Sense on Cents

Attorney Representing Amerivet Securities Makes Claim FINRA Insider Confirms Investment in Madoff

Posted by Larry Doyle on September 4th, 2009 1:20 PM |

Did we just find the smoking gun which indicates that FINRA (Financial Industry Regulatory Authority) actually invested in the Madoff Ponzi scheme?

I was on a panel last evening on America’s Nightly Scoreboard on Fox Business News (the entire transcript can be found at this link). The topic was one which regular readers of Sense on Cents are most familiar, that being FINRA.

The show is hosted by David Asman. Panelists included Richard Greenfield, an attorney representing Amerivet Securities in its suit against FINRA; former SEC chair Harvey Pitt; Madoff Victims Coalition head Ronnie Sue Ambrosino and her husband Dominic; and yours truly.

I commend the host of the show, David Asman, for being thorough, professional, balanced, and aggressive in addressing the topic. We covered a number of angles including:

1. Amerivet Securities complaint vs. FINRA

2. Mary Schapiro’s tenure and compensation at FINRA

3. FINRA’s investment portfolio, including its sale of auction-rate securities.

4. Did FINRA invest in Bernard Madoff’s Ponzi scheme?

There were a few bombshells that came out of our discussion, including a claim by Mr. Greenfield, the Amerivet Securities attorney, that “somebody well-placed within the organization (FINRA) that told us, in no uncertain terms, there was an investment with Madoff.”

Additionally, former SEC chairman Harvey Pitt provided a qualified endorsement of FINRA opening its books and records in an acknowledgement of the need for greater transparency.

I am happy to provide the transcript of the dialogue which encompassed these two momentous statements:

ASMAN: Harvey, for example, I used to work at the “Wall Street Journal” and we had very strict restrictions about what we could buy, how long we could hold stocks if we bought it, and how we had to disclose it and that sort of thing. It doesn’t seem at least that those disclosure policies apply to FINRA, at least in the case finding out whether they invested with Madoff.

PITT: I don’t — there has been a fair amount of, shall we say, opacity with respect to what the investment activities are and the like. In a real sense, I think that’s probably ill-advised for an enterprise that has regulatory responsibilities.

But so putting that to one side, I do think that people are entitled to know where their money is coming from, where their money is going, what it is being spent and the like. The fact of the matter is the SEC does oversee all these operations. It does overlook all these things. FINRA has been under the microscope at the SEC for many, many years, long before Mary Schapiro got to the SEC.

ASMAN: I want to bring in other parties. But I want to go back to Counselor Greenfield.

Richard Greenfield, how did you get information suggesting that indeed FINRA was investing with Madoff?

GREENFIELD: Well, we got the information, number one, in two different ways. Number one, it has been rumored through many people on Wall Street that there was an investment either through a feeder fund or some other means. Secondly, we also got information from somebody well-placed within the organization that told us, in no uncertain terms, there was an investment with Madoff.

ASMAN: OK. All right. So I think it’s fair to say that FINRA owes the public some answers here.

So joining us now with — are some people who are demanding answers. Larry Doyle, a Wall Street veteran, 23 years, who currently operates his own web site, Sense on Cents — “sense” with an “S” and “cents” with a “C” — which is geared to help people navigate the landscape.

Ronnie Sue and Dominic Ambrosino, good friends of “Scoreboard”, they are Madoff victims who are mobilizing a campaign for greater transparency.

Thanks for coming in.

RONNIE SUE AMBROSINO: Thank you.

ASMAN: Larry, first to you. What do you think about Harvey’s description of the situation?

LARRY DOYLE, WALL STREET VETERAN & SENSE ON CENTS WEB SITE OWNER: I would say two things in regard to the former chairman’s statement. First and foremost, Madoff did not become a registered investment advisor until 2006. FINRA obviously wasn’t formed until 2007. FINRA’s parent, that being, FINRA was formed from the regulatory arms of the New York Stock Exchange, and the NASD.

ASMAN: Right.

DOYLE: The fact is, the NASD did have oversight of Madoff, and so there is an obligation by, to look into the NASD’s activities because, at that point, it was just a broker-dealer.

ASMAN: Have you formulated your own opinion whether there was a conflict of interest here?

DOYLE: Without a doubt. Without a doubt. The fact of the matter is FINRA is a big-money organization. We know they invested in hedge funds, fund of funds, private equity. And they also had a significant investment in auction rate securities, which is sector of the market that has been designated as a fraud by federal judges. The fact of the matter is we know, and have learned from FINRA, that FINRA exited their auction rates securities position, $647 million worth, in mid 2007, as the market was failing, and when they were supposed to be protecting investors.

Further along in the dialogue, we engage in the need for FINRA to open its books and records:

ASMAN: That is great point, Ronnie Sue.

And, Larry, it goes to the point that a lot of people are looking from the outside at what goes on inside in Wall Street and Washington. It’s that Wall Street, Washington nexus. They see all these folks kind of related with each other. The SEC related with FINRA, and related with NASD. You look at Mary Schapiro’s career and you see that. They can miss things because they’re only talking to each other.

DOYLE: I think the term there is incestuous. So the fact of the matter is Washington has an opportunity through this financial regulatory reform to bring total transparency.

ASMAN: How would you do that? Open the records of FINRA?

DOYLE: Open the books. What — what individual in America right now wouldn’t make — doesn’t it make sense for FINRA to be forced to open their books and records, full and total transparency? The markets demand it. The economy demands it. Ronnie Sue and Dominic demand it. For market confidence.

ASMAN: Harvey, if we demand it of banks, why not FINRA or for that matter, why not the Fed? We have a lot of people in Congress saying everybody needs to open the books, everybody needs to be transparent?

PITT: Well I think there’s no question that we need far more transparency throughout the regulatory environment, both for those regulated and those doing the regulation. That, I think, is a very clear proposition, and one that I’m hopeful will be addressed in whatever new legislation comes about.

ASMAN: So we have to leave.

But, Harvey, does that mean you’re in favor of FINRA opening the books so we can find out if they invested in Madoff?

PITT: I’m in favor of there being far more transparency, permitting privacy concerns to allow certain information to be withheld, as long as somebody is overseeing what they’re doing.

I am thrilled that these issues which Sense on Cents has been focused on for the last 8 months are coming into the public light. That said, there remains plenty of work left to do to generate the truth, transparency, and integrity that our markets, economy, and country so badly need.

You can help by spreading this story amongst friends and colleagues. While the Amerivet complaint vs. FINRA will be addressed in the Washington D.C. courts, the fact is the issues revolving around FINRA and regulatory transparency need to be highlighted in the court of public opinion.

What do you think?

If you like what you see and read here, please subscribe to Sense on Cents via e-mail, Twitter, Facebook, or an RSS feed. Thanks for your support.

Related Sense on Cents Commentary

Madoff Victims Call Out FINRA (September 3, 2009)

Amerivet Complaint Against FINRA Alleges Madoff Investment (August 25, 2009)

How Courageous is Mary Schapiro? (June 4, 2009)

U.S. Attorney and SEC Investigating Lehman’s Auction Rate Securities Sales; They Should Also Investigate FINRA’s (May 21, 2009)

FINRA Is Supposed to Police the Market (April 29, 2009)

Comments (2)

Unemployment Report: September 4, 2009

Posted by Larry Doyle on September 4th, 2009 9:14 AM |

The widely anticipated September Unemployment Report covering the month of August was just released. Let’s dive right in and take a look at the numbers . . .

Unemployment Rate
June: 9.4%
July: 9.5%
August: 9.4%
September: 9.7%!!

>>LD’s comments: higher than the expectation of 9.5%. Recall that the rate moved down last month from 9.5% to 9.4% as the labor pool shrunk. This move higher puts the rate back on the track it previously held and would project to a likely double digit unemployment rate in the 4th quarter.

Where’s the stimulus? Where are the jobs? Bulls would say the employment situation is stabilizing. Pragmatists look at the numbers and see an economy settling in to a likely low growth path at best. The unemployment rate of 9.7% is the highest since 1983. The underemployment rate of 16.8% is very sobering!!

Non-Farm Payroll (click here for definition of this term)
June: loss of 322k
July: loss of 467k initially revised to a loss of 443k and now revised to a loss of 463k
August: loss of 247k revised to a loss of 276k
September: loss of 216k

>>LD’s comments: Close to consensus, but the prior two months had revisions showing further declines of 49k. (The prior month was revised from a loss of 247k jobs to 276k. July was revised from a loss of 443k jobs to 463k jobs). Manufacturing lost 63k jobs, government showed a loss of 18k jobs with more of these at the state level.I repeat my comments from above. We are not witnessing any inclination by private companies to start the rehiring process. As such, the likelihood of long term structural unemployment is growing. This fact will serve as a real drag on consumers in general and the economy as a whole.

Average Hourly Earnings
June: +.1%
July: 0.0%
August: +.2% revised to +.3
September: came in at .3 with the prior month revised to .3 as well.

>>LD’s comments: Largely due to the increase in the minimum wage. Do not look at this increase as an indication of potential growth in retail sales.

Average Hourly Workweek
June: 33.1 hours
July: 33.0 hours
August: 33.1 hours
September: 33.1 hours

>>LD’s comments: as expected the average hourly workweek remained unchanged. This number, which remains mired at a level last seen in 1964, is an indication that an expected rebuild in inventories is not on the near term horizon.

Further Color: the economy remains significantly challenged. Despite all of the government stimulus and government programs, in my opinion the economy is very vulnerable. Behind these numbers, the consumer is seeing few signs of improvement in the jobs space. That reality is impacting the sluggish retail sales along with the continued increase in delinquencies and defaults on the credit front.

Market Reaction: futures have been bouncing up and down post-report. Prior to the report, equity futures indicated a slightly positive opening to the equity market. Now the futures are closer to unchanged.

Interest rates have also bounced around, but the front end of the yield curve seems better bid as the unsettledness behind these numbers makes investors nervous.

The dollar index is somewhat improved but not in a meaningful fashion.

Add it all up and I see the following:

>> the cheerleaders can put away the pom-poms

>> the pure doom and gloom guys who have been short forever remain frustrated

>> the economy remains challenged and will bump along the bottom. No “V” recovery, but more like the “caterpillar” designation assigned by our Sense on Cents Economic All-Star Bob Rodriguez.

Get used to it because it is not going to change appreciably anytime soon.

I repeat my market call from the other day in which I believe equities will retreat from current levels.

Please track our work here at Sense on Cents via Twitter, Facebook, RSS feeds, or e-mail subscription. Visit and comment often!!

Comments (3)

Banks Are Forestalling Rather Than Foreclosing

Posted by Larry Doyle on September 3rd, 2009 12:22 PM |

What happens when a bank forecloses on a home? It has to book a loss. How are banks dealing with the rapidly increasing rates of delinquencies and subsequent foreclosures? They are forestalling the losses by allowing homeowners to remain in the home for a protracted period. Are they doing this out of generosity? Don’t be that naive. The banks are utilizing the ‘hope’ hedge. That is, they ‘hope’ the economy and housing market will rebound so the values of these homes increase and the loss is mitigated.

Over many years of trading and investing, the ‘hope’ hedge is a recipe for further losses. Why? Please refer to my Rule #1 from yesterday’s “LD’s Rules of Trading”: The Market Goes in the Direction Which Hurts the Most People.

Homes that would otherwise be in foreclosure create a massive overhang of supply in the shadow housing inventory. Do banks believe that buyers do not appreciate this? That would be even more naive. The excess supply will keep a lid on home prices and consumer wealth which directly impacts retail sales.

High five to MC for sharing a recent report from American Banker addressing this phenomena. Kate Berry writes Postponing the Day of Reckoning, which I am able to access from Bank Investment Consultant. Ms. Berry shares some very sobering insights:

“The goal is to hold off on foreclosures and take losses as slowly as possible to keep balance sheets up,” said Deborah Voelz, the chief financial officer of National Asset Direct Inc., a New York buyer and servicer of distressed loans. “Everyone is looking at what the ultimate loss is going to be and whether it makes sense to hold off another year or two and mitigate the results.”

The foreclosure process — and it is a process — now takes, on average, 18 months to two years, up from 15 months a year ago, according to Amherst Securities Group LP. Backlogs in county courts and at servicing companies, along with local government moratoriums, have contributed to the delays. But plenty of signs indicate that the mortgage companies themselves are in no hurry to seize their collateral.

Rick Sharga, a senior vice president at RealtyTrac Inc., an Irvine, Calif., company that monitors foreclosure filings, said banks often start proceedings but then decide “they don’t want the property” and suspend the process indefinitely.

Of the 2.3 million homes that received foreclosure notices last year, one-third had been repossessed by yearend, according to RealtyTrac.

Banks also “are allowing borrowers to be delinquent for longer and longer periods of time before initiating foreclosures,” Sharga said.

These perspectives are totally consistent with those of John Lounsbury, my guest this past Sunday on NQR’s Sense on Cents with Larry Doyle. John pointedly detailed that only 10% of homes being sold currently entail ‘willing sellers.’

What are the implications for this forestalling?

>> Continued pressure on housing overall.

>> Continued pressure on bank earnings from these mortgages.

>> Continued underwhelming trends in retail sales by consumers.

>> Prospective home buyers, especially in the higher price ranges, can remain patient.

Regardless of what bank analysts or others may want to say, these forestalled homes are not going away.

Comments (3)

Madoff Victims Call Out FINRA

Posted by Larry Doyle on September 3rd, 2009 8:26 AM |

Is Uncle Sam, in the form of the SEC, attempting to issue a mea culpa, mea culpa, mea maxima culpa in the bungling of the Madoff investigation and trying to conveniently turn the page?

The American public learned very little with the release of the SEC Inspector General David Kotz’s review of the SEC’s failure to expose the Bernard Madoff Ponzi scheme. In fact, having just finished reading the Executive Summary of his investigation, I would maintain it is largely an extended regurgitation of much of what Harry Markopolos provided in his Congressional testimony last February.

What was Harry’s conclusion of his exhaustive pursuit to expose the Madoff scam? The SEC is incompetent.

What was the Inspector General’s conclusion from his investigation? In so many words, Kotz lays out the same results. The SEC was incompetent on so many fronts from the early 1990s until Madoff was exposed last December. For those who would like to read Kotz’s 22-page summary of his investigation, just click on the image below.

Is this all the public gets? Is this all the public can expect from our regulators? Nothing more than a mea maxima culpa? How about a real pursuit of the total truth? This Madoff affair has many more legs. Let’s navigate.

Ronnie Sue Ambrosino, head of the Madoff Victims Coalition for Investor Protection (my guest on NQR’s Sense on Cents with Larry Doyle on August 16th), and her husband Dominic comment on the Inspector General’s report and simultaneously call out FINRA last evening during an interview on Fox Business News.

Ronnie Sue and Dominic effectively connect the dots while highlighting the following:

1. Current head of the SEC Mary Schapiro formerly headed FINRA

2. Harry Markopolos defined FINRA as being “in bed” with the industry when he provided Congressional testimony this past February detailing his decade-long pursuit to expose the Madoff Ponzi scam.

3. FINRA had an internal investment portfolio (Sense on Cents would add that the portfolio was invested in hedge funds, fund of funds, and also had hundreds of millions in Auction-Rate Securities).

4. Amerivet Securities has recently filed a complaint against FINRA. The complaint indicates it has information and reason to believe that FINRA’s investment portfolio invested in Madoff.

Sense on Cents would add that the Amerivet complaint looks to have FINRA provide a full and thorough review of the following:

>> interactions with the major Wall Street banks

>> its compensation practices

>> its liquidation of its auction-rate securities position in 2007

>> all investment activities

Sense on Cents would further add that the Madoff family had extensive relationships with the NASD, Nasdaq (Bernie helped establish this exchange) and FINRA.

Let’s listen to Ronnie Sue and Dominic Ambrosino:

Is the Madoff investigation over? Any rational individual can understand there are many more regulatory questions needing answers. Where do those questions lead us? Inside FINRA and specifically to its investment portfolio. Why shouldn’t a Wall Street self-regulatory organization mandated to protect investors be obligated, and if need be compelled, to provide total transparency of all its business dealings?

I can only hope major media outlets and Washington pick up this story and understand the need to fully investigate FINRA.

I ask you again . . . is the Madoff investigation over? Not by a long shot!

What do you think?

Comments (4)

LD’s ‘Rules of Trading’

Posted by Larry Doyle on September 2nd, 2009 3:17 PM |

I loved my 15 years worth of trading experience on Wall Street. I thrived on the energy, competitiveness, and discipline critically important to generating long term profitability.

While many media outlets focus on the energy and competitiveness involved in trading, rest assured the real key to successful trading and investing is discipline. In my opinion, this characteristic receives far less focus and attention than it deserves.

I believe discipline is both an intrinsic and acquired trait. In fact, often the real benefits from a disciplined approach are the lessons learned from being undisciplined. Believe me, I learned many of these lessons early on and throughout my career on Wall Street. I accrued plenty of losses in the process.

How did I develop and maintain a disciplined approach during my 23 year Wall Street career? Very simply, I kept a written list of ‘trading rules’ on a piece of paper typically taped to my computer terminal.

High five to AS with whom I developed these rules back in the mid 1980s. These rules not only helped me generate profits, but more importantly kept me from making trading mistakes and thus avert losses.

Let’s review the rules that I applied to trading mortgage-backed securities in the 1980s and 1990s. In many respects, I continue to apply a semblance of these rules today.

LD’s Rules of Trading

1. Market Goes in the Direction Which Hurts the Most People
I would check the stochastics regularly to monitor when the bond market (typically the government bond market) was approaching an overbought or oversold condition. Assessing this measure is decidedly more challenging currently given the presence of Uncle Sam in the marketplace.

2. Never Short a Specified Bond
How often I would see traders short specified bonds without any appreciation for the available float. Initial short sales may appear to be profitable only to turn into nightmares when the trader had to find the bond for delivery to the buyer.

3. Never Set Up for a Trade
This rule specifically addresses a trader’s inclination to establish a trading position based upon color from a client that the client himself planned to enter into the trade. Experience taught me that often the client would find a reason not to execute the trade and now the trader was stuck with the position. Read the rest »

Comments (6)

Uncle Sam’s Continuation of the Housing Bubble

Posted by Larry Doyle on September 2nd, 2009 8:57 AM |

With housing prices down 30+% on average over the last few years, is Uncle Sam blowing fresh air into the housing balloon and actually creating another housing bubble? I believe that’s exactly what is happening.

If you are scratching your head and think I am off base with my assertion, please navigate this path along our economic landscape with me.

What drove the housing bubble? Cheap rates and undisciplined lending from the private sector. What added to the bubble? The internal ‘hedge fund’ portfolios of Freddie Mac and Fannie Mae.

What is perpetuating the housing bubble if not creating another mini-bubble of sorts? Cheap rates and undisciplined lending directly from Uncle Sam or supported by Uncle Sam. What is adding to this bubble? Those same internal portfolios at Freddie and Fannie.

What entities within Uncle Sam’s domain are providing the cheap rates and undisciplined lending?

1. The Federal Housing Administration ( FHA-insured loans are packaged into GNMA securities, which have the explicit backing of Uncle Sam)

2. The Federal Reserve’s quantitative easing program in which it has purchased hundreds of billions in mortgage-backed securities with authority to purchase a total of $1 trillion+ in MBS is also blowing fresh air into the balloon.

3. Freddie and Fannie are also supporting the bubble by providing fresh capital via their portfolios.

People may say that Uncle Sam had to provide this capital because the private sector would not. In fact, The Wall Street Journal makes that very assertion this morning in writing, Industry Seeks Fannie, Freddie Overhaul:

Together with the Federal Housing Administration, Fannie and Freddie now purchase or guarantee nearly nine in 10 new mortgages, since private buyers of such loans have been absent amid the housing bust.

I categorically do not accept this assertion. There is more than enough private capital in the system to purchase these mortgages. The issue is that the private capital will only purchase these mortgages at appropriate risk adjusted prices. Freddie, Fannie, the FHA, and the Federal Reserve are stepping ‘through the market’ and subsidizing mortgage rates by at least 50 basis points and, in turn, crowding out private buyers. The WSJ continues:

Fannie and Freddie have taken nearly $96 billion of capital infusions from the U.S. Treasury since last November. The companies have received nearly 10 times that amount in additional support through purchases of debt and mortgage-backed securities by the Treasury and the Federal Reserve.

Who is benefiting from these subsidized rates? New homeowners. Do not think for a second, however, that risks are properly aligned in this current mortgage dynamic.

The continued mispricing of risk will mean our housing market will experience more protracted levels of delinquencies, defaults, and foreclosures than if mortgage rates were higher and real discipline were instituted into the lending process.

In fact, unless our country accepts a fully socialized mortgage finance system, mortgage rates will have to move higher to reflect private sector pricing. Risks and returns will then be properly aligned and the bubble will deflate.

Related Sense on Cents Commentary:
“Uncle Sam Guaranteeing Sub-Prime Loans” (May 4, 2009)

Comments (2)

Give Me a Hard Eight on AIG, Freddie, Fannie, and Citi

Posted by Larry Doyle on September 1st, 2009 3:35 PM |

Want to play craps? How about a little roulette? Black jack? Or should we merely play the slots?

On the topic of casinos and gambling, I hope traders, investors, and the general public fully appreciate the extent to which our wards of the state (AIG, Freddie, Fannie, and Citi) have dominated equity trading volumes over the last few weeks. On many days, these stocks have represented upwards of 25% of the overall volume.

I addressed this point in my August 2009 Market Review and wrote:

A large percentage of market volume has centered on those stocks in which Uncle Sam is heavily involved (Citi, AIG, BofA, Freddie, Fannie). I view these particular stocks as very speculative in nature. That said, there are large short bases in these stocks. The shorts were punished during the month. The stocks did trade off significantly on the last day of the month.

Are we supposed to make assessments of our future economic health and overall market performance based upon stocks in which Uncle Sam holds anywhere from a 40-80% equity stake? I think not. I view trading these stocks as pure gambling, not investing. I challenge any analyst who would say otherwise.

What sector of the market is leading the overall market lower today? Financials!! Which companies in particular? Our friendly Market Data page from The Wall Street Journal highlights the following:

So there you have it, 6 of the top 8 most active stocks being traded today are wards of the state, or a close cousin, that being CIT. Ford is a fully independent entity. Many view General Electric as an extension of the government politically, while the company itself has clearly benefited from government-backed financing.

Don’t take my word for the speculative nature of AIG, Citi, Freddie, and Fannie. The Wall Street Journal highlights the same in writing, Financials Lead Broad Selloff. Specifically the WSJ asserts:

>>Among the weakest was American International Group, which sank 17%. Sanford C. Bernstein & Co. downgraded AIG to underperform from market perform, estimating that if the government’s support and other goodwill were discounted, AIG would have a negative book value of $6.4 billion.

>>Mortgage lenders Fannie Mae and Freddie Mac also traded lower, falling more than 15% after FBR Capital Markets analyst Paul Miller wrote to clients that “[t]here is no fundamental value remaining” in the companies.

I ask you how much money you want to invest on a long term basis in companies which have negative book value or no fundamental value?

The first rule of gambling is ‘only play with money you can afford to lose.’ The same is to be said for money put into these companies which just so happen to be dominating the overall market volume.

Come on, brother, give me a hard eight!!

Comments (1)

Buy the Rumor, Sell the News

Posted by Larry Doyle on September 1st, 2009 11:48 AM |

Why does a market seem to improve prior to the actual reporting of positive economic news only to fade when the news is reported? Welcome to the world of trading and investing in which market participants will often ‘buy the rumor’ and ‘sell the news.’

This phenomena is, in fact, the perfect description for today’s price action.

Prior to the market open this morning, equity futures were indicating a slightly weaker opening. In fact, the equity markets did open in slightly positive territory. At 10am, we received economic data which collectively would be viewed in a VERY POSITIVE light. This data includes:

1. Institute of Supply Management Manufacturing Index rose to 52.9 versus last month’s reading of 48.9 and an expectation of 50.5. This month’s reading of above 50 is the first indication of growth in manufacturing in a year and a half. Manufacturing represents approximately 12% of our economy. All other things being equal, this report is an indication that our recession is ending or actually has ended.

In the spirit of full disclosure, the employment component of the ISM Index showed only marginal improvement. This release continues to highlight that an economic recovery will not be robust in terms of improved job prospects and overall employment.

Another somewhat disturbing component of the ISM Index entails Prices Paid. In a big surprise, this release details that Prices Paid rose to a 65 level from 55 last month and against an expectation of 57.8. The increase in prices paid will further pressure profit margins and may be an indication that an increase in inflation is closer than we may think.

Despite, the employment and price components, a return to growth in manufacturing is a critical development in bringing a semblance of stability to our economy.

2. Pending Home Sales also generated a surprisingly strong 3.2% increase versus an expectation of a 1.5% increase. Be mindful, though, that this report had generated a 3.6% increase in July. While analysts will portray this report as a positive development overall, I continue to believe that the housing sector of our economy needs to be viewed primarily through the prism of delinquencies and defaults. Unless and until those statistics start to decline, housing will not be a strong indication of our overall economic health.

3. Construction spending shows little improvement. Against an expectation of a flat reading, the report came in at -.2%. Additionally, the prior month’s report was revised down from a .3% reading to only .1%.

4. Deal activity today is focused on eBay’s sales of its Skype internet phone unit for $2.75 billion. That figure is a very strong valuation for this business.

Despite this generally very positive news, in the last 45 minutes while I have been writing this commentary, the equity markets have had a major selloff and are now down more than 1.5%!! WHY??

Well, let’s be mindful that the economic fundamentals have been totally disconnected from market price action and overall valuations for a protracted period.

Please check my commentary from the August 2009 Market Review in which I wrote:

While it has been foolhardy and painful to fight the Fed and the massive liquidity pumped into the system, I see some real signals in a variety of sectors that this rally is running out of steam. The markets have not truly had a meaningful correction in the last 6 months. Are we due for one? I personally think it would be very beneficial. Why? The disconnect between Wall Street and Main Street has never been greater. I do not view that gap as healthy.

Call me crazy, but I project September will have a 5-7% retraction across the major equity market averages based on reading the tea leaves as highlighted in this review.

What do you think?

One day nor merely a few hours does not a market call make, but I do think the signs we are seeing in the emerging markets and commodity markets are real warning signals that we ignore at our peril.

If you like my work please receive it regularly via e-mail, Twitter, Facebook, or an RSS feed. Links provided on every page here at Sense on Cents. Thanks!!

Comments (0)

August 2009 Market Review

Posted by Larry Doyle on August 31st, 2009 9:28 PM |

monthly-market-review2 August represents the sixth month in a row in which the equity markets have posted positive returns. Has the rally been built upon a solid economic foundation? Does the rally have even further to run? Is it too late to get in? Should investors be more cautious at these levels?

What do the numbers on Wall Street mean for people on Main Street? How are the powers that be in Washington responding to the markets? What do we learn from international and emerging markets?

Let’s review the monthly performance, look beyond the numbers, and project what may lie ahead.

Equities

Unlike the explosive performance in July (equities up 8-10%), the market had a much more subdued performance in August. Be mindful that August is the heaviest vacation month for market participants. Over and above that, total volume in the equity markets has been rather light. A large percentage of market volume has centered on those stocks in which Uncle Sam is heavily involved (Citi, AIG, BofA, Freddie, Fannie). I view these particular stocks as very speculative in nature. That said, there are large short bases in these stocks. The shorts were punished during the month. The stocks did trade off significantly on the last day of the month.

Are we supposed to make assessments of our future economic health and overall market performance based upon stocks in which Uncle Sam holds anywhere from a 40-80% equity stake? I think not. I view trading these stocks as pure gambling, not investing. I challenge any analyst who would say otherwise.

I am concerned about the equity markets going forward. Why? What sector has led the equity markets overall? Emerging markets, specifically China. What is happening in those market segments? China sold off close to 6% on the last day of the month and is down over 20% from its high. That decline is technically termed a ‘bear market.’ Analysts I respect view China’s market as an asset bubble. Emerging markets overall have had an unbelievable run but appear to be losing momentum as both the U.S. markets and developed markets outperformed the emerging markets this month. What drives the emerging markets? Primarily the exporting of commodities. Let’s review that segment.

Commodities

The DJ-UBS Commodity Index is also showing signs of losing momentum. In fact, the index was down -.6% for the month while it is off a full 4-5% from the highs seen in July. While oil is approximately 7% off its highs, natural gas had a significant decline this month (down approximately 30%) and corn also sold off hard early in the month (down approximately 10%) before stabilizing.

The Baltic Dry Index is a good indicator of activity in the commodity space and as a link to activity in the emerging markets, especially China. What does the trend line on the BDI look like? Not very good. The BDI closed today at 2686, down approximately 20% from the highs seen in July.

Interest Rates/Bonds

Ben Bernanke announced in August that the Fed will leave the Fed Funds rate unchanged at a range of 0-.25% for an extended period. There is little doubt that Ben knows there remain major hurdles on the economic landscape. Clearly, both Bernanke and Geithner view improved financial markets and an improved financial industry as a pre-condition to a healthy economic recovery. Against this backdrop, U.S. Treasury debt rallied while other sectors of the bond market added marginally positive returns.

Does it make sense that both equities and bonds would rally in sync? No, but equity and bond markets both continue to trade more on technicals (that is, excess liquidity provided by Big Ben and his friend Uncle Sam) than pure fundamental value.

U.S. Dollar

The U.S. dollar continues to gradually erode in value. Is this any surprise? Many major trading partners of the U.S., from China to Japan to France, are calling for lessened dependence on the greenback as the international reserve currency.

Economy

While the industrial segment of our economy appears to be stabilizing, from my perspective the consumer (remember 70% of our economy is tied to the consumer) remains severely stressed. Delinquencies and defaults continue to run at a record pace across almost every form of debt (mortgages, credit cards).

The next shoe to drop is in the commercial real estate space.

I particularly like Sense on Cents‘ Economic All-Star Bob Rodriguez’s characterization of our economy. Bob views our economic landscape not as a “V,” or a “U”, or a “W” but rather as a caterpillar. What does he mean? He believes the economy will slowly move up and down for the foreseeable future. I concur.

Summary

While it has been foolhardy and painful to fight the Fed and the massive liquidity pumped into the system, I see some real signals in a variety of sectors that this rally is running out of steam. The markets have not truly had a meaningful correction in the last 6 months. Are we due for one? I personally think it would be very beneficial. Why? The disconnect between Wall Street and Main Street has never been greater. I do not view that gap as healthy.

Call me crazy, but I project September will have a 5-7% retraction across the major equity market averages based on reading the tea leaves as highlighted in this review.

What do you think?

P.S. If you like what you see here at Sense on Cents, please track my work via e-mail subscription, become a fan on Facebook, follow Sense on Cents on Twitter, or connect via any of the RSS feeds.

Comments (2)

Custom Derivatives are the Darkest Corner of the Wall Street Casino

Posted by Larry Doyle on August 31st, 2009 4:16 PM |

Why is it that Wall Street is lobbying VERY heavily to delay and dilute expected reforms for the derivatives market? Well, given that Wall Street is making multiple billions in this space, it is not difficult to understand that the industry will spend millions to protect the franchise. In fact, the industry has been aggressively lobbying to maintain the veil of secrecy on this segment of the market.

The profits generated in this space are centered on 5 banks: JP Morgan, Goldman Sachs, Citigroup, Morgan Stanley, and BofA. Bloomberg takes a peek into the highly profitable but excessively opaque world of derivatives in writing, Wall Street Stealth Lobby Defends $35 Billion Derivatives Haul:

Wall Street is suiting up for a battle to protect one of its richest fiefdoms, the $592 trillion over-the-counter derivatives market that is facing the biggest overhaul since its creation 30 years ago.

The Washington fight, conducted mostly behind closed doors, has been overshadowed by the noisy debate over health care. That’s fine with investment bankers, who for years quietly wielded their financial and lobbying clout on Capitol Hill to kill efforts to regulate derivatives. This time could be different. The reason: widespread public and Congressional anger over the role derivatives such as credit-default swaps played in the worst financial crisis since the Great Depression.

Wall Street would clearly like to keep the derivatives enterprise running in a ‘business as usual’ format. How might some light shine into this corner of the casino? Require the banks to report trading activity. I detailed this topic in July when writing, “Can We TRACE JP Morgan’s Business?”:

There is little to no transparency in the world of customized derivatives and as a result the bid-ask spreads are very wide. Cha-ching, cha-ching. Jamie and his friends on Wall Street are working extremely hard to keep it this way.

In their defense, it is likely not functionally feasible to move many customized derivatives to an exchange. What should regulators compel them to do? JP Morgan and every other financial firm on Wall Street should have to report every derivatives transaction to a system known as TRACE, which stands for Trade Reporting and Compliance Engine. This system currently only covers transactions within the cash markets and not derivatives. What does that mean for investors? No transparency and price discovery for investors in the customized derivatives space. As such, Jamie and friends can keep those bid-ask spreads nice and wide and ring up huge profits in the process.

I won’t make many friends on Wall Street, and perhaps lose some of my current friends, but TRACE should be implemented across all product lines. For those involved in the markets, please access the TRACE system to gain a wealth of pricing data while keeping your brokers and financial planners honest!!

Bloomberg offers a similar sentiment today in writing:

“Part of the pull and tug is that the banks are trying to prevent more and more of the product from being commoditized in the sense of being exchange-traded,” said Charles Peabody, an analyst at Portales Partners LLC in New York, which provides institutional equity research. “Like anything that starts to get commoditized — we’ve seen that with Trace on the bond side — it’s obviously going to pressure margins.”

Trace, shorthand for the Trade Reporting and Compliance Engine, was created in 2002 to post prices on all registered corporate bonds 15 minutes after trades occur. The public disclosure meant bond dealers no longer had better price data than clients, and profit margins in the business shrank by more than 50 percent, according to a Bloomberg News review of trades and a study published by the Rochester, New York-based Journal of Financial Economics.

If derivatives were required to be reported via TRACE and also had to be settled via a clearance system, would AIG have been able to take such massive systemic risk? Doubtful. Yet, Wall Street wants to keep the lights dimmed in this corner of the casino. Will they ever learn?

Comments (0)

« Newer Posts — Older Posts »