First The Good News, Then The Bad

Most of my portfolio is now solidly shrugging off Yellen’s slip of the tongue. Our good bankster friends over at JPMorgan said it best – Yellen is fresh and inexperienced, and she still needs to learn how to speak without actually saying anything.

It will come. It will come.

Despite my state of shock at watching Yellen crack the market like an egg yesterday, I didn’t react. I want to watch a few more days before I make a move, even if they should lose me money. With a +14% year going, I have buffer room.

Now, the good word here is that CCJ and BAS are both moving higher. I suspect HCLP will join in soon as well (that position can be rewarded a little breather, it’s come a long way). The energy themes are solid and intact.

The bad side of the coin is that fear/reality of higher interest rates is going to just ravish the REIT and associated housing space. Check out VNQ over a five day period, and you can almost sink the cracking point up with Yellen’s comments. My current position AEC is breaking down again this morning, and an old position MAA is following.

This has to be treaded carefully. If you’re juggling garbage like NLY, I’d say you’re one four day panic away from another round of 30% losses.

I’ve said well before today, back when I never imagined Yellen would spook interest rates higher, that I was interested in rebuying MAA. This is sort of a blessing in that regards. I’d venture a guess that long term damage to multifamily REITs from higher interest rates will hover somewhere between “negligible” and “not damaging, actually positive”.

But well before that point, there will probably be a lot of indiscriminate selling from emotionally driven fund managers. The climax of that, if it should materialize, is the buying opportunity.

Between then and now, it’s important to keep a wary eye on reform efforts to Fannie and Freddie. There’s been some “bipartisan chatter”. Mortgage origination is >70% dominated by the government backed mortgage giants, and the entire housing market is totally dependent on them. A poorly thought out reform effort could rain chaos. But there’s no sense even having a discussion about that just yet. First things first, interest rates.

Soon Government Will Be Incentivized To Have Higher Interest Rates

For the moment, the Fed remains leading the charge to hold interest rates low, based on what I would say is a faulty premise that the US economy just needs more expensive homes and homeowner tax income to get out of the hole it finds itself in.

The primary advantages of low interest rates are:
1) Cheap borrowing/refinancing, taking pressure off consumers
2) Allegedly easier to acquire homes, raising tax receipts (except for banking restrictions on lending)
3) Increased home sales enable retirees to downsize without collapsing pricing/bankrupting themselves
4) Support prices of goods and services, avoiding debt spiral

Each of these virtues, however, comes at the assumption that the consumer had the leeway to borrow more, and would take the pause to put themselves on solid footing, paying down debt and restructuring. Cheap credit was (and is always) supposed to be a momentary stepping stone to a better tomorrow.

In reality, it always becomes a game a chicken.

Consumers haven’t repaired their savings accounts at all. Debt levels should be something like three quarters of what they are – we’ve had near zero interest rates for five years and banks have so many programs running to help consumers pay off loans, it’s ridiculous. But it hasn’t happened. Consumer finances remain horrible, the money has largely been spent in ways that haven’t strategically benefited the recipients, and the low interest rates have seeded a newer, more dangerous problem.

The nation’s retirement system is on the rocks.

Looking at the state of public pensions and private 401k’s, the baby boomer’s retirement is in peril. Misallocations into housing and malinvestment have taken their toll. This isn’t exactly breaking news.

However, heretofore the assumption has been that the Fed’s knee jerk reaction to keep rates low was the only pathway and that there would be no push to counter this until unemployment levels and economic prosperity returned.

I would suggest that within the next few years, as baby boomer retirement heats up and the ability to create a virtuous cycle built on higher home prices and cheap credit slips away, the pressure on the Fed to maintain low rates will actually begin to cave to a growing murmur from the crowd demanding higher rates to maintain retirement obligations.

While this move will be a death knell for economic growth, from the point of view of aging boomers (the reigning political powerhouse and largest voting segment) economic growth would be a hollow victory as their own retirement obligations come under pressure and we increasingly see benefit cuts, such as are being witnessed in Detroit or California. Maintaining the status quo at the expense of economic growth puts them ahead, as they have a larger share of current goods and services, whereas permitting growth would ultimately lead them personally to greater poverty.

High interest rates takes pressure off of pension systems, and enables savings accounts to grow rapidly (such as those of boomers who have taken the final steps of downsizing homesteads and transferred much of their wealth into fixed income investments). It also improves quality of life for those savers by putting pressure on pricing.

Within three to five years, I expect interest rates get pushed up above 6% annually, for the purpose of refinancing retirement accounts for the benefit of boomers, at the expense of the rest of the country (planet?). When this occurs, I don’t think it will be because the Fed has lost control of the bond market. I actually believe it will be done intentionally, driven from political expediency.

Select Multifamily REITs Benefit From Higher Interest Rates

I’ve been sleeping on several issues that impact my two multifamily companies (AEC and CLP).

These issues are the effects of higher interest rates as they determine mortgages, the subsequent demand for rental units, and the ability of the space to borrow money to finance growth.

It’s a pernicious structuring, for sure. No easy answers here; as the effects seem to run counter to one another and can vary immensely depending on who you are and what your positioning is.

However, my general feel for the situation is this:

For the moment, financing for multifamily/REITs is generally secure. Conservatives are salivating to dismantle Fannie and Freddie, and the public probably concurs with those sentiments, but that would strike at the heart of liberal incentives. So any attempt to reform those institutions will probably be shut down or deflected.

However, this financing is set to get more expensive, if bonds keep rising. If you’re a company saddled with debt, this could cause all sorts of trouble. I remember back when I was first perusing through the space for purchases, I saw a lot of multifamily REITs that were knee deep in loans with bad cash flow and not enough on the books. If financing for apartment construction goes up and you’re holding the wrong companies, growth will go out the window and these badly situated players turn into takeover targets for the best of breed.

Meanwhile, there will most likely be shown to have been a small upsurge in housing purchases this last month. Players on the sidelines who became fretful that the window of opportunity was permanently closing likely rushed out to lock in a house purchase. After that surge though, the path to homeownership is getting harder, not easier, with the treasury selloff. This should solidify the 95% occupancy rates these companies have been experiencing, and get any apartment communities they construct filled.

I like AEC and CLP because they have had a vigilance about paying off debt, improving credit ratings, reinvesting into the business, and controlling operations. Their cash positions are well padded, and if push came to shove, they could quickly turn their cash flows on the liabilities, locking the companies down. I’m not worried about either of these two companies getting swept away from higher rates.

AEC just finished their second equity offering, and CLP is busy merging with MAA to make one of the largest multifamily REITs in the country.

Thus, until I see contradictions to these beliefs, I’m inclined to feel that both AEC and CLP will benefit on net from raising interest rates, even though it may momentarily hamper their growth. They are in superior positions relative competitors thanks to smart management decisions. And I am holding firm here.

The Bond Story No One Is Talking About

Greece’s 10 year has soothed down tremendously, now trading inside of 10% yield, just above 8%. It was above 30% just this time last year.

It appears that a Greek default has been taken off the table. If anyone actually made a pile of money on that move (as opposed to averaging down or getting back to even) well then, I congratulate you. I certainly wasn’t going to touch it.

So what happens now?

Well, 8% is still very expensive. Greece has a host of problems mostly stemming from economic contraction and, I suppose if you really believe they even tried to implement any, austerity. And I believe the europroblem demands further attention and, most importantly, central bank intervention. If the EU ultimately holds it together, or if they decide to part ways, the euro will need to be accommodating in either case.

Now I think it was a year ago, I ran into a piece that was analyzing the behavior of countries who had debt market problems – I can’t quite remember who was the author.

But the gist of the material was that countries actually don’t tend to default on their obligations in the middle of the crisis. They wait until they have things under control and are in a more stable position. And that’s when they look at their books and realize how well they’d be doing if they didn’t have to be making payments.

It’s when the country is in a good place that they actually hit the switch.

The study looked at places like Russia and Argentina and the defaults they underwent; which were largely unexpected.

Another paper I was able to track down comes from Stanford University, authored by Mr. Tomz and Mr. Wright. The good folks at Stanford found that countries do default more during the middle of crisis, but that the correlations was remarkably weak: http://www.stanford.edu/~tomz/pubs/TW2007.pdf

In any sense, the development in the Greek bond market is a remarkable turnaround. I am not convinced that we’ve seen the last of the consequences to come from the last twenty years. And I would not be surprised if, at some undisclosed time in the future, the market was ear holed by a surprise default from at least one of these countries.

But at present the Greek turnaround is incredible to watch. One can only marvel at it all.

Danger Passing For Now, Or So It Seems

I have to hand it to the EU countries. We are now years into this crisis, and still they manage to keep their bonds funded. Spanish bonds are easing back down from the 5% mark that had me on my toes. It would appear that the flare up has been contained…for now.

But that’s not the name of this game. They can save themselves as many times as they like. It would be better to ask, “what are the odds they save themselves every time one of these crises kicks up.” Much like a kid juggling eggs in his mom’s kitchen, the prudent bet is that he drops them. The moments leading up to the inevitable wrath bearing down on him are of entertainment value only.

Gasoline prices are imploding. That is merely a factual statement. I can’t decide what to think about it yet. Lower gasoline prices are inherently good for the consumer, it is true. But following the economic reports we’ve been receiving, and right out of Christmas and the optimistic projection parties that come with that time of year, and I’m not entirely sure of the thing being good.

My preference remains withdrawn defensiveness. Lots of cash, hand picked hedges. And only names of quality that I don’t mind being left holding without a bid.

Selloff Will Prolong A Week Or Two, Then We Go Higher

So far, taking a check at the state of affairs, I still think we can turn back around. Look at the sheer price run and know that we are only now approaching what could be called “top of the range”. I cannot become concerned by bond prices, as they remain at all-time lows and, thanks to central banks, are not allowed to sell off significantly anyway. Why shouldn’t bonds go up? (I know, that logic cannot hold, but for the moment it’s a sticky sort of rule of thumb). Bonds selling off hard are a cause for concern. Bonds being bought are a given.

But I am most assuredly fixed on the yields of France, Italy, Spain and Greece. Yesterday, Italy managed to eradicate three months of goodwill for themselves and their neighbors in what amounts to sheer idiocy. Italians obviously don’t understand the concept of a Catch 22 – in this case, they can pick between austerity or being left for dead (a compelling choice, I know).

Italian 10 years are now approaching the 5% level; effectively lifting ~1% in a matter of two days. While that is certainly a warning sign, I wish to see if that price can hold.

Also, remember that France is intricately tied up in all of this. If we were getting ready for a true panic, I would expect France yields to be getting murdered here.

I’m also not sure what I think of the EURUSD. It’s sitting at around 1.3, which has really been a sort of center for the currency swap during the last 2-3 years. Any time there’s trouble or rebound, it seems like we make the decision around 1.3.

If we were ready to crater, part of me thinks we’d be seeing a bigger initial euro rally, as European financials stock up on emergency stores of euros. Yet, we certainly have had a large resurgence of the EURUSD off the lows, and perhaps that was driven by European financials as much as anything, gathering that very same I have just described.

Also, even though I suspect demand for currency would create a spike before any major selloff, ultimately the euro is destined to go lower, either through devaluation necessary to hold the EU together, or its abstract worthlessness when the EU begins to come apart.

In any major event I expect the euro to move sharply and with conviction. The sashaying it’s undergoing at the moment makes me think this selloff will pass with time.

Until I’m more confident of that though, I’ll be keeping a wary eye on bonds and currencies.

First The Good News, Then The Bad

Most of my portfolio is now solidly shrugging off Yellen’s slip of the tongue. Our good bankster friends over at JPMorgan said it best – Yellen is fresh and inexperienced, and she still needs to learn how to speak without actually saying anything.

It will come. It will come.

Despite my state of shock at watching Yellen crack the market like an egg yesterday, I didn’t react. I want to watch a few more days before I make a move, even if they should lose me money. With a +14% year going, I have buffer room.

Now, the good word here is that CCJ and BAS are both moving higher. I suspect HCLP will join in soon as well (that position can be rewarded a little breather, it’s come a long way). The energy themes are solid and intact.

The bad side of the coin is that fear/reality of higher interest rates is going to just ravish the REIT and associated housing space. Check out VNQ over a five day period, and you can almost sink the cracking point up with Yellen’s comments. My current position AEC is breaking down again this morning, and an old position MAA is following.

This has to be treaded carefully. If you’re juggling garbage like NLY, I’d say you’re one four day panic away from another round of 30% losses.

I’ve said well before today, back when I never imagined Yellen would spook interest rates higher, that I was interested in rebuying MAA. This is sort of a blessing in that regards. I’d venture a guess that long term damage to multifamily REITs from higher interest rates will hover somewhere between “negligible” and “not damaging, actually positive”.

But well before that point, there will probably be a lot of indiscriminate selling from emotionally driven fund managers. The climax of that, if it should materialize, is the buying opportunity.

Between then and now, it’s important to keep a wary eye on reform efforts to Fannie and Freddie. There’s been some “bipartisan chatter”. Mortgage origination is >70% dominated by the government backed mortgage giants, and the entire housing market is totally dependent on them. A poorly thought out reform effort could rain chaos. But there’s no sense even having a discussion about that just yet. First things first, interest rates.

Soon Government Will Be Incentivized To Have Higher Interest Rates

For the moment, the Fed remains leading the charge to hold interest rates low, based on what I would say is a faulty premise that the US economy just needs more expensive homes and homeowner tax income to get out of the hole it finds itself in.

The primary advantages of low interest rates are:
1) Cheap borrowing/refinancing, taking pressure off consumers
2) Allegedly easier to acquire homes, raising tax receipts (except for banking restrictions on lending)
3) Increased home sales enable retirees to downsize without collapsing pricing/bankrupting themselves
4) Support prices of goods and services, avoiding debt spiral

Each of these virtues, however, comes at the assumption that the consumer had the leeway to borrow more, and would take the pause to put themselves on solid footing, paying down debt and restructuring. Cheap credit was (and is always) supposed to be a momentary stepping stone to a better tomorrow.

In reality, it always becomes a game a chicken.

Consumers haven’t repaired their savings accounts at all. Debt levels should be something like three quarters of what they are – we’ve had near zero interest rates for five years and banks have so many programs running to help consumers pay off loans, it’s ridiculous. But it hasn’t happened. Consumer finances remain horrible, the money has largely been spent in ways that haven’t strategically benefited the recipients, and the low interest rates have seeded a newer, more dangerous problem.

The nation’s retirement system is on the rocks.

Looking at the state of public pensions and private 401k’s, the baby boomer’s retirement is in peril. Misallocations into housing and malinvestment have taken their toll. This isn’t exactly breaking news.

However, heretofore the assumption has been that the Fed’s knee jerk reaction to keep rates low was the only pathway and that there would be no push to counter this until unemployment levels and economic prosperity returned.

I would suggest that within the next few years, as baby boomer retirement heats up and the ability to create a virtuous cycle built on higher home prices and cheap credit slips away, the pressure on the Fed to maintain low rates will actually begin to cave to a growing murmur from the crowd demanding higher rates to maintain retirement obligations.

While this move will be a death knell for economic growth, from the point of view of aging boomers (the reigning political powerhouse and largest voting segment) economic growth would be a hollow victory as their own retirement obligations come under pressure and we increasingly see benefit cuts, such as are being witnessed in Detroit or California. Maintaining the status quo at the expense of economic growth puts them ahead, as they have a larger share of current goods and services, whereas permitting growth would ultimately lead them personally to greater poverty.

High interest rates takes pressure off of pension systems, and enables savings accounts to grow rapidly (such as those of boomers who have taken the final steps of downsizing homesteads and transferred much of their wealth into fixed income investments). It also improves quality of life for those savers by putting pressure on pricing.

Within three to five years, I expect interest rates get pushed up above 6% annually, for the purpose of refinancing retirement accounts for the benefit of boomers, at the expense of the rest of the country (planet?). When this occurs, I don’t think it will be because the Fed has lost control of the bond market. I actually believe it will be done intentionally, driven from political expediency.

Select Multifamily REITs Benefit From Higher Interest Rates

I’ve been sleeping on several issues that impact my two multifamily companies (AEC and CLP).

These issues are the effects of higher interest rates as they determine mortgages, the subsequent demand for rental units, and the ability of the space to borrow money to finance growth.

It’s a pernicious structuring, for sure. No easy answers here; as the effects seem to run counter to one another and can vary immensely depending on who you are and what your positioning is.

However, my general feel for the situation is this:

For the moment, financing for multifamily/REITs is generally secure. Conservatives are salivating to dismantle Fannie and Freddie, and the public probably concurs with those sentiments, but that would strike at the heart of liberal incentives. So any attempt to reform those institutions will probably be shut down or deflected.

However, this financing is set to get more expensive, if bonds keep rising. If you’re a company saddled with debt, this could cause all sorts of trouble. I remember back when I was first perusing through the space for purchases, I saw a lot of multifamily REITs that were knee deep in loans with bad cash flow and not enough on the books. If financing for apartment construction goes up and you’re holding the wrong companies, growth will go out the window and these badly situated players turn into takeover targets for the best of breed.

Meanwhile, there will most likely be shown to have been a small upsurge in housing purchases this last month. Players on the sidelines who became fretful that the window of opportunity was permanently closing likely rushed out to lock in a house purchase. After that surge though, the path to homeownership is getting harder, not easier, with the treasury selloff. This should solidify the 95% occupancy rates these companies have been experiencing, and get any apartment communities they construct filled.

I like AEC and CLP because they have had a vigilance about paying off debt, improving credit ratings, reinvesting into the business, and controlling operations. Their cash positions are well padded, and if push came to shove, they could quickly turn their cash flows on the liabilities, locking the companies down. I’m not worried about either of these two companies getting swept away from higher rates.

AEC just finished their second equity offering, and CLP is busy merging with MAA to make one of the largest multifamily REITs in the country.

Thus, until I see contradictions to these beliefs, I’m inclined to feel that both AEC and CLP will benefit on net from raising interest rates, even though it may momentarily hamper their growth. They are in superior positions relative competitors thanks to smart management decisions. And I am holding firm here.

The Bond Story No One Is Talking About

Greece’s 10 year has soothed down tremendously, now trading inside of 10% yield, just above 8%. It was above 30% just this time last year.

It appears that a Greek default has been taken off the table. If anyone actually made a pile of money on that move (as opposed to averaging down or getting back to even) well then, I congratulate you. I certainly wasn’t going to touch it.

So what happens now?

Well, 8% is still very expensive. Greece has a host of problems mostly stemming from economic contraction and, I suppose if you really believe they even tried to implement any, austerity. And I believe the europroblem demands further attention and, most importantly, central bank intervention. If the EU ultimately holds it together, or if they decide to part ways, the euro will need to be accommodating in either case.

Now I think it was a year ago, I ran into a piece that was analyzing the behavior of countries who had debt market problems – I can’t quite remember who was the author.

But the gist of the material was that countries actually don’t tend to default on their obligations in the middle of the crisis. They wait until they have things under control and are in a more stable position. And that’s when they look at their books and realize how well they’d be doing if they didn’t have to be making payments.

It’s when the country is in a good place that they actually hit the switch.

The study looked at places like Russia and Argentina and the defaults they underwent; which were largely unexpected.

Another paper I was able to track down comes from Stanford University, authored by Mr. Tomz and Mr. Wright. The good folks at Stanford found that countries do default more during the middle of crisis, but that the correlations was remarkably weak: http://www.stanford.edu/~tomz/pubs/TW2007.pdf

In any sense, the development in the Greek bond market is a remarkable turnaround. I am not convinced that we’ve seen the last of the consequences to come from the last twenty years. And I would not be surprised if, at some undisclosed time in the future, the market was ear holed by a surprise default from at least one of these countries.

But at present the Greek turnaround is incredible to watch. One can only marvel at it all.

Danger Passing For Now, Or So It Seems

I have to hand it to the EU countries. We are now years into this crisis, and still they manage to keep their bonds funded. Spanish bonds are easing back down from the 5% mark that had me on my toes. It would appear that the flare up has been contained…for now.

But that’s not the name of this game. They can save themselves as many times as they like. It would be better to ask, “what are the odds they save themselves every time one of these crises kicks up.” Much like a kid juggling eggs in his mom’s kitchen, the prudent bet is that he drops them. The moments leading up to the inevitable wrath bearing down on him are of entertainment value only.

Gasoline prices are imploding. That is merely a factual statement. I can’t decide what to think about it yet. Lower gasoline prices are inherently good for the consumer, it is true. But following the economic reports we’ve been receiving, and right out of Christmas and the optimistic projection parties that come with that time of year, and I’m not entirely sure of the thing being good.

My preference remains withdrawn defensiveness. Lots of cash, hand picked hedges. And only names of quality that I don’t mind being left holding without a bid.

Selloff Will Prolong A Week Or Two, Then We Go Higher

So far, taking a check at the state of affairs, I still think we can turn back around. Look at the sheer price run and know that we are only now approaching what could be called “top of the range”. I cannot become concerned by bond prices, as they remain at all-time lows and, thanks to central banks, are not allowed to sell off significantly anyway. Why shouldn’t bonds go up? (I know, that logic cannot hold, but for the moment it’s a sticky sort of rule of thumb). Bonds selling off hard are a cause for concern. Bonds being bought are a given.

But I am most assuredly fixed on the yields of France, Italy, Spain and Greece. Yesterday, Italy managed to eradicate three months of goodwill for themselves and their neighbors in what amounts to sheer idiocy. Italians obviously don’t understand the concept of a Catch 22 – in this case, they can pick between austerity or being left for dead (a compelling choice, I know).

Italian 10 years are now approaching the 5% level; effectively lifting ~1% in a matter of two days. While that is certainly a warning sign, I wish to see if that price can hold.

Also, remember that France is intricately tied up in all of this. If we were getting ready for a true panic, I would expect France yields to be getting murdered here.

I’m also not sure what I think of the EURUSD. It’s sitting at around 1.3, which has really been a sort of center for the currency swap during the last 2-3 years. Any time there’s trouble or rebound, it seems like we make the decision around 1.3.

If we were ready to crater, part of me thinks we’d be seeing a bigger initial euro rally, as European financials stock up on emergency stores of euros. Yet, we certainly have had a large resurgence of the EURUSD off the lows, and perhaps that was driven by European financials as much as anything, gathering that very same I have just described.

Also, even though I suspect demand for currency would create a spike before any major selloff, ultimately the euro is destined to go lower, either through devaluation necessary to hold the EU together, or its abstract worthlessness when the EU begins to come apart.

In any major event I expect the euro to move sharply and with conviction. The sashaying it’s undergoing at the moment makes me think this selloff will pass with time.

Until I’m more confident of that though, I’ll be keeping a wary eye on bonds and currencies.

Previous Posts by Mr. Cain Thaler