"Many of our fears are tissue-paper-thin, and a single courageous step would carry us clear through them" Brendan Francis

One thing that has most certainly surprised me during the Money Show in DC was the fact that there are still were so many visitors, despite the fact that the world is supposedly crumbling around us as we speak. The talk of the Great Depression and Armageddon hasn't really disappeared after the election as one might have hoped, and the only thing that seems to be changing daily is the finger pointing part- one day it's the Wall Street, the next day it is the Bush administration and the next day it's Alan Greenspan.

Despite all this I am still sticking with my October projection for the markets during the next year- US equities are likely to go nowhere and thus if one wants to earn a positive return during the next 12 months there are only two real choices out there:

• Trading like mad and taking gains as fast as you see them, or
• Generating dividend-like income by selling options and shifting more money towards asset classes that have a higher chance of sustaining their dividends-like prefs for example

My personal strategy of dealing with this slowdown is still focused on preferred stocks and buy-write closed end ETFs for now. I still believe that chances of JPM, WFC, HBC, BAC etc canceling their pref dividends are quite low and thus consider trade off quite favorable. However, to be completely objective, despite all the efforts by the government, there are continued issues with some of the fundamentals of the banks. Below are several charts summarizing most recent developments in the residential and commercial real estate related securities markets- short summary- things gotten worse again...Source for all - markit.com

AAA - residential paper- recent declines have taken out lows from earlier this year and that means more write off and potentially more failures, unless Fed steps in very quickly with another rate cut...

Same thing with BBBs- worthless...

The news are actually even worse on the commercial mortgate front:

AAA- spreads are setting all time highs- that's bad news especially for banks with large balance sheets like C, DB and UBS, as prices move in the opposite direction to spreads... That single digit price for Citi now seems like a realistic possibility...

BBB spreads are completely out of whack as well and point to complete dissaray...

However, here is positive- while common stocks of all the Top 10 banks could stay under pressure for a while, the good news is that Preferred dividends are still very likely to be paid without interruptions for most banks that have been approved for TARP money, as the preferred stock is really the only way the Big Boys can raise capital now and the government is in for a pari passu with my pref ride as well...

More on that tomorrow, stay safe,
Skepticalcapitalist@gmail.com

Quick update on my prefs spreadsheet as requested by some readers...

once again not a recommendation but rather an example of how I use the methodology- read the disclaimer...

P.S. Read this article from MarketWatch to learn more about them...

Many investors like to think of preferred shares as a blend of stocks and bonds. Preferred stocks, which generally don't carry voting rights, tend to pay higher dividends than the common shares. Preferred shareholders receive their dividends before common shareholders and also have certain advantages if a company liquidates

Click on the full entry to see the rest of them...

I simply could not resist reposting a great quote I saw today at the Big Picture- "Markets eat like a bird, but shit like a bear"

The decline in prices of all commodities over the last three months has been nothing short of spectacular. I simply can't believe that just a few months ago predictions of oil going to $250 were actually considered to be credible just because Goldman Sachs said so? What a joke :)

I actually found few of the interviews I gave to MoneyShow.com and Andrew Horowitz from DisciplinedInvestor.com back in August when commodities were still flying high.

Video 1 from Money Show
Video 2 from DisciplinedInvestor

In one of these interview, I also said that I believed at that time that big money center banks likely hit the bottom in July. Surprisingly enough, despite all the negative news in the financial sector since than -only one of the "big boy" banks- Citi has taken out the low from July for now. (Bank of America does seem likely to join C in taking out these lows very soon though...)

I also remember quite clearly receiving some hate mail after these videos and MSN articles, especially from MOS and POT fans. One of the Mosaic employees called me funny names in his email like mor.n, idi.t etc for refusing to buy into the agriculture hype and oil and gas plays...:) Anyway, I honestly hope he is doing well today and that he did sell some of his stocks back at $100+ a share...

P.S. To finish off with the usual bad news/good news summary- because of the change in scope for TARP program, I adjusted (higher) my required preferred returns for a number of big balance sheet/higher leverage banks and now all of the prefs for Goldman/Morgan and most of Citi (except P and M series) look even more overvalued than they did a few weeks ago...

Another point as relates to prefs is that for any of the larger regional banks like STI, KEY, FITB etc now there is a new significant risk factor -potential Citi takeover. If that happens- preferred valuations for some of these regionals could easily come down -regardless of premiums paid to the common stock holders. Because for example yields on Citi are much higher than those of STI (SunTrust), which will reverse in the case of a take over. I am, for example, now officially out of all STI's prefs. Remember this is not a recommendation to do anything, just my thoughts...

Good news is that using an ultra short index ETFs like SDS as a hedge for prefs and closed end ETFS so far has worked ok, even though I do think we are now getting awfully close to a break point/washout day for most major indices. I am not as bearish as most of my colleagues, but do think that computers (technical traders) could easily take S&P to 800 tomorrow. Where we go from there is anybody's guess, but in the short term, path of least resistance is most certainly down as analysts keep dragging their feet in adjusting projections down, which means a continued stream of headline bad news...

Stay safe out there- remember, hedging is very important- no one should be 100% long the market at any time

skepticalcapitalist@gmail.com

Still wondering why hedge funds are blowing up? Listen to Ackman- by far the most impressive interview I've seen in years...

I've tried to explain the past- blame the SEC short selling ban for a big chunk of the recent mess...

skepticalcapitalist@gmail.com

Was Paulson's decision to pull the plug on the original TARP idea of investing into the illiquid assets a smart thing to do? I am almost certain that while the original goal has never been too realistic to begin with the implicit existence of a potential "cleanup fund" has certainly helped to slow the decline in security values for a little while, so cancelling it now does not sound like a smart idea. In my opinion, it is just another example of government intervening into the economy by changing the rules in the middle of the game and potentially making things worse instead of better.

Simply glancing at the prices of both residential and commercial mortgage backed securities, as presented by Markit.com since the TARP announcement, confirms that situation deteriorated so rapidly, that even I now suspect that we might very well need another round of equity injections into the "big boy" banks before it's all over...

The recent decline of values in both commercial and residential securities has been simply stunning to say the least. I am not sure if free fall is the right word, but it certainly does not look promising. It does appear that there were quite a few investors expecting to unload their paper to the government, and with the "purchase" program now all but cancelled these investors unloaded their paper simultaneously over the last several days likely making losses even more painful for a whole bunch of financial sector players.

Residential MBS values...

source: markit.com

Commercial MBS spreads- higher number means lower values...

source: markit.com
The only fundamental question now is whether these declines represent the real underlying asset values or are they merely an indication of the accelerating liquidity crunch? Most of the number crunching points to the first scenario; however, too many of the current players might not make it long enough to find out...

Being safe out there now is much tougher than just a week ago...Go SKF?
skepticalcapitalist@gmail.com

Unfortunately my most recent prediction about implications of Paulson's fiasco with TARP seems to be coming true- run on the "next weakest" bank- Citi. Now according to this WSJ article- Citigroup's execs are considering following the steps of Wachovia and Merrill by selling out? While I personally believe that despite all the negative news Citi actually has quite a valuable franchise, and appears to have plenty of capital to get them through this mess, shorts decided differently and now are certainly having a great time running them into the ground...The only question now is who could possibly buy Citi in one piece? HSBC is really the only bank that could possibly pull it off at this time.

"The internal discussions are at a preliminary stage and don't signal that Citigroup's board and management are backing down from their insistence that the New York company has ample capital, funding and strategic direction, these people said. But with the stock down another 26% Thursday, its worst one-day percentage decline ever, Citigroup officials have decided they need to reckon with a range of scenarios that were unthinkable only weeks ago."

Bad news don't stop there- it is now official- current decline is worse than the one in 1929. Below is a great chart from Doug Short's blog showing how the worst bear market declines unfolded. Surprisingly enough, current fiasco is already worse than the first leg of the 1929-1932 bear market.

The only good news I can come up with after reviewing many of these charts is that we have to be nearing a point of a pretty significant counter trend rally. What can trigger it? I am not yet sure but most likely some kind of government action like short selling ban, massive stimulus announcement or simultaneous global rate cut. Because of that possibility I decided to take profits on my SDS ultra short position today as these ETFs tend to move much faster on the downside than on the upside...

Stay safe out there, I know it's tough skepticalcapitalist@gmail.com

I know that everyone is tired hearing the same gloomy predictions from every financial expert out there but, unfortunately, this flow of news is simply not going to get better any time soon. What surprises me though is the extent of the stock declines in response to some of these "old" negatives that one should have expected to be priced in a long time ago. Just look at the chart of most recent bear market declines from my my previous article- we are now past the decline from the 1980-82 recession, but the really negative economic news are only starting to come out...

I mean, let's get real here- who did not know we were in recession? Forget the media's "two quarters of negative GDP growth" definition- the "domestic" recession likely started almost a year ago and it is very likely that most of the other economies will follow the US down the negative GDP road. What's more, it is very likely that negative GDP trends will persist at least for 3-4 more quarters, which implies that job losses should be expected to at least match or even exceed the 1980-82 level, which in turn means many more months of 200K+ payroll declines.

Below are some graphs from the ClevelandFed that compare the YTD payroll picture to the past- the punch line is losses are likely to get much worse during the next few quarters as we are way early in the cycle.

Current losses are still minor compared to the 80s (this does article does not yet include October's numbers and revisions to September where losses have accelerated to 200k+ range)

Since January, the U.S. economy has shed 760,000 jobs. During the four previous official recessions net employment losses were higher: 837,000 in the 1980 recession; 2,172,000 in the 1981-1982 recession; 1,282,000 in 1990-1991; 1,629,000 in 2001. The magnitude of job losses depended on the duration of each recession. For example, the 1980 recession lasted just seven months, while the 1981-1982 recession lasted seventeen and the 1990-1991 and 2001 recessions were each nine months long.

Another great chart from Doug Short confirming my belief that markets declines might have gone a little too far in a very solidly visual way...

Citi Bailout terms are out and in my opinion they are not as bad as some might have expected. The worst case outcome has been prevented in my opinion.

"Size: Up to $306 bn in assets to be guaranteed (based on valuation agreed upon between institution and USG).

Term of Guarantee: FDIC standard loss-sharing protocol: Guarantee is in place for 10 years for residential assets, 5 years for non-residential assets.

Deductible: Institution absorbs all losses in portfolio up to $29 bn (in addition to existing reserves)

Any losses in portfolio in excess of that amount are shared USG (90%) and institution (10%).

USG share will be allocated as follows: UST (via TARP) second loss up to $5 bn; FDIC takes the third loss up to $10 bn;

Preferred Stock: Institution will issue $7 bn of preferred stock with an 8% dividend rate (under terms described below). $4 bn of preferred will be issued to UST. $3 bn will be issued to the FDIC"

skepticalcapitalist@gmail.com

"The only reason a great many American families don't own an elephant is that they have never been offered an elephant for a dollar down and easy weekly payments"
Mad Magazine

I guess I should have known that it was coming... Yesterday, my three year old son who has previously developed an uncanny ability to separate Treasury's Hank Paulson and Neal Kashkari from each other despite their nearly identical haircuts, and who now knows that Barney is not only the name of his favorite toy, but is also the name of the infamous Chairman of the Financial Services Committee Barney Frank, said to me very clearly, that he now needed a bailout from his house cleaning duties. I simply could not believe it- if a three year old now knows what a bailout is, where do you think is our capitalist system is heading?

Emboldened by the ever growing billion dollar numbers thrown at us every day by the mainstream media, and the seemingly bottomless demand for US government debt, everyone and their mother is now asking for a bailout of some shape, size or form. First it was Wall Street, then the Big Three, followed by city of San Diego, state of California etc...

Yesterday, Wall Street Journal reported that homebuilders have now joined the banks and auto makers by making a plea for an additional $250B stimulus package called "Fix Housing First". They are arguing that instituting a large tax credit of up to $22,000 for home purchases will somehow help to cure the fundamental problem of the current crisis- declining home prices and thus will help the economy to recover faster and help the struggling consumers along the way.

Yea, right! We've heard this story before- they are obviously doing it simply because of the philanthropic concerns about the struggling homeowners and consumers?! My brain simply refuses to comprehend why in the world anyone in their right mind would propose a policy designed to stimulate constructing more new homes at a time when inventories of the unsold ones are at the still hitting all time highs? Wouldn't we all be better served if homebuilders instead stopped building for a year or two? But, I mean, if my son needs a bailout, why wouldn't homebuilders qualify for one?!

I guess we now all wake up wondering who is going to be asking for money next? There are so many industries struggling that I am afraid I might have overlooked a few in my "important industries to bailout next" list below, but you will have to forgive me as my patience has simply run out for now... To create the list below I looked at some of the sectors that have declined the most during the current crisis and I hope you will find my ideas at least as useful and rational as most of the other ones out there. At least I spend some time thing through mine...

I say let's start with the gaming industry. One could easily argue that Las Vegas titans like LVS, BYD and MGM are way more qualified for a bailout than Wall Street ones. Because while their basic business models are quite similar (both are a legalized form of gambling), at least average visitors to Vegas are warned ahead of time that they should expect to lose money, while Wall Street is still feeding their frequent visitors/retail investors that normal "buy, hold and earn 9% returns in the long run" routine is the "sure bet" in the long run...

After that, I suggest we move on to the entertainment sector. It is quite clear that many of the well known brands like PLA (Playboy) and LGF (Lion Gate) are suffering from the same forces that are now destroying Detroit- unionized workforce, negative cash flows and inability to compete with more advanced players. If you ask me- throwing a lifeline to the Bunnies is a much better investing decision for the government as we at least know that PLA's medical liabilities will be largely limited to the working off the effects of plastic surgeries instead of the golf induced disability epidemic...

Obviously, we cannot and should not forget to bail out the struggling firearms industry. Smith and Wesson (SWHC) seems a much more prudent bet in the long run than California. I know that Mr. Governator is a very tough and forward looking budget fighter, but I would still argue that with all the turmoil, wars and fears out there, demand for shotguns is almost certainly going to outperform the growth in property tax revenues of the Inland Empire.

And last but not least, I say that instead of throwing a lifeline to nation's largest homebuilders we should ask Uncle Sam to buy some preferred stock in nation's largest funeral and cemetery service providers. While we almost certainly have plenty of houses already built up to last us for at least a few more years, funeral home companies like SCI and STEI, not only have a more predictable and secure revenue stream, but they also seem to have a solid growth potential with millions of baby boomers no longer being able to afford decent health care or peaceful retirement in general...

I hope you get the point... Let's all get together and stop this socialist "bailout madness" and focus on what's really important- reducing wasteful spending, creating jobs and recapitalizing the financial system in a proper/accountable way. Stopping the media from infusing the "bail everyone just because they need money" doctrine into the heads of our nation's young generation is equally important as personally would have never the original communist society to join the emerging "New Deal" one.

Please feel free to forward this message to your senator and tell him/her, that while we realize that we really did not have a rational choice, but to rescue our large money center banks like BAC, JPM and WFC because of the potentially immediate collapse of the entire Capitalist system as we all knew it, we should now all be prepared to say "no more" to anyone who hasn't learned their lesson...

Stay safe out there, I know it's not easy but please do so if you still can, skepticalcapitalist@gmail.com

Last week I started writing articles for Motley Fool's CAPS by utilizing some of the basic screening concepts with an intent of trying to prove that simply outperforming the S&P is not that difficult.

So far so good :) All of the picks are in the green. Check it out...I've used CAPS before as a supplementary screening tool as I personally did find that over the long haul, with everything else being equal 4 and 5 star stocks tend to do better than the rest.

http://www.fool.com/investing/dividends-income/2008/11/19/7-stocks-to-cure-your-dividend-ills.aspx

http://www.fool.com/investing/general/2008/11/24/7-financials-that-dont-need-tarp.aspx

Stay safe out there, skepticalcapitalist@gmail.com

By the way check out the mortgage rates today- I've never seen rates plunge 75BP in ONE day. This certainly a welcome relief for banks!

At Bank of America Corp., call volume was roughly twice what was expected at call centers and via the Internet, said Matt Vernon, national sales executive. "It's the folks who have been sitting on the sideline. They're jumping in with this news."

Rates on 30-year fixed-rate mortgages dropped by roughly half a percentage point to about 5.5%, for borrowers with good credit scores and substantial equity in their homes, say mortgage brokers and lenders.