Tuesday, November 4, 2008

Debacle Exposes Gross Incompetence

Stocks surged today as investors anticipate a year-end rally:
Investors believing that Wall Street is on the verge of a yearend rally piled into the market Tuesday, brushing off more weak economic data while they scarfed up stocks and propelled the Dow Jones industrials up 300 points to its highest close in four weeks.

It was the biggest Election Day rally ever for the Dow, which rose 3.28 percent and topped the 1.2 percent gain seen in 1984 when Ronald Reagan defeated Walter Mondale. Prior to 1980, the market was closed on Election Day.

Broader market indexes were also up more than 3 percent Tuesday.

Some analysts said the market rose on relief that the presidential election was about to be decided. But others said investors were anticipating a year-end recovery from Wall Street's huge sell-off and bought to be sure they didn't miss out on its start.

"I seriously doubt it has much to do with the election, other than we're all looking forward to it being over," said independent investment strategist Edward Yardeni.

The fact that Wall Street is in the final stretch of a tough year is probably lifting stocks more than the elections, he said. "It's almost been a classic textbook crash in September and October followed by a year-end rally."

Steven Goldman, chief market strategist at Weeden & Co., said, "historically, we were at the most oversold levels since October 1974."

"We've come to levels that would tend to discount a lot of bad news," he said.

There's still a feeling the market might fall back and retest the trading lows reached Oct. 10 before entering a true bull market. But it's possible that the retrenchment won't happen until 2009 -- in similar oversold markets in 1974 and 2002, Goldman said, the return to the lows of the bear market did not happen until two months later.

As I have stated many times, hedge funds are hemorrhaging, mutual funds are bleeding and pension funds are reeling so you can pretty much bet that institutions are buying this sucker up going into year-end. They need to window dress their pathetic returns.

But make no mistake about it, this is a huge bear market rally, not the start of a new bull market in stocks. Forget it, you can pray all you want but the the game is over, and there are many, many more shoes left to drop in 2009.

The great deleveraging that started last summer, and hit full throttle in mid-September to mid-October, is still going on and it is is wreaking havoc on alternative investments like hedge funds, private equity and real estate.

Moreover, the debt overhang from private equity deals will pinch many companies:

Private equity firms embarked on one of the biggest spending sprees in corporate history for nearly three years, using borrowed money to gobble up huge swaths of industries and some of the biggest names - Neiman Marcus, Metro-Goldwyn-Mayer and Toys "R" Us, among them.

The new owners then saddled the companies with the billions of dollars of debt used to buy them. But now many of the loans and bonds sold to finance the deals are about to come due at the worst possible time. Like homeowners with adjustable-rate mortgages that just went up, some of private equity's titans are facing a huge squeeze. And that is coming at the same time as consumers are staying home with their wallets closed.

Already this year, big U.S. retailers backed by private equity, like Linens 'n Things, Mervyn's and Steve & Barry's, have filed for bankruptcy. And analysts expect an even broader array of companies backed by private equity - including resorts like Harrah's Entertainment and lenders like GMAC, the financing arm of General Motors - to face more pressure as profits shrivel and creditors come knocking.

On Monday, the problems for private equity deepened. Kohlberg Kravis Roberts, the leveraged buyout firm, said it would postpone its plans to go public as the credit crisis worsened.

"There's absolutely going to be a lot of pain to go around," said Josh Lerner, a professor of investment banking at Harvard Business School, who wrote a seminal paper on private equity. "The big question is how apocalyptic it will be."

Private equity firms, which are lightly regulated, use investors' money to buy undervalued public companies and take them private.

The shakeout could have enormous implications for both the U.S. and the global economies: People who work for companies owned by private equity firms could lose their jobs as the companies cut costs to meet debt obligations. And private equity firms like Apollo Management, which owns Harrah's and Linens 'n Things, face deep markdowns on the value of their holdings.

Pension funds and university endowments that invested in these funds in recent years hoping for big returns are likely to suffer as well, and many of those investors could face a cash squeeze because they are probably going to have to hold on to the investments for years, until the economy turns around.

"The dangling other shoe is now about to drop," said Jeffrey Sonnenfeld, senior associate dean of the Yale School of Management.

The shoes are dropping like flies and you know things are bad when you read Harvard University's $36.9 billion endowment is in talks to reduce its private-equity holdings as the financial crisis makes leveraged buyouts less profitable:

Harvard officials are in preliminary discussion to sell some of its stakes in private-equity funds, said the person, who asked not to be named because the negotiations are private. The Wall Street Journal reported today that the Cambridge, Massachusetts, school is seeking to drop about $1.5 billion in partnerships managed by companies including Bain Capital LLC.

Endowments such as Harvard's, the world's largest university fund, and pension-plan managers pumped a record $1.01 billion into buyout firms in 2006 and 2007 as they chased returns that exceeded those available from public stocks and bonds. They are scaling back as the credit shortage makes it almost impossible for buyout firms to acquire and sell companies, crimping investment profits.

Commitments to private-equity pools fell to a three-and-a- half year low of $82.3 billion in the third quarter, according to researcher Private Equity Intelligence Ltd. in London.

A Harvard official declined to comment.

The private-equity portion of Harvard's endowment returned 9.3 percent in the year ended June 30, compared with an overall return of 8.6 percent, according to a Sept. 12 letter from Harvard Management Co., which oversees the fund.

Private equity had a 10-year annualized average return of 28.3 percent, beating the endowment's 13.8 percent average annual return, Harvard said in the letter. Harvard Management has been led since July by Chief Executive Officer Jane Mendillo, who formerly oversaw the endowment of Wellesley College in Massachusetts.

Model Portfolio

Harvard's policy portfolio, a benchmark model against which it measures the fund's performance, calls for 13 percent of the holdings to be allocated to private equity in the current fiscal year, an increase from 11 percent in the year ended June 30, the management company said in the letter.

Investors are seeking buyers in secondary markets for private-equity, real-estate and hedge-fund interests so they can limit their stakes in those asset classes. A drop in the value of public equities has pushed the percentage of assets allocated to private-equity funds too high for some managers.

And how are hedge funds responding to this onslaught of redemptions? What else? They are telling their clients the gates are closed so bugger off and wait until the good old days come back.

I am serious. GLG, one of Europe’s largest hedge funds, sent a letter to investors this past weekend saying it is to launch a “liquidity review” of its funds.

Liquidity review?!? Is that a new euphemism in Hedge Land to cover up for gross incompetence? Give me a break.

Bloomberg also reported that Autonomy Capital halted withdrawals from its flagship fund and Permal Group temporarily blocked clients from taking money out of two hedge funds that invest with NWI Management LP while NWI changes its redemption rules.

More bloody incompetence! Who the hell would invest with any hedge fund or fund of hedge funds that blocks or extends the waiting period of your redemption? This is ludicrous, giving new meaning to the term dumb money.

Speaking about changing redemption rules, I heard about one large Canadian public pension fund that is about to change its real estate benchmark in 2009. More incompetence!!!

Of course, their incompetence was rewarded with large bonuses for their real estate team and senior managers who kept mum as they easily beat bogus benchmarks in private markets, claiming they were adding "significant alpha". Yeah right!

But now the real estate benchmark needs to be changed because the economy's downdraft is blowing through commercial real estate:

With few lenders doling out money these days, commercial real estate sales -- including office, mall and warehouse properties -- are expected to be less than half of last year's record-setting $514 billion, according to Real Capital Analytics of New York. More than $14.5 billion in deals have been canceled or pulled away from this yearincluding about $1 billion in the Washington region, according to Cassidy & Pinkard Colliers.

In addition, growing layoffs and falling profits mean companies are giving up office space at rapid rates. Nationwide, more than 19 million square feet of space -- enough to fill more than 300 football fields -- has been emptied by office users this year, the most since the months after the Sept. 11 attacks. Locally, about 1 million square feet of office space is dark and empty, according to Reis Inc., a New York based real estate research firm.

PriceWaterhouseCoopers and the Urban Land Institute concluded in a recently released report that "U.S. commercial real estate faces its worst year since the wrenching 1991-1992 industry depression."

Analysts say that nationwide, rents are stagnant and likely to drop. Vacancy rates at offices, shopping malls and hotels are expected to rise and billions of dollars of loans are coming due next year.

"This is a record-setter because it transcends real estate," said John Germano, managing director of the mid-Atlantic region for CB Richard Ellis, one of the country's largest commercial real estate firms. "You've seen companies that real estate depends on like Merrill Lynch, Lehman either be retrenched, sold or go under."

Things will get worse if unemployment rises nationwide and consumers continue to cut back on spending, according to analysts. Stores and businesses would lease less space, probably resulting in a glut of office space and lower rents.

"We haven't had the second shoe drop," said Dan Fasulo, a managing director at Real Capital Analytics, the real estate research company. "You're going to see more tenants closing up shop."

"If we get pushed into a recession, all bets are off. This is affecting everybody," he said. There are a few large, blue-chip projects around the country that are having troubles -- a sign that has brokers, developers and lenders in the industry worried that even deals in good, solid locations with established developers behind them are at risk.

I am wondering what happened to all these geniuses who "measured risk" and "managed risk"? They forgot the biggest risk of all ...SYSTEMIC RISK!!!

Bruce Friesen, an independent and extremely competent consultant who runs Global Investment Solutions, sent me these words of wisdom:

The premise that is so often repeated by the investment world "changing asset mix is timing and we all know you can't time the markets" needs to be challenged. Winning the Loser's Game by Charles D. Ellis says it all in the asset mix. We need to rethink active asset allocation. Those that did move assets out of equities when assumptions of the growth of the economy were so stretched the last few years need to be rewarded.

Instead, board of directors of large public pension funds rewarded gross incompetence as their pension fund managers ramped down government bonds to plow billions into public and private equity, hedge funds, real estate, commodities, CDS, CDOs, ABCP, and all sorts of sexy investments that were suppose to match pension liabilities without taking "undue risks".

Now that is total incompetence!

And on that note, let me end it here and savour a historic moment as Americans vote in a competent president who represents real change.


No comments:

Post a Comment