Fannie Mae’s Thin Margin
“The new capital will enable Fannie Mae to maintain a strong, conservative balance sheet....”
The Heard On The Street column in today’s WSJ, “Will $6 Billion Do For Fannie?” (subscription required), caught my attention.
Fannie announced 1st quarter results yesterday (Tue) before the open. In conjunction, they announced they will be raising another $6 billion in capital (FNM 1Q Earnings Release).
But the article raises the issue of if this is really enough. They are exceeding their regulatory capital requirements but from a fair value standpoint Fannie Mae appears to be skating on thin ice.
According to their Fair Value Balance Sheet, they have $854.4 billion in liabilities and $866.7 billion in assets. That means the net worth of the company, the difference between the value of what they own and what they owe, is only $12.2 billion.
That means they can only absorb a 1.4% drop in the value of their assets, which are primarily mortgage backed securities and mortgages, before their entire net worth is evaporated.
Given the current state of the housing, mortgage and secondary mortgage markets, such a drop in the value of their assets doesn’t seem far fetched. In fact, it strikes me as an all but certainty.
It appears that Fannie Mae is on pretty shaky ground.
Do Disney’s Numbers Really Reveal A Strong Domestic Economy?
You might think that in a weak economy, consumers would cut back on things like trips to Disney’s theme parks. But their theme park revenues and earnings for the quarter ended March 31, released yesterday, were impressive. Revenues were up 11% and operating income 33% (DIS FY 2Q Earnings Release).
A couple caveats though. The press release notes: “Higher attendance was primarily driven by the benefit of the shift of the Easter holiday”.
The other caveat was that the number of foreign visitors to Disney’s US theme parks was up 25% compared to the year ago period, the Wall Street Journal cited CEO Bob Iger as saying (Disney Parks Flourish Despite Economic Drought” (subscription required), The Wall Street Journal, Wednesday May 7, B1).
The latter really gets me to thinking. Disney’s report is supposed to be a sign that the domestic economy isn’t really as weak as some people are saying. But how much of Disney’s domestic theme park strength was driven by a weak dollar and foreign visitors? If that’s what’s driving it, it is consistent with a weak US economy.
Disclosure: Top Gun has no position in Disney (DIS) shares.
Toyota’s Culture Of Excellence
How has Toyota stayed ahead of the pack?
The answer has a lot to do with another distinctive element of Toyota’s approach: defining innovation as an incremental process, in which the goal is not to make huge, sudden leaps but, rather, to make things better on a daily basis. (The principle is often known by its Japanese name, kaizen—continuous improvement.) Instead of trying to throw long touchdown passes, as it were, Toyota moves down the field by means of short and steady gains..... Cumulatively, every day, Toyota knows a little more, and does things a little better, than it did the day before.
- “The Open Secret of Success” , James Surowiecki, The New Yorker, May 12, 2008
I came across this good article on Toyota’s culture of excellence. It is applicable to all of us who want to get better. You become great not by making giant leaps but by continous, steady improvement over a long period of time. Day to day it might not seem like much progress. But over a long period of time your growth and increased powers are apparent.
The Bear Market Rallies of 2000-2002
History doesn’t repeat itself, but it does rhyme.
Tim Knight of The Slope of Hope put up an excellent post yesterday covering the bear market rallies of the 2000-2002 bear market. Again and again, powerful rallies were interpreted as marking the end of the bear. And again and again they turned out to be wrong.
The charts in the post are priceless.
I also read the WSJ article “Stock Investors Start To Believe That The Worst May Be Over” (subscription required - anybody who wants to read this blast from the past, which I highly recommend, e-mail me for a link; ES Browning, June 5, 2001) he links to. Note the comparisons between that article and the one in last Monday’s WSJ that I wrote about (“Excellent WSJ Article On The Sentiment Shift”, Top Gun FP, April 28).
Why Yesterdays Rally Is Happening Today
Whenever the Fed says or does something that is subsequently misinterpreted, they have a few back door methods to correct the error. Two in particular were used fairly regularly. Call it the Fed edit/correction methodology.
When John Berry was at the Washington Post, he could be discretely contacted. He’s now the Fed columnist at Bloomberg, and while I’m sure he maintains his FOMC contacts, we haven’t seen him “break news” like his WaPo days. He primarily does analysis, and he is very insightful as to what the the Fed is thinking. That’s quite valuable, but its not the same as “getting the call.”
These days, that takes place with the WSJ’s Greg Ip.
With no one quoted, and no speech is cited, one has to assume this is straight from the horse’s mouth. The WSJ doesn’t print factual statements about the Fed on the front page without knowing this is precisely what they are thinking. That’s simply not how they roll.
- “What Is The Fed Really Thinking?”, The Big Picture, March 27, 2007
The Federal Reserve cut interest rates Wednesday for the seventh time in eight months but signaled that one of its most aggressive rate-cutting campaigns in a generation may be nearing an end.
In a statement the Fed indicated that, although the economy remains under stress, the “substantial” rate cuts and other measures it has taken to lubricate the financial markets have reduced the risk of a severe recession. That language suggested that the Fed intends to pause in its rate-cutting while keeping the door open to more cuts if the economic outlook deteriorates.
The Fed’s decision to signal a pause..... [Bold and Italics added]
“Fed Cuts Key Rate, Signals A Pause” (subscription required), Greg Ip, The Wall Street Journal, May 1, A1
Sometimes you just have to laugh. And the modern Federal Reserve system provides many opportunities to do just that.
Because of the power the Federal Reserve wields via its control of the money supply, a lot of money can be made by understanding their perspective. That’s why Fed Statements are scrutinized like ancient tablets (see, for example, my “A Role For Ancient Sanskrit Scholars In Today’s Market”, Top Gun FP, March 21 2007).
Sometimes, however, the message the Fed wants to get across doesn’t. Greenspan was notorious for his convoluted and incomprehensible remarks. Bernanke is much more transparent, but even he fails on occasion to get the point across.
That’s where Greg Ip comes in - as Barry so nicely explained.
That’s what’s going on today as Greg Ip published a front page WSJ article titled “Fed Cuts Key Rate, Signals A Pause” (subscription required). As I pointed out yesterday, the statement wasn’t really as hawkish as markets were expecting. They were expecting more of a suggestion of a pause, more hawkishness on inflation, which would have led to a continued selloff in commodities and rally in the dollar and stocks. They didn’t get the “pause signal” and so those moves reversed themselves somewhat with commodities rallying a bit and the dollar and stocks selling off (see also Bob Pisani’s excellent “Fed Statement For Traders: Blah, Blah, Blah”, Trader Talk, Wednesday April 30, 4:15pm EST).
Well, today Greg Ip is out telling us that the Fed did in fact signal a pause. And so the rally we were supposed to have yesterday is happening today.
I wish I was joking.
Two Decades Of Easy Money
Do we have the wit and the wisdom to restore an environment of price stability without impairing economic stability? Should we fail, I fear the distortions and uncertainty generated by inflation itself will greatly extend and exaggerate the sense of malaise and caution ... Should we succeed, I believe the stage will have been set for a new long period of prosperity.
- Paul Volcker (subscription required), 1978, Chairman of the Federal Reserve, 1979-1987
When shall we stop appointing as Fed chairmen either academic economists – out of touch with the messy real world? – or lightweight commercial economists and find someone with solid banking experience? Would a banker with even a hint of John Pierpont Morgan in him have allowed such a sad deterioration of credit and banking standards? Where was Mr Volcker when we needed him? Fired for doing unpleasant but necessary things. So perhaps we get the Fed we deserve.
- Legendary Investor Jeremy Grantham, “Fed needs tough chief in Paul Volcker mould” (registration possibly required), Financial Times, April 29
I want to encourage everybody to read Jeremy Grantham’s fine article in the Financial Times yesterday. Here’s the money excerpt:
Not believing in bubbles and/or being unwilling to risk unpopularity by moving against them leaves the two Fed bosses with no alternative but to give free rein to speculators on the upside and focus on the downside. But, even on the downside, did they have to be so generous?
It created an extreme form of moral hazard: it allowed risk takers to win too big and too easily; it helped spawn a huge hedge fund industry; and, worse still, it helped turn formerly discreet bankers into speculators. If you even partially bail out Bear Stearns – leveraged at 40 to 1 – next time someone will try 50 to 1.
The Fed must show some backbone. If you always take the friendly way out, no bubbles will ever be pricked and we shall always be reacting to crises in an increasingly speculative world. Paul Volcker, the Fed chairman before Mr Greenspan, had the character to do tough, unpleasant things where necessary. His two successors have not.
Bernanke Plays It Safe
Today’s FOMC decision is kind of a dud. They played it pretty much as safe as they could: they cut 25, as everyone was expecting, and they made only very, very slight adjustment to the accompanying statement (FOMC April 30 Press Release).
In fact, the only significant change to the statement appears to be the removal of the sentence “However, downside risks to growth remain” from the policy paragraph. This suggests a slight shift in concern away from economic growth and towards inflation.
Many of the sentences on growth and inflation are identical to the March 18 statement. There is no suggestion of a pause on the horizon that many were looking for.
This doesn’t really provide any fuel for a continuation of the dollar rally/commodity selloff or for more upside in stocks. Markets appear to be essentially unchanged from before the decision.
Bulls Have Eye Of The Tiger Ahead Of Fed
Risin up, back on the street
Did my time, took my chances
Went the distance now I’m back on my feet
Just a man and his will to surviveIts the eye of the tiger,
Its the thrill of the fight,
Rising up to the challenge of our rival,- “Eye Of The Tiger”, Survivor
In my imagination, all across Wall Street, on trading desks, at mutual fund and money management companies, I can picture them: they’re at their computers, they’re feeling confident, the mood is upbeat, and “Eye Of The Tiger” is playing at medium volume in the background.
On the “strength” of a 0.6% annualized rise in 1st quarter GDP (BEA GDP Release) and ahead of the much anticipated Fed Decision at 2:15pm EST, the bulls have rallied all the major indexes. The S&P is poised at the brink of 1400 and appears ready to breakout on almost anything the Fed might decide to do.
*****
Some are saying that the report is essentially indication of recession because .8% of the increase is due to a build up in inventories rather than end demand.
Barry wrote an eminently reasonable post “Congratulations! Its A Recession!” arguing that for all practical purposes this report indicates recession because the inflation deflator being used underestimates inflation and regardless of the number we are experiencing a “significant decrease in economic activity”, which is a criteria for the NBER, the official arbiter of recessions.
The Captain points out that consumer spending, up only 1% annualized, was notably weak, including a 1.3% decline in nondurable goods spending, only the fourth decline in this category in the last 15 years.
But reason is beside the point today. If you could put the bulls response into words it might be something like: Ain’t no thing but a chicken wing.
*****
Next up is the Fed Decision in about 2 hours at 2:15pm EST. The consensus is for a 25 basis point cut to 2.0% and more emphasis on inflation concerns and the suggestion of a pause in the near future in order to asses the impact of prior rate cuts in the statement.
Some are even suggesting the Fed could pause today.
Either way, it’s going to be interpreted, along with the GDP number, that the economy, while not great, is holding up well enough for the Fed to step back, pause and start to concern itself more with inflation.
My feeling is that we’re going higher today. Today’s the day. We’re going to breakthrough 1400 on the S&P. The bulls will be euphoric. I’m looking for a moment of maximum complacency and minimum fear. The question then becomes: Will it last?
Excellent WSJ Article On The Sentiment Shift
Some market participants are beginning to wonder whether the last convulsion of turmoil in March - when Bears Stearns Cos. nearly collapsed, J.P. Morgan Chase & Co. stepped in to save it and the Federal Reserve announced emergency measures - marked a final washout.
- From “Risk Aversion Abates, a Bit, as Investors Test the Markets” (subscription required), The Wall Street Journal, Monday April 28, C1
The trick for investors is to figure out whether what they are seeing is a mirage..... I think this is a head fake.
- Jason Trennert (subscription required), Chief Investment Officer, Strategas Research Partners LLC
An excellent article (subscription required) in The Wall Street Journal today provides an overview of the massive shift in sentiment we’ve seen over the last 6 weeks, since the acquisition/bailout of Bear Sterans. For the most part I’ve been going over all this stuff for awhile here:
- S&P has rallied about 11% over the last 6 weeks
- Investors have sold safe haven US Treasuries, pushing the yield on the 2 year note from a low of 1.33% on March 17th to 2.42% at the close last Friday
- Investors have sold off gold, another traditional safe haven, with gold closing below $900 last week
- Spreads on investment grade and junk rated corporate debt are narrowing, signalling investors willingness to buy these issues
- Merrill Lynch has rallied 33% since March 17th and Citigroup and Lehman Brothers more than 40%; other financial stocks have also performed well
One thing I didn’t know was that Cadbury-Schweppes was able to issue $1.7 billion in just above junk rated debt to spinoff its Dr Pepper Snapple Group business. This deal has been in the works for a while and it finally got done on Friday.
Merrill, B of A and Citi also raised a bunch of money last week through preferred stock sales: $2.55 billion, $4 billion and $6 billion respectively. This again signals investors willingness to put money to work in risky issues.
It has been a truly interesting shift in market sentiment and this article does an excellent job of reviewing it. Anybody who wants to read it, send me an e-mail and I’ll send you a link.
Buffett Expects Recession To Be Worse Than Most Think
Buffett was on CNBC’s Squawk Box this morning to talk about his Wrigley (WWY) deal, but what caught my attention were his comments on the economy (his comments on the economy start around the 7:40 mark):
On retail: “Gotten a little worse.”
On housing: “No uptick at all.”
On the economy: “My general feeling is that the recession will be longer and deeper than most people think.”
“My feeling from what I see in the economy is that this will not be short and shallow.”
So, while Bill Miller and others believe the bottom is in, the Oracle of Omaha appears less bullish*.
* It’s a little more complicated than that as the stock market anticipates the economy and is therefore a leading indicator. So, Bill Miller thinks there is more pain in the economy but that financial markets have bottomed. Buffett made sure to be clear that he was talking about the economy and not the stock market. Nevertheless, if he is right about the recession being deeper and worse than most expect, I think it follows that that is not priced in and he is more cautious/less bullish than Miller and others.
