Looking to Put Money to Work? Here Are Some Thoughts.

I've gotten a number of questions regarding places to put money. Stocks are beaten down, so are bond yields. What's an investor looking to put money to work for 2-3 years to do?

1. Calpine (CPN)
- This utility trades at a HUGE discount to its enterprise value, likely due to investors attempting to front run expected liquidations by CPNs HUGE hedge fund/ private equity holders.

2. Shaw Group (SGR)
- This Jim Cramer favorite has a great backlog (a few BILLION), yet trades near its cash holdings of a bit above ONE billion. This stock, likely beaten down due to its major hedge fund holders, has a diversified group of businesses and will be a TOP rebound candidate once markets turn.

3. Agency Capital Corp. (AGNC)
- This American Capital Strategies (ACAS) affiliate invests in Freddie, Fannie and Ginnee Mae paper which, due to recent government guarantees, should trade like treasuries. Dislocations in the market, however, have created shocking opportunities to invest in guaranteed securities, which AGNC does on a leveraged basis. Huge >20%+ yield.

4. Mosaic (MOS)
- This ag favorite is trading at the same price it was in early 2007 when sales AND prices were lower. At this price, growth expectations make this stock hard to pass.


If you're in it for the long run, it's going to be hard to bet against these plays.

How far we've come.

“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate … purge the rottenness out of the system”

- Andrew Mellon, Treasury Secretary under President Herbert Hoover

Citigroup: RFP for Lunesta

Justin Killion: You know what Citi needs?
Evan Plisner: Money and a reverse stock split?
JK: Nope
JK: Sleep.
JK: Otherwise their insomnia is going to turn into a dirt nap.

Overshot Pt. 2

Those who think oil prices are sustainable in the $40s are just as crazy as those who thought oil was worth buying at $150 (Goldman Sachs). If I may introduce the concept of economics and the "invisible hand of the free market": As oil prices decline, fewer pipelines are filled to capacity, rigs are taken offline for maintenance, and overall production decreases, reducing supply and moving prices back up. This is, of course, without the eventual return to global growth vis-a-vis EVERY COUNTRY IN THE WORLD. Ladies and gents, while oil may trade as low as $40 before year's end, don't expect it to stay that way for long...better fill up now.

EP

Yield Curve, Quantitative Easing and CMBS

Last Thursday, the treasury had quite a poor auction of 30-year bonds. Yet over the past few days, we have seen an unprecedented spike in the price of the very same long-term treasuries. I have read some speculation that this could not occur and is largely short-term for various spurious reasons. I contend that this is a result of the Feds recent admission about the reality of quantitative easing despite the fact that informed speculators have claimed this as the only inevitable policy for quite some time. Besides the fact that the Fed seems to have completely lost control over the fed funds rate (see image, blue is target FF, red is effective FF), it appears to have decided to embark on a path of quantitative easing. This is precisely what Japan had to resort to after its asset-bubble burst. The fundamental idea is that with short-term interest rates so low, any further reductions have very little, if any, affect as stimulus. Accordingly, the central bank rapidly increases the money supply to prop up asset prices (avoiding deflation) and aims to decrease long-term interest rates (to effectively avoid a liquidity trap). Also, under a policy of quant easing the Central Bank tries to grow its balance sheet by increasing the amount of bank reserves held with it. (Interestingly, some Fed papers have concluded that quant easing largely failed in Japan.)

This is all in favor of a flattening yield curve. But wait...theres more! As the Treasury shifted its TARP investment away from ABS, they (even investment-grade CMBS) have simply collaped in price. Accordingly, Dresdner (via FT Alphaville for us non-Dresdner clients) notes the possibility of increasing use of +10 year treasuries in convexity hedging for MBS. Since most mortgages are ~30 year it seems to me that even later maturity treasuries would be used, particularly since most of this securitization came from the hay-day of the 2000s. (I know very little about convexity hedging, any help with this is appreciated!).

Being as I'm not an expert on any of these subjects, all comments, questions, and criticisms are welcome. If you're reading this, stay tuned for a post on the USD sometime soon. Think third-world-style devaluation.

Disclosure: As of this writing, I intend (though may not) take a position in long-term maturity treasury bonds.

The Market Remedy

The major indexes were down at least 5% today bring them down to the lowest level we have seen in many years. No one is really sure what is going to happen next. Personally I thought we would see more resistance when the Dow broke below 8000, but the selling continued throughout the day. If we are to get out of this mess we need to start fixing the problem areas of the economy. Housing, housing, housing! I get sick of all this talk about the auto industry when we need to consider solving the problem of foreclosures. This is trickling down to the banks which is freezing financing which leads to higher loan rates for consumers which leads to less spending on things like autos. Liquidity in the market for MBS related products is non-existent which is causing distress in the financial sector. TARP was signed into law to hopefully combat this liquidity problem but now it has been announced that TARP is on hold. Why make all the fuss for the bill and then not follow through? I just don't get it and now we have Congress basically just waiting until the next year when they will be able to pass legislature to their liking. Market intervention is the preferred avenue to correcting the economy, but maybe we should just sit back and pass the steering wheel to the Adam Smith.

Mark Cuban

If you haven't already heard, Mark Cuban has been accused of insider trading by the SEC. It is alleged that he sold approximately 6% of Mamma.com back in June 2004 after getting some information from the CEO about a PIPE (private investment in private entity) financing. The company announced the financing in order to raise capital but through this financing existing shareholders are diluted which is why Cuban wanted to sell in the first place. He apparently sold the day before the announcement and saved some $750,000 in losses.

He also runs a Web site called Sharesleuth.com, which bills itself as providing "independent Web-based reporting aimed at exposing securities fraud and corporate chicanery." -CNBC

That is pretty ironic. Cuban obviously denies the charges brought against him, but the evidence seems pretty clear. If it took 4 years to discover this I am going to bet that they spent a good deal investigating the case. No matter what happens, I just hope that his legacy isn't ruined. I mean, he's been ejected from more NBA basketball games than Joe Dumars, and who could forget his Dancing With the Stars performance.

Citigroup Cuts 53,000 Jobs!

It was announced officially this morning that Citigroup is going to cut its labor force 20% from its peak of 375,000 employees in 2007. In October, there was an initial round of job cuts and more were expected given the market in the last 3 months. But I don't think anyone expected this many people. The hard line stance from Vikrum Pandit is bold, but it may pay off. Citigroup needs to reevaluate the way they do business as many bets against mortgage related securities have soured. Stronger competitors have emerged and will begin to take market share away from Citigroup if they don't make changes. I think this is a step in the right direction (Yes it sucks for the people losing their jobs). In hard times, firms need to be agile and adaptable in order to emerge a better company. With less employees they will be focusing better on the areas of business that have the best margins. Also I think we will start seeing the other banks (JP Morgan, Wells Fargo, B of A) do the same. It's impossible to maintain employment levels from an economy growing at 3-5% when currently there is negative GDP growth. If production levels are down then less labor will be needed to provide the goods and services.

TRS: Bad News

The Total Return Swap, or TRS, allows an investor to gain exposure to the economic return of an asset without actually holding the underlying security. The swaps, often used by activist investors, allow funds to gain economic control of a large number of shares in a company without largely disclosing their stake, as they do not technically own the shares, simply an investment tied to them. The flip side of this is that the bank with which they enter into the swap agreement hedges their exposure to the swap by purchasing the underlying shares.

My thoughts, however, are that TRS's tied to leveraged loans are actually artificially depressing loan prices. Because the banks issuing the swaps linked to the loans already have huge inventories of the securities on their own balance sheets, it's simple for the bank to simply set up an entity to purchase the loans on behalf of the swap-issuer from the bank (yes, a bank subsidiary purchasing loans from its parent). By doing this, there is no need for purchases to take place on the open market, therefore preventing large buyers from stepping into the market and providing bids.

How did AIG get stuck with all these CDSs

A question a lot of people are asking themselves is why such a strong (?) company like AIG gets stuck with so many CDS contracts. Well, here is a great post by Blogonomics explaining that AIG was essentially collecting free money by writing protection on CDOs that they assumed would never loose their value.

You don't need to know about CPDOs or about the spread between CDS and bond yields in order to answer this question. It's much, much simpler than that. The fact is that AIG didn't use "shareholders' and policyholders' cash to write protection against debt instruments". If it wanted to buy bonds, then it would have needed to come up with some cash to do so. But writing protection, by contrast, was a way of receiving money, not spending it.

When AIG wrote protection on CDOs and the like, it got insurance premiums in return, and considered those premiums to essentially be free money, since (according to AIG's own models, and those of the ratings agencies) the chances of those CDOs defaulting were essentially zero.

Now, of course, it's clear that those insurance contracts constitute an enormous contingent liability for AIG -- one so big that without government help the company would have gone bust. But at the time, no one at AIG was worried about that, so busy were they raking in the dollars insuring CDOs which they were positive would never suffer any losses.

AIG's biggest mistake was in failing to realize that this business couldn't scale in the way that most insurance does scale. Most insurance does scale: if you insure a house against fire, for instance, it's easy to lose much more money than was paid in insurance premiums. But if you insure houses across the country against fire, you'd need a nationwide conflagration in order to lose lots of money.

The CDO market doesn't work like that, however. The reason AIG's models said the CDOs couldn't suffer any losses was that house prices don't fall in all areas of the country simultaneously. Since AIG was only insuring the last-loss CDO tranches, investors with lower-rated tranches took the risk that prices in Florida, or Arizona, or California might fall. AIG would only lose money if prices fell in all those states at once -- which is, of course, exactly what happened.

But AIG never stopped to think that the event which would precipitate a payout on one CDO was exactly the same event which would precipitate a payout on all the other CDOs as well. AIG could easily afford any given CDS contract. What it couldn't afford was lots of CDS contracts -- because with CDS, unlike with most insurance, there was no safety in numbers, only more danger.

The investors in CPDOs, at least, put their money up front, and looked to make their relatively modest profits slowly, over time. They lost their money, but at least they had their money before they lost it. At AIG, the financial products group booked its profits immediately, without spending any money at all. When their losses arrived, the firm had to scramble to find the cash, since it had never allocated much in the way of capital to the group.

Insurers are always happy to take your money. But spending money on insurance is always fraught. You've spent your money up front, and now you hope that if the thing you're insuring against comes to pass, the insurance company will do the right thing and pay out. Your big fear is that they won't, either because they think they've found a reason to reject the claim, or because they've gone bust.

That's why insurers need to be very highly regulated. If they weren't, anybody could set themselves up as an insurer, take in lots of premiums, and then simply disappear. But that's also why AIG was writing protection on bonds rather than buying bonds outright. Under the insurance model, you can rake in your premiums and provision very little capital against them, so long as you wow your regulator with enough whiz-bang models saying that you'll never need to pay out on those policies. If you buy a bond, by contrast, the seller wants cash up front. And where's the fun in that?

Initial Unemployment Claims at 2001 levels

Source: calculatedrisk.blogspot.com

The Department of Labor reports that...

In the week ending Nov. 8, the advance figure for seasonally adjusted initial claims was 516,000, an increase of 32,000 from the previous week's revised figure of 484,000. The 4-week moving average was 491,000, an increase of 13,250 from the previous week's revised average of 477,750.

With these levels of unemployment I would not think of touching any stock related to consumer spending. Even if your thinking that companies who target the more affluent will be fine, just be careful. Nothing is recession proof. TRLG...No Thanks.

Congress looking to take the "hedge" off economic pain

Be sure to tune in to C-Span tomorrow to see the Nation's most prominent money managers give their side of the story.

Congressional Schedule

St. Joe Update

On November 4th The St. Joe Company posted a 2008 Q3 net loss of $0.21/share versus the consensus that group 5 stated during their presentation of a net loss of $0.03/share. This is compared to a net loss of $0.09/share for the Q3 of 2007. For more information see their 10-Q filing and earnings call transcript.

Disclosure: I'm a member of the group that pitched the JOE position.

Economic Reports

The next two days of trading are going to be driven by the these four economic reports:

Thursday:
-Chain Store Sales for October (These are going to be awful)
-Jobless Claims

Friday:
-Employment Numbers (Unemployment Rate)
-Pending Home Sales

The basic idea of economic indicators revolves around a consensus (expected) number that economists compute. The market will move up if the numbers are better than expected or lower if the data is worse than expected. For example so Friday they are expecting the unemployment rate to be 6.3%, but if the data reports a 6.7% unemployment rate the market will sell off because of labor market fears. If the unemployment rate reported was 5.9% traders would be buying the market because the labor market is in better condition than most people expected.

*There is no cause and effect relationship between the consensus number and the reported figure. Proceed with caution because the market doesn't always act this way, but in general this is what occurs.

What President Obama Has to Say to Wall Street

"There are just so many problems and there's no money," says Kathy Boyle, president of Chapin Hill Advisors in New York. "I wouldn't want this job if you paid me $3 trillion a year."

I'm pretty sure Obama is excited about what lies before him, but he must be careful not to alienate Wall Street because he needs them to get out of the crisis we're in now. He can talk all he wants about health care, tax breaks for the middle class among other things but nothing is as important as dealing with this recession we are in now. Every person in America is being affected by this and people need to be able to trust that they will have income from steady jobs.

Right now the labor market is extremely weak among manufacturing companies. GM is planning to announce more job cuts and an overhaul of their current labor structure on Friday. This sector is heavily unionized compared to the rest of the market and there is concern that union support of Obama may lead to stronger unions in the economy. This goes for manufacturing jobs, steels jobs and union jobs across the country. Unions aren't the most efficient organizations in the economy just look at GM right now. The problem is not the idea of the union but the terms they agree to with their workers are just not competitive. GM pays just as much in health care liabilities as it does for wages which puts the company at a huge competitive disadvantage with Toyota.

So maybe unions are the way to go but jobs still need to be created and Obama plans to do so with the alternative energy sector. Cleaner and more efficient energies are going to be pushed by his administration which is going to favor wind and solar companies over the oil complex. These jobs will come through new research in alternative energy and infrastructure build up. Currently we can't feed the world's energy needs without fossil fuels but we can depend less on it by building new alternative energy facilities. While there will definitely be a shift to alternative do not forget natural gas which is a much cleaner and efficient fossil fuel. The price of nat gas has increased approximately $1 over the last week in anticipation of the new administration energy policy. Chesapeake (CHK) is up over 10% today!

Like alternative energy, the health care sector will benefit from the new administration. Inflation in the sector has forced many would be buyers out of the sector because they rightfully believe that the companies are not going to be able to pass on higher costs to customers. Obama plans to "subsidize" these costs which will make the companies more profitable.

Regulation in the Financial Industry

Democrats now control the executive and legislative branches (well not quite yet...Bush might pull something out of his hat) and this means that certain regulatory legislation will be passed. Barney Frank is going to become a household name for people outside of Massachusetts. This might not be a bad thing it if provides confidence in the market which will help solve the credit crisis. But there is also the concern that legislation right after an popular incident might go to far. Many people believe that Sarbanes Oxley went too far dealing with WorldCom and Enron accounting scandals making U. S. business less competitive because of more stringent accounting rules than the international ones used everywhere else. Mortgage lending will definitely be an area of concern because the predatory lending helped spread this crisis. However they also need to address public education on mortgage and financial issues. Other legislature will come up because everyone wants to make sure that this episode never airs again.

Obama has a lot on his plate but with the right people helping him out we can turn this economy around!

Greenlight, Redlight.

Greenlight Capital, the long/short hedge fund run by wunderkid David Einhorn, has hit an exceptional "rough patch". I'll be honest, I hate to write this story as I have enormous admiration for David, both professionally (HE was the one who called out Lehman Brothers) and personally (very philanthropic...ALD).

While Greenlight has averaged greater than 25% per annum, I don't believe we'll be seeing such performance this year. To begin, the "word on the street" is that Greenlight was heavily involved in the VW/Porsche trade, which obviously didn't play out so well. Next, his $7.3MM stake in VeraSun Energy has now been all but wiped out, as the company filed for Chapter 11 bankruptcy protection on Friday. Then there is Greenlight Capital Re, Ltd. (NGS:GLDE), Greenlight's Grand Cayman P&C reinsurer. The company, which invests via David's DME Advisors, has seen its shares drop 40% this year alone.

So has this poker champion lost his touch?

Not a chance. Put me down as the first one to bet on an Einhorn comeback.