Mad Hedge Fund Trader

Dubai and AIG - What's the Difference?

bfr Who did Dubai’s emir, Mohammed bin Rashid Al Maktoum, think he was kidding? He launched one of the biggest construction booms in history, erecting the Burj Dubai, which at 161 stories is the world’s tallest building. He built artificial islands in the Persian Gulf with lofty names like “The World” that are so big they are visible from space. He bought the legendary Queen Elizabeth II, a ship that holds many fond memories of transatlantic crossings for me, to convert into a floating hotel at unimaginable expense. The spending didn’t stop there. His spending binge went global, taking a partnership role in the Las Vegas City Center, which became the worst commercial real estate project since the Tower of Babel. The problem is that all of these acquisitions were done on credit, with only a fig leaf of equity, and the wind is now blowing with hurricane force. Dubai property values have slid 50% in a year, and the plunge shows no sign of abating. No surprise then that development arm Dubai World has defaulted on $59 billion in debt. The spendthrift emir spent way too much time on horse racing and not enough on research. Sure, turning Dubai into the next Hong Kong was a laudable goal, but did anyone think this through? While the former crown colony is backed by the sweating masses of China, tiny Emirate is surrounded on two sides by 2,000 miles of sand and on the other two by the not so friendly maritime neighbors of Iran and Iraq. Oil, you may ask? My Caesar salad has more oil than Dubai. Haven’t they heard of peak oil? I always thought Dubai would revert to a ghost town once the neighborhood ran out of Texas tea. Now that Dubai’s debt has been correctly marked down to junk the big question is who else this hubris gone wild is going to take down. The shareholders of the UK’s Standard Chartered Bank and HKSB, the lead lenders, are going to take a body blow, and a rash of hickies will spread among the many syndicate members. Greece and Ireland could be next, as the premiums for their credit default swaps have skyrocketed. Things could get ugly in Dubai when the country’s 360,000 migrant Indian workers find out they aren’t going to get paid. How do you say “domino theory” in Arabic?

U.S Treasuries: Heading for a Rally or an Implosion?

I vote for implosion. Reviewing the current political and monetary landscape, I would be remiss, irresponsible, even negligent, if I didn’t revisit one of my favorite ETF’s, the Proshares Ultra Short Treasury Trust (TBT). This is the 200% leveraged bet that long Treasury bonds, the world’s most overvalued asset, are going to go down. While the Fed is going to keep short rates low for the indefinite future, it has absolutely no direct control over long rates. The only political certainty we can count on is the continued exponential growth in the supply of government bonds of all maturities. Like all Ponzi schemes, their eventual collapse is just a matter of time. It’s simply a question of how many greater fools are out there (sorry China). Look at how they are trading now. We currently have the greatest liquidity driven market of all time, and the ten year is only eking out a 3.40% yield, pricing in near zero inflationary expectations. The average yield on this paper for the last ten years is 6.20%, a double from the current level. Get the yield back up to 5%, a distinct possibility in 2010, and that takes the TBT from the current $45 to $70. Sure, we may get a sideways grind in yields for a few months, which will be expensive due to the mathematic idiosyncrasies of the 2X ETFS. But a security that is unchanged if I am wrong, and doubles if I am right is the kind of risk/reward ratio that I will take all day. And I believe that in my lifetime Treasuries may lose their vaunted triple “A” rating and be priced closer to subprime (warning: I am old). That could enable the TBT to deliver the holy grail of trades, your proverbial ten bagger.

Counterparty Risk Falls Further

You really see this in emerging market bonds. A number of readers have asked me tocome up with a safe, high yielding investment in which to hide out incase the equity markets swoon again. That means they are looking for a security that offers a high fixed return, denominated in a strong currency that will benefit from future upgrades that will boost theprincipal over time. All of that is another name for the Invesco PowerShares Emerging Market Sovereign Debt ETF (PCY). The fund has 40%of its assets in bonds issued in Latin America and 31% in Asia, with the bulk of the maturities exceeding ten years. The two year old fund now boasts $340 million in market cap and pays a handy 6.42% dividend.This beats the daylights out of the nine basis points you currently earn for cash, the 3.40% yield on 10 year Treasuries, and still exceeds the 6.42% dividend on the iShares Investment Grade Bond ETN (LQD),which buys predominantly single “A” US corporates. The big difference here is that have a rosy future of further creditup grades to look forward to. It turns out that many emerging markets have little or no debt because until recently, investors thought theircredit quality was too poor. No doubt a history of defaults in Brazil and Argentina in the seventies and eighties is at the back of theirminds. With US government bond issuance going through the roof, the shoe is now on the other foot. A price appreciation of 125% over the past year tells you this is not exactly an undiscovered concept. Still,it is something to keep on your “buy on dips” list.

Tough Decisions Loom for the Fed

tye ) I spent the evening with David Wessel, the Wall Street Journal economics editor, who has just published In Fed We Trust: Ben Bernanke’s War on the Great Panic. I doubted David could tell me anything more about the former Princeton professor I didn’t already know. I couldn’t have been more wrong. Bernanke was the smartest kid in rural Dillon, South Carolina, who, through a series of improbable accidents, ended up at Harvard. He built his career on studying the Great Depression, then the closest thing to paleontology economics had to offer, a field focused so distantly in the past that it was irrelevant. Bernanke took over the Fed when Greenspan was considered a rock star, inhaling his libertarian, free market, Ayn Rand inspired philosophy. Within a year the landscape was suddenly overrun with T-Rex’s and Brontesauri. He tried to stop the panic 150 different ways, 125 of which were terrible ideas, the remaining 25 saving us from the Great Depression II. This is why unemployment is now only 9.8%, instead of 25%. The Fed governor is naturally a very shy and withdrawing person, and would have been quite happy limiting his political career to the local school board. But to rebuild confidence, he took his campaign to the masses, attending town hall meetings and meeting the public like a campaigning first term congressman. The price of his success has been large, with the Fed balance sheet exploding from $800 million to $2 trillion, solely on his signature. The true cost of the financial crisis won’t be known for a decade. The biggest risk now that having pulled back from the brink, we will grow complacent, and let needed reforms of the system slide. How Bernanke unwinds this bubble will define his legacy. Too soon, and we go back into a depression. Too late, and hyperinflation hits. Let’s see how smart Bernanke really is.

Will the Market's Party End?

yte Reviewing the current political and monetary landscape, I would be remiss, irresponsible, even negligent, if I didn’t revisit one of my favorite ETF’s, the Proshares Ultra Short Treasury Trust (TBT). This is the 200% leveraged bet that long Treasury bonds, the world’s most overvalued asset, are going to go down. While the Fed is going to keep short rates low for the indefinite future, it has absolutely no direct control over long rates. The only political certainty we can count on it the continued exponential growth in the supply of government bonds of all maturities. Like all Ponzi schemes, their eventual collapse is just a matter of time. It’s simple a question of how many greater fools are out there (sorry China). Look at how they are trading now. We currently have the greatest liquidity driven market of all time, and the ten year is only eking out a 3.40% yield, pricing in near zero inflationary expectations. The average yield on this paper for the last ten years is 6.20%, a double from the current level. Get the yield back up to 5%, a distinct possibility in 2010, and that takes the TBT from the current $45 to $70. Sure we may get a sideways grind in yields for a few months, which will be expensive due to the mathematic idiosyncrasies of the 2X ETFS. But a security that is unchanged if I am wrong, and doubles if I am right is the kind of risk/reward ratio that I will take all day. And I believe that in my lifetime Treasuries may lose their vaunted triple “A” rating and be priced closer to subprime (warning: I am old). That could enable the TBT to deliver the holy grail of trades, your proverbial ten bagger.

Banking on Volatility Will Spike: Time to Buy Put Options on Financials?

ooym The retirement of John Mack as the CEO at Morgan Stanley truly marks the end of an era at the venerable, once white shoed investment bank. I knew John 30 years ago when he ran fixed income sales, and every bond salesman lived in terror of his very shadow. He was truly aggression distilled, and is the main reason I became an equity guy. The former Duke football player once had counters installed of his department’s phones to tally outgoing calls, and fired the least loquacious producers, earning the sobriquet “Mack the Knife.” Another time when the firm was trying to muscle its way into a bond business, he spent months recruiting a bond trader from another leading house, only to fire him on the first day. To a class of young incoming MBA’s he showed a slide of a heavily hirsute man laughing man walking out of a shower, wearing only soap suds in the key areas and told them “This is how we like to leave our clients, plucked clean and happy.” Jaws dropped when we realized it was a picture of him in his frat days. He surfed a massive wave of government and corporate debt issuance to the top of MS. When a prestigious golf club turned him down for membership, no doubt because of his Lebanese heritage, he set up his own. I shall leave the darker urban legends confined to the dustbin of history. Waleed Chama will take over as president of Morgan Stanley International, a more sober banker there never was. We traipsed around the Person Gulf sheikdoms together in the old days, when the long range artillery from the Iran-Iraq war kept us awake at night at the Kuwait Hilton, and shark eaten bodies of soldiers would wash up on the beach every morning. John will hang on as chairman, which means playing golf full time with the firm’s largest clients. As for the stock, you can expect another double after its near death experience at $6, once the economy gets back to normal.

Four Reasons We're Headed Even Higher

xcvnn. Well, you certainly don’t need my help anymore. With everything in the world going up but the greenback, you certainly don’t need the advice of financial advisors, brokers, pundits, or sadly, even this humble online columnist. I never thought I’d see the day when stocks, bonds, gold, silver, oil, natural gas, copper and collectable beany babies were all up in unison. Not only is the punchbowl ubiquitous, but the Kool-Aide is spiked with ecstasy, and it is so large, that there is a risk we might fall in and drown. Industry analysts are now putting out forecasts for their individual companies implying a 5% GDP growth rate next year, but macroeconomists at those very same houses see 2% as a stretch. All of this in the face of a catatonic consumer, $3.40/ gallon gasoline, and banks maintaining a death grip on lending to any but the primest of borrowers. I guess this is what happens when the Fed is determined to keep interest rates at zero, for as far as the eye can see, and the printing presses in Washington DC are running so fast that I can hear them here in San Francisco. With $4 trillion in cash sitting on the sidelines there is a risk that the faith based rally will continue. Is the Fed trying to cure a burst bubble with a profusion of bubbles?

Report from Europe for Friday, Sept. 4

igitn. So who was the dummy that waited until August to lay off their workers? Fire the bastard! Apparently, there are a large number of managers out there who don’t read newspapers, watch TV, or talk to anyone, and waited until the Great Depression was nearly two years old to cut costs. That is one of many conclusions I am forced to draw on the news that the August non-farm payroll showed a further hemorrhage of 216,000 jobs, better than the 230,000 consensus, and a big improvement over the 273,000 July figure. But it included downward revisions of 50,000 in June and July, not good. The unemployment rate came in at 9.7%, continuing its relentless march towards double digits. The net net is that the economy has jumped off the top of the Empire State Building, but is now plummeting towards 5th Avenue and the meat wagon at a slower rate. The usual culprits were there; 65,000 jobs lost in construction, 63,000 in manufacturing, and 27,000 in finance. What was truly amazing to me was to see losses in education at the start of the school season. And what is going to happen to the 1.5 million who will exhaust their unemployment benefits by year end? The figures are all proof that there will be no economic recovery without bank lending. Running a business without credit is like trying to complete a marathon while holding your breath. Bring on the “L.” My many US Navy readers should seriously consider re-upping, as the economy will not see net hiring for a very long time. Just hope we don’t invade anyone new.

Report from Europe: Does September Mean Sell?

fdghj. While the month of October has the reputation as the neighborhood slut, it is in fact September that does the real damage to your pocketbook. Yes, that September, the one that started yesterday. Since 1929, the average September has dropped by 1.3%, compared to an average rise of all months of 0.5%. Remember, Lehman went bust in that month last year, and with lead market Shanghai suffering a diabolical August, you have to wonder if history will repeat itself once again.

Post Traumatic Crash Disorder?

sdfgh. Don’t kid yourself into thinking that the real estate collapse is over. Yes, you can be forgiven for thinking so with July new home sales up 10%, the Case-Shiller home price index up two consecutive months, and homebuilder stocks like Toll Brothers (TOL), D.R. Horton (DHI), and Lennar (LEN) through the roof. Nationally, home prices have fallen back to their historic average of 3.2 times earnings. The problem with all of this is that crashes don’t end at the averages, they overshoot. Some cities like Los Angeles, New York, and Washington DC are still historically expensive. Take away the life support of ultra low interest rates, the $8,000 first time buyer tax credit, the $6,000 California tax credit, $1 trillion in Fed purchases of securitized debt, and toss in another five million expected new foreclosures, and that might give you your final bottom. But that isn’t happening this year. Rent, don’t buy.

It May Be Time to Go Contrarian

tyui. US stocks are now the most expensive they have been in seven years, and never really got cheap during the March low, just fairly valued. At least I have some good company in my views, which are also shared by David Rosenberg of Gluskin Sheff, the former chief equity strategist at the late Merrill Lynch. The “faith based” rally is now discounting a GDP growth rate of 4.0%, which has a snowball’s chance in Hell of actually occurring. This is up dramatically from the 2.5% growth rate the S&P 500 was discounting when the index was at 667. The best stock market rally since 1933 added an unprecedented eight PE multiple points to stocks, and there is now more risk in the market than the 2007 peak. Underweight portfolio managers and momentum driven day traders are to blame. It’s what happened after the 1933 rally that scares me. Needless to say, stocks offer no value here. You can sign up for David’s well thought out research for free by going to his website at www.gluskinsheff.com/.

Is There 22% Less Volume Behind the Current S&P Rally?

Not a good sign. I have successfully avoided bears of a different sort this summer, those of the stock market kind (see my July 15 warning not to sell to soon by clicking here at www.madhedgefundtrader...). Never have I seen such a disconnect between the markets and the real economy. All of a sudden the world has gotten expensive. Stock prices have been levitated by vapor. The bulk of the trading volume is now accounted for by worthless zombie stocks like Citibank (C), (AIG), Fannie Mae (FNM), and Freddie Mac (FRE). Cost cutting, not sales growth, has artificially boosted earnings above subterranean forecasts. Commodity prices have soared because of stockpiling and not consumption. Puzzled CEO’s of every stripe are seeing no recovery in their businesses whatsoever. But bears who have sold into the summer rally have gotten a severe spanking. We are left with momentum players and chartists to grind out ever diminishing returns. I have used the big up days to sell short dated out of the money calls in small size which, mercifully, expired worthless, sometimes just by pennies. That’s because I keep my favorite quote from John Maynard Keynes pasted to my monitor; “Markets can remain irrational longer than you can remain liquid.” Better to wait for a more convincing break on the charts before piling on those shorts again.

Trash Seems to Be King, As Lehman Shares Surge

fghkl. I have successfully avoided bears of a different sort this summer, those of the stock market kind (see my July 15 warning not to sell to soon by clicking here at www.madhedgefundtrader...). Never have I seen such a disconnect between the markets and the real economy. All of a sudden the world has gotten expensive. Stock prices have been levitated by vapor. The bulk of the trading volume is now accounted for by worthless zombie stocks like Citibank (C), (AIG), Fannie Mae (FNM), and Freddie Mac (FRE). Cost cutting, not sales growth, has artificially boosted earnings above subterranean forecasts. Commodity prices have soared because of stockpiling and not consumption. Puzzled CEO’s of every stripe are seeing no recovery in their businesses whatsoever. But bears who have sold into the summer rally have gotten a severe spanking. We are left with momentum players and chartists to grind out ever diminishing returns. I have used the big up days to sell short dated out of the money calls in small size which, mercifully, expired worthless, sometimes just by pennies. That’s because I keep my favorite quote from John Maynard Keynes pasted to my monitor; “Markets can remain irrational longer than you can remain liquid.” Better to wait for a more convincing break on the charts before piling on those shorts again.

Where Are We in This Rally's Lifecycle?

fdfg. I have successfully avoided bears of a different sort this summer, those of the stock market kind (see my July 15 warning not to sell to soon by clicking here at www.madhedgefundtrader...). Never have I seen such a disconnect between the markets and the real economy. All of a sudden the world has gotten expensive. Stock prices have been levitated by vapor. The bulk of the trading volume is now accounted for by worthless zombie stocks like Citibank (C), (AIG), Fannie Mae (FNM), and Freddie Mac (FRE). Cost cutting, not sales growth, has artificially boosted earnings above subterranean forecasts. Commodity prices have soared because of stockpiling and not consumption. Puzzled CEO’s of every stripe are seeing no recovery in their businesses whatsoever. But bears who have sold into the summer rally have gotten a severe spanking. We are left with momentum players and chartists to grind out ever diminishing returns. I have used the big up days to sell short dated out of the money calls in small size which, mercifully, expired worthless, sometimes just by pennies. That’s because I keep my favorite quote from John Maynard Keynes pasted to my monitor; “Markets can remain irrational longer than you can remain liquid.” Better to wait for a more convincing break on the charts before piling on those shorts again.

Expecting a Sell-Off: 35 Ways to Protect for Less

aertt. Wow! One triple digit move down in the Dow, and all of a sudden, everyone is bearish. Once invisible falling home prices, soaring deficits, bogus corporate earnings, catatonic consumers, a crashing Shanghai market, and a suicidal Baltic Dry Shipping Index are now staring nervous stock owners in the face, eyeball to eyeball, and the picture is not pretty. Expect a run at Walmart on the Imodium and Kaopectate supplies. Even Robert Prector, of Elliot Wave fame, was on the tube proclaiming an end to a bear market rally. Did all the BSD bears just come back from family vacations to find the short selling opportunity of the year? Technical analysts think so.