3/7/08

Economics

fiscal profligacy (Government spending as a percent of GDP is too high and the looming explosion in entitlement expenditures will make it worse. There is no good solution save spending discipline.). Is this too good to be true?:

http://www.cqpolitics.com/wmspage.cfm?parm1=5&docID=news-000002682132

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So much for investors’ lessening worries over credit market problems. Yesterday there was news of margin calls and bankruptcy among hedge funds and other highly leveraged (non bank) financial institutions which intensified concerns about the growing illiquidity in the banking system. While margin calls are not pleasant affairs and do impact all Market participants via declining asset prices, it is important to note that there are two major differences between illiquidity in non bank institutions and illiquidity in the banks: (1) the non banks don’t have FDIC to protect the value of their investors’ principal and they don’t have the Fed’s discount window and (2) illiquidity in the banking system means lack of credit to finance future economic growth; illiquidity in the non bank institutions means some investors are going to lose money (when they get margin calls) and some are going to buy bargains.

The point here is that (1) by far the more important problem is the banking system’s growing inability (or unwillingness) to extend credit and hence foster the continued growth of the economy and (2) it is an easily solvable one: via the discount window, the Fed simply buys (trades) the [illiquid] sub prime loans on the banks’ balance sheets for cash (US Treasury bills). That eliminates the issues of sub prime loan valuation and bank balance sheet liquidity--which would allow the bank to resume lending presumably using tighter credit standards than in pre-sub prime environment but at least they could resume lending. There is, of course, the risk that the Fed gets stuck with some worthless paper; but if history is any guide, the Fed will make money on this transaction.

The lesser problem is margin calls and bankruptcy among the highly leverage non bank institutions (Thornburg and Carlisle). Those guys made risky bets and now that credit risk has started to be re-priced [fixed income securities decline in price], they have no recourse to a margin call but puking out their investments irrespective of the quality of those investments. But that is a security price problem (i.e. assets being liquidated at distressed prices) not an economic liquidity problem (i.e. insufficient credit to finance economic growth) and it is a zero sum game, i.e. the puker is a loser (selling securities at distressed levels) and the pukee is a winner (buying securities at distressed levels).

Bottom line: the Fed can take steps to solve the current bank liquidity problems. It won’t solve the stupidity problems of institutional investors that bet large sums of money using vast amounts of leverage with virtually no protection to the downside. Nevertheless, the Fed has to act and soon or the non bank failures will likely precipitate bank failures with all the implications for future economic growth (headlines coming across the newswires are suggesting something along this line may be afoot).

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Politics

Domestic

Obama’s potential plan for withdrawal from Iraq:

http://www.powerlineblog.com/archives2/2008/03/019958.php

More on Obama and NAFTA:

http://www.american.com/archive/2008/march-02-08/doing-a-job-on-nafta

International War Against Radical Islam

The Market

A look at the current valuation of the S&P:

http://bespokeinvest.typepad.com/bespoke/2008/03/sp-500-earnings.html

Technical

Yesterday was not so pleasant. What was most troubling was that the S&P closed below its January low close (circa 1310) and that set off all kinds of alarm bells among the technically oriented. As you know, I am not a technical purist (although I do believe that all those resistance/support levels and other esoteric presumptions about stock price behavior are grounded in the supply and demand for stock); so I am not quite so sensitive to an absolute single point price level. Hence, I would observe the following: (1) yes, the S&P closed below the January low close [1310]; however, it did not close below the January intra day low close [1269], (2) it also didn’t approach the 1982 to present up trend line which is now around the 1282 level, and (3) the DJIA didn’t get close to either its January low close (circa 11900) or its January intra day low close (circa 11600).

The point being that stocks are clearly testing the recent Market lows but there is by no means sufficient evidence to conclude that they are heading much lower. Certainly, today could be ugly; indeed, if it were so [down big with heavy volume; but holding above S&P 1269, DJIA 11600], I would interpret that positively, i.e. I believed that there would be a test of those January intraday lows, so bring it on and let’s get it over.

That said, I have no sense of the probabilities of whether or not stocks have begun another down leg. What I have is our Price Disciplines; and as of the close yesterday, only one stock in our three Portfolios violated its Stop Loss Price (see below). Further, in a screen against the five price markers I have been watching (the August 2007 intra day low, the August 2007 low close, the November 2007 intra day low close, the January 2008 intra day low close, the trend in place in August 2007 and the trend in place since the mid 2007 highs) most of the stocks in our Portfolios remain above at least two of those markers. So the evidence from the worm’s eye view of our Portfolios would suggest that stocks have not started another leg down.

Bottom line: I am assuming that stocks are testing the January lows. However, given the Market’s current volatility, this is a day to day judgment; so betting money on that assumption is a high risk/reward proposition. Today is likely to be tumultuous, so we will revisit the issue at day’s end.

All that said, these are the stocks about which I am concerned: in the Dividend Growth Portfolio: Bank of Nova Scotia. McGraw Hill, Brown Forman, Abbott Labs, and General Electric. In the Aggressive Growth Portfolio: Schwab, CME Group, UnitedHealth, Eaton Vance and Expeditors Int’l.

Fundamental

Subscriber Alert

American Eagle Outfitters (AEO-$18) reported disappointing sales and the stock got clocked, falling below its Stop Loss Price. Because of the increased volatility described above, the Aggressive Growth Portfolio will Sell one half of its position at the Market open today.

The stock price of Best Buy (BBY-$41) has fallen below the lower boundary of its Buy Value Range. Therefore, it is being Removed from the Aggressive Growth Buy List. Because the Aggressive Growth Portfolio doesn’t own this stock, no action is necessary.

http://finance.yahoo.com/q?s=BBY

The stock price of Sun Hydraulics (SNHY-$26) has risen above the upper boundary of its Buy Value Range. Accordingly, SNHY is being Removed from the Aggressive Growth Buy List. The Aggressive Growth Portfolio will continue to Hold this stock.

http://finance.yahoo.com/q?s=SNHY

The stock prices of McGraw Hill (MHP-$49) and General Electric (GE-$33) have fallen below the lower boundary of their respective Buy Value Ranges. Accordingly, MHP and GE are being Removed from the Dividend Growth Buy List. For the moment, the Dividend Growth Portfolio will continue to Hold these stocks.

http://finance.yahoo.com/q?s=MHP

http://finance.yahoo.com/q?s=GE

The stock price of Martin Midstream Ptrs (MMLP-$35) has fallen below the lower boundary of its Buy Value Range. Therefore, it is being Removed from the High Yield Buy List. The High Yield Portfolio will continue to Hold this stock.

http://finance.yahoo.com/q?s=MMLP

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