Saturday, February 21, 2015

Subprime Is Back

Great infographic from the Wall Street Journal showing the return of subprime loans in America. 40% of loans issued for autos, credit cards and personal borrowing went to subprime borrowers in the first 11 months of 2014. At its previous peak in 2007, 41% of non-mortgage lending was subprime so we have essentially round tripped right back to peak insanity.

This data does not include the newest member of the subprime universe that has taken the credit market by storm since 2007; student loans. The default rate for student loans surged past credit cards in 2012, and the next major recession will push this default rate through the roof.

Below you can see the staggering size of this market that shows no signs of slowing growth:

At $1.2 trillion in size, U.S. student loan debt has already surpassed the size of the Australian economy and is closing in on Canada.

Yes, mortgages have been issued more responsibly than they were in 2006. However, home buyers have found new ways to obtain 0% to 3% down loans, and the credit/income spectrum borrowers are working with continues to move us back closer toward pre-crisis underwriting.

Making people more comfortable today is that behind the scenes the U.S. government now explicitly backs mortgages, student loans and auto loans. This will make people less comfortable when the global government debt bubble implodes.

Friday, February 20, 2015

The Death Of Inflation

Part of the reason why bond investors are paying astronomical prices (buying bonds with zero to negative return) is the built in assumption inflation will stay low forever. Bonds are pricing in a stagnating economy which will keep inflation low.

In the meantime, global stocks are closing in on all time record highs. Stocks are pricing in a surge in global economic growth. 

One of these markets will ultimately be wrong (stocks or bonds). The black swan event no one anticipates is that both markets are wrong and mis-priced. In that world, the one I believe we live in today, cash and safety are king. 

Thursday, February 19, 2015

Apple's Valuation Moves Further Into Uncharted Territory

I'm not a technology guy so as I mentioned this morning discussing Snapchat you have to take my views with a grain of salt. I'm a real estate guy that can provide you with a full underwriting package for a $100 million commercial building and put a management team in place to run the day to day operations. However, when it comes to a company like Apple I struggle to explain how it can be worth $700 billion and only offer essentially two products (iPhone and iPad).

I understand the revenue from the iPad and iPhone are large enough to equal the size of other large companies combined. iPhone:


What Apple is doing today with their sales is unquestionably remarkable. I also see their growth potential on paper with new markets in Asia and around the world.

My problem is that another company can enter the market in the blink of an eye and provide an equal or better phone or tablet at a lower cost. They do not have control of these markets the way Microsoft had with Windows in the 1990's. When my phone contract runs up every year or two I go to the store and look at my options. I have never purchased an Apple product so that either means I do not understand the value or I am not blinded with emotional bias.

If the overall U.S. market continues its path further into valuation absurdity, it's certainly possible Apple could reach $1 trillion in value and make me look stupid for taking the time to pen this post. But I don't want any part of it. I'm not brave enough to short the stock, but you will not find it in my portfolio any time soon.

Here are a few updated charts on Apple's staggering valuation from Bianco Research. First up, Apple's market valuation vs. the next largest companies around the world. Apple is in a world all to themselves:

Next up is the ongoing race for size dominance between Apple and Exxon. With the most recent energy collapse, Exxon appears to be down and out once again. However, if these two stocks were my only investment options I would open a pair trade long Exxon and short Apple with the expectation these lines will cross one day again in the future.

Apple also just reached another milestone. It crossed the inflation adjusted market value high for NTT (Nippon Telegraph and Telephone) from way back in May 1987. NTT was the highest valued company on earth that month at $348 billion, which dwarfed IBM, the next closest competitor. NTT was the darling tech company during Japan's incredible stock market run in the 1980's.

Just as with Apple today, the shares delighted investors but worried some analysts.

People think it would be impossible for Apple to ever experience a fall from its current dominance, but I see it as an inevitability based on the barriers to entry I just discussed.

h/t Wall Street Journal, Quartz, Bianco Research, Slate

Snapchat Valued At $19 Billion: No Profits, No Problem

Here we go again. Another tirade from some old geezer on why social media companies are overvalued. As a warning, I don't use Facebook, I don't use Twitter, and I don't use Snapchat. I get my information through a program called Feedly (which organizes articles from sites I want to read every day), and when I want to communicate with friends I usually pick up the phone to call them or go visit them in person. 

I know, I know. I have no understanding of how the world works today. 

With that disclaimer in place, let's look at this week's valuation bombshell; Snapchat. They just completed their most recent round of venture funding which valued the company at $19 billion. Snapchat is a program that allows you to send pictures to friends, which then disappear after 10 seconds. 

The company just recently began their advertising program, which will generate some revenue for the company. As with most tech start-ups, the profits will come later, hopefully. Here is the $19 billion valuation crowd Snapchat finds itself in today. You can see that around them are Mosaic, Omincom and Consolidated Energy, which bring in over $1 billion in net profits annually. 

Being the old geezer I am, I think in a few years Snapchat is going to be worth less than $19 billion. Much, much less.  

h/t Quartz

Tuesday, February 17, 2015

Should Americans Only Invest In Stocks While They Are Sleeping?

Alpha Architect published an article this week showing the investment returns between intraday holdings (U.S. market open to close) and overnight holdings (U.S. market close to open). The results are staggering.

The chart below shows the growth of $1 invested in night returns (blue line) vs. day returns (green line) from 1993 to 2006 in the S&P 500 (SPY) exchange traded fund. The SPY is widely considered a broad measure of the overall U.S. stock market.

Alpha Architect provides mathematical equations and discusses the impact of trading and momentum positions from institutional U.S. investors, but could the answer to the incredible performance gap above be a more simple explanation?

During 1993 to 2006 there was an explosion of growth from emerging markets around the world. The general trend was to export goods to the United States, receive dollars as payment and reinvest those dollars back into the United States to keep their domestic currency from appreciating rapidly. While a large portion of this capital made its way into the U.S. debt markets (both government bonds and Fannie/Freddie mortgage backed securities), there was a steady stream into the stock market as well. That capital would be employed while those countries were awake and U.S. investors were sleeping.  

I don't know the answer because it is impossible to track the day to day investments of the People's Bank of China or Saudi Arabia's sovereign wealth fund, but this seems like a more logical explanation.

Monday, February 16, 2015

The Chain With Raoul Pal & Kyle Bass

The Chain with Kyle Bass from Real Vision Television on Vimeo.

Game Theory In Greece: Mutual Assured Destruction On The Table

The game theory standoff taking place between Greece and the rest of the Eurozone is fascinating. Last week John Mauldin described what occurred in Greece after they were "saved" with the previous bailout:

The solution forced Greece into a depression that reduced GDP by 25%, saw unemployment rise to 25% (nearly 60% among youth), forced Greeks (at least some of them) pay their taxes, and obliged the Greek government to try to balance its budget (kind of, sort of), the debt simply got worse. Now debt-to-GDP is 175%. If the Greeks couldn’t pay their debt at 120%, they have zero chance of paying it at 175%.
Eventually, Greek voters noticed that the agreement with the Troika (the ECB, the IMF, and the European Commission) didn’t seem to be working for them, so last month they voted in a new government that promised to change the agreement. The party that won the election, Syriza, had made lots and lots of promises about how they would make those mean old Germans back down and fork over the money. If we threaten to not pay the debt, the new government assured its citizens, the Europeans will give us more money, and we can even make them change the agreement. Of course, if the Greeks don’t get more money their system will be completely bankrupt, and their economy will collapse even further. (The technical economics term is that their economy will be screwed.)
This threat is somewhat like holding a gun to your own head and threatening to commit suicide if you don’t get your way. 
Both parties understand there is Mutual Assured Destruction if a compromise is not met. The perspective from the rest of the Eurozone is pretty easy to understand. Banks throughout Europe holding a ton of Greek debt will experience massive losses if Greece were to exit and default. There would be even larger eruptions within the derivatives market. 
The second and probably even more important event would be the chain reaction in the bond markets for Spain and Italy. Right now everyone believes the system will be held together "at any cost" which allows the market to value all debt as backstopped by the entire Eurozone and the ECB. A change in this psychology would instantly bring us back to where we were in early 2012 before the "whatever it takes" announcement from the ECB. 
From the Greek side of the negotiation table, a Grexit would be catastrophic to their economy and citizens in the short term. Sober Look walked through how a Greek exit would impact both sides:
First of all it's important to point out that the so-called "Grexit" is equivalent to a complete failure to pay on obligations by the Greek government, its banks, corporations, and households. While everyone is focused on the €315 billion Greece owes to the Eurozone, the IMF, and others, the damage to the euro area would actually be much greater.

What nobody wants to talk about is the fact that internally most Greek loans - including mortgages - are in euros (some are even in Swiss francs). Greek banks hold €227 billion of loans and €12.4 billion of Greek government debt (plus roughly another €25 - €50 billion of Greek-based private sector bonds). Under a Grexit scenario, most debt (including government debt) will be converted to the new drachma at a preset exchange rate.
As the drachma collapses - and there is little question that it will - Greek banks, who would now have drachma assets and euro liabilities, will quickly fail as well, leaving the Bank of Greece holding the bag. The Bank of Greece which is currently part of the Eurosystem will therefore default upon exit. But before it exits, the Bank of Greece will draw on Target2 from the rest of the Eurosystem as Greeks quickly move their deposits out. And there is no question Greeks will try to move a great deal of their deposits out before they are converted to drachmas. In December alone they pulled €4.6 billion euros out of Greek banks - and that's before the Syriza victory.

The default by the Bank of Greece could cause even more damage to the system than the losses to EFSF and to other entities such as the IMF. Between the government bonds the Eurosystem holds and the Target2 losses, the ECB may need to be recapitalized - a political disaster. Market anxiety alone could push the euro area back into recession as credit conditions tighten again (potentially similar to the Lehman situation).
I said over 5 years ago as this all began that Greece should default, devalue and start again with a fresh balance sheet. It would have been absolutely horrible for their country and their economy for about 3 years, but they would have eventually found a bottom and my guess is their country would be stronger today than it is now with the bailout option they chose. In addition, they would not have the impossible weight of their debt burden crushing them. 
No politician will ever ask their citizens to suffer in the short term to ensure the long term strength of the country and the economy. Promises will always be made for short term fixes, which pushes more debt and printed money into the system and create a larger problem tomorrow. Greece is the perfect example. Next up, the rest of the world. 
My guess is a Greek compromise will be met and the global day of reckoning will be pushed back for just a bit longer.