Monday, December 17, 2007

The World in 2008 - A Sneak Preview

As I’ve been traveling and preparing this post for a while, the world in the interim has rather frighteningly been validating my carefully prepared though probably not-so-contentious prognostications for 2008, albeit too early. I do wish I had some more provocative and non-consensus forecasts, for as a seer with a contrarian streak, I am distinctly uncomfortable extrapolating current trends forward. Yet I believe that many of these below have secular staying power.

UK Housing - Especially High-End London - Gets Decimated.
Apologists and those who are long to their eyeballs in overpriced bricks & mortar might say there is no bubble in London real estate. All I have to say in reply is that as I drove past Lambeth Palace last night, past the big round-a-bout on the door of St Thomas' Hospital, I noticed that there is a large hole in the ground that will be "luxury" apartments. Yes, right smack in the middle of a one of London's largest and busiest (not to mention smokiest) round-a-bouts. Perhaps there are sufficient numbers of Bangalore or Bombay noveau riche who've seen their friends make money in London real estate and who will buy on spec without a clue about location. But surely, for the price, it might be nice to open the window, at least once-in-a-while.

Warren Lichtenstein's Steel Partners Japan Experiences Redemptions & His Investors are "Shocked" to Learn That Mark-to-Last is 30-to-40% (maybe more) above Liquidatable NAV.
The problem with buying stock at higher and higher prices particularly where the higher and higher prices are the direct result of one's own market purchases, is that if one stops, entropy will ensue, and this will be counter to price movements in the recent past. Even worse is that when said shares are illiquid, and the position sizes unimaginable large in relation to turnover or market appetite, and the market figures out that one is actually SELLING, they will be most unmerciless and veritably pound the bids down until one wishes they were a mere US domestic activist, rather a globally-active one. And….ooooohh this will be so unpretty. Think train wreck. Blood, gore, horror, Ringu, things you wouldn't want your children to see, let alone experience. Or imagine another paradoxical scenario: above abusively tagged activist investor investing unwelcomely in Japanese companies meets activist investor in Fund wondering how it will all end and how to escape whole, in turn actively activizing upon the activist. "Distribution in-kind" will be something more investors will realize is a distinct possibility in 2008.

Buy-to-Let Turns into "Bought-and-Forget" as Foreclosures Increase.
Leveraged finance for-the-masses in the guise of "buy-to-let" schemes will also comes unraveled as both amateur, and over-leveraged professional specs discover the meaning of "capital loss" upon their optimistic one-way cash-flow and capital-gains projections from an entry-point of low yields, post-high price-appreciation. Net result? Negative equity, foreclosures and financially-humbling discovery by property investors that property markets are in fact cyclical and that there is rarely a free-lunch, particularly from a position of poor value. The slowdown in construction will cause hordes of East Europeans to return to the continent for better opps, further easing demand pressures, particularly in the southeast.

Biggest & Nastiest Atlantic Hurricane EVER Hits Major Florida Connurbation. Reinsurers & Hedge Funds Get Decimated.
Some high-end construction is built to a code that can withstand even a big one. But much of Florida is still shitty two-by-four, gingerbread, penny-wise, pound-foolish construction, and the Category-5 storm will cause extensive damage, tearing roofs off many-a-shitbox, while flattening uncountable others. More meaningful for financial markets will the huge hit to reinsurers, a hit which in hindsight will be seen as a double-whammy, with whammy#1 being the actuarily-soft-rates realized as a result of hedge-funds naively deploying capital to an inherently mark-to-model strategy that spins 1.25% a month until the binary outcome event vaporizes allocated capital, and whammy#2 being inflating reconstruction costs that will prove to outpace those modeled. An additional whammy#3 might occur when said insurers are forced to liquidate holdings into weak markets to make whole on the the risk underwritten.

London Commercial Real Estate Comes-a-Cropper.
Many of the self-confessed brightest in London in London finance circles have started to believe their own bullshit, and in so doing, have failed to see how much of the London Boom (in residential but especially commercial real estate) are a function of global credit and liquidity expansions that are, in short, non-extrapolatable. But the economy is investing in a reality that somehow assumes further liquidity and credit expansions of similar magnitudes in excess of the growth in the real economy, despite the near-deterministic imminence of recession (in UK & USA) , and a throttling of consumption and the bubble of The American Way of Life more generally, something it must be said, that cannot be good for overinvestment in general and commercial real estate prices. For the web of dependencies extends far-beyond flats on the Chelsky-Prospekt or a Dacha in Wiltshire to goods and service providers throughout the south of England from impossibly luxurious kitchens that will be used laughably infrequently, to the web of service-providers buzzing around the hive when things are good.

Disinvestment Bests Investment By Wide Margin
The advice to invest is more often than not, a god one. This is certainly true over time. But there are times – such as the present – where disinvestment bests investment. It usually occurs AFTER large asset price run-ups, when inflation is accelerating, but before full-on recession, or recognition of stagflation. Pick your overvalued asset class of choice and short it (or buy puts which remain, in many markets, reasonably priced alternatives. Caveat: watch your counterparty risk this time around.

North v. South Currency Debate Takes Center Stage.
The dollar's topped out against EUR and Cable. But all three (as well as yen & CHF) remain undervalued to GCC and Asian Mercantile units. Oh what to do...what to do?? This crisis is not one of the USD, but of BWII, and will make it to the cover of the Economist magazine before my mid-summer holiday in 2008.

US Election Campaign Moves Ordinary People to Tears.
I doubt I will be the only one cringing and throwing things at the TV as the primary season heats up, and we must endure all the inanities and ass-lick that American political "news" coverage has to offer. Where is Jeremy Paxman when you need him? But alas, the American political debate will painfully tame at the best of times, even though current conditions demand the precise opposite - not in terms mud-slinging, racial-slurs, or other underhanded smear-tactics and issue-distraction popularized by the Republicans - but rather good old fashioned debating based upon - as much as possible - the facts as best determined by independent observers. Why not put the candidates into a situation resembling “X-Factor”, where the panel is a group of globally chosen critics, writers, academics, (and perhaps even an economist!) whose purpose would be to "buzzer them" (i.e. call them out) when they deviate off-topic, waffle irredeemably, or speak infactually. They could - and even should have - their policy advisors there so we can see who and how slimey they are since we will be living with them for the next four years. Would America have voted for Bush had they had the chance to evaluate Karl Rove, Richard Perle, Paul Wolfowitz or Andrew Card a-priori?? I think not.

Huge Scandal Hits at Least One Major Hedge Fund Over Class-2 & Class-3 Security Valuations.
Frodo is of course a fiction of Mr Tolkien’s imagination, but the mesmerizing, indeed devouring lure of the ring's metaphorical power, is real and has rarely if ever been resisted in modernity - not in junk bonds, US S&Ls, Japanese stocks, real estate, mortgage securitisation, tech stocks, I&C equities, nor in almost any situation in which someone could take advantage of a market or systemic loophole for parochial gain. Imagine the temptation now-faced by large hedge funds -some with investment bank-like percentages of their portfolio considered class-2 or class-3 from a liquidity and pricing perspective. Everyone is [temporarily] served by optimism, for increases in NAVs - whether real or imagined - result in huge bonanzas for everyone including the layers of agents and intermediaries in between as well as all service providers from accountants, lawyers, primer brokers to traders etc. When the shit slams into the proverbial fan, NO ONE is incented to be brave and mark to prevailing or anything resembling reality. Private equity and VC will be hit worst, as will most layers of associated debt. If you're an investor in a large hedge fund, a letter like this will be coming to a mailbox near you soon
Dear Investor,
Pursuant to section 5, paragraph 7, clause c3.21, of the by-laws of the Fund, you are the now the proud owner of $15,720,112.36 of face value in Mezzanine Up-step Coupon "Klassics" (hereafter "MUCKs") obligations of American Municipal Bond Assurance and Stadium Revenue Bond Guaranty Corp. that were formerly of the Undersigned's Sidecar in the issuer. Note that there is no liquid market in the instruments and that our current estimate of market value is 37% less than that upon which we coincidentally accrued and collected incentive fees on at the previous valuation date, just three-months prior. This, was due to no fault of our own, but rather a highly unusual and statistically rare confluence of events, so if you have any problems, please call our attorney's who will be pleased to explain your recourse, and why you are screwed. Should this fail to clarify the issue of our responsibility, please contact our D&O underwriters, who also will be glad to explain why you're indeed, (in the legal vernacular) S.O.L.

Good luck with their sale, and just so you know, if you're in a pinch, we are 17-1/8 bid for the bonds, which we understand is a long long way from the current market, but are certain you'll understand our attempt to squeeze earnings from wherever we can during these are difficult times given the increase in the cost of kerosene and rising private jet charter rates.
Yours Truly,
(Mr) I.M. Effing-Smarte (Managing Member)
URSOL Partners

P.S. - I have taken the liberty of withdrawing the incentive fees that I've earned in order to diversify my portfolio across other strategies and is now safely in Trust in Liechtenstein. My children will thank you one day

Gordon Broon Unable to Right Labour's Ship.
Much like the externalities of a leveraged buyout, a government that invests NOT, sells what is in the public interest to private interests for short-term parochial gain that results from spineless leaders unable to parse the policy choices for the people and define long-term vision, will ultimately suffer from the cumulative effects of their actions (and it won’t be pretty) having in short, borrowed from the future to pay for the present. Mr Broon will bear the brunt of Labour’s smoke-and-mirror financing that until now has passed for "eating-your cake and having it too". Soaring costs for using historically public goods, or services, now private with gluttonously high returns on equity, on the premise of weak-founded grounds of private enterprise bettering the public in goods and service provision just make people angry. They can of course QonnecQt the dots. The all-in value proposition engendered by these bargains is horrendously poor, which, coupled with two wars, scandals, mis-steps, and arrogance, will lead to someone being made culpable, and that someone will be the dour PM of Scotland. (note that this is coming from one historically sympathetic to the left)

Despite Magazine Cover Contra-Indicators, Food Price Inflation Continues Apace.
Increasing global population, rising incomes in BRICs and other emerging economies, changing dietary habits in developing world, coupled with natural disaster, diversion of food crops to bio-fuel, palm oil, etc. peaking of yields due to limits of intensity, drought and desertification all spell a continuation of demand-led robustness to ag & food prices. DOTW take note...

Condaleeza Rice Resigns

Yet one more nearly-a-voice of reason gone. The reason will ostensibly be to pursue other interests (which won;t be Carlyle Group), but insiders and blogs will be reporting the real reason as a Cheney racial or gender insult that broke the proverbial camel's back. Rice seeks affiliation with a contender and her nam is thrown about as a potential VP nomination.

Mortgage Credit Continues To Be More Difficult to Obtain, Despite Lower Prices
One of the financial world's great paradoxes is that when money is cheap and credit is easy, there's little to buy, and when there is loads to buy, credit is difficult to find and its price is high. The sensible observer can see the problem with this, which is why there is merit in a central bank making determinations upon asset prices, precisely to prevent the market from doing what it does best which is doing whatever it does until its irrevocably stupid-silly, leading to the disturbing non-singularity of having to loosen credit and reduce the price of it, to correct the fact that you loosened credit and reduced it. This time however, creditors and central banks may find themselves in the uncomfortable position of something that, in the West, has only been seen in textbooks during our lifetimes: "pushing on a string".

Shorting IPOs Returns To Become A Vogue Strategy.
One knows one is getting on in one’s years when one pines: "Ahhh those were the days".... But those really were THE days when a healthily skeptical market [correctly until 1997] doubted the conjuring of the vast quantities of paper wealth that are presumed to materialize as a company moves from ownership by the so-called smart-money as a private-market to the suckers in the public markets. Global liquidity growth, the resulting money illusion, and passive benchmarked strategies, have made shorting IPOs dangerous and even unprofitable in recent years. But Sir John Templeton made fortunes doing just this during less pervasively-one-way markets. These days are set return, and with them, some tried-and-true, but recently cast-away strategies, of which this is one.

Google Screws Up and Shutters Its Ill-Conceived Wikipedia Competitor
Is this the tell-tale that indicates GOOG is too big, powerful, and arrogant?? One can only imagine what the Rupert Murdoch entry in Wikipedia would look like where Fox & NewsCorp are larger advertisers. It will resemble GOOGs spineless approach to censorship in China. Wikipedia is not without its flaws, but its pretty awesome and I for one hope GOOG gets visibly and embarrassingly toasted on this.

Ryanair announces huge losses when jet-fuel prices [that they've hedged] temporarily plummet. Services Cut. Some People Cheer.
The problem when a curmudgeonly soul like myself finds a beautiful, isolated and unspoiled corner of paradise, is that one would like it to remain a secret. The quickest way to ruin such a place – may of which remain tucked away in the french countryside is to let Ryanair fly there. Soon thereafter, the local “Bar-Jeu” becomes “Le Chanterelle” boucheries, and epiceries smarten up sufficiently that the word “gouging” comes to mind, and the high street will have untold numbers of estate agents frothing and swarming and speaking zee eenglish such that one might as well be back in England. Fuel hedging has lifted Ryaniar in the past, but I cannot help wonder whether they might find themselves in a little Metallgesellschaft-moment when crude swoons lower once the economic flesh-rot manifests itself more overtly. Those enjoying the periodic absence of the union jack and its holiday-swarming masses, will not be too upset at the prospects of fewer and dearer flights to some of the still-unspoiled parts of the world.

Japanese Stocks Finally Outperform MSCI World-Ex Japan - Both in USD & Local Terms.
This one is easy. It has to happen at some point. Why not in 2008? The lesser of evils indeed!!


Macro Man said...

Interesting list. I'd suggest that London real estate will play out somewhat differently....uber-high end remains well supported by the "sheikh bid", middle market runs into a spot of bother, but collapse unlikely given dearth of supply.

I presume you meant that that $, €, et al were OVERvalued against GCC and mercantilists, hence BWII pressure in '08. You know I agree there.

Nice to see I'm not the only one who loathes Ryanair...."making the Tube seem pleasnant" would be an apt slogan.

OldVet said...

Thank you Sir or Madame (can't call you Saddam!), so happy to get my Krispmus present. Unfortunately I now live surreptitiously aboard a Ryannair jet due to mortgage problems . Can't get off to get my little remaining money from broker who won't answer phone, but will deplane once rents go under $10/month again. Have a happy Big One. :)

Charles Butler said...

Just saw the first, to me, of the buy-to-rent-to-profit ads for Málaga. It was, I think, you borrow 80% of the money off us over 30 years and we rent your place out and 'guarantee' you 8% pa return over the first three years. I think.

Anonymous said...

I'll steer clear of substance, and simply comment on style -- superb writing made this post.


Charles Butler said...

re, property AND IPO's.

MTF appeared on the Madrid market yesterday, partly a fusion and partly an IPO, at 18.45. Right now, 18.12.

"Cassandra" said...

MM - And O'Leary is such a nice fellow too!! I'll bet he enjoyed tearing wings off butterflies as a child.

OldVet - Keep an eye out for that "Girls of Ryanair Calendar" in xmas stocking...

CB - Can you explain to me the USD$130bn Spanish merchandise trade imbalance?? (back of Economist) Is this offset by tourism, second and third homes, or bricks&mortar assets now available as timeshares, 2nd homes what have you? It seems awfully large and persistent, making italians look like the Calvinists of Europe...

Brad - *blushing* ...thanks! you are very kind!

Macro Man said... fave O'Leary story is when he bought himself a Dublin taxi license so his chauffeur could drive in the bus lanes. This so incensed the good burghers of Dublin town that they mandated that any car with a taxi license MUST have the rather garish blue and yellow 'taxi' sign on the top of the car, and further to pick up ANYONE who waves it down. Needless tosay, 'taxi' signs clash with Maybach exteriors, and Mikey soon began waiting in traffic with the plebs....

Anonymous said...

Fundamental, Cass, is that they don't actually make much here, the main 'exports' of the country, as you said, being locations that have good weather and serve tapas. I guess the merchandise balance was cherry picked out of recently released current account statistics which continue to be very, but less, negative. The guv has had the luxury of being able to fund the ca deficit with gold sales, whilst maintaining the dollar value of their reserves constant.

But yeah. Good question.


"Cassandra" said...

That is precious. I feel a bit like "Glenda Slagg" here "Dontcha just LUV him...?" "Dontcha just HATE him?". He is clearly both clever and cheeky. There is an amusing BBC half-hour where he goes head-to-head with Tim Sebastian during a "Hardtalk". My recollection is that they BOTH ended the session rather bruised, with no discernible victor, though O'leary's image a aviation's enfant terrible, still intact.

Joshua said...

Afraid your Steel Japan prediction will be wrong, de facto, due to liquidity terms of Steel Japan's investors.

Anonymous said...



I only became a reader last fall, so I didn't see this until now.