What was Congress thinking? Markets collapse in the wake of "No" Vote.

I'm not going to mince words. The U.S. Congress showed its true lack of leadership, and its total ineptitude in the face of the worst economic crisis in the last 80 years. Congress is holding the world hostage, in the face of an election. This may be the first time in a few years that I have felt that George W. Bush, who has nothing to gain from pushing the $700B package, appeared to be acting in the best interests of the United States (and the world for that matter), while the U.S. Congress was doing just the opposite. In order to get re-elected, these people are willing to vote down an economic plan to unfreeze the credit markets (not "bailout" the financial system, as everyone is stating) by purchasing already discounted debt-backed securities, providing much-needed liquidity to the banking system, so that they can lend to each other, and more importantly open credit markets up for businesses and people. I'm surpised the markets didn't fall further. You only have to look at the terrible deal Caterpillar had late last week to see how bad it has gotten.

A company of the caliber and creditworthiness of CAT having to pay huge premiums in the credit market makes me question whether many companies will even be able to borrow to finance short term cash requirements, like employee salaries and working capital requirements. This means obvious things to me: companies are going to hoard cash, reduce their payrolls by cutting staff, and reducing capital spending over the next year. This ultimately will result in pushing us further into a deflationary market, worldwide. A credit crisis as intertwined as this means no country is immune to its issues. Deflation is the worst disease to strike an economy. It results in a downward spiral - this toilet will flush like it's broken, and we don't have a plumber to fix it. As deflation occurs and Wall Street suffers, people on Main Street will lose their jobs, lose their homes, lose everything - I'm not trying to be an alarmist, but the market needs intervention, because it won't resolve itself until most banks in the U.S. fails (the small regionals - remember, over 1,000 failed in the 1980s and 1990s in a less serious crisis). We only have to look at the Japanese markets to see that this can be a long drawn issue. Eighty years of inflationary growth presents a potentially long-term deflationary issue for the markets.

So what does one do in this market? The only thing I can see myself doing (and I'm not an expert nor am I recommending you follow my advice) is reducing risk and buying the companies that I feel are best of breed. I will not be selling in this market: as much as I hate the actions of the US government, I still feel that things can change in an instant, and I know that I am not smarter than the market. Not only will I maintain my asset allocation while facing this uncertain and tough market, I will actually add to my portfolio in stocks with little or no debt, but only in cases where their competitors have moderate to vast amounts of debt. Stalk these companies - they are being punished in the down market, and they may earn less money in the future. However, these companies will have pricing power, and they will have long term competitive advantages. As their competitors fail or downsize, they will be able gain market share for many years to come. And if they haven't raised money in the equity markets (as a substitute to the credit markets) over the last 3-5 years, even better. These companies are growing organically, and won't need capital while others suffer looking for it, and getting punished in a risk-averse market. In my retirement accounts, where I hold no individual stocks, I will simply continue my pre-authorized purchases, and re-allocate at the end of October.

U.S. Actions on the Markets

This was an unprecedented week in the markets (but isn't every week unprecedented?), with the US financial landscape forever changed with the bankruptcy of Lehman Brothers, the acquisition of Merrill Lynch by Bank of America and the US taxpayers' bailout of AIG, the world's largest insurer by assets. Only one word can be used to describe this: wow!

With the markets in turmoil, and financials falling precipitously Thursday morning, word spread of a government-sponsored plan to thaw the frozen credit markets with an RTC like entity (RTC was formed and funded by the government in the 1980s to buy assets of banks and sell them in the markets. It ultimately made the US taxpayer a tidy little profit). This was an incredibly bullish move for the markets, and investors were right to cheer this move as it will only benefit the world credit markets, and prevent the world from falling into a severe depression, and destroying tremendous value in the markets. This plan was announced later Thursday evening in a bipartisan news conference.

While I cheer the moves of the Treasury Secretary Paulson, along with Bernanke and US Congressional leaders, I think that the SEC has overstepped their bounds. The SEC thought it would be wise to ban all short selling on 799 financial stocks (including many that I own). By banning short-selling, essentially we have prevented one of the most efficient corrective measures in the marketplace - we as investors can sell shares of stocks we believe are overvalued to bring them down to fair value. The SEC has blatantly allowed short selling on all stocks at all times, even as they fall (selling on "downticks" - when a stock's price is falling on the exchange), and now, instead of reimplementing the "uptick" rule (that was first implemented after the Crash of '29), they eliminate the practice altogether? This socialistic move will not prevent the declines in the marketplace for financial stocks, and really is a targetted move against hedge funds - it's funny how politics gets in the way of free market capitalism. The US (and UK, I may add) took a giant leap backwards with the full ban of short-selling on financial stocks, and this will not ultimately stop the declines in the marketplace.

A final note: what was happening to financial stocks was not unhealthy. It is important to note that banks were lending callously and without regard to risk when they sold mortgages to unworthy customers. The investors in these banks should be punished for reckless abandonment of risk-reward modelling. While the world governments need to protect everyone from complete collapse of the financial system (by saving those "too big to fail" like AIG), they should not stop the markets from running effectively. There is always collateral damage in the marketplace - let the system cleanse itself, even if it involves a little hemorrhaging. We will see in the weeks following October 2nd whether the short selling ban really "saved the death spiral".

The Financial Market Turmoil - a Thesis

I've been a short-term bear of the market for some time, but I will never EVER get out of the market because of this. I may invest in ETF's that short the market (as I have since Bear Stearns collapsed) with SDS, HXD (on the TSX) and FXP (shorting China), but I always want to maintain my positions in the market, as you never know when the market will return to the good old bull days (of course, as a value investor, I'm a long-term bull). That said, I believe we are in the late innings of the financial crisis, but we are only in the first few in the US and global recession.

This credit crunch has been a lot deeper than most people really thought. The subprime mortgage mess was perpetuated by 1% interest rates in 2002-2003, and resulted in millions of US households investing into an already heated real estate market. Because housing prices were flying high, banks were giving away mortgages like they were candy: with little income and little downpayments, people were buying houses way over their budget. The banks packaged these loans and sold them to other banks (mortgage backed securities - or MBS). Banks also buy insurance against borrowings amongst each other when they either swap securities or lend cash (credit default securities). All of these securities are under pressure these days. Liquidity is drying up, as individuals shift monies out of financials and into the safety of treasury bills (taking the money out of the banking system, and banks are now trying to deleverage themselves. This is problematic for the world market.

Since banks are deleveraging themselves, they are essentially trying to sell assets (or even denying mortgages/loan renewals) and thereby getting liabilities off their books - by repossessing assets, or by allowing other companies to lend the funds to the companies that they have denied. Banks are also failing to lend new projects, including formerly lucrative gold or oil projects. As banks reduce their liabilities, investors have less money to invest with, and consumers have less money to borrow so that they can consume. Essentially this lowers demand for everything, including commodities. Therefore, we see commodities falling, companies lowering earnings and revenue estimates, as everyone tries to pay down their debts.

The cycle then brings down world markets as demand dries up for foreign products by US consumers. As the biggest consumer of foreign goods, this will destroy growth stories for the BRIC countries further than they already are, and Europe will continue to weaken. The world markets will continue to decline, until the US banks lend again, and the US consumer spends again. Disinflationary or deflationary pressures will bring prices down as the price of consumer goods decline (since unemployment will increase, and commodities will continue to fall), and no consumer wants to buy something today, when it will be cheaper tomorrow. Therefore, prices will continue to fall, similar to what is happening in Japan for years.

Once again, this is just a theory. Your comments are welcome.

I have long positions in FXP, SDS and HXD.

Potash Share Buyback - Best use of Money?

On Thursday, Potash Corporation announced that it will increase its stock repurchase program to up to 10% of the shares outstanding at this time. First, let's note that a planned stock repurchase program does not necessarily mean a single share will be repurchased. The company can repurchase the shares at whatever target price they may have decided. The question is, if I were a shareholder (which I'm not, and I have no position in this company), is this the best plan for the company?

I certainly don't believe this makes the most sense for the company. First of all, the company would need $5b cash based on current market capitalization to buy back 10% of the company. the company only has about $250m cash according to its last quarterly report (as per Google finance). This shows that, in order for the company to complete this repurchase program, at current prices, they would need to borrow the funds to buy the shares off the market. Therefore, current shareholders would basically be mortgaged to buy the selling shareholders. The cost of such a move could be tremendous. The company would essentially be buying shares and leveraging the company in the process - what shareholder or bondholder would want such a move to take place?

Finally, I take an issue, as a value investor, to this type of transaction for any company - if the company is a growth company, and the belief in the market is that Potash is, then shouldn't the company use its cash proceeds to continue to build or purchase the capital infrastructure necessary to mine more potash out of the ground, and increase revenues? If not, why should the stock price be maintained at this level, and why shouldn't all shareholders benefit immediately from the company's apparent success? In my opinion, the best use of funds in a growth company, if it has no better use of funds (when it has excess cash - which Potash doesn't even have) would be to pay a special cash dividend for all current shareholders, rather than mortgaging the current shareholders for the ones exiting from the company. Only time will tell if this move by Potash bears the fruit that the board and CEO intend for it to do.

Whirlwind Weekend for the Stock Market

On Friday, the stock market settled relatively flat ahead of one of the most crucial 48 hour periods of the last 30 years for the financial markets.

First, a hurricane, half the size of the Gulf of Mexico is making landfall over Galveston, Texas, with reports of levee breaches in New Orleans, and causing 25% of North American refining capacity to be shut down. This has already been felt at the pump, as gasoline around Toronto (where I live) increasing $0.12 to $0.13/litre, and increases of over $1.00/gallon in many states across the U.S. It will be interesting to see whether this impact will be long-lasting, or another short term spike to oil and gasoline prices as it continues to plummet.

Second, and probably more impactful to the financial world, it appears that Lehman Brothers is up for sale, and will probably not make it past the weekend unless someone buys the company out. The real significance is not the fact that this is a Bear Stearns re-dux. The real significance is that this may represent a watershed moment for the U.S., as the Federal Reserve and Treasury allow Lehman Brothers to fail, or at least avoid assisting any party in the buyout process. With Bear, Fannie and Freddie, the Treasury and Fed backstopped the bailouts, allowing the assets to be taken over in a more logical and streamlined way. Should the Fed and Treasury allow Lehman to simply fail, this will at least cause asset prices across the markets (equities, bonds and others) to fluctuate dramatically, and, worse case scenario, could cause a catastrophic domino effect across the financial sector.

In these times, it takes alot of courage to stand in the face of such turbulence in the markets, and like the calm before Ike struck Texas, the markets (overall) showed very little signs of any impending implosion. This market has become a forced test on all investors of their conviction and their ability to stay the course. All I can advise is that these are the best times to learn about yourself, and whether you truly have the right asset allocation to stomach the most volatile of times.

Fallout from Freddie Mac and Fannie Mae Bailout

The historic bailout of Freddie and Fannie will have immense implications for the financial world, and will probably cause tremendous anxiety in the markets over the coming weeks. The mere fact that the U.S. government is now on the hook for $6 TRILLION of U.S. mortgages does not bode well for U.S. treasuries or the U.S. dollar. But, the market may see otherwise. The dynamics of such an event are so complex - the real importance of such a bailout is this: short-term, dramatic government intervention can buoy or destroy market confidence, but, in the long-run market and financial fundamentals prevail.

Always stay the course during hectic times in the market, even if your head or heart tell you otherwise. Market psychology plays an important role in making you money, and not losing your shirt.

Getting your financial health check-up

One of the most important things to do to move towards your financial dreams, no matter whether you obsess about money (like me) or just want to get your priorities in order, is to develop a financial plan and an investing/saving strategy. The biggest thing problem I have witnessed is that many are in denial or even downright ignore their financial future.

Many are overwhelmed with just simply starting their financial plan. I have often heard people say that they are "scared" to prepare a networth statement, or a monthly income statement. I often tell these people (friends and co-workers) that, justlike getting your car "checked up", or just like you get an annual "check up" with the doctor, it is definitely important to get your financial check up. The key is just to act!

For many, simply adding their bank accounts, their investments, their home and investment properties and deducting all liabilities is as simple as logging into one or two bank accounts online, and throwing a few numbers on an Excel spreadsheet. Yet, why do people not actually do this? FEAR! They fear knowing that they are not financially secure, or that they have more debts than they can afford.

The fact of the matter is this: no matter whether you review your financial health or not, your financial condition is what it is. The real fear should be ignorance itself - you can only develop a plan when you know your starting point. Without a roadmap, you can't get to your destination. The same holds true with your financial health.

To conclude, make sure you check your financial health every quarter to see how you stand, and what you need to do to keep yourself on track. If you are more obsessive, maybe check monthly. A little work will go a long way to achieving your financial goals!