past few years. 

Zuckerberg gets de-friended

The Treasury curve is up across the board this morning.  The 10-year spot is up half a point to trade at a 1.71% and the Dow is off roughly 200 points to trade at 12,312. More people are “de-friending” Facebook today as Bloomberg is reporting that there is already a lawsuit being filed against the underwriters.  I’m not an “Equity IPO Historian” but I’d have to guess it’s rare for both an IPO and a lawsuit against the IPO to be filed in the same week.

That’s it from here.  If you have any questions or if there is anything I can be doing for you just let me know.

Slower than a grass fight

Yesterday morning there was a conversation here in the office about landscaping.  One of my co-workers mentioned that he has Bermuda grass in one section of his yard that is encroaching on some fescue in another section.  His comment was that it was going to be a battle-royal to see who would survive.  My first thought was that the battle he was describing might be the single most boring battle in the history of nature.  The only thing more difficult to watch than two types of lawn-grass in a slow-motion fight to the death would be watching yesterday’s market activity.  For most of the day the entire Treasury curve was virtually unchanged and the domestic stock indices weren’t much different.  I didn’t check but coffee futures might have taken a big jump to the upside based solely on yesterday’s caffeine intake in my office. 

It was slooooow…slower than two grasses fighting.  Maybe it was this slow pace of activity that gave my brain too much free time, but as I sat here in front of my Bloomberg screens something started to seem…familiar.  It wasn’t an “a-HA” moment…it was like one of those times when you can almost remember the name of the band that sings the song you’re hearing…and it’s on the tip of your tongue…but you just…can’t…remember.  It was one of those types of things. 


Today I got a clearer idea of what was buzzing in the back of my head.  I pulled up some data on the 10-year Treasury from the past few years.  Look at the 10-year yield as of May 1st from the past three years:

01 May, 2010 – 3.72%

01 May, 2011 – 3.32%

01 May, 2012 – 1.96%

 *yields are from the closest trading date to 01 May.

The NBER says we exited the recession in June of 2009.  At that time the 10-year was trading around a 3.72%.  The further we go into the “recovery” the lower the 10-year Treasury yield gets. 

 That made me recall that the pattern over the last few years has been one where everyone explained away our poor first quarter performance by saying that they expected the growth to occur in the second-half.  Each time they were disappointed as the growth didn’t materialize and people piled back into Treasuries as a safe haven.  Global problems also added fuel to the fire in the Treasury market.  This morning I pulled up graphs on the 10-year Treasury for the past three years.  What you’ll see is that yields began to drop in the second quarter, and continued to slide into the summer.  Yields bottomed out somewhere between August and October in both 2010 and 2011. 

I’m not saying history will repeat itself…but it doesn’t escape my attention that as we start the second quarter of 2012 yields are again dropping, growth is still sub-par, and we are still haunted by global economic problems.  As Yogi Berra used to say…it’s like déjà vu all over again.


Currently the 10-year Treasury is up almost half a point in price to trade at a 1.82% yield.  You may not like the yields we have available today, but if history does repeat itself you might find yourself wishing you had put more money to work at these levels.  Ultimately I think it makes sense to put money to work when you have it rather than trying to time the markets. 

If you have any questions or comments on this material shoot me a message.

Friday, May 11, 2012

FW: Market Update 5 11 12 _ JP Morgan's "Achilles heel"

Wake up call

There we were…just sitting in front of our Bloomberg’s on a lazy Thursday afternoon.  The hands on the clock slowly crept past 3:30 Central (closing time for the NYSE) and then something happened.  The Bloomberg scrolling news headline screen flickers all day long on one of my four monitors as news stories pop up on the screen and then quickly scroll down off the bottom.  It is one long continuous flow of binary that converts the pulse of the markets into headlines that keep us informed about everything that happens in the financial world.  If the CEO of a big company has a drink spilled on him at lunch we usually see a headline.  Given the sheer volume of news it can get overwhelming…so when there is something really important going on Bloomberg usually posts the story with a big red background. 

Yesterday afternoon I was going through a mountain of paperwork and I was almost asleep at my desk when a headline with a red background appeared at the top of the scrolling news screen.  It read:

“JP Morgan says CIO unit has significant mark-to-market losses”  The acronym “CIO” stands for “Chief Investment Office.”

“Wow” I thought…”that is very interesting”.   Shortly after that another red block popped up…

“JP Morgan likely to post $800 million loss in 2Q.”

“That’s a lot of money”.  A few more minutes pass and we get:

“Dimon says $2 billion trading loss on synthetic positions.”  Now THIS is getting very interesting. 

“Huge losses on synthetic positions?”  Man, this is just like the old days when hedge funds were melting down and Wall Street firms were going under.  There is no way I can focus on paperwork now.  At this point I’m furiously working the keyboard trying to find out more about what is going on.

Another red headline hits:

“JP Morgan says portfolio strategy flawed…”  Dude…understatement-of-the-year

Five minutes later:

JP Morgan CEO says “this is not how we want to run the business.”

In less than five minutes time the previous “understatement-of-the-year” has been dethroned by that line.  He goes on to state:

“These were egregious mistakes…and self-inflicted”

To his credit Jamie Dimon said he didn’t want to use “market disruption” as an excuse for the losses…nor did he want this to necessarily implicate any other bank as he said “Just because we’re stupid doesn’t mean everybody else was…this puts egg on our face and we deserve any criticism we get.”

Achilles Heel

Bloomberg news stated this morning that JP Morgan’s push into the riskier positions that caused these huge losses was led by an employee named Achilles Macris…the irony alone could kill me. 

If you pay attention to the articles being written about JP Morgan’s current problem you’ll pick up on the theme that some of the positions they took were so big that even some former employees thought that unwinding them could disrupt whole markets. 

That type of statement should sound eerily familiar to market historians.  The first thing that came to my mind was Long Term Capital Management.  It too was run by a bunch of very smart folks, and it too amassed positions so large that they skewed not only the market…but the historical data they were using with which to make their trading decisions. 

LTCM is joined in the history books by a lot of other very smart people who went down in flames by either under-estimating or miscalculating the riskiness of their positions.  Others still were destroyed from within due to poor controls that allowed “rogue traders” to circumvent procedures until they did so much damage that the brought down the house (i.e. Nick Leeson who brought down Barings PLC… Britain’s oldest bank).

Food for thought

This event really makes me wonder.  If this could happen in what is arguably the most highly regulated period in our financial history, and before the economy could “recover” from the Great Recession, could we have another round of huge financial firms blowing up that drags us back into another recession?  And with the overnight rate at 0.25% and a hugely swollen balance sheet…is the Fed in a position where they could handle a second wave of failures?  Those questions and many more are simply food for thought.  They are the types of things that keep my mind busy when I’m out fishing.  But they are worth consideration.  The more you ponder those points the better you’ll come to understand the markets and you’ll have a better idea of what could happen as these types of events unfold.

I don’t see this as a regulatory failure...regulations can only do so much (although that fact seems to be lost on those in charge of instituting new regulations).  Regulators will never be in a position to know everything an institution is doing.  Ultimately you need solid management, proper risk management, and controls in place that keep good and well intentioned ideas from spiraling downward into stupidity and losses. 

What surprises me the most is that in this “Post-Great-Recession-and-Financial-Meltdown” era, procedures and risk management are so slack at some institutions that it’s possible to have losses this big...especially considering the number of huge bankruptcies in our very recent history that were caused by similar types of errors.  Below is a list of recent hits that should jog your memory…and apparently the hits will keep on comin’:

-          Bear Stearns
-          AIG
-          Lehman Brothers
-          MF Global
-          CIT Group
-          WaMu
-          Amaranth Capital rogue trader incident
-          Societe General rogue trader incident
-          Credit Suisse rogue trader incident
What does the market think?

There is information in pricing…and the price of JP Morgan is down about 5% at the moment.  Credit default swaps on their debt are up almost imperceptibly…these metrics don’t indicate that the Market sees this as a death knell for the firm.

The bigger picture is that the domestic stock indices are largely unchanged this morning and the Treasury market is relatively flat out to the 10-year spot on the curve.  The JP Morgan story doesn’t appear to be having a widespread effect on the markets.  For now it seems that the primary impact of this story will be as a risk management reminder for everyone. 

If you have any questions or comments, or if there is anything I can be doing for you just let me know.

Friday, January 6, 2012

2011 Year in Review

Four Years

In the summer of 2008 there was a kid who graduated from high school somewhere in this country.  His parents likely told him how lucky he was to be going to college because the job market was getting bleak.  They likely told him to study hard, have a good time, and that things would be better when he graduated college in 2012. 

So our man graduated high school and like the sea-of-youth that surrounded him he drove off to college where he passed the time studying diligently.  Now…he may have skipped a few classes and he might have even gone to a bar or two, spoken with some girls, hunted and fished all he wanted, and occasionally had to run from the campus police…but I’m confident that he at least studied a bit.  Ultimately he was in a position to side-step the economic carnage, study for four years, and then take the job market by storm when he graduated.

That kid is now 6 months away from graduating college…and his job prospects are even worse today than when he started as a freshman 3.5 years ago.  In the summer of 2008 the Unemployment Rate was at 5.80% and was just starting its climb to 10.00%.  If he is a business major he might even know that this is the fourth consecutive year we’ve entered with Fed Funds at zero percent.

You heard that correctly…2009, 2010, 2011, and 2012 all began with Fed Funds at zero percent.  If this kid is on the honor roll he might also know that the Fed is telling us that 2013 will start that way too!  That makes me feel very old all of a sudden…someday I’ll be saying things like “I remember when the Fed kept rates at zero percent for five years!”  And I think I might be lucky if I’m saying it was only five years. 

Today our college graduate is facing some bleak prospects…the worst of which might be having to transition from a life of keg parties and dating, to moving back in with his parents…who are likely not having keggers and could also be unwilling to finance his dating schedule.  Oh the humanity!

This kid is going to grab his diploma, walk off the campus, and wade into a huge pool of unemployed Americans where he will tread water and hope to be rescued quickly.  As he works to stay afloat he may strike up a conversation with some of the others in the pool…almost half of the people he talks to will tell him that they’ve been in this pool for more than 27 weeks. 

Our man will now begin to wonder how long he can keep his head above water.  Almost half of these people have been unemployed for more than 6-months.  His mind now starts to wander toward thoughts of Grad School.  If he can find the money he can be back in the comfort and safety of an academic/party setting by September.

If our man was a member of the national honor society he might even be aware of the fact that it takes roughly 150,000 jobs a month just to absorb people like him (the new entrants to the work force).  Given the fact that there are 12.9 million people on the “official” unemployment rolls, and that only 9 of the past 36 months have posted more than 150,000 non-farm payroll additions he can do the math and see that it is going to take a long, long time before everyone that wants a job can get one.  This economy can’t even generate the jobs needed to absorb the new entrants to the job market…much less to start digging into 13 million unemployed that are treading water in the unemployment pool.

So what is our man to do?  What is the outlook right now?  Is the data telling him to stay in the pool because the economy is coming back and a job should float along shortly?  Or is the data telling him that the economy is bad enough that he should go back to Grad School pronto before he misses the application deadline?

Given what we know about the economy we should be in a good position to help this kid make a decision.

Let’s start off with a very brief review of 2011 (not necessarily in chronological order)

-         The year started with Fed Funds at zero percent

-         Unemployment started at 9.8 and ended at 8.6

-         Tsunami in Japan

-         Nuclear Meltdown in Japan

-         8% of total unemployed apply for McDonald’s position in April!

-         Fed commits to keep rates low ‘til 2013

-         Refi story keeps coming back to us

-         The “Arab Spring” sweeps across the middle east

-         The Fed shuffles their maturities with Operation Twist

-         Fed routinely says things should pick up in second half

-         US gets downgraded by Moody’s

-         Moody’s confused when Treasury prices RISE after the downgrade!

-         It’s good to be AA+ in a BBB world

-         Goldman says it could be end of decade before rates rise

-         Greece causes problems in the Eurozone

-         Austerity and riots in the streets in Greece

-         Second half finally got here…and brought no growth with it

-         Italy, Portugal, and Spain, begin having problems too

-         MF Global goes under (a US Primary dealer)

-         Osama Bin Laden gets to meet SEAL Team 6

-         Meredith Whitney no longer remembered as the gutsy, genius analyst that predicted that Citigroup would cut their dividend

-         Year ends with Fed Funds at zero percent


You’ll notice that there wasn’t a tremendous amount of good news on that list.  That fact didn’t escape the Fed either…which is why we still have Fed Funds at zero percent and the Fed searching for new and improved ways to tell us that rates will remain there for a while longer. 

If you read all of the FOMC statements…and it’s an unfortunate fact that I have…the tone you get is that we are in the midst of a very modest and fragile recovery where any bit of positive data that they can conjure up is offset by a laundry list of risks that offset it.  There is no glaring positive news that they can put on a pedestal and say “that right there is a very good sign for this economy”.

Instead they say things like this:

The unemployment rate dropped to 8.6 percent in November, and private nonfarm employment continued to increase moderately during the past two months. Nevertheless, employment at state and local governments

declined further, and both long-duration unemployment and the share of workers employed part time for economic reasons remained elevated. Initial claims for

unemployment insurance moved down, on net, since early November but were still at a level consistent with only modest employment gains, and indicators of job openings and businesses’ hiring plans were little changed.”


That paragraph came from the most recent FOMC minutes and it’s typical of recent descriptions of economic activity from the Fed.  You’ll notice that they have to dig to find data that is somewhat positive…and after they lay it out there they come back and hedge it until you lose any excitement you might have had.

It’s a bit like a doctor telling you he was wrong when he told you that you only had 18 months to live…and you start to get excited and then he cuts you off and says “I should have said 24 months.”  The news is “less bad” but it’s certainly a long way from “good”.  That’s kind of where the economy is right now. 

What will 2012 bring?

As you begin to ponder what the next twelve months will bring, and you hold board meetings and make forecasts…keep in mind that the Feds job is to maximize employment and maintain price stability.  Those two things will dominate much of their thinking as we move forward.

There are certainly other things they will have to deal with as the global crisis ebbs and flows.  They will continue to be involved with the global issues but keep in mind that their primary focus will be jobs and inflation.

So…where are those things right now?

Everyone on the FOMC committee says the same thing with regard to jobs…because it’s obvious…the unemployment rate is too high and it is falling at a rate that is unacceptably slow.  Too many people are out of work and they have been that way for far too long and will likely stay this way for a long time to come.  Boom…on to the next part of the dual mandate.

With regard to inflation, the Fed isn’t worried.   They continue to state that long run inflation expectations are stable and that they are below their long term target levels.  We are free to agree or dis-agree with their opinion on this matter…but the fact is that they are the ones who set the target Fed Funds rate and that’s the way they see the inflation picture.  If we want to have the slightest hope of figuring out what they are going to do with rates then we need to know what page they are on. 

The outlook for low and stable inflation coupled with the high rate of unemployment give the Fed a green light to stay on hold.  In fact, at the last FOMC meeting the lone dissenter wanted MORE accommodation as opposed to less.  When you take this a step further and consider that there will be new voting members rotating onto the committee this year whose outlook is more in line with those who prefer accommodation, you can get even more comfortable with the fact that rates are likely to remain low for a long time.

The most recent news from the Fed is that they will now be providing us with their internal forecasts for where they see Fed Funds going.  A friend of mine laughed recently and said “so much for the Fed Funds Futures market.”  I had to laugh too…what will all of those traders do now that the Fed has pulled the rug out from under them?  I put out a short Market Update on 1/4/11 that gives an overview of the Feds new communication policy if you are interested in their new communication plans.

What to think about 2012

As you think about 2012 and what it might bring I want challenge you with the following task.  Find a way to fill in the blank on the following question:  “In 2012 economic growth will come from _______”. 

If you come up with an answer that you find believable then you will likely be planning on increased economic growth and higher interest rates right around the corner.

If you can’t fill in the blank with a believable answer then you’re in good company.  I don’t know what to put in that blank, and I haven’t spoken to anyone who can fill in that blank.  The Fed certainly can’t…which is why they are committed to holding rates low through at least mid-2013…and there is no shortage of speculation that they could leave them there a lot longer than that. 

To me it looks like 2012 will be another year full of excuses for why we won’t have any decent growth.  In 2011 earthquakes and uprisings in the middle-east were the excuses for our lack of growth in the first half of the year.  The longer it went on the more we were told that we’d get our growth spurt in the second half.  Then the second half got here and there was no growth…and then Europe started melting down…and then everyone realized it just wasn’t going to happen in 2011.

Now we are starting 2012 with slim pickin’s for growth prospects…and a whole new slate of potential excuses for why we’re still in the ditch.

Wildcard events for 2012

Below are a few items that should haunt the headlines at some point in 2012.  These all have the potential to become roadblocks to growth in 2012.  I’m certain there are a lot more out there…these are just the ones I could think of with one cup of coffee in me.   

Iran – There is a lot of talk about somebody smacking Iran hard before they can build a nuke.  I have no idea what the odds are of this happening…but I think I’m safe in saying that if that happens we should expect a big rally in Treasuries with prices going up and yields dropping.

North Korea – North Korea just lost their leader.  You might think he was just a guy with a bad haircut that wore a Members Only jacket and platform shoes…but apparently he talked/coerced many into believing that he was a god of some sort.

This is a country that launched a missile at Hawaii on the 4th of July when they had STABLE leadership.  I can see why the experts are concerned about their potential for creating instability now that there is a new and untested twenty-something year old guy at the helm. 

Europe – At this point it feels like the consensus is becoming that Europe will just be a big drag on everyone.  It seems like a lot of the big scary stories about the breakup of the Euro and “war-on-the-continent” have faded and now it has become a game of “how long we can drag this out before we have to admit that it won’t work.”

The Election – We will surely get a non-stop drumbeat of news this year regarding the economic plans and fixes from both the incumbent and the challengers.  I wish we could just fast forward to the end but it’s not that easy…we’ll have to put up with 11 months of headlines and debates that will jostle the markets along the way.  This is a big wildcard for sure.  I have no idea how the election will impact the markets…but I know that it will impact them.  There isn’t much more color I can provide on that topic.

Military drawdown – If you’re a student of history you know that once the wars are over the US makes drastic cuts to its military.  It happens after every war and given our current fiscal condition one might expect these cuts to be even deeper than usual. 

This should have at least two impacts.  First is that it’s a drop in government spending, which in the absence of a corresponding increase in another area will have a negative effect on GDP (this isn’t an argument for keeping the military at current levels…it’s just worth noting that government spending has been propping up GDP and this will be a reduction in that support).  This spending has been on items ranging from salaries for active duty military and civilian contractors to the acquisition of high dollar weapons systems. 

Many people don’t realize how expensive military hardware really is.  Sebastian Junger gave a good example of the economics of conflict in his recent book about combat in Afghanistan titled “War”.  He said that one day he marveled at the complexity of it all as he watched an $80,000 shoulder fired missile, get launched by a guy who doesn’t make that much in a year, at a guy who doesn’t make that much in a lifetime.  The point is that governments spend a LOT on war when it happens…and that spending will soon be cut drastically.

Additionally, these cuts will transition a lot of people from government contract work and military service…into the domestic job market…where there are very few opportunities awaiting them.  This will put some amount of upward pressure on the unemployment rate.

So what should we tell our recent college graduate?

So now I’m sitting here staring at the college graduate across from me and pondering what to tell him.  From where I sit his choice is this…he can go out into the real world where he will likely have to wait a long time just to find a low paying job that doesn’t match his skill set…or he can go back to college, study a little, hit happy hour three nights a week, go to football games or hunting or fishing on the weekends, and ride out the worst business cycle he is likely to see in his lifetime in relative ease.

My answer is that he better apply quickly…because grad school sounds pretty sweet and I might beat him to it if he doesn’t.

What will you tell him? 

If you have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP



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Thursday, December 15, 2011

Market Udpate 12 15 11 _ Against the wind

It’s been a boring few weeks around here lately.  No fishing, no jumping out of planes, no mountain biking, no travelling…it was all rainy days and sick kids until Saturday.  What changed on Saturday? Last week I got an invitation to go to the Bob Seger concert at the FedEx Forum here in Memphis…and these were front row seats.  I immediately jumped on the invite and began counting the days until the show. 

The first thing you notice at a Bob Seger concert is that Bob Seger has gotten really, really old.  His hair is gray and he’s wearing orthopedic shoes, and the stage is padded/carpeted and you start to feel a little sorry for the guy when he walks out.  The average age of the band looks to be about 100.  The second thing you notice is that these guys absolutely rock.  Halfway through the second song I turned to my wife and told her I hope I’m half as cool as Bob Seger when I get to be his age.  She assured me I’m already that cool but I think she was just saying it so she wouldn’t have to walk home.  It was an awesome event…many times you could hear the entire stadium singing along over the volume of the band.  Everyone was on board and rocking in the same direction.  This was a really strong performance for a guy whose first album came out the year I was born.

What does this have to do with monetary policy?

The first thing that comes to mind is that the Fed, like the members of Bob Segers band, is almost 100 years old.  The Federal Reserve System was founded in 1913…the same year the Post Office began parcel deliveries…which might be an ominous parallel.

The second thing that comes to mind is that not everything ages well.  Bob Seger is going to rock all the way to the grave…he will be as relevant the day he dies as the day he released his first album.  The Fed, however, may not have what it takes to remain as relevant. 

In fairness, the Fed has a much more difficult operating environment than Seger does.  In the old “US Centric” model the Fed had a lot of leverage and could exert significant control over the system with the traditional tools they had available (Open Market Operations, Reserve Requirements and the Discount Rate).  Nowadays we have a global economy, with many developed economies working to maximize their positions versus the rest of the world.  Hundreds of economies and currencies, many with powerful central banks, are all working day and night to advance their own positions on the global stage.  Capital can flow into and out of most countries almost instantaneously, and the exchange rate of that capital is also fluctuating in real time.  This is the world in which the Fed must now operate.  It is a far cry from the environment that spawned them in 1913.  In 1913 most people didn’t own cars...there had never been a phone call from the west coast to the east coast…and I find it interesting to note that prior to 1913 there was no personal income tax in the United States…my what a different world that must have been.  Nowadays most families have at least two cars, everyone over the age of 8 has a phone, and I don’t even want to start talking about income taxes.  

Many of the tools the Fed has used for the past 100 years are no longer as powerful as they once were.  Years ago in the old US-Centric model the Fed may have been able to create a significant economic impact with a 50 basis point cut in the overnight rate.  Now with a high-tech and fast-paced global economy we are down to zero percent on Fed Funds…and it’s still not enough.  The Fed can’t get the traction they desire so they come out with various Quantitative Easing programs in an attempt to get additional leverage on the problem.  Those measures have also come up short.  We are now four years into this economic downturn, the fed has ballooned its balance sheet, taken the overnight rate to zero, unemployment is still hovering near 9% with many arguing that “structural” unemployment is taking hold, and just this week they reiterated their pledge to leave rates at zero through mid-2013.

Despite all of the Feds actions the economy is still in the dumps.  They simply can’t jump start things the way they used to.  As we enter 2012 I think it’s helpful to take a good hard look at where we are, and what we should realistically expect from the Fed over the next 12 months. 

I wouldn’t count on the Fed riding to the rescue of the economy in 2012.  It is readily apparent that they don’t have a magic bullet for the issues that confront us…but it will be helpful to know what their plans are none-the-less.

What can you count on?

If you can bank on one thing it’s the Feds statements.  They have gone to great lengths to improve communication with regard to policy.  When they’ve told us they were going to do something…they have done it.  So while their monetary policy tools may not be as effective as they used to be…they at least have a solid track record of following through on their statements. 

The first thing to recall is that their baseline forecast is for the overnight rate to remain at zero percent through mid-2013.  If you are still holding your breath in Fed Funds hoping for a rapid rise in the overnight rate it looks like you’re might pass out before that day comes.  We have an analysis that shows “the cost of waiting” to help people determine if they are better off staying in Fed Funds or investing given their outlook on rates.  If you’d like to see this report just shoot me an e-mail and we can run the report.  This report will show you the difference in income between your Fed Funds projection and any investment you’d like to use as a comparison.  

The second big item is that they remain committed to reinvesting cash flows from their securities portfolio to fund the purchase of longer maturity Mortgage Backed Securities.  The goal here is to help the housing market by keeping downward pressure on mortgage rates. 

As we enter 2012 these seem to be the “constants” that we are getting from the Fed and I would certainly build them into my thinking for 2012.

So these are just some random thoughts on the Fed, their past, and our future. 

Now every time I read an FOMC statement I think of their 1913 start date and I look at all they’ve done right up until yesterday…and my focus fades from the words leaving Bernanke’s mouth at the press conference…and I start to hear Bob Seger singing softly in the background…

The years rolled slowly past
And I found myself alone
Surrounded by strangers I thought were my friends
I found myself further and further from my home
And I guess I lost my way
There were oh so many roads
I was living to run and running to live
Never worried about paying or even how much I owed
Moving eight miles a minute for months at a time
Breaking all of the rules that would bend
I began to find myself searching
Searching for shelter again and again

Against the wind
A little something against the wind
I found myself seeking shelter against the wind

If you have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP




INTENDED FOR INSTITUTIONAL INVESTORS ONLY. The information included herein has been obtained from sources deemed reliable, but it is not in any way guaranteed, and it, together with any opinions expressed, is subject to change at any time. Any and all details offered in this publication are preliminary and are therefore subject to change at any time. This has been prepared for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs of any individual or institution. This information is, by its very nature, incomplete and specifically lacks information critical to making final investment decisions. Investors should seek financial advice as to the appropriateness of investing in any securities or investment strategies mentioned or recommended. The accuracy of the financial projections is dependent on the occurrence of future events which cannot be assured; therefore, the actual results achieved during the projection period may vary from the projections. Interest rate swaps and derivatives are offered and sold via Vining Sparks Interest Rate Products, LLC. The firm may have positions, long or short, in any or all securities mentioned. Member FINRA/SIPC.

Wednesday, November 30, 2011

Market Update 11 29 11 _ Holiday Cheer

Yaaaay…it’s all better!

Yesterday morning we had snow here in Memphis, TN.  Normally just the forecast of snow would mean car crashes and snarled traffic in this town...but yesterday it was magical…there were no traffic problems at all and I arrived at work remarkably un-stressed from the commute.

After I parked my eco-friendly 5,500 lb, 4x4, V8 powered pickup truck I walked through the parking garage where I could see the snow falling outside and the intercom system was playing Bruce Springsteen’s “Santa Claus is Coming to Town” and the air was just crisp enough to remind you that it’s early winter.  I sipped my coffee as I walked and took in the sights and sounds and I felt very much in the holiday spirit for the first time this year.  I even passed a sign near the front door that read “Santa Parking Only”.  Geez…this is perfect.

For a moment I thought I had landed in Mayberry.  Then I came inside, sat down at my desk, and saw the headlines.  Troubles continue to rage in the Eurozone…a breakup is being rumored…businesses and governments are making plans on how to deal with the potential disaster.  A co-worker then pointed out what had to be the quote of the day.  It came from Poland’s foreign minister Radek Sikorsky.  He was giving a speech about the euro and he expressed that Poland’s largest threat wasn’t an attack by a neighboring country or rogue state…their biggest threat was the collapse of the Euro; and he viewed Germany as the one player that could avert that disaster.  He said:

And I demand of Germany that, for your own sake and for ours, you help it (the Euro) survive and prosper. You know full well that nobody else can do it. I will probably be first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity.”

I frequently joke that if I were Greece I would be very uncomfortable having my fate in the hands of the Germans due to historical precedent.  But that’s just little-ol-me…a fixed-income salesman and former Marine from Memphis TN with a dark sense of humor…nobody cares what I think.  Here, however, we have no-less-than the foreign minister of POLAND…the country that hosted Germany on their first away-game of WWII…saying something not too far removed from my quip on Greece.  Poland now sees Germany as its best chance of survival.  I’m starting to hear tones of Princess Leia ringing in his statement:  “Help us Obi-Wan, you’re our only hope”. 

So, yesterday went from “winter wonderland and Christmas music” to seeing the victims of the Blitzkrieg begging for help from the Germans of all people.   Just when I’m confident that this crisis can’t get any weirder this happens.

What a difference a day makes

Today we have a much different set of stories in the market.  On September 9th I wrote a piece titled “Smells like Coordination”.  That piece basically said that based on what I was seeing at that time it seemed like another round of coordination between Central Banks might be in the offing.  As it turns out it appears that they were in fact scheming along those lines…this morning we see the results…six Central Banks have announced coordinated efforts to help ease pressure created by the crisis in Europe. 

The Fed, ECB (European Central Bank), Bank of Canada, Bank of England, Bank of Japan, and the Swiss National Bank have all coordinated their efforts.  The short story is that they are essentially providing guarantees of cheap liquidity in a number of currencies through February.

European banks had seen their cost on dollar denominated loans increasing recently as potential lenders watched with alarm as problems in Europe escalated.  Fear not…the Central Banks are riding to the rescue with more cheap money.  This is a continuation of the recurring strategy of “buying time” that has come to define much of this business cycle.

It’s like Broadway

I don’t often go to see a “play”…you know…like on a stage in a theater.  I have however been to one or two in the distant past so any of you who like to call me completely uncultured will have to dial it back just a notch. 

Today’s market activity reminds me of the theater.  On stage right now I have a group of actors who are singing about a recovery.  The songs are all about the ADP Employment figures being higher, and Pending Home Sales rising, and Black Friday Sales going through the roof...and the Dow is up 400 and the 10-year is up to a 2.09%, and all of the actors are happy and singing and everything is great.   But backstage behind the curtain the stagehands (represented by the Central Banks) are fighting like mad to put out a fire that is threatening to burn up all of the props needed for the next scene…and maybe even the theater itself.

Seen from this point of view it’s difficult for me to get excited that the play is going to be a great one.  Normally what would happen is that during the intermission I could try to talk the wife into going to a sports bar instead of seeing the second half of the play…but I’m afraid this one will end like the others…I have no hope of getting out of watching the whole thing unfold.  Good or bad we’ll all have to stay here and watch the rest of the play.

If you have any questions or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP



Monday, November 7, 2011

Market Update _ Grocery shopping and sector analysis


Last night I was in the kitchen when the wife came home from the grocery store.  As she was putting the groceries away she announced that she had just bought some special apples that taste like grapes.  Curious, I asked how much she paid for them.  She responded with “I don’t know…why?” 


“Because if they’re more expensive than grapes we just got robbed.” I replied.  After all, why would I pay up to get something that “tastes like” grapes if I can get the actual grapes cheaper?  She quickly brushed aside my economic commentary on our groceries and left the room.  Tough crowd. 


Many people will look at the “apples that taste like grapes” story as tale of a unique culinary/scientific achievement…but when I see these grape-flavored apples on my counter-top I see a sector-analysis story. 


Why do these funky apples remind me of sector analysis?  Because if I like grapes, but grapes are expensive, I might be able to find a really good grape-substitute in another part of the fruit world.  In this case if I can get the grape-flavored apples cheaper than grapes themselves then there is some value available there and I’m willing to purchase them.  Same grape taste in a little bit different package at a lower price?  Great…sign me up.


This in turn leads me to the investment portfolio.  If I’m an Agency Callable buyer, but callable yields have dropped, maybe I can find some yield in another product that has the same maturity/average life/price volatility characteristics.


How about an example?


A very recent example is in the world of Callable Agency bonds.  Consider the following numbers:


A 3 year non-call 1 year with a one-time call will bring you a 0.75% yield today


A basket of 3 year CD’s with no call options, and zero risk weight will bring you a 1.50% yield (with the convenience of DTC delivery)


You get a lot more grapes for your money with the CD than with the callable.  In fact you get twice as many grapes for the same price.  Supplies are limited on the CD side so there is a limit before you have to go back to buying callables but it shows that you can occasionally get some shots off at much better levels if you keep looking in all areas.



Another example would be:


A 4 year non-call 3 month brings 1.125% with -11.00% price volatility this morning


A 10 year 3.00% MBS currently brings 1.65% yield in the base case with -11.00% price volatility


Again we get more grapes for our money.


Wrapping it up


If you’re looking to put money to work as we head into the end of the year remember to look around and pick up value where you can find it.  Compare sectors and make sure you’re getting the most bang for your buck. 


If you have any questions or if there is anything I can be doing for you just let me know. 


Steve Scaramastro, SVP