Several weeks ago I posted an “Open Thread” where readers have now left more than 90 thoughtful questions and comments. What a phenomenal response!
It was extremely hard to pick 10. I’ll definitely be answering more of your questions in upcoming issues.
Thank you, everyone, for your insightful queries, which include…
- What definitive, critical event will tell us that the Super Crash is on its way?
- Why did Warren Buffett make such a big bet on AAPL?
- PIMCO’s Dynamic Income Fund (PDI): Yes or no?
Plus, you’ll find out some things about me…
- Why do I like helping the “little guy” so much, anyway? What’s in it for me?
- And what are the three most vital indicators I look at every morning when I first check the markets? (Thanks, Carlos, for that one.)
Click here to read the rest, and to see my answers.
The last one, especially, may surprise you.
Q: Hi Michael. Just wanted to get more insights on the credit markets and how you process information. My specific question: when you fire up your Bloomberg in the morning, which are the first 3-4 indicators/markets you look at to get the feel for the general market and why? Thanks! – Carlos
A: I look at the following things first – S&P 500 futures, 2 and 10 year Treasury yields, and the US dollar. These give me a general sense of what happened overnight and what the trading day may look like. But these are only short-term indicators that set the table for the market opening and can be more distracting than useful in determining what is really going on. My frames of reference are longer term and focused on trends in yields, the Treasury yield curve, the dollar, the S&P 500, and macroeconomic data. The market tends to react to one-off data (for example, the disappointing May jobs report) but the real story is that the last three months’ jobs reports have broken trend and been disappointing, perhaps signaling a downturn. It is most important to separate out short-term noise from long-term signals that are meaningful to make sound investment decisions (unless you are a short-term trader in which case short-term information is useful).
Q: Billionaire investor Warren Buffet made headlines when news hit the wires that Berkshire Hathaway made a staggering $1 billion bet on Apple Inc. (NasdaqGS:AAPL). Why did he do it? – Daniel Sevigny
A: Actually Buffett didn’t do it – one of his associates who runs about $10 billion of money for Berkshire Hathaway made the purchase without Buffett’s involvement. A $1 billion investment is not that large for Berkshire Hathaway; it has many much larger portfolio and operating company investments. The case for buying AAPL is that it is a “cheap” stock – ex-cash it trades at a single digit multiple to earnings. The problem with the stock is that with a $500 billion market cap, the company has to keep earning an enormous amount of money each quarter to maintain its growth rate, which is very difficult. AAPL is unquestionably a great company but its ability to maintain its growth rate is largely dependent on growth of iPhone sales, which are definitely slowing, or the introduction of a blockbuster new product on the scale of the iPhone, which is going to be very difficult to accomplish. The company is also experiencing slower growth and other difficulties in China, one of its most important markets. Despite its low multiple, AAPL may be fully valued unless it pulls a rabbit out of its hat.
Q: In today’s investment climate, is a closed end income fund, like PIMCO’s Dynamic Income Fund (PDI) worth considering? – James Thomas
A: PDI has disappointed a lot of people over the past couple of years with poor performance and now trades at a discount to NAV and a high yield. With those attributes, it is probably a decent investment today. PIMCO remains one of the best credit shops in the business with many talented people. The firm has stabilized after the departure of founder Bill Gross. The biggest problem with PDI and all fixed income products is that the Federal Reserve has destroyed fixed income as an asset class by reducing interest rates to zero and keeping them there for 8 years. The Fed is talking about raising rates but is unlikely to do so aggressively this year, which bodes well for bonds. PDI is a reasonable investment for a portion of your cash after a period of underperformance along with other closed end funds trading at discounts to NAV.
Q: First, thank you for your advice and insight, I find it immensely valuable. What is your motivation for helping the little guy, as I don’t see any financial motivation for you – or am I missing something? I apologize for the cynicism if you are just trying to stop the entire middle class from getting screwed AGAIN! Secondly, what is your opinion on Technical Analysis? I am undecided if it’s just a lot of marketing to sell TA platform products or has real merit. It seems to me that volume doesn’t tell you why the big players are buying/selling. Covering, manipulation, genuine speculation, and all lagging indicators are just manifestations of price and don’t really tell you anything. Thank you. – Mac Mcluskey
A: People often ask why I try to help the little guy and speak truth to power. My very honest answer is rage – rage at the corruption, rage at the stupidity, rage at the complacency, and rage at the hypocrisy of the system. I hate bullies and I hate idiots. I recently described myself to someone as a serial killer of idiots and morons – not literally of course but verbally and intellectually. I have zero tolerance for bull—- and zero tolerance for dishonesty. The little guy is constantly being lied to and ripped off by the government and Wall Street. If I don’t speak up, who will?
As for your second question, a very wise man once told me that technical analysis is nothing more than the study of behavior. When he told me that, a light went on in my head. Until he said that, I was skeptical of technical analysis. But suddenly I understood that technical analysis is just studying the behavior of the market. It is seeing what investors are doing. It is telling a story about what is happening and is a useful guide to what is going to happen. It is not the only tool for reading markets but it is a very useful one.
Q: Hi Michael. I’m well versed on the state of global economies today, on central bank interventions in the market, and most importantly on the dangerously high levels of private, corporate and government debt. I often wonder how all of this will unwind over the coming months and years. During the next crisis selloff, there is a real risk of bank failures. What is your opinion on counterparty risk in the options market? Will I be able to exercise my put options and collect my investment if the market tanks? – Marc Bisson
A: You are correct to identify counterparty risk as a very important consideration in evaluating systemic risk in today’s highly leveraged world. I believe that you have to evaluate counterparty risk on a case-by-case basis. I believe most large US banks are in good shape from a liquidity and capital standpoint. That said, BAC, GS, C and JPM have derivative exposures that dwarf their book values by hundreds of times. If there were a blow-up, they would be toast. There is only a small chance of this happening but it is not an impossibility. The risk would likely not come from inside the US but from a European bank – most likely Deutsche Bank, which has over $50 trillion of derivatives on its books, a huge amount of bad loans on its books, and is terribly managed. DB is the closest thing we have today to an AIG, whose failure almost blew up the system in 2008. I would avoid using DB as a counterparty but understand that if DB fails no institution would be safe and governments would have to come in and stand behind the system to prevent a collapse.
Q: Regarding your recommendation in CZR: Instead of investing directly in the shares, is it possible to buy the 2nd lien bonds (in default), and then get converted to shares? If the answer is yes, are all the bonds equal in the capital structure, as I can see there are 5 issues with maturity in 2018? – Jan
A: The most liquid bonds to buy are the 10% Second Lien Notes of 2018. Unfortunately, it appears that this mess is going to take more time than I thought to clean up. The private equity sponsors who looted the company, Apollo Management and Texas Pacific Group, increased their original settlement offer from $1.5 billion to $4.0 billion, but the owners of the Second Lien Debt, who include some large hedge funds, rejected this offer because more than $4.0 billion was stolen from the company. If this case goes to trial, I believe Apollo and Texas Pacific Group will not only be publicly humiliated but found liable for billions of dollars of damages and possibly for civil fraud. In the end, however, the company will receive a large payment that will inure to the stockholders. Over time, the stock prices should reflect a strong recovery in a company that was ruined by the greed and dishonesty of its private equity owners.
Q: Clearly the price of gold is subject to a lot of powerful fundamentals – interest rates, currency moves, geo-political events, risk-on/off sentiment, buying by central banks, plus probably various forms of manipulation, etc. Two questions: 1) Given all that, how do a few vague, non-committal words out of the Fed every month or two move the price so much ? Gold acts more like a thinly traded stock after earnings than the world’s oldest and safest currency. 2) What do you make of the thesis of some (like Agora’s Rickards) of the inevitability of the return of gold-backed currencies resetting the price to $10k/oz? It seems like the price volatility undermines the argument that it’s a stable, reliable store of value. – Tom Freeland
A: Gold is money of the mind. Its value is based on people’s belief that it is a store of value in an unstable world. James Grant writes that it is a play in monetary instability. I believe gold is the anti-fiat currency – as central banks destroy the value of paper money, the value of gold rises. The reason gold rises when the Fed speaks is because the Fed is telling us that it wants more inflation, which is another way of saying it wants to devalue the dollar. By making the dollar worth less, it makes gold worth more. Gold is a generational investment, not a short term investment. It is something to buy each month and put away and not think about. A country like China, which is thinking in terms of generations and wants its currency to someday compete with the dollar as the world’s reserve currency, is a huge buyer of gold. That should tell you something about how they view gold. The dollar has depreciated by over 90% since Nixon took the US off the gold standard in 1971. I believe it will depreciate another 90% over the next 40-50 years. If you put a price on that, $10,000/oz is a chip shot.
Q: In your opinion, what critical event would indicate that the “Super Crash” is imminent? – Eugene Becker
A: The first sign will be a recession. In previous recessions, the Fed has lowered interest rates by 300-500 basis points. With rates near zero, the Fed obviously isn’t in a position to do that this time. That means the Fed will have to resort to more QE. But while QE boosted stock and other financial asset prices (ie real estate, art, collectibles), it didn’t create sustainable economic growth. The mere launching of more QE could spook markets. The point is that a recession could be the first in a series of steps that leads to a market crisis that leads to a Super Crash, meaning a market crisis that cannot be contained or stabilized by central bank intervention. Remember, in 2008 the Fed’ balance sheet was under $1 billion and today it is $4.5 trillion; the federal deficit was $7 trillion and today it is over $19 trillion. Similar stats can be cited for other central banks around the world – for example, China had $7 trillion of debt in 2007 versus $35 trillion today. The world is so much more leveraged today than in 2008 that a recession alone – especially a severe one – could trigger a Super Crash. Now what are the signs for a recession? The key sign is a flattening Treasury yield curve – and the 2/10 curve has flattened by nearly 200 basis points over the last 2 years to roughly 92 basis points today. That is a dramatic flattening that tells us that the economy is slowing. Usually it takes an aggressively tightening Fed to cause such a flattening but this time the curve flattened all by itself (the strong dollar definitely helped as did the Fed ending QE). But all the signs are there for a recession to creep up on us and that would be the first step toward a Super Crash.
Q: With the Fed on the verge of raising interest rates, is now a bad time to invest in REITs and BDCs? -Larry Levret
A: I would avoid BDCs because credit quality is deteriorating badly inside them. The reports I am getting from inside the industry are that BDCs are reaching for yield by taking riskier pieces of deals which means that they are going to see higher defaults. BDCs traffic in the lower rungs of the credit space and with a weakening economy now is the time to avoid taking those types of risks. As for REITS, certain types of REITS such as mortgage REITS trading at discounts of NAV such as NLY and CIM are ok. I would avoid mall REITS since they will be seeing rising defaults among their tenants as the retail industry continues to struggle over the coming years.
Q: Michael, do you believe Zoomlion will end up buying Terex? – Calvin Wineinger
A: I don’t know. I will do some more research on this.