Monday, October 15, 2012

Tax the Car to Save the Cart

The China data is on the face of it a bit of something for everyone. The headline's were a surprise to some, but not to all (see our last post), but market response has been pretty muted and in general are pretty quiet, which is a theme that is probably worrying anyone who has to make a daily shilling to pay the fixed costs that don't go away. Fine for the long term investor, in fact a relief, but for speculators without other day jobs it must be getting painful.

Market volatility falling
Market volumes falling
Opportunity falling
Margins tightening
Profits falling
Speculators being squeezed out.
Reduction in staff levels at banks.

 Does it sound as though the score is
Regulators 1   -  0 Finance Industry ?

If the public, political and regulatory environment is morally against you making money by any other means than being a nurse, teacher or doctor is it worth trading in markets that are under more scrutiny and where profits are more highly visible.? Is the reaction of public opinion and regulatory oversight driving those on the margins that most need regulating out of sight? Why ever list and bear the burden of regulatory burden or shareholder pressure when instead you can fund through loans through private investments? Why list as a fund when you can slip below many radars as a "family office"?

So that's the financier's argument - Regulation stealing our lifeblood and driving the margin underground. Now TMM have never been in favour of such idiotic ideas as transaction taxes or procyclical accounting rules, but they do get a sense that their compatriots are not being entirely honest with themselves. In TMM's careers, trading floors have been stuffed with plenty of eejits that can barely count, let alone exhibit analytical understanding of the complex drivers of economics, markets, or even things as simple as what a cash flow actually is.  In prior jobs, TMM lost count of the number of times they were asked to do a USD/JPY trade for "value yesterday" - it is staggering just how many in finance do not understand what happens once you have pressed "Yours" or "Mine" because, you know, it's kind of important (especially when your counterparty is about to go bust).

Without wishing to spark a debate about academics vs. practitioners, because this is not at all what this is about, TMM reckon that the inability of the industry to make money post crash and the associated staff cuts, are more a case of The Invisible Hand catching up. Witness, for example, the creeping transformation of businesses like FX towards the Sales-Trading model or even just the Direct Market Access model (see the eruption of electronic platforms).

Ditto, the realisation that under Basel III - a regime that has deservedly met much criticism for its pro-cyclicality at a time like this. But if you designed a regulatory system for banks from scratch, you probably wouldn't have designed anything particularly different. So TMM are continually reminded by a UBS report last year suggesting that BarCap would never have turned a profit over the past decade or so (we forget the exact dates) under such a regime.

So the question becomes - and this relates to a previous post on RBS and UK banks- to what extent did banks merely make profits as a result of the implicit subsidies put upon them. And related to that, their staffing levels - it is particularly staggering in the UK that productivity in the financial industry has fallen dramatically and has been suggested as one of the principal contributors to the UK's productivity puzzle.

So is the conclusion really that it is NOT:

Regulators 1 - 0 Financial Markets

And instead:

The Invisible Hand 1 - 0 Financial Luddites

Now let's have a look at private wealth buying up productive assets. As "C" put it in comments to our last post - 

"With hindsight somewhere down the line I think the world will wake up and realise that while most of it was hiding, long term real wealth was busy buying up the worthwhile productive assets available. I really think that is what is happening quite insidiously many of today's assets won't be coming back for sale at significantly lower prices for the foreseeable future. They're now being held by people who don't need ,or want to sell simply because there is an ever diminishing pile of worthwhile productive assets left to chase with whatever money they liquidate."

TMM  agree that this is happening but the argument that regulation is driving deals underground or at least away from regulatory scrutiny does not pass muster as the one true driver. There are plenty of agreements now between tax havens and "everyone else" to go after these kind of things too re: regulation/taxation. Perhaps the real reason, is a function of Mark To Market  volatility as you don't have to MTM private holdings in the same way as listed equity. Exactly what we are seeing with volumes falling as faster money is being transferred to "stronger hands". Long term 1 - Short term 0.  The fact that equity is so cheap, with the Equity Risk Premium at levels not seen since the early 1980s,  makes expected returns look fantastic especially against debt. De-equitisation has certainly been a theme over the past 5 or so years and TMM would argue that this is more the reason than anything more sinister.

So TMM are left in conclusion that the reduction in volumes, the reduction in volatility, the pressure on margins and the evolution of markets is part of a natural rebalancing that has been long overdue and it is unclear as to whether any one set of factors can be blamed more than it just being a natural confluence of inevitability. But as we know, everyone has an agenda and there are enough excuses for failure amongst the probable causes for everyone to find their own "not my fault guv".


Anonymous said...

It turns out that sell side and to a large extent buy side are just another set of jobs right now and not that popular at that. Arguably that is the way it should be: more control, less character and (at some point) prudent lending. I would like banks much more with simple model which is difficult to break than with endless booking mistakes and uncalibrateable parameters. There is one problem though (well, one which is curious, represents a trend and not obvious straightaway). It used to be that the brightest and smartest graduates (and I am really talking about competent undergraduates as opposed to MBAs) were eager to work in finance. Where do they go now? Consulting firms are the most desirable employs or so I hear. In my opinion that is a waste. Nick

Anonymous said...

IMO every rocket scientiest who really builds rockets instead of going into finance, because you can't beat the money, is a movement in the right diretion.

Anonymous said...

You are probably right, unless one has the PhD there is nothing else to do but to build rockets

Leftback said...

Speaking of rockets, the Spooz just launched vertically like a rocket ship. Hope Mr Shorty has plenty of intestinal fortitude, because a visit from Cold Steel seems not unlikely this week.

Dear old Anna Lee (NLY) taking it on the chin today. We sold the common around $17, seems like this stock gets nailed at least once a year. Still in the preferred shares, also have some TWO.

The mREITs all seem to be allergic to any hint of stronger data or rate hikes. The rental REITs, e.g. ARR, seem to be a lot more stable. Wonder if the annual shearing of the dividend and slaughter of the lambs is upon us? It's always fun to buy 'em back across the whole sector when the yield gets up to 20% again.

Dee Dee Humberside said...

LB, not to pat oneself on the back but I am quite happy we have had that very mREIT discussion at the near top of the 6m move. Massive asset spread compression is even more to blame than rate fears IMO .

Buying Anna back after a move like this is always good Pavlovian fun, but let's not be too overconfident: one of these days, the refi wave will be for real and support will be much lower than it has been for the past three years. Not likely this time around yet, but let's keep it mind.

Dee Dee Humberside said...

CIM's outperformance is also very telling. Principal recovery dominates rent capture. Bullish rotation innit?

Leftback said...

As a wise man once told me, a big part of the business is to be able to avoid the big dumps. That way you are able to catch the falling knife rather than be holding on to it when it descends at Mach 1.25:

Skydive from Space

Agreed on the mREITs, let's wait until the parachutes have opened!

abee crombie said... BCA clients got the memo last week I assume.

NLY and the rest are having trouble finding yield but the trade is still decent. Rates arent going up, so funding stays low. Expectations just need to be ratcheted down. When the refi wave comes, sell AGNC, not NLY, whose been more conservative. CIM should actually do well, non-agency trade at discount. if you get a refi wave, hello 20% IRRs

Cold Steel said...

Hello Shorties! I know that I have been gone for a while, but I am back and now I am loving all of you at the close in my special way.

I see that many of you are actually quite small Bears with exceedingly tight stops. Exquisitely pleasurable....

Anonymous said...

C says'
hardly Macro,but is this the first Monday for quite awhile that has not been early spike sold off to close? Interesting.

By the the way it's been about 4 years now that I have been taking a more psycholgical appraisal of what we might see across the financial world in terms of change from prior long term behaviour. That is ,the reaction to what had gone before.I'm not unhappy to see that a good number of the changes that I thought would happen have occurred, and are continuing to happen. Nothing really anything to worry about.From a psychological perspective the changes are really only to be expected. Human behaviour at it's almost predictable best.

Anonymous said...

Cold Steel, love you much, Hot Bear. Have to wait and see, may be the big seller out of US is done and the rebalancing is over

Dee Dee Humberside said...

Agreed abee. The same reason that has sent mReits crashing down (low asset yields) is the one that will make investors settle for 13ish in the end (not many alternatives really). But as said before, if you get the best of both worlds (better housing, low rates) CIM could be very yummy. Lots of intestinal fortitude required on the way there though. And the refi wave's key demo probably not your typical non agency borrower (at least not at the onset).

abee crombie said...

CIM should be a great investment, on paper, you would think they are doing something similar to TWO and Doubline, only more aggresive with non agency paper...but the fact that the divy has been cut by half in 2 years along with the fact that they havent filed with the SEC in 15months (cant read up on holdings) has probably left many holders wondering...

Anonymous said...

Johnny Retail here, still holding Anna Lee. Wishing I read you guys more often....


Anonymous said...

C says'
Though I've been loath to go US equity after this latest round of QE I'm going to stick my neck out here on some assumptions which if they don't play out will leave me on the wrong side of a trade. Namely, I am going to assume the US is going to continue with a multi year recovery ,and to date the effects of QE have helped the larger caps ,and global multis the most. However, assuming a dribble down effect inevitably happens in such a recovery I have decided to register an interest in US small caps to outperform other US equity.
Much of this is predicated also on the assumption that what i see in the US re data on the recovery of banking ,autos and housing data continues.
Whilst this cycle has been in place for years up to this point I would suggest that only in this year do we see what I would really expect to see quite early in a normal recovery regarding the Industries mentioned. So, in essence what I am suggesting is that the abnormal effects of the GFC have served to elongate the normal economic recovery cycle. So ,I am now looking for the dribble down effect to pick up speed.Place your bets !

Dee Dee Humberside said...

Some would argue that the bank low from Sept last year was the beginning of that process.

Just witness the massive ramp in homebuilders since then for example.

For the geekier minds amongst us, ABX indices are a nice confirmation point too.

Anonymous said...

C says'
DD, that si pretty much the way I also see it,but now I am looking to se the combination of those effects that you mention start to ripple out through the samll cap sector that feeds off this type of economic activity. Again, many years ago I running such a business so I am simply speaking from personal experience.
Of course the assumptions are that we get continuity ,and therin is where I ams ure we wil have opposing views to mine.

Anonymous said...

My typing is truly dreadful ,but in my defence I have one keyboard for this stuff ,and I am trying to write a book on another one so if I start heading off into the incongruous at least you might know why.

Leftback said...


Not to get all granular on you, but energy and materials are lagging and look as though they may continue to underperform. A lot of energy and materials in the small cap universe. Just sayin'...

S&P Sector Analysis

We like the large cap tech here, um, AAPL, GOOG, etc. which are oversold and due to play catch up.

Leftback said...

Shorties looking a little uncomfortable again today. They don't like it up 'em, Captain Mainwaring..

Cold Steel

Anonymous said...

C says'
LB,posts have moved on,but your post to me was here so here I will reply. Bear in mind my friend that when I take this initial position I;m looking further out beyond the current situation for small caps.

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