The rooftop bar at the Peninsula Hotel in midtown Manhattan is apparently the place to have a drink after work if you're a hedge-fund manager. I headed up there with my newspaper yesterday around 5 p.m. for a cocktail... walking through the crowd was like being at a hedge-fund conference. Jim Chanos was there looking sullen, the poor guy. Jim is one of the world's biggest short sellers. And stocks have gone straight up for five months. I settled next to a trio of pretty well known hedge-fund managers who were all talking about the incredible story of Steven Schonfeld, from the front page of the Wall Street Journal.
Schonfeld, whose background includes a stint at a boiler-room penny stock firm, launched his own brokerage firm to serve day traders in the 1990s. Schonfeld's firm has repeatedly been censured by various regulatory agencies – at least 16 different violations. In short, it isn't the kind of place most of the world's top traders would dream of getting a job. And yet... his firm has become one of the top repositories for Wall Street's elite traders, who are fleeing the big banks thanks to the government's compensation regulations.
If there's a better example of unintended consequences, I haven't seen it yet. The banks, which desperately need their most talented employees and the profits of their trading desks, are losing out to a smalltime, day-trading firm. Schonfeld now brags about his $90 million mansion and his personal golf course. If I were Schonfeld, I'd offer OBAMA! a standing invitation to play my golf course any time he wanted.
Demand for electricity is always a more accurate gauge of economic activity than the government's figures. According to electricity wholesalers interviewed by the Wall Street Journal, demand for electricity fell 4.4% in the first half of this year. That suggests the recession has been deeper than most people realize. Looking at this year's decline in demand for electricity and the decline in demand for electricity in 2008, this could be the first two-year decline in electricity demand since the Great Depression.
It's a bizarro economy we're in... Economic activity and employment are still falling. But money supply and total credit are soaring. Boiler-room type brokers are buying $90 million mansions and hedge-fund managers are drinking $50 glasses of champagne after work, like it's 1999. And despite weak demand, commodities like copper, oil, and gold have remained at elevated levels. If we didn't know better... we'd assume the Fed was printing money like crazy and shoving it into the financial markets, hand over fist. Of course, we know that's exactly what's happening. We just don't know how it will end. But we have a well-educated guess: badly.
Because the Fed is fighting aggressively to keep rates down and credit flowing (through the purchase of fixed-income securities), its balance sheet has doubled to over $2 trillion in the past year. It now has so many assets to manage, it's hiring new traders – lots of them. The Federal Reserve Bank of New York, which implements monetary policy, is looking to increase its staff of traders to 400, up from 240, by year's end. For those of you with a bit of time on your hands, we suggest a research project. Do a correlation study between the number of Federal Reserve employees and the corresponding decline in the value of the dollar over the following period. We'd bet the two variables are nearly perfectly correlated.
The day after we mentioned failing real estate investment trust (REIT) Maguire in The Digest, Moody's downgraded 163 commercial mortgage-backed securities (CMBS) classes because they had exposure to the doomed company. Moody's wrote:
Maguire continues to experience ongoing levels of high effective leverage, declining operating performance, and an inability to cover dividends from operating cash flow.
The market hates uncertainty, and it's tough to get a true value for commercial properties across the country because so few have changed hands this year. Only $5.7 billion in office-building sales closed in the first half of 2009, down from $30.9 billion in the first half of 2008. Only eight office buildings were sold in Manhattan in the first half of this year, at an average price of $470 a square foot. In the same period last year, 43 properties sold at an average price of $877 a square foot. That's a more than 46% drop for commercial property in one of the hottest real estate markets in the world... And firms are still having trouble dumping property at these prices.
Despite the obvious shortcomings in the market, JPMorgan is hoping to dump 23 office properties – with a combined 7.1 million square feet of space – after having acquired so much space following the Bear Stearns and Washington Mutual takeovers. The portfolio includes two key Manhattan properties and important buildings in both Seattle and Houston. It's believed to be the largest portfolio of properties to hit the market this year, and is expected to fetch around $1 billion. The Wall Street Journal article notes JPMorgan's poor timing, "amid the worst property market in decades" for the property sales... saying the bank will likely have to do a sale-leaseback (where JPM would sell the building, but promise to lease a portion of it from the new owner) or provide financing for the purchase.
New high: Addax Petroleum (AXC.TO).
In the mailbag... Why not invest in bankrupt bonds? Mike Williams explains. Send us a note here: feedback@stansberryresearch.com.
"I appreciate Mike Williams' safety-first conservative approach in True Income. I have purchased many of your recommendations at deep discounts late last year. I feel your letter alone is worth my Alliance membership. But I also engage in higher risk plays and was considering the Tribune bond. At less than 10 cents on the dollar, the risk to reward looks interesting. It seems that zero gain and/or a delayed payoff date would be about the worst case outcome. Any comments?" – Paid-up subscriber Barry
Mike Williams comment: The investment strategy you propose is a valid one. In my view, it takes a special set of skills to do this successfully. First, you need to be very practiced and fluent in the bankruptcy process and its opportunities and risks. You also need to have excellent credit skills to analyze the value of a company's assets and their liquidation value. You need to be knowledgeable in the ways of corporate behavior, which are often not motivated by what's in the best interest of the shareholder. And finally, you need to be familiar with bond trading. The worst outcome is much worse than you suggest...
The worst outcome is a total loss of your capital after committing it for several years. This is a high-risk, high-return strategy requiring special skills and a long-term investment horizon. There are investors who succeed in this strategy. But they possess this special skill set and are willing to make the huge time commitment necessary and commit a significant part of their portfolio to this strategy. They also take a portfolio approach, which means they buy a collection of bankrupt bonds so they spread their risk.
Editor's note: We're publishing the August issue of True Income tonight. Mike's latest recommendation is a bond that will pay you 9.0% in cash and earn you 16.2% a year for the next four years. It also has a convertible aspect, meaning you have unlimited upside potential in the common stock. Click here to learn more.
"No political stuff please. I subscribe to an investment newsletter, not a political talk show. Let economic facts speak for themselves without cheap shots such as 'Komrade Obama' remarks." – Paid-up subscriber Rob Starnes
Porter comment: We promise to stop talking about politics when the politicians stop trying to run the economy.
"I was just looking through some of the S&A archives, specifically May 22, 2009, and I just wanted to be clear. You are saying, based on today's real negative yield of the Treasury Bond, that you forsee gold reaching $2000 within the next 9 months? Does your research still lead you to this same conclusion?" – Paid-up subscriber Karen B
Porter comment: We don't have a firm opinion about the timing of the next big up leg in gold. Our best guess is sooner, rather than later. But honestly... we don't think whether it's 2010 or 2015 matters very much, considering the scope of the change we're expecting.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
August 12, 2009