James Picerno
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The financial industry has been transformed to a degree that few thought possible only a few weeks before. But this is all a sideshow to the real story of change as it relates to the economy and deciding how Main Street will fare in the months and years ahead.
Still, it's hard not to gawk at the spectacle that is Wall Street. First observation: Wall Street as it existed just a few weeks ago is gone. The news that Morgan Stanley (MS) and Goldman Sachs (GS) -- the last two large, independent investment banks standing -- will transform their businesses into bank holding companies completes the decimation of the old investment banking model. The boys had a good run. Unfortunately, they blew up the industry and now all that's left is a bunch of humbled Citigroup wannabes.
That's not so bad, if only because Citigroup (C), sprawling and unwieldy as it is, didn't self-destruct. Neither did J.P. Morgan (JPM) or Bank of America (BAC). One reason: those three, as bank holding companies, operate under a tighter, more constricting regulatory framework, and so by law they were forced to operate more conservatively compared to Bear Stearns and Lehmans of the world. No problem: some of our favorite institutions are plain old banks and the world will probably survive just fine now that they've ascended the throne.
But let's not get too giddy. Keep in mind that there are still a lot of little Lehmans and Bear Stearns in the world, otherwise known as hedge funds. Collectively, this gang runs a lot of money, much of it leveraged, and some of it--perhaps most of it--is managed unintelligently. We don't really know, of course, but given what's transpired in recent weeks we're inclined to wonder.
Overall, there are still a lot of financial bodies buried in the rubble, and quite a few more that are ailing. It's unclear how much price-cutting will be necessary in the various assets held by banks, hedge funds and other institutions. Unknown or not, the unwinding rolls on. And there are still lots of dicey securities sitting on balance sheets the world over. Meanwhile, reassessing their value, and the resulting impact on companies and economies, is still in its infancy.
It's tempting to think that now that Wall Street as we knew it is effectively gone we can all breathe a sigh of relief. Indeed, the U.S. government, we read, seems likely to buy up a fair chunk of the toxic securities that caused so much pain. Assuming the bailout plan arrives, the government-sponsored buying will help drain some of the poison from the system.
Even under the best-case scenario of a quick government action that's focused on purchasing what no one else wants, there's plenty of heavy lifting to be done on the economy generally. And deciding how the macro picture unfolds is where it gets really tricky.
Predictably, there are some who see lots of trouble ahead for the economy. The headwinds start with a chastened consumer and rolls on with a weakened outlook for growth in corporate earnings.
For most investors, there are four major groups of asset classes with which to build investment portfolios: equities, bonds, REITs and commodities. The question before the house: How will the new world order impact the prospective returns for these big four?
Let's start with equities. It seems likely that raising earnings and profits will be tougher going forward as a general proposition. Some industries and sectors will fare better, or worse than others, as always. But overall, it's hard to see equity returns on a global basis besting their best pace from the recent past.
Yes, equity prices are substantially lower today than they were a year or two before. If this was a normal cyclical downturn, the outlook would be brighter for stocks at this point. But this is not a normal cyclical downturn and so it's hard to get excited by prospective equity returns until prices and valuations fall further. At the end of last month, global equities posted a 2.88% dividend yield, according to S&P/Citigroup Global Equity Indices. No doubt that's higher now, thanks to falling prices in September, But even at 3%, we're not yet convinced this is the time to overweight equities generally, although opportunistic nibbling is encouraged.
True, some regions of the world offer better value. That starts with stocks beyond the U.S. The S&P/Citigroup Global ex-U.S. Index reported a trailing dividend yield of 3.48% at the end of August, substantially above the U.S. number.
Nonetheless, higher dividend yields look set to be offset by lower earnings for the time being. Short of additional markdowns in prices for stocks--which we expect--the outlook for earnings growth is still sufficiently modest to warrant a cautious outlook on equity allocations generally. As prices go down from here, however, allocations should go up.
As for bonds, interest rates at the moment are too low to get excited about loading up on bonds. Although few are talking about it yet, the government bailouts will produce inflationary winds through the U.S. economy. This risk isn't imminent, and it probably won't be an issue for months, perhaps even a year or two. The deleveraging and unwinding of risk comes first. But eventually, bonds will suffer as interest rates rise and so long-term fixed-income weights should reflect this future. The 10-year Treasury yield closed Friday at 3.78%. Thanks, but no thanks. If it's safety you want, we'll lean to the short end of the curve. A 1-year Treasury yield, for instance, was 2.05% on Friday: more than half of the 10-year's yield at 1/10 of the maturity.
REITs, meanwhile, will attract attention for their relatively high yields. Globally, REIT yields were a hefty 5.8% at the end of last month, according to S&P/Citigroup. That's a modestly alluring margin of safety, although it's offset by the headwinds that commercial real estate faces in the new world order. Nonetheless, long-term investors will do well to focus on adding to broad-based REIT positions at those moments when Mr. Market is selling the asset class.
Then, there are commodities. A good buy? Maybe, although until we get a better sense of timing and outlook for the global economy it's premature to load up on the asset class, even when it stumbles. Nonetheless, taking advantage of price corrections is tempting, particularly for those with zero or low relative exposure to commodities in their portfolios.
Cash, finally, is still an attractive holding since it represents opportunity to exploit the continued turbulence that we think is coming. Granted, the new turbulence will be of a lower-grade than the headline-shocking experience of late. But the troubles ahead will be a slow burn, unfolding relatively quietly over time, and inspiring little in the way of massive new government handouts as solutions.
Having lived through the biggest financial calamity since the Great Depression, investors must now grapple with the economic consequences. No, we're probably not going to fall into a depression nor is the likely recession going to be especially deep. But the path back to growth could be a long, hard trek. Recovery will take longer than many think. Indeed, the addict has only just come to the conclusion that he has a problem. Several years of group therapy are coming, and it's only just begun.
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This article has 23 comments:
Lived through? The 'financial calamity' is far from over. The people who caused the problem in the first place are now 'fixing' it with taxpayer money. The worst is yet to come. Batten down the hatches and plan accordingly.
In a weird sort of way, to me, this looks like the first step toward re-establishing sanity in this country. Maybe with the vampires on Wall Street gone, large manufacturers and conglomerates can actually make decent returns and reinvigorate the real wealth creating sector of our economy.
I find your dismissal of depression foolish, just as you would have dismissed the likelihood of the complete destruction of 100% of the major investment banks one year ago. We must think the unthinkable and prepare for it. We must (though it is impossible) attempt to get threee moves ahead and hedge everything where possible. But there is no perfect hedge, since there is always counter-party risk.
It is a new world order and the vast majority of the public is sleep-walking throught it today. Daddy Bush and Paulson have told them not to worry, go about their business as ususal, the economy is strong, strong, strong! Oh, and like after 9/11, please don't even think about saving or paying down debt. Go out and spend, spend, spend. Pay your taxes. It's the patriotic thing to do!
Did you also notice the commentary on weekend television about whether your 401-k was "safe". The explaination was that 401-k accounts were insured up to $100,000! How stupid can you get. Show me a 401-k statement that contains CD's.
Stop envying Goldman Sachs’ Lloyd Blankfein already. Don’t begrudge Bear Stearns’ Jimmy Cayne and Lehman’s Dick Fuld their millions. Let Merrill’s Stan O’Neal and Morgan Stanley’s John Mack get paid more than Croesus. You heard it here first: They deserve it. In fact, they deserve more than they earn now.
Those five men are underpaid because they are about to make you very rich if you buy their stocks. Personally, I’m partial to Goldman Sachs, the most undervalued stock of the quintet. But the truth is, you can own shares in any one of these companies and I would expect you to make 50 percent on your money within the next year, and double it within the next three. Despite their immense profitability, the stocks of these companies are some of the least expensive of all the thousands I follow, and, after crushing declines since the year began, they’re ready to begin a steep ascent.
50% in 6 months and 100% in 3 years. Wow.
Once the "big kids" on Wall Street started playing with other people's money -- e.g., when the firms converted from private partnerships with their own money at risk to public corporations, it was only a matter of time.
It wasn't pure greed that killed them.
It was simple arrogance.
Or, as a wise sage once told me during the peak of the bull market, "they're like fat guys riding their bicycles downhill thinking they're going fast because they're good athletes."
The Fed was created in 1913. They contributed greatly to the depth and pain of GD1.
"The trade, the epic no brainer trade of all time right now, is to arb the corporate bond spread. Buy 10 year investment grade corporates in distress, and borrow half the money to do it twice."
OMG, the treasury is breaking open ink jugs and you want people to buy bonds! Lolz! The spreads will close, but not in the direction you say.
Welcome to the Great Republican Recession!
I am usually an optimistic guy (which is why I have lost a stupid amount in my portfolio this year)
But let's look at it.
If you are standing on level ground and you dig down 1 foot (debt) and step in, you're not doing bad. You can probably pretty easily fill that hole back in and get back. But if you are in a hole up to your neck, that 1 foot puts you underground, and it is REALLY difficult to reach out and start pulling dirt back in.
700 BILLION DOLLARS - that is a tremendous amount of debt to add onto the existing deficit. Oh yes we MAY get some of it back, but I would not count on getting much back. Have you guys forgotten that THE DEFICIT IS BAD FOR THE ECONOMY??
Where is this money going to come from? Not many options. The government can borrow it from Saudi Arabia (they have lotsa $$ now from selling us oil) or from China (that great bastion of democratic values), OR we can print more dollar bills – another 1/2 Trillion of them.
But let’s just remember that there is a price to pay. In either case, the world will devalue the dollar. Then prices will go up (especially OIL). In other words, there will be inflation. Inflation + slowing economy = Stagflation. Unfortunately, I think it is going to take us a lot of years to get out of this one!
Notice how oil is already up on the bailout news!
Point is: If we were not so far in debt (Federal Deficit), mostly from the Iraq War, then we might have weathered this much better.
Welcome to the Great Republican Recession!
Therefore, I offer the 12 steps of Debtors Anonymous (D.A.):
We admitted we were powerless over greed, and that our lives had become leveraged to the hilt.
We came to believe that a power greater than ourselves, the mighty US Treasury, could restore us to sanity.
We made a decision to turn our paychecks over to the care of the US Treasury for the next fifteen generations.
We made a searching inventory of all of our material possessions.
We admitted to our credit counselor and our bankruptcy advisor the exact nature of our wrongs.
We were entirely ready to have our credit cards cut up, our SUVs repossessed, and our 5000 sq ft homes foreclosed on.
We humbly asked the pawn shop for a fair price for our flat sceen tvs and coach purses.
We made a list of all of creditors, and became willing to forgo Chapter 7 for Chapter 13.
We declared Chapter 13.
We continued to consume conspicuously, but paid only with cash.
We sought through prayer and meditation to improve our ability to save.
Having had a rude awakening as a result of our greed, we decided to live more simply and became happier as a result!
www.bloomberg.com/apps...
Buy a used car, get a share of GM!
The FED printeth and the fine print taketh away. The most efficient means I can conceive to ruin a business would be to make the government a shareholder.
Next thing you know the FED will be sending their agents from business to business offering 'protection' from neighborhood ruffians in return for a cut of the profits.
At last the true colors shine through. Think mob racketeers.
rnfc.org/ivey/wp-conte...
They were just doing what the shareholders demanded - take huge risks for double-digit profit growth in the short term, regardless of the long term danger. Truth is, any investment bank CEO who promised 2-5% earnings growth through safe, sustainable business practices would have been fired a long time ago in favor of the latest hot shot derivitives gunslinger.
As long as most stock traders are short-termers who only care about short term profits, and as long as bonuses and stock options are awarded based on short term performance, companies will be geared to self-destruct trying to make a quick buck.
so...
Government = National Debt + Taxpayer Equity
Which do you think has control over the assets - the foreign creditors who own the debt or the taxpayers?
Since the government would run out of money if the lending was ever cut off, I would say the foreign creditors. Just like in a bankruptcy, the assets have been seized and used to try to make the creditors whole. The fact that our own government would shift open market investment losses from the creditors to the taxpayers illustrates this realization nicely. We no longer own the government. We squandered it away on silly wars and porky budgets.
Are you kidding me?? Execs in the know shorted their OWN companies and walked away with a profit. They're in better positions financially BEFORE this whole mess.
This was one orchestrated act, so that Congress will have an excuse to raise tax rates on the working/middle/upper middle/rich (READ: NOT WEALTHY), to "save our American system, and long standing pillars of commerce, blah, blah"
And who really runs Congress? Not the people it says it represents. Welcome to the new world.
"The most efficient means I can conceive to ruin a business would be to make the government a shareholder. "
Well, Fannie Mae USED to be a government agency, and it worked pretty well at that time. (see below). It seems like it failed only when run privately!
As for wanting a share? You betcha! We bail you out, damn straight I want a share. As for "buy a used car want a share of GM" DUDE, the failed banks, etc ARE the used cars! What you are suggesting is that the taxpayers pay billions to bail out business X, and then the owners of X make all the profit after they get back on their feet. Why don't we just call it charity!
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Wikipedia:
"Fannie Mae was founded as a government agency in 1938 as part of Franklin Delano Roosevelt's New Deal to provide liquidity to the mortgage market."
www.wallstreetcoffin.c...
We are donating 15% of our sales to charity to do what we can to help during these tough times.