The US Government and
Federal Reserve have initiated a multitude of programs to try and restore the
economy to its prior state. According to Bloomberg.com, the US government and
the Federal Reserve have spent, lent or committed $12.8 trillion as of March 31,
2009, an increase of 73% since November 2008 when Bloomberg first estimated the
funding, loans and guarantees at $7.4 trillion. Bloomberg’s most recent tally
follows:
--- Amounts (Billions)---
Limit Current
===========================================================
Total $12,798.14 $4,169.71
-----------------------------------------------------------
Federal Reserve Total $7,765.64 $1,678.71
Primary Credit Discount $110.74 $61.31
Secondary Credit $0.19 $1.00
Primary dealer and others $147.00 $20.18
ABCP Liquidity $152.11 $6.85
AIG Credit $60.00 $43.19
Net Portfolio CP Funding $1,800.00 $241.31
Maiden Lane (Bear Stearns) $29.50 $28.82
Maiden Lane II (AIG) $22.50 $18.54
Maiden Lane III (AIG) $30.00 $24.04
Term Securities Lending $250.00 $88.55
Term Auction Facility $900.00 $468.59
Securities lending overnight $10.00 $4.41
Term Asset-Backed Loan Facility $900.00 $4.71
Currency Swaps/Other Assets $606.00 $377.87
MMIFF $540.00 $0.00
GSE Debt Purchases $600.00 $50.39
GSE Mortgage-Backed Securities $1,000.00 $236.16
Citigroup Bailout Fed Portion $220.40 $0.00
Bank of America Bailout $87.20 $0.00
Commitment to Buy Treasuries $300.00 $7.50
-----------------------------------------------------------
FDIC Total $2,038.50 $357.50
Public-Private Investment* $500.00 0.00
FDIC Liquidity Guarantees $1,400.00 $316.50
GE $126.00 $41.00
Citigroup Bailout FDIC $10.00 $0.00
Bank of America Bailout FDIC $2.50 $0.00
-----------------------------------------------------------
Treasury Total $2,694.00 $1,833.50
TARP $700.00 $599.50
Tax Break for Banks $29.00 $29.00
Stimulus Package (Bush) $168.00 $168.00
Stimulus II (Obama) $787.00 $787.00
Treasury Exchange Stabilization $50.00 $50.00
Student Loan Purchases $60.00 $0.00
Support for Fannie/Freddie $400.00 $200.00
Line of Credit for FDIC* $500.00 $0.00
-----------------------------------------------------------
HUD Total $300.00 $300.00
Hope for Homeowners FHA $300.00 $300.00
-----------------------------------------------------------
Both the objectives and the
means of achieving them have been questioned by many. Martin Hutchison, a
financial commentator, provides an opinion in his recent article titled
“Subsidizing Failure.”
Counterproductive economic pathologies have been
encouraged, financial structures that endangered global prosperity have been
bailed out and trillions of dollars have been poured into industries that
obviously needed to downsize. Far from providing “stimulus,” such subsidies
both deepen the recession moderately and extend its duration inordinately.
Hutchison goes on to critique the TALF program:
The theory behind TALF (Term Asset-backed
Securities Loan Facility – to provide liquidity for securitized loans) breaks
down when you remember that the U.S. economy has been imbalanced by a savings
rate near zero, while the balance of payments deficit has soared to 6% of Gross
Domestic Product. In order to arrive at an economy that is sound in the long
term, the balance of payments deficit must be eliminated, or close to it, while
the U.S. savings rate needs to rise to its long-term average of 8% - or
preferably rather higher, to rebuild savings depleted from past savings
shortfalls and asset price collapses. Subsidizing credit card, automobile and
home mortgage loans is pushing the consumer towards behavior that has wrecked
the economy, in precisely the reverse of the direction he needs to go. The $1
trillion is thus a subsidy to failure; as a side effect it will produce a high
percentage of loans that eventually default.
He didn’t think much of the financial support
provided to AIG either:
Of the capital injections into financial
institutions, the most damaging of all, even worse than prolonging the
destructive careers of Fannie Mae and Freddie Mac, has been the $180 billion
injected into the insurance company, AIG. Not only has this subsidized the
continuation of AIG’s financial products operation, about the most
wealth-destructive participant in a highly wealth-destructive era on Wall
Street, but it also has subsidized by some large fraction of $180 billion the
wholly unsound credit default swaps business. Had AIG been allowed to fail, the
CDS market…would have been exposed as the destructive scam it is. Those AIG
counterparties who themselves survived would have fired their CDS dealers and
redeployed resources into more productive – or at least, less destructive –
operations.
Due to the large government
budget deficits now underway, BCA Research finds the secular outlook for equity
markets in the G7 countries, especially the US, to be “problematic.”
First and foremost, the dramatic actions taken
to rescue the world economy are creating enormous distortions which will only be
corrected over time and which will cause renewed economic stress and
financial-market tensions. Public-sector finances within the G7 world will
inevitably careen toward some kind of crisis over the next few years, with
bloated fiscal deficits, high and rising public-sector debt levels and a
deteriorating revenue base as a result of a structural downshift in
growth….total U.S. public-sector debt, now at 73.2% is projected to reach
95-100% of GDP in 2011.
It is not difficult to see taxes in the G7 being
raised, probably quite sharply at some point down the road. The Obama
administration has already made it clear it intends to cut the budgetary deficit
to 3.5% (of GDP) in 2012 from its projection of a 12.3% deficit in 2009. Hence,
at some point, the U.S. economy will have to endure a dramatic shift from
massive fiscal thrust to draconian fiscal restraint if President Obama makes
good on his promise. If, on the other hand, the U.S. government does not rein
in its fiscal imbalance, then real bond yields may have to rise in order to
reflect the large public-sector requirement. Either way, U.S. economic growth
will have to suffer in the next three to five years.
The Organization for
Economic Co-operation and Development (OECD) estimates that by 2011, only three
member countries will have government gross financial liabilities that are
higher as a percentage of GDP than the US: Japan, Italy, and Greece. Under such
circumstances, it is difficult to imagine the US dollar continuing to serve as
the world’s reserve currency.
It is doubtful that the US
Treasury will be able to sell all of the bonds that they plan to issue to
investors, so the Federal Reserve will be the buyer of last resort. Fed
purchases of US Treasury securities will immediately create credit balances in
the banking system which can be used for the purchase of goods and services,
which should lead to higher inflation.
Germany had its own
experience with extraordinary government policies when it monetized
progressively larger sums of government debt during the five years from 1918 to
1923. In October 1918, the exchange rate for the German mark was 4.0 to 1 US
dollar. By November 30, 1923, the exchange rate was 4.2 quadrillion German
marks to 1 US dollar. Investors simply did not cooperate with the German
government’s plans. Guido Giacomo Preparata provides a summary of the causal
sequence of the hyperinflation in his book, Conjuring Hitler:
(1) to pay interest on the enormous war loan,
the Reich commissioned to the Reichsbank a vast amount of cash and check money,
which was shot in the system, causing domestic prices to climb steadily; (2)
when the rich perceived that the inflation was eroding their wealth and fearing
(Finance Minister) Erzberger’s draconian tax reform, they began to cash in their
war loan certificates and send their capital abroad; (3) the evaded capital
denominated in marks was converted beyond the border into dollars, guilders,
pounds and francs: thus the mark depreciated steeply against these
(currencies)…(4) the tax shortfall at home forced the Reich to run further into
short-term debt: it printed more bonds, half of which until 1922 were converted
into cash by the central bank, the other half being bought by private savers;
(5) to pay for reparations, Germany purchased foreign cash, pawning gold and
spending marks, and thus weakened even more the Reichsmark vis-ŕ-vis the other
currencies; (6) this reinforced external depreciation affected the price of
imports, which in turn affected the cost of living, and so prices kept soaring;
(7) the Reich sank ever more deeply into debt, but for about two years
(1920-1922) the foreign and domestic subscriptions of government bonds prevented
the inflation from detonating the meltdown; (8) after the invasion of the Ruhr
in early 1923, the final repudiation of the floating (short-term) debt left the
government and the Reichsbank no choice but to reimburse in cash, mark for mark,
all the certificates that the investors, foreign and otherwise, were no longer
willing to renew; from then on all new bond issues, which the Reich emitted to
pay for its expenditures, were shouldered by the central bank alone: it sucked
in all the bonds and converted them into….bank notes – the mark accordingly
plunged.
In coming weeks, I plan to
continue to increase the allocation to foreign securities and position
portfolios for higher inflation and interest rates in the US.
Additions
The Nuveen Florida Quality
Income Muni Fund (NUF) was purchased at a 22% discount to net asset value. The
fund uses leverage and had a 6.1% tax-exempt yield at the time of purchase.
The iShares Silver Trust (SLV)
and SPDR Gold Shares (GLD) were purchased. The exchange-traded funds invest in
physical silver and gold, respectively. Given the actions of the Federal
Reserve and other central banks, I expect gold and silver to appreciate in value
during the next few years.
Apartment Investment &
Management Co. (AIV) operates approximately 163,000 apartment units located in
44 states. AIV announced that it would reduce its quarterly common stock
dividend to $0.25 from $0.60 per share beginning in 2009. Average physical
occupancy for the fourth quarter of 2008 was at 94.7% compared to 94.5% during
the fourth quarter of 2007. AIV expects to sell approximately $2 billion of
assets during the next two years. AIV management expects funds from operations
of $1.65 to $1.95 per share for 2009. Based upon the reduced dividend level,
the dividend yield at the time of purchase was 14.7%.
Advantage Energy Fund (AAV)
is a Canadian income trust that recently announced it will discontinue cash
distributions and recommend that shareholders approve a conversion to a
growth-oriented corporation. AAV has significant natural gas development
opportunities at Glacier, Alberta that it would like to develop over the next
few years. AAV plans to sell some of its properties for estimated proceeds of
C$400-500 million. The trust estimated its net asset value at C$14.03 per unit
before tax as of 12/31/08, based upon a reserves report and price forecast
prepared by Sproule Associates, an independent petroleum consulting firm. AAV
currently sells for C$3.11 per unit, a large discount to its estimated net asset
value.
The American Century
International Bond Fund (BEGBX) and government bonds of Australia and Norway
were purchased during the quarter to increase the foreign currency fixed income
allocation in portfolios.
The Yellow Pages Income
Trust (YLWPF) owns 98% of the Yellow Pages Group, which is Canada’s leading
commercial search provider. It publishes 340 Yellow Pages and residential
directories and owns Canada’s most visited online directories. The trust also
owns Trader Corp, which has over 160 publications and 20 web sites to cover four
product categories: automotive, real estate, generalist, and employment. Trader
Corp’s publications include Auto Trader and Home Renters Guide. 2008 revenue
for the trust increased by 4.5% compared to the prior year. At the time of
purchase, YLWPF had a dividend yield of 22%.
China Pharma Holdings, Inc.
(CPHI) is a specialty pharmaceutical company that develops, manufactures, and
markets treatments for a wide range of medical conditions in China, including
cardiovascular, infectious, and digestive diseases. For 2008, CPHI’s revenue
increased 54% over the prior year to $51 million. The company reported 2008
earnings per share of $0.44 and currently sells for $1.39. The stock has low
trading volume. Small positions in CPHI were purchased for tactical allocation
accounts.
Deletions
Methanex Corp. (MEOH) was
sold. Product prices have declined substantially and the consensus forecast of
analysts is now a small operating loss for 2009. I believe the company is well
managed and will consider purchasing shares again in the future when the outlook
for product prices looks more favorable.
ConocoPhillips (COP) and
Canadian Natural Resources Limited (CNQ) were sold to reduce the weighting of
the energy sector and to provide a source of cash for stocks with higher
dividend yields.
Icahn Enterprises Preferred
Units were sold. The partnership has changed over the years with acquisitions
of subsidiaries that operate in the home fashion and automotive parts
industries. The acquisitions and other changes have resulted in a higher risk
profile.
Bunge Limited (BG) was
sold. Earnings estimates have declined since the company was purchased six
months ago. Other securities appear to offer higher expected returns.
Several tax-exempt
closed-end funds were sold or reduced during the quarter. Nuveen Premier Muni
Income Fund (NPF), Investment Grade Muni Income Fund (PPM), and Delaware
Investments National Municipal Income Fund (VFL) were sold. These tax-exempt
closed-end funds employ leverage and invest in municipal bonds with relatively
long maturities. Although tax-exempt yield are currently high relative to US
Treasuries, I expect bond yields to rise and wanted to reduce exposure to
long-maturity bonds.
MFS Charter Income Trust (MCR)
was sold at a discount to net asset value of approximately 9%. Given recent
market volatility, many closed-end funds have been selling at larger than normal
discounts to net asset value.
The Aberdeen Asia-Pacific
Income Fund (FAX) was sold at a discount to net asset value of approximately
7%. The fund will be considered for purchase in the future if it is selling at
a larger discount to net asset value.
Updates
Gramercy Capital Corp. (GKK)
reported funds from operations of $2.61 per share for 2008. Since 12/31/08, GKK
has continued to strengthen its balance sheet with property sales of $133
million and an additional $62 million of properties under contract for sale. A
group of lenders has also agreed to settle and discount a pre-existing loan of
$174.6 million for cash payments of $60 million by GKK.
Idearc, Inc. has announced
that it filed voluntary petitions for reorganization under Chapter 11 of the US
Bankruptcy Code. The company expects to be able to file a plan of
reorganization by the end of April. Under the agreement in principle with the
agent bank and steering committee, total debt will be reduced from approximately
$9 billion to $3 billion of secured bank debt. It is anticipated that the
senior notes will be converted to common stock. Idearc reported 2008 net income
of $183 million and currently has a cash balance in excess of $600 million. It
is not clear why management didn’t buy Idearc senior notes in the secondary
market at a deep discount to par value to reduce interest expense and leverage.
The John Hancock Patriot
Premium Dividend Fund II (PDT) announced the results of its self-tender offer to
purchase 5% of outstanding shares at 98% of net asset value. The shares of all
clients were tendered and 30.17% were accepted by PDT at a price of $6.9787.
The acquisition of Brasil
Telecom has been completed by Tele Norte Leste Participacoes SA (TNE) and
financial statements will be consolidated for the first quarter of 2009.
Management expects synergistic cost savings of R$600-700 million in 2009 and
unspecified savings in following years. The combined entity will cover nearly
the entire country of Brazil.
Trina Solar Limited (TSL)
should benefit from Chinese government plans to subsidize the installation of
approximately half the cost of solar photovoltaic installations greater than 50
kw. Analysts expect China to limit subsidies to 180 MW for 2009, compared to
China’s installed solar capacity of 100 MW at the end of 2007.
If you have any questions
regarding your accounts, please contact me.
Sincerely,
Robert G. Kahl
CFA, CPA, MBA
Sabino
Investment Management, L.L.C.