September 2008

“A gifted teacher is as rare as a gifted doctor, and makes far less money.”


The Professional Opinion

S&P 500 Index: 1282.83


The market is taking a lot longer than expected to go through the bottoming process which eventually leads to new highs.  Bob didn't think it would take this long and I didn't either.  The Societe Generale scandal, the Bear Sterns bailout, high oil and the Freddie Mac, Fannie May debacles have had a continuing impact on the recovery process.

S&P ranges from the low to mid 1200's are viewed as attractive for purchase.  Bob expects the S&P to challenge the closing highs of 1550+ next year as the market works it way out of the current malaise.

Recession Risk

Recession in terms of the classical definition has so far been avoided but we are not out of the woods yet. The housing slump is expected to continue on into next year. Pricing stability, tighter lending practices and high fuel prices are significant headwinds when it comes to housing recovery.  Home heating oil prices are likely to further eat into the consumer's discretionary income.  The automobile industry is under pressure while transitioning from the low mileage gas guzzlers to more fuel efficient models and this is going to take a while.

And if that isn't enough, a slowdown in foreign economic activity is expected to accelerate because rates are too high and that will impact economic growth. The risk of recession in Euroland is growing.  Europe with its single currency and its ratcheting up of interest rates in the interest of fighting inflation with little regard for the impact of rate increases on economic growth, is due for a stall.

The stronger dollar will also moderate the strong exporting environment we've had for the last few years, which means odds are we will be shipping less stuff overseas as Europe economic activity weakens.

The last quarter of 2008 and the first quarter of 2009 are going to be challenging ones.  We are not out of the recession woods yet.

Inflation Risk

Core inflation is still relatively low at 2.4%.  Headline inflation is up and is sitting at 5.6%.  Headline inflation should come down as oil prices ease and the commodity bubble shrinks.    

Another important factor is unit labor costs, which have risen only 1.5% in the second quarter.  Low unit labor costs and a strengthening dollar lowers the inflation outlook going forward.

Interest Rate Risk

Fed interest rates are currently sitting at 2% and are expected to remain virtually unchanged as we are in a presidential election year.
Rates of  2-3% are expected for the rest of 2008 and most, if not all of 2009.

'Although 2009 may get off to a slow start, we expect the economy to enter a meaningful recovery phase as the year progresses.'

Valuation Risk

The market is viewed as undervalued at these levels, with room for a significant swing to the upside.  The joker in the pack is energy prices, oil in particular.  The current S&P 500 index multiple based on  expected 2009 earnings estimate stands at  13.9.
There is a lot of room for growth as the economy works its way out of its current slump.


VFWIX has been added to the list of Brinker approved funds.  This is an international fund ex-USA.  This will not be added to the
regular portfolios anytime soon because there is no desire to increase overseas exposure at this time.


The market is in the midst of an important bottoming process and it is taking place over an extended period of time as investors wait by the sidelines until indications of a stable economic recovery materialize.  The market is forward looking and evidence a recovery is underway usually begins about six months from the event itself.  Investors have a lot to keep them occupied; high energy prices, the housing woes, Iran vs the rest of the world, tight credit which hampers economic growth, and a presidential election.

A Dollar Cost Average approach is recommended for new monies.

One Heavy Haul

Now this is one heavy haul.  Up in this section of the Yukon, one has to contend with Muskeg (Canadian for Swamp), black flies, mud, spruce bugs and mosquitoes with '747' tattooed on their wings.  

Transporting something like this is no small feat.  The road you see here is compacted, smoothed out flat and then has 2x8 boards laid over the top.  I wish I had some photos of the pick which landed this into its final resting place, but I don't.  

The area can be so thick with bugs that entire glycol fin-fan heat exchanger which is one of the largest I have ever seen, is enshrouded  in beefed up window screen.

Meanwhile back in the states, the Olympics were underway.  I much preferred watching what might have been.

Personal Portfolio
Ending August, 2008
I think it is safe to say Bob missed the boat this time around, proving that timing doesn't always work. I have not major qualms with that though. No one's perfect.  I think what really threw a monkey wrench into the markets this year was the spike in oil on top of the sub-prime problem.

Oil goes up, markets go down - and vice versa.

I changed my opinion on letting the commodity mutual funds run after oil seemed to be topping out and reduced those positions to around 4% of the portfolio. They were closing in on 10%.

Charlie Maxwell, the famous energy analyst who works for Wheaton and Co. things oil is going back below $100.00, where it will fluctuate for several years before running up again. Short term, that would be my guess but who knows given the problems in Africa and the middle East.

These times seem to be made for the value investor. There are many dividend paying stocks out there trading at lows not seen in recent history and I think it is a good time to go shopping. 

It's hard to say how low some of these stocks can go but if you have a longer term horizon, I think there are some real bargains out there.

The long term ones I like I now have:  GE, MAS, BAC, ITW
Possible long term:  BGS, RF, SIMG
Speculative / Trading:  ABK, ETFC, RNIN
Sell on nice run-up:  WM

No comment on the mutual funds this month other than to say I have been decreasing European exposure. The other funds are pretty much all in the same boat.     

What a Month.

The dramatic seems to happen whenever I leave the country and of late the dramatism usually errs towards pessimism.   It certainly started looking that way this particular morning.
I had just got done reading 'Confessions of a Sub prime Lender: An Insider's Tale of Greed, Fraud, and Ignorance' by Richard Bitner.
The book was written in layman's language and very easy to understand. The last chapter of the book discussed Alt-A mortgages, something I had not heard of.  These mortgages offered very low interest rates, some as low as 1%.  If someone took the 1% option then the loan principle actually increased each month, which is called a reverse amortization loan.  

Why is this bit of information important?  Imagine you have one of these Alt-A mortgages in Las Vegas.  You bought a home for lets say, $500,000 two years ago.  Two years later the house is now worth  $300,000 and your 1% Alt-A loan interest is due to reset at the going rate.  Your mortgage is going to shoot through the roof at a much higher interest rate and your original $500,000 loan is now $550,000 because you chose the 1% interest rate for the first two years and you thought you would be flipping the house before the rates rose.

These loans allowed people who couldn't get into a house any other way to get in.  Odds are they couldn't buy a home because they didn't have a down payment and their income was marginal at best.  Multiply one of these loans by who knows how many homes in Nevada, California and Florida and add in all the home flippers who used these loans to buy at the top .... can you say 'Disaster, Part 2?'  According to the book, the first major wave of these  Alt-A mortgages are due to reset sometime in 2009.  

Ever had the feeling you were being nudged?  I got that feeling and started searching for banks and other lending institutions that hold these Alt-A mortgages.  I was specifically looking for banks I currently hold.

What appeared the following morning?  An article by the WSJ in which it reported that Wells Fargo is holding quite a bit of this paper and they are using various accounting maneuvers to push out and delay reporting on Alt-A losses:

Wells Fargo Snippet


I sold the position.

Some sobering Bill Gross Commentary:

U.S. Must Buy Assets to Prevent `Tsunami,' Gross Says 

By Jody Shenn

Sept. 4 (Bloomberg) -- The U.S. government needs to start using more of its money to support markets to stem a burgeoning ``financial tsunami,'' according to Bill Gross, manager of the world's biggest bond fund.

Banks, securities firms and hedge funds are dumping assets, driving down prices of bonds, real estate, stocks and commodities, Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., said in commentary posted on the firm's Web site today.

``Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,'' Gross said. ``If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury.''

The government needs to replace private investors who either don't have the money to buy new assets or have been burned by losses, Gross said. Pimco, sovereign wealth funds and central banks are reluctant to fund financial firms after losses on investments they made to support the companies, Gross said. The world's biggest banks and brokers have raised $364.4 billion in new capital after more than $500 billion in writedowns and credit losses since the beginning of last year.

Since financial markets seized up a year ago as the subprime-mortgage market collapsed, the Standard & Poor's 500 Index has fallen 13 percent and home prices are down more than 15 percent. Yields on investment-grade corporate bonds, debt backed by commercial mortgages as well as credit cards reached record highs last month relative to benchmark rates.

`Mom and Pop'

Gross cast a bleaker view for the prospects of the world's financial markets than in previous notes to clients. The fund manager has previously called on lawmakers to support housing with legislation passed in July that allows lenders to forgive some of homeowners' debt and then refinance them into government-insured loans.

Pimco, a unit of Munich-based Allianz SE, is seeking to take advantage of declines in home-loan bonds. The firm is raising as much as $5 billion to buy mortgage-backed debt that has plunged in value, according to two investors with knowledge of the matter. The Distressed Senior Credit Opportunities Fund will invest in securities backed by commercial and residential mortgages, said the people, who asked not to be identified because the fund is private.

Paulson Rescue

Treasury should support not only mortgage finance providers Fannie Mae and Freddie Mac, but also ``Mom and Pop on Main Street U.S.A.,'' by subsidizing rates on home loans guaranteed by the Federal Housing Administration and other government institutions, Gross said. A new version of the Resolution Trust Corp., which bought assets from failing institutions during the savings-and-loan crisis of the 1980s, may also work, he said.

U.S. Treasury Secretary Henry Paulson arranged a rescue package for Washington-based Fannie and Freddie of McLean, Virginia as concern escalated the government-chartered companies didn't have capital to withstand the housing slump. Treasury pledged to pump unlimited debt or equity into the companies should they need it.

As Fannie and Freddie, banks, securities firms and hedge funds shrink, yields on all debt assets will rise compared with benchmark rates and volatility will increase, Gross said. The declines will end once sellers have depleted their assets and sufficient capital has been raised, Gross said. Unless ``new balance sheets'' emerge, prices of almost all assets will drop, even those of ``impeccable'' quality, he said.

`Anorexic' Appetite

The extra yield demanded on Ginnie Mae's 30-year, current- coupon mortgage-backed securities over 10-year Treasuries has climbed to 1.75 percentage points, from 0.87 percentage points at the start of last year, according to data compiled by Bloomberg. Bonds guaranteed by the U.S. agency are backed by the U.S. government. Spreads on 2-year AAA rated bonds composed of federally backed student loans have climbed to 0.95 percentage points over benchmark rates, from 0.01 percentage points below, Deutsche Bank AG data show.

``There is an increasing reluctance on the part of the private market to risk any more of its own capital,'' Gross said. ``Liquidity is drying up; risk appetites are anorexic; asset prices, despite a temporarily resurgent stock market, are mainly going down; now even oil and commodity prices are drowning.''

Home Prices

The decline in home prices hasn't been seen since the Great Depression, Gross said. That drop translates to an even bigger decline in overall wealth as the effects ripple through markets, Gross said. Home prices in 20 of the largest U.S. metropolitan areas fell 15.9 percent in June from a year earlier, according to an S&P/Case-Shiller index.

Fannie and Freddie 30-year fixed-rate mortgage bond yields, which influence the rates on most new home loans, have probably risen 75 basis points because of the waning demand, Gross said. A basis point is 0.01 percentage point.

The Pimco Total Return Fund returned 9.8 percent in the past 12 months, beating 97 percent of its peers in the government and corporate bond fund category as of Sept. 3, according to Bloomberg data. The returns are 5.76 percent annually over five years. Pimco has about $830 billion of assets under management.

About 61 percent of Gross's holdings were mortgage-backed securities as of June 30, mostly debt guaranteed by Fannie, Freddie or Ginnie Mae, according to data on Pimco's Web site.

``In a global financial marketplace in the process of delevering, assets that go up in price are rare diamonds as opposed to grains of sand,'' Gross said.

There must be some good sized banks with no sub prime exposure and trading at fire sale prices so I started doing some searching and came up with this:

Regions Financial

Regions Financial

I got it a eight and change and it looks like it has room to run.  Fitch and Company had some comments on the stock as well.  
The Report is Here:

Ambak Financial


Later that morning another article came out in which the ratings services stated they were taking Ambak and MBIA off their watch list, prompting a sharp run-up in the stock which prompted me to sell into it and I managed to get back into it at another nice price.
Sold it again the other morning. I imagine there will be more chances to buy this a bit lower.

BGS Foods

I used the proceeds to double my position in BGS foods.  They actually do pay out that healthy dividend and the stock is trading
near its lows.  They didn't make as much the last time around because of an increase in syrup prices.  No big surprise there.

E-Trade Financial

I also doubled down on E-Trade Financial in the low 3's.  They have been increasing their subscriber base and are issuing positive-sounding statements.  I don't know how much if any Alt-A paper they have and that is a big question mark.
I bought this before I finished reading the last chapter in the book.  Research is ongoing.


Masco (MAS) is one of the stocks I hold in an after-tax DRIP plan and it is down significantly off its highs. I decided to add this stock to the retirement portfolio, with dividends set to reinvest. The stock is yielding around 5% at this prices, which is more bang for the buck than GE.  Should have bought in the 14's, but I didn't have any real idea which direction the stock was headed.

Wireless Ronin

Time to nibble on Wireless Ronin (RNIN) again?  I think maybe so and picked up a little in the low 3's.  A steady stream of PR's usually
pushes the stock price up and rumor control has it that more news may be the case.  One thing about RNIN's news releases - there is not a lot of fluff.  They are pretty good about just reporting the facts.  Here is one of the latest:

Spitfire - RNIN

ITW DRIP Registration - Part IV

OMG, I don't believe it!  The account is set up in well under six months!   I'd better quit while I am ahead.  One thing about ComputerShare that is going to make this kind of hard is once you set up one DRIP through them, you can easily establish DRIP's in any of the other plans they are sponsoring.

Closing Thoughts

This coming Alt-A reset has me concerned.  There has been some noise out there about it but nothing to catch the attention of our fear mongering media in any major way.   I think it is time to start building reserves in a taxable account so I decided to knock the 401k contributions back to the company match.  The extra money will go into low risk, tax efficient instruments.   There may be some eye popping deals on vacation properties in a couple years for people who can swing the down payment.  It wouldn't hurt to be one of them.

We were also socking so much money away in 401k's and 403B's that we couldn't fund the ROTH's last year. This is another tax efficient way to save for the future and it is not taxed when you start withdrawing funds for retirement.  401K's and 403B's are.

Dream Getaway

~ In the land of the coming Alt-A mortgage reset, significant cash reserves may very well be king.