Archive - May 2010

It’s not all about making money. Listen to the story of Colonel Mitchell Paige on Guadalcanal in 1942.

Even as futures are feeling buoyant as a result of the JPY drop following the collapse of the Japanese ruling coalition (which in itself will likely spell serious JGB troubles in the days ahead), Middle-east geopolitical issues have once resurfaced... or technically submerged as the case may be. The Sunday Times reports that "three German-built Israeli submarines equipped with nuclear cruise missiles are to be deployed in the Gulf near the Iranian coastline." Presumably, this a defensive move: "The first has been sent in response to Israeli fears that ballistic missiles developed by Iran, Syria and Hezbollah, a political and military organisation in Lebanon, could hit sites in Israel, including air bases and missile launchers. The submarines of Flotilla 7 — Dolphin, Tekuma and Leviathan — have visited the Gulf before. But the decision has now been taken to ensure a permanent presence of at least one of the vessels." We are not sure Iran will take the news with the required dose of stoic acceptance. But at least we now have confirmation that Israeli subs are not being used by the Obama administration as a means of delivering nuclear armaments to the continental shelf (unless this too, is another Criss Angelesque Emmanuel Rahm masterpiece).

Goldman's Erik Nielsen has yet to disclose if he is joining his Euro-pal Jim O'Neill in declaring all out war on the bears (for those unsure about the reference see here, and FYI Jim, the grizzlies send their love... and in keeping with the animal references, they don't really give a rats ass about the occasional dead cat bounce). What he has no problem disclosing, however, is his latest round of rose-colored ebullience, even as other, "slightly" more objective europundits see the end of the Eurozone as ever more imminent. It is stunning how cognitive dissonance can lead two people to the following diametrically opposite conclusions: Erik Nielsen: "The European recovery continues to look pretty good and solid to me" and Ambrose Evans-Pritchard: "[the Pan-European austerity package] can end only in two ways. Either Germany tolerates massive monetary reflation by the ECB or Spain will be forced out of EMU, setting off a catastrophic chain-reaction through north Europe's banking system." Of course, when one is in the business of perpetuating ponzies, while another has a page view quota, the truth likely is somewhere inbetween. Then again, "inbetween" two polar opposites is a wide range. Anyway, since we will likely see a lot more pain "on the plain" shortly, here are some soothing words for all those who are still long and strong and need goal-seeked analyses.

Our earnings are robust, our compensation has returned to its naturally high levels and, as a result, we have very nearly regained our grip on the imaginations of the most ambitious students at the finest universities — and from that single fact many desirable outcomes follow. Thus, we have almost fully recovered from what we have agreed to call The Great Misfortune. In the next few weeks, however, ill-informed senators will meet with ill-paid representatives to reconcile their ill-conceived financial reform bills. This process cannot and should not be stopped. The American people require at least the illusion of change. But it can be rendered harmless to our interests. - From Wall Street's Man In Washington

The world has been fighting the financial crisis by using every possible trick according to John Maynard Keynes‘ playbook. But, as The Great Depression taught us, extreme government spending tends to cause about as much problems as it solves. Perhaps it’s time to put Keynes back on the bookshelf, and pull out the 200 year old theories of David Ricardo.

Time to look past short-term market turbulence and see why fundamentals are improving. It will be volatile, but the market will keep grinding higher. Choose your stocks and sectors carefully, however, the big beta moves are over.

Why we will deflate in terms of Gold but hyperinflate in terms of the dollar...

"Most economists seem to think that QE puts us in uncharted waters. It doesn?'t. Printing money to finance government expenditure is a very well trodden path which is as old as money itself: persistent monetisation causes inflation. Of course the current monetisation need not be persistent. Central banks can theoretically just stop it at any time. But with government balance sheets in such a mess across the developed world (even with yields at historically unprecedentedly low levels), government funding crises are likely to be a recurring theme in the future. Since banks hold so much ?risk free? government debt, those funding crises point towards more banking crises which point towards more money printing. When do they stop? When can they stop?
But what does it all mean? The question to my mind isn'?t whether or not inflation will accelerate from here. If government balance sheets are in as big a mess as I think they are, inflation is inevitable. The more interesting question is what kind of inflation can we expect?" - Dylan Grice, SocGen

A week ago at the CFA Institute's 2010 Annual Dinner, Baupost's Seth Klarman stole the spotlight by announcing to everyone that he was "more worried about the world than ever" while making it clear that he was on the same Jim Grant and Julian Robertson "Treasury put" bandwagon. Yet another speaker present at the event, who undeservedly received much less attention, was CLSA'a Russell Napier, who has long been warning about precisely the thing that all asset managers are realizing rather belatedly, that Treasuries are a very "fundamental asset bubble." The only relevant questions, which Napier has previously discussed extensively, are "when do treasuries crash" and "what do you do" when that happens. The attached presentation provides some color on both.

Investor sentiment has turned bearish here, and this is our "fat pitch".

Oh, what a tangled web we live in. On one side of the Atlantic, there is a fundamentally broke European Union. On the other, the world’s largest debtor nation, these United States. Rotate the globe and you discover China, the world’s most populous nation: a nation whose economy is desperately dependent on export revenues, without which its government may find it hard to meet the population’s soaring aspirations. And who is China’s largest trading partner? The European Union, that’s who. The web also encompasses the role that the U.S. dollar plays in the relationship between the European Union and the Chinese. Or, more specifically, the role the peg plays that China maintains with the U.S. dollar. As long as the U.S. dollar is weak, the Chinese yuan is weak and therefore competitive in European markets. The problem now is that, with the euro falling, in order to remain competitive, Chinese companies must reduce their margins. Therein lies the rub, because the razor-thin margins of the Chinese companies – estimated to be on the order of just 2% -- face the very real danger of thinning to the vanishing point. After which the best a Chinese company will be able to hope for is to make up its losses on volume. That was a joke.

As we’ve discussed recently, persistent deflationary forces do not augur for a repeat of Japan circa 1990s or the US in the 1930s. Instead, because of the inability of governments to finance their current and future debt burden (there is a dearth of domestic savings and global capital), deflationary forces will ultimately lead to severe inflation or hyperinflation. In today’s missive, we explain how this will happen but in various stages.

Private sector mortgage insurance was excluded from the financial regulation debate. Why?

C'mon you wimp.  The Russians nuke these things all the time.  Here is your big chance to show up Putin.  Run with it, baby.  We'll just watch from a confortable distance.  To wit:

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With concerns about implications on GoM drilling post the Macondo spill dominating the investing world, as every day millions of gallons of fresh oil spill into the Gulf of Mexico, we present reports by Bank of America and JPM which disclose possible consequences from regulatory intervention, as well as all the rigs and operators in the GoM likely to be impaired by either surging insurance premiums, or something much worse, now that US offshore drilling policy is in greater flux than even ongoing financial reform. With today's adverse BP developments, Tuesday will likely see another bloodbath within the offshore drilling space, where RIG CDS have blown out more than in 2007 when the company was rumored to be a take private candidate more often than Radioshack is today (speaking of, in breaking news, today the market did not leak a new rumor about some idiot LBOing RSH ). The attached reports should provide a sufficient perspective on which managers and which operators are most likely to suffer the wrath of a skittish market.