PrefBlog

Well, let’s all be happy that day’s done, shall we?

Canadian equities are now down on the year, notwithstanding a monster rally that took it up almost 400 points from the lows.

A record 708.1 million shares changed hands in trading on Toronto today, surpassing the previous record of 499.8 million set on July 12, according to an e-mailed statement. The number of trades was 996,311, exceeding the 707,853 made Aug. 10.

Similarly:

NYSE Euronext (NYSE Euronext: NYX), the world’s largest and most liquid exchange group, today reported record transaction volume in its U.S. cash equities trading operations on NYSE Group exchanges with 5.73 billion shares traded, based on preliminary results.  Additionally, the NYSE also achieved new records in orders, trades and quotes.

So far this month, trading volume on NYSE Group U.S. cash equities markets in August 2007 is 110% higher than August 2006.

as US Equities plunged, then rocketted to close slightly up on the day.

Moody’s warned that a LTCM-like collapse is not entirely out of bounds, and a Wall Street type warned that Moody’s isn’t invited to his next birthday party:

“To see Moody’s make forward-looking negative statements about hedge funds, who may well be suffering in large part as a result of their reliance on Moody’s now evidently worthless ratings, is to witness the height of chutzpah.”

He’s not alone, as Sarkozy wants an investigation into Moody’s. There is, as yet, no indication as to whether Sarkozy will be investigating asset managers who underperformed their benchmarks; Sarkozy’s track record was not disclosed. I am willing to bet that Gary Jenkins will also be relieved that he will not necessarily be investigated:

“Rating agencies should be regulated and they should be paid by the investor — not by the issuer, not by the structurer,” said Gary Jenkins, a partner at London-based hedge fund Synapse Investment Management, which manages $650 million of debt assets. “It’s so obvious, so simple that it’s the one thing that probably won’t happen. They shouldn’t be paid by the people selling the bonds.”

There are others who have the maturity and personal integrity to resist the temptation to blame the rating agencies: they blame the Fed:

The result: a crisis of confidence among investors who say Bernanke must abandon his focus on inflation and prevent a deeper slide in markets that endangers economic growth.

To restore my limited faith in humanity, there is at least one other person arguing, in effect: ‘Sure, the financial markets are risky. That’s what they’re for.’

All the money the Fed has pumped in seems to be going into T-Bills, which wasn’t quite what they had in mind.

The yield on the three-month Treasury bill tumbled 0.48 percentage point today to 3.62 percent, after falling 0.54 percentage point yesterday.

The money certainly didn’t go into the Commercial Paper market, which shrank significantly. About time – have a look at the actual Fed data, particularly the “Outstandings”. It would be a mistake to draw any conclusions from data without investigating further … but boy, it sure looks as if reliance on short-term funding in the US has increased a lot over the past five years!

Amidst all the equity fear and flight to safety, Treasuries had a monster day, and the 2-10 spread widened slightly to 45bp from 44bp yesterday. Given a gappy day like today, though, a lousy beep doesn’t mean too much. Canadas were much more restrained, with more steepening, the 2-10 spread increasing from 14bp to 17bp. Actual corporate bonds are still extremely illiquid.

The Yen did well, on what is presumed to be carry-trade unwinding; outlook for the USD is still probably grim.

There was cheering in the streets early on, as banking executives from all walks of life celebrated what I think must the demise of a competitor … er, I mean, they were happy that investors aren’t being wiped out in the restructuring of the Coventry funds. The commercial paper will be converted into floating rate notes with a maturity matching that of the underlying assets; if you want to pick up a little money-market yield by investing in Asset Backed paper in the future, you are now much more likely to purchase a rock-solid security, issued by a rock-solid trust. One that’s run by, um, a bank.

Given the events of the day – corporates in general not seeing much action; stocks getting hit; retail assuming that a preferred share is simply an equity that hasn’t gone down yet – it should be no surprise that the pref market did not do very well. As has often been the case lately, the Pfd-3(high) & lower issues took a hammering [which makes more sense than the higher issues getting hurt, anyway!]: NTL.PR.G, -5.33%; DW.PR.A, -5.27%; CCS.PR.C, -4.42%; STQ.E, -4.30%; YLD.PR.B, -3.81%; WN.PR.C, -3.61%; BBD.PR.C, -3.30%; BBD.PR.B, -3.18%; WN.PR.E, -2.56%; BBD.PR.D, -2.38%; NTL.PR.F, -1.81%; CGQ.E, -1.56%; WN.PR.D, -1.53%; BPO.PR.K, -1.47%; YPG.PR.A, -1.02%.

I’m not trying to pick on the junky stuff, there are lots of investment grade issues listed below! There was one junky gainer, IQW.PR.D, +1.92%.

Lets have another look at the junky-but-not-quite-junk sampler:

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

Not quite so many links as has been the case lately, thank heavens, but those that I am going to put up are of exceptional interest … so read carefully!

Coventree was able to roll $600-million worth of paper today, which is good news, but noted:

“This ABCP was purchased primarily by investors who elected to renew or roll over their ABCP that matured (Tuesday),” Coventree stated.

I suspect there’s something of Mexican standoff implicit in the above remarks … if Coventree had to enter CCAA Protection it would be worse for both the company and the creditors.

There was a hint that much the same thing might be happening in the States, with Countrywide Financial stock plunging when Merrill Lynch changed its recommendation from “Buy” to “Sell” based on liquidity concerns. The analyst’s track-record was not disclosed. As in many such cases, this accellerated concerns to the point of becoming a self-fulfilling prophecy:

Countrywide credit-default swaps soared 225 basis points to 600 basis points, according to broker Phoenix Partners Group. That means it costs $600,000 a year to protect $10 million of Countrywide bonds from default for five years. The contracts have risen more than sixfold in the past month.  

The rout intensified after CNBC reported that Countrywide’s 30-day asset-backed commercial paper was being quoted by dealers at a 12.54 percent yield. The company previously borrowed at 15 basis points, or 0.15 percentage point, over the London interbank offered rate, which currently is about 5.57 percent for 30-day borrowings, the cable-television network reported

Even one of the bond market’s golden boys is affected, though admittedly the damage is largely self-inflicted: Nestle lost its triple-A status:

Nestle’s was cut one level to AA+ by Fitch and to Aa1 by Moody’s after the Vevey, Switzerland-based company said it plans to repurchase 25 billion Swiss francs ($21 billion) of stock, its biggest-ever share buyback. The downgrade leaves only Johnson & Johnson, Toyota Motor Corp. and Exxon Mobil Corp. holding AAA ratings from both Moody’s and Standard & Poor’s as well as Fitch.

In late news that might broil the markets tomorrow:

Australia’s Rams Home Loans Group Ltd. has been unable to refinance A$6.17 billion ($5 billion) of short-term U.S. loans because of a “lack of market liquidity” caused by the global credit rout.

Rams cited the “tightening of the global credit markets” for failing to sell the so-called extendable commercial paper, the company’s largest source of funding for its loans, it said in a statement today.

The lender has been given temporary funding of A$1 billion by two of its providers, Rams said.

In turn, both American and Canadian equities tanked. Today’s fearless prediction: pundits in tomorrow’s paper will note that the Canadian index is now more than 10% off its peak, meeting the generally accepted definition of a “correction”.

Reminds me of my back-office days back in 1987. I was asked quite seriously if I thought the 502-point drop in the Dow was a “crash” or a “correction”. I said I thought it meant the Dow was down 502 points, which wasn’t considered a particularly penetrating answer.

All the angst got the central banks moving. The Bank of Canada lowered its standards for repurchase agreements and the current month Fed Futures are now showing an expectation of an average Fed Funds rate for August (this month! August!) of 4.99%, twenty-six bps below target. This follows disclosure that the dollar-weighted average of actual Fed Funds transactions yesterday was 4.54%, with a low of half a point. We can be thankful that inflation numbers were benign and were met with cheers. A Fed governor, Poole, reminded the markets not to take anything for granted – the Fed cares about the real economy, not bit of Wall Street paper.

Given the de facto easing, it is not surpising that Treasuries had a really good day, with the two-year yield declining six basis points, although the spoil-sports trading ten-years took yield up 1bp, for a marked steeping. Canadas did not behave in anywhere near so dramatic a fashion, but 2-10 still steepened 2.3bp.

Rotten day in the preferred market, with all but one of the indices down on the day – and that one (FixFloat) was due to exceptional performance by BCE.PR.T, which accomplished this feat on zero volume. It’s very tempting to try to read something into this performance; but then again, in such a retail dominated market, strange things can happen.

Again, lack of interest in the lower rated credits was noticable, with the following performance stand-outs: YLD.PR.B, -4.55%; IQW.PR.D, -4.43%; HPF.PR.B, -4.26%; STQ.E, -3.01%; IQW.PR.C, -2.83%; DC.PR.A, -2.29%; GT.PR.A, -2.15%; NTL.PR.F, -2.07%; BBD.PR.C, -1.40%; BBD.PR.B, -1.32%; BPO.PR.J, -1.22%; and YPG.PR.A, -1.09%. Some of the lower rated credits bounced, but not many: WN.PR.C, +1.06%; WN.PR.D, +1.41%.

Just for fun, I’ll update the ‘Junky but not quite junk’ list (and remember, this is not representative! While the selections were not entirely random, they’re not entirely representative, either!).

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

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.