The Rude Awakening
Laguna Beach, California
Wednesday, February 28, 2007 ------------------------------ - Can a rally save us?
- The ramshackle scaffolding of private equity,
- Worldwide Indexes play "The Biggest Loser," and more…
------------------------------ A safe distance from the Wall Street carnage, Joel Bowman reports… Yesterday a few investors lost their shirts…a few more lost their entire wardrobe. The Dow Jones Industrial Average paused only for a brief moment after lunch on its way to its largest one day capitulation since the first day of trading after September 11, 2001, The final Dow tape read for the day: 416 points down, or a loss of 3.29% During the spectacle U.S. stocks gave back all of this year's gains, mercilessly erasing some $600 billion in market value along the way. Preceded by a 9% decline in Chinese stocks the previous day, the DJIA was not alone languishing in the doldrums at yesterday's close. London's FTSE slumped 148 points, Germany's DAX shed almost 3% of its weight and the Nikkei chipped in, dumping another 2.85% overnight. This sudden bout of stock market bulimia was not unique to the robust indexes of the world's leading economies either. Brazil's Bovespa gave back 6.63% of the year's gains, Mexico's Bolsa stood 5.8% lighter on her scales and Argentina's Merval index posted an impressive 7.49% loss. We should have seen this coming though. The news is a flutter these days with record highs and soaring investor confidence. Prima face, everything looked just the way we want things to look when everybody is making money…tranquil and predictable. In reality, there is only one thing that is predictable when something rises to the lofty highs of recent months…that it should correct itself and revert to the mean. But money is deceptive temptress…once we taste our first fix, we are ever more susceptible to her blinding addiction. We become so enthralled by her allure, we sometimes forget the simple laws of gravity. Instead of reinforcing our financial foundations, we reach for the bountiful heavens on stilts made of straw. We call this ramshackle scaffolding "leverage," and we expect it to stand in the strongest of gales. Read on as Lord Rees-Mogg holds a finger up to the prevailing winds of recession and investigates what it could mean for a glut of over-levered companies… ----- Make 600% While The Markets Crash ----- Protect your wealth with the only two investment strategies the world's most respected economist will endorse this year. Learn this simple, but powerful hedge against a collapsing stock market. The payoff should be huge - about 600% over the next nine-12 months ahead. Don't wait for the next 400 point plummet - Read this report and protect your wealth
now… -------------------------------------------------------------- Respecting Leverage
Lord Rees-Mogg The worst mistake I have made in recent years in economic forecasting was to expect the 2000 crash well before it happened. I started warning that a stock market recession was due in 1996 - I was still hung up on the 1989 to 1992 recession which had been more serious in London than in New York. Nevertheless, the recession did eventually come, though by 2000 the bears had mostly lost confidence and been converted into belated bulls. I should never have tried to time the downswing at the end of the boom, and I am not about to repeat that mistake. However, there are a number of worrying developments which justify increasing caution. Most of them involve the risks of leverage. Everyone knows that increasing the leverage is one way in which the financial performance of a stock can be improved without any improvement in the underlying commercial performance, and can be improved still more when the underlying performance itself is improved. Writing in the Financial Times, Roberto Mendoza, the Chairman of the Trinsum Group describes the process: "A more efficient capital structure (typically more debt); highly disciplined management (cost-cutting); strategic focus on core competencies (selling under performing assets) and aligning management and owner incentives (pay, based on performance). This is the mechanism by which private equity works. It is good for the shareholders because profits are higher and good for the management because bonuses, in some form or another, are also higher. It is not so good for the staff because jobs are lost. It is good for the economy in the short term, but may not be so good in the longer term. Private equity seldom takes a long term view - that is for someone else. This is not a win-win situation, because it can squeeze the interest of the workforce. In the United Kingdom, Brendan Barber, the General Secretary of the T.U.C., argues that "in companies that are often leveraged to the hilt, employees end up shouldering much of the risk, with downward processes on pay, pensions and job security." There is also the problem of transparency. Private equity discloses much less than is required of public companies. However, it is the leverage which worries me most, because excessive leverage, or what proves to be excessive leverage can create a lose-lose situation. The Congressional inquiries after the 1929 crash largely focused on the disaster of over-leverage in circumstances of recession. A company with low leverage is seaworthy in a storm. It is very unlikely to run out of cash, which is the problem which causes businesses to become insolvent. It will have assets which can be sold, or can be borrowed against. The metaphor is that of the sailing ship. An over leveraged company has a huge spread of sail, and can travel fast in favorable conditions; in a great storm she can keel over. A ship which carries light sail, does not win the race in favorable weather, but can survive a storm. The assumption shareholders make when they increase leverage is that there is not going to be an early recession or perhaps that there will be no recession at all. Early in a bull market, this assumption may be a safe one. Later in a bull market it becomes less safe, but investors feel safer because they have become accustomed to good times. Finally the recession comes, probably at the time that the last bear has run for cover. Now we have a fashion for high leverage - in derivatives, in private equity and in hedge funds. The global financial system has spread its sails. The momentum is awe-inspiring. There is less transparency than there used to be - investors do not understand derivatives; hedge funds are less transparent than old fashioned investment businesses; private equity is less transparent than public companies. Any traditional value investor reads balance sheets with more confidence than he reads profit and loss accounts. The global P&L looks pretty good, but if the global balance sheet does not scare us - it certainly should. Joel's Note: Yesterday's blindly unhedged investors are undoubtedly suffering from some severely bruised derrieres this morning…and probably the effects of a rather restless sleep last night. The market will close for another day in a matter of hours and, like all honest observers, we have only guesses as to where it will head. Will investors pile back in, trying desperately to mount a rally of sorts? If so, how long will the rally last? What will the effects be if this hypothetical rally is swiftly crushed by further frantic sell-offs? What if there is no rally at all? We are sure of only one thing when confronted with such hyper-volatile market conditions: Smart investors hedge their bets. Earlier this year Dr. Richebacher warned against a meltdown in stocks and, fortunately for his readers, advised a surefire way to hedge against such a scenario. Maybe the battered Dow Jones Industrial Average will recover in record time and snap back by midday…or maybe a hedge is in order. If you are at all interested in buying some wealth protection, you may find the following report of use: Wealth Insurance - Hedging Your Bets --------------------------------- 
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