Confused Crisscrossing Markets

Posted by T.W. Hanson - Mar 12th, 2008 at 21:03

 directions

Since the current financial trouble started in the summer of 2007, stock, credit, currency and commodity markets have moved severely.  Interesting is the lack of coordination.  The past 48 hours are a good illustration of this phenomenon.  Equity markets found the $200 billion in lending from the Fed to be fabulous news while the bonds of some of the very same equities didn’t really move.  Traders in the currency markets were convinced early today that the Fed action would fail in its purpose, and pummeled the dollar.  It took the equity market until the end of the day to react in a seemingly similar fashion.  What is the cause of this confusion?

Analytics and quantitative models have lost the faith of the market.  Tools used to value everything from the value of a mortgage to probabilities of corporate defaults are coming scrutiny.   The equations, machines and historical correlations that have typically governed market behavior broke down over the summer.  The variations of models used to value everything from bonds to mortgages to credit default swaps are more disjoint, leaving traders with less uniform valuation techniques.  Think of a heard of buffalo all losing their sight while barreling across the Serengeti.  One example was the lack was the lack of any consolidation of opinions on what the quantitative impact of the Fed’s $200 billion infusion will be.

Without the unifying models and historical correlations, specialization in training on Wall Street becomes another force decoupling the markets.  As my former superiors in investment banking liked to say, “The days of the generalist are over.”  Foreign exchange, corporate credit and equity people work on separate floors; it is even rare to see them at the same social functions.  With all of the current turmoil, each of these worlds is interpreting data differently.  For example, credit analysis often focuses on the past performance of a company while equity markets usually value securities based on future cash flows.  The equity world is much more likely to forgive big write downs and look to the future while credit investors have their attentions squarely on the trauma of the past half year.  We have seen more than a handful of days in 2008 where equities have traded higher while bond spreads have increased, truly irreconcilable moves in “efficient markets.”

What this will bring in the weeks ahead is volatility.  Until it is somewhat clear in what direction the economy is moving or at least what the general effect of Fed policy will be, the markets will continue to move in confounding directions.  Rumors will continue to fly, which have already almost brought down institutions like Bear Stearns.

Tomorrow, we get to see how the markets will interpret retail sales numbers.  Consumer spending makes up over 2/3 of the economy.  The number isn’t likely to be pretty, but how much of that is already priced in to the market?  Wait, how much of that is priced into which market?

Work = Force * Distance

Posted by T.W. Hanson - Mar 10th, 2008 at 20:03

Hopefully physics class in high school didn’t keep you awake at night like it did for me. One puzzle that always bothered me was the formula work = force * distance. Lying in bed, it was very clear that I was in the same spot where I began the day. My net displacement was zero meters. Therefore, the amount of work I accomplished was zero. How much work has the stock market done since January 14, 2000?

INDU

The Dow Jones Industrial Average closed today March 10, 2008 at 11,740.15. It closed on January 14, 2000 at 11,722.98. 0.1% price appreciation! This is not adjusted for inflation. In purchasing power, the January 2000 value is significantly higher.

Over the past 8 years, we haven’t moved very far. I’ll leave it to you to figure out how much work we have accomplished.

What to Look for Tomorrow: The Jobs Report

Posted by T.W. Hanson - Mar 6th, 2008 at 21:03

worker

Every four to five weeks, we get to see whether more or fewer people are finding jobs.  The number comes out on the first Monday of each month.  This is one of the most important economic releases of the cycle.  It shows us what happened is happening in the U.S. labor markets and allows us to better forecast what is coming next.  Look for it not only to set the tone for the markets for the rest of the day but permeate into political discourse as well.

Economists are currently forecasting an increase of 25,000 jobs and an unemployment rate of 5.0%.  A large deviation from either of these numbers will move the financial markets.  If the numbers are as predicted, you will only need to suffer a few newspaper headlines and political rhetoric as the statistics are spun.

Watch the futures at 8:30AM Eastern for the reaction.

Biting the Dust in Santa Fe

Posted by T.W. Hanson - Mar 5th, 2008 at 20:03

ghost town

In the latest chapter of the current credit crisis, Thornburg Mortgage received a notice of default from JP Morgan.

Thornburg Mortgage is a Santa Fe based mortgage lending institution that invests in a portfolio of highly-rated adjustable-rate mortgage securities and loans.  The company specialized in “jumbo” mortgages, large mortgages used to finance the purchase of large homes.  Thornburg especially suffered from federally sponsored entities like Fannie Mae being prohibited from purchasing these jumbo loans.

This means that we have another casualty of the current economic environment and that people are defaulting on large mortgages.

If this trend continues, vicenarians may be able to accumulate mansions on the cheap.

The Bond Insurance Version of “My Dog Ate My Homework”

Posted by T.W. Hanson - Mar 3rd, 2008 at 21:03

homework dog

Radian Group, one of the bond insurers, notified investors and the SEC today that they are unable to file their annual report. When a company cannot file a report on schedule, they must cite reasons. Radian’s was that they couldn’t keep people employed who knew how to value their assets. Their exact wording follows.

We did not maintain a sufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with our financial reporting requirements. Specifically, this deficiency resulted in audit adjustments to Derivative Liabilities and Change in Fair Value of Derivative Instruments line items in the consolidated financial statements for the year ended December 31, 2007 primarily arising from insufficient (1) identification of derivative instruments; (2) review, approval and testing of complex derivative valuation models, including assumptions, data inputs and results; and (3) identification of contract terms and transactions requiring consolidation in accordance with generally accepted accounting principles, related to such financial statement line items.

Wow! Is this what the end of capitalism looks like?

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