The news moving markets today centers around fears about renewed economic weakness and continued credit market deterioration. I have included a number of stories below offering a good cross-section of the situation.

Meanwhile, traditional technical analysis helps tone down the noise and offers a pure indication of who is in control: the buyers or the sellers.  To that end, the chart below of the NYSE composite (60 min. bar chart) will help put this week’s trading into prospective.  As you can see, the market is in a well defined downtrend. This week’s rally was simply a move to the top of the channel helping to alleviate a serious oversold condition. The index will need to break above the down trend line and the 20 day moving average, both around the 6905-6910 area, before this selloff can be declared over.  We remain bearish and will look to book profits on the short side as the market nears the bottom of the channel.  

Banks’ Overnight Deposits With ECB Increase to Record

June 3 (Bloomberg) — Overnight deposits with the European Central Bank rose to a record yesterday as the sovereign debt crisis made banks wary of lending to each other.

Banks lodged 320.4 billion euros ($394 billion) in the ECB’s overnight deposit facility at 0.25 percent, compared with 316.4 billion euros the previous day, the Frankfurt-based central bank said in a market notice today. That’s the most since the start of the euro currency in 1999. Deposits have exceeded 300 billion euros for the past five days.

Banks are parking cash with the ECB amid investor concern that a 750 billion-euro European rescue package may not be enough to stop the crisis from spreading and spilling into the banking industry. The ECB said on May 31 that banks will have to write off more loans this year than in 2009 and their ability to sell bonds may be hampered as governments seek to finance fiscal deficits.

Read More…

Goldman Sachs weighs in on economic woes…

Nonfarm labor productivity grew a downward-revised 2.8% (annualized) in the first quarter, below the first release of 3.6% and a bit less than expected, as output was revised down and hours worked were revised up. However, with compensation per hour also revised down, unit labor costs still fell 1.3%, only a bit less quickly than the first release of 1.6%. On a year-on-year basis, unit labor costs are still down 4.2%, the most rapid pace of decline in the history of the series (since 1947) except for the 2009Q4 drop of 5.1%. Thus, labor cost trends remain a strongly disinflationary force.

Next up, Briefing offers a good explanation of the employment numbers announces today…

Employment Report a Major Disappointment

The latest payrolls data confirmed the stagnate labor market that was implied from yesterday’s weak ADP report and the lackluster jobless figures over the past four weeks. Nonfarm payrolls increased by 431,000 in May, a disappointment from the 500,000 increase expected.

The details of the payroll numbers were even worse. The consensus estimate expected government hires would increase by roughly 275,000: temporary Census hiring would push up employment by approximately 300,000 while other government employment would decline by 25,000. This leaves the more stable private payroll growth at 225,000 for the month. However, government hires exceeded expectations by 115,000. The private sector produced only 41,000 jobs in May, 184,000 less than the consensus estimate.

Further, out of the 41,000 new hires, 31,000 new jobs were deemed temporary. If consumer demand suddenly decelerates, these hires will lose their jobs quickly. The only good take away from the payrolls data was that manufacturing payrolls increased by 29,000, its fifth consecutive monthly increase. The data confirm that the expansion in the manufacturing sector has not been impeded. The unemployment rate ticked back down to 9.7% in May after temporarily increasing to 9.9%, and it beat the median estimate of 9.8%.

However, like the payrolls data, the details of the move were a major disappointment. Economists were expecting that the move down in unemployment would be due to healthy gains in private payrolls. Unfortunately, the number of people employed actually declined by 35,000 in May. The reason for the drop in the unemployment rate was due to workers again leaving the labor market in droves. The labor forced declined by 322,000 for the month, its first monthly decline since December 2009. If the labor force remained at April’s level, the unemployment rate would have remained at 9.9%. On a positive note, personal incomes looked stronger in May. Average hourly earnings increased 0.3%, well above the consensus estimate of 0.1% growth. Weekly hours increased from 34.1 to 34.2. In all, average weekly earnings climbed an impressive 0.6%.

Tags: ECB, employment report, euro, europe, Goldman Sachs, NFP, Nonfarm payrolls, NYSE, NYSE Comp., productivity

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Over the last couple of weeks we have witnessed a series of conflicting reports from all over the media complex as to why equity markets are under pressure. Predictably, as soon as the markets recover a bit these same pundits come up with all sorts of reasons to cheer.  Needless to say these hysterical reports, bullish or bearish, are entirely worthless.  CNBC, with its ridiculous “fat finger” report, has proved its irrelevance as a financial news source. In fact, this embarrassing story (released with less than an 1/2 hour to go in the trading session) stinks of manipulation and seems to implicate CNBC as a pawn in a propaganda ring.

But I digress, my purpose today is to offer a little clarity to the situation. So without any further ado, let’s map the market developments and see what, if any, conclusions may be reached.

Support:

Government support is the primary reason equity markets have traded higher over the last year. That support has taken the form of, to name a few, ‘cash for clunkers’, foreclosure prevention, home buyer credits and a myriad of Fed liquidity programs.

The result of this support has been the release of government supplied economic numbers that appear promising and suggest GDP expansion (Did you pick up the sarcasm in that sentence? Sorry!).

To sum up, large quantities of Fed-provided quantitative easing and rosy economic numbers are the fuel driving markets higher.

Now Europe and the European Central Bank (ECB) have joined the fray. Supposedly close to $1trillion of liquidity will be thrown into the gaping mouth of the debt monster.

Pressure:

Abysmal – as in the size of an abyss – amounts of world debt are swallowing up prodigious amounts of liquidity.

China - China’s equity markets have for some time been a leading indicator for US markets and risk assets in general.  Recently, the Shanghai Index reached into bear market territory with a 20% decline from the highs of the year.  This is not a good omen.  Moreover, China’s economic expansion could be labeled the lynchpin of world economic growth and the recent measures by China’s central bank to tighten liquidity is, to say the least, problematic for a world drowning in debt. The recent increase in consumer prices of 2.8% in China only exacerbate the problem as it would appear inflation is accelerating.

GS – Common knowledge suggests the markets swooned because of violence in Greece. This is absolutely not the case.  We can draw a direct line to the beginning of this most recent market drop and the day Goldman Sachs faced the Senate tribunal.  Government crucifying of the financial space is heating up and will only get worse as senators fight for re election this November.  GS is the undisputed heavyweight champ of the financial space and if they fall the financials as a whole will experience painful P.E. multiple contraction.  In the last few weeks GS’s credit curve has inverted. Credit protection on GS cost more for 1 year than 5 years. If this trend persists a debt downgrade for GS could be in the offing which would in turn send financial shares tumbling.

This Just In: As I write this the “Senate Finance Committee votes on amendment to create a new ratings agency; yay’s have it 64-35, amendment agreed to…” Can you hear that? That’s the sound of a GS debt downgrade being written. The congressionally approved ratings body will likely remove the conflict of interest inherent in the current private rating agencies business model. Hence, we would not be surprised to see Moody/Fitch/S&P make a preemptive downgrade.

Financial Group (FINs) – FINs have always been a leading indicator for overall market direction. If GS drags the FINs down the rest of the market will suffer. Make no mistake, as the volume of negative news and behavior towards the FINs grows louder the equity markets will suffer.

Andrew Cuomo Investigating Whether Banks Duped Rating Agencies – Huffington Post

Senators Seek Proprietary Trading Ban for Big Banks – WSJ

Greece – I would be remiss if I didn’t include this component as part of the pressure on the markets. The proposed Trillion $ bailout seems dubious at best.  Lest we forget weeks were required to raise just $30 billion and now somehow the finance ministers got together over the weekend and $700 billion was pledged?! Now these ministers must go back to their respective countries and try to get funding. This funding request should be a tough sell. After all, the German people recently voted the ruling party out of one house after the first 40 bil Euro bailout.  In fact, rumor has it a reintroduction of the German Mark may be in the offing. How about England? They have yet to participate in any bailout and now elections have created a coalition (read: do nothing) government.

The simple fact remains that all this talk of bailouts is actually missing the real point: Greece has a solvency issue not a liquidity issue.

Conclusions/Questions:

Q: Will liquidity expansion trump debt implosion?

Q: Will excess liquidity continue to find its way into the equity markets?

Q: Will Chinese tightening and supposed European austerity plans actually drain marginal liquidity?

C: As my mom would say, “we must live the questions and the answers will reveal themselves.” So, remain vigilant, defend principal and let the markets be your guide. Don’t force your will on the market and avoid complacency at all costs.

C: No matter which is the victor, the Tidal Wave of Liquidity or the Trench of Debt, one asset class will not only survive but flourish.  The precious metals, Gold and Silver, are now advancing to new highs against all fiat currencies. I have written repeatedly over the last few years that the true inflection point for Gold and Silver will arrive when their values increase even in the face of a rising US$.  The time is now.  Please hold on to the Bar!

Tags: China, Credit, ECB, euro, Fed, financial, gold, Goldman Sachs, Greece, GS, Inflation, precious metals, silver, US$

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Today, I’d like to address a curious phenomenon developing in the Treasury market.

March 31st supposedly marked the end of the Fed’s quantitative easing (Q.E.) phase. We were told the Fed would no longer print money and buy mortgage backed securities. There was, of course, no discussion about the Fed printing money and buying other assets. However, ‘ending Q.E.’ carries certain implications and it would not be a stretch to say market participants were led to believe Q.E. in all forms was coming to an end.

Enter ‘curious phenomenon’: Treasury market behavior since March 31st would suggest Q.E. is alive and well. During the month of April, long rates rallied from about 4% to roughly 3.7%.  Treasury prices went up as rates went down after the Fed allegedly stopped Q.E.?! Needless to say this is not the response most market participants would expect.

I’m sure we can come up with more than one reason for this Treasury strength. Perhaps the issues emanating from Europe have driven investors into the relative safety of  US debt. Or maybe Goldman Sachs led financial fears are responsible for the Treasury bid.

However, the following excerpt from ‘The Privateer’ (A favorite publication of ours) offers a compelling argument supporting the theory that the Fed is continuing a Q.E. assault on the credit markets. If this theory is accurate, we would expect any equity market selloff to be contained to a normal uptrend retracement. Moreover, precious metals prices should continue to advance as more Q.E. equals further currency debasement which is a tasty recipe for higher Gold and Silver prices….

The US Treasury auctioned $11 Billion worth of “TIPS” on April 26. They started to sell the regular stuff on April 27 with an auction of $44 Billion in two-year paper. With the Greek debt downgrade to “junk”, hardly anyone noticed. Hardly anyone, that is, except the bidders for US Treasury paper. Indirect bidders (read foreign central banks and governments) bid for only 28 percent of the paper, down substantially from the average demand in 2009.

But much more troubling was the massive 24 percent of the paper on offer taken by the so-called “direct bidders”. The rest was presumably taken by the “primary dealers” in Treasury paper. The “direct bidders” had taken as much as 10 percent of the auction on only 12 of 42 auctions since July last year. They had taken that much only six times in all the auctions held by the US Treasury in the FIVE years from the beginning of 2004 until the end of 2008.

Even more disquieting, the identity of those who are included as “direct bidders” is never disclosed. The fact that the amount of Treasury debt taken by “direct bidders” has blown out since the Fed officially ended its quantitative easing at the end of October 2009 has led to speculation that the Fed has not REALLY ended its policy of monetising Treasury debt after all. More and more analysts (including some mainstream analysts) have come to the conclusion that the “direct bidder” is none other than the Fed. They are almost certainly right, but nobody can know for sure because the “direct bidders” are secret….

Tags: Fed, gold, Goldman Sachs, precious metals, Q.E., Quantitative Easing, silver, treasury market, U.S. Debt

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I expressed my belief last week via twitter that this GDP number could be interesting. I suggested the number may be less than expected as the inventory build is coming to an end. Now real intrinsic growth will need to surge in order to satiate the appetite of the GDP prognosticators and I believed that would be a tall order.  Well results are in and the number was in fact less than forecast. I  expect this may be the beginning of a trend…

ECONX GDP Increases for the Third Consecutive Quarter

As expected, growth remained positive for the third consecutive quarter as GDP increased 3.2% in Q1 2010 after rising 5.6% in Q4 2009. The consensus estimate called for a rise of 3.3%. Similar to last quarter, the bulk of GDP growth was allocated between consumption and inventory investment. Consumption expenditures rose 3.6% and contributed 2.55 percentage points to GDP growth. Inventories turned positive for the first time since Q1 2008 and contributed 1.57 percentage points to GDP growth. Construction expenditures deteriorated in both the nonresidential and residential space as investment fell 14.0% and 10.9%, respectively. This was the first decline in residential investment since Q2 2009. Net exports contributed negatively to GDP as export growth (5.8%) increased at a slower rate than import growth (8.9%). Government spending declined for the second consecutive month as state and local expenditures decreased 3.8%. Federal spending was up 1.4%.

Meanwhile, the markets continue to try and ignore the Goldman Sachs (GS) issue. However, I fear the morass (emphasis in the last syllable) is only growing thicker. Hairs are beginning to stand on the back of my neck as the current disregard for the severity of the GS issue creates a déjà vu feeling. I can recall countless talking heads on CNBC down playing Bear Sterns’ troubles in ‘08….

Criminal Probe Launched Into Goldman Sachs

Time for the media circus to go nuts. The AP reports that the Feds have just opened a criminal probe into Goldman: now it is getting interesting. And everyone was thinking that Eric Holder is a toothless puppet (well, that still has to be refuted).

As the AP reports, “The investigation by the U.S. attorney’s office in Manhattan stems from a criminal referral by the Securities and Exchange Commission, a knowledgeable person said Thursday. The person spoke on condition of anonymity because the inquiry is in a preliminary phase.”

Read More…

The following post by Zero Hedge is a must read if one wants to really understand the issues of the Goldman/Paulson case.

Did Paulson Have A $2 Billion Bear Stearns CDS Short In Late 2006? Novel Observations On Abacusgate

…Most relevantly, in what could be damaging disclosure by Fabrice Tourre, the Frenchman notes that as a result of Paulson’s mistrust of Goldman’s counterparty risk, the Abacus AC1 deal was structured in a novel way in which “they would be acting as protection buyer, facing the ABACUS SPV (as opposed to a structure where Goldman is protection buyer as is usually the case).” This little legalistic variation could make a world of difference in an Attorney General’s hands…

…Direct from Tourre E-mail, “As you know, a couple of weeks ago we had approached GSC to ask them to act as portfolio selection agent for that Paulson-sponsored trade, and GSC had declined given their negative views on most of the credits that Paulson had selected….

Read More…

Tags: Abacus, CDS, Credit, GDP, Goldman Sachs, GS, John Paulson, Tourre

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Tea Leaves; in the last couple of days there have been a lot of them, so let’s start reading:The tangible parts of GS’s earnings were suspect (Investment Banking -38%, Asset Management -6%, Trading and Principal Investments -7%) while the FICC unit (Fixed Income, Currency, Commodities) showed all the gain. “Net revenues in FICC were $5.99 billion, significantly higher than the third quarter of 2008. These results reflected strong performances in credit products and mortgages, which were significantly higher compared with a difficult third quarter of 2008.” In other words, last quarter this division had mark downs and this quarter the assets were marked up. Is that a sign of a strong business or clever accounting? ECONX Industrial Production Surges
Industrial production rallied for the third consecutive month as production increased 0.7% in September. The consensus expected a much more moderate increase of only 0.2%. The jump in production was expected to be driven by the auto industry, and the sector didn’t disappoint as motor vehicle production rose 8.1% as assemblies of autos and light trucks increased 13.0% to 7.15 million vehicles.What has been the Fed’s response to all these tea leaves? Read on…

Fed’s Fisher says keep rates low, inflation not a risk - Reuters.com
Reuters.com reports the U.S. economy is recovering but the upturn will be slow and it makes no sense to raise interest rates in this climate since inflation is not a risk, a top Federal Reserve official said.(I humbly suggest someone clue in Fisher to the reality that (all together now) Inflation is a currency event, not an economic event.)

Earnings from the technology space, Intel & Google to name a couple, have been well above expectation. This could be a positive development, but of course expectations are a joke. Analysts constantly get it wrong so let’s dispense with the “better than expectations” farce. A note a caution on the Intel number and others on that end of the food chain; an inventory rebuild is occurring at an aggressive pace. This rebuild is only a good thing if consumers spend. I would be more apt to cheer a good earning number out of, say Best Buy, as that would show end user demand. Inventory build without end user demand spells trouble for the economy in Q1 of 2010.

I am loath to discuss the earning of the banks. JP Morgan and Goldman Sachs showed strong results. However, when we parse the numbers it appears that earning were again created with clever accounting.

 JP Morgan’s results were similar to GS. Should we cheer or should we be concerned with this ugly little fact buried in the announcement: “JPMorgan’s loss provision to cover current and future home loan defaults rose to $3.99 billion, while its provision for credit card losses surged to $4.97 billion”

We will choose to be concerned. However, the share prices of the financial group remain in an uptrend and while it may be stupid to believe the earning “surprises” it may be equally stupid to fight the trend of higher share prices. I would suggest you keep the above discussion in the back of your mind so when prices begin to falter you will not be the proverbial “deer in the head lights.”

A review of our investment strategy may be in order before we begin the reading of economic tea leaves. I have established over the last few months that the inflation trade is under way. Assets are inflating, both the commodity and equity markets, because of increasing U.S.$ weakness. Hence, weak economic numbers are actually positive for the aforementioned markets because the Fed can not raise rates and defend the U.S.$ while the economy is still in trouble.

So, how is the economy looking?

 The numbers were even better than the headline suggested as total manufacturing excluding motor vehicle production rose a healthy 0.5%. This includes strong growth in consumer goods excluding motor vehicles, which jumped 0.3%.

There is a drawback to the strong production numbers. We have not seen orders for manufactured goods pick up. If orders stay low we could end up with a big increase in manufacturer inventories. This would cause manufacturers to pull back on their production. If this scenario occurs, manufacturing production will see a “double-dip” as production rises today and quickly falls back in a few months.

Ok, we know from the recent spat of “good” earnings that production is up, but as we discussed this will be negative down the road if consumers don’t wake up.

How is the consumer doing…? Briefing: October University of Michigan Sentiment-prelim 69.4 vs 73.3 consensus. This was a bad miss and could spell trouble. Again I will say, this is good for stock market investing.

One reason for this bad Michigan number may be related to the on going problems in real estate as evidenced by this Fitch story…

Fitch Sees 60% of Current RMBS Borrowers Underwater

“The majority — 60% — of remaining performing borrowers within ‘06- and ‘07-vintage residential mortgage-backed securities (RMBS) bear negative home equity, meaning they are underwater on their mortgages and owe more than their houses are worth.The rating agency noted the number of non-agency borrowers 90 plus days delinquent reached 1.66m in September — the highest level on record. The rating agency expects US unemployment to peak at 10.3% in the middle of next year, further pressuring current borrowers. House prices will ultimately decline another 10% over the next year.”

“I am worried about unemployment and I see an enormous amount of slack. I hear it everywhere,” Federal Reserve Bank of Dallas President Richard Fisher told Reuters in an interview. “I am super-hawkish on inflation. I don’t think that is where the risks are right now,” Fisher said.

His comments will reinforce the impression that the U.S. central bank is in no hurry to raise interest rates,despite guarded optimism that the U.S. economy is healing. Fisher, who takes pride in a reputation as an anti- inflation policy hawk, said the U.S. central bank would not lose sight of its long-term obligation to keep price pressures at bay. But he stressed that this was not the current issue. “Right now that is not the risk. The risk is a disinflationary/deflationary risk,” he said…

Fisher, who is not a voting member of the Fed’s policy-setting committee this year, said it would take “a while” to work off excess capacity in the economy. “I don’t see a ‘V’-shaped recovery. I see a couple of quarters of growth and then the question is where do we go from there. That is the real key question in 2010 and 2011.”

Tags: central bankers, Fed, Fisher, Goldman Sachs, Google, Inflation, intel, interest rates, investment strategy, JP Morgan, new global currency, stock market investing, US$

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If you ask ten different hedge fund professionals to explain the difference between third party marketing and capital introduction, you are bound to get ten different answers.  Though often confused, each practice serves a vital role in attracting capital to the industry.  Recently in his Hedge Fund Capital Introduction Blog, Evan Rapoport, Co-founder of HedgeCo Networks, spent some time dissecting the two practices.

Capital introduction, according to Rapoport, is typically done by prime brokers.  The largest prime brokers, such as Goldman Sachs & Co., Morgan Stanley, and Merrill Lynch all have teams assembled within their ‘prime services’ divisions that help clients of the firm to find investors suitable for their funds.

In order to properly utilize the services of a prime broker, you need to meet a few parameters:

First, your fund must be doing enough business with the prime brokerage firm to be able for the firm to afford their employees time, and risk. That’s right risk. Most hedge fund managers do not understand what it means to have a series 7 and therefore have never had to worry about a client suing them for a poor recommendation. This is exactly the risk these licensed individuals and firms take on when making introductions to your fund. If your fund fails, they are at risk of client complaints and lawsuits, and if you commit fraud…..whoa boy! They can say goodbye to their career, or at least thousands of dollars defending themselves as to how they had no knowledge that this low life manager decided to run off with their clients money. Anyway, point is, if you are not trading or borrowing, don’t expect too many investor introductions from your prime broker.

Second, your fund needs to perform. It is hard to make investor introductions for a fund that is down thirty percent. Stellar performance obviously makes it easier to make investor introductions.

Next, your fund infrastructure must be solid whereas no one can question the integrity of the information coming out of your firm. This includes having an independent fund administrator, industry recognized auditor, larger firm prime broker and custodian, and knowledgeable legal team. With these providers in place the capital introduction team can feel more confident their investor referrals will have access to the proper information when needed regarding your fund.

In contrast, Third party marketers are individuals, licensed by FINRA, that raise capital on behalf of multiple hedge fund products.  Typically, they work for a fee that amounts to about 20% of the hedge fund’s fees.  In essence, they receive a portion of all management and performance fees throughout the relationship with the investor client.  Similar to capital introduction, third party marketers set up all investor meetings, conference calls, and road shows.  However, unlike the cap intro business, where the representative is responsible for making the introduction, third party marketers assume a much more active role.  Not only do they pique the investor’s initial interest, but they also follow up with potential investors after manager meetings and conference calls, update the prospective client with monthly performance, and do everything they can to facilitate the investment (provided, of course, that it makes sense for the client).

Just like with capital introduction, there are a few requirements for a fund to work with a third party marketer:

One is length of track record. As a result of taking on the risk of marketing your fund to investors, third party marketers typically like to work with funds that have several years worth of track record. I would say the typical minimum to be considered for most third party marketing platforms is around eighteen months worth of track record that is actual to the fund (no pro-forma!) with the standard being thirty-six months.

Assets under management are also important. The smaller the fund the harder it is for the third party marketer to raise assets. Again typical minimums to be considered for most third party marketing platforms are about fifty million USD and average about one-hundred million USD plus.

Hedge fund strategy is the next item of importance. There are specific times that certain strategies are simply out of favor. If your strategy is out of flavor currently, don’t expect many third party marketers to come to your rescue. However, if your strategy is this year’s Miss Universe, then you may not need to go looking for third party marketers, they will come finding you.

Fund manager pedigrees are another factor third party marketers look at before representing a new fund. If the manager was a plumber and now has decided to start a hedge fund because he doubled his money at Ameritrade, chances are, third party marketers will pass. However if the fund manager was formerly at one of the larger hedge funds, and has a portable track record and strategy, this certainly will help to move him to the top of the marketers list.

Fund infrastructure is equally important to third party marketers. The reasons are the same as mentioned for capital introduction, but maybe even more so being that third party marketers are paid a fee by the fund and therefore are perceived to have more responsibility for their recommendations as opposed to capital introducers that simply make a referral. Having top tier providers makes due diligence much easier for these firms and their clients.

Lastly, and probably most important again, is positive fund performance. It simply is harder to sell a hedge fund with poor performance as opposed to one that has performed. As a third party marketer, we usually have access to multiple products and being that my pay is often tied to their performance….well, nuff said. I do always keep in mind however what is right for individual clients portfolios. and also do realize sometimes the best time to invest in hedge funds is when they have had a short term losing period, especially if this type of strategy has paid off in the past. If I don’t include that last disclaimer I will get tons of hate mail from poorly performing managers.

Bear in mind, using a third party marketer does not make sense for all hedge funds.  For some funds, they may be small and growing in size and cannot afford to pay hefty fees.  Meanwhile, others may already employ their own marketing teams internally.  This approach, while more expensive in the short term, actually tends to be more cost effective over the long run.

In summary, there are a number of effective means of raising capital for your fund.  A few key points to consider when deciding between using capital introduction or third party marketing include:

-Hedge Fund Track Record
-Hedge Fund Monthly Trading Volume
-Current Firm/Fund Assets Under Management
-Hedge Fund Age
-Hedge Fund Capacity
-Current Marketing Budget

Decide what is most important to your fund, and take action accordingly.  Then, watch (and hope) the capital introduction or third party marketing teams work for you!

If you are looking for help with capital introduction, prime brokerage, or third party marketing for your fund feel free to email me for consideration at evan@hedgecosecurities.com.

Evan Rapoport is a registered principal and offers securities through HedgeCo Securities LLC. Member FINRA, NFA, SIPC.

Tags: administrator, auditor, Capital Introduction, custodian, FINRA, fraud, fund administrator, fund infrastructure, Goldman Sachs, Hedge Fund Capital Introduction Blog, HedgeCo, Merrill Lynch, Morgan Stanley, Not Categorized, prime brokers, prime services, series 7, third party marketing

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            Documentarian Michael Moore’s latest project, Capitalism: A Love Story aimed at highlighting a number of flaws concerning the economic system upon which our country is built. In his film, Moore infiltrates Wall Street and Washington D.C. to “explore the root causes of the global economic meltdown.” In one scene, he attempts to make a citizens arrest of the AIG board of directors. In another, he drives an armored car to Merrill Lynch and attempts, kind of, to collect $10 billion on behalf of the American people. While searching for answers in high-profile places, Moore asks financial professionals to explain complex terms, such as derivatives. In an attempt to provide this answer for Mr. Moore, I thought I would revisit a scenario I created last year. The following is a fictional example. It never happened, except for in my head.

            There is and always has been stiff competition between Las Vegas casinos. Located miles from the strip, Sin and Tonic Casino relies on clever ideas from their owner, Dale, to increase profits. In the summer of 2005, Dale decided to unveil a ‘Play Now, Pay Later’ program to his loyal customers. Dale’s customers, most of whom rarely left the casino because they had no home or job to maintain, were allowed to gamble and drink while management kept tabs on how much money they were each blowing through.

            The customers told all of their friends down by the river about Sin and Tonic’s new program and soon the casino was always filled to record numbers for the property.

            Dale decided to lower the payouts on all of his table games and slot machines and also increase the price of alcoholic beverages. But, because his customers were not required to pay right away, no one seemed to complain. Dale’s sales blew through the roof and caught the attention of local banks. One bank referred to Dale’s customers’ debts as “valuable” and offered to increase Dale’s borrowing limit.

            With Dale’s customers’ debts as collateral, the bank turned the debts into securities known as Sin-a-Bonds. Soon, the Sin-a-Bonds were being traded on security markets nationwide. Investors across the country, and soon across the entire world, never knew the AAA-rated Sin-a-Bonds were, in reality, the debts of homeless gambling addicts.

            Leading brokerage firms were selling loads of Sin-a-Bonds and their prices continued to escalate at a surprising rate. Everything was fine until pesky risk managers started poking around and demanding the gamblers to start making payments on their debts. On a busy Saturday night at Sin and Tonic, Dale informed his customers that payments needed to start being made that Monday. The remainder of Saturday night and all day Sunday, Sin and Tonic was filled to capacity.
            On Monday morning Dale and his employees were witness to the first day without customers in the casino’s history. Not one of the customers came in to make payments on their debts and the ones that stumbled around drunk in the parking lot claimed they “hadn’t got no money.” Dale told the bank he could not pay back any of the money they lent him and he quickly decided to claim bankruptcy.

            Sin-a-bonds dropped to near-worthless levels and investors lost their money. Plus, the bank that issued the Sin-a-Bonds saw its capital depleted and they were consequently unable to offer any more loans. The bank laid off all of its employees and closed.

            Dale was unable to pay any of his bills and all the companies that granted him payment extensions had to take massive losses, as Dale was their largest customer. The carpet cleaning service was forced to downsize, the vending companies were left with handfuls of damaged machines that no one else was interested in and alcohol suppliers were left with large inventories that could not possibly be consumed without Dale’s heavy-drinking clientele.

            The brokerage firms that sold the Sin-a-Bonds were in heavy distress. Eventually, the government stepped in to save them by creating a bailout package that was funded by taxpayers from states where gambling is prohibited.

            Dale retired from the casino business and is now rumored to be heavily involved in politics.

Absolute Returns Absolutely

            An increasing number of investment firms looking to capitalize on the fears of their investors have started offering “absolute return” funds that boast the ability to always produce returns. Investment advisors are pushing mutual funds that are designed to produce positive returns no matter how badly the stock market is performing. The idea has been around for decades, but now major financial companies such as Goldman Sachs, Dreyfus and Putnam have all launched similar absolute-return funds.[i] In response to the growing group of clients who want to be able to rely on their portfolio’s positive performance, investment firms have started heavily marketing absolute-return funds. But, are these funds worth all the hype?

            Similar to hedge funds, absolute-return funds focus on making money in all market conditions. By taking long positions in stocks and balancing them with short positions of similar value and in similar assets, absolute-return funds aim to produce returns slightly higher than Treasury bills.  In a dropping market, gains on the short positions are meant to offset losses on the long positions. In a rising market, the long positions are supposed to outperform the shorts; therefore producing modest returns for passive investors. If the sheer makeup of an absolute-return fund is not producing, fund managers also attempt to achieve their target by employing a number of different strategies. For instance, short-selling can help offset market falls and derivatives can shield from undesired volatility.  

            Generally, the techniques used by absolute-return fund managers to stabilize your portfolio’s ride are the sort of diversification practices you can do yourself, without having to pay hefty annual fees. In a recent Reno Gazette Journal article, Registered Investment Adviser Robert Barone recommended the following three steps in order to achieve consistent positive returns:

            First, reduce the allocation to equities in your portfolio to the 30-to-40 percent range. Remember to hold equity positions in companies with sound business practices and low levels of debt.

            Second, increase the allocation to fixed income to the 40-to-50 percent range, but keep the maturities relatively short (no more than three or four years to maturity).

            Third, because of weak dollar policies, increase the normal allocation to commodities to the 10-to-20 percent range.[ii]

            The discussion of investment strategies in this article should not be considered an offer to buy or sell any investment. As always, consult an investment professional to assist you in meeting your investment goals.  

A Broken CIT Will Trip up Small Businesses

            On October 1^st CIT announced the launch of a plan which will aim to enhance its capital and improve its liquidity. According to the official press release, the restructuring plan is designed to “ensure continued financing support for small business and middle market clients.” After being denied financial support from the Treasury in July, CIT was forced to create a restructuring plan in order to attempt to sidestep bankruptcy court. But, because of concerns with CIT’s financial stability, the FDIC has forbidden the company from increasing its deposits, which severely limits the restructuring tools in its belt.

            The target of the restructuring plan is to slice CIT’s $31 billion dollar debt load down to about $25 billion. But, some experts have argued that the amount is not nearly enough to persuade the FDIC to again allow CIT to accept deposits. CIT is offering voluntary exchange offers for certain unsecured notes. Current holders of an “existing debt security would receive a pro rata portion of each of five series of newly issued secured notes, with maturities ranging from four to eight years, and/or shares of newly issued voting preferred stock.”[iii]

            The future success of CIT relies on a significant increase in capital. The restrictions imposed by regulators and the troubling credit freeze have created enormous obstacles for CIT. Financial companies, like CIT, without direct access to Federal Reserve emergency loans rely on funding from short-term debt markets. But, with these markets already shriveled, the possibility of finding new debt buyers has all but disappeared.

            With CIT operating in more than 50 countries, it is peculiar that the government did not deem CIT “too big too fail,” as it has a number of other institutions. The last company of this size that was denied a bailout was Lehman Brothers and its resulting bankruptcy filing tore the financial market to ribbons.

            For over a century CIT has been a huge player in providing loans to small and medium-sized businesses. The company has more than one million corporate borrowers; including popular businesses such as Dunkin’ Donuts and Dillards. If (or when) CIT collapses, the biggest problem will be the scores of small businesses that will find it even more difficult to find capital to fuel their ventures. As constantly noted, small businesses are crucial to our recovery. The credit freeze has already built a wall between businesses and available capital. The crumbling of CIT will only exacerbate the problem and highlight the importance of private capital in the marketplace. Without capital, our financial system cannot begin to encourage economic growth, and without growth a recovery is out of reach.

All My Best,

Thomas J. Powell

Tags: absolute return, absolute return funds, AIG, capital, Capitalism: A Love Story, CIT, credit freeze, derivatives, Dillards, Dreyfus, ELP Capital, FDIC, Goldman Sachs, growth, investment advisors, Merrill Lynch, Michael Moore, Not Categorized, powell perspective, Putnam, Recovery, T bills, Thomas J. Powell, tom powell, Treasury Bills, Wall Street

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By now, I think most people have heard about the ex-Goldman software programmer who was arrested in July for allegedly stealing some of Goldman’s high-frequency trading software code. I am not a criminologist or legal expert, nor am I a software expert that could tell you if accidentally sending small pieces of the code while sending other software to an outside server in Germany is a plausible defense. But, I do want to touch on one piece of the story.

No Bailout for Programmer

According to Alex Berenson of The New York Times, a federal prosecutor asked that Sergey Aleynikov, the ex-Goldman programmer, be held without bond because the software could be used to “unfairly manipulate” stock prices. It took me a little while to understand why I kept coming back to that sentence, until it struck me that a federal prosecutor was asking for a man to be detained without bail for being such a dangerous force to society by having Goldman’s proprietary high-frequency trading program, or actually just a small piece of it (32 megabytes of the 1,224 megabyte code).

I want to mention that the prosecutor might have used the “potential” danger of possessing this code just to keep a man behind bars, which is the job of the prosecution. However, if the prosecutor believes that this program has the ability to upset financial markets and send society into economic upheval, why should Goldman have the right to manipulate the markets? Goldman Sachs has the platform and capital to take advantage of high-frequency trading, and quite simply, Sergey Aleynikov does not.

An Afterthought on High Frequency Trading

I want to say that I don’t particularly see a problem with brokerage firms using high-frequency trading programs. For years and years, floor traders have been using strategies to squeeze out some extra money on bid-ask spreads and getting in ahead of orders for large blocks. Electronic trading has squeezed the profitability of capitalizing on bid-ask spreads, and trade orders come in so fast now that no human would be able to keep up. High-frequency trading programs allows trading firms to use their old world strategies with new world technologies to make money in the modern day exchanges.

Furthermore, I would suggest that high-frequency trading is not the danger that the federal prosecutors make it out to be. If a programmer steals software from his old employer, he is a criminal, but is he a criminal mastermind capable of causing damage to the financial markets that would warrant holding him in jail during his trial to protect society? I mean, the strategy is profitable, but if the big investment banks were capable of manipulating the markets with software, why would the Goldman’s and JP Morgan’s of the world need a bailout in 2008?

Tags: Goldman Sachs, High Frequency Trading, Investing Strategies, Investment Banking, trading, Trading Strategies

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This is a re-post of the original article from Evan Rapoport’s Capital Introduction Blog

I often hear the terms Capital Introduction and Third Party Marketing used interchangeably. They actually however, represent two different services within the hedge fund asset gathering space.

Capital Introduction is a service usually provided by hedge fund prime brokers. The biggest teams coming from the largest prime brokers, firms like Goldman Sachs & Co., Morgan Stanley, Merrill Lynch, etc. These prime brokers have teams within their ‘prime services’ divisions that will help clients of the firm to find investors suitable for their funds.

How do they introduce investors you may ask? Well, investor introductions are made through occasional capital introduction conferences, road shows, one on one investor meetings, and individual investor conference calls. When done properly, this service can help to raise a fund millions of dollars at no cost to the general partner and no harm to the limited partner.

The real trick here, is finding a firm that actually follows through with what they claim. Many smaller trading firms and ‘mini-primes’ claim they offer capital introduction when in reality all they offer is a list of fund of funds or introductions to third party marketers.

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Tags: Business, Goldman Sachs, hedge fund, Investing, Merrill Lynch, Miss Universe, Morgan Stanley, Private equity

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The cause and durability of this equity market rally continues to be a hotly contested debate. I would like to throw my hat in the proverbial ring and offer some thoughts on durability.

Every market rally – whether it be a bull market or bear market bounce – has a group that leads the move. By studying this group we can get some insight into the strength of the overall move. In this case, the financial sector clearly led the markets off the bottom and an examination of the ability for this group to continue its rise may be helpful. The rise off the bottom for the financials can be attributed to a few main reasons:

1)Dramatically oversold conditions led to a much needed reprieve
2)Launch of TALF
3)Launch of PPIP
4)Fed monetizing of debt (announces $300 billion program to buy U.S. Treasuries)
5)Real estate numbers released by the government are “sold” as positive. (Only a sucker would buy this idea. Please see the 3/25/09 blog for more details.)

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Tags: Goldman Sachs, Meredith Whitney, Rally sustainable

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