Tied to the Mast

[EJ]

Tied to the Mast

The world changed in August, but the Fed has so far failed to notice

Top of the news today is not the latest tedious 100 plus point plunge in the DOW, which along with 100 plus point up days over the past month or so have acclimated investors to a steady tossing, like ferry travelers settled in for a two hour ride through stormy seas. (Okay, so it's a corny metaphor. Wait until I get back from Vegas. You'll be praying for corny metaphors.) The news is the growing evidence that the world changed in August, but the Fed has so far failed to notice.

Investors are wondering if the volatility will soon decline toward the mean, or get meaner.

Today we learn that, at least for now, Professor Ben expects the former likely. He read the Beige Book and announced: "Outside of real estate, reports that the turmoil in financial markets had affected economic activity during the survey period were limited."

We believe the latter; our Myth of the Slow Crash theory picked up a few more data points today. Data point number one:

Lay-offs surge 85 pct in Aug vs July: survey
September 5, 2007 (Reuters)

Planned U.S. lay-offs rocketed in August as the housing slowdown and subprime mortgage debacle led to record job cuts in the financial sector, an independent report showed on Wednesday.

Announced lay-offs surged 85 percent to 79,459 in August from 42,897 in July, according to Challenger, Gray & Christmas Inc, an employment consulting firm. August's job cuts were the highest since February, when they totaled 84,014.

"Nearly half of the August cuts came from the financial sector, as dozens of mortgage and subprime lenders caved under the pressure of a sinking housing market," Challenger, Gray & Christmas said in a statement.

As usual, four out of five economists are surprised by the data. These layoffs included an unusually large component of financial services industry personnel, whose employers since mid July took a major hit. Circumstantial and personal data collected by yours truly, visiting friends in NYC during the July turmoil, includes evidence of the nearly instantaneous impact on businesses attached to the finance industry; discretionary spending, such as on third party marketing–advertising and PR–was immediately cut. No need to spend money pitching what everyone believes is unsalable. Reminds us of Wall Street after the tech stock bubble crashed, but not quite the same.

Another predictor predated that July NYC visit, our interview with John Challenger, the founder and CEO of Challenger, Gray & Christmas in early July. No shock that firms associated with the PE bubble were going to lay off a lot of folks. (Listen to the interview if you are curious to know what happens next.)

After the third-party advertising and PR firm cuts come the sales and marketing folks at the financial firms themselves. The crashing tech stock bubble extruded a hoard of tech-centric investment bankers who re-convened the party at the Hedge Fund Bar & Grill. Now that the private equity and hedge fund booze has run out, they stagger off to the golf course, leaving behind only the hard working and experienced hedge fund industry founders to muddle their way through the mess the me-too party-happy followers created, until rumors of the next party start to circulate to get the animal spirits moving again.

Until then, more "surprising" data pour in. Which brings us to data point number two:

Pending Home Sales Sink in July
September 5, 2007 (Alan Zibel, AP Business Writer)

Pending Sales of Existing Homes Fell in July to Lowest Level Since September 2001

A near-record low for an index that forecasts near-term home sales suggests borrowers in expensive areas are struggling to finalize home purchases amid mortgage market troubles.

What happened September 2001 that might have put a crimp on home sales? Oh, yes. Now I remember. The 9/11 terrorist attacks. In July 2007 we have post September 11, 2001 levels home sales activity, except without the confidence sapping impact of the worst terrorist attack on US soil ever. This coincides with our recent observation that we are seeing the worst housing market since The Great Depression, except without a depression. More importantly, we still don't even have post credit crunch housing numbers which will show the initial impact of the lack of availability of credit. Expect them this month. The housing market downturn will rapidly accelerate during an actual recession, with rising unemployment.

We warned October 2006 of a recession starting in Q4 2007 and see no reason to modify our view. The view from the ground is not as antiseptic as the view from the air, which brings us to data point number three:

Metro housing slide keeps repo man busy
September 5, 2007 (TAMMY JOYNER - The Atlanta Journal-Constitution)

'Snowball effect' from mortgage woes, easy credit keeps lot overflowing

Swing by Richard Grosvenor's business for a closeup of how quickly the nation's housing market is unraveling.

In the last six months, Grosvenor and his repo drivers have hauled in hundreds of vehicles in the course of normal business.

Among their more recent hauls: a trailer packed with windows destined for a new home; two backhoes, two Bobcats, two dump trucks, as well as pickup trucks belonging to electricians, landscapers, plumbers and home builders. He's even repoed Realtors' luxury cars.

"The housing market is just taking a toll. It's an instant snowball effect," Grosvenor said strolling through the three-acre gravel lot at Speedy Recovery, a Lithonia business he started 14 years ago. He points to a plumber's black 2007 Corvette. Behind it is a Bobcat. A few yards away under a tree is a white Dodge Ram 3500 pickup voluntarily turned in by the owner of a construction company.

Our iTulip Beige Book, so to speak, comprised of reports from our level headed–according to our surveys–professional community, now 3,500 strong, indicates a rate of change that is typical of secular turning points in credit cycles, changing from gradual to not at all gradual. This includes reports from our iTulip Prosper Lending group of nearly zero defaults up until July and then a huge spike in August.

The "Myth of the Slow Crash" might in the current instance be called the "Silent August 2007 Crash." When rates of change are themselves changing rapidly, the usually innocuous lag time between economic events and the economic data that reflect them become significant.

To wit, the unusual August drop in mortgage applications is still not on the Fed's radar. In fact, mortgage applications were reported as up, bringing us to our fourth and final data point:

Mortgage applications climb
September 5, 2007 (CNNMoney.com)

Mortgage application volume increased 1.3 percent in the past week, according to a report Wednesday.

Not so.

Paul Descloux, creator of the National Mortgage Application Index, reports that for the week ending August 31, 2007: "Mortgage applications continue to plunge. Down another 5.1 percent the last week of August, total activity is now down a staggering twenty percent the past three weeks as the fallout from August’s credit crunch reaches Main Street. Equally dramatic is the slowdown in reported California home sales data, now down 25 percent versus the same four week period last year."

Returning to Professor Ben to conclude, we suspect that he may, like the academic he is, be the kind of guy who waits for clear data. He's waiting for the men in the engine room to report that the first two sections of the ship are full of water before deciding that it's time to start the pumps. The US 1929 and Japan 1990 experience suggest that by then most of the passengers in-the-know who still have their wits about them have already slid off in one of the in-short-supply life boats. And we're not talking about four or five quarter point rate cuts, already priced in. We're talking about the kind of drastic response the Japanese failed to see was needed, and that perhaps Ben doesn't see is needed either. Not because he isn't smart, but because other factors–a weak currency and huge deficits– have already tied his hands, so he doesn't want to see the August 2007 rate of change and impossible choices facing him.

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[jk]

Re: Tied to the Mast

"tied to the mast" puts me in mind of ulysses, tied to the mast so he could hear the sirens' song without being able to steer his ship in their direction and destroy it on the rocks. if this is indeed the reference [i suppose an alternate would be tied to the mast to receive a flogging], i'm trying to figure if it's us or ben who's tied to the mast, and whether the sirens' are singing "don't worry, be happy" [which we resist] or a dirge [which ben resists]. otoh, if it's the flogging you have in mind, i'm not sure i want to hear about it.

[Uncle Jack]

Re: Tied to the Mast

JK, tying yourself to the mast was the way old sailors would ride out storms. Nothing to do but hang in there and hope for the best.

[jk]

Re: Tied to the Mast

JK, tying yourself to the mast was the way old sailors would ride out storms. Nothing to do but hang in there and hope for the best.

so it's the flogging one way or the other.

[Rajiv]

Re: Tied to the Mast

JK, tying yourself to the mast was the way old sailors would ride out storms. Nothing to do but hang in there and hope for the best.

Here is an interesting quote from the Chairman of Leucadia National's (LUK) 1999 letter to share holders

A passage titled "A Dream" in the 1999 report is a prescient jab at dot-com mania in the form of a parable. Two groups of people stand on opposite sides of a pile of "brown organic material." One group believes the material has world-changing "mysterious powers" that will provide "untold riches through a new economy." On the other side, others hold their noses and grumble about the smell of rotting tulip bulbs.

"There is no such thing as a perfect economy, much less a new one, we hope this too will pass without leaving a tornado-like devastation in its wake," the report says.

From the 2006 letter to the shareholders

Rules of the Road

1. Don’t overpay, no matter what the madding crowd is up to.
2. Buy companies that make products and services that people need and want and provide
them as cheaply as possible with consistently high quality. Lower cost and higher quality
is a relentless and never-ending task.
3. Earnings sheltered by NOLs are more valuable than earnings that are taxed!
4. Compensate employees for performance and expect hard work and honesty in return.
5. Don’t overpay!

.
.
.
The Future

These are confusing economic times. There are galvanic economic and political power shifts in the world. China, India and the rest of Southeast Asia are roiling. The U.S. had an economic and political hegemony from the end of World War II until the end of the last century. We are now bogged down in a senseless war in Iraq, the House and Senate are constantly bickering and getting even, and are not able to manage our country. Education, healthcare, Social Security, Medicare, Medicaid, immigration policy, among others, are all difficult issues. We need the best and the brightest, patriots all, to hammer out the thoughtful compromises necessary to assure a prosperous and full future. Will the world ever again look at us as a bright light on top of the mountain? Asia rises and we flounder, where this leads, we know not.

One of us thinks the sky is falling and the Dollar on the edge of debasement. One of us thinks the efforts of half the global population who struggle towards the western standard of life and liberty will cause a global bull market that could last a long, long time.

Meanwhile, we have committed over $1 billion in the last twelve months and have added a few very experienced deal folk to join our team. The beat goes on.

[akrowne]

Re: Tied to the Mast

I suspect the Fed has "noticed", but as you say, their hands are tied. Perhaps more assertively, the Fed seems to be following the programme it has followed over the past year: refusing to feed the mega-bubble, which requires ignoring or down-playing data that indicate economic pain, so as to avoid a headline rate cut.

So far, the Fed has virtually moved heaven and earth to stick to that programme: from more than a year of disappointing Wall Street with rate increases and failure to lower, to using the discount window for showy bridge loans instead of lowering the funds rate to liquefy generally.

Will they capitulate? I suspect not. The Fed knows: they just won't.

[EJ]

Re: Tied to the Mast

I suspect the Fed has "noticed", but as you say, their hands are tied. Perhaps more assertively, the Fed seems to be following the programme it has followed over the past year: refusing to feed the mega-bubble, which requires ignoring or down-playing data that indicate economic pain, so as to avoid a headline rate cut.

So far, the Fed has virtually moved heaven and earth to stick to that programme: from more than a year of disappointing Wall Street with rate increases and failure to lower, to using the discount window for showy bridge loans instead of lowering the funds rate to liquefy generally.

Will they capitulate? I suspect not. The Fed knows: they just won't.

It's not that simple. Bernanke's program is more than 20 years in the making. Our Fed contacts, while indirect, indicate that the suddenness of the impact of the mortgage industry on the economy is not fully appreciated. Maybe our data isn't any better than the Fed's, but we enjoy the luxury of making less politicized interpretations.

A well respected asset manager wrote today in a private note to clients:

"Have the Fed's moves been successful? Our review of market liquidity conditions since the inception of the liquidity crisis on August 9 clearly shows that liquidity conditions have not improved in most of the affected short-term markets, despite the Fed's recent actions. In fact, market liquidity problems have since spread to other sectors, such as short-term municipals and auction rate preferreds. The current liquidity crisis could be much worse if it were not for the prevailing market expectation of an impending ease in the Fed Funds rate. What will the Fed do?"

More on the Bernanke program, with relevant notes from a key adviser to the Bank of Japan here.

[Spartacus]

Re: Tied to the Mast

(repeating an earlier post)

remember the movie "Airplane!" ?
The Lloyd Bridges character, (the Air Traffic Control boss)
That's Bernanke, trying to bring the economy in for a soft landing ...

"Picked the wrong month to quit sniffing glue ... "
"Picked the wrong month to quit mainlining speed ... "
"Picked the wrong month to quit smoking reefers ... "


hope your models break, bet that beard is fake ... I'll be watching yooooouuuuu.

A well respected asset manager wrote today in a private note to clients:
"Have the Fed's moves been successful? Our review of market liquidity conditions since the inception of the liquidity crisis on August 9 clearly shows that liquidity conditions have not improved in most of the affected short-term markets, despite the Fed's recent ac

[algerwetmore]

Re: Tied to the Mast

My question is this: Are all sovereign markets across the world so tightly wound in this liquidity crunch?
I am trying to figure out relatively safe places to invest, that avoid much of the credit risk and volatility that I have seen the last month. I am also trying to avoid the debasing of the USD.

[jk]

Re: Tied to the Mast

My question is this: Are all sovereign markets across the world so tightly wound in this liquidity crunch?
I am trying to figure out relatively safe places to invest, that avoid much of the credit risk and volatility that I have seen the last month. I am also trying to avoid the debasing of the USD.

in crises, just about everything gets highly correlated. this is what usually leads to trouble for investors, hedge funds,, etc- you think you're diversified but you're not. this is what killed ltcm, all the diverse markets that were usually uncorrelated suddenly became highly correlated. or, alternately, things that usually correlated become inversely correlated. this is what hurt quant funds recently. so much money was on the same populations of longs and shorts, that when a liquidity squeeze required liquidation of positions, all the correlations started working backwards.

[GRG55]

Re: Tied to the Mast

in crises, just about everything gets highly correlated. this is what usually leads to trouble for investors, hedge funds,, etc- you think you're diversified but you're not. this is what killed ltcm, all the diverse markets that were usually uncorrelated suddenly became highly correlated. or, alternately, things that usually correlated become inversely correlated. this is what hurt quant funds recently. so much money was on the same populations of longs and shorts, that when a liquidity squeeze required liquidation of positions, all the correlations started working backwards.

The correlation also extends to the non-FIRE economy, and in that case is not so dependent on a crisis. For example when US consumers reduce their purchases of toys, it backs up to the manufacturer in China, which in turn impacts the lead mining companies in Australia, and maybe the aromatic plastics petrochemical supplier in Saudi Arabia too.

[jk]

Re: Tied to the Mast

The correlation also extends to the non-FIRE economy, and in that case is not so dependent on a crisis. For example when US consumers reduce their purchases of toys, it backs up to the manufacturer in China, which in turn impacts the lead mining companies in Australia, and maybe the aromatic plastics petrochemical supplier in Saudi Arabia too.

i love that you included the lead mine in this chain.

[algerwetmore]

Re: Tied to the Mast

So, again I ask what is the best play here? I am thinking about investing in
oil & gas royalty trusts, and Central Fund of Canada. Should I look at soft commodities instead? I am basically a "buy and hold" type of investor.

[GRG55]

Re: Tied to the Mast

So, again I ask what is the best play here? I am thinking about investing in
oil & gas royalty trusts, and Central Fund of Canada. Should I look at soft commodities instead? I am basically a "buy and hold" type of investor.

If you are expecting detailed financial advice this site may fail to meet your expectations (the site serves a much higher purpose, see below). Having said that I offer the following observations in no particular order (NONE of which is investment advice, just my opinions):

• I suspect most of this community have a wee bit of gold (coins, bullion, GLD, CEF, etc) for "insurance";
• Most commodities have had a good run and many are now in corrections - one that I think may be near the end of its correction is Canadian natural gas. If you decide you like it, buy companies that have long-life, unhedged reserves in the ground. The gas levered royalty trusts look interesting, but tax changes create uncertainty and balance sheet risk is high for some. Do your homework.
• Cash is an investment position (not necessarily US $ cash though);
• Avoid the "crowded trade". You may be right in the long run but you won't likely hold it long enough.
• Remember that people tend to react instead of anticipate. They react by doing what they wish they had done a year or two earlier. iTulip is trying to help us anticipate (in an intellectually rigorous way; not baseless speculations of which there appears no shortage at present) instead of being surprised, as the Fed appears to be right at this moment.

One final observation from grizzled market veteran Richard Russell "Everything does what it's supposed to...but never when"

[algerwetmore]

Re: Tied to the Mast

Thanks for the insight!