Sunday Musings: Downgraded To “Mean”

Ulli Uncategorized Contact

Minyanville had a hilarious piece in Kevin Depew’s “Five Things You Need to Know.” This one was number five and it dealt with General Mills’ move back in June to raise the price of its cereal while decreasing the box size so that customers would hopefully be fooled by the cost increase.

Some applauded the move, upgrading the stock from “Earnest” to “Sneaky,” while other Wall Street analysts found the whole thing confusing.

Minyanville obtained a transcript from a portion of that previous analyst call (not to be taken too seriously):

Analyst: So let me see if I understand this. The price of your cereal is going up?

General Mills Spokesperson: That’s correct.

Analyst: But the price per box is actually going down?

General Mills Spokesperson: Correct.

Analyst: So then how is the price going up?

General Mills Spokesperson: Because we’re making the box smaller.

Analyst: Ok, but you just said the price of each box is going to be less.

General Mills Spokesperson: Yes, that’s true.

Analyst: So then you’re actually lowering prices.

General Mills Spokesperson: No, we’re raising prices.

Analyst: How?

General Mills Spokesperson: Look, you’re an analyst, you work with numbers.

Analyst: Right. Ok. I got it.

General Mills Spokesperson: Next question.

Analyst: Uh, actually, I don’t get it. How can you raise the price by lowering the price?

General Mills Spokesperson: Because we’re decreasing the size of the box.

Analyst: Ok, but you’re charging less for each box.

General Mills Spokesperson: Yes. Because we’re decreasing the size.

Analyst: Ah, I get it. So then the price is really the same, you’re just making the box smaller which makes the price look lower.

General Mills Spokesperson: No, no, no! Listen. We’re raising the price of our cereal.

Analyst: But –

General Mills Spokesperson: Shut up! Now listen, we’re raising the price of our cereal.

Analyst: (Silence).

General Mills Spokesperson: Say it.

Analyst: We’re raising the price of our cereal.

General Mills Spokesperson: Good. We’re raising the price of our cereal… while simultaneously making the box smaller. Go on, say it.

Analyst: While simultaneously making the box smaller…

General Mills Spokesperson: But… and this is the important part… but we’re raising the price more than we’re decreasing the size of the box… go on…

Analyst: But we’re raising the price more than we’re decreasing the size of the box.

General Mills Spokesperson: So…

Analyst: So…

General Mills Spokesperson: That…

Analyst: That…

General Mills Spokesperson: Come on…

Analyst: Come –

General Mills Spokesperson: No, I mean, come on and follow the thought. So that…

Analyst: Oh. So that…

General Mills Spokesperson: The…

Analyst: The… price is lower?

General Mills Spokesperson: No! So that the customer…

Analyst: So that the customer…

General Mills Spokesperson: Will.

Analyst: Will.

General Mills Spokesperson: Oh good Lord. So that the customer will think the price has gone down when it’s really gone up!

Analyst: Oh.

General Mills Spokesperson: See? Price increase. Smaller box. Larger price increase than smaller box.

Analyst: Right. I still don’t get it.

General Mills Spokesperson: You know what? Just forget it.

Analyst: I’m going to have to downgrade your stock, you know.

General Mills Spokesperson: Good. Good. You do that.

Analyst: I will.

General Mills Spokesperson: I don’t even want you to rate our stock positive.

Analyst: Good, because I won’t.

General Mills Spokesperson: It would be an insult to the company for you to rate it positive.

Analyst: I’m downgrading your stock to “Mean.”

New Mortgage Rules

Ulli Uncategorized Contact

With all of the hastily arranged government plans to resolve the credit crisis and/or solve the mortgage/housing debacle, there were bound to be some solutions offered that makes you wonder how somebody could actually have the guts to put some of the proposals in writing.

I was reminded of that when I read the story “Fed proposes mortgage rules to protect borrowers.” If this matter wouldn’t be so serious, it would qualify as the joke of the week. Here are some snippets from the article:

Lenders will have to confirm that a borrower can afford a mortgage before making a loan under protections proposed by the Federal Reserve on Tuesday, following defaults and losses on U.S. subprime mortgages this year.

The proposals are intended to replace loose lending standards that have put many Americans at risk of losing their homes because they took out mortgages they could not afford and may not have fully understood.

The proposed regulations would require that lenders confirm a borrower can afford a home loan by verifying his income and assets with tax records, payroll receipts, and other documentation.

The new rules are aimed at ending the recent practice of so-called “stated income” loans in which borrowers state their income without any evidence.

Wow, these are truly far reaching new ideas. How dare they? I will actually need to verify my income and thereby demonstrate that I can afford the mortgage? It’s just not fair. Isn’t that what they did in the last century? I thought we made some progress here by simply being able to write down our income and get a loan with no questions asked. What’s the world coming to?

OK, so just in case I mess up, here’s something that should help:

The new rules will not assist today’s struggling homeowners but would give consumers the right to sue mortgage lenders who act unfairly and deceptively in preparing loans in future.

Ah, that sounds good and makes me feel better! I am sure that I can find something that is not right with my new loan, just in case I fall on hard times and can’t make the payments again; I then simply sue the bastards. I love it when the government comes up with unique ideas, don’t you?

No Load Fund/ETF Tracker updated through 12/20/2007

Ulli Uncategorized Contact

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Today’s rebound rally pulled the major indexes out of the doldrums and into positive territory for the week.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has moved to +4.81% above its long-term trend line (red) as the chart below shows:



The international index dropped to -1.82% below its own trend line, keeping us in a sell mode for that arena.

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Subprime Municipal Bond Fallout

Ulli Uncategorized Contact

The Subprime/credit crisis of 2007 was bound to move into unexpected areas as well. MarketWatch’s feature “Moody’s warning ripples through municipal bond market” describes the unprecedented effect on the muni bond market.

Moody’s put the triple-A ratings of Financial Guarantee Insurance Company (FGIC) and XL Capital Assurance on review for a possible downgrade after re-evaluating the companies’ exposure to potential Subprime mortgage losses.

The story goes on to say:

“By issuing warnings on FGIC and XL Capital Assurance, the agency is also putting more than 90,000 securities that the companies had guaranteed on review for a possible downgrade, according to global fixed-income analysts at UBS.

The majority of those securities — 89,709 — are in the public finance sector, the analysts said, noting that this was “unprecedented” in the municipal bond market.

Bond insurers agree to pay principal and interest when due in a timely manner in the event of a default. It’s a $2.3 trillion business that offers a credit-rating boost to municipalities and other issuers that don’t have triple-A ratings.

But if a bond insurer loses its triple-A rating, the securities it has guaranteed also lose their top rating.

“I can’t think of a credit watch action in my 32 years in the muni bond market that had that many securities involved,” Richard Larkin, a municipal bond expert at JB Hanauer & Co., said in an interview on Monday.”

Why should you care? If you hold any municipal bonds, the rating, and therefore its value, could be adversely affected. Read the above bold part again!

I have used municipal funds over the years for my own account and that of clients to generate tax-free income. When the Subprime news first made headlines during this past summer, we started selling off most holdings since many funds slipped off their highs considerably. At this time, we are only holding a few funds, which I will liquidate on a need-to basis.

Let me go on record by saying that at this point I no longer can recommend new investments in muni bonds. While I may change my view in the future, right now I want to stay aside and watch how this debacle plays out—and I prefer doing that without real money on the line.

More Subprime Slime

Ulli Uncategorized Contact

Reader Nitin submitted another worthwhile article which was written by NYT columnist Paul Krugman a few days ago titled “After the Money’s Gone.” It’s a refreshing and very realistic view of the circumstances surrounding the latest Fed efforts to clean up the Subprime slime. Here’s what he said:

On Wednesday, the Federal Reserve announced plans to lend $40 billion to banks. By my count, it’s the fourth high-profile attempt to rescue the financial system since things started falling apart about five months ago. Maybe this one will do the trick, but I wouldn’t count on it.

In past financial crises — the stock market crash of 1987, the aftermath of Russia’s default in 1998 — the Fed has been able to wave its magic wand and make market turmoil disappear. But this time the magic isn’t working.

Why not? Because the problem with the markets isn’t just a lack of liquidity — there’s also a fundamental problem of solvency. Let me explain the difference with a hypothetical example.

Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.

Even if the rumor is false, it can break the bank. If everyone, believing that the bank is about to go bust, demands their money out at the same time, the bank would have to raise cash by selling off assets at fire-sale prices — and it may indeed go bust even though it didn’t really make that bum loan.

And because loss of confidence can be a self-fulfilling prophecy, even depositors who don’t believe the rumor would join in the bank run, trying to get their money out while they can.

But the Fed can come to the rescue. If the rumor is false, the bank has enough assets to cover its debts; all it lacks is liquidity — the ability to raise cash on short notice. And the Fed can solve that problem by giving the bank a temporary loan, tiding it over until things calm down.

Matters are very different, however, if the rumor is true: the bank really did make a big bad loan. Then the problem isn’t how to restore confidence; it’s how to deal with the fact that the bank is really, truly insolvent, that is, busted.

My story about a basically sound bank beset by a crisis of confidence, which can be rescued with a temporary loan from the Fed, is more or less what happened to the financial system as a whole in 1998. Russia’s default led to the collapse of the giant hedge fund Long Term Capital Management, and for a few weeks there was panic in the markets.

But when all was said and done, not that much money had been lost; a temporary expansion of credit by the Fed gave everyone time to regain their nerve, and the crisis soon passed.

In August, the Fed tried again to do what it did in 1998, and at first it seemed to work. But then the crisis of confidence came back, worse than ever. And the reason is that this time the financial system — both banks and, probably even more important, nonbank financial institutions — made a lot of loans that are likely to go very, very bad.

It’s easy to get lost in the details of subprime mortgages, resets, collateralized debt obligations, and so on. But there are two important facts that may give you a sense of just how big the problem is.

First, we had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.

Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.

As home prices come back down to earth, many of these borrowers will find themselves with negative equity — owing more than their houses are worth. Negative equity, in turn, often leads to foreclosures and big losses for lenders.

And the numbers are huge. The financial blog Calculated Risk, using data from First American CoreLogic, estimates that if home prices fall 20 percent there will be 13.7 million homeowners with negative equity. If prices fall 30 percent, that number would rise to more than 20 million.

That translates into a lot of losses, and explains why liquidity has dried up. What’s going on in the markets isn’t an irrational panic. It’s a wholly rational panic, because there’s a lot of bad debt out there, and you don’t know how much of that bad debt is held by the guy who wants to borrow your money.

How will it all end? Markets won’t start functioning normally until investors are reasonably sure that they know where the bodies — I mean, the bad debts — are buried. And that probably won’t happen until house prices have finished falling and financial institutions have come clean about all their losses. All of this will probably take years.

Meanwhile, anyone who expects the Fed or anyone else to come up with a plan that makes this financial crisis just go away will be sorely disappointed.

This has been my point all along. The lack of transparency of who holds what type of (bad or very bad) debt has lead to a tremendous distrust in the worldwide financial community. Until all of the facts are in the open, the lack of trust is bound to continue and calmness can’t be restored.

Moving Closer To A Domestic Sell

Ulli Uncategorized Contact

With the Dow now having lost some 560 points over the past five trading sessions, concern about a slowing economy is catching up with the markets. I have touched on the apparent “disconnect” from a rallying market to the ever worsening Subprime/crisis before, just maybe some reality has finally sunk in.

While the “R” word (as in Recession) has now made it to front page news, at least a short-term trend reversal can be seen on our charts representing the domestic and international Trend Tracking Indexes (TTIs). We continue to be in a Sell mode for broadly diversified international equity funds/ETFs (since 11/13/07). As of yesterday, that indicator has dropped below its long term trend line by -3.60%.

Weakness has also spread to the domestic TTI, which still remains above its long-term trend line by +3.12%. Technically, this still constitutes a “buy” mode; however, I will not add any holdings at this time due to the possibility of more downside activity and the subsequent potential move into bear market territory. I suggest you do the same.

The markets continue to display great uncertainly and it pays to be conservative and only hold those funds/ETFs, which have not violated their sell stop trigger points. With a little more slippage to the downside, we could find ourselves in a 100% cash position very soon.