I was at a talk given by the owner of an investment firm in a major city, here are the issues he sees. These are transcribed from my notes taken at the talk. Draw your own conclusions. I’m not responsible for errors in my work or any mis-statements in his remarks. I'm not able to discuss many of his specifics in detail, but I understand the gist of what he was saying. The YOYO principle applies (You’re On Your Own).
2007 YTD
- 26 new highs. Lots of new money coming in, especially in/since April 2007.
- Week of 11 June 2007, China buys $3.3B stake in Blackstone IPO. (Note: IPO opened at 31, went to 38, now at $29.xx)
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Liquidity is everywhere. Massive amounts of money floating around.
- Merger & Acquisition (M&A) guys are buying up good companies hand over fist. (What will be left for we small investors??)
- Raging Bull Market (BM) worldwide.
- Lots of volatility.
- Rates are going up. Risk is being repriced. Dollar is going down.
Items of Concern per the speaker:
- BM is overextended. BM is 14 months older than the average for BM’s.
- BM is up 95%, while average BM is up 80% before it’s over.
- Market is @10-15% over-valued.
- Small caps @25% over-valued.
To consider:
- Bear Markets are usually in the range of a 25-30% decline.
- Inflation genie is out of the bottle.
- Producers are worried about the price of everything, including labor.
- Global capacity is pretty well topped out. (We’ve all seen news report that gasoline refineries are running at max.)
- CPI up 0.7% last month, not good news.
- Chinese minimum wage up 21% from last year….inflationary development.
- Ten year T-Bill at 5.3% the week of 11 June 2007, indicates upward pressure on rates.
- Effects of inflation hurts both stocks and bonds, rippling effects can last up to 5 years.
- Consumer spending is 2/3 of GDP, so far it is holding steady. Beware of decline.
- Corporate confidence is at a low point.
- Productivity growth may be slowing down. The personal computer revolution is very mature.
- Job growth is in low-pay, low-tech restaurants and health care, i.e., does not improve standards of living for workers.
- Conditions are lining up for a round of stagflation.
- Value of derivatives is $100T, vs GDP of $13T. FYI, Warren Buffet thinks poorly of these.
- US Corporate Bond Debt is $2.5T
- Credit derivatives outstanding are at $13T, over 5X the underlying value (junk??). When bad news hits, look out.
- Enron was all about derivatives.
- A live hand grenade, and derivatives, are about the same thing.
More stuff to consider:
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Money bubble. More money available today than at anytime in 100 years. Lots of corporate cash and central bank funds. Tons of money out there. All sorts of buyouts and deals.
-- (Mike: is money chasing stocks? Washington Post on 24 June 2007 says money & small investors are now chasing commodities, to see article:
washingtonpost.com (
http://tinyurl.com/24k9hm - broken link)
- In 2006 saw $1.6T in buyouts. Too much money out there, it always burns the house down.
- Wild M&A activity, everyone’s doing it - hallmark of later states of a BM.
- LBO’s are being done on a mountain of debt. (Sure sounds familiar, I recall the late 1980’s.)
- Private Equity Funds (PEF) usually return @11.5%, but seeing @6% if deals is over $1B. Better to be in an S&P500 vehicle at 12.2%. One reason is PEF deals usually have way too many fees and advisory charges dragging them down. (Consistent with Professor Edesess’ book, The Big Investment Lie.)
- The SPREAD is at 275 basis points, seems credit is being mispriced??
- Eerily similar to 1987: a real estate boom, stock buybacks, rising rates, large caps, performance chasing. (Mike: Before the 1987 crash, saw same “small investor is in the market” stories.)
- S&P says the credit situation is over stretched.
- Easy credit situations are transitory, usually last @5 years at max. Maybe a year left?
- Higher interest rates will close the candy store for the M&A and PEF deals.
- Sub Prime Mortgage (SPM) problem will cause tighter credit, squeeze out first time & marginal buyer. Ripples will last years.
- Professor Shiller, of Yale University, says homes are 15-25% over valued, that rising rates will reduce home prices, price people out of real estate market. (Mike: seems to make it harder for homeowners to get equity out of their homes and spend it.
Home Page of Robert J. Shiller )
- Building permits for SFH’s down 22%.
- Currently 2.2M vacant units, twice the normal level.
- $1T in ARMS to reset in next few years, many teaser rates will rise to 10-11%. Ouch! Trouble!
- Moody’s foresees 900K foreclosures, vice normal 500K.
- Collateralized Debt Obligations (CDO’s) an area of worry. Half have SPM debt. A type of instrument called Mezzanine Asset Backs are made up of 70% SPM’s. S&P and Moody’s are now cutting the ratings, not a lot, just a bit - so far.
- On 6-14-07, a Bear Stearns fund down 23%. BS raised $600M, leveraged X 10 to buy $6B of SPMs.
- UBS recently shut a hedge fund. (see my note below on hedge funds.)
Lastly:
- Mania starting to subside.
- Commercial property holding strong. (Some REITs may actually be good buy.)
- Maybe buy some TIPS, I-Bonds, Preferred Convertible Stocks.
- Thinking is 10-15% in cash / 50% in equities / 35-40$ in bonds or fixed income securities.
- Be careful picking up nickels in front of a steamroller.
Misc, from my own reading on the web:
- Delinquencies up in 1st Quarter, consumers behind on 2.42% of installment loans in 07-Q1, was 2.23% in 06-Q4. Highest rate since 01-Q2, when entered the last recession. Home equity delinquencies rate is up to .60% from .57%. Credit card delinquencies remain at "stratospheric" level. Trend is going in the wrong directions. Less ability to spend means lower sales & profits - possible stock price declines too. See Washington Post:
washingtonpost.com (
http://tinyurl.com/yt58wv - broken link)
- Hedge funds remain an unregulated black hole, poorly understood, highly profitable for those selling them, many hold risky SPM debt. See Washington Post:
washingtonpost.com (
http://tinyurl.com/2yq9bp - broken link)