The Tasgall Group

What to make of the strong finish in today’s market…? The Dow reversed a full 300 points to finish down only 16 points for the day…? that’s a whopping 3% drop, followed by a 3% rally all in the span of a single trading day.? That kind of action usually signals a short-term bottom, but I’d be careful making that assumption…

We had a similar big one-day reversal as recently as Friday, August 10… the dow hit a low of 12,958 before closing back at 13,239 — a 281 point recovery. What happened next? Bad news on Monday caused this week’s price action, and all of the liquidity injections from the central banks could not get stocks in the black for even a single day (so far).

Interestingly, the Dow and the NDX closed spot on their 200 day moving average. The S&P 500, nasdaq composite, and Russell 2k are all well below their 200 dma. Medium term (1 year+) trend lines have already broken on most of the major indexes.

After today’s strength, tomorrow is set up for a bullish day. If there isn’t strength, then most likely we’re going to have some additional jarring drops. If there is strength, then the question of the day will be, how long with the strength last?

Also worthy of note is the yield spread… the 30 year / 3 month has shot up like a bat out of hell. Looking at a longer term view, there’s still a long way to go… And the contraction is happening even while the FOMC has pushed the overnight rate down to 4.9% despite the lip service about not lowering rate targets.

Here’s a quote from Mish:

Yes, already. David Greenlaw at Morgan Stanley noted that although the Fed Fund rate is officially 5.25%, as a result of various Fed open market operations “the funds rate averaged 4.51% yesterday [2007-08-14], and then opened at 4.75% this morning [2007-08-15]. Indeed, the cumulative average for the 2-week maintenance period that ends today is 5.04% — well below the official 5.25% target.” Greenlaw went on to call this a ?temporary? easing of policy on the part of the Fed.

I’ve personally moved to a hedged position — puts offsetting the longs that haven’t hit trailing stops or that I don’t want to sell (yet) for tax reasons…? There might be a sizable bounce over the next few days/weeks, but I’m in capital preservation mode and don’t feel like risking more than is appropriate given the recent price action.

Here’s a good point from Mish:

The European Central Bank, in an unprecedented response to a sudden demand for cash from banks roiled by the subprime mortgage collapse in the U.S., loaned 94.8 billion euros ($130 billion) to assuage a credit crunch.

…? The ECB said today it provided the largest amount ever in a single so-called “fine-tuning” operation, exceeding the 69.3 billion euros given on Sept. 12, 2001, the day after the terror attacks on New York.

The rest of the article is worth reading and has some good points about what is/may be happening in the big banks and brokerages.? The reaction by the ECB is what one would expect in an emergency, so you can either think that the ECB is panicking out of order, or there is a real emergency somewhere.

Quite a while ago, we discussed drawdown analysis for mutual funds, and how understanding drawdowns can help in setting properly positioned stop losses… With two of my mutual funds dropping down against their stop loss levels, it’s time to revisit the analysis.

We’re looking at OAKMX and OAKIX, both long term value oriented mutual funds run by Oakmark Funds. OAKMX focuses on large cap value; OAKIX focuses on large cap international value. Here are the 3 year performance charts of the two mutual funds:

Wow, good runs on both funds. (more…)

Here’s an interesting trick, in a roundabout explanation thanks to the latest GMO Quarterly Letter – investing without margin calls.

Imagine this, you’re a wealthy investor and have confidence in the long term growth of the economy and the markets. You want to get leveraged long as much as possible to benefit from this long term growth, but know that the inevitable dips and swoons are a threat to using too much margin.

Enter the concept of investing without margin calls. Think it’s not possible? Think again — it’s been happening at a record pace in the last year in the form of Leveraged Buy Outs (LBOs). The long-term investors who buy these companies are sometimes able to lever up as much as 10 to 1, so they might put up $100 million to buy a $1 billion company. They sell bonds (backed by the company’s assets and earning power) to cover the rest of the $900 million difference, and are able to get much more leverage than if they were simply getting 50% margin (2 to 1 leverage) from their stock broker.

But there are plenty of risks, such as the cost of? servicing all that debt, getting the company to grow as much as it would have under public ownership, etc.

It’s an interesting trick if you have enough money to pull it off.? It’s effectively a risk-reversal where the risk of a margin call is shifted from the equity owner to the debt buyer.

Jim Cramer is nothing, if not attention getting. Here are two different videos from Jim on the subprime situation that are quite interesting… I have presented them in chronological order for effect. (more…)

I wanted to highlight a specific trade that I’ve been in, as well as some commentary to go along with it.

There has been much hullabaloo in the market press lately about the subrpime fallout. We’ve seen credit markets contract, lending standards shoot up, mortgage rates climb, etc. One of the principle instruments of this trend are the CDSs (Credit Default Swaps) and similarly abbreviated CDOs, CDLs, etc.

A while ago, I found a mutual fund that invests in the opposite side of the CDS market, and benefits if defaults or perception of default start to rise.

It trades under the symbol AFBIX with the long name, Access Flex Bear High Yield Fund. Here is a chart of the mutual fund’s price: (more…)

Here are the numbers for this week:

• Dow Industrials – down 4.2%
• S&P 500 down 4.9%
• Russell 2000 down 7%, now in the red for the year
• REITs down 8.8%

The two day rout on Thursday and Friday were quite dramatic, but the declines are still in single-digits across the broad indexes. The panic and consternation are certainly overdone. Several headlines and commentary are acting like we just went through a full bear market, claiming that “stocks are so cheap now” or “where was the plunge protection team — surely we needed it this week!” I’m sorry, but if a 5% price dip makes a stock “cheap”, you don’t understand what the word cheap means and you have no sense of scale. (more…)

If you really want to aggressively bet on a singularity approaching, you could do some pretty reckless things with the latest thing from Wall Street: life settlement backed securities.

From Business Week: Profiting From Mortality

Death bond is shorthand for a gentler term the industry prefers: life settlement-backed security. Whatever the name, it’s as macabre an investing concept as Wall Street has ever cooked up. Some 90 million Americans own life insurance, but many of them find the premiums too expensive; others would simply prefer to cash in early. “Life settlements” are arrangements that offer people the chance to sell their policies to investors, who keep paying the premiums until the sellers die and then collect the payout. For the investors it’s a ghoulish actuarial gamble: The quicker the death, the more profit is reaped.

I don’t want to have every post I write be about the subprime fallout and real estate…? fascinating though it may be.? So, in the interests of changing subjects, here is an old joke…

A guy who goes to his financial planner and says, “I want the best possible returns and I’m willing to take whatever risks are necessary.”

The financial planner says, “Great! I have just the ticket for you if you have the risk tolerance. The risks are high that you could lose everything, but it has the best possible return of anything you could put your money into. If it pays off, you would have a 3 billion percent return on the initial investment on average.? In some cases the numbers are much higher. ? This investment is the only place you’ll be able to find a 3 billion percent return with a holding period of less than a day…”

The customer is salivating at the mouth, waiting to hear the answer…

The answer: Take all your savings and buy lottery tickets for the next big jackpot drawing!? If you really don’t care about the risks (of losing 100% of the money “invested”), it does provide the best possible return compared to the $1 you pay for the winning ticket!

There’s an excellent article titled “How professionals dump their toxic waste on you” by Paul Tustain that is worth reading. He starts with much of the current situation in subprime loans that we’ve talked about before… but then goes on to some additional interesting topics… below are some highlights.

Many investment funds (pension funds, bond funds, etc.) are holding CDS (credit default swap) portfolios as income generating bond-equivalent securities. The catch is that many of the CDSs are not actually insuring against default, but the other side of a speculative position that a risky borrower would default. The example cited was Delphi Corp’s recent fall from grace — when their debt was defaulted on, an astounding 10 times the amount of the debt was executed in the form of CDSs on their debt.

So these pension funds, hungry for bond-like returns, basically took the other side of a bet that Delphi would collapse. Not exactly investment grade, but thanks to financial alchemy, a pool of these CDSs were highly rated, and most likely offered to the buyers with leverage. (more…)