Felix Rohatyn and New York City

The great thing about holiday weeks - besides being able to catch up with my family (whether they want to or not!) - is that I get a chance to read some of the books I've been wanting to catch up on.

For example, I just finished Felix Rohatyn's memoirs entitled Dealings. Rohatyn was a leading investment banker for many years working as a senior partner at Lazard Freres. The book is a fairly easy read, perfect for the holidays. As one review suggested, reading Rohatyn's book is like listening to a rich uncle tell stories, full of anecdotes about famous people.

Rohatyn's most notable work, in my opinion, occurred in the mid-1970's, when he was a major player in helping New York City avoid bankruptcy. The City at that time was desperately short of cash, and when President Gerald Ford told the City's leaders that no federal help would be forthcoming (thus eliciting the famous headline in the New York Post: "Ford to City: Drop Dead") it looked like New York would be forced to default.

Of course, New York did not default, although it did restructure some of the terms of its debt obligations.

It was very instructive to anyone who invests in municipal bonds to read the section of Rohatyn's book which discusses the immense effort that City leaders made to avoid any delays to the payments of their debt.

Everyone involved - from the mayor to the heads of the very powerful unions in New York - realized that any sort of default would be a catastrophe.

Even President Ford - who earlier in the process had been steadfast in his belief that New York would have to figure matters out on their own - eventually approved federal approval of guarantees to aid New York.

This episode - and others like it - make me confident of the credit quality of most municipal debt. Yes, municipal finances are a mess, and tough choices will need to be made.

But the bottom line is that most municipalities need the credit markets more than the markets need any debtor, and municipalities will do almost anything to avoid timely repayment of interest and principal.

Do Rising Commodity Prices Indicate Inflation on the Horizon?

The other day some friends of mine took their parents to see a local bank. Their aging parents, they felt, could benefit from some professional financial management, and this well-respected trust company seemed to fit the bill.

After the meeting my friends asked me to look at the material the bank had given their parents.

I'm not going to comment on the presentations of my competition (even though I would like to!), but I was struck by one aspect of the proposed plan:

"We will keep bond maturities very short in anticipation of higher interest rates ahead".

This is a very common theme among investment professionals: Interest rates are going to rise.

All you have to do, they argue, is look at the prices of commodities, which are roaring higher. Gold and copper in particular are usually cited as good harbingers of future inflation.

Well, maybe, but perhaps the rise in commodities is really more a function of an expanding world demanding more resources.

Paul Krugman's column this morning in the New York Times discusses this. Here's an excerpt, with the full link below:

What about commodity prices as a harbinger of inflation? Many commentators on the right have been predicting for years that the Federal Reserve, by printing lots of money — it’s not actually doing that, but that’s the accusation — is setting us up for severe inflation. Stagflation is coming, declared Representative Paul Ryan in February 2009; Glenn Beck has been warning about imminent hyperinflation since 2008.

Yet inflation has remained low. What’s an inflation worrier to do?

One response has been a proliferation of conspiracy theories, of claims that the government is suppressing the truth about rising prices. But lately many on the right have seized on rising commodity prices as proof that they were right all along, as a sign of high overall inflation just around the corner.

You do have to wonder what these people were thinking two years ago, when raw material prices were plunging. If the commodity-price rise of the past six months heralds runaway inflation, why didn’t the 50 percent decline in the second half of 2008 herald runaway deflation?

The Finite World - NYTimes.com

I continue to believe the larger risk to many investors - including the aging parents of my friends - is the possibility that interest rates remain lower than most anticipate. Keeping your money in a money market fund today in anticipation of higher rates ahead may seem like a sound strategy but it is also an expensive one.

Time to Party Like It's 1999?

I saw in the Financial Times the other day that the market value of companies like Facebook and Twitter have soared in the last few months.

Based on transactions in the private market (since the company is not publicly traded), the value of Facebook has jumped by almost +50% since the summer. Facebook is now apparently valued at $41 billion, even though its total revenue for the past year was around $2 billion.

Now, I am a huge fan (and believer) in the future potential of social media, but reading stories like this give me a gnawing feeling that I've seen this movie before. Remember 1999, when technology stocks were all the rage? Cisco was even supposed to become the first company worth $1 trillion (today the company is worth about 2/3 less than it was valued 10 years ago).

I hope we're not going down this path again, but there seems to be an awful lot of optimism about stocks among the Wall Street community (even though Main Street does not share these same sentiments). Valuations are much more reasonable than 1999, of course, so perhaps the market will be OK, but with the S&P up +20% since early September (thank you Ben Bernanke and QE2) we could be setting ourselves up for a more rocky year in 2011 than many are anticipating.

There was an article in this morning's New York Times talking about this growing optimism; here's an excerpt from Paul Lim's column:

INDEED, some market strategists worry that investor optimism itself may be a headwind to another strong year for the market. Consider how stocks performed in other recent periods of optimism. In October 2007, a survey by the American Association of Individual Investors found that 55 percent of investors were bullish; in the 12 months that followed, the S.& P. 500 fell 37 percent. Similarly, in March 2000, investor bullishness reached 66 percent. And a year after the fact, stocks were down 25 percent.

It just goes to show that by the time the market thoroughly convinces investors to be optimistic, most of the good news is already behind us.

Stock Market Optimism May Be a Red Flag for 2011 - NYTimes.com

Floyd Norris of the NY Times: U.S. Investors Turn Away From Domestic Stock Funds - NYTimes.com

Just a short blog post today - we're busy getting ready for Christmas tomorrow.

However, there was a good article in this morning's New York Times. Floyd Norris points out the prevailing negative sentiment about the stock market that seems to abound among investors. This despite the fact that it looks like 2010 will be the second year of solid gains for stocks.

Here's an excerpt from the article:

The stock market collapse in 2008 and early 2009 appears to have inflicted far more psychological damage — damage that may have been intensified by the collapse of home values and the deep recession that hit the country, and by the fact that many stocks had not recovered the highs they had reached in 2000. For perhaps the first time since the late 1970s, many Americans seem to have become pessimistic about the future of their country.

For the 10 years through 2010, figures for the final two weeks of the year will determine whether there was any net investment in domestic stock funds. (The estimate for the decade so far is that $4 billion flowed out.) By contrast, in the 10 years before that, Americans put $1.3 trillion into such funds.

In some ways, the current mood is reminiscent of the one that prevailed then. In 1979, Business Week published a cover article on the “Death of Equities,” which it attributed in large part to rising inflation. By 1982, inflation had begun to fall, but the country was in a deep recession. That is when the great bull market of the 1980s began. Few investors seem confident that such a renewal of optimism is likely this time.

U.S. Investors Turn Away From Domestic Stock Funds - NYTimes.com

Deborah Jacobs: Married's Couple to the New Estate Tax Law

I have written about Deborah Jacobs and her excellent book Estate Planning Smarts on this blog before.

If you have any interest in the subject, or know anyone who should, I highly recommend her book (and, no, I do not have any financial interest in this matter, nor have I ever met Ms. Jacobs).

Here's the link to her web page:

www.estateplanningsmarts.com.

Deborah also has written a very useful column in Forbes.com about the new estate tax law. The new package contains a number of features that can be very tax-friendly to wealthy couples. Here's an excerpt from her article, with the full link below:

The sweeping tax overhaul that President Obama signed Dec. 17, raising the exemption from federal estate tax to $5 million a person, includes a wonderful new break for widows and widowers. Starting in 2011, they can add the unused estate tax exemption of the spouse who died most recently to their own. This dramatic change enables spouses together to transfer up to $10 million tax-free. It also eliminates the need in many cases for the tax-planning gyrations that lawyers routinely recommended to preserve each spouse's estate tax exemption amounts.

Forbes.com - Magazine Article

S&P 1250

The stock market finally breached the 1250 threshold yesterday despite economic news that was really more on the weaker side.

Not only is level psychologically important (since the market had made several failed attempts over the last few weeks to close above 1250) but it also marks the return to where we were in September 2008, right before the Lehman Brothers collapse.

This morning's Financial Times noted the recovery of the S&P to current levels by making some other comparisons to the fall of 2008:

Most sectors have barely budged but after two years of crisis and recession one surprise is that the consumer discretionary sector is the best performer, worth 22 per cent more than it was pre-Lehman. The financial sector, meanwhile, is down 24 per cent. More surprisingly, Standard & Poor's data show the proportion of the index in financials at 15.9 per cent, is actually larger than the 15.3 per cent pre-Lehman, because new banks have entered the index. This is still down from the 20 per cent peak in 2007. As to the future, the market is cheaper as a multiple of earnings but pays almost a fifth less in dividends. It is not time to relax.

Imagine that: if in the tense days of the September and October of 2008 I had suggested to you that we load up your account on retailing and other consumer discretionary stocks you probably would have thought I was crazy. And yet in hindsight that was the correct decision.

A few other points. In the period since September 2008, where the stock market has returned essentially 0% (since we are just back to where we started), gold has risen by +169%, and oil is up +48%. Commodities have been the true growth of the past couple of years, and with global demand continuing to rise despite tepid economic growth in the developed world this trend seems likely to continue.

Second, while the S&P has recovered the lost ground of the past couple of years, we are still -19% lower than we were in October 2007. From this standpoint, then, the market could easily show significant gains ahead.

Finally, interest rates on longer-dated Treasury securities have barely changed in the last couple of years. The 10-year US Treasury was yielding slightly more than 3.7% in September 2008, and now yields 3.35%. With all of the talk that the rise in stock and commodity prices are foreshadowing a rise in economic growth, as well as inflation, the bond vigilantes remain very calm.

Let's hope that continues into 2011.

Meredith Whitney and the Municipal Bond Market

If you've been at the investment management business for a while - as Random Glenings has been - you can recall numerous situations where some analyst makes their fame and fortune through making a market prediction that appears to be outrageous at the time but turns out to be true.

For example, when I first got into the business in 1982, a technical market analyst named Joe Granville correctly predicted that a major stock market correction was imminent.

Elaine Garzareilli was at Lehman Brothers when, in August 1987, she correctly forecast a huge market downturn was near - and sure enough, October 1987 saw the markets drop by -25% in a single day.

More recently, perma-bears like Nouriel Roubini from New York University and economist David Rosenberg (formerly of Merrill Lynch) correctly foresaw the economist crisis in 2008.

But what do all of these folks have in common? They never change their tune. They all attempted to repeat their forecasting feat, and make more outlandish predictions that turn out to be wildly wrong.

I remember talking to a client who told me a story about his grandfather. Right before the crash of 1929, his grandfather had correctly foreseen the crash, and sold all of his stocks.

Problem was, once his grandfather re-entered the market, he kept seeing warning signs ahead, and would try to repeat his feat of 1929 over and over again, only to watch the stock market roar ahead.

Which brings me to Meredith Whitney.

Ms. Whitney is a good bank analyst who correctly predicted the problems in the banking sector in 2007 while she was at Oppenheimer. She was particularly prescient on her views on Citigroup, and forecast the huge drop in price and massive dividend cut that eventually occurred.

So Ms. Whitney took her newly-found fame and went off to start her investment management consulting firm.

She turned her attention to the municipal market and found municipal finances in tough shape (quelle surprise!). She then went public with some very dire predictions for the municipal bond market, and even appeared on 60 Minutes last Sunday (did I mention that Ms. Whitney is very attractive?).

I've gotten a few calls on her appearance, and sufficient to say that I do not agree at all with Ms. Whitney. Today I saw a column on Bloomberg that does a pretty good job at summarizing my thoughts.

Here's an excerpt, with the full link below:

There will be between 50 and 100 “significant” municipal bond defaults in 2011, totaling “hundreds of billions” of dollars.

So said banking analyst and new municipal bond expert Meredith Whitney on the “60 Minutes” show on Sunday, in perhaps the boldest, most overreaching call of her career.

Hundreds of billions of dollars? The one-year record, set in 2008, is $8.2 billion. You can see how an estimate of “hundreds of billions” would get people’s attention...

...This isn’t the Whitney scenario. No, she envisions between 50 and 100 -- or more -- counties, cities and towns making the choice to renege on their bonded debt.

My question is: Why?

Why would a governmental entity go out of its way to provoke or alienate its best source of finance? In the old days you might say that bondholders were a distant class of banks and plutocrats mainly centered in the Northeast. That’s no longer true, and hasn’t been since at least the passage of the Tax Reform Act of 1986, which made bonds less attractive for banks and insurance companies, among other things. Today, a city’s bondholders might live in the municipality itself, and almost certainly reside within the state.

Debt Service

Why would a governmental entity choose to default on its bonds, especially if they make up a relatively small proportion of its costs?

“Debt levels for U.S. local and state governments are relatively low, with annual debt service representing a relatively small part of budgets,” Fitch Ratings said in a special report in November.

Meredith Whitney Overreaches With Muni Meltdown Call: Joe Mysak - Bloomberg.com