RiskTrade

Avoid Banks' Common Shares; Opt for Preferreds, Minibonds

Pointless Article. Buying pref rather then common makes little sense. Buying pref only caps your upside while really exposing you to the same risk as common. In a default pref holders and common holders both get nothing. Whats worse is that bank pref suffers from the risk of forced conversion to common. Further pref usually involves liquidity risk relative to the common. Also from a relative value perpsective it makes more sense to buy the sub debt rather then the pref.

Thoughts on the Worthless Equity Value of Some Banks

As I understand it your view is that the currently depressed bank sub-debt prices imply that sub debt holders are likely to suffer either coupon deferral/ or out right capital loss and therefore anything in the banks capital structure below sub debt gets wiped out. I agree this is very possible but it is based on one critical premise -i.e. that current prices of sub debt are correct. Clearly, no one knows if the current prices are correct and so what if sub-debt prices have fallen too far and and are actually cheap ? Would that not imply a better survival probabilies for the equities ?. Point is trying to extract long term equity survival probability from sub debt market prices is pointless.

TIP ETF: A High Dividend Stock and Inflation Hedge?

JAH,
As you say TIPS have an inflation factor determined by the MoM CPI figure. This factor is used to adjust the principal upward upon which the stated coupon is calculated thereby leading to coupon income that is indexed to inflation. Hence TIPS keep their value when inflation occurs as the numerator (i.e the indexed coupon cash flows) increases when inflation occurs. However that is only the numerator element of a TIP. The denominator is the interest rate at which you discount cash flows (i.e the respective nominal treasury rate) Hence as the central bank increases interest rates in order to reduce inflation the PV of each coupon payment and the final payment at maturity decreases. This is basically encaspulated in the TIPS interest rate duration. Hence when interest rates rise TIPS will decline in value if the effect of the indexed coupon does not offset the increase in the nominal rate. As TIPS have positive duration both in response to a parrallel shift in real yields and nominal yields they will decline in price if interest rates increase significantly.





On Jan 28 05:36 PM jhowle wrote:

> puttster: It could be a good reason, the logic is that if interest
> rates are up it is because of a rise in inflation. The 2 do not necassarily
> move in tandem. When you buy a TIP bond you are simply locking in
> a 'real rate of return' over and above an expected positive inflation
> rate. If inflation goes negative you can earn no interest but the
> Treasury will pay you back par value. Be warned that the older TIPs
> bonds have accrued inflation factors and that value can go down.
> Be careful out there.
>
> JAH

TIPS: The Swiss Army Knife of the Bond Market

I bought TIPS in October as breakevens were negative at the time but recently sold my position. If you start by taking the view that the market is rationale and collectively the market is smarter then individuals then it would stand to reason that at any point in time the market is fairly priced. By this I don't mean that you can't take a view that will make money as variables change but only that at any point in time the market accurately reflects all publicly available information (i.e. markets are efficient).

If you agree with this, then the question is not whether or not inflation is underpriced but rather why does the market reflect this level of inflation expectations ?. As you point out the reason is deflation expectations. The market is now coming to grips with the fact that deflation is likely over the forseeable future. What we know today is the MoM deflation numbers are likely to be negative and therefore the income I recieve from purchasing a TIP is likely to decline in the forseeable future. The author claims that one should invest in TIPS as 10 year breakevens are historically low. This is true but it doesn't mean that the markets estimate is wrong. It is very possible to have inflation average 1.25% over 10 years if you have a period of sustained deflation in the initial years. A sustained period of deflation is likely as people lose their jobs and ability to purchase goods and services.

The Federal reserve has cut interest rates to historic lows to get the economy moving again. When the economy moves again the Fed will raise rates quickly to stem inflationary pressures. Hence as a TIPS holder you are betting that a) The markets estimate of inflation is wrong and b) risking lower coupon income should deflation occur c.) betting the fed won't be able to curtail inflation risk in the future by raising rates quickly enough d) taking interest rates risk (duration risk) as rates will need to rise in the future and e.) uncertainty about when inflation will finally occur ( if you have to wait 5 years then isn't TIPS as an asset class as attractive as any other asset class).

Given, all the risks involved - may be thisn't the slamdunk investment that everyone thinks it is?

Government Risk Rises: Credit Markets Face Structural Collapse

The reason some traders have bought protection on the US Sovereign is not because they expect the US to default but because they think things could get worse and spreads will widen thereby allowing them to close their position at wider spread levels. If the U.S were to run in to trouble with its budget deficit we would more likely see a downgrade rather then an outright default/ or debt restructure. Downgrades are not credit events and so the CDS is unlikely to be triggered.
Honestly, if the US were to default the rest of the world would be in far more problems as they are dependent upon u.s consumers, and investors.

Yields on treasuries will no doubt rise, and the u.s dollar will at some point fall, and markets will take a while to recover but we are not in danger of a systemic collapse.

Thoughts on Mohamed El-Erian's 'When Markets Collide'

Nothing new here. Also El - Elrian has it wrong. In today's world the U.S is the new emerging market. U.S investors today face a risk profile that would suggest higher then average risks and hence potentially higher then average expected returns. So if El- Elrian really believes that emerging markets are the place to invest - then I wonder how soon it will be before he starts loading up on U.S stocks ?

Libbey Inc.: The Glass is Half Full

First let me say I have not actively followed this stock but from what I can see the downside to owning this stock is far more then the upside on a 6 month view.

Firstly, this company is highly leveraged, and has no hope of refinancing it's debt at a cheaper rate. If AIG still A rated raised additional sr debt at 8.25% then do you really think this company will be able to raise debt cheaply?

Secondly, As the author mentions, this company primarily makes its money in the US restaurant market. I think we can all safely say a recession is looming and casual dining is going to be the first victim of the recession. This has already started happening - e.g. Darden's recent profit warning.

Further, the company recently guided revenue's towards the lower end of the range previously indicated suggesting softening demand.

Seems to me that you have a vicious combination of softening sales, rising costs, and high debt costs which will undoubtedly result in declining and negative EPS.

Which Banks Will Survive?

This article omits most of the facts - AIG sold its 10 year deal on the basis of reverse inquiry i.e. investors asked for the issuance. The reason they asked for the deal is because AIG spread is indicative of a single B rated bond. AIG debt is great value for 4 simple reasons:
1. You are buying a AA rated credit at mid B levels.
2. AIG's business model is not at risk.
3. Leadership and operating performance have been weak but both are being addressed via new leadership and attempts at cleaning up the balance sheet.
4. Eventually, CDO's and other structured instruments will find a floor and a bounce will occur. I don't know when that will happen. I do however know that once a floor is found you will see that previous write downs were too conservative and hence AIG and others will actually record a mark to market gain on some of these assets.

Implications of the Slowing Global Economy

I agree with some of your analysis - particularly the points about an impending global recession, the declining threat of inflation and the possibility of deflation. I think the dollar rally is occurring largely because, despite its obvious short comings, the dollar is still seen as the true risk free currency. However, unlike you I don't believe that corporate bond yields and preferred yields will sky rocket. In the past few days both Citigroup & AIG have issued debt based on reverse inquiry. By this I mean investors sought an issuance of debt as opposed to the company. Infact JPM priced its perps a full 25 bps less then the indicative coupon. This tells you there is strong pent up demand for high yielding good quality paper. When you give this some thought it makes perfect sense - Given interest rates are low, and inflation expectations are also low, the most natural strategy is to buy longer term high yielding paper of high quality issuers and earn the interest differential carry. This is what is happening now, and as this begins to increase yields on preferreds and corporates will actually come down significantly. Think about it and consider how much money is out of the market right now and how attractive corporate
and preferred yields look.

Annaly Capital Management: Epitome of Low Risk, High Reward

The analysis misses the fundamental risk in the investment - NLY does exactly what a bank does it borrows short and lends long using leverage to magnify it's returns. This is a great strategy when markets are not volatile - however when markets are volatile, as they are now and treasury vs agency spread widens then the value of NLY's agency bonds gets marked down. When the assets are marked down NLY can no longer has the asset base to support the leverage it is using and thus has to sell assets at a loss to reduce its leverage levels. The arguement you make is that basically agency spreads will revert to the mean and that NLY will benefit from the mean reversion when it happens. This may be true but betting on mean reversion is very risky as there is not guarantee it will happen and even if it does you don't know when. LTCM and many others have gone bankrupt playing this same game. Make sure you understand the risk before you jump headlong intot his investment.