PrefBlog

I have another barrage of links for you today, so brace yourselves.

First, the obligatory Canadian news: Peter MacKay is no longer the Minister in Charge of Signing Agreements and is now the Minister in Charge of Shooting Off. What his dog thinks of the change was not disclosed.

BCE has filed its proxy statement and disclosed that financing for the takeover is coming from Citigroup, Deutsche Bank, The Royal Bank of Scotland and the Toronto-Dominion Bank. Now, it’s very nice to have financing committments, but they don’t necessarily mean anything. The Sallie Mae takeover is in trouble, with the borrowing buyers attempting to use an escape clause and the salivating sellers trying to slam it shut. Years of litigation ahead on that one, I’ll bet.

One of the financing consortium, Citigroup was in the news today.

Citigroup Inc., the biggest U.S. bank by assets, may forfeit as much as $1 billion of third- quarter profit because of the credit crunch in mortgages and high-yield debt, according to analysts at Sanford C. Bernstein & Co. LLC.
…
“The key question is how the market absorbs deals coming in September, when spreads may widen out to July levels or worse, or may renormalize, with spreads coming in to June levels,” the analysts wrote.

Mason and Howard said mark-to-market losses on leveraged loans in July could have been 15 percent to 20 percent. Lending spreads have tightened so far in August, they said.

Citigroup is the third-ranked provider of leveraged loans in the U.S. this year, behind JPMorgan Chase & Co. and Bank of America Corp., according to data compiled by Bloomberg.

Conventree is claiming that back-up liquidity providers for its commercial paper programme are refusing to provide back-up liquidity … lawsuits ahead there!

European Central Bank intervention eased off amid hopes that conditions are adjusting. Robert Eisenbeis thinks the ECB was too easy on the market.

It is being argued that central banks should actually make markets in instruments that have suddenly become illiquid … I don’t buy it. That’s the private sector’s job … central banks, as I said yesterday, can and should ensure that the biggest, best capitalized financial market intermediaries can make their decisions without having to get particularly nervous about their financing.

I also don’t buy recommendations that the ceiling on mortgage insurance be increased. The maximum mortgage that the agencies can buy is USD 417,000. Sorry! Anybody who’s taking out a mortgage in excess of USD 417,000 doesn’t need government help, implicit or otherwise. Insuring or providing loans of that size to individuals should be strictly private sector.

There was a comment reported by Bloomberg:

“Something that’s triple-A clearly shouldn’t be this volatile,” David Watts, an analyst at bond research firm CreditSights Inc. in London, said.

It may be that the Bloomberg reporter wrote the story to imply deprecation of the AAA ratings, but I hope the explanation for that remark is that he was deprecating the market. I agree with the other guy:

Ratings are “a measure of risk on a buy-and-hold basis and say nothing about the pricing volatility of an investment,” said Gareth Levington, a senior analyst at Moody’s in London. “The market level isn’t hugely relevant for the rating.”

Now for the really interesting stuff: Fed Funds. Truly one of the wildest and interesting sectors of the market, but not usually. Today Fed Funds Futures for the current month closed at 94.96, indicating that the market feels the average rate on Fed Funds for August will be 5.04%. Given that the Fed Funds target rate is 5.25%, this seems very strange indeed. But there are rumours that an emergency cut is imminent and there are more than just rumours. Federal Reserve Data indicates that the actual average rate so far in August has been about 5.17%; on 8/10 the Effective Rate was 4.68% and on 8/13 the ER was 4.81%. On both those days, the low for the day was 0%. So roll that up and smoke it … the interventions have had some effect! I found another primer on how this works, for those who are interested.

Potential cuts in the Fed Funds rate got a boost from mild US Inflation data which is projected by many to come inside the Fed’s comfort zone. Exports are up, which is logical since emerging nations are the only ones who have any money.

Sub-prime is even affecting national currencies … the Kiwi/Yen carry trade is losing popularity and funds are pouring into the US dollar.

With all this going on, Walmart’s profit warning ushered in every-day discounts on US Equities and financials led the crap-out in Canada.

There was continued flight to quality and curve-steepening in both Treasuries and Canadas. US Investment-Grade corporates narrowed in a little.

A lot of lower grade credits in the preferred share market got hit today: WN.PR.D, -3.49%; DW.PR.A, -2.46%; WN.PR.C, -1.72%; DC.PR.A, -1.55%; YPG.PR.B, -1.53%; STR.E, -1.35%; IQW.PR.D, -1.19%. This illustrates my theme of minimizing exposure to the Pfd-3-type credits!

Just for fun, I’ll update my recent comparable list:

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

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.