PrefBlog

Link heaven today, since everybody’s talking about interesting stuff! You know things are getting weird when the words “Ruble” and “Safe Haven” are mentioned in the same sentence.

Things were going well until Coventree announced it wasn’t able to roll its commercial paper and was therefore extending the term of their extendible notes. As they explain in a very good promotional essay, written in 2002 and still on their website, Extendible Notes provide liquidity protection for issuers similar to that of having stand-by lines with major banks, while being much less costly to support. Whether or not anybody will be willing to buy these things after seeing all the damage an extension can do in practice, is something we will just have to wait and see.

After Coventree’s announcement, American and Canadian equities tanked, ruining what had been a pretty good day ’till that point. Equities had, until then, been able to laugh off a Goldman Sachs bail-out of one of their funds, to the tune of $3-billion.

The Global Equity fund has about $3.50 in borrowed money, or leverage, for each $1 of client money, down from $6 before the capital infusion announced today, Viniar said. The fund plans to keep leverage at the current level.

When you are levered 7:1, there isn’t much room for zig-zags in market prices! This, I think, is one of those occasions where patient money that isn’t marked to market every single day can find some good bargains. High-quality spread product has been suggested.

There was more central bank intervention on the day and some fast-money is betting that this will turn into rate cuts. I don’t buy that myself … but I can’t deny that the market is expecting cuts. Jim Hamilton wrote a great essay defining a liquidity event and attached a graph of Fed-Intervention-Sizes I can’t help reproducing here:

Wow! The WSJ posted a primer on the mechanics of this. My own homely example of a liquidity crunch is … say you have to sell me your house … maybe you’re moving or something. It’s worth $400,000 – we both agree on that. But I can’t get financing! All the bank is willing to lend me is $300,000! At that point, you might have to swallow hard and sell it to me for the latter figure … and I’ll have to keep my nose clean for the next while so the bank doesn’t foreclose on me.

The central banks are desperately afraid of this type of thing happening … it’s what happened in Japan in the late eighties, and we’ve seen how that story plays out. So they are lending the top-tier banks as much money as they want at the overnight rates, simply to ensure that these banks can then make business decisions based on expected returns relative to the overnight without having to worry about their own financing. With luck, this liquidity will trickle into the marketplace and – since everybody agrees your house is really worth $400,000 – I’ll be able to get financing for the original figure. I’ll have to, since if I don’t somebody else will. But a prolonged liquidity squeeze can lead to deflation – and fighting deflation is like trying to push a rope uphill.

There is money around, so we needn’t all panic just yet. J&J just came out with a massive bond issue that was sharply increased in size once they realized how much demand there was for triple-A product. There are warnings that the same reception won’t be found by lesser credits, however.

As one might imagine, government bonds had an entirely reasonably good day, with Treasuries up a tad and Canadas up a tad more.

In continuing stories, there is argument that sub-prime is NOT Greenspan’s fault and, having made their point, China backed off the financial Armageddon thing.

The preferred share market was quiet, drifting slightly downward on not much volume.

There were five other $25-equivalent index-included issues trading over 10,000 shares today.

Well, that was a week-and-a-half, that was!

As proof, I offer up the TSX Press Release which states:

There were 707,441 trades today on Toronto Stock Exchange, a new historical high. The previous high was 704,261 trades on August 9, 2007.

I feel a bit sorry for August 9 – setting a new high and only getting one day in the sun! It’s a bit like breaking the world record for something at the Olympic Games, only to find you have to settle for silver.

The number of trades will be a function of the rise of Algorithmic Trading, which should not be confused with Quantitative Investing, which should most definitely not be confused with Technical Analysis.

Algorithmic trading is the practice of feeding a few simple rules into a simple computer programme and having the programme place orders into the market place as required. For instance, you can tell your programme that you want to sell X to buy Y at a take-out of $1.00, up to a limit of 50,000 shares, to stay on the offer and bid, respectively, to the extent that if you get filled on one side you can take market action on the other, as long as you stay within 1,000 shares of equal execution. Or something like that. Such a programme could lead to a huge number of orders, as it executed in pieces over the day. But who cares? It cost you two minutes to input these specifications, five minutes to check up on it through the day and five cents worth of electricity. The Financial Times did a series on it.

Quantitative Investing, on the other hand, is the practice of measuring investment characteristics and making investment decisions on the basis of these numbers. Anybody who has ever compared P/E ratios has invested quantitatively, at least to some extent. Practitioners of Quantitative Investing, known as Quants, make most, if not all, of their investment decision based on such numbers. The programmes used for Quant investing range from moronic six line spreadsheets to things like (cough, cough) HIMIPref™.

Technical Analysis is the practice of making an idiot of yourself through the creative use of graph paper, different colours of ink, sacrificed chickens and dirt taken from a graveyard at midnight. It is not suitable for discussion in polite society, such as, f’rinstance, in this blog. A slightly more favourable description of the process is at Investopedia.

Yeah, so anyway, the TSX had a huge day in terms of trade volume and I hope the tech guys are enjoying a relaxing beer at this point.

The day was wild, both in the US and Canada, as sub-prime worries struggled with confidence-boosting cash from the Central Banks for investors’ hearts and minds.

No hedge funds actually went bust today, as far as I know, but there are reports that Goldman’s Alpha Fund is now down 26% for 2007 to date. Deutsche Bank has disclosed that a fund with no sub-prime exposure has experienced 30% redemptions in August alone.

This scale of redemptions sucks up liquidity like crazy, which is one reason the central banks are stepping up. The CEO of Countrywide Credit thinks it will have a salutary effect on confidence (he’d better hope so!) and even the Bush administration has made a cheerleading effort, although not everybody buys what they’re selling. There’s much more confidence being expressed in the technocrats – e.g. Bernanke. Most comment is favourable.

The Treasury market stopped the panic buying as did Canadas, with the long-end continuing its weakness on fears all this money’s going to cause inflation.

The preferred market had a poor day, with all but one of the HIMIPref™ Preferred indices down on the day. But … that means yields are going up! In keeping with the “flight to quality” theme, there were quite a few lower rated (and non-index-included) issues down substantially on the day: BBD.PR.D, -4.15%; GT.PR.A, -2.93%; SPL.A, -2.87%; DC.PR.A, -2.64%; NTL.PR.F, -2.35%; WN.PR.A, -1.48%; DW.PR.A, -1.46%; WN.PR.E, -1.22%; BBD.PR.B, -1.06%; and finally IQW.PR.D, -1.00%. The two Mulvihill funds in that list, GT.PR.A and SPL.A are showing amazing yields … if they don’t default … which is not as likely as one might wish.

The TSX’s record trade count didn’t get much help from preferreds, as volume was pretty low.

There were five other $25-equivalent index-included issues trading over 10,000 shares today.

The markets giveth and the markets taketh away.

The trouble started in Europe, when BNP Paribas halted redemptions on some hedge funds, due to an inability to find a bid on some of their holdings.

“The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating,” BNP Paribas said in a statement.

This caused panic – or, at least, a major recalculation of just how bad things actually are. Overnight LIBOR increased 53bp and the European Central Bank stepped up to flood the system with cash. There is, as yet, no word on whether they have started renting helicopters. Similarly, the Fed pumped in liquidity (albeit not so much) and the Bank of Canada proudly announced that its employees showed up for work today.

The stock market did not like being reminded of sub-prime and showed its displeasure in both the US and Canada. The market is so upset that it has been knocked back all the way to where it was on Monday at about 2pm:

As might be imagined, the bond markets did interesting things. The flood of short-term money from the central banks sent two-year Treasury yields sharply lower. Fears that this money might fuel inflation steepened the curve considerably, both in the US and Canada. It would be really, really nice to see a decent term premium again, y’know? The WSJ has a round-up of reactions to the liquidity pumping.

Thirty-day Fed-Fund Futures are now indicating a rate of 5.20% for August and 4.73% for next February, but it’s an open question about how reliable this predictor is. There’s a lot of arbitrage problems with this contract – it’s hard to short Treasury Bills – as well as segmentation problems.

In stories of continuing interest, Joseph Stiglitz blames the sub-prime mess on Greenspan & Bush and Brad Setser has some things to say about China’s Reserve Policy sabre-rattling.

The preferred share market saw increased volumes today – back to normal levels, perhaps even normal+, with three issues trading in excess of 100,000 shares without being internal crosses or dividend capture plays.

PerpetualDiscount managed to squeak out another daily gain, while perpetualPremiums fell a bit, but nothing too exciting.

In keeping with the “flight to quality” theme, a number of lower-rated issues not included in the indices performed poorly today: NTL.PR.G, -2.89%; HPF.PR.B, -1.71%; DC.PR.A, -1.66%; EPP.PR.A, -1.45%; NTL.PR.F, -1.16%; and our friend from yesterday, YPG.PR.B, -1.14%. I will note that DBRS rates HPF.PR.B as Pfd-2(low), but I don’t understand why.

There were twenty-six other $25-equivalent index-included issues trading over 10,000 shares today.

OK, everybody, we can relax now! George W. Bush has stated “I’m not an economist, but my hope is that the market, if it functions normally, will be able to yield a soft landing. That’s kind of what it looks like so far.”  The equity markets immediately responded with a huge advances, both in the US and in Canada.

Sub-prime is old news, as evidenced by the fact that the IMF is pontifficating on the subject. The Europeans say investors can take their lumps anyway. Of far greater interest is rumblings from China that they may be willing, under certain circumstances, to flex their treasury muscle and use their currency reserves as a political weapon. Bush says that this would be foolhardy, and it’s therefore surprising that anybody is still taking the threat seriously. But … there is some concern the Fed doesn’t have the same influence over longer-term rates that it used to. Tom Graff has some comments and I have previously noted the effect of Chinese investment on Treasuries. Their trade surplus rose again in July, so they’ve got plenty of ammunition.

Treasuries got thumped, and whether that’s a rebound of the flight to quality or a China Syndrome is a matter of taste. Canadas followed Treasuries, unnoticed by media and bloggers.

The Wall Street Murdoch is Magnificent Journal posted an interesting comparison of credit markets, now vs. the LCTM blow-up. Given the state of economic education, however, nobody will notice.

It was a good day in pref-land, with volume picking up a bit and numerous “Scraps” issues (those not included in the indices due to either low volume or poor credit) gaining over 1% in price (bid / bid). The PerpetualDiscount index continued to shine and – who knows – might even make it back to its 2006-6-30 level of 1,000.00 before too long.

BAM had an interesting day, with two of its floating-rate issues and one of its perpetualDiscounts gaining over 1% (bid / bid). There seems to have been some pickup in activity in the BAM.PR.M / BAM.PR.N issues but whether this is meaningful remains to be seen. The fund has a position! An attractive yield, anyway – but I will confess I don’t know how many, if any, the underwriters of BAM.PR.N still have to unload. Certain the blow-out sale on EPP.PR.A I was told about has fizzled – the issue immediately started trading below the price I was told and has remained there since.

There were sixteen other $25-equivalent index-included issues trading over 10,000 shares today.