Helping the Fellow Out

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

After biotech stocks hiccupped on Thursday, April 11, 2014, ISI analyst Mark Schenebaum told the world: "Horrible day in biotech. I'm frankly at a loss for an explanation. And it's my job to know why. [The reason he gets paid the big bucks - FJS.] Schenebaum "has been following the sector since 2000," but maybe spent too much time golfing.

  NASDAQ 2000: To the Brink and Back

	Closing Price	Point Change	Percent Change
March 10	5048	+182	+1.7%
March 13	4907	-141	-2.8%
March 14	4706	-201	-4.1%
March 15	4582	-124	-2.6%
March 16	4717	+135	+2.9%
March 17	4798	+81	+1.7%
March 20	4610	-188	-3.9%
March 21	4711	+101	+2.3%
March 22	4864	+153	+3.2%
March 23	4940	+76	+1.6%
March 24	4963	+23	+0.5%
March 27	4958	-5	-0.1%
March 28	4833	-125	-2.5%
March 29	4644	-189	-3.9%
March 30	4457	-186	-4.0%
March 31	4572	+115	+2.5%
April 3	4223	-349	-7.6%
April 4	4148	-75	-1.8%
April 5	4169	-21	+0.5%
April 6	4267	+98	+2.3%
April 7	4446	+179	+4.1%
April 10	4188	-258	-5.8%
April 11	4055	-133	-3.2%
April 12	3769	-286	-7.1%
April 13	3676	-93	-2.4%
April 14	3321	-355	-9.6%
April 17	3539	+218	+6.6%
April 18	3793	+254	+7.4%

Source: John Hancock Quarterly Market Review and Outlook, July 3, 2000, Frederick J. Sheehan, Andrea Whalen

Schenebaum is not alone. "Biotech Rout Perplexes Analysts," ran the Wall Street Journal headline. On April 10, the NASDAQ Biotechnology Index (NBI) fell 5.6%. The day before, it rose 4.1%. This is familiar ground. The NASDAQ (composite) chart from early 2000 - "The NASDAQ - To the Brink and Back" - shows many days a believer found encouragement to plunge on, but this was not the wise course.  

            Dr. Joseph Lawler, Senior Managing Partner at Merus Capital Management, told a Grant's Interest Rate Observer conference audience (April 8, 2014) the NBI trades at 42 times reported earnings. To arrive at that multiple, several leaky faucets need to be plugged. Removing the contrivances, including losses, the NBI is poised at 2,200 times current earnings. The NBI market capitalization is greater than the domestic automobile and aerospace industries added together.

Speculators want to make money. They buy what is going up. If it keeps going up, they buy more of it. They may "climb the wall of worry," as the saying goes, but get used to that. More savers decide they need to gamble so that they can eat, so jump in. The increasing participation is common to market excesses. Then more savers stare at the cat food in the cupboard and climb aboard.

            Leverage contributes to the rising tide. Glenn Holderreed at Quacera L.L.C. in Sacramento, California reported on April 6, 2014, New York Stock Exchange margin debt is close to $500 billion. This is well above the highs in 2000 and 2007, after adjusting for price inflation.

            It is often said how much faster a bull market dives than the time it took to rise. The reason involves panic, or a synonym of that. There is also a mechanical reason. It resides somewhere in our minds but the mechanism is worth repeating after a period of relative calm. From the April 6, 2014, Quacera Chronicle: "When setting up a margin account with a stock brokerage, the typical maximum for margin debt is 50% of the value of the account. In order to prevent a margin call (a request to raise collateral* in the account), the margin debt must remain below a specified percentage level of the total account balance, known as the minimum margin requirement. If stock prices fall the brokerage insists the margin debt be reduced, either by putting up additional money or selling stocks.... Unfortunately [for the margined punter in bio or Tesla - FJS] brokerage firms and banks want margin calls (demand for debt payments) paid on the same day." A brother-in-law broker might "want" and wait, for the rest, without payment, their stocks are sold.

*Collateral: There is probably no part of what remains of the so-called financial system that is more an illusion than collateral. The central banks have taken possession of government and agency securities that are ranked at or near the top in the hierarchy.

At the most basic level of collateral, we can wonder until Doomsday why the United States government has refused to return the German government's gold stored in New York. In January 2013, Germany demanded the U.S return 300 tons of the 1,500 tons it keeps stored at the New York Federal Reserve. At last count, the U.S. has returned three (3) tons. As a working assumption, the U.S. government cannot return it. It therefore does what it can to drive the price of gold down. A few minutes after Ukrainians and Russians (or their proxies) started shooting this morning, April 15, 2014, gold opened for trading in New York. Almost immediately, "over half a billion dollars of notional... gold futures contracts" were dumped. "This smashed gold futures down over $12 instantaneously, breaking below the 200 [day moving average] and triggered the futures exchange to halt trading in the precious metals for 10 seconds." (Zero Hedge)

It does not pay (over time, one must add) to mess with mother nature. Nothing is worse (in the long run) than attempting to destroy the very roots of money.  For at least 5,000 years, money has been an immovable object planted in bedrock to protect the people from the folly and vanity of human weakness. To cripple gold's function destabilizes the financial ecosystem at every level. Witchcraft hexes on currencies, through money markets, bonds, common stocks, and uncommon stocks including the never-never, nothing-nothing, gossip and Peeping Tom shares as well as the medicine man miracle cures begs for annihilation.

Inflation - The Real Thing

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

"[T]he concept of the general price level is extremely vague and we cannot even speak of a very approximate determination of the average price level. Every index number is to a certain extent arbitrary: the selection of the commodities that are to be included, the choice of the weighting, the base from which the index starts, and, lastly, the mathematical processes applied, are all arbitrary..."

                                                            -Wilhelm Röpke, Crises and Cycles, 1936

            As everyone not beholden to the current corrupt structure knows, prices are rising at an unseemly pace. Röpke had it right. The corrupt structure abuses the trust it is accorded by claiming "inflation is too low," then publishing inflation figures not worth the paper they are printed on.

            Although everyone knows prices are rising fast, there has not been, in general, a rush to get rid of dollars, as there was in the 1970s. The rush was to buy before prices went up. We are approaching a moment or period of recognition, all the more predictable since incomes are flat to falling. Incomes rose through the 1970s.

The backlash will open with revulsion towards government scrip (dollars) and a rush to stuff will follow, particularly into gold and silver. 

            Without the slightest attempt to cover the waterfront, a portrait follows.

            Flipping through a "What to Do" pamphlet when staying in New York, the price for assaulting the Empire State Building, $25, struck an ill-tuned cymbal.  

An armchair investigation turned up the following:

Top of Empire State Building:

2001:

Adults - $9

Children - $4

2013

Adults - to 86^th floor - $25

Adults - to 102^nd floor - $42

"Express Pass to Top" (whatever that means) - $47.50

Children to 86^th floor - $19

MOMA - Museum of Modern Art -

2001 -

Adult - $10  

Child - free under 15

2013 -

Adult - $25

Children - under 16 for free

Cloisters - Metropolitan Museum of Art, at 190^th street in Manhattan:  

2001 - adults - $10 "suggested"

2013 - adults - $25 "suggested"

Cab from JFK to Manhattan:

2001 -

Standard rate - $30, plus, pay for tunnels, bridges, which certainly cost more than in 2001. Tip - for the consistent 15% tipper, was lower on the 2001 fare than on the 2013 fare.

2013 -  

Standard rate - $52, plus etc.

New York City taxi -basic charge (leaving out: "after 8 PM", bridges, tips)

1 mile -

1987 - $2.20 ($1.15 first 1/8^th mile, 15 cents, each add'l. 1/8^th

2004 - $3.20 ($2.00 first 1/5^th mile, 30 cents for each add'l. 1//5^th mile)

2013 - $4.50 ($2.50 first 1/5^th mile, 50 cents, for each addl. 1/5^th mile)

Source for 2001 prices = Frommer's New York City with Kids

            Over the post-millennial period, what served as the better conduit to save or invest for the weekend getaway to New York? The S&P 500 peaked at around 1550 in March 2000 and is about 1660 today. Since 2001, gold (from around $300 to $1200) and silver (from about $4.50 to $19.00) did a better job of paying the bills.  

Big Money

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (Aucontrarian.com, 2009)

            The difficulties of institutions that need cash for payment have grown acute during the chalk-brained professors' zero-interest-rate pogrom. Insurance companies are one victim, pension plans another. Looking specifically at defined-benefit pension plans, the plan sponsor (corporation, maybe, or municipality) is obligated to pay current and future retirees a specific dollar amount from now until a spouse's death.

            The discrepancy between income received from investments and cash needed to pay beneficiaries of public (state, municipal) pension plans dumbfounds the mathematically inclined. Actuaries make long-term projections of returns on assets and the change in liabilities. The assets on hand to pay benefits in 2025 will not look as susceptible to downgrade if the actuary projects annual investment returns at 8% rather than 3%. Thus, 8% is a typical investment return projected on plan assets today. High-yield bonds are often a sanctuary to justify such assumptions. Now in our fifth year of interest-rate confiscation, such bonds are bought, then bid up for their yields, thus compromising the virtue of such holdings since the higher prices drive the yields lower.

            Investment managers supply what pension funds want. It has been a curiosity that private-equity funds, that do a little bit of everything today, have been buying houses in quantities not seen since the Bolsheviks annexed Moscow. Among others, Texas Pacific Group (TPG Capital Management LP) is planning to buy at least $1 billion of real estate later this year. Others with similar initiatives, who are known better for buying companies, taking them private, then selling them back to the market, are Blackstone Group, Carlyle Group, and KKR. Other than the certainty that most similar organizations, be they private-equity firms or banks, spend more time looking at their competitors than at the investment, thereby misestimating the end of the cycle, why might there be this lurch for houses in 2013?

            Art Cashin, at UBS wondered the same, and asked one of the "very smartest" investors he knows. He quoted his informant in the March 15, 2013, "Cashin's Comments":     

"The more headlines I see like this [TPG buying $1 billion of real estate - FJS], the more I think these mega fund managers (KKR, Carlyle, Blackstone, Apollo) are gearing for the next leg of the MACRO economy. My opinion, this aggressive move into real estate is not just allocating capital to take advantage of a distressed sector. Funds managing $50 to 100 billion and more in some cases have determined that there is just not enough hedging product (CDS, options) to offset massive positions in private equity, credit, etc. I believe they have made the bet that economic theory has not changed that much in 500 years and the next leg will be much higher interest rates and consequently inflation. What is the poor fund manager to do when he has been forced to hold largely illiquid securities (private equity, credit)? Find a hedge. With none available at 35,000 feet you move to 70,000 feet. Hard assets combined with LONG term financing. I would guess that these funds are borrowing as much as possible in the debt markets for as long a duration is possible. (Not just funds, Disney and others have 100 year bonds)

"Conclusion, smart money is betting on coming inflation, possibly hyper-inflation. Hard assets and long term borrowing prudent at this point. Thesis supports a bid under real estate, so bubble is not imminent. Buy as much real estate as possible, borrow as much as possible (FIXED RATE), for as long a duration as possible. 

"And of course, stay very nimble with a tip of the hat......"

"The next leg" of inflation is apparent all day long: subway, parking, magazine, soup, sandwich, oil change, groceries: from $3.29 to $3.69, a seven-ounce rather than nine-ounce serving. The collective American mind, having been told otherwise for so long, may, in a flash, think: "it's 1973!" and the concerted efforts to inflate assets ("massive positions in private equity, credit, etc.") will come undone when the real costs of living are hot news.

It is impossible to hedge an entire market. The Smart Investor surmises Big Money is preparing and is buying the least bad alternative (for a company managing $100 billion). They are borrowing at miniscule interest rates, as much as possible, at a FIXED RATE, and buying long-term assets that may get squashed in the short- to middle-term. The squashing is a worst case, not assured, but one the investor should consider. When interest rates rise ("they have made the bet that economic theory has not changed that much in 500 years"), the value of assets, which are priced now for no interest costs, could - surprise a lot of people.

The May 15, 2013, Wall Street Journal published a laundry list under the title: "Private Equity Firms Build Instead of Buy." The heart of such an approach was expressed by David Foley, head of energy investing at Blackstone Group LP: "We always look at our returns as buy and hold forever, because you might."

Blackstone, teaming up with the Aga Khan Development network, built a new dam at the headwaters of the White Nile. The dam produces almost half of Uganda's electricity which Blackstone sells "at rates that ensure profits for Blackstone for years to come."

David Foley may have frowned when reading "ensured," since there are untold contingencies that could disrupt a steady flow of profits. Speculating a bit here, a pension fund may invest in Blackstone's project and be permitted to log an 8% (for example) return-on-investment each-and-every year, for the next 30 years, or, until the dam is sold. Should evil spirits temporarily halt the flow of electricity ("rituals had to be performed to appease spirits.... A feud between two diviners who laid competing claims to remove the spirits went on for two years"), the fund may still be permitted to log an 8% return, given the long-term objective.

The Wall Street Journal story discusses other such projects: "Blackstone is pursuing similar dam projects elsewhere in Uganda, in Tanzania and along Rwanda's border with the Democratic Republic of the Congo. Using its power-plant builder Sithe, the firm has plants under construction in India and the Philippines.... Apollo [Global Management], for its part, is managing the investment of money that small savers put into fixed annuities promising them a steady rate of return.... KKR is developing a tract of houses and apartments in Williston, N.D., for the oil workers pouring into that region.... [KKR] has teamed up with Chesapeake Energy Corp. to drill for oil for years to come."

A similar strategy was described in the May 17, 2013, issue of Grant's Interest Rate Observer. NovaGold (NG) is "nature's own hyper-leveraged option on a much higher gold value expressed in terms of Federal Reserve notes...." In one estimation: "Only a value on the order of $2,000 an ounce would justify the projected outlays..." Tom Kaplan, through his Electrum Group LC, and owner of 86 million NovaGold shares, has done well buying resource companies that do not meet the criteria of the standard institutional investor: "[I]f you're trying to make 100 times on your money, whether or not you're right in 24 months or 60 months, it doesn't matter."