Monday, November 30, 2009

For How Long Will Cash Be Trash?/Money Market Yields as a Source of Funds for Global Risk Trade/Sold PST

1. Money Market Funds as A Funding Source for the Risk Trade: In a few recent posts, I discussed the carry trade as a funding source driving increased prices for risk assets on a global basis. End of the Carry Trade-Not Likely/Euro vs. U.S. Dollar U.S. Dollar and the Carry Trade Another source, also created by the zero interest rate policy of the Federal Reserve, is the flight from money market funds, many of which are yielding zero to .25% for the exceedingly generous ones with low expense ratios. Andrew Bary pointed out in his column in Barrons that money market funds have suffered 271 billion in withdrawals since the start of 2009.

Those funds are largely finding their way into risk assets, helping to facilitate a rise in prices, along with other funding sources, based on increased demand. Bary points out that bond funds, for example, have been receiving 8 billion dollars or more in recent weeks. I have made similar observations about investors searching for any kind of yield by jumping in mass into bond funds paying less than 4%. The sums are staggering year to date: see Item #4 /LONG TERM BEAR MARKETS/Bought Vanguard Bond Funds-Another Rule Violation In fact, I was one of them recently, investing a very small amount in two Vanguard bond funds. And, I am no fan of bond mutual funds at their current yields: For BND: Is it Safe is not the Right Question. Instead Ask What are the Risks & Rewards/Assume Lost of Principal Possible In that last linked post, which was written in June 2009, I discussed several of the risks associated with bond funds and why I was investing then in alternatives to bond funds. Since then, my intellectual defenses, still viewed as sound and persuasive, against buying a bond fund are starting to wear down a tad after more months of earnings nothing in money market funds, and looking at many more to come. So, I understand what is motivating other investors to transfer funds from a money market fund to a bond fund. Ultimately, the Fed will produce a number of speculative asset bubble prices by keeping rates near zero for another year. One such asset class will be bonds, particularly treasury bonds, for the reasons outlined above. And when that bubble is burst, a lot of individual investors will be burned.

Bary also points out the recent newsletter from Bill Gross (PIMCO) which I discussed in an earlier post, where Bill recommended electric utility stocks as a possible alternative to cash earning nothing. I already own several electric utility stocks, and will probably buy a few more. After reading that column from Gross, I did add 100 of XLU: Bought 100 XLU/Bought 100 QAI/SOLD AUY Bought 30 ZBPRC at 18.4/

In his letter, Gross was kind enough to do a calculation of how long it would take to double your money at .01%. The answer is around 6,932 years, and the Old Geezer said upon hearing that: "I don't think I will make it". The LB replied that the actual number would be longer after taxes. You might have to go back to the time when Adam and Eve walked with the dinosaurs (Creation Museum), and count forward, to double your money after taxes and inflation at .01%. LB noted that, with those caveats, money would never double even if you started with those amoeba swimming in some kind of hot tub.

2. LGF (owned Lottery Ticket category): Now that I own a tiny slice of a motion picture company, I find myself checking the weekend box office numbers for its current releases. Lions Gate has one film in the top ten, and it has started to lose steam. For the three day weekend ending November 27, the estimated revenues for the movie "Precious", a LGF release, were 7.1 million, down from the 11 million in the prior week , but enough to keep the film in the top ten at number 8. The total to date is estimated at 32.4 million. A Wikipedia article has a detailed discussion about this film. A few Oscar 2010 nominations may help to spur ticket sales some. I have started to see some commercials for the next LGF release called "Brothers" scheduled for release 12/4: LIONSGATE

3. Ian Shepherdson's Opinions Summarized in Morgenson's NYT Column-Cash is Trash and For How Much Longer? I read with some interest Gretchen Morgenson's column in Sunday's NYT that focused on the opinions of Ian Shepherdson, the chief economist for High Frequency Economics. While many have focused on the positive ISM releases on manufacturing activity, including me, Shepherdson pointed out the weakness in similar type surveys conducted by the National Federation of Independent Businesses which still indicates recession level activity. I have noted the same in a recent post, but my review of that data is more balanced than the pure negativity expressed in Ms. Morgenson's column: See Item # 4 Retail Sales/Chinese Currency/The Movie "Precious"-LGF/Medicare Fraud & the Government/ING The index developed by this association of independent businesses has started to rise from the depressed levels in March, and the last reading was close to the threshold level of 90 in that index. I am following this data series, and I am concerned about the results contained in the last survey.

I was more interested in Shepherdson's opinions about when the Federal Reserve will start to raise rates again, and the reasons given for his opinion. I am not a theoretical person but a practical one. I want to gain some meaningful feel for how long cash will be trash which will dictate in part the risks that I am willing to assume now. His prediction is for the first increase in the spring of 2011. His opinion is based on the precipitous fall in bank credit by 8% since October 2008, a trend that is accelerating. To prevent a collapse in the broad based money supply, the Fed has embarked on its asset purchase program, still continuing for mortgage backed securities, which creates deposits to offset the credit contraction. Until that credit contractions stops, Shepherdson does not see the Fed raising rates. Some of this credit contraction talk was echoed recently by Meredith Whitney. /Sarah and Meredith Before trying to measure the importance of a decline in credit availability, you need to assess how much of that contraction is just the withdrawal of excessive credit availability, created with abnormally high leverage undertaken by financial institutions. Relying on raw numbers, without context, can result in drawing erroneous conclusions.

I has had a different take away than Shepherdson on the N.F.I.B.'s survey about the availability of credit to small business. Shepherson believes this data shows that "credit continues to remain troublingly hard for small business to come by". This is what the November survey said about credit, and one can draw their own conclusions:

"For those who want to borrow, getting a loan continues to be difficult, with
a net 14 percent reporting loans harder to get than in their last attempt.
Thirty-three (33) percent reported regular borrowing, unchanged from
September. . . .

Twenty-nine percent reported all their borrowing needs met (down 1 point)
compared to 9 percent who reported problems obtaining desired financing
(down 1 point, not seasonally adjusted)."

It is clear though that small businesses have not seen the kind of recovery reflected in the ISM manufacturing surveys.

So, what does all of this mean? For now, I would say that it is currently highly probable that the Fed will remain on hold for six more months with its nil interest rate policy, and more probable than not on hold for another 6 to 9 months which is sufficient for me to continue to use cash, earning close to nil, to increase my exposure to income generating securities, generally defined today as meaning a security yielding more than 5% for a stock, 7% for a bond, and 8% for an equity preferred stock.

4. Sold 30 PST at $50.06 (see Disclaimer): Based on my view now that 10 year treasury rates will continue to remain abnormally low for at least a few more months, I took a loss on PST and will start to establish to establish my hedges for my long corporate bond portfolio next year when I have a better feel for how long the Fed will keep the federal funds rate at 0 to .25%. I intend to use both PST and TBT as hedges for my overweight corporate bond portfolio. /Hedging Bond Positions/ This brings me, for now, back to no position in either PST or TBT. I am going to use those funds to increase a hedge for a different asset.

The PST shares were sold at a small loss with the position just established 0n 11/10 at $52.45. Item # 4 Added 50 of the TC DKK/Bought 70 PYT at $15.75/Sold All Shares TIP ETF/Started Hedge for Corporate Bonds/Added 50 of ABWPRA

5. India GDP: India is doing its part to bring the world out of the Near Depression. India's GDP grew 7.9% in the 3rd quarter compared to the same quarter a year ago.

6. Chicago PMI: This index rose to 56.1 in November, the highest reading since August 2008.

7. Dubai: Just another black hole for lenders. I read with interest this morning a statement by a fellow, Abdulrahman al-Saleh, director general of Dubai's Finance Department. He said that sure Dubai owns Dubai World, but the government does not guarantee the debts of its controlled entity. Wow-not responsible for its own debts! Do they have any idea how that sounds to a Western ear? So, why would anyone lend anything to Dubai World? It would be negligent for a Western financial institution to extend them any credit at all. Do they think there is any legal protection in a Dubai court after the government owned Dubai World defaults?


  1. I'm not sure why Dubai (the state) should be held responsible for Dubai World debt. If any one thought that there was any implicit guarantee he was a fool. Isn't the whole reason to have a legal business entity to take away any liability from the owner?

    About the interest rate: I bet that the first rise will be in Q4 2010. Why? Just a guess based on the fact that people always exaggerate these kind of things. A bull market never ends, a bear market will always go lower and interest rates will always stay at 0%.

  2. There is a fundamental difference between entities established by governments and private actors. A private actor can form a business entity for the purpose of attempting to avoid personal liability for the entities debts (as a practical matter, many are required to guarantee the corporations obligations anyway) It is not irrational for someone to view government created entities as having the implied backing of the sovereign.

    In fact, the U.S. ended up guaranteeing the debts of Fannie and Freddie even though they were private corporations. Governments have all sorts of entities that they create, and are viewed, rightly or wrongly, as part of the sovereign entity, usually without too much attention paid to the legal niceties. In the eyes of many the default of Dubai World would be viewed as a sovereign default. I would view it as such, though not a technically legal default apparently (based on the comments of al Saleh). When you pierce the veil so to speak, everything is controlled by Sheikh Mohammad bin Rashed al-Maktoum and his family using a bunch of aliases. But at least this will be a wake up call to those wishing to lend funds in the future to one of the entities created by the Sheikh to avoid responsibility for the debts incurred. Personally, I think lending money to one of these Dubai entities is per se negligent. Fortunately most U.S. banks have withdrawn from that type of lending after being burned big time with loans to Latin American governments back in the early 1980s that almost bankrupted several of them.

    The European banks have filled that void. The story that I referenced in a post recently about the Kazakh Bank was filled with names of mostly European lenders:

    The current consensus forecast by economists polled by the WSJ for a rise in the federal funds rate is around September 2010.