When interviewing various investment managers, one of my favorite approaches is to discuss their mistakes. Managers who do not admit mistakes or provide shallow answers are unlikely to be future managers of my clients’ accounts. A number of the world famous managers who I have known over the years are often very quick to discuss their mistakes and frequently how these errors have changed something about their own approaches to investing. I believe we all should periodically review our own mistakes, with an honest attempt to avoid similar ones in the future. Ideally, we should only make new mistakes in the future.
One of my mistakes was that I owned the stock of Lehman Brothers at the end of its fall. Technically I never bought the stock, but got it when Lehman acquired a money management firm for stock. Toward the end, my mistake was that I did not believe comments from European-based managers that Lehman would fail. I relied on the firm’s published balance sheets, statements from management, and regulatory capital requirements. Even if one was smart enough at the time to write off Lehman’s real estate equity holdings, it still had sufficient capital to continue to stay in business. Like others, I was looking at the wrong thing and did not fully comprehend the structure of the business. The critical issue for Lehman Brothers was liquidity. Its ability to borrow in the overnight market rapidly disappeared at the very same time as its prime brokerage clients were drawing down their balances, which were essential to maintain Lehman’s level of business. What was not clear to me, was that Lehman’s separately incorporated (and guaranteed) subsidiary had much looser credit terms than the New York prime brokerage operation. I will let various investigations and books determine whether the hedge funds that withdrew some or all their money from Lehman’s London accounts were also the sources of the rumors of the firm's decline. I do not know whether Lehman in the end was a victim of a “bear raid” by short sellers or just a firm that lost control of its finances. No matter the cause, the firm is no longer with us, and its demise was a tragedy for many good, honest hard working people within the firm, as well as brokerage clients who sustained major losses.
I should have known better! My Grandfather lectured me, either on walks or sitting in his study, about his experiences as the senior partner of an important brokerage firm. One of the things he said that I did not completely value until now, was the statement, “In periods of duress one can not borrow money, even if one has cash sitting in a safe deposit box.” There were two things I did not fully appreciate. First, the ability to borrow when times are tense is critical to survival. Second, that cash or other hidden assets are not good collateral if the lender can not see them or seize them.
This brings us to Europe this week.
Sovereign Debt and Bank Capital
While most of the attention focused on the Jackson Hole conference was on the minuet of Chairman Ben Bernanke, the most market-moving comments came in the last panel, when Christine Lagarde, the new head of the IMF, called for the recapitalization of major European Banks. The reaction on the Continent was severe shouting, that the former French Finance Minister did not understand the situation. The comments quickly focused on the distinction between liquidity and capital for the banks loaded with sovereign debt, particularly of the Mediterranean and Irish varieties. Similar to my unfortunate experience with Lehman and the warning from my Grandfather many years ago, the ability to borrow was particularly critical when the lenders questioned the value of the capital. New cash capital automatically improves their ability to borrow.
I suspect that the falling value of European bonds is the market’s way of downgrading the bonds before the credit agencies do it. Bond prices reflected in yields, and the prices for Credit Default Swaps (CDS) are more substantive than a bunch of letter grades from the agencies.
The US Impacts
If the credit values of European issuers fall, two things happen on this side of the pond. First, various US financial institutions and some multi-national companies should look at whether they need to repair their own balance sheets. Already we have seen considerable flows out of some US money market funds containing European exposure, with assets shifting to US Treasury-only funds. Second, if the Europeans do go on a wave of capital raising, they will have to offer rates high enough to draw capital from other parts of the world, including the US. Quite possibly we will see signs of this in a Labor Day-shortened week. Regardless of what the President says in his jobs speech, (scheduled just prior to the opening of the National Football League regular season Thursday night), we could be in for high volatility. I for one will be watching the Asian markets tonight (Sunday) and the European ones on Monday.
Crisis Betting
If we get increased turmoil, as investors what should we do? I speak with the bias of an investment manager of portfolios of mutual funds and the portfolio manager of a private financial services fund. I believe it is too late to be doing any meaningful amount of selling. In terms of buying, my bias is combined with a contrarian nature. In this week’s Barron’s there is a series of interviews with 12 established market strategists. They were asked which sectors they favor and which they would avoid. Only one would invest in financials, and three would avoid them. Considering that these stocks have led both on the way up and on the way down, I expect that these stock prices will rise along with any general market rise. However, as I started this blog post with some thoughts on liquidity and capital, adding to the subject, I believe the market is questioning the values resident on a number of balance sheets of leading banks and some insurance companies. Thus, the price-to-book value or the Tangible Common Equity Ratio may, in truth, be higher than what the other bulls are using. Statistical cheapness has never been a convincing argument for me. With a long term view, I feel that some of these stocks are attractively priced because of their sheer brain power. Those brains will be able to figure out new ways to make money coming out of the world’s liquidity and capital needs. I am looking for the rainbow after the storm.
What do you see?
____________________________________________
To read last week’s Blog from Mike Lipper, click here.
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Showing posts with label sovereign debt. Show all posts
Showing posts with label sovereign debt. Show all posts
Sunday, September 4, 2011
Sunday, August 28, 2011
Storms on Both Sides of the Atlantic
Normally I think about my blog communications to you throughout the preceding week, then I spend Sunday working on my first draft in order to get a completed version before the end of the evening. As I sit here on Saturday night before the impact of Hurricane Irene is forecast to hit us Sunday, I am concerned that some fallen trees might knock us off the electrical grid. Thus, I am pulling together my scraps of paper and other thoughts about 24 hours earlier than normal. The result is a collection of questions and observations on various bits of news and commentary I have reviewed this week.
Europe: What will it be?
There are two concerns which are keeping investors away from the stock market. The first concern is whether the US will tip into recession (more on this in a minute), and the second is Europe. At its core, the issue in terms of Europe is whether Germany will provide the capital to bail out the Mediterranean and Irish governments, and more specifically, their banks and the banks’ counter-parties in the more solvent countries. The European bureaucrats have maneuvered their creation, the European Central Bank (ECB), into buying sovereign debt issues of some of the peripheral countries in the secondary market. On September 7th, a senior German court will rule as to whether this was in violation of the law (and spirit) of the agreement to create the ECB. Logic from afar suggests that it was in violation, and now questions whether Europe as we know it will continue to exist. Any form of disequilibrium created by these events and discussions will have some unpleasant impacts on US securities, particularly commercial banks.
What does 1% (actually 0.99%) mean to the US?
The latest reading on the growth of the US Gross Domestic Product (GDP) for the second quarter, was a gain of 0.99%, generously translated to be 1%. Subsequent quarters were expected to be higher, with the final quarter generating a 3% growth rate. (Many believe a 3% growth rate or better is required to make a meaningful dent in US unemployment and under-employment statistics.) As disheartening as the 1% figure is to the economy, it suggests other concerns to me. While the financial community will gladly do battle over 1% (or as we most likely will refer to it, as 100 basis points) in this period of declining volume and excess capacity, there is a deeper concern on the part of number crunchers like me. What is rarely discussed (but is included in the full breakdown of the national accounts) is a line item called Errors and Omissions. Considering how often there are significant corrections or adjustments to federal government numbers, I wonder whether there was any growth in the US in the second quarter! My concern was heightened when I read the following excerpt from a fellow member of our blog community who is a corporate environmental counsel and a former FDA counsel. He summarized his interactions with the government:
“The overhead of any program and waste consumes a substantial fraction of the funds allocated. They are spent on feeding the 'perpetual bureaucracy' or temporary managers as administrative costs or the money is simply wasted and does not go to any economically productive use.”
Bear in mind that the government is spending roughly one of every five dollars counted in our economic progress.
Are We Creating a Self-Induced Recession?
Much has been written about the “wealth effect” which states that when people believe that their wealth is growing they will spend more. This was one of the excuses for QE2. It didn’t work in a meaningful way. But are we seeing the reverse, when the uncertainties created by the politicians on both sides of the Atlantic are causing investors to stay away from the market? There are always circumstances when investors desire to sell their securities. In the absence of securities buyers, the forced sales will generate lower prices; that in turn makes bystanders feel poorer, and therefore they reduce their spending for various goods and services.
The “Halo Effect”
Jason Zweig, in his weekend column in the WSJ, places halos on Steve Jobs and Warren Buffett, and then does a good job of reporting on the mistakes each has done without diminishing their overall record. Also, the Financial Times Saturday edition, in reporting on Mr. Buffett’s latest purchase of Bank of America preferred stock with warrants, notes a number of quotes whereby he acknowledges less than perfect foresight into financial services companies. (Disclosure: Berkshire Hathaway is a position in my private financial service fund as well as my personal account.) The halo effect is a constant worry to me in selecting mutual funds to invest for my institutional and high net worth clients. We all find it easier to invest with a successful investor than one who is currently not doing well. We gloss over the past mistakes of our heroes and focus on the mistakes of the current laggard. Mr. Buffet reminds us of his fallibility by maintaining his corporate name on a very bad operating investment he made.
As we are moving into particularly troubled financial, economic and political waters, we should be aware of the risks attached to the halo effect.
Am I Premature?
In a recent investment committee meeting with a number of well-known investment professionals, I was asked whether I was premature when I took contrary positions to the perceived knowledge. My respect for the questioner was such that I had to examine my past thinking on investments in order to answer thoughtfully. As often is the case with this individual, he was right. I tend to look at investments as an entrepreneur rather than as a trader. I look for structural imbalances and opportunities. Most of the time I would prefer to be early than late. Even though it was a favorite song of my late daughter's, when I was expressing frustration about change, I couldn’t relax to go along with her view of “Que Sera, Sera,” but she was a calmer person than me.
Reactions to any of these observations?
Note: We will be in London in late September visiting with investors and managers. Are there additional people we should see if appointments can be arranged?
____________________________________________
To read last week’s Blog from Mike Lipper, click here.
Add to the Dialogue:
I invite you to be part of this Blog community by commenting on my blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.
Please address your comments to: Email Mike Lipper's Blog .
To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of www.MikeLipper.Blogspot.com
Europe: What will it be?
There are two concerns which are keeping investors away from the stock market. The first concern is whether the US will tip into recession (more on this in a minute), and the second is Europe. At its core, the issue in terms of Europe is whether Germany will provide the capital to bail out the Mediterranean and Irish governments, and more specifically, their banks and the banks’ counter-parties in the more solvent countries. The European bureaucrats have maneuvered their creation, the European Central Bank (ECB), into buying sovereign debt issues of some of the peripheral countries in the secondary market. On September 7th, a senior German court will rule as to whether this was in violation of the law (and spirit) of the agreement to create the ECB. Logic from afar suggests that it was in violation, and now questions whether Europe as we know it will continue to exist. Any form of disequilibrium created by these events and discussions will have some unpleasant impacts on US securities, particularly commercial banks.
What does 1% (actually 0.99%) mean to the US?
The latest reading on the growth of the US Gross Domestic Product (GDP) for the second quarter, was a gain of 0.99%, generously translated to be 1%. Subsequent quarters were expected to be higher, with the final quarter generating a 3% growth rate. (Many believe a 3% growth rate or better is required to make a meaningful dent in US unemployment and under-employment statistics.) As disheartening as the 1% figure is to the economy, it suggests other concerns to me. While the financial community will gladly do battle over 1% (or as we most likely will refer to it, as 100 basis points) in this period of declining volume and excess capacity, there is a deeper concern on the part of number crunchers like me. What is rarely discussed (but is included in the full breakdown of the national accounts) is a line item called Errors and Omissions. Considering how often there are significant corrections or adjustments to federal government numbers, I wonder whether there was any growth in the US in the second quarter! My concern was heightened when I read the following excerpt from a fellow member of our blog community who is a corporate environmental counsel and a former FDA counsel. He summarized his interactions with the government:
“The overhead of any program and waste consumes a substantial fraction of the funds allocated. They are spent on feeding the 'perpetual bureaucracy' or temporary managers as administrative costs or the money is simply wasted and does not go to any economically productive use.”
Bear in mind that the government is spending roughly one of every five dollars counted in our economic progress.
Are We Creating a Self-Induced Recession?
Much has been written about the “wealth effect” which states that when people believe that their wealth is growing they will spend more. This was one of the excuses for QE2. It didn’t work in a meaningful way. But are we seeing the reverse, when the uncertainties created by the politicians on both sides of the Atlantic are causing investors to stay away from the market? There are always circumstances when investors desire to sell their securities. In the absence of securities buyers, the forced sales will generate lower prices; that in turn makes bystanders feel poorer, and therefore they reduce their spending for various goods and services.
The “Halo Effect”
Jason Zweig, in his weekend column in the WSJ, places halos on Steve Jobs and Warren Buffett, and then does a good job of reporting on the mistakes each has done without diminishing their overall record. Also, the Financial Times Saturday edition, in reporting on Mr. Buffett’s latest purchase of Bank of America preferred stock with warrants, notes a number of quotes whereby he acknowledges less than perfect foresight into financial services companies. (Disclosure: Berkshire Hathaway is a position in my private financial service fund as well as my personal account.) The halo effect is a constant worry to me in selecting mutual funds to invest for my institutional and high net worth clients. We all find it easier to invest with a successful investor than one who is currently not doing well. We gloss over the past mistakes of our heroes and focus on the mistakes of the current laggard. Mr. Buffet reminds us of his fallibility by maintaining his corporate name on a very bad operating investment he made.
As we are moving into particularly troubled financial, economic and political waters, we should be aware of the risks attached to the halo effect.
Am I Premature?
In a recent investment committee meeting with a number of well-known investment professionals, I was asked whether I was premature when I took contrary positions to the perceived knowledge. My respect for the questioner was such that I had to examine my past thinking on investments in order to answer thoughtfully. As often is the case with this individual, he was right. I tend to look at investments as an entrepreneur rather than as a trader. I look for structural imbalances and opportunities. Most of the time I would prefer to be early than late. Even though it was a favorite song of my late daughter's, when I was expressing frustration about change, I couldn’t relax to go along with her view of “Que Sera, Sera,” but she was a calmer person than me.
Reactions to any of these observations?
Note: We will be in London in late September visiting with investors and managers. Are there additional people we should see if appointments can be arranged?
____________________________________________
To read last week’s Blog from Mike Lipper, click here.
Add to the Dialogue:
I invite you to be part of this Blog community by commenting on my blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.
Please address your comments to: Email Mike Lipper's Blog .
To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of www.MikeLipper.Blogspot.com
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