The Stupid Stock Index and Rates

* Introducing Rick’s Stupid Stock Index – the stock of Ambac, the monoline insurance company has risen from a recent price of 53 cents, to over $3 briefly yesterday. There is no reason why this stock should be anything other than zero point zero. The stock pays no dividend, and up until last month, was paying out $120 million a month in claims against the $35 billion of mortgage insurance they had written. Last month, the Wisconsin insurance commissioner suspended payments to holders of the mortgage securities, and is in the process of re-apportioning the resources of Ambac, so that the other insured classes of debt have assets to claim against. Does anyone think this means that money will be left over for the equity holders? I do not think so. Even though holders of MBS securities who are entitled to claims, are expected to now receive only 25% of the amount they are owed in cash, the MBS claimants are expected to receive a 75% preference note, which should wipe out any money left over for equity holders.


It is likely that this is some sort of short squeeze. As of the most recent reporting date, there were 60 million shares sold short. At a price of 50 cents, I do not know why anyone would bother lugging that short around. Nonetheless, there is no other real explanation for the rally in Ambac shares. There are four other stocks which should also be worth zero: FNMA, Freddie Mac, MBIA (the other mono-line) and AIG. I can equivicably say that each of these stocks should be worth zero, with the exception of AIG. I preclude AIG from this level of confidence only because I have not spent any time looking at the particulars of the businesses they are comprised of. When I look at all 5 stocks, I have noticed that each of these stocks have all rallied together. 

I constructed and have attached my “Stupid Stock” graph, which is all 5 companies, scaled to a price of 10, as of last night’s close, for a cumulative price of 50. As you can see, these stocks are up 33% over the last week. There is no reason for any of this. The attached graph shows this index in White, versus the S&P in orange. Over the last year, there have been three spikes higher. The first occured last May, and preceeded a 2 month correction. The peak in August only was coincident with a minor 2 week correction. 


The best I can suggest is that the stupid stocks are indicative of the very bullish sentiment running through the equity markets. Consistent with this, I believe we are close to a high on stocks in the context of an end to the bullish seasonal time period, which runs through April. (I know I have been wrong about a stock market top since the fall, but I have been on target since 2007, so I will hang my hat on that credential). And for any reason if you own any of these stocks, this would be a good time to sell them, and use the money for a night on the town. At least you will have that positive memory, instead of the thousands of dollars you lost on these stocks.


* Inflation on the local level – I recently renewed my NY state fishing license, and discovered that the price to renew rose approximately 50%, from $19 a year to $29. I also noticed that the life-time fishing license rose in price from $350 to $460, for a 30% increase. Given the financial pressure which state and local governments are likely to encounter going forward, I purchased the life-time license. When the annual fee rises to $50, it will look like an even smarter move.


* US Rates follow-up – Yesterday I made the short term bullish and contrarian case for bonds, especially with a back-drop of the universally held view that rates have to rise. While I agree with the premise behind the bearish bond market strategy, I think everyone is early and for the time being, leaning the wrong way on this one. A corollary to the situation in the US is the fact that hedge funds have lost tens of millions of dollars betting against the Japanese bond market over the last 15 years. The difference between the US and Japan is two-fold:


1>    Japan has deflation, while US CPI index is slightly positive. That fundamental can explain some amount of the really low rates in Japan, and why Japanese rates have not risen; and 


2>    Japan is able to internally fund their debt, while the US relies on foreigners to finance a good percentage of our debt.


My point in comparing the US to Japan is that while the consensus that rates to rise is rampant in both countries, eventually US rates are likely to lead Japanese rates higher.


A reader writes in with this comment, which supports my short term bullish perspective:


“Rick, here is a caveat to the universally held bearish bond market views:


1>    tax receipts may very well be higher than expected (see Wash Post Tuesday),


2>     TARP costs may be way down from projections (WSJ Monday), and the treasury may be cutting coupon amounts in future auctions (they have made these statements recently);


3>     other than the March quarter-end auction (Asian Fiscal year end also), the auctions keep getting record-high bid/cover ratios, with big US and foreign bank buying, as well as money managers;


4>     mortgage rates are falling after QE ended…so supply/demand equation for the next, say 10 months, might look much better than virtually everyone fears, and


5>     loan demand also is nowhere (see FDIC and Fed web sites).”

(end of readers comment)


In the past I have documented the drop in loans on the books of the nation’s banks, and this is one of the arguments for the deflationary view. A look at the FDIC’s data base shows that the nation’s banks have seen their collective balance sheet drop $730 billion over the last year (through 12/31/2009). Of this drop, $641 billion can be traced to a drop in lending. Coincident with a drop in lending, there has been a $465 billion increase in securities held, of which only $69 billion is from treasuries, $185 billion in GSE debt (including MBS), and a surprising $108 billion increase of foreign debt securities. Combining the increase in securities to the drop in loans, there is still $450 billion of balance sheet shrinkage which needs to be explained. Predominately, banks have taken down their trading account securities by $235 billion, and ‘Fed Funds sold’ has dropped by $308 billion. Here is the general snapshot:


Total balance Sheet          $13,109 B    – 732 B

Loans                        $ 7,058 B    – 641 B

Securities                    $2,500 B    + 465 B

Fed Funds Sold                   414 B    – 308 B

Trading Accounts                 711 B    – 236 B


One could make the case that banks are moving assets out of their trading accounts and into the less speculative classification of securities portfolio holdings. The other $200 billion increase in securities could also be linked to a shift away from selling Fed Funds, and to longer term, and higher yielding securities.


My take-away here is that while the banks have much capacity to buy treasury debt, especially in light of falling loan demand, I cannot link the drop in loan demand to a new found love for treasury securities, especially given the paltry $69 billion increase in treasury holdings over the last year. The banks will not save the day, unless the heads of banks get those late night coarsive phone calls, like the call Ken Lewis got before he acquiesced to the merger with Merrill. In the heat of the next crisis, it will be surprising how many orifices the government finds to stuff our debt. But that will only happen once 10 year rates start rising beyond the 5-6% that many people are calling for.