Oct 5, 2013
The October issue of The Credit Strategist is posted - “Taper Capers”. If you are not already a subscriber, be sure to subscribe today!
July 5, 2013
The July issue of The Credit Strategist is now out – “The Mirror Cracks.”
May 31, 2013
The June issue of The Credit Strategist will be posted on Monday, June 3, 2013. Entitled “The Illusion of Stability,” it discusses my view that it is unlikely that the Federal Reserve will alter its current policy regime for the foreseeable future. For that reason, the current equity market sell-off is likely no more than a run-of-the-mill correction after seven consecutive months of gains. Such a correction was entirely predictable, which is why I suggested that investors start reducing equity positions last month and take profits. The key take-away from the market’s recent action is that the mere hint of any change in Fed policy is sufficient to send investors running for the exits, suggesting a lack of conviction in the rally reinforced by tepid economic data and leftover scars from the financial crisis. Fed policy is becoming less and less effective in terms of stimulating the economy, yet any policy change that allows interest rates to rise is likely to hurt both the economy and markets. For that reason, markets are correct to sell off if they believe that such policy changes are imminent. I simply don’t believe that such changes are imminent, and for that reason I believe the correction will be limited. Credit conditions remain healthy in the corporate space though the distressed bonds and loans of the next cycle are definitely being manufactured in today’s new issue markets. The best opportunities remain short duration special situation and event-driven bonds and loans and select mortgage securities.
May 13, 2013
Health problems have kept me away from blogging but they have certainly not kept stock and bond markets from reaching new heights (or in the case of bonds, new lows in yields and spreads). While virtually nobody can point to a reason for the party to end, the absence of bearish arguments is troubling in itself. After all, reality is never one-sided; markets don’t go straight up or straight down. At this point, the divergence between bond and stock markets and equity markets and economies are stark enough to call into question investors’ traditional assumptions about virtually everything. Unprecedented central bank policy has moved the world into uncharted waters and the tools we have relied on in the past may be insufficient to guide us in the future.
There are a few things that are clear. Investors should not be buying high yield bonds at yields under 5%. They should not be lending money to the U.S. government for 10 years at under 2% or for 30 years at around 3%. Those yields guarantee negative real returns. By way of comparison, it is hard to argue with the proposition that equities paying a 3% dividend offer a much better proposition since they at least offer the prospect of principal growth while bonds offer lenders a paltry yield and a pat-on-the-back but nothing more if things work out. Over time there is little question that reasonably valued equities are a better bet than low yielding fixed income securities.
We also know this: in the next 3-5 years, the world will be faced with central banks trying to withdraw the largesse they have been bestowing on markets since 2009, at first out of necessity and then out of some ill-placed belief that they could manage the business cycle and take the place of fiscal policy. That process is unlikely to go smoothly because the world’s economies will be unable to generate sufficient income to service all of the outstanding debts that will have been created. As a result, those debts will have to be reduced in value by means of inflation, currency devaluation and outright defaults; they can not be repaid in constant currencies. How the world gets from where it is today to where it needs to go is the challenge facing policy makers and investors. It is a challenge the world has never faced before and will require novel thinking, bold leadership, moral courage and strong character.
April 7, 2013
I am starting to have serious concerns about the Bank of Japan’s extraordinary monetary stimulus. While last week’s announcement that the BOJ would be doubling its purchases of Japanese Government Bonds (JGBs) and other financial assets (including foreign securities) did not come as a surprise, the magnitude of its efforts combined with those of the Federal Reserve, the European Central Bank (ECB) and the Bank of China are nothing short of overwhelming. Japan alone will be doubling (almost – they will be purchasing about $80 billion per month compared to the Fed’s $85 billion per month) the Federal Reserve’ quantitative easing efforts. But other major central banks are also purchasing enormous amounts of government securities, which force feeds huge amounts of liquidity into the financial system. The fact that these floods of liquidity are not pushing asset prices up faster than they are should be raising more alarm bells than it is. Monetary policy is having a minimal effect on real economies while it is rewarding financial market speculators. It is no accident that there is such a high correlation between the rise in the S&P 500 and the growth in the Federal Reserve’s balance sheet. Compare that with the lack of correlation between those two and the growth of the U.S. economy, or jobs growth, or other meaningful measures of economic growth.
One of two scenarios is likely to unfold very soon: the flood of money will just be added to the already massive piles of money sitting on central bank balance sheets and not make it into circulation in the real economy, which will continue to suppress interest rates and feed speculation in financial markets, or it will enter circulation and push up prices fairly suddenly. The first scenario will simply push further into the future any possible date at which the Federal Reserve can change policy, and the second scenario will lead to a rout in bond markets worldwide.
In the April 5, 2013 issue of his invaluable GREED & fear, Christopher Wood makes the point that the lines between monetary and fiscal policy are eroding, and that central bank policy is becoming increasingly unconventional. As a result, he writes that “rather than contemplating exiting such [unconventional] policies, the central banks are moving further and further away from the exits.”
In the case of Japan, one could argue that this was a decision of the voters, who placed Prime Minister Abe in office with a clear mandate for the type of change that is now occurring. In the United States, the Federal Reserve is an unelected body and the direct line between it and the voters is far more mediated (although clearly the Obama administration was seen as supportive of easy money). But we are clearly in uncharted waters and we are likely to experience unforeseen consequences as a result of the unprecedented, coordinated massive quantitative easing policies of the world’s central banks. The most likely consequence in the near term will be an end to extended period of low volatility that markets have enjoyed since the beginning of the year.
April 1, 2013
The May 2013 issue of The Credit Strategist will be published tomorrow – “Sanctities of Contract.” If you are not already a subscriber, be sure to subscribe today!
|March 17, 2013 Last week saw some sharply contrasting events that speak to the current poverty of political and business leadership.The election of a new Pope is a moving and dramatic event even in an age where faith is constantly called into question. The choice of Pope Francis was particularly noteworthy as the first Pope from the “new world” – Latin America – and the selection of a genuinely humble man who is devoted to returning the Catholic Church to its roots in a modern world. In a world filled with leaders driven by ego and spectacle, it was refreshing that the Church chose a man whose strength comes from humility and simplicity.The contrast came from two ugly events on Wall Street. The Senate released a damning report that accused JP Morgan and its highest executives, including Jamie Dimon, of lying and obstruction of justice in the London Whale matter. This was followed by a tedious hearing at which those employees (other than Mr. Dimon) responsible for the matter were questioned at length. It is clear that anyone other than Mr. Dimon would be fired if these allegations were in fact accurate. The question is whether they are an accurate characterization of what occurred and, if they are, whether the system will “man up” or whether crony capitalism will again prevail. Either way, JP Morgan has been badly tarnished.The second scar on the system was the payment of a $600 million settlement by beleaguered hedge fund firm SAC Capital Advisors to resolve insider trading charges. Innocent firms do not pay $600 million to make legal matters go away – they fight those charges. It is likely that this is not the end of the matter and that SAC is going to lose more clients and perhaps see more of its executives, including Steven Cohen, indicted. This also calls into question the firm’s long-term investment record. These kinds of settlements tell investors that the game is rigged. It is time that regulators wrap this matter up – they owe it to Mr. Cohen, to his investors, and to the system. Half a dozen SAC employees (or ex-employees) have already pleaded guilty. There was a systemic problem at the firm that cannot be tolerated. Shame on SAC and shame on regulators for letting this go on so long. Wrap it up already.February 18, 2013
On February 15, Judge Ellen Bransten of the New York Supreme Court issued her ruling in the case of Harch International Limited v. Harch Capital Management, Inc., Index No.: 601312/05. This lawsuit was brought in 2005 by Harch International Limited (HIL), a fund controlled by Old Hill Partners that claimed that Harch Capital Management, Inc. (HCM) had been improperly paid an incentive fee with respect to its management of Harch CLO I Limited in March 2005. In addition to filing this lawsuit, Old Hill attempted to injure the reputation of HCM and its principals. Fortunately, HCM’s clients and counterparties not only knew better but stood by the firm. HCM completed two more CLOs and managed them successfully through the 2008 financial crisis. I left the firm in 2011.
Judge Bransten categorically rejected HIL’s breach of contract and fiduciary duty claims after a six day bench trial that took place in Sept. 2011 in her Manhattan courtroom. She did so after considering the testimony of the witnesses, giving weight to that testimony, and determining the reliability of that testimony (her words). As the witness who spent the most time testifying – approximately 12 hours if memory serves correctly, much of it under hostile cross-examination – I was very gratified by the judge’s decision and evaluation of my testimony and credibility.
HCM managed Harch CLO I through the 2001-2 debt crisis which, until the 2008 financial crisis, was the worst debt crisis since the Great Depression. HCM’s skillful management resulted in an IRR for HIL, the owner of Harch CLO I’s equity, of 15.46%. Old Hill Partners purchased a majority of the equity in HIL at a discount, forced the liquidation of the CLO against the advice of HCM, and realized a 100%+ profit in a 12-month period. It then filed suit claiming that HCM should not have been paid the incentive fee that was established by the plain language of the documents governing the transaction.
It should be noted that HIL/Old Hill did not win a single substantive ruling during the entire case. In her Feb. 15 ruling, Judge Bransten categorically dismissed the last of HIL’s baseless legal claims, providing HCM and its principals with complete vindication. I never doubted the result, but it is still gratifying to finally see justice done.
Thanks are due to the attorneys who represented HCM at trial, Jared Greisman of White Fleishner & Fino, LLP of New York City and Mitchell Shadowitz of Shadowitz Associates of Boca Raton, FL. These two gentlemen are fine trial attorneys and did one hell of a job in a complex and highly contested trial.
Michael E. Lewitt
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