The Tasgall Group

This may be a dumb question, but any idea why the market is often surging in one direction or the other primarily starting at 3:30? It’s been more common than not lately, and is strong late market action in-and-of-itself an indicator of some sort?

You can’t click on a link on the net today, it seems, without coming across someone talking about the unraveling of the carry trade. Will the Japanese raise rates and end the party? Everyone knows that the ZIRP (zero-interest rate policy) of Japan is a major spark for carry trades since to have a carry you need one higher interest rate and one lower one to make it work. And zero is pretty low.

Everytime I hear?about it, I want to throw something. First of all, it’s a matter of principle. (more…)

Here’s an interesting trick, in a roundabout explanation thanks to the latest GMO Quarterly Letter – investing without margin calls.

Imagine this, you’re a wealthy investor and have confidence in the long term growth of the economy and the markets. You want to get leveraged long as much as possible to benefit from this long term growth, but know that the inevitable dips and swoons are a threat to using too much margin.

Enter the concept of investing without margin calls. Think it’s not possible? Think again — it’s been happening at a record pace in the last year in the form of Leveraged Buy Outs (LBOs). The long-term investors who buy these companies are sometimes able to lever up as much as 10 to 1, so they might put up $100 million to buy a $1 billion company. They sell bonds (backed by the company’s assets and earning power) to cover the rest of the $900 million difference, and are able to get much more leverage than if they were simply getting 50% margin (2 to 1 leverage) from their stock broker.

But there are plenty of risks, such as the cost of? servicing all that debt, getting the company to grow as much as it would have under public ownership, etc.

It’s an interesting trick if you have enough money to pull it off.? It’s effectively a risk-reversal where the risk of a margin call is shifted from the equity owner to the debt buyer.

Jim Cramer is nothing, if not attention getting. Here are two different videos from Jim on the subprime situation that are quite interesting… I have presented them in chronological order for effect. (more…)

Here are the numbers for this week:

• Dow Industrials – down 4.2%
• S&P 500 down 4.9%
• Russell 2000 down 7%, now in the red for the year
• REITs down 8.8%

The two day rout on Thursday and Friday were quite dramatic, but the declines are still in single-digits across the broad indexes. The panic and consternation are certainly overdone. Several headlines and commentary are acting like we just went through a full bear market, claiming that “stocks are so cheap now” or “where was the plunge protection team — surely we needed it this week!” I’m sorry, but if a 5% price dip makes a stock “cheap”, you don’t understand what the word cheap means and you have no sense of scale. (more…)

There’s an excellent article titled “How professionals dump their toxic waste on you” by Paul Tustain that is worth reading. He starts with much of the current situation in subprime loans that we’ve talked about before… but then goes on to some additional interesting topics… below are some highlights.

Many investment funds (pension funds, bond funds, etc.) are holding CDS (credit default swap) portfolios as income generating bond-equivalent securities. The catch is that many of the CDSs are not actually insuring against default, but the other side of a speculative position that a risky borrower would default. The example cited was Delphi Corp’s recent fall from grace — when their debt was defaulted on, an astounding 10 times the amount of the debt was executed in the form of CDSs on their debt.

So these pension funds, hungry for bond-like returns, basically took the other side of a bet that Delphi would collapse. Not exactly investment grade, but thanks to financial alchemy, a pool of these CDSs were highly rated, and most likely offered to the buyers with leverage. (more…)

I’ve read plenty of vitrol about the Sharpe Ratio (return divided by volatility) and how dangerous is can be and how insufficient it is as a measure of risk, but I’ve never been one to go all black & white about any piece of information. I find it hard to believe that something valuable can’t be gleaned from what it is saying to an investor, at least on a relative scale. My current experience with UP (Uberman’s Portfolio)?has brought it to my attention just how much of an uphill battle we often create for ourselves when we invest. Part of why UP has done well in recent times is that it’s a rare blend of high yields on reasonable volatility with very dynamic risk control capabilities such as low costs and small incremental lot size. In other words, the Sharpe Ratios in the forex world are historically high. The volatility of the markets, especially when diversified, is not a large multiple of the yields. (more…)

Mike Shedlock (a.k.a. Mish) tends to have a bearish bent, but does good analysis of the macro scene.? He’s got some very good articles about the Bear Sterns hedge fund situation, and what is happening behind the headlines…

• The Redemption Trap & the Merrill Lynch Cover-Up
• Who’s Holding the Bag?

Here are some of the high-points:

Losses at hedge funds are being masked by “mark to model” pricing.? That means that their illiquid holdings are worth what the hedge funds say they’re worth, not what they can actually be sold for.? This is important for many reasons, one is that it goes into the monthly balance sheet, which determines bonuses for the hedge fund managers.? Think there’s an incentive to avoid realistic pricing?

State pensions are currently holding large amounts of sub-prime related securities, and will likely see losses in those investments if subprime loans continue to fail.

Normal markets can become illiquid in rare cases (e.g., the 87 stock market crash), illiquid markets have the same problem, but start further down the spectrum of problems.

“The derivatives business is like hell — easy to enter and almost impossible to exit.”

News hit last Friday that Western Digital was going to buy Komag Inc., a maker of hard drive parts. The impressive thing is that the premium paid is small to the price before the news (8%), and is lower than the average price of the last year (the average price can simply be the 200 day moving average: chart).? What a bargain for Western Digital.

I owned some Komag shares a while back as a value-based trade, but the grinding downtrend and my trailing stop loss trigger knocked me out well before it could damage my account capital. ? Ironically, I bought above the $32.25 price that WD is offering for shares, so even had I done the buy-and-hold thing (it was a value play for me, after all) I would still be taking a loss despite being right on the underlying value.

And, of course, someone knew about the deal before the news broke and (illegally) bought a lot of calls…? which doesn’t make sense to me.? The risk of getting caught seems too high relative to the returns…? but one thing I’ve learned is that we can always rely on some speculators not understanding the risks they are taking.

There are two very good articles worth reading on the current issues at Bear Stearns, and the funny money action at a few hedge funds.

Side Pockets @ The Big Picture

Toxic Waste @ Bullion Vault (by Paul Tustain)

The whole thing is starting to sound like a Ponzi Scheme to me…? and if the impact is large enough, we could see buyouts start to struggle (already happening) and eventually share buybacks start to slow down.

Bulls and bears trade places on the margin, so if the sub-prime issues are not “well contained” but have even a slight impact on the overall market/economy, we could well see the tide shift.? It doesn’t look like it yet, but these are the things to keep our eyes on for further indications of change.