Want more scary stuff? From the News Hour last night:http://www.pbs.org/newshour/bb/business/july-dec08/psolman_1...NASSIM NICHOLAS TALEB: Now you understand why I'm worried. I hope I'm wrong. I wake up every morning -- actually, I don't wake up every morning now. I start to wake up at night the last couple of weeks hoping that I'm wrong, begging to be wrong.I think that we may be experiencing something that is vastly worse than we think it is.PAUL SOLMAN: And we think it's pretty bad.NASSIM NICHOLAS TALEB: It's worse. Of all the books you read on globalization, they talk about efficiency, all that stuff. They don't get the point. The network effect of that globalization, OK, means that a shock in the system can have much larger consequences.. . .PAUL SOLMAN: What is the doomsday scenario? I mean, what actually happens tomorrow, next week?NASSIM NICHOLAS TALEB: I mean, I am convinced -- there's been a package recently of $700 billion. It's pocket money, because you don't understand -- they don't understand the ripple effect that hedge funds have, OK, that the banks not lending to hedge funds will force hedge funds to liquidate positions.PAUL SOLMAN: Sell off?NASSIM NICHOLAS TALEB: Sell off positions. These positions, sold off by hedge funds, will impact other entities.PAUL SOLMAN: Driving down the price.NASSIM NICHOLAS TALEB: Driving down the price. Driving down some prices. That a supermarket, OK, needing funding, will not be able to find a bank solvent enough to lend them money against inventory to make payroll, OK?You may have chain reactions we've never imagined before. And these come from the intricate relationships in the system we don't understand.Mandelbrot and Taleb are as droll as can be. Taleb hopes he's wrong. Swell. I have a feeling he's 100% in cash. I am beginning to wonder if the dire prediction of a complete and total meltdown of the financial system is a virtual certainty at this point.
"I am beginning to wonder if the dire prediction of a complete and total meltdown of the financial system is a virtual certainty at this point."Nearly all the experts seem to be saying the same thing. This is the greatest risk to the global capitalist economic system since at least the great depression. Total collapse is possible.This is a perfect storm situation in the economic sense. Major portions of the banking system threaten to stop working. And getting them restarted may take more money than the governments of the world have. If that happens, then what?Let's hope the efforts being made to keep things functioning will succeed. They are certainly trying. But clearly the crisis is not over. This is only the end of the beginning as they say.
But clearly the crisis is not over. This is only the end of the beginning as they say. Or the beginning of the end. We simply have no way of knowing. The SPX is already down 43%, so in terms of equity prices we are past 'the beginning' by any reasonable definition.
But recession numbers are just beginning to trickle in. We have no idea how long the economic slowdown will last, how low it will go, how high unemployment will get, etc, etc.If real estate prices fall by half from here, we have a long way to go to the bottom.
General press coverage of the stock market is almost always terrible and just adds to the extremes of optimism and pessimism. I actually have a lot of respect for Taleb and what he does but why wasn't he getting more interviews two years ago, when the stock market was hitting new highs monthly and volatility was at an all time low? Here's my take on the press:When stock market is way down:The press starts writing about or interviewing those who currently have a bearish view far more often than those with a bullish view.The press places a much higher emphasis on the bad news rather than the good news (How many articles have you seen lately talking about the rapidly improving trade deficit? Now think back to how many you saw about the rapidly deteriorating trade deficit back in 2003).Worst of all, the press (and I most assuredly include things like Marketwatch with the "press") invents all sorts of reasons for why the stock market is down in the last hour, or last day, or last week.When the stock market is way up and has been up several years in a row:The press starts writing about or interviewing those who currently have a bullish view far more often than those with a bearish view.The press places a much higher emphasis on the good news rather than the bad news.Worst of all, the press (and I most assuredly include things like Marketwatch with the "press") invents all sorts of reasons for why the stock market is up in the last hour, or last day, or last week.It's really simple: The stock market goes down when investors get more pessimistic and fearful. The stock market goes up when investors get more optimistic and confident. If you want to buy low and sell high, you buy when fear is high and sell when fear is low.But aren't there problems and risks right now? Yes, of course there are. The stock market might go down another 10%, 20% or 30% before it ultimately bottoms.But there are all sorts of positive things the press is under-reporting right now, such as:1) Valuations by most long term measures put the stock market at the cheapest they've been for the last 13 years, perhaps longer. This is great news for those below the age of 50 because it means that means a no-nothing approach of dollar cost averaging into a couple of market indexes is likely to lead to returns of around 6% or 7% better than inflation over the next 20 years.2) Energy prices are way down - helping to reduce the cost of living for most people.3) Home prices are down. This is great for people who are about to become first time home owners.4) The trade deficit is very rapidly improving and will improve even more rapidly in the next couple quarters thanks to dropping oil prices. 5) The internet revolution that was supposed to transform our lives for the better in the late 90s is actually really transforming our lives for the better now, and the price just keeps getting lower. Google essentially makes 70%+ of the functionality of MS Exchange server available to individuals for free, allowing email and calendar to be available anytime, anywhere, and shareable within your organization. You can buy 10" laptops for under $400 and desktops for less. The internet has greatly lowered the cost of mobile telecommunication. The list goes on. You saw this in the news all the time in 1999 when it was really just a dream. Now it's happening and (unless it's related to iPhones or iPods) doesn't get much press outside of tech-oriented magazines and web sites.6) Global cooperation in dealing with this crisis is unprecedented. In the early 30s, there was little cooperation which led to collapsing economies in many parts of the world - and some believe that this created the conditions which led to WWII. You can argue that some measures are not very smart, or that governments are doing too much or too little - but the global coordination is incredible and will perhaps mean that this global economic bust will not lead to another world war as happened 60-80 years agoI could go on, but my point is made. I could also go on about all the negatives right now - of which there are a bunch - but you've already read about them ad nauseam in the press, and you'll keep reading them until the market goes up a lot - then you'll start reading about all the positive things again.
Why is it the hedge fund intricacy of relationships has any control of what the business is doing just because they happen to own the stock? The market place may be broken, hedge funds go under, millionaire investors may not be able to cash out, prices of stock goes down as the hedge funds liquidate. but honestly what the **** does any of that have to do with Pfizer's cash flow or 3Ms cash on the balance sheet? Global business is slowing but all these giant blue chips I cover--3M, PFE, UNH, ---are not guiding to total dissolution and meltdown and shutting the doors. When we buy stock are we not buying what the company does and even though the price is hedge fundish the business is not? is every business in the world going to shut down.Is this the final Black Swan event for Taleb? the end of days?it's hard not to take financial geniuses like Taleb seriously but the constant doomsaying and end of days postulating is starting to get on my nerves. I don't want to sell at all time lows for companies I like, who are not in financial trouble and who may get slower for X number of years but eventually have a future in the bright new dawn that will surely follow all this disasterUnless of course the sun goes red giant next week and toasts the galaxy but that's a different story
KKK, count me in the group that thinks there is worse yet to come. Collateral damage is of course stock prices that are sometimes insanely ridiculously far below what they're worth, even among the best companies.All this does have some impact on the future performance of all companies however. Compared to standards assumed over the last 10 years, WACC will rise, growth assumptions will moderate, uncertainties about the future will increase, including the threats of inflation/deflation. All these affect inputs to valuation models, forcing valuations down both due to impact on the company's performance and the margin of safety that should be used to arrive at valuations. These things could add up to a factor of 1.5 - 2 even for very good companies, especially given the extreme sensitivity of valuation to discount rates, long term growth rates, and the competitive advantage period assumption.I think, IMHO, valuation model inputs we're used to using are strongly influenced by the economic climate we've been in for 20 years, which has been a bit (and occasionally extremely) unusually positive. For my own work I am ratcheting up the valuation conservatism in all areas going forward.-Mike
All this does have some impact on the future performance of all companies however. Compared to standards assumed over the last 10 years, WACC will rise, growth assumptions will moderate, uncertainties about the future will increase, including the threats of inflation/deflation. All these affect inputs to valuation models, forcing valuations down both due to impact on the company's performance and the margin of safety that should be used to arrive at valuations. These things could add up to a factor of 1.5 - 2 even for very good companies, especially given the extreme sensitivity of valuation to discount rates, long term growth rates, and the competitive advantage period assumption.I think, IMHO, valuation model inputs we're used to using are strongly influenced by the economic climate we've been in for 20 years, which has been a bit (and occasionally extremely) unusually positive. For my own work I am ratcheting up the valuation conservatism in all areas going forward.http://www.indexuniverse.com/sections/research/4622-active-i...http://www.indexuniverse.com/sections/research/4665-active-i...It is time to question past assumptions and expand our views to market and economic conditions that existed all the way back to the panic of 1873, which was a time more like that of 2007-2008 than any other crisis period (more on this later; see http://www.itulip.com/ for 1873 comparisons). to see Mr. Market readjust his view on equity valuations. He is moving equity prices from levels that were sustainable in a leveraging world to values that are better suited for a world in which we hold much less debt. Since 1994, equity P/Es expanded from 14 aided by a massive degree of leveraging. They are now in the process of contracting via a massive forced deleveraging (since the 2nd quarter of 2007).
http://traderfeed.blogspot.com/2008/10/coping-with-challengi...Coping With Challenging Markets By Hedging Your Bets: Financial and Personal It really has been an amazing time; I've traded the equity markets since late 1977, and I've never seen market and economic conditions like these. It's not just the ferocity of the decline: it's also the extended high volatility and the way that so many of the major asset classes: commodities, bonds, and stocks have been hit hard--and simultaneously.Traditional logic says that such pervasive bearishness should lead to favorable market returns going forward. After all, who's left to sell when everyone is bearish? In normal times, that logic holds. Although I'm currently working with a scenario of stock market bottoming and an eventual intermediate-term rally, I'm not sure the traditional logic makes for sound investment policy. At some point, qualitative differences yield quantitative ones: when negativity is pervasive, it affects future decision-making, with self-fulfilling effects for the economy. That's what we saw at important secular market bottoms in the 1930s/1940s and in the 1970s/early 1980s. Undervalued markets stayed undervalued for an extended time; bottoming took years.In times of stress, we tend to anchor our thinking in the most salient pieces of information; behavioral scientists refer to this as the availability bias.Prudent investment planning, however, suggests that neither extreme is necessary. The important consideration is identifying which assets (stocks, bonds, etc.) are likely to outperform the general markets during any period of extended weakness and ground investment in those. Then, hedge your bets. If you think that some companies that offer value to consumers--or that offer necessities--will outperform those that do not, you can be long the attractive names and short the unattractive ones. Or you can be long the attractive names and short the broad stock market. You hedge your bet by reducing your exposure to overall market risk. Your investment becomes a relative value play, rather than an outright directional one. I almost never hear financial planners talk about that, and I almost never hear of such strategies from the general investment public.That having been said, one antidote for abnormal markets is to ground ourselves in normal, daily life and the things we can control and enjoy.Looking out the next 2-3 years, do we have to become long-short hedge funds and swing traders to make money??? As a thread on the Berkshire board was discussing, is buy and hold dead, at least for the next few years. http://traderfeed.blogspot.com/2008/10/cross-talk-deleveragi...That is the way of psychological trauma: a single set of painful, powerful emotional events can reshape perception and action. As the deleveraging of the consumer unfolds, I believe we'll see a similar reshaping of views: fiscal prudence will become a mantra for households--and eventually will be expected of government. Not all of that will be for the worst. In the interim, however, that deleveraging--and the accompanying shift in attitudes--will create winners and losers on Wall St. Companies that produce necessities and that create unique value will prosper over those that connote luxury; firms that are well-capitalized and generate significant free cash flow will have the advantage over those that depend upon borrowing--their own, and that of consumers.
what the **** does any of that have to do with Pfizer's cash flow or 3Ms cash on the balance sheet? Global business is slowing but all these giant blue chips I cover--3M, PFE, UNH, ---are not guiding to total dissolution and meltdown and shutting the doors.==========================If the credit-dependent spending by consumers drops 5 percent in a downturn and unemployment goes from 5 percent to 8-9 percent and the number of people without health insurance goes up even further, who is going to be buying the drugs Pfizer makes out of their own pocket? If people aren't working, they'll be even less able to afford the insurance from United Healthcare that their former employer used to purchase for them.Assuming that drug and healthcare stocks are indispensible services that won't be as affected in a downturn like cars / retailing assumes the ability to get / afford insurance is relatively unchanged. That may not be a safe assumption with falling wages, rising unemployment and consumers forced to choose between paying their electric or heating oil bill versus getting their yearly physical or renewing a prescription.WTH
Assuming that drug and healthcare stocks are indispensible services that won't be as affected in a downturn like cars / retailing assumes the ability to get / afford insurance is relatively unchangedi am not assuming it will be business as usual. The examples are just a few of the companies I follow that have reported earnings. What I was looking for is companies that can survive even if growth is flat or down. healthcare insurance suffers in high unemployment scenarios like nowDrugs do to.I know that and am already seeing it. But two things this type of company has are: built in demand that may slow but will reassert itself when the economy permits and the assets to survive. These types of companies have amazing cash flow, manageable debt and good credit that allows access to commercial paper backed by their word because they have the resources to back it. That goes for 3M and a whole lot of others.In other words barring a true Black Swan event like a super nova sun frying planet earth, at very cheap prices with every hope of survival, it may be worth buying them at 52-week lows or 3 year lows or 5 year lows (as is the case with Zimmer today) rather than yielding to terror and the instinct to run and selling at a loss or never buying at all. And I don't mean to focus just on healthcare, but it is one I follow.i think the same could be said for energy--is Exxon Mobil going to die? Or Conoco Phillips. These companies make money and generate significant cash and own real stuff(oil and gas) and need only survive until the price of oil goes up. it will. Energy services companies ditto if the balance sheet allows. The things human beings need are not going to go away forever in a recession--they may go into the deep freeze. With 6 billion people on the planet, we are going to use everything until it's gone and that's the time I would be selling i listened to the entire interview and have huge respect for both But it was maddeningly vague and chaos would say it can go right just as easily as it can go all wrong. Turbulence--who can predict where it will throw us? Could end up throwing us back into the track we came to know and love after the 1907, '29, most of the '30's, '74 and '87 and 2000 chaos. If there is an end to this as history suggests, then can't we own some survivors without feeling like we are being as utterly stupid as the media tells us we are every day? So much noise
Concerning the media's bi polar approach to news. They don't know anything about economics or finance, and they don't care. They are in the business of selling newspapers or getting media viewers. During bad times it's easier to sell bad news, that's what the audience wants. Vice versa during good times. But scandals and sex sell well any time.
Last year, I wrote what turned out to be a surprisingly popular post about the wild swings of optimism and pessimism in the press in conjunction with rising and falling stock prices. I think I was a bit wrong in one specific section:When the stock market is way up and has been up several years in a row:The press starts writing about or interviewing those who currently have a bullish view . . . I guess I should have said "When the stock market is way up and has been up several MONTHS in a row."FWIW, I am as usual at odds with the popular press reporting of the current financial situation. I'm far more bearish than I was on 10/22/09, despite the overall value of the U.S. stock market only being up a modest 15% or so since then.The housing market is what is scaring the living daylights out of me, and the near complete refusal of the press to discuss anything but the headline numbers (which are misleading for a variety of reasons).There is an enormous amount of shadow home inventory throughout the system that is being withheld from the market - sometimes due to insufficient administrative capacity, sometimes due to direct government intervention, sometimes due to banks wanting to delay as long as possible taking losses onto their books. I don't know how long the charade can continue - but eventually these homes have to come to market at a faster rate, and that means further pressure on home prices and all the corollary effects. Add to that the pressure from rapidly rising prime loan delinquencies that will eventually convert to foreclosures . . . .Let's just say that I don't share the optimism of the commentators.While I don't really have the understanding of an MDCigan when it comes to all the various technical market indicators - I basically share his view that we're likely to revisit the lows of March 2009 (if not blast through them). I think the catalyst will be the second leg down for the housing market.The irony is that I've been very bearish on the home market since 2003 and expected a big catastrophe - it distorted my view of many an investment (i.e. too scared to touch Home Depot in 2003). But the actual reality as I see it (through the lens of home inventory data) is considerably worse than what I expected.
Completely anecdotal one off story coming from a state with 15% unemployment, but...I have a friend who bought a house in 2003, for $160k. Now this is not exactly the nicest house, it's in the middle of nowhere, 3 miles on a dirt road off a highway that's about 15 miles from the nearest location with a significant number of "good" jobs. He of course put 5% down and has been paying PMI for the past 6 years. He has paid the mortgage down to less than 80% of the purchase price and wants to get rid of PMI.The mortgage company does an appraisal. Now he is realistic, he doesn't think the house is worth anything close to $160k. but he owes ~$120k on a mortgage. He pays it every month on time. Even pays a little extra principle each month. It's a 6% 30 year fixed rate mortgage.The appraisal says it's worth ... $66k. If he was to sell it, they suggest listing it at $72,900.He owes $120k. He makes too much money to get the terms of the mortgage modified under the "Help for Homeowners" program.So he's talking to some attorneys about how to approach the lender (GMAC, of course), about reducing the principle owed. If they don't feel like working with him, he's already looking into contingency options... His exact words to me, "other than my conscience, what the he11 is my motivation for paying the mortgage?" He feels he can go 7 years without credit if necessary...So anyway, long winded way of saying, anyone who thinks housing has bottomed or that bank's balance sheets have taken enough write-downs, may just be in for a surprise. This is a completely performing 6 year old mortgage that's worth about $0.60 on the dollar. Oh, and Zillow says the house is worth $113k. On a positive note, there are houses in my subdivision which have recently sold at what do not appear to be fire-sale prices. I have no idea if we'll revisit the lows or not, but I do think the market is going to correct. And I'll keep losing money buying puts until that happens!
His exact words to me, "other than my conscience, what the he11 is my motivation for paying the mortgage?" He feels he can go 7 years without credit if necessary...D*mn, that is a sad story. I feel for the guy, but it is a tough call here, right? I mean he has already put in a 8K down payment + how many months of payments + the extra principal he has paid. Technically, that is a sunk cost now but do you just walk away from all the money you've already poured in? If he likes where he lives and can see being there another 10-20 years, maybe eventually we get a decent rebound, although I suspect home prices are going to stay depressed much longer then many people fathom (the demographics are terrible).http://alephblog.com/2009/09/04/tickers-for-the-latest-portf...Measure twice, cut once. Risk control is best done on the front end, analyzing what you will buy,Not to be a d***, but sometimes the best solution to a problem is to make sure you don't make terrible mistakes to begin with.I have no idea if we'll revisit the lows or not, but I do think the market is going to correct. And I'll keep losing money buying puts until that happens!Don't fight the tape. :) There will come a day to buy puts but that day is not yet IMO.
At least with a house you can live in it, it has utilitarian use in itself. Which is more than I can say about the stocks that I lost money on.
Meredith Whitney on CNBC this morning said housing has 25% more downside left... I hope she's wrong.
Meredith Whitney on CNBC this morning said housing has 25% more downside left... I hope she's wrong.I hope (even pray) she is right this time too.
I hope (even pray) she is right this time too. May I ask why? The only scenario where praying for a 25% decline in home prices makes sense is one in which you will personally profit, either through buying property at lower prices or being short a bunch of stocks or indices that will suffer as this happens.But personal gain, as much as it may be, unless it's of the John Paulson variety, will likely be overshadowed by years of recession like living conditions. Regardless of how much I would stand to make, I can't think years of suffering for so many people would be an acceptable outcome.At least I can't think of another situation where a 25% decline in housing prices is a good thing...Her argument was that economists see home ownership returning to the 65% level from the 67% level today, which means less demand and equal supply, hence prices go down. She didn't say where the 25% number came from...
I hope (even pray) she is right this time too.May I ask why?The only scenario where praying for a 25% decline in home prices makes sense is one in which you will personally profitHow about if the person doing the praying thinks there's plenty of room for a further 50% decline?(Note: I am not of that opinion myself - at least not on a national scale. I think that a further 50% decline may be plausible in a couple of metropolitan area and a larger number of specific neighborhoods, but I don't think the national average will see anything like that. At least not in nominal terms, and in real terms it'll take probably more than five years if it happens at all.)
The mortgage company does an appraisal. Now he is realistic, he doesn't think the house is worth anything close to $160k. but he owes ~$120k on a mortgage. He pays it every month on time. Even pays a little extra principle each month. It's a 6% 30 year fixed rate mortgage.The appraisal says it's worth ... $66k. If he was to sell it, they suggest listing it at $72,900.He owes $120k. He makes too much money to get the terms of the mortgage modified under the "Help for Homeowners" program.An alternative point of view is that the mortgage company has lowballed the estimate of the house's worth. Going from $160k in 2003 to $66k in 2009 does not pass the smell test, unless something is seriously wrong with the house and he paid way too much. The Zillow estimate sounds more in line with the kind of declines we have seen in most places, unless he lives in Detroit or something.More likely, the bank is quoting a figure that is way under market value. If the guy turns over his keys, and the bank sells the house for $130k, then they are off the hook for another mortgage. (I don't know if they have any legal requirement to refund the excess, i.e. the 10k above the 120k they are owed, to your friend.)I think he should get a 2nd opinion about the value of the house before he gives up on his house.Regards, BP
unless he lives in Detroit or somethingAbout an hour north of the city. An alternative point of view is that the mortgage company has lowballed the estimate of the house's worth.yes, that is a possibility, but there are vacant, foreclosed homes around him, with asking prices not to far from the appraiser's number (I think $79k)... The house across the street has been vacant for 2 years, I don't know if it's even on the market anymore.The biggest issue he faces is it's just an area that nobody wants to live. As I mentioned, it's 3 miles on a dirt road just to get to his little "sub", and it's 15 minutes to the nearest shopping "stuff" (other than the odd corner store/gas station). So nobody is going to choose to live here unless it's the only place they can afford a house of the size they want (how he ended up here). But times have changed since he bought, and there are much nicer houses closer to civilization. Prices have come down in other areas where anyone moving from an apartment on a single income doesn't need to move where the house to afford a house.It's basically an issue of no demand...
ok, but if it's around Detroit, it is not really a harbinger of what's in store for the general economy. It's a tough quandary to be in, I don't know what I would do. Given the fact that the value of the house is probably related in some way to how business goes with Govt Motors and Ford, I would not be very optimistic about price recovery, and I would be looking for some way to get my conscience in line with the sensible economic decision...Regards, BP
I would be looking for some way to get my conscience in line with the sensible economic decision..Me too. That is a tough one. If he LIKES where he lives he could buy one of the neighbors for $60k and walk away from the $120 loan. He might want to have a new house in hand before he trashes his credit. That option introduces a serious morale dilemma I think. There would be some transfer costs in that plan and some credit pain and suffering so maybe he can work with the bank on a solution that is win-win (Maybe reduce the loan to $85k). Maybe they'd reduce the loan down a bit to something more reasonable if the possibility of being stuck with an unsellable house is the only other option. He might have some leverage if the bank provided contact to the original assessment. Maybe he could put more money down to sweeten the offer and make his chance of walking later less likely.Talk to the bank, esp. if it is a local bank. Nothing ventured, nothing gained.
There would be some transfer costs in that plan and some credit pain and suffering so maybe he can work with the bank on a solution that is win-win (Maybe reduce the loan to $85k).The irony of the situation is all he wanted to do was stop paying PMI. The lender does an appraisal which says his house is worth a fraction of what is owed and won't get rid of PMI now. So he's considering handing them the keys as he doesn't want to be living in the house in 10 years.Of course the lender feels they're "safe" since they have insurance on the loan, he's not delinquent and makes enough money to cover the payments easily, so why would they modify it?It will be interesting to see what happens here. I'll report back if anything changes.
<<he could buy one of the neighbors for $60k and walk away from the $120 loan. >> And his neighbor could do the same. Each winds up with a very similar house at half the cost.I'm surprised that more of this isn't going on. Defaulting on your loan is the sensible thing for many people. The negative credit ramifications don't extend much beyond two years into the future. But it isn't just a house you are defaulting on, it's a home and maybe that's what's holding people back.
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