Big Four To Audit Spain's Banks

[ubuy2wron]

Sanjeev,

 

You must admit that you are a phenomenal market timer. Last year at the bottom and now this year at the top you have made some phenomenal calls. Wouldn't you agree though that the articles you post on here in support of your current market view are more or less coincidental with the current market movements and that the market is going to do what it wants regardless of the particular negatives or positives you highlight? For example, the weekly posts last year highlighting continuing strength in carload strength was how you defended your bullish US economy thesis, which to the average poster would seem to be the reason for market strength since last October, when in reality it was merely coincidental with the market moving up in order to clear the excessive negative sentiment built up last September. And likewise, you have discontinued posting the continued strength in carloads and instead switched to posting about the problems in Spain in order to support your view that we are going to run into a period of higher volatility - again, what I think we can consider coincidental to the market moving lower in order to clear out the excessive optimism built up since October.

 

All that to say - why are Spain's excessive asking assets relative to GDP and its lack of ability to deal with the crisis any different than last year or the year before? Couldn't you make the argument that Europe is more capable of dealing with the crisis this time around given they have proven they are willing to print (i.e. The LTRO program) and are now widely discussing Eurobonds, deposit insurance and an ECB-financed ESM recap facility despite what is just absurdly ridiculous posturing by Merkel who has practically zero say in the matter whatsoever (again proven by her willingness to look past the LTRO program) with Germany only having what two votes on the ECB?

 

Perhaps we continue to free fall from here, but there seems to be a very healthy amount of fear building up to allow for a reversal upon some data point the market deems sufficient to justify a turnaround....feels pretty good though having individual securities going down literally multiples of the market. Just goes to show the importance of holding cash for these types of opportunities - congrats on the phenomenal call....

 

With great respect, Calls are only as good as the returns they produce. We were down 9% last year net of fees, up nearly 40% as of March 2012 and now "only" up 5% as of Friday. Sanjeev would you care to share your returns for the same  periods (Dec 31 2011, March 31 2012, and Friday May 31)

I could not find the series of posts which appeared earlier in the year where some were bragging about their returns, I used that as a signal to start raising cash now sitting around 40%. I suspect that around the time of the Grrek elections we may see something more positive emerge with mkt trends. I suspect a Greek Euro exit maybe Europes Bear Stearns moment and a larger countries exit would be their Lehman moment. The record low 10 years yields on treasuries and Bunds indicate to me that the deflation trade is pretty crowded at the moment. I personaly have found it a difficult mkt, I am a few percentage points away from new high water marks but have been relagated to being happy with single digit returns for the last 5 years because I am unwilling to go all in when stuff looks cheap. I have never been willing to take my cash below 20%.

[SharperDingaan]

Had the post Lehman outcome been as widely known before it actually happened, do you not think the market would have been far lower heading into that fateful weekend?

 

Most would have refused to take the paper losses, or front the cost of the hedges, for fear of appearing 'weak' or 'unamerican'. The market would have been lower - but not low enough; as few would believe that it might ever actually be allowed to happen.

 

The 'old' name for "Redemption Fund" is "Reparation Fund". Reparations are payments intended to cover damage or injury during a war. Generally, the term war reparations refers to money or goods changing hands, rather than such property transfers as the annexation of land. http://en.wikipedia.org/wiki/War_reparations

 

 

 

 

 

[bmichaud]

Had the post Lehman outcome been as widely known before it actually happened, do you not think the market would have been far lower heading into that fateful weekend?

 

Most would have refused to take the paper losses, or front the cost of the hedges, for fear of appearing 'weak' or 'unamerican'. The market would have been lower - but not low enough; as few would believe that it might ever actually be allowed to happen.

 

When would investors have refused to take paper losses? If they had known the consequences of letting Lehman fail?

 

I think it is safe to say "Lehman 2.0 not being allowed to happen" is currently priced into markets, as most believe governments will act. BUT, there is a much higher probability of it taking place priced into stocks, as evidenced by the market currently selling for 18.4 times median 10y Schiller earnings versus nearly 24 times right before Lehman, since the dreadful outcome of a Lehman scenario is very much on everyone's mind.

 

I don't understand the redemption fund thing....are you saying the redemption fund currently being discussed won't be implemented until after a market catastrophe?

 

 

[ERICOPOLY]

Aside from the plummeting real estate that had lots of room left to fall, you had:

 

Bear Stears

Countrywide

IndyMac

Wamu

Wachovia

Merrill

AIG

Lehman

GM

Fannie

Freddie

Citigroup

and on

and on

and on

 

You had real estate prices falling off the cliff and everybody losing their jobs en masse. 

 

Then you had short selling bans.  TARP.  Money market funds breaking the buck.

 

There is nothing that I see in this Europe quagmire that is uniquely terrifying for America this time around.  We don't export much to them as a % of GDP.  Yes, it will not be a positive for America, but grounds to completely freak out????

 

And what do you mean that equity prices haven't reacted yet?  WFC trades at the same price today as what it did at the end of 2008.  There never was a recovery!

 

There once was a time (not too long ago) when "rising recession risks" didn't mean the large banks should trade at 5x-7x multiples at a time when they are well capitalized -- in fact the best ever.

[Packer16]

I also agree that possibility of a decline is also priced into the prices of some stocks.  How else could there be some many stocks for less than 5x FCF and for banks selling at good sized discounts to book?  For these to be fairly valued their earnings are going to have to decline by 2/3rds or book value decline by 50 to 60%? I could be wrong but I don't think that is in the cards given the already negative sentiment for stocks.

 

Packer

[Parsad]

Aside from the plummeting real estate that had lots of room left to fall, you had:

 

Bear Stears

Countrywide

IndyMac

Wamu

Wachovia

Merrill

AIG

Lehman

GM

Fannie

Freddie

Citigroup

and on

and on

and on

 

You had real estate prices falling off the cliff and everybody losing their jobs en masse. 

 

Then you had short selling bans.  TARP.  Money market funds breaking the buck.

 

There is nothing that I see in this Europe quagmire that is uniquely terrifying for America this time around.  We don't export much to them as a % of GDP.  Yes, it will not be a positive for America, but grounds to completely freak out????

 

And what do you mean that equity prices haven't reacted yet?  WFC trades at the same price today as what it did at the end of 2008.  There never was a recovery!

 

There once was a time (not too long ago) when "rising recession risks" didn't mean the large banks should trade at 5x-7x multiples at a time when they are well capitalized -- in fact the best ever.

 

Completely agree with you Eric!  For the record, I've never said this was a repeat of 2008, but a mini-version of it and on distant shores.  I'm completely long on the United States and we haven't sold a single warrant or share in the two banks we've owned...WFC and BAC.  We've added two other positions this week that we did not own before. 

 

We raised more cash because of two things...money came in and we thought things were deteriorating faster in Europe (in particular Spain) than we had thought.  We just did the prudent thing and kept more cash because we felt there would be more volatility for us to take advantage of.  The investments we owned where the risk premium was adequate or they would grow further in uncertain circumstances when their peers could not, we continued to own and had no plans on selling regardless of what happens in Europe.  Cheers!

[ERICOPOLY]

This is how I would treat some of the posters bordering on hysterical:

 

 

Just kidding.  Everyone has a right to their opinion.

 

And for those who as despairing over not having sold -- and are now feeling the tight collar:

 

 

[Rabbitisrich]

I could not find the series of posts which appeared earlier in the year where some were bragging about their returns, I used that as a signal to start raising cash now sitting around 40%. I suspect that around the time of the Grrek elections we may see something more positive emerge with mkt trends. I suspect a Greek Euro exit maybe Europes Bear Stearns moment and a larger countries exit would be their Lehman moment. The record low 10 years yields on treasuries and Bunds indicate to me that the deflation trade is pretty crowded at the moment. I personaly have found it a difficult mkt, I am a few percentage points away from new high water marks but have been relagated to being happy with single digit returns for the last 5 years because I am unwilling to go all in when stuff looks cheap. I have never been willing to take my cash below 20%.

 

There was a March thread about YTD results that was a definite warning sign. When the Corner of Berkshire and Hathaway starts reporting YTD results in March...

 

 

[ERICOPOLY]

I'm still up 40% YTD.  There, I jinxed it and you can take that as a sign to sell everything tomorrow.

[Rabbitisrich]

I'm still up 40% YTD.  There, I jinxed it and you can take that as a sign to sell everything tomorrow.

 

The problem with the March YTD thread was less about luck, and more about the use of short-term market results to validate business theses. It's an easy habit to form, and fairly dangerous.

[Valuebo]

Thank you for the reminder Rabbitisrich. We should all have a longer time horizon and view our results in terms of years and decades, not months and quarters. We have to be patient on different levels. In the last few months I have learned that I have a long way to go, too ambitious!  :-X

[SharperDingaan]

The Eurozone & the US are not islands. US sub-prime brought down the Eurozone, & that distress is washing across the US.

 

Lehman-2 is a guess. Nobody knows what the mechanics might be, if, when, why, or how deep the fallout may go. You take your best guess on probability, & loss magnitude, & ensure you have the capital to cover it; hedge, sell down, new cash - your choice. You survive.

 

Lehman was also a black swan, and results were worsened because nobody had experience in anything remotely like it. We have no idea what would happen in today’s markets if multiple sovereigns were to hit the debt wall in short order.

 

We live in an imperfect world. We know downside risk is consistently underestimated, & there is resistance to holding capital against remote 'tail' events. If you're right you get a bigger return (& bonus), if you're wrong you blow up.

 

bmichaud. The last article referred to the idea of issuing jointly guaranteed long-term 'redemption' bonds, following a redraft & tightening of fiscal responsibilities within the Eurozone.

 

In the old days when you went to war & lost - you paid the winner war reparations to compensate them for the cost of going to war with you. To get the money you had to build new plant, borrow from the winners, & give sweetheart industrial deals, on extortionate terms. Put bluntly, you issued long term, high coupon, participating bonds - & had minimal say in the terms. The new name for these would appear to be 'Redemption' bond.

 

Of course it doesn’t mean that the defeated issuer will actually repay. Lenin didn’t repay Czarist debt, & Hitler didn’t repay WW1 debt. A ‘Redemption’ junk bond doesn’t sell  ;)

 

[ERICOPOLY]

The Eurozone & the US are not islands. US sub-prime brought down the Eurozone, & that distress is washing across the US.

 

So is this your position:

 

The US banks today are loaded up with European risk the same way that European banks were loaded up with US subprime?

[ERICOPOLY]

I'm also considering that:

 

Europe depends on the US more than vice versa.  For example, US purchases about 8.8% of Germany's exports, but Germany purchases about 4.1% of US exports. 

 

Exports are more than 40% of Germany's GDP whereas they're only 13% or so of US GDP.

 

So no, I don't think looking at how US subprime spilled over to Europe is a terrific analogy.

 

The US GDP falling off a cliff in 2008 and 2009 was much more painful to them.

 

[Parsad]

I'm also considering that:

 

Europe depends on the US more than vice versa.  For example, US purchases about 8.8% of Germany's exports, but Germany purchases about 4.1% of US exports. 

 

Exports are more than 40% of Germany's GDP whereas they're only 13% or so of US GDP.

 

So no, I don't think looking at how US subprime spilled over to Europe is a terrific analogy.

 

The US GDP falling off a cliff in 2008 and 2009 was much more painful to them.

 

Yes, that would be correct.  Also remember, that part of any European tides washing ashore in the U.S., will be offset by lower commodity prices and a stronger U.S. dollar to purchase European exports.  I think longer term, Europe's woes may actually benefit the U.S., but in the short-term the headwinds will make the recovery a little more difficult. 

 

The U.S. is not Europe in 2008/2009...that may actually be China who were loading up on European debt because they were concerned about the U.S...how ironic!  Cheers! 

[txitxo]

  My bet is that the US and UK markets will have negative returns during next year. There is still too much optimism.

 

  I am also betting that the eurozone markets will produce good returns, not only the eurocore, but specially Greece, Spain and Portugal. As Templeton said, one should buy at the point of maximum pessimism. And we are pretty close to that point. If things get sorted out in Europe, it will necessarily involve lots of money printing by the ECB, something positive for stocks. If, on the other hand, the euro breaks up, and you can't take your cash out of your country, which is the only safe thing to buy? Stocks. Look at Argentina in the 90's or to the Weimar republic. Gold can get confiscated, cash evaporates, bonds default. Only people owning stocks kept their wealth long term. So nobody knows when the bottom will be (probably a few days after a country leaves the euro zone, or the day before the ECB switches on the printer), but that bottom has to be close, the markets are ridiculously cheap. Buttonwood's column explains it very well : http://www.economist.com/node/21556299.

 

About my returns, I am down by 7.9% since January 2nd 2011. Not stellar compared with other people here. But not too bad taking into account that I've been almost 100% invested in European stocks (French and German), and the Eurostoxx50 is down by 27.15% since that date. 

[bmichaud]

The Eurozone & the US are not islands. US sub-prime brought down the Eurozone, & that distress is washing across the US.

 

Lehman-2 is a guess. Nobody knows what the mechanics might be, if, when, why, or how deep the fallout may go. You take your best guess on probability, & loss magnitude, & ensure you have the capital to cover it; hedge, sell down, new cash - your choice. You survive.

 

Lehman was also a black swan, and results were worsened because nobody had experience in anything remotely like it. We have no idea what would happen in today’s markets if multiple sovereigns were to hit the debt wall in short order.

 

We live in an imperfect world. We know downside risk is consistently underestimated, & there is resistance to holding capital against remote 'tail' events. If you're right you get a bigger return (& bonus), if you're wrong you blow up.

 

bmichaud. The last article referred to the idea of issuing jointly guaranteed long-term 'redemption' bonds, following a redraft & tightening of fiscal responsibilities within the Eurozone.

 

In the old days when you went to war & lost - you paid the winner war reparations to compensate them for the cost of going to war with you. To get the money you had to build new plant, borrow from the winners, & give sweetheart industrial deals, on extortionate terms. Put bluntly, you issued long term, high coupon, participating bonds - & had minimal say in the terms. The new name for these would appear to be 'Redemption' bond.

 

Of course it doesn’t mean that the defeated issuer will actually repay. Lenin didn’t repay Czarist debt, & Hitler didn’t repay WW1 debt. A ‘Redemption’ junk bond doesn’t sell  ;)

 

Please explain how redemption/euro bonds would be junk....here is Kiron Sarkar's description (http://www.ritholtz.com/blog/2012/05/euro-zone-continues-down-the-plug-hole/):

 

The UK’s Daily Telegraph reports on a proposed German scheme known as the “European Redemption Pact”. The plan drafted by the German Council of Economic Experts was dismissed by Mrs Merkel in November last year. However, with the opposition SPD supporting the idea and the Greens pledging to vote against the fiscal compact in the German upper house the Bundesrat (and bear in mind that the CDU fared badly in regional elections), it looks as if Mrs Merkel may have to change her mind. The plan would ensure that 60% of EZ Sovereign debt would remain Sovereign. However, amounts above 60% would be transferred gradually into a redemption fund, which would be able to issue joint bonds ie Euro Bonds. The redemption fund would retire the debt over 20 years, financed by a kind of “Solidarity Surcharge”. Countries would have to pledge their gold and forex reserves to the Redemption Fund as collateral. The Redemption Fund gets around German Constitutional Court issues. The scheme would reduce interest rates for the periphery, in particular, though they would still have to stick to austerity measures. However, rates would rise for the core countries, compensated by prospective future higher growth.

 

 

Any jointly-guaranteed bond out of the Eurozone would be pretty high quality IMHO, would it not? As a whole, is the EZ not potentially in better shape than the US? Fiscal unity and Eurobonds with an ECB functioning how the Fed does here would create a rock-solid "United States of Europe". Yes, yes when you add in banking sector debt the situation becomes more precarious, but there is no possible earthly reason why those who lent all those liabilities to the EZ banking sector cannot take a loss and/or turn their liabilities into equity. Then just use the ECB to backstop deposits.

 

 

Anyway - please explain how they are junk. I'm not being difficult, I'm just struggling to follow. Your posts, while extremely insightful, take quite a bit of work to understand....

[vinod1]

I'm also considering that:

 

Europe depends on the US more than vice versa.  For example, US purchases about 8.8% of Germany's exports, but Germany purchases about 4.1% of US exports. 

 

Exports are more than 40% of Germany's GDP whereas they're only 13% or so of US GDP.

 

So no, I don't think looking at how US subprime spilled over to Europe is a terrific analogy.

 

The US GDP falling off a cliff in 2008 and 2009 was much more painful to them.

 

I would think a dis-orderly breakup of Eurozone would reduce GDP of Europe as a whole by anything from 5%-20%. I see several transmission mechanisms

 

1. Direct export of goods to Europe would be severely impacted for American companies with european exposure.

 

2. European operations of American companies would likewise be severely impacted reducing their subsidiary profits which would trigger some job losses in US as companies try to stabilize profits.

 

3. A break up of the most viable alternative to USD would cause Dollar to appreciate probably quite significantly as the obvious safe haven further reducing US exports and US company profits.

 

4. Large US banks with CDS, Swaps and Futures exposure would have quite a mess on their hands. Trade finance would freeze up. This in turn would impact emerging markets in which European banks are big players. US insurance companies with european bonds, etc in their investment portfolios would be severely stressed as well. Main point here being there are too many unknown unknowns and too many ways in which this could impact banking and availability of credit.

 

All in all, I do not think a Euro break up would only have a temporary effect on Asset values. This is something that would fundamentally alter the earnings power of many of the large US companies.

 

I have significant investments in equities but the above is why I am not all in even though I know many companies are at very attractive valuations.

 

Vinod

[vinod1]

 

If the above sounds like a very confusing train of thought, thats because it is. On one hand I still believe this secular bear comes to an end somewhere below 800 on the SPX, but then on the other hand how can I pass up such undervalued securities that will most likely do extremely well over the next three to five years regardless of the market? Then on the third hand, why on earth if the general market falls to below 800 would BAC NOT get hammered even from here?

 

Welcome to my mind!

 

Vinod

[yitech]

Europe mulls major step towards "fiscal union"

 

http://www.reuters.com/article/2012/06/03/us-eurozone-union-idUSBRE85207J20120603?feedType=RSS&feedName=businessNews&utm_source=dlvr.it&utm_medium=twitter&dlvrit=56943

[Viking]

Interesting thread. At the end of the day I think we are all trying to find an approach to investing that fits with our emotional makeup and understanding of the markets. To be a 'value investor' does this mean one must buy and hold for ever and usually be 100% invested? Of course not. We all can be value investors and at the same time do very different things. We are all very different animals with different backgounds, different objectives and different risk tollerances. We also will have very different measures of value. The key is finding a strategy that delivers acceptable returns and lets you sleep at night.

 

Personally, I like to hold high cash balances and sit in the weeds and wait for market dislocations like we are seeing right now. Kroger (KR) is an interesting case study and representative of much that has been happening to stocks the past decade. Kroger's business is stronger today than perhaps at any time in their history. And the stock is trading today where it was trading in 1998 (14 years ago). Earnings are muchg higher. The market PE has been contracting. Are we done? No idea. Buy and hold has been a very difficult strategy since the 2000 market top (I am talking in aggregate). Everyone has been given many opportunities to buy low and sell high and this will continue. Buy and hold (long term) will again be a great money-making strategy in the future; just not sure when.

[bmichaud]

 

If the above sounds like a very confusing train of thought, thats because it is. On one hand I still believe this secular bear comes to an end somewhere below 800 on the SPX, but then on the other hand how can I pass up such undervalued securities that will most likely do extremely well over the next three to five years regardless of the market? Then on the third hand, why on earth if the general market falls to below 800 would BAC NOT get hammered even from here?

 

Welcome to my mind!

 

Vinod

 

 

Vinod - this quote by F. Scott Fitzgerald comes to mind:

 

“The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function.”

[SharperDingaan]

“However, amounts above 60% would be transferred gradually into a redemption fund”. Put another way:  All EZ sovereign debt (including Germany) gets a 40% haircut, & you get a zero-coupon long term CDO backed by grossly inflated assets.

 

All CDO’s are constructed from low grade debt, salted with some kind of favorable covenant, & resold at a higher price. In this case – default debt, backed by central bank gold & forex reserves, & a ‘Solidarity Surcharge’. On origination, the reserves are pledged into the thing at historic highs, & the quality of the remaining debt improves because its debt coverage rises (higher prices).

 

But ….

 

The gold & forex reserves already back ALL EZ sovereign debt. Re-assigning it to the CDO tower, removed the liquid collateral from the remaining debt; & turned it into debentures backed with nothing more than a ‘promise to repay’.  Except that every financial hiccup following origination now goes directly against that ‘promise to repay’ – effectively making it ‘never’.

 

The gold & forex wasn’t sold into the market – because it could not be. So how exactly do you exchange this paper for say 10 tons worth of the pledged gold & forex collateral? & how do you ensure that the collective EZ sovereigns will actually give it to you? The fact is that you cannot – it is just another collective sovereign ‘promise to pay’.

 

Central banks hold gold & forex reserves for diversification &  ‘emergency’. So when they are pledging those reserves, en-masse, it must be some monumental emergency;  yet supposedly the central bank  ‘promise to repay’ did not get any riskier ? Debt prices should go down, & aggressively – once it is realized.

 

Where is the collateral margin maintenance, & what does it get paid in? If the collateral goes from 1600/oz to 400/oz is the difference paid in fiat toilet paper - or more gold & forex?  Odds are it will be toilet paper.

 

The reserves are pledged, not sold; if the collateral goes to 2000/oz, the central banks pocket the gain. Now if I was a central banker why would I NOT print Euros to inflate my way to growth? I could devalue my ‘promise to repay’ paper, buy it back cheap (& book a cancellation gain), & use the gain in gold prices to issue still more reserve backed paper.   

 

If the collective EZ sovereigns can only pay $6 of debt service + Solidarity Surcharge, instead of the original $10; how exactly is the Solidarity Surcharge NOT going to end up as being zero when it comes time to actually pay it (ie: the collective EZ sovereigns determine it, write the enabling laws, collect it,    etc.). And if the charge is not zero, isn’t it really a Ponzi scheme payment - because the central bank wants to issue more of these bonds? 

 

Remove the wrapper. This is really a Ponzi coupon bond backed by toilet paper, & exists primarily to avoid/mitigate CDS payouts. At best you get to collect coupons & sell it on – but only if inflation bites & gold rises. At worst you get your money back years from now, in a currency nobody wants.

 

Looks like a junk bond.

 

[Valuebo]

Hollande lowers France's retirement age from 62 to 60 for those working from age 18-19. Will cost 1.2b euros this year, 3b at final speed. Jikes!

[Kraven]

All CDO’s are constructed from low grade debt, salted with some kind of favorable covenant, & resold at a higher price.

 

What about high-grade CDOs?  What about muni CDOs?  What about trust preferred CDOs?  Granted, none of these are being done really anymore, but there's not much activity in the CDO market anyway.  Plenty of CLOs as well weren't low grade through and through and they have more or less done fine.  That's the little secret the financial media, regulators, etc don't share.  CDOs in general performed exactly as they should have.  That is, they performed the same way the underlying assets performed.  Fill it with crap, get crap.  No different from a mutual fund that owned technology stocks in 2000.  The vehicle is only as good as its passengers.