Archive for June, 2008

• Junk Default Recoveries Maybe Lower Than Usual
  Eddy Elfenbein, June 24th, 2008 at 10:31 am

  I’ve been surprised by the wide yield spread between low-risk bonds and high-risk bonds. Just look at the downward drift of Vanguard’s High-Yield Corporate Bond Fund (VWEHX).
  
  I called Vanguard and the fund pays a dividend yield of 8.61%. Wow, that creams just about anything else you can find today.
  Of course, they’re called junk for a reason. High-yield bonds have a greater risk of defaulting than investment grade debt. In today’s Wall Street Journal, Liz Rappaport says that if defaults do happen, the amount recovered could be less than it has been in the past.

  A report to be published Tuesday by Moody’s Investors Service argues that the explosion of loans issued by junk-rated companies in the past few years means that if they default, the recoveries on these loans might be less than in the past.
  The highest-priority loans, called first-lien senior secured bank loans, will likely recover on average 68 cents on the dollar upon default in this downturn, compared with a historical average of 87 cents, Moody’s said.

  Here’s the money quote:

  Now, Moody’s expects loan investors to fare almost as badly as investors in riskier junk bonds have done in previous busts. “It doesn’t matter what you call something,” says Kenneth Emery, author of the report. “What matters is where you sit in the liability structure.”

  Historically, it’s fairly rare for a bond, even a junk bond, to default. The long-term rate for junk is about 2.6%, but for investment grade bonds, the default rate is just 0.1%. However, defaults can often spike dramatically higher. There have been times when the junk default rate has hit 15%, while it’s never gone above 1.6% for the highest-grade bonds.
  Reuters reports today:

  The U.S. default rate on junk bonds, high-yield debt that is below investment grade, rose to 1.89 percent in May, a 26-month high, from 1.64 percent in April. The rate is expected to rise to 4.7 percent within a year and there is a 20 percent chance it could go as high as 8.5 percent, S&P said.

• Goldman Admits It Goofed
  Eddy Elfenbein, June 24th, 2008 at 9:34 am

  You don’t find the word “goofed” in many financial headlines, especially ones dealing with Goldman Sachs, but Reuters has the goods:

  Goldman cuts financials, admits goofed on upgrade
  Goldman Sachs & Co strategists urged stock investors on Monday to “underweight” U.S. financial and consumer shares, admitting it was wrong when it upgraded both sectors just seven weeks ago.
  The downgrades sparked selling in the two sectors as investors feared that weakening consumer demand and deterioration in the credit markets will weigh on profitability.
  “We boosted our consumer discretionary and financials weights in May on the belief the sectors would benefit from bank recapitalizations and fiscal stimulus,” Goldman strategists led by David Kostin wrote. “Our thesis was clearly wrong in hindsight.”

  Good for them for reversing their call. One of the biggest mistakes investors make is refusing to admit defeat on an investment. People will hang on to the worst sorts of stocks just so because they don’t “want to take a loss.” Stocks don’t have egos. Sometimes it’s best just to let it go.
  Here’s a look at how the S&P 500 Financials and Consumer Discretionary Indexes have done since the beginning of last year.
  
  This chart reminds me of another big mistake investors make: “It’s already down so much, it can’t possibly go any lower?”

• UNH Under $27
  Eddy Elfenbein, June 23rd, 2008 at 3:07 pm

  Unitedhealth Group (UNH) got down to $26.35 today. That’s the lowest price in over four years. The company said that it expects earnings this year of $3.55 to $3.60 per share.
  I’m going go out on a limb here and say, I don’t think the market believes that.

• Aussie Power Crisis Leads to Flat Beer
  Eddy Elfenbein, June 23rd, 2008 at 2:40 pm

  Talk about globalization. Thanks to demand from China, a town in Australia is booming. That is, until an explosion cut off natural gas supplies.

  Hotels are turning off heaters, dirty laundry is piling up and restaurants and bars expect shortages of beef and draught beer. The crisis may shave a quarter point off Australia’s gross domestic product as mines and processing plants cut production, slowing the state’s commodities-driven boom, estimates Brian Redican, a senior economist at Macquarie Group Ltd. in Sydney.

  It’s a nightmare deciding what stays on and what stays off. My favorite quote:

  ”When it gets to the stage where you can’t pour a beer in a pub, you know this crisis has the potential to affect every aspect of business,” says Bradley Woods, CEO of the Australian Hotels Association’s West Australian branch.

• Buy! Buy! Buy! Wait, I Never Said Buy.
  Eddy Elfenbein, June 23rd, 2008 at 2:11 pm

  Oh Jim.
  
  (Via Felix via the tireless Don Harrold)

• Market Failure Versus Government Failure
  Eddy Elfenbein, June 23rd, 2008 at 1:57 pm

  Here’s an interesting article from the Washington Post looking at the government’s ability to handle market failures.

  “How well does government do in helping the market to improve what it does?” asked Clifford Winston, an economist at the Brookings Institution and the author of the 2006 book “Market Failure Versus Government Failure.” “The research consistently finds that, in fact, government efforts to correct market failures have little effect, or actually make things worse.”
  “There is a tendency for people to say, ‘If things are safer, then I will take more risk,’ ” he added. “It does not have to involve government interventions: Drugs are developed to reduce blood pressure, so people say, ‘Okay, I can eat more, and it does not matter if I gain weight, because I can take this pill.'”

  I think people are inherently poor judges of risk.

  Previous research has shown that people drive faster in vehicles that feel safer, attempt to bike on more dangerous terrain when they wear helmets and pay less attention to infants being bathed when the children are in seats that are said to reduce the risk of drowning.
  Winston does not believe in one-size-fits-all solutions — whether interventionist approaches that liberals favor, or the hands-off strategies that conservatives prefer. Rather, he argues that solutions need to be tailored to produce measurably successful outcomes.
  He once studied the effect of installing air bags in cars at a time when automakers were offering customers the option of buying cars with and without the safety devices. Winston found that people who bought cars with air bags tended to be the safest drivers to begin with. And now, lulled into a sense of security, they tended to drive faster, effectively canceling out the safety benefits.
  The wrong lesson to draw from this is that air bags are useless. The right lesson is that air bags can improve safety when they are targeted at the riskiest drivers. As the safety devices become standard issue, for example, risky drivers are automatically protected. And as the safest drivers stop feeling they are extra safe, they may take their foot off the gas.

• RIP: George Carlin
  Eddy Elfenbein, June 23rd, 2008 at 1:38 am

• Nasdaq Composite and Long-Term Support
  Eddy Elfenbein, June 20th, 2008 at 11:03 am

  I’m not much of a market technician, but I’m passing along this chart because the time period is so long.
  
  In March, the Nasdaq came within 10% of hitting the long-term support line. Even though it looks close, the black line is around 2050 today, which is far below where the Nasdaq (^IXIC).

• Doomsdays Past and Present
  Eddy Elfenbein, June 19th, 2008 at 4:33 pm

  RBS issues global stock and credit crash alert

  The Royal Bank of Scotland has advised clients to brace for a full-fledged crash in global stock and credit markets over the next three months as inflation paralyses the major central banks.
  “A very nasty period is soon to be upon us – be prepared,” said Bob Janjuah, the bank’s credit strategist.
  A report by the bank’s research team warns that the S&P 500 index of Wall Street equities is likely to fall by more than 300 points to around 1050 by September as “all the chickens come home to roost” from the excesses of the global boom, with contagion spreading across Europe and emerging markets.
  Such a slide on world bourses would amount to one of the worst bear markets over the last century.

  I love British understatement (“very nasty period”), but I think their metaphors are a bit mixed up. Chickens can’t come home to roost while the contagion spreads. Perhaps Chickenpox could spread, but certainly not roosting chickens. If the chickens were paralyzed, well…that just seems rather cruel.
  Of course, predicting crashes is a great way to get attention. It’s also not so new. Nearly 151 years ago, on June 27, 1857, the New York Herald predicted a market panic (which indeed began in August).
  The founder and publisher of the Herald, James Gordon Bennett, editorialized: “What can be the end of all this but another general collapse like that of 1837, only upon a much grander scale?”
  What did he mean by “all this”?

  Government spoilation, public defaulters, paper bubbles of all descriptions, a general scramble for Western lands and town and city sites, millions of dollars, made or borrowed, expended in fine houses and gaudy furniture; hundreds of thousands in silly rivalries of fashionable parvenus, in silks, laces, diamonds and every variety of costly frippery are only a few among the many crying evils of the day.

  Yes, we’ve always had purple prose Doomsday writers. It sells better than balanced reporting.
  By the way, 1857 is a…Fibonacci Number…dun..dun…DUNNH.

• Krugman Misled America!!
  Eddy Elfenbein, June 19th, 2008 at 2:48 pm

  Five years ago, Paul Krugman wrote:

  The big rise in the stock market is definitely telling us something. Bulls think it says the economy is about to take off. But I think it’s a sign that America is still blowing bubbles — that a three-year bear market and the biggest corporate scandals in history haven’t cured investors of irrational exuberance yet.

  And.

  In short, the current surge in stocks looks like another bubble, one that will eventually burst.

  Well, there was one stock that was in a bubble.
  
  Krugman lied. Profits died.