Bill Ackman, legendary activist investor recently published its 1st quarter investment letter. The fund has performed strongly to date, with 9.3% returns and has large holdings in Canadian Pacific, General Growth Properties, Citigroup, and J.C. Penney. If he still owns them, the latter two companies may create some trouble for his firm in the future.
In this investor letter, Ackman discusses the idea of time arbitrage, which is taking advantage of forced sellers for the benefit of long term profit. This is because stocks are often more volatile than their underlying businesses, and few firms and individuals can stomach volatility.
He also discusses that private equity portfolio companies, because of their higher implied leverage, have much more volatile returns, but unfortunately, you do not see a mark-to-market as you do in publicly traded equities.
Here I present key take-aways from George Soros’ in depth Bloomberg interview on the current European fiscal and banking crisis, Angela Merkel, the Spanish bailout, and Greece leaving the Eurozone.
The video is also below:
Banking & Fiscal Issues
“There is an interrelated problem of the banking system and the excessive risk premium on sovereign debt – they are Siamese twins, tied together and you have to tackle both.”
Soros summarizes the forthcoming Eurozone Summit ‘fiasco’ as fatal if the fiscal disagreements are not resolved in 3 days.
There is no union without a transfer.
Europe needs banking union.
Germany will only succumb if Italy and Spain really push it to the edge (Germany can live in the present situation; the others cannot)
Europe needs a fiscal means of strengthening growth through Treasury type entity
What is needed is a European fiscal authority that will be composed of the finance ministers, but would be in charge of the various rescue mechanisms, the European Stability Mechanism, and would combine issuing treasury bills.
Those treasury bills would yield 1% or less and that would be the relief that those countries need in order to finance their debt.
Bill would be sold on a competitive basis.
Right now there are something like over €700bn euros are kept on deposit at the European Central Bank earning a 0.25% because the interbank market has broken down, so then you have €700bn of capital that would be very happy to earn 0.75% instead of 0.25%, and the treasury bills by being truly riskless and guaranteed by the entire community, would yield in current conditions less than 1%.
Governments should start a European unemployment scheme, paid on a European level instead of national level.
Soros’ solutions, however, are unlikely to prove tenable in the short-term as he notes “Merkel has emerged as a strong leader”, but “unfortunately, she has been leading Europe in the wrong direction”.
“Euro bonds are not possible because Germany would not consider euro bonds until there is a political union, and it should come at the end of the process not at the beginning.
This would be a temporary measure, limited both in time and in size, and thereby it could be authorized according to the German constitution as long as the Bundestag approves it, so it could be legal under the German constitution and under the existing treaties.
The political will by Germany to put it into effect and that would create a level playing field so that Italy and Spain could actually refinance debt on reasonable terms.
LTRO would be less effective now
At 6%, 7% of Italy’s GDP goes towards paying interest, which is completely unsustainable
Spain may need a full bailout if summit is not successful
Financial markets have the ability to push countries into default
Because Spain cannot print money itself
Even if we manage to avoid, let’s say an ‘accident’ similar to what you had in 2008 with the bankruptcy of Lehman Brothers, the euro system that would emerge would actually perpetuate the divergence between creditors and debtors and would create a Europe which is very different from open society.
It would transform it into a hierarchical system where the division between creditors and debtors would become permanent…It would lead to Germany being in permanent domination.
It would become like a German empire, and the periphery would become permanently depressed areas.
Greece will leave the Eurozone
It’s very hard to see how Greece can actually meet the conditions that have been set for Greece, and the Germans are determined not to modify those conditions seriously, so medium term risk
Greece leaving the euro zone is now a real expectation, and this is what is necessary to strengthen the rest of the euro zone, since Greece can’t print money
By printing money, a country can devalue the currency and people can lose money by buying devalued debt, but there is no danger of default.
The fact that the individual members don’t now control the right to print money has created this situation.
A European country that could actually default. and that is the risk that the financial markets price into the market and that is why say Italian ten-year bonds yield 6% whereas British 10-year bonds yield only 1.25%.
That difference is due to the fact that these countries have surrendered their right to print their own money and they can be pushed into default by speculation in the financial markets.
On Angela Merkel
Angela Merkel has been leading Europe in the wrong direction. I think she is acting in good faith and that is what makes the whole situation so tragic and that is a big problem that we have in financial markets generally – she is supporting a false idea, a false ideology, a false interpretation which is reinforced by reality.
In other words, Merkel’s method works for a while until it stops working, and that is what is called a financial bubble
Financial bubbles look very good while they are being formed and everyone believes in it and then it turns out to be unsustainable…
The European Union could turn out to have been a bubble of this kind unless we realize there is this problem and we solve it and the solution is there.
I think everybody can see it, all we need to do is act on it, and put on a united front, and I think that if the rest of Europe is united, I think that Germany will actually recognize it and adjust to it.
Stay in cash
German yields are too low
If summit turns out well, purchase industrial shares, but avoid everything else (consumer, banks)
Conclusion: We are facing conditions reminiscent to the 1930s because of policy mistakes, forgetting what we should have learned from John Maynard Keynes.
You thought you had heard the last of Swiss based Glencore, the famed diversified commodities trading firm, with the news of its multi-billion dollar IPO. Now rumors of a nearly $20 billion takeover? Looks like Glencore’s management team is taking advantage of its new currency. According to ENRC’s 3 founders, Alexander Mashkevitch, Patokh Chodiev and Alijan Ibragimov, who control 45% of the company, Glencore’s CEO recent discussed a possible merger. ENRC, a Kazakhi miner, trades at a 15% discount to its peers, using a trailing P/E multiple, and is down almost 30% this year.
HISTORY OF GLENCORE
Glencore, headquartered in Baar, Switzerland, is the world’s largest commodities trading firm, which a 60% market share in the trading of zinc, and a 3% market share in the trading of crude oil. The company is also the biggest shipper of coal in the world. Glencore’s 485 traders own and run the company today. It was formed by a management buyout of Marc Rich & Co AG in 1974. Marc Rich, now a billionaire commodities trader at the time was charged with tax evasion and illegal business dealings, fleeing to Iran. Years later, he was pardoned by President Bill Clinton.
In 1994, after failing to corner the zinc market, the company lost $172 million and nearly went bankrupt, forcing Rich to sell his share in the company back to the firm, which was renamed Glencore. It was run by Rich’s inner circle, including Willy Strothotte and Ivan Glasenberg.
Over the years, Glencore has also been accused of illegal dealings with rogue states, including the USSR, Iran, and Iraq (under Hussein). It has a history of breaking UN embargoes to profit from corrupt regimes.
The company owns stakes in Rusal, Chemoil, Xstrata, Minara Resources, PASAR, Evergreen Aluminum, Katanga Mining, Windalco, OAO Russneft, and many other firms.
INITIAL PUBLIC OFFERING
With its initial public offering weeks ago, Glencore was valued at about $60 billion, and raised about $10 billion. Each of the 485 traders received average payouts of $100 million through the flotation.
I highly recommend reading, “Secret Lives of Marc Rich.”
The foreign exchange market is finally beginning to garner mainstream attention. The Bank of International Settlements estimates that the average daily volume in the fx market is around $4 trillion, which makes it by far the largest financial marketplace in the world. Surprisingly, however, many novice investors and traders have never even heard of this market.
Until the late 1990’s, the only players allowed to execute trades in the foreign exchange market were investment banks, hedge funds, and very wealthy private investors. Since the minimum contract size was generally $1,000,000, smaller traders were effectively denied entrance into the market.
In the late 90’s, however, this all changed. The advance of the internet and technology led several online forex brokers to open shop and begin catering to smaller investors and traders. This led to the birth of the retail foreign exchange market. In this article, we are going to discuss three key elements to forex trading: Leverage, Margin, and Equity.
The idea of leverage in the fx market has been under intense debate over the last several years. Since the market is decentralized and worldwide, regulation was largely absent from the fx market until recently. In 2010, the National Futures Association instituted some major changes, one of them being a cap on leverage at 50:1. This means that an fx trader in the United States can trade on leverage at a ratio of 50:1. Thus, if a trader has $1,000 in his account, then he is able to leverage that $1,000 into $50,000 and trade much larger positions in EUR USD. Until the National Futures Association passed this regulation, some brokers were offering traders up to 400:1 leverage, which means that with a $1,000 account, traders were able to control a $400,000 position in the market. Note that leverage is a two-edged sword. It will increase both losses and profits.
Margin is the life of a trader. If a trader does not have enough margin, then he cannot open a trade. Furthermore, if a trader has an open position moving against him, he may eventually not have enough money to act as margin, which means his account would suffer a “margin call.”
Margin is the amount of money required to open a leveraged position. For example, if Broker ABC offers 50:1 leverage, and Bob the Forex Trader wants to open a position of $100,000, then Bob has to put up $2,000 of margin. If Bob’s trade begins to move against him to the point where his account equity becomes less than $2,000, Bob will suffer a “margin call,” which basically means that his broker will call for more margin if Bob wants to keep the position open.
Everyone knows that one of the leading causes of business failure is a lack of initial capital, and trading is no different. If a trader opens an account with a few thousand bucks and trades heavily leveraged positions, his chances of success are nominal.
Equity is essential to trading success. The question many new traders have is, how much money do I need to open an account? Well, the answer to that question is different for everyone, and it largely depends on what your goals are. If you simply want to get some trading experience, but still have a full-time job, then a person can open an account with a few thousand bucks. However, if you are trying to generate enough capital gains to sustain a living, then the initial account balance should be much, much higher.
Leverage, Margin, and Account Equity are three essential aspects of fx trading that every trader must be familiar with.
The following special report on oil (LA Blog Only, leverageacademy.com/blog) discusses the oil market, providing reasons to be bullish on the commodity given unrest in the Middle East, Nigerian elections in April, and rising domestic consumption in oil producing countries, including Venezuela, Nigeria, and Iran. According to the article, the rise of oil prices could easily cause the next recession. In 2010, soft commodities outperformed energy, but that will certainly change given the political headwinds abroad and continued monetary easing in the developed world. Therefore, the Bernanke “Put,” combined with political unrest will be to blame for continued sharp price increases in the energy commodity sector.
Emerging market demand, especially in China, which now consumes nearly 10mm barrels of oil per day, will also be driving the demand side of the equation. Money supply in China was also up 19.7% in 2010, because of the rapid credit growth the country has experienced over the past 2 years.
On the supply side, Middle Eastern youth continue to riot, causing political unrest across the globe. In Egypt, Libya, Morocco, Saudi Arabia, Tunisia, and Bahrain, youth unemployment is over 20%, which is a severe concern, given the oil wealth of these nations. The Iran crisis could also re-emerge as the country continues to develop nuclear weapons. As Iran is mostly Shiite, it poses a great threat to its Sunni neighbors, including Saudi Arabia. Major risks in the area include that the Straights of Hormuz and Malacca could be blocked in the Middle East if major riots break out. These two passages account for 32 million barrels of crude transport per day. The Straight of Hormuz alone carries 33% of oil transport by sea. Furthermore, one should question how much Saudi Arabia can increase supply, as the country overstated its oil reserves by nearly 300 billion gallons in 2010. Even if it does increase supply, how will this supply be transported to the West if passages are blocked?
There has not been one year in recent history where Nigerian elections have not posed a threat to the country’s oil supply. Elections are often bloody, and there is no reason for the upcoming 2011 elections being held in April to be different.
To make things worse, the IEA increased its oil demand forecast by 1.6%.
On December 6th, Brent futures were traded in backwardation for the first time in two years, which means that futures with shorter maturities are more expensive than those with longer maturities (similar to an inverse yield curve). Backwardation occurs in tight markets, whereas contango occurs when there is oversupply.
What will be the effect of these changes in the oil supply/demand equation? Well, an increase in oil price tends to affect the economy with a time lag of at least 4-6 months. An increase an oil price of $10 would cause GDP to fall by 25 bps and S&P earnings to fall by $3.00.
According to the IEA, 4.1% of GDP was spent on oil consumption in 2010. A sustained price above $100 would mean that the percentage would increase to 5%. Oil at $120 would mean a percentage increase to 6%, which would be devastating.
As a follow up to our story on shorting treasuries using TMV, the Direxion Daily 30+ year treasury bear, the LA team wanted to discuss Bill Gross’s move to dump government securities. Bill Gross runs the world’s largest bond fund and has surprisingly decreased his treasury holdings completely. His fund is now in 23% cash, the highest cash balance since 2008. PIMCO manages $1.24 trillion of assets, mainly fixed income securities. According to Gross, if the U.S. transitions into quantitative easing v3 (QEIII), yields on government securities will may increase 150 bps by 2012, resulting in large gains for those net short the 30 year treasury.
According to Bloomberg, “Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., eliminated government-related debt from his flagship fund last month as the U.S. projected record budget deficits.
Pimco’s $237 billion Total Return Fund last held zero government-related debt in January 2009. Gross had cut the holdings to 12 percent of assets in January, according to the company’s site. The fund’s net cash-and-equivalent position surged from 5 percent to 23 percent in February, the highest since May 2008.
Yields on Treasuries may be too low to sustain demand for government debt as the Fed approaches the end of its second round of quantitative easing, Gross wrote in a monthly investment outlook posted on Pimco’s website on March 2. Gross mentioned that Pimco may be a buyer of Treasuries if yields rise to attractive levels.
Treasury yields are about 150 basis points too low when viewed on a historical context and when compared with expected nominal gross domestic product growth of 5 percent, he wrote in the commentary. The Fed is scheduled to complete purchases of $600 billion of Treasuries in June.
Gross in his February commentary urged investors to reduce holdings of Treasuries and U.K. gilts and buy higher-returning securities such as debt from emerging-market nations. “Old- fashioned gilts and Treasury bonds may need to be ‘exorcised’ from model portfolios and replaced with more attractive alternatives both from a risk and a reward standpoint,” Gross wrote.
Gross last month increased holdings of emerging-market debt to 10 percent, the highest since October, from 9 percent in January. He cut holdings of mortgage securities to 34 percent from 42 percent in January.
The Zero Hedge website first reported the change in assets today. Pimco doesn’t comment on changes in holdings.
Treasuries returned 5.9 percent in 2010, according to Bank of America Merrill Lynch Indexes. The securities lost 0.6 percent so far this year.
Ten-year Treasury yields have risen for each of the past six months, according to data compiled by Bloomberg, the longest run since June 2006, as the economy showed signs of improvement and prices of commodities climbed. The 10-year yield fell six basis points to 3.48 percent today.
Gross kept the holdings of non-U.S. developed debt at 5 percent in February.
Gross’ fund has returned 7.23 percent in the past year, beating 85 percent of its peers, according to data compiled by Bloomberg. It gained 1.39 percent over the past month.
As the Fed maintains its target rate at a record low range of zero to 0.25 percent and has made an increase in inflation a cornerstone of its monetary policy, Gross noted that inflation may be a bigger factor than many suggest.
Gains in so-called headline inflation matter more for the U.S. than Fed Chairman Bernanke suggests and rising oil prices may cut U.S. gross domestic product by a quarter to half a percentage point, Gross said March 4 in a radio interview on “Bloomberg Surveillance” with Tom Keene.
“Bernanke tends to think this doesn’t matter — at least in terms of headline versus the core — we do,” Gross said.
Pimco’s U.S. government-related debt category can include conventional and inflation-linked Treasuries, agency debt, interest-rate derivatives, Treasury futures and options and bank debt backed by the Federal Deposit Insurance Corp., according to the company’s website. The fund can have a so-called negative position by using derivatives, futures or by shorting.
Derivatives are financial obligations whose value is derived from an underlying asset. Futures are agreements to buy or sell assets at a later specific price and date. Shorting is borrowing and selling an asset in anticipation of making a profit by buying it back after its price has fallen.
Pimco, a unit of the Munich-based insurer Allianz, managed $1.24 trillion of assets as of December.”
Investment bank earnings estimates are truly bullish for 2011. Applying a 16x-18x multiple to these forward earnings brings you to S&P levels unseen since 2007. Unfortunately, something not included in these estimates is that for every $10 crude oil increases, S&P earnings fall by $3. This does not even factor in the fall in consumer confidence when citizens across the globe realize that they are soon going to pay $200 to fill up a mid-sized sedan, once QE3 is unveiled and Middle Eastern governments are overthrown once and for all. After all this is done for, oil could easily reach $130+ on a supply disruption in Saudi Arabia.
Of course, BofA’s Bianco will not discuss this. Neither will the analysts at Barclays, who just revised their S&P 500 earnings estimates up from 1,420 to 1,450.
Please view LA’s blog entry to see the S&P earning’s table below.
People have no SHAME. Wing Chau, president of Harding Advisory is suing Michael Lewis, the author of The Big Short for “unfairly casting him as a villain.” Listen Wing, you cheated investors and blatantly ignored your fiduciary responsibility. Give it a break.
In his book, Lewis writes about a handful of Wall Street outsiders who realized the subprime mortgage business was a house of cards and found a way to bet against it, making billions for themselves. He also discusses the perpetrators and poor underwriters that were the cause of the subprime collapse:
“Author Michael Lewis was sued by Wing Chau, president and principal of Harding Advisory LLC, who accused the writer of defaming him in his 2010 book “The Big Short: Inside the Doomsday Machine.”
Chau, a manager of collateralized debt obligations, according to a complaint filed Feb. 25 in NY federal court, claims the book unfairly casts him as one of the “villains” responsible for the 2008 financial collapse.
The book “depicts Mr. Chau as someone who ignored his professional responsibilities, made misrepresentations to investors, charged money for work that was not performed, had no stake in the CDOs he managed, was incompetent or reckless in carrying out his responsibilities, and violated his fiduciary duties by putting the interests of ‘Wall Street bond trading desks’ above those of his investors,” according to the complaint.
Also named in the suit, which seeks unspecified damages, are the book’s publisher, W.W. Norton and Steven Eisman, managing director of FrontPoint Partners LLC, whom Chau describes in the complaint as “one of the principal sources Lewis relied on in writing ‘The Big Short.’”
Lewis, a columnist for Bloomberg News, didn’t immediately respond to an e-mail seeking comment on the suit. Norton spokeswoman Elizabeth Riley had no immediate comment
The case is Chau v. Lewis, 11-cv-1333, U.S. District Court, Southern District of (Manhattan).”
To contact the reporter on this story: Bob Van Voris in New York.
After closing three strong years of performance (2008 – 2.5%, 2009 – 36.5%, 2010 – 15.6%), Greenstone shares its outlook for 2011, as the year of “dividend chasing.” 2010 was certainly a year of “credit chasing,” where all funds searched for yield in high yield bonds, leveraged loans, and REITs. About 80% of the Greenstone portfolio is investing in traditional deep value securities, and 20% is invested in “special situations.” The last bullet point in Greenstone’s themes is that historically, “economies with the highest growth produce the lowest stock returns by an immense margin (yes, you read that right). In fact, stocks in countries with the highest economic growth have earned an annual average return of 6%; those in the slowest-growing nations have gained an average of 12% annually (source: Credit Suisse Global Returns Yearbook). This could be especially true in 2011, where equity investors in emerging markets are fighting policymakers.”
Here are Greenstone’s selected themes for 2011:
• We still like equities, particularly in the U.S. While they currently seem short-term overbought, and a technical correction is possible, we still see the most value in this area, especially when we consider the alternatives.
• In reviewing our letters from early last year, we talked about 2010 being the “Year of the Yield Chaser” in the credit space. We cut the majority of our credit exposure in Q1 and Q2 of 2010 because of what we thought was limited further upside appreciation potential. We can see 2011 being the “Year of the Dividend Chaser”.
• Offshore deepwater drilling is the last bastion for hydrocarbon discovery. We think a lot of “first time” emerging market demand characteristics and higher oil prices will lead to increased deepwater programs by the IOCs and NOCs. We have a handful of positions that give us exposure to this area.
• We would consider shorting natural gas companies because of the supply/demand dynamics and high valuations. We could see a scenario where the contrarian call is to go long physical natural gas because 1) it’s unloved and 2) the historical ratio between gas and oil prices is creating the perception that gas might be a buy. However, even with increasing demand for natural gas expected in the U.S. this year, we still have a tremendous overabundance of supply. We’re keeping an eye on high multiple natural gas companies and MLP’s that derive a generous amount of “other income” from hedging programs that are set to roll off.
• The M&A space is one that, for various reasons, we see doing well going forward. This primarily derives from the cash reserves on S&P 500 company balance sheets, which are at the highest level in ten years (currently over $1.2 trillion). This is almost 50% more than the $825 billion held in cash in September 2008. Information technology is the leading sector with cash reserves. With a near 0% interest rate environment, how long can companies hold so much cash? VC’s and Private Equity have not had a genuine chance to monetize their portfolios for 2-3 years now, and we believe they will search out the cash rich/public company exit option. We currently have 5+ names in the portfolio that we believe could benefit from such a trend.
• This year could finally be the year where companies have the ability to pass through their increased input costs to consumers. This would result in inflation showing up in the U.S., despite what the CPI is saying.
• Along with middle of the road valuations, allocation shifts could be a boom for the equity market in 2011. It is interesting to hear people like Byron Wein say that “Institutional portfolios have to have more of their money invested in places like China, India, and Latin America,” essentially saying that developing countries are generating a majority of the world’s growth, and institutional portfolios should have exposure to these markets. Mr. Wein recommends large conventional institutions substantially increase their allocations to hedge funds and emerging markets.
• European and municipal debt issues will once again provide buying opportunities when the markets turns south on these worries. With municipal budgets due in early June, expect more movement in and around this time frame. We have taken advantage of market gyrations that these events have previously offered, and would look to do so again.
• The dramatic equity rally from the lows at the end of June occurred almost entirely with net outflows from domestic equity funds, and net inflows into domestic fixed income funds. Late in the fourth quarter, this dynamic switched for the first time in a long while, with inflows into equities and outflows from bond funds. If this trend continues, which it appears that it might, even more fuel could be added to the recent stock market rally.
• Even in light of the money flows just mentioned, we don’t expect John Q. Public will come charging back into the market any time soon. We are wary, however, about the potential shift of pensions and endowments (who manage John Q. Public’s money) into equity markets. Essentially, there are way too many underperforming endowments (relative to their liabilities), and they may be forced to chase returns in order to meet their obligations.
• In contrast to the Byron Wein bullet point above, Elroy Dimson of the London Business School has decades of compelling data from 50+ countries to support the view that high economic growth in emerging markets doesn’t ensure high stock returns. His book, ‘Triumph of the Optimists: 101 Years of Global Investment Returns’, along with several other studies, have underlying evidence that economies with the highest growth produce the lowest stock returns by an immense margin (yes, you read that right). In fact, stocks in countries with the highest economic growth have earned an annual average return of 6%; those in the slowest-growing nations have gained an average of 12% annually (source: Credit Suisse Global Returns Yearbook). This could be especially true in 2011, where equity investors in emerging markets are fighting policymakers (who are trying to cool off overheated economies with monetary policy, etc), while developed markets are receiving tailwinds from policymakers (who are aggressively trying to lift the prices for risk assets). While many are clamoring for additional exposure to emerging markets, we believe the best risk/reward is to continue to find value in developed markets like the United States.