bizzXceleration: Performance, Value and Profit

Housing Updates

• Case-Shiller: House Prices Tracking More Adverse Scenario
• House Prices: Real Prices, Price-to-Rent, and Price-to-Income

Market Situation Readings

On this week's Consuelo Mack WealthTrack: a television exclusive with Yale's Financial Wizard, David Swensen. The renowned Chief Investment Officer of Yale's $20 billion dollar endowment discusses the strategy behind the fund's extraordinary long term track record, recent criticisms of the "Yale model" and his investment recommendations for individual investors.

Quick Hits Macro Man's a bit tied up this morning, so it's another edition of quick hits: * Orgy of optimism? The latest BofA/ML Global Fund Manager Survey showed the highest degree of optimism over the economy and profit growth since 2004. The survey also showed a massive re-allocation into EM equities, which has taken positioning there from underweight to euphorically overweight in a matter of three months. It seems quite clear that managers are hitching their wagon to China, and are looking for more of a "check mark" recovery than a V. From Macro Man's perch, these guys are looking at green shoots and mistaking it for a redwood forest. Regular readers will know that he harbours a suspicion that this will end badly. * Speaking of ending badly, no sooner does Macro Man pooh-pooh the market's renascent dollar bearishness than EUR/USD breaks through its recent highs around 1.3740 and accelerates above 1.38. The move was belatedly helped, of course, by the Fed, which was sufficiently worried about the economic outlook that it contemplated bumping up the size of QE three weeks ago. * Proof that everything has its limits: The UK is linked arm-in-arm with the US, strolling down the yellow brick road of huge deficits and central bank monetization. You can almost hear Merv, Ben, Alistair, and Timmy singing "lions and tigers and bears! Oh my!" Sadly, they forgot to look out for ratings agencies, as S&P has downgraded the UK's outlook to negative. This really shouldn't come as a total shock, but the timing (an hour before a Gilt auction, and just after sterling had broken through ressitance against both the $ and the €) was unfortunate, to say the least. Is the US next? Inquiring minds want to know....

• Summertime
• Five-Minute Macro

Hmmmmm For all the talk of "green shoots", "second derivative improvements", "positive feedback loops", and "Chinese stimuli", perhaps the most important economic development of the year thus far as been sharp fall in credit costs to the US private sector (demonstrated by the Merrill Lynch indicator below.). Putting aside the issue of whether you can borrow your way back to prosperity (hint: you can't), this development (itself a product of the Fed's panoply of programs) has been a critical one. Frankly, Macro Man hasn't paid enough attention to the issue, which is why he has remained considerably more bearish than is good for his P/L. Because unsurprisingly, there has been a strong correlation between private-sector credit costs and the SPX. Since Obama strode into the White House, even a simple chart overlay demonstrates that the trend in credit costs has been mirrored by the trend in equity markets. So what, then, are we to make of recent price action? Yesterday's five-year auction didn't come off too badly, and indirect bidders once again stepped up to the plate. (We'll see if they have an appetite for today's seven-years.) Yet price action in bonds remains little short of execrable. 30 year swap rates have jumped 50 bps in a week, , and conforming 30 year mortgage yields are now litle more than 50 bps above the equivalent Treasury yields. Sure, the bond sell-off could just be the usual cheapening ahead of supply, but the scale of these moves suggests something deeper (including convexity hedging.) Heck, even LIBOR has started to tick up. So what does this imply for private sector borrowing costs? And what does that, in turn, suggest for the green shoots/second derivative/confidence boost and, more importantly, for the direction of equities?

Stocks Drop as Yields Surge  Stocks dropped Wednesday, giving back much of the previous day's steep rally, as Treasury yields jumped -- a potential threat to the recovery if it drives up the cost of borrowing for corporations and consumers. The Dow Jones Industrial Average, which surged 196 points in the previous session, declined 173.47 points, or 2.1%, to 8300.02. Financial stocks led the drop, with J.P. Morgan Chase sliding 5.2% and American Express falling 4.4%. Losses stretched across the board, as all but two of the Dow's components slid. The S&P 500 sank 17.27 points, or 1.9%, to 893.06. The Nasdaq Composite Index dropped 19.35 points, or 1.1%, to 1731.08. Despite a well-bid five-year note sale and another round of Treasury buying by the Federal Reserve, Treasurys sold off. The selling kicked the yield on the 10-year note to a fresh high of 3.732%, a level it last reached in November. The benchmark yield curve, the gap between the two- and 10-year Treasury yields, widened to a new record, surpassing the record gap hit in August. Stocks' declines were exacerbated after the yield on 10-year Treasurys broke above 3.55%, which had recently proven a tough level to break. Traders sold Treasurys and stock-index futures as the yield pierced that level, which in turn pushed cash prices for stocks lower. "The equity market and Treasury market are reflecting the current concerns about increased Treasury issuance," said Craig Peckham of Jefferies. "It's just more and more supply and we're really concerned about pressure on the dollar from Treasury issuance and the Fed's balance sheet." Cantor Fitzgerald strategist Marc Pado said that professional traders appear to bracing for a possible wave of inflation, though he believes such a development isn't imminent. "Just yesterday, everyone was happy about the consumer, and now people are wondering about the flip side: What happens if consumption gets out of hand?" Mr. Pado said. "But inflation tends to lag so much, I don't think we should be worried at this point."

• Ratings Fears Roil Markets

Can Markets Get Cash Pile Back in Game? Sometimes focusing on the sidelines can be as instructive as watching the game.The sharp bounce in stocks since the dark days of early March has been eye-catching. One reason that many hope the market will go higher still: the piles of cash still held by investors. The value of money-market funds exceeded stock funds earlier this month for the first time in 16 years. By comparison, the value of stock-fund holdings was more than three times greater than money-market funds in the summer of 2007, just before the market peaked that October. Meanwhile, private-sector cash holdings, a combination of U.S. households and nonfinancial companies, recently reached 70% of U.S. gross domestic product, a postwar high, according to Wells Capital Management. The figure has been moving higher since 2000, when it hit about 52%. U.S. money-market funds still total $3.3 trillion in assets, even though investors have pulled $113 billion out in the last three months. And they added almost $11 billion to stock funds in April alone, a month after the market bottomed out, according to Morningstar. The bull case is that cash will continue to chase the market higher. That might be true up to a point. While new money flowing in could extend the life of a rally, higher stock prices need to be based on strong fundamentals. With scared consumers rebuilding their savings, it is hard to see a V-shaped economic recovery. And it takes a leap of faith to assume that individuals so risk-averse in their everyday spending will charge headlong back into risky assets, especially after their recent traumatic experience with stocks.

Rosenberg Says U.S. Stock Market May Test March 9 Low The Standard & Poor’s 500 Index may fall beneath the 12-year low reached on March 9 because consumer spending hasn’t recovered from the longest recession since the 1930s, economist David Rosenberg said. “We have to get confirmation the March lows are going to hold,” Rosenberg, the chief economist and strategist at Gluskin Sheff & Associates Inc. in Toronto, said in an interview with Bloomberg Television. “The conventional view was the November lows were going to hold. As we found out in the opening weeks of March, no, those lows didn’t hold.”  Rosenberg said he will “keep an open mind as to whether the lows from March will hold or not as we go into the second half of this year. I’m not sure where the buying power is going to come from.” Rosenberg is the former chief North American economist at Merrill Lynch & Co., the brokerage bought by Bank of America Corp. in January. He left the firm this month. The S&P 500 rallied as much as 24 percent from an 11-year low of 752.44 on Nov. 20 to Jan. 6 on speculation the economy will recover amid government efforts to rescue banks and automakers. The measure erased those gains and fell another 10 percent to a 12-year low of 676.53 on March 9 as losses at lenders mounted and unemployment continued to rise. Rosenberg said the nine-week gain that began March 10, the steepest over similar spans since the 1930s, was a “gargantuan short-covering rally.” A so-called short covering rally happens when investors who have borrowed shares, hoping to buy them back at lower prices and profit from their decline, are forced to purchase the shares to close their bearish bets. Rosenberg said he doesn’t expect the economy to recover in the second half. “I’m seeing no revival of consumer spending in the second quarter,” Rosenberg said. Retail sales in the U.S. unexpectedly dropped in April for a second month, indicating that rising unemployment is prompting consumers to conserve cash. The 0.4 percent decrease followed a revised 1.3 percent drop in March that was larger than previously estimated.

• Rosenberg Interview on Bloomberg

Strategic Concern Readings

MIA Analysts Give Companies Worries Whether due to layoffs, attrition, retirement or brokerage firms moving analysts around, Wall Street's map of corporate coverage is shrinking these days. The process is standard for market upheavals and was made worse by the demise of Lehman Brothers and Bear Stearns, which covered hundreds of companies. It is leaving smaller companies like Intevac with fewer analysts to help tell their stories to investors. Between September and mid-May, a period capturing the worst of the troubles for Wall Street and the economy, there were more than 2,200 cases of analysts formally dropping coverage of a company, representing about a quarter of research reports during the period, according to data compiled by FactSet Research Systems Inc. By comparison, from September 2006 to mid-May 2007, capturing the run toward the Dow Jones Industrial Average's all-time high above 14000, just 6.4% of research reports were issued to announce an end to coverage. Small companies aren't the only ones feeling the pinch. Midcap and large-cap companies have been losing analyst coverage as well. There were nearly 1,350 instances of analysts dropping coverage of midcap stocks, or 17% of all analysts reporting in the period, more than triple the pace of 2006-07. More than 15% of analysts tracking large-cap stocks dropped coverage, more than double the previous rate. Lost coverage can be meaningful not just to smaller companies but to their investors. Analysts link corporate management with both institutional and, to a lesser degree, retail investors. Though they are faulted at times for being too cozy with companies and too bullish on their stocks, analysts build a mosaic of information and analysis that can help drive interest in a particular company. The good ones do an even better job of understanding when corporate operations are struggling and thus warn investors away.

Key Number: The 52-Week High With their spreadsheets and teams of math geeks, investment bankers like to show their deal work as a kind of deep science. Some new research from Harvard pulls back this veneer, showing just how powerful a role psychology plays in pricing deals. In particular, it is one number, the 52-week high for a company's stock, that matters most. The research is also a reminder to companies looking to sell themselves. They need to act quickly, or risk losing that psychological advantage. The 52-week high stock price has always had a fetishistic role in merger discussions. By custom, boards are insulted if a merger offer doesn't breach this price level. Banker presentations focus on whether an offer is greater or lower than the 52-week high. Harvard Business School's Malcolm Baker and two colleagues set out to quantify just how strong that pull really is. Sifting through a database of 7,500 deals from 1984 to 2007, they have begun to reveal how psychology drives pricing. In a rational world, the prices of merger deals would vary wildly, depending on what an acquirer calculates about the future value of the target. Some per-share prices would fall above that 52-week-high figure. Others would fall below. The distribution should look random. Where a stock once traded shouldn't tell you where it belongs. In sifting through the data, Dr. Baker, Harvard colleague Xin Pan and New York University's Jeffrey Wurgler discovered strong patterns instead. It turned out that the data bunched noticeably around those 52-week highs, like a vine wrapped around a tree trunk. Consider these oddities. More deals priced at exactly the 52-week-high than at any other price. About three-fifths of deals fall above the 52-week marker. And each deal that is priced above the high has a 76% chance of shareholder approval, while deals falling below the high succeed 69% of the time.

Value Vet Weitz Regains His Mojo After blowing up his funds in 2008 with disastrous financial picks, veteran value manager Wally Weitz has changed strategy and staged an impressive comeback this year. Weitz Partners Value fund is up 14% while the Standard & Poor's 500-stock index total return is still down about 2%. That is a big improvement from last year, when the fund fell 38%, much the same as the broad market. That followed an 8.5% drop in 2007. The results illustrate how value managers are starting to dig out of their embarrassing losses. Helping value mavens like Mr. Weitz are the drastic changes they have made to their portfolios, after accepting that their approach has been wrong. Still to be seen is whether the improved results will be enough to lure investors back to the value fold. Value managers' biggest selling point -- that they can find cheap stocks that will rally in coming years -- is lately open to question. Mr. Weitz's changes are among the most significant in value land. He is cutting back on stocks like Washington Post Co. and Wal-Mart Stores Inc., which once represented some of his best thinking in media and retail. Instead, he is buying oil stocks for the first time in decades. He also is snapping up shares of tech giant Google Inc., which is usually considered a quickly expanding "growth" stock. He thinks last year's market crash left such stocks oversold. That has been a smart call so far -- Google and another recent Weitz pick, oil stock XTO Energy Inc., are up 30% and 20%, respectively, this year. Mr. Weitz has studied the energy area for years but stayed away because he worried the companies were too dependent on oil prices, which is a factor that is outside their control. Now that the commodity bubble has burst, with energy prices remaining well off their peaks, he is diving in, also buying stock like ConocoPhillips. Mr. Weitz's thinking is that energy prices falling below the cost of production has set the stage for gains.

Tilson: Buffett Hasn't Lost It, And Bank of America's Still A Dog In his book More Mortgage Meltdown, Whitney Tilson says the house-price collapse is in the 7th inning but that bank loss writedowns are still in the early innings. Why? Because banks will eventually have to write off almost $4 Trillion of bad loans, in Tilson's estimation, and to date they've only written off a little over $1 Trillion. The good news, however, is that now that they're stuffed chock-full of taxpayer bailouts the big banks probably won't go bust.  They'll just limp along for years with their earnings crippled by ongoing write-offs. Which financial organization will do well in this environment?  Wells Fargo and American Express, says Tilson.  They have enough earnings power that they'll be able to earn their way out of the problem. Bank of America, meanwhile, will continue to struggle, eventually having to raise another huge slug of equity and diluting current shareholders. As for Warren Buffett, who two months ago was written off by many as a geriatric has-been?  He's better than ever, says Tilson.  His big derivative bet on the stock market will eventually pay off, and Berkshire's stock is still undervalued.

Time for a New Strategy? IF the last 18 months have taught Americans anything, it’s that market collapses don’t discriminate. Even the most sophisticated and affluent investors lost big chunks of their fortunes. Access to the most exclusive hedge funds did not always limit the damage, as many participants had hoped it would. As a result, a new mentality has emerged among some investors, who are rethinking the traditional approach to asset allocation. The upheaval in the markets and in the broader economy has led them to question long-honored principles of investing and to sound a death knell, at least for now, for the buy-and-hold mind-set. Moving away from the conventional mix of stocks, bonds and cash, many affluent investors and their advisers are turning to alternative investments — like managed futures and hedged mutual funds — that are liquid but behave differently from the rest of the investment pack. And some of the wealthiest investors are beginning to shed the bunker mentality, at least long enough to exploit shorter-term opportunities. “In an environment of extraordinary uncertainty, the traditional role of asset allocation and long-term investing is far more difficult,” said Michael Sonnenfeldt, chief executive of Tiger 21, a forum for wealthy investors who meet monthly to discuss financial matters. “Many of our members believe we are in a trader’s market where long-term investing should be shunned but trading opportunities should be seized.”  Indeed, many investors are reluctant to place longer term bets and cling to larger cash allocations, anticipating continued volatility. “The landscape going forward is extremely uncertain,” said Hans Olsen, chief investment officer at J.P. Morgan’s private wealth management unit. “There are many possible outcomes. You need to have a portfolio structured to reflect many possible futures. It comes down to the first principles of diversification.” But how you define diversification is evolving. In a bull market, we don’t tend to care that our portfolio investments seem to behave the same, but I believe this bear market has uncovered a long-term problem,” said Jerry Verseput, a financial planner in El Dorado Hills, Calif., noting that technology and globalization have diluted the effectiveness of diversification based on company size and location. So he has embraced a new approach, using a portfolio of exchange-traded funds, or E.T.F.’s, that track different sectors of the economy, like energy and health care. “The buy-and-hold strategy, which was almost universally accepted by the investment and academic community over the past several decades, is no longer the sole investment strategy to be employed in order to deliver solid investment returns,” Mr. Speargas said. “A thoughtful balance between long-term investing and short-to-intermediate term trades is likely the recipe for investment success in the volatile years ahead.”

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