Credit Market Overview

March 10, 2010

http://www.marketstrategiesmgmt.

Before there were dedicated 24-hour sports networks ABC would broadcast “Wide World of Sports” every Saturday afternoon.  The tagline for that show: “Spanning the globe to bring you the constant variety of sport… the thrill of victory… and the agony of defeat… the human drama of athletic competition… This is ABC's Wide World of Sports!", seems as if it could apply to today’s financial markets without too much editing, “Spanning the globe to bring you the constant variety of economic indicators…the thrill of finding an indicator you can believe….the agony of finding out you can’t…the human drama of trying to make sense of all of the cross currents of information…these are today’s financial markets.”

In my effort to “span the globe” in search of information indicating whether this recovery is lasting or temporary I thought we might look at those things that span the globe.  Well, span might be a bit overarching, but at least those things that criss-cross it frequently and that would be the massive container ships carrying raw materials in one direction and finished goods in the other.

One of the main indices for shipping activity is the Baltic Dry Index (BDI), the “dry” here meaning not “wet” which really means anything that is not oil.  The problem is that what was a very accurate indicator of global commerce is being watered down by the supply of new ships that were ordered when it looked like the world would continue on its path to ever higher consumption. 

Given the lag between order and launch those ships are hitting the water at a time of less than peak demand.  “What you’re witnessing is a huge number of ships ordered during the peak of the market in 2007-08 being delivered now due to the usual lead times involved,” was how Amrita Sen, a commodities analyst at Barclays Capital in London put it.  Because of this Plamen Natzkoff, a dry bulk freight strategist at Citigroup in London, believes that the BDI “will be less responsive to shifts in demand as the over supply of vessels becomes more pronounced.”

Interestingly, as the fog rolls in on the BDI Genko Shipping has decided to carve out a piece of itself and offer 16.3MM shares of an entity it will call Baltic Trading (BALT) at about $15 per share.  This equity is meant to mimic movements in the BDI and if the IPO is successful, BALT will use the $245MM raised to buy six big bulk carriers which will ply the planets oceans in search of spot shipping assignments.  The entity will have no debt so its shares are designed to more accurately reflect changes in global shipping rates.

To the extent that BALT will provide a lighthouse of information on the dark waters of global commerce data there is a risk that folks might not like what they see. 

Shedding some of its own light on shipping, A.P. Moller Maersk AS (MAERSKB DC DKK) recently reported its first loss since the company floated its first boat in 1904.  “The loss was significant, but 2009 was an extraordinary year with historically low rates and low demand”, was how CEO Nils S. Andersen put it.  Nils went on to say that he expected Maersk to turn “a modest profit” in 2010.  Emphasizing his view that “shipping is not a commodity” and that Maersk “wants to provide superior service based on customer needs”.  These are wonderful sentiments but the BDI and BALT could make for some rough seas in convincing people of such.

There are no CDS traded on Maersk and there are no good substitutes within the CEC universe as all of the names there represent air and ground shippers.  It should be noted, however, that the CEC strategy is currently long 10 of the 11 stocks in that sector with the exception of YRC Worldwide (YRCW) which is more of a story stock at this point given its brush with bankruptcy caused by outsized pension obligations.

As for shipping in general, needless to say it would be a good thing if all those ships “spanning the globe” pulled into harbors of profitability.

Enjoy the week.

Jim Delaney



Credit Market Overview

March 9, 2010

http://www.marketstrategiesmgmt.

In solving most white color crimes the key to finding the culprits is following the money.  While in no way suggesting such nefarious goings on, it is quite useful to apply this tactic to Wall Street when trying to determine where the strength and weakness might be across various business lines and asset classes.

In early February Barron’s interviewed Roger C. Altman, CEO of Evercore Partners.  The part of that Q&A most germane to today’s theme was this “A” that came after one of Larry Strauss’s “Q’s”: “Historically, you see that the upcycles last five to eight years, and the downcycles typically two to three years. We have just come through more than a two-year down cycle, and it is clear to me that we have turned the corner.”

This view was bolstered when it was reported last week that when data from Capital IQ was analyzed by the WSJ it was found that the 382 non-financial firms in the S&P 500 were sitting on top of $932BN in cash and short term securities.  The answer to the question of what to do with all that dough has been in part supplied by the fact that stocks are still trading about 27% below their 2007 highs.

The result is best exemplified by Walgreen’s (WAG) $618MM cash bid for Duanne Reade (Private).  Wade Miquelon, CFO of WAG reasoned it this way: “We are sitting on a lot of cash and generating a lot as well, sitting around on all that cash and have it earn very little really does not make a lot of sense.”  Wade went on to say, “We are conservative with our cash, but hoarding it right now isn’t probably the best use of it.”

Like the WAG deal, cash does seem to be king at the moment, or at least the preferred method of acquisition as through 2/28 the percentage of cash deals in the U.S. more than doubled from the same period in 2009 according to Thomson Reuters with 50% of this years deals being paid for outright vs. about 24% in 2009.

The activity appears to be stretching across wide swaths of the economy as India’s Essar Group just agreed to fork over $600MM greenbacks to buy U.S. coal producer Trinity Coal from U.S. based P.E. firm Denham Capital.  Additionally, while not the major thread of this morning’s monologue it should not be lost that there is increasing demand by the world’s fastest growing economies (India and China) to lock up supply of the raw materials those countries need to continue their growth.

Coal is used is used in those industries where a lot of heat needs to be generated and the two that come most quickly to mind are energy and steel.  That second use is adding more fuel to the M&A fire as Wayzata Investment Partners, a P.E. firm has been quietly acquiring small foundries across the U.S. in places like St. Cloud, Minn., New Castle , Ind. and Iron Mountain, Mich.  While the deals are not big ($70MM for Grede Foundries in St. Cloud) the folks at Wayzata believe the resurgent economy will make foundries a “hot” investment.  In support of their idea the national trade group for America’s foundries is quick to note that 90% of man-made products in the U.S. contain a part made in one of this or another country’s 2,100 foundries.

For proof of the “other country” part of that last statement we need to look no further than two of the grand pillars of the private equity business Kohlberg Kravis Roberts & Co. and TPG Capital who appear close to inking a deal to buy Morgan Stanley’s stake in China Capital Corp.  If successful KKR and TPG would split MS’s current 34.3% stake in CICC with Henry Kravis and David Bonderman, founders of their respective firms, gaining seats on CICC’s board.

Needless to say none of this activity would be going on if all of the very smart people involved in these deals didn’t believe the outlook for the world’s economy was more positive than negative.  It is also worth being reminded that bids, whether they come from another company or a P.E. firm, are usually at a premium to current market prices in order to entice holders to surrender their stakes.  As such M&A activity is usually not a bad thing for anyone lucky enough to own part of a target company or for stocks in general.

Investment grade CDS spreads continued lower yesterday closing at 83bps.  That level was last seen on Jan 10^th of this year while spreads were on their way up to their 106bps peak on 2/8.

High Yield spreads closed at 519bps yesterday which matched the 1/20 close, which like IG spreads, were on their way higher at the time cresting at 637bps on 2/15.

In the period leading up to the market’s highs in October of 2007 M&A deals were paid for with heaps of debt which was used to pay the acquirers huge upfront dividends.  The current mode of cash acquisitions leaves the acquisitors with a lot more skin in the game.  Needless to say, if you follow the money, this should lead to more careful corporate stewardship.

As for Mr. Altman’s view on the prospects of M&A, all we can say is roger, Roger.

Enjoy the week.

Jim Delaney

Credit Market Overview

March 4, 2010

http://www.marketstrategiesmgmt.com

Have the horses all escaped?  Has the barn door been locked and nailed shut?  Has every precaution been taken to ensure that those things that created the last crisis won’t create the next one?

From the parade of TARP and TALF recipients that were forced to endure made for TV congressional hearings put on to allay any fears in those people who believe what they see on TV that those on the dais were really looking out for the good of their constituents and not just campaign funds for the next election, I think we can say yes to all of the above.

Now that we’re all feeling completely safe and secure in the ability of regulation to prevent anything bad from ever happening again I would like to ask a question.  Have you ever heard of a “Longevity Swap”?

Longevity swaps are the latest concoction dreamed up by the same financial engineers that brought you CDO’s^3, CBO’s and a rash of other products that could be made to look like completely harmless, safe as money in the mattress investments; until they weren’t.

Technically speaking, longevity swaps are a risk transference vehicle used to move the liability that pensioners in a specific pension fund will live longer than the actuarial models say they are supposed to.  Now, unlike some of the early proposals in the health care initiatives where Rahm Emmanuel’s brother raised the concept of offing people once they got too old, pension funds are required to pay the allotted amounts for as long as the pensioner lives.  By using longevity swaps the pension fund can remove some of this liability.

The Life and Longevity Market Association came into existence on February 1^st of this year with the goal of taking longevity swaps into the “mainstream”.  Which I take to mean making sure investors around the world buy a whole bunch of them and the products created with them so we can have another complete global meltdown in 10-15 years.  John Fitzpatrick, a partner and director of the LLMA, has a slightly different view of the product and said “the group wants to produce ‘standardized products that will attract investors and create liquid market’”.

Jonathan Graham, head of longevity swap pricing at Swiss Re said: Longevity capacity exists within the insurance market at present but there simply isn’t enough to cover the long-term future needs”.

The list of players are names we can all repeat in our sleep by now; Deutsche Bank, J.P. Morgan Chase, Royal Bank of Scotland, Axa SA, Legal & General Group PLC, Pension Corp, Prudential PLC, Swiss Re and Credit Suisse.

If your next question is, how far along is this product?  Last week BMW off loaded £3BN ($4.65BN) of U.K. pension risk to Deutsche Bank which was the largest deal to date in Britain.

While this all might seem like the brand spankingest new thing, longevity swaps have existed for some time.  France used one in 1997 to reach its 3% of GDP deficit goal to stay within the confines of the Eurozone when it took on the pension liability (off balance sheet) for a €5BN payment (on balance sheet) from France Telecom and Antigone Loudiadis, the woman now known as having arranged the infamous currency swap between Greece and Goldman, is now at another Goldman subsidiary, Rothesay Life, and has been transacting longevity swaps since 2005.

Financial innovation is a great thing and unlike Mr. Volcker, for whom I have the utmost respect, I do not think the ATM was the only new thing to come along in the last 25 years that has value.

I think the real point here is that innovation is as inherent and necessary on Wall St. as evolution is to Darwin’s finches.  To believe that risk can be legislated away will put us all right next to the Dodo Bird.

For the most part, the names listed above as participants in the longevity swap market are tracking the current move lower in CDS spreads and higher in stocks that began back on February 8^th.

The longevity swap market is still in a nascent stage and as such none of the institutions mentioned have substantial risk to this product.  As with most if not all financial innovation, longevity swaps are at the stage where they are addressing an economic need; over burdened pension plans and an increasingly long lived populace.  If any of the lessons of the last crisis have been learned, and I know that is a stretch, than longevity swaps do not necessarily have to be a problem waiting to happen.  For that, however, we will have to wait and see.

Enjoy the week.

Jim Delaney

Credit Market Overview

March 3, 2010

http://www.marketstrategiesmgmt.

There is a famous Indian legend that depicts six blind men encountering an elephant.  Each in turn walks up to a different part of the animal and as such comes away with a different impression of what the beast actually is.  To give you an idea here is the second paragraph:

The First approach'd the Elephant / And happening to fall / Against his broad and sturdy side / At once began to bawl: "God bless me! but the Elephant / Is very like a wall!"

This story came to mind while hearing of some of the changes the International Monetary Fund (IMF) has been considering as possible policy objectives in the wake of the credit crisis and the effect it is having as it ripples through some of the less stable economies.

The credit crisis itself is a result, in part, of this kind of thinking but not by the IMF but by that other supra-national financial body the Bank for International Settlements (BIS).  As a part of what is known as Basel II, the BIS decided to allow banks to base capital requirements on the volatility of the instruments they were reserving against.  The lower the volatility the less capital needed.  This was supposed to be a more enlightened form of risk management as it allowed banks to use more of there capital which, it was thought, would allow them to prosper during the “Great Moderation”.  Needless to say when things became “un-moderated” there weren’t enough reserves and . . . well, you’re living through the rest of the story.

So now that we’ve come through what is hopefully the worst part of the storm everyone is running around trying to close all those gates that the horses left through.  Not to be left out the IMF has a few proposals of its own.

One of the more interesting comes from the IMF’s top economist, Oliver Blanchard, who reasons that if the world’s developed economies were to target an inflation rate of 4% instead of the current 2% than the next time there is a credit tsunami there will be more room to lower rates, relieving the need for measures such as quantitative easing and TARP and TALP initiatives.

One of the other ideas being floated is that emerging economies should institute tax and regulatory regimes to moderate the vast inflows of capital they are experiencing as investors leave the hobbled west behind and seek markets where they expect stronger growth.

The IMF is also urging the leaders of the world’s western economies to coordinate regulation via multilateral agreements to remove the possibility of regulatory arbitrage.  Dominique Strauss-Kahn, the IMF’s managing director said recently, “I am worried about the possibility of inconsistency of different countries proposals”.

The latest idea to be floated is one where the IMF would provide assistance to a group of countries vs. individual nations which is intended to remove the stigma associated with receiving aid from the world’s lender of last resort.  While on a grander scale, this would seem to be somewhat similar to the U.S.’s Federal Reserve encouraging the use of the Discount Window during the depths of the crisis.

To discuss the pros and cons of each initiative would take many more pages than I have neither the time to write nor you, the time to read.  The lesson here is similar to that of the blind men and the elephant and that is that perspective makes all the difference when making decisions.

With that said there are two encouraging things to report in the credit markets.  The first is that sovereign protection for Greece closed at 320bps last night, down from its recent high of 428bps on 2/4 and the lowest close since that date.  Whether the austerity plans or the unwillingness of its stronger Euro partners (Germany and France) to let Greece fail are the cause of this or even if it is the combination there of, the global financial system didn’t really need a sovereign default to deal with at the moment so averting that disaster has to be a good thing.

The other credit related news pertains to AIG whose CDS closed at 409bps last night.  Given that in more normal circumstances 400bps would be nothing to brag about AIG has been through nothing that looks like normal circumstances.  The last time AIG’s CDS traded lower than last night’s close was September 8^th of 2008.  Hopefully I don’t have to recount for you what happened right after that.

Enjoy the week.

Jim Delaney

Credit Market Overview

March 2, 2010

http://www.marketstrategiesmgmt.

On the evening of September 16^th 1992 the British government announced its exit from the ERM (European Exchange Rate Mechanism) and reverted back to the pegged pound.  In the two weeks leading up to what is known in that country as “Black Wednesday” George Soros, leading a band of speculators, sold billions of Pounds short forcing the Bank of England to raise rates to 12% and buy as many of those Pounds as the Exchequer could afford which in the end was not enough to prevent the eventuality.

In July of the next year, Mr. Soros focused on the French Franc and published a statement in La Figaro which said, “It is futile to attempt to protect the EMS by abstaining from trading in currencies when the anchor of the system, the Bundesbank, acts without regard to the interests of other members”.

A few days later he said, “I continue to believe that the European Community needs some kind of currency system and I hope that the ERM will be reconstituted along the lines outlined in my article in Le Figaro. I feel free to resume trading in the French franc after making this announcement.”  To which he added, “After the decision of the Bundesbank not to lower the discount rate, I feel no longer bound by the declaration I made in Le Figaro on 26 July”.

A crusader against ill informed global monetary policy?  Maybe, but also a ferocious speculator that thought nothing of taking on central banks.

In 2003 George teamed up with none other than Warren Buffett in a bet against the USD.  A fund manager at the time was quoted as saying, "I have heard that both Soros and Buffett are shorting the dollar. There's a growing belief on Wall Street that the dollar is looking like a one-way bet downwards."

Given his proclivity to speculate, albeit profitably, it was interesting to hear George declare during the early 2008 run up in oil prices that, "Speculation... is increasingly affecting the price," he said. "The price has this parabolic shape which is characteristic of bubbles".

This was made all the more curious by another proclamation in June of 2009 when Mr. Soros said, "Some derivatives ought not to be allowed to be traded at all. I have in mind credit default swaps. The more I've heard about them, the more I've realized they're truly toxic”, while appearing at a banking conference.  Later he emphasized, "CDS are instruments of destruction which ought to be outlawed."

This all reads like a Hollywood script.  The young Lion speculating against central banks and winning and then, in later life; possibly seeing the error of his earlier ways, calling for kinder and gentler markets, possibly an end to speculation as we know it.

If it is a movie in the making then get ready for the surprise ending as it was recently reported in the WSJ that Monness, Crespi, Hardt & Co., a boutique investment bank, hosted a dinner in Manhattan on February 8^th which was attended by an elite group of hedge fund managers.  The topic of the evening was the future of the Euro.  Having fallen from $1.5134 on November 25^th of last year to around $1.35 recently, the views reportedly expressed at dinner were that parity with the Dollar was not outside the realm of possibility and may be well within it.

That a hedge fund manager or more than one has a rather polarized view of the world is nothing new.  Betting against the banks in 2007 and 2008 took crystal clear vision and nerves of steel.  Betting with them in March of 2009 took these same qualities only a magnitude or two more so.  Paulson and Tepper stand as examples.

 What I found most interesting about that early February dinner was that one of the attendees was none other than George Soros.  A lion in winter he might be but one more round of currency speculation, it seems, is just too much of a good opportunity to ignore.

Now what was that about those nasty speculators?

There is no Credit Default Swap traded on the Euro as it is not a sovereign government and as such cannot issue debt.  The largest economy within the Eurozone is Germany and as such is used as a proxy when examining the financial health of the common currency, due respect given to France and the other members.

Germany’s CDS traded around 20bps last fall, moved as high as 47bps during the height of the Hellenic hullabaloo and closed last night at 39bps.

The problems in southern Europe are far from over as is the case in most other parts of the world.  It would appear, though, that the efforts of the stronger countries to protect the weaker members of the EU and keep the Euro intact have staved off a collapse for now.

If nothing else, the EU’s show of unity should make things that much more interesting for George and the boys.

Enjoy the week.

 Jim Delaney



Credit Market Overview

March 1, 2010

http://www.marketstrategiesmgmt.

Jef I. Richards holds a Ph.D. in Mass Communication from the University of Wisconsin, a J.D. from Indiana University, a B.S. in Photography from the Rochester Institute of Technology and an A.A.S. from the same school in the same discipline.  A learned man by most standards but someone who might have stayed off the radar had he not he said two words that have resonated through all forms of media since they were uttered.  Those two words?  “Sex sells”.

In all fairness to the good professor, and to my own journalistic integrity Dr. Richards actually said "In advertising, sex sells. But only if you're selling sex."

Without getting too far off topic this morning; given all the advertising we are bombarded with each day, all I will say with regards to the qualifying portion of Jef i.’s quote is that there must be a lot of sex for sale because there is an awful lot innuendo broadcast in every form of media.

Of a bit more relevance, hopefully, is the equivalent of the “sex sells” modus operandi in the news.  A headline alerting of present or possible crisis goes much further in grabbing out attention, and our dollars, than one proclaiming all is right with the world.  A recent example of this has to do with the United States’ relationship with China.

On February 17^th my favorite newspaper the Wall Street Journal (seriously), took a third of page A8 for an article describing how China sold a record amount of its U.S. Treasury holdings which resulted in the Middle Kingdom ceding the title of Uncle Sam’s largest foreign holder of his debt to Japan.  China, it was reported, sold $34BN Treasuries bringing its holdings to $755.4BN.  That number was slightly less than the $768.8BN reportedly held by those from the Land of the Rising Sun and the first time there was a lead change since August of 2008.

This news helped stoke fears that China was moving beyond rhetoric in its displeasure with the United States for the $6.4BN worth of arms sold to Taiwan as well as President Obama’s meeting with the Dalai Lama, the Tibetan spiritual leader whom the Beijing denounces as a separatist for his efforts to win greater autonomy for the Himalayan region.  Secretary of State Hillary Clinton was to meet with His Holiness on Thursday although I am not sure how that was viewed by Beijing.

Adding a little fuel to the fire, China announced a day later that Zhang Yesui, originally a vice minister for China’s Ministry of Foreign Affairs, who then went on to become the head of China’s United Nations Mission, would become the new ambassador to the U.S., putting a non-U.S. specialist in the post.

Not to be lost in any of this is the pressure the U.S. has been putting on China to allow the Yuan to float as the view from Pennsylvania Avenue is that the currency is under valued.  Towards this end a White House official said, “We expect to see actions by China” to help rebalance global trade flows, adding that ‘if Beijing fails to act, that “will put greater and greater pressure on the U.S. to respond’”.  Nice way to speak to your ex-biggest customer!

In total the amount of newsprint allocated to describing the tensions between the two nations was, by rough count, about 1¾ pages.  A reasonable amount when considering everyone’s focus on costs these days and the amount by which add spending is down.

Where it gets interesting is that this past weekend in the “World Watch” section of the Saturday edition of the WSJ there was a small piece, about 20 lines, saying that no such lead change had occurred and the China was still in 1^st place on the holders lists for Uncle Sam’s I.O.U.’s.  The Treasury department, it seems, needed a little extra time to count all of China’s holdings which Geithner & Co. now say equal $894.8BN.

Was it much ado about nothing or does China believe that to really hold Uncle Sam’s feet to the fire they have to be on top of the league tables?

Sovereign CDS for China closed at 76bps on Friday off of a near term peak of 91bps on 2/8.  The 90-91bps level has proven considerable resistance has it has not been meaningfully broken since May of 2009 when the CDS entered the 91bps-58bps range from much higher levels.

The CDS for the U.S. has come off of a peak of 63bps on 2/8 and closed on Friday at 46bps.  Leading up to the 2/8 high there was a spike to 42bps so that might provide some unwanted support.  Having said that the 48bps spike hit last May did not impede the current move lower’s progress so if things continue to calm down on the sovereign stage there could be continued progress lower.

Enjoy the week.

Jim Delaney