The Human Condition

Of all the verbiage and meaningless words, terms and expressions that have come to define the English language, I cannot think of a more annoyingly useless one than “human condition.”

If there was an example of anti-Euclidean expressionist propaganda permeating our culture, this is it. The PC (politically correct) crowd loves it, therefore it must be wrong.

The Chairman of the Board, aka Whitey Ford, said in a recent interview in one of the New York papers that his idol growing up was Joe DiMaggio. The first game he attended at the polo fields he witnessed the Yankee Clipper go 1-6 with a home run and 5 long fly outs, which Whitey estimated to be in the neighborhood of 380 feet based on the 400ft wall in the outfield.

Fast forward a few years after Whitey had transitioned from a batter to a pitcher and had the luxury of watching Joltin’ Joe up close, at you guessed it, a remodeled Polo Fields. As Whitey made his way onto the diamond from the outfield he realized had his first glimpse of DiMaggio been at the present, he would have gone 6 for 6 with 6 home runs, as the newly designed field had considerable shortened the distance to the outfield stands.

This story could have a lot to do with the “human condition,” or nothing at all—depending on whether you see the world as it is or what you want to see. You can go into any situation looking for something and inevitably find it, if you look hard enough. The author of The Black Swan, Nassim Taleb challenges us to look for issues, items, ideas, etc. that refute our opinions and color our bias. Because the stock market exists in “Extremistan” and not “Mediocristan,” anything can happen, literally (you have to read his book(s) because you owe it to yourself to understand the link between randomness and the market, or markets).

The point is that the benchmarks are always changing and in reality Joe DiMaggio did go 1-6 that day.

If you apply this to the market you must understand that what is going on now is not Long Term Capital, the Russian Crisis, Asian Crisis or a bubble. Sure history does repeat itself but it is clever enough not to let us know until it is too late. This particular sub prime problem is not going to chart its course according the preceding disasters—if it is “disaster” at all. Odds are that the transparency of the US financial infrastructure—namely banks and lenders, not to mention the actual borrowers have given us more than a window into what is to come. In addition, the fail-safe mechanisms put in place by congress, FDIC, SIPC and the Federal Reserve (as well as all of the guidance the Fed has provided to the governing bodies in order to prevent a meltdown) are not in vain. While Taleb would argue that anything is possible (I don’t argue with his premise), look for data (thanks Euclid) that contradicts a financial blow up. There is plenty out there, starting with the economy, the global acceleration of free trade, the consumption of China and India, etc.

If starting now: the carry trade does come to an end, banks literally shut off the credit spigot and a major financial player does go under then I will write the MLB a letter imploring them to go back through the history books and tack 5 more home runs on DiMaggio’s career total. But as of right now, as much as I love and revere Joe for everything he was—a gentleman, athlete and role model, he went he flew out 5 times.

Needless to say, the human condition is salaciously juicy, sparse and funny.

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Why, Why, Why?

Why, Why, Why?

And

The CNBC Indicator

One of the flavors in the Tropical Fruits roll of Lifesavers has a fishy aftertaste. While I am curious as to what flavor and why, this is not the point of today’s column. As I write, the Dow Industrials have rebounded from a session low down 315 points up to being down only 238. Lots of people have been asking me why, so I thought I would share my thoughts with the 7 people that read this column.

The debt market is a crazy place, especially when tens (maybe hundreds) of thousands of people are getting ready to pay the piper for the extravagant dwellings usually known as homes. Remember no money down mortgages? Trust me, these people will never forget. Right now they are being presented with their first stab at principal and you guessed it, they cannot afford it. So they will do what anyone does that is in way over their head without any chance of paying their debt off—file for Chapter 11 Bankruptcy protection.

Not so fast.

One of the legacies of the republican majority in congress is their successful attempt to pre-empt people from simply filing for Chapter 11, a process akin to the speed, service and overall experience of going to the DMV. Sure it’s annoying but in the end; after clutching onto your numbered ticket until you are called by a bureaucrat focused more on their game of solitaire on their PC as opposed to helping you change your address.

To file now is not easy as you must not only go through paperwork and sit before a judge; you need good faith on your side. A person making $45,000 a year with no other form of income or a substantial asset base has no business buying a 2 million dollar house. While this logic may differ from the expertise of the mortgage brokers at New Century, Nova star and Countrywide Financial—it’s just plain stupid.

In other words, there are no guarantees Chapter 11 is in your future and you may well face other consequences of the lack of prudence by all parties involved.

So now these mortgage lenders are sitting on a lot of bad loans, many of which they financed through lines of credit (some secured, some not) from banks and other lending institutions. Banks then took said loans and pooled them together and then proceeded to issue separate securities like CMO’s (Collateralized Mortgage Obligations) and other instruments designed to offset their risk.

Enter Hedge Funds, traders and other institutions eager to play the housing market. They bought these securities, in many cases packaging them together—a few AA rated, some BBB’s a few junk; even using a “PIPE” (Private Investment in Public Equity) or Structured Pipe in passing these on to other funds and whomever was looking for exposure. In many circumstances buyers knew they were buying a package of trouble debt with the hopes that if one lender made good on their bonds that it would be a windfall. Sounds like a good strategy to me….

Let’s take a case study of the two Bear Stearn’s funds that went under. To my knowledge, they began as a $3 billion investment, opened to accredited investors. While the market was booming, it supposedly went up to $6 billion. One of the fund’s strategy, might I add, was supposedly investing in high grade debt or investment grade. When New Century went bust and BSC investors saw the wave of panic heading toward them they opted to withdraw their money from the funds.

Not so fast.

In order to sell something, you need a buyer. In the case of these structured debt investments liquidity was not their strong suit, to say they are illiquid is an understatement. Then take into account that word had leaked (via the WSJ I believe) of the dire straits these funds were entering. Just as in the ocean, when there is blood in the water on Wall Street the sharks tend to show up and in numbers. The BSC fund managers could not unload their portfolios for anything resembling a fair price while the counterparties knew they had no choice but to sell. As I am sure you figured out, these funds have both closed and once again (to my knowledge) they are worth nothing.

If the story ended here it would be bad, but not necessary capable of sounding a death knell for lenders and large banks. Guess what? It doesn’t end here.

Long Term Capital may seem like a long time ago, but the lessons should last a lifetime—especially the part about leverage and how a few eggheads almost took down the global economy using said leverage, along with derivatives.

Derivatives are dangerous, especially because for all intents and purposes, they have no value. Banks may think they have value, or a value; but they don’t. Derivatives can be designed to hedge an investment (think like selling a covered call) or to leverage a “long” or “short” position in order to profit more from small moves in a market. The big problem is that nobody really knows how to value them. Fischer Black and Myron Scholes were pretty sure they knew how to find fair value. Turns out they didn’t and it didn’t turn out too well.

Anyway, this is the markets fear. People default on mortgage lenders, mortgage lenders unable to pay back banks, banks sell securities (and buy) to other funds etc. and large swaths of the economy either tighten lending requirements so much it doesn’t allow capital to flow where it is needed (even legitimately sound investments) or lenders go under.

My take is simple—stay away from anything involving real estate, financial services or anything the average person reaches into his pocket to pay for, especially if he uses a credit card. Why? Because soon the other shoe will invariably drop. I know bears have been predicting this since the market crashed in 2000, but the real estate sector has far more reaching consequences for the average Joe than the stock market.

Finally, let me address the CNBC indicator. Whenever CNBC takes it upon themselves to explain an investment and/or how to do it to their audience is used by some as a contrarian indicator. For instance, when CNBC starts trotting out guests that are bearish and then follow up the segment detailing how to go about shorting a stock, contrarians take this to be a signal to go long.

The reason I bring this up is because this is exactly what happened during lunchtime. Bob Pisani, their reporter from the floor of the NYSE explained the mechanics of a short sale to his audience. He also mentioned several ETF’s (Exchange Traded Funds) that make bearish bets against the market, so you can basically purchase an instrument that is betting against indexes or sectors going higher. In short, you make money when stocks go down.

Bull Market End?

Much of the reason behind the U.S. Bull market over the past 5 years has been the strength of the global economy and a very weak U.S. dollar. In fact, earnings from blue chip Dow member Caterpillar (CAT) late last week were a very nice summation of what cyclical stocks will be facing in the coming quarters: flat domestic orders, increase in foreign orders. Free trade has been a boon for our economy.

Democrats feel that this is wrong and that America should take a more “protectionist” approach toward international economic affairs. They fear the outflow of manufacturing labor to China and India (as well as smaller, lesser-known havens like Cambodia) has hurt the country (Edwards and his “two Americas” talk) and more importantly, they have lost a strong voter base in the process: organized labor.

The Wall Street Journal reported a few weeks back that many of the software jobs (engineers and designers) that moved to Bangalore are now commanding salaries of approximately $75,000 (US) which is on par with earnings here, leading to a repatriation of sorts by returning those jobs to Silicon Valley. This should come as no surprise to free traders, as efficient markets operate efficiently only when a lack of intervention applies. There is no doubt that a similar effect will occur as China continues to move toward the free-flotation of the Yuan, dulling the impetus of American companies to seek lower wages abroad to manufacture their products.

The point I am making is that regulation and over-regulation are bad. Look at how the U.S. has ceded its investment banking and financial services advantage through the introduction of Sarbanes-Oxley. It is no coincidence that smaller and middle size corporations simply cannot afford to take their companies public at home because they are unable to maintain compliance with the act, leading to a loss of share to London which is benefiting from a buoyant banking sector.

Recently Treasury Secretary Hank Paulson commissioned several different studies to scale back some of Sarbox’s most tedious rules and regulations and reopen our capital markets to the private sector, some of which have already been implemented. This should not serve to obfuscate politicians and central bankers from their mandate to keep our economy strong, however bent they are on twisting facts.

Wal-Mart, Microsoft and Exxon did not originate as global behemoths; nor did Blackstone, SAC Capital and many other funds. There are no two Americas, no matter how catchy it sounds. There is only one and we are all affected.

If protectionism returns, coupled with the expiration of the “Bush Tax Cuts” and the addition of the “Blackstone Bill,” our economy will be on the rocks. I can only speculate at this point since the President has a remaining 18 months in office and he has promised to veto any tax increases that reach his desk. As his term in office draws to a close and if it looks likely that any of the three front-running democrats (Clinton, Obama and Edwards) will beat their opponent in the general election, it may be an infection point for the market and a damn good time to rebalance your portfolio.

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Murdoch Industrial Average Hits 14000

Not only did the Dow Industrials break 14000 yesterday and set another record high, but the Dow Theorists out there will be eager to point out that the Transportation Average confirmed the move. As Matthew McConaughey would say, “alright, alright, alright—patience darling, there is a fiesta in the making.” Not exactly Aerosmith tickets for the summer, but there you go.



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