Citi bailout Awakens Cynicism
Before I begin, Michael Lewis has written the best financial article I've read in a few months and probably one of the top five I've ever read.On to today's subject: I have for years learned not to be cynical and thought myself to look at verifiable facts and reach conservative conclusions, if any at all. Over the past few months, many people with similar inclinations have drifted towards cynicism. While I've remained far behind, I feel much closer to their point of view after this weekend's bailout of Citigroup. Nothing justifies the lack of consequences for those at the top. It may be wise to bail out the company, but taxpayers need to recover as much funds as possible, get as high an interest rate as possible, as large an equity stake as possible and believe that their government is doing the most it can.
And when this doesn't happen? People start gettign cynical, thinking ahead and visualizing (perhaps accurately) a disturbing destiny. Personally, the structure of these bailouts lead me to ponder whether they are needed at all. Paulson and the Fed appear biased in favor of saving Wall Street. Today on a radio talk show, a guest pointed out that if Citigroup fails, it's not as if "a big volcano will erupt and cover us all with lava". I agree! America has had depressions before and bank failure chains as well. Guess what? It not only emerged from these calamities but emerged as the world's only true superpower. It's true that things are a bit different in 2008 and that this depression is more akin to Europe's depression in 1873, but the point still holds.
There is an argument out there that bail-outs will sink us into an ugly type of socialism, the kind that America has always criticized. While some people think we'll have a lost decade like Japan, a subset of these and others fear that this will cause massive U.S. Dollar inflation. Indeed, today U.S. government CDS widened to record spreads, clearly as reaction to Citi's bailout.
As this crisis continues, I continue to look for the next big bet, the next flagrant mispricing, and right now the leading candidate seems to be "short U.S. treasuries" - the last bubble that has not yet popped. Many prominent bears such as Peter Schiff and Yves Smith believe we're headed in that direction. Other bears such as Nouriel Roubini and Calculated Risk seem a bit more sanguine. I have yet to make up my mind but I'm getting cynical about inflation, cynical about politicians, cynical about their abilities to see ahead and cynical about how Americans can hurt their own country. I would not rule out the possibility of a nasty public war between CEOs, members of congress and/or other Americans. I continue to play around with GDX calls, as I have for the past year. Gold has held up better than other commodities and I increasingly believe in it as a very attractive storage of value.
Two words of optimism in all this: Obama, maybe.
posted by Eyal Bar at 8:02 PM
3 Comments:
I think WE need a bailout.
Check out current bailouts for us.
Bailout Types for 2009
Hello Eyal,
Great calls, it's been a pleasure reading the investment musings of a fellow Montrealer (I will always regret not following through with a short on GS)
A comment about gold: one key driver for the price of gold is performance in the financials (I think this explains the recent run-up). I don't think gold has much more upside, unless you expect the banks to become worthless, or you expect inflation to make a come back from the grave, or you expect Obama to be an exact repeat of FDR and buy up all the gold in the world.
Just one question: how do you derive fair value for the stock market at large? You said that you thought stocks were properly valued now.
Hi Emil,
And as a blogger it's nice to see a fellow Montrealer comment!
First, regarding gold, I think all of these arguments lack an actual valuation of gold so it is all kind of speculative. You seem to be suggesting that gold's performance is directly related to its status as safe haven in times of uncertainty. In other words, you would go long as a bet that many others will too once they get scared of FDR-type measures, and you would go short if they're all scared for nothing.
This argument is good but I see other factors come into the equation. A similar rush to panic could occur if the world were to project all the new government programs into the future. In other words, it's not just the stimulus program itself but the uncertainty it creates.
Regarding gold valuation, there is the dow/gold ratio which is imperfect because as time goes on the dow outperforms (dividends and growing GDP) but if you look at the chart it looks like a typical mean-reverting chart on a slope. So gold should revolve around a linear function. Another important point is the valuation of gold relative to other commodities. The Gold/Oil ratio is very useful in this regard. When I wrote up the USO short, the ratio was around 7. It is now close to 15. In that sense, going long gold looks like a poor investment but I think the ratio will stay high for a longer time due to the economic situation and oil-specific factors.
What I like about GDX calls at this time is that some equities are bargains now, so it's a double bet. But there are better ways, I am sure, to play the fear of future inflation. Julian Robertson is buying steepner swaps. In any case, I am not 100% sure that inflation will overwhelm deflation once the deleveraging slows. The debate is still up in the air and I'm only playing GDX with modest amounts.
As to company valuation, there are many measures but the two that I think stand the test of vagaries are the Graham P/E and the Market Cap to GNP ratio, which is the price/sales ratio of the entire economy. This one is Buffett's favorite because is removes sensitive profit margins from the equation and assumes things will go back to normal one day. Of course, companies might be overleveraged and subject to debt-to-equity conversions, which brings us to use EV/GDP. This measure would give us the total valuation of the companies to all investors (debt + equity) but still doesn't tell us enough about just the equity or just the debt since there might be biases in favor of one of them. In today's case, I don't think there are biases. Both debt markets and stock markets have crashed hard and I wouldn't say one asset class is dramatically better valued than the other.
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