Tuesday, November 18, 2008

Cash and Patience 

For many years now, investors have had a disdain for cash and its associated returns, which typically are low, and for which tax rates are high.

Today, cash is a fine-looking asset (said with genuine respect and appreciation), and as deposit rates are going up, cash looks even better. It can't hurt you.

Many investors, some of the smartest and most accomplished in the world with 30+ years of experience, have been decimated by the current market. Money managers in the public market and the private market have come too soon to the party, and the raging fire has burned their money to ash. The renowned TPG led a $7bn rescue financing of Washington Mutual, only to see the bank seized by the FDIC after a $17bn run on deposits within months of their investment. Bill Miller, the legendary fund manager from Legg Mason, who outperformed the S&P for 15+ years, has seen his record come to an ignominious conclusion. Blackstone and Fortress, money management firms responsible for a range of investment products from hedge funds, to private equity, to real estate, have seen their shares - taken public at the height of the boom - collapse to 20% and 7%, respectively, of their highs.

Every bottom the market seems to have made has in fact been a false bottom, and each time investors have plunged ahead to seize what they viewed as opportunity, they have instead been crushed.

So here we are today. A bottom?

Mmmm, maybe not. While we have seen margin calls and associated forced selling from broken financial institutions and hedge funds, we have not seen - yet - the wave of corporate downgrades and defaults which will force new sellers to come to market and meet a weaker bid (typically if you buy something at 55 or 60, you lose the stones to buy it when you see it at 35). These credit owners - called CLOs and CDOs - ar next. They have contractual agreements which do not allow them to own more than x% of credits of a particular (low) rating. When those contractual buckets fill up, they have to sell. Sometime after 4th quarter results are in, and the rating agencies react to what will likely be surprisingly poor results, watch out. The credit market will likely have another leg down. And with that wave of horrible news flow - bad earnings, credit downgrades, a default wave, increasing bankruptcies - it's hard to see why anything goes up.

Still no bid.


By Blogger Escort81, at Tue Nov 18, 12:50:00 PM:

This comment has been removed by the author.  

By Blogger Escort81, at Tue Nov 18, 12:51:00 PM:

I agree, CP, the worst may not be over. There are structural and timing reasons, as you point out. It just takes time for markets to clear, especially with respect to the bad underlying mortgages that TARP was supposed to deal with. Liquidity is just not there in certain markets.

This may be a grinding 1970s-style bear market. I fully expect to see Dow numbers near 7,000. Cash is not trash, as you point out, and it is a good time to be a muni bond buyer, if you happen to live in a state with issuers that are of good credit quality.

Trailing 10 year return figures on the Dow and S&P are as bad as any in history, and have been for most of the decade (except briefly for last fall, perhaps), so once the bear is over, I hope for a period of steady, unglamourous positive returns.

I also beleive that starting in the second half of next year, there will be opportunities (perhaps particularly in private equity) to purchase very nice quality assets at attractive prices.

The good new is that there is no bubble asset class -- everything has been popped.

Well, maybe there is a political bubble -- the Bubble of Obama, who is being written about as if he is a cross between FDR and Lincoln, and he doesn't take office for two more months. Look, I don't want the guy to mess up, but let's not raise the bar too high, OK?

If we are sitting here two years from now in roughly the same situation, maybe those FDR comparisons will be apt -- that is, if you take 1934 or 1938 as your point of comparison. Things weren't going too well for the author of the New Deal until he became a wartime president.  

By Anonymous Anonymous, at Tue Nov 18, 01:14:00 PM:

This is already an ugly bear market, in terms of percentage decline and duration. Of the fourteen postwar primary bear markets, this looks like the second worst as measured by decline from the top. But it's still relatively average in duration, at 262 days.

If protectionism can be constrained in the next Congress and if Obama will back off his tax increases, we might see some improvement in the market in 2009, based on the history of past bear markets. Another possibility, of course, is that as taxes increase and protectionist sentiment rises, we could see another decade like the thirties, a decade that encompased 11 discrete bear markets. Can you imagine modern America where unemployment peaks as high as in the thirties? Not a fun prospect.

Here's a few charts that liven up everyone's day.  

By Blogger Mrs. Davis, at Tue Nov 18, 02:24:00 PM:

The good new is that there is no bubble asset class -- everything has been popped.

While it is not a financial asset, higher education has not yet popped. Look for that this spring. Along with the penultimate batch of mortgage teaser rate adjustments.  

By Anonymous Anonymous, at Tue Nov 18, 04:02:00 PM:

In the long run, however, cash is the biggest loser of all, as the paltry returns (again, historically)do not keep up with inflation.

Market timers lose. You need to have at least some of your money in equities, unless you are near the end of the road.  

By Anonymous Anonymous, at Tue Nov 18, 04:35:00 PM:

This is just a bit off topic, but last winter when the DOW dropped below 12000, I encouraged my 81 yr old Dad to cash out of the market. He said, "No. I don't want to pay the taxes on the proceeds." In August, I asked my 75 yr old former boss the same question and got the same answer. So my question is this: Is the fact that there is a capital gains tax propping the market up by discouraging selling, or are people like my old dad and former boss too small of a percentage to have any impact? Had it not been for taxes they would have both gotten out.  

By Blogger Cardinalpark, at Tue Nov 18, 05:02:00 PM:

feeble - hard to know frankly. Many people worried about capital gains tax increases under a new administration sold to realize a lower tax rate.

There is one good thing about paying taxes. It means you made money. Never be talked out of selling for good reasons and into holding for tax reasons.  

By Blogger Who Struck John, at Tue Nov 18, 07:55:00 PM:

This isn't the bottom. Too many shoes left to drop.  

By Blogger Purple Avenger, at Tue Nov 18, 09:25:00 PM:

Bottom at 6500. That's my story and I'm sticking to it.

Although I'm thinking hard about jumping into some American Express right now...  

By Anonymous Anonymous, at Wed Nov 19, 02:48:00 AM:

I suspect a lot of people will, like me, be getting refunds this year.

My estimated taxes paid-in were projected upon modest capital gains. Instead I lost and sold some of the losers.

This may occur to many others in the next fifty days. I expect sellers to drive the market lower for now.

I am making small buys of good utilities. Some are paying seven perscent.  

By Anonymous Anonymous, at Wed Nov 19, 03:13:00 AM:


What are your thoughts on deflation? If asset values are down and net worths are down, how can most people continue to pay for goods at the same prices as they did when the Dow was 50% higher, especially when they are close to or closer to retirement and will be living off a much smaller corpus than they had even 6 months ago? Perhaps there's a difference between day-to-day needs -- gasoline, food, clothing -- and longer-term ones -- residential real estate, cars, higher education -- but will there be a deflationary spiral to contend with too? If so, on what, and how will that affect the overall economy?

The Centrist  

By Blogger Cardinalpark, at Thu Nov 20, 09:43:00 AM:

Centrist - deflation is certainly a threat and a danger. Prices for all goods, commodities and services are rapidly declining (discounting, liquidations, etc). The Fed is trying to ensure an adequate monetary supply growth to combat it.

Another important risk factor.  

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