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.

Europe

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. 

 a-HA!

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 1^st 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.

Conclusion

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.

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.