Published on March 23, 2009
1 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? The 7US$ and 6:1 (again 7) D/E ratio push for a 7% rally on Wall Street; BUT where from now; is it a sign of changing times? Invest just US$7 for exposure to US$ 100: The rally continues on the back of Geithner’s GALLOP on the back of his PPP plan for banks toxic/legacy assets and FOMC shocker. Geithner’s PPP plan unveils that under a typical transaction, for every $100 in soured mortgages being purchased from banks, the private sector would put up $7 and that would be matched by $7 from the government. The remaining $86 would be covered by a government loan provided in many cases by the Federal Deposit Insurance Corp with bank loans to be auctioned to the highest bidder with respect to legacy loans (more details on today’s plan given below in the article). March 23, 2009 Source: US Dept. of Treasury Vinit Tulsyan http://vinittulsyan.wordpress.com
2 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? What was the rally alike? All the three indices i.e., DJIA, S&P 500 and NASDAQ rallying almost 7% in today’s trade. There was 2 separate rallies, one was pre open (Geithner’s plan pre open), mid morning rallying on the back of better than expected existing home sales. The broader index, S&P 500 since 6th Mar’09 has rallied almost 22% and had it’s best monthly gains since December 1991. This rally was DJIA biggest rally since October 28, 2008. Dow Jones is up more than 10% in March’09 alone. THE BEAR MARKET RALLY CONTINUES ON THE BACK OF GEITHNER’S SENSE OF WISDON AND FEDERAL SHOCKER. TWO OF THE EVENTS ARE OVER FROM MY EXPECTATION OF FIVE-SIX EVENTS WHICH I FELT, AS AND WHEN UNFOLDED WOULD PROVIDE DIRECTION TO GLOBAL EQUITY MARKETS. THE OUTCOME OF ONE MORE EVENT (G20 SUMMIT) OUT THE LEFT THREE MIGHT NOT HELP IN FURTHER CONTINUATION OF THIS MASSIVE STRONG BEAR MARKET RALLY BUT COULD SUPPORT IN CONSOLIDATION OF THIS RALLY. THREE OTHER EVENTS WHICH COULD FURTHER FUEL THIS RALLY (MIGHT NOT BE ON A DAILY BASIS BUT OVER SHORT TO MEDIUM TERM) INCLUDES: 1. TREASURY DETAILS ON BANK STRESS TEST 2. EVENTS UNFOLDING IN CHINA AND EXPECATION OF FURTHER STIMULUS 3. EXPECTATION OF SIMILAR MOVES BY THE ENTIRE EUROPEAN REGION ESPECIALLY UK, FRANCE ON THE LINES OF LAST WEEK FOMC SHOCKER AND TODAY’S GEITHNER’S PLAN Continuing from my article dated 12th Mar’09 and 16th Mar’09 (refer ―Hope: The March 23, 2009 rally lives on…‖ and ―Fading dark clouds‖), my belief was that this rally has got some more steam left. And this confidence stemmed from my expectation that equity markets worldwide would find direction from five events which are going to unfold in next few weeks). I still continue my stance on my earlier view since 10th Mar’09 (refer Bulls are back at-least for now with markets trying to find a bottom on the back of hope), that Indian equity market, in wake of less or no news flows on Vinit Tulsyan http://vinittulsyan.wordpress.com
3 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? domestic front will move largely on the back of 1) moves seen by global equity markets, and 2) global news flow or as events unfold globally especially US. Excerpts from my article dated 12th Mar’09 Till now markets had little expectations from Mr. Treasury Secretary Plan, but with increased news flow, now the expectation is having some positive bias. The positivity has come because of market expectation of his details on dealing with getting rid of TOXIC ASSETS from banks balance sheet, which he will be outlining in next couple of days. This time market believes that his plan to involve private sector in dealing with toxic assets will bring in transparency and will put in a floor for these toxic assets pricing. The markets are largely awaiting his plans to get unveiled and HOPING that these toxic assets in form of SUB-PRIME MORTGAGES, MBS, ABS, CDS, CDOs, CLOs etc , most of them which are illiquid; bringing in private investors or private parties will bring in some sort of liquidity and stability in this market, which is the need of the time. Excerpts from my article dated 16th Mar’09 Dark clouds to fade further on the back of five events, which will provide direction to global equity markets including Indian Markets: The dark clouds will fade in color further at-least on the back of five events which will shape up in near future. I believe these events will provide a direction to US equity market and in turn to Indian Equity Markets. 1. Geithner’s banking plan announced on 10th Feb’09 on banks’ toxic asset: First and the biggest is the expectation that US Treasury Secretary will unveil details on ―BANK TOXIC ASSET PLAN‖ (refer my previous article for March 23, 2009 dated 12th Mar’09 for more on Geithner’s Toxic Asset Plan). Geithner’s program had three main elements: 1. Injecting fresh government capital into some of the country’s biggest financial institutions; 2. Establishing a public-private partnership to handle as much as $1 trillion of Vinit Tulsyan http://vinittulsyan.wordpress.com
4 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? banks’ bad assets; and 3. Starting a credit facility with the Federal Reserve of as much as $1 trillion to promote lending to consumers and businesses. The stress test should be the opportunity to identify the toxic asset and get rid of it. Banks on the back of this, will be able to attract private capital. And this plan if successful, I believe will provide further positive direction to the markets. I believe if private capital starts flowing in the banking and the financial system, then the confidence would further gain momentum as the biggest concern for the banks since the time this crisis started was on front of raising capital from private sources. And private capital was just not available on the back of uncertainty prevailing the banking and financial system. Uncertainty regarding: The quantum of toxic assets prevailing on bank’s balance sheet, Illiquidity prevailing in the market with respect to those assets, Massive write downs taken by financial institutions on the not having a liquid market and prevalence of ―Mark-to-Market (MTM)‖ rule. I believe that participation of private capital within this segment of banking industry will at-least make this market more liquid and put at-least a floor to these toxic asset value. Today’s plans as unveiled by treasury secretary basically has three basic principles with two components: 1. Using $75 to $100 billion in TARP capital and capital from private investors 2. Public-Private Investment Program will generate $500 billion in purchasing power to buy legacy assets – with the potential to expand to $1 trillion over time 3. Private Sector Price Discovery March 23, 2009 The Two components of this plan are as follows: 1. Legacy Loans: The overhang of troubled legacy loans stuck on bank balance sheets has made it difficult for banks to access private markets for new capital and limited their ability to lend. Vinit Tulsyan http://vinittulsyan.wordpress.com
5 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? 2. Legacy Securities: Secondary markets have become highly illiquid, and are trading at prices below where they would be in normally functioning markets. These securities are held by banks as well as insurance companies, pension funds, mutual funds, and funds held in individual retirement accounts. How will the program work with respect to Legacy Loans and Legacy Securities? (Source: US dept. of Treasury) Steps for sample investment under the Legacy LOANS Program 1. If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC. 2. The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio. 3. The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector – in this example, $84 – would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages. 4. Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity. 5. The Treasury would then provide 50% of the equity funding required on a side- by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6. 6. The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis using asset managers approved and subject to oversight by the FDIC. Steps for sample investment under the Legacy SECURITIES Program March 23, 2009 1. Treasury will launch the application process for managers interested in the Legacy Securities Program. 2. A fund manager submits a proposal and is pre-qualified to raise private capital to participate in joint investment programs with Treasury. 3. The Government agrees to provide a one-for-one match for every dollar of private Vinit Tulsyan http://vinittulsyan.wordpress.com
6 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? capital that the fund manager raises and to provide fund-level leverage for the proposed Public-Private Investment Fund. 4. The fund manager commences the sales process for the investment fund and is able to raise $100 of private capital for the fund. Treasury provides $100 equity co-investment on a side-by-side basis with private capital and will provide a $100 loan to the Public-Private Investment Fund. Treasury will also consider requests from the fund manager for an additional loan of up to $100 to the fund. 5. As a result, the fund manager has $300 (or, in some cases, up to $400) in total capital and commences a purchase program for targeted securities. 6. The fund manager has full discretion in investment decisions, although it will predominately follow a long-term buy-and-hold strategy. The Public-Private Investment Fund, if the fund manager so determines, would also be eligible to take advantage of the expanded TALF program for legacy securities when it is launched. March 23, 2009 Vinit Tulsyan http://vinittulsyan.wordpress.com
7 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? In my view three or four more events going forward will further help consolidate this massive bear market rally One of these events is expectation from G-20 to align a different interest, which looks increasingly possible at this point in time. With G20 meet in London due within a week and the expectation built in around this summit, might provide further direction to equity markets, though the direction might not translate into a further massive rally from here on but it could help market consolidate at these levels. I personally have little expectation from the his summit on the back of different priorities, different problem characteristics within different economies, clash of interest, China along with other emerging market economies demanding more autonomy and others. The detail on stress test for banking companies which the US treasury is continuing with will assume significant importance as and when it is unveiled. And with the probability that most of the large banks (with whom the word ―troubled‖ was attached ten to fourteen days back) will clear this stress tests, and the debate over fear of banks being ―NATIONALISED‖ will lose its sheen. With further expectation of most of the banks and financial institutions such as CITI, BOA, JP Morgan Chase, HSBC, Barclay, AIG are well capitalized (as claimed by heads of these troubled banks), and these banks will not require any further assistance either from FED or Treasury. I am not an expert on how their financials look like, my confidence stems from the statements made by these heads such as their banking institution was profitable in the first two months of this year, they do not need any further assistance from the govt.. And the biggest source of confidence comes from the market reaction towards these positives in the last 10- March 23, 2009 12 days. I believe this event would be watched with as much of enthusiasm as it was with Geithner’s Plan related to PPP with respect to bank toxic asset plans and would largely determine whether this bear market rally continues further or not… Vinit Tulsyan http://vinittulsyan.wordpress.com
8 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? With EUROPEAN region in larger mess than US, I believe (based on just broadening my perspective a bit) that EUROPEAN REGION either cumulatively or individual countries within this region might come up with similar plans on the lines of plans announced by FOMC (Federal Open Market Committee) and today’s plan by Mr. Geithner’s regarding involvement of private parties/investors with respect to banks and financial institutions toxic assets. The final event which could provide direction to world equity markets apart from the other two as pointed above is events unfolding in CHINA and its stand in G20 summit. China’s importance ahead of G-20 meet has gained momentum (partly on the back of US$ 1.9 trillion in reserves with most of them being dollar investments) and this time around I expect China to play a greater role in shaping up and directing the plans and policies unfolding at the summit. China remains the biggest foreign holder of U.S. Treasuries, after its holdings rising by US$ 12.2 billion to US$ 739.6 billion. This events is largely related to news flow unfolding in China, whose premier has again reiterated that China will maintain its growth rate at at-least 8%. The entire world would be watching the headline macro data figures coming out of China and would be keenly waiting on another fiscal stimulus, expectation on which are increasing faster on the back of continued bad data news flow regarding FDI, exports, consumer spending, unemployment, deflationary fear etc. This rally started with assuring words from Banking Giants CEOs This rally started with assuring words from Mr. Pandit, CEO of the most troubled US banking giant i.e., CITI Bank. Mr. Pandit in a letter sent to employees said ―the bank had an operating profit of US$8.3 billion before taxes and special March 23, 2009 items through February—its best performance since the third quarter of 2007″. These statements were duly supported by more statements by more banking giants CEOs of banking institution such as JP Morgan Chase, Bank of America, HSBC and some others. Vinit Tulsyan http://vinittulsyan.wordpress.com
9 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? Rules modification over marking assets to market value to marking assets based on cash flows valuation method Then this rally further got steam from the controversial debate over MTM (Mark to Market) and subsequently SEC changed the rule from marking the assets to market in wake of falling prices, no price discovery mechanism and its ripple effects on banking institutions balance sheet in form of massive write downs to marking the assets based on cash flow valuation. I continue to believe what Mr. Obama and his economic team is doing is right and with today’s unveiling of PPP program for bank toxic assets in my view will create a market which will bring in little bit of liquidity in this extreme liquid market and at-least put a flooring (whatever it might be) in price terms I continue to believe on what I wrote in my article dated 10th Mar’09 that Mr. Obama is doing is just right though Market does not seem to believe it. And further today by unveiling this 1 trillion US$ Public Private Partnership program with regard to banks toxic assets, I believe rather than taking all the risks on their own balance sheet, they are by providing incentives (in various forms such as FDIC guaranteed debt and under securities plan by providing financing under TALF/TARP) to private parties are in my view making sure that these illiquid assets at-least have a flouring (in price terms) in place. And secondly, by doing this there would at-least be a market for these illiquid securities, which would attract private capital to these troubled banking giants. Attraction of private capital (as and when these financial institutions are able to) I believe will be the ultimate time, when one can expect to believe that the financial sector has seen the worst of times and one is now going to see a sign of stabilization. His earlier plans of economic stimulus with respect to TALF, for US home owners, and last week plan of FEDERAL RESERVE to influence long term interest rates (for the first time since 1960s) by buying up to US$300 billion in longer-term Treasuries over the next six months; in-turn March 23, 2009 encourage lending by lowering interest rates and buying an additional US$750 billion of agency mortgage-backed securities (MBS) and further doubling its purchases of agency up to US$200 billion provided a sense of relief to investors and these financial institutions that these toxic assets (reason for massive looses for these giants) could once again liquid enough. Vinit Tulsyan http://vinittulsyan.wordpress.com
10 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? In my view some liquidity (at whatever price) is better than having absolutely no liquidity and these financial institutions continue having massive write-downs with no floor in place with respect to pricing of these assets. One more move of FED with respect to starting a US$1 trillion program to jump- start consumer and small business lending which could further be expanded to include other financial assets gave a sense of confidence to small businesses and investors all across US, that credit market would now at-least be accessible to them as well. (For details refer my article dated 19th Mar’09 FOMC Shocker) A DIFFERENT THOUGHT/PERSPECTIVE Equities rallying, commodities rallying, bond yields falling, rising bond prices, activities started to emerge in credit market, and given that Commodities being a leading indicator in providing direction about the economy, if any inference has to be withdrawn, can we now say that these are times of bottoming out. Or do we have a bottom in place with respect to equities market. Copper, oil and gold rallying stupendously over plans unveiled by FOMC in last week and by treasury secretary today and on the back of assurance provided by troubled financial institutions, a better retail sales data than expected, a better real estate starts than expected and so on so forth, does these signal provide a direction or a way that these commodities are rallying and coupled with falling yields and lower interest rates on the hope that these signals would help in stimulating demand. I am not saying that the jobless claim data or unemployment rate or retail sales or housing sales data or housing starts or data on larger macro fronts will start improving from now onwards, but at-least they are rallying and the rally has to have some reason as I am strong believer in that fact that markets reacts . March 23, 2009 One reason could be that the expectation with respect to earnings (corporate), retail sales expectation, housing starts data had been built so low that any figure which is going to be reported will be reported better than expected though they might well be tilting towards downside, as seen in last week retail sales data or today’s housing sales data. Vinit Tulsyan http://vinittulsyan.wordpress.com
11 Rally Continues due to GEITHNER GALLOP and FOMC shocker, BUT where from Now? Sign of private money coming to financial sector and leading this race is Goldman and JP Morgan Chase Furthermore with respect to increased oversight by govt. on the back of AIG bonus saga, couple of banks are planning to pay off the money they recd. from the govt. towards TARP program. Leading this chart is GOLDMAN SACHS, and this looked from other perspective suggests a rosy picture which is that these troubled banks had a tough time raising fund since almost a year, and it was more tough for them to raise money from private investors. But now with talks of many banks such as Goldman and JP Morgan Chase raising private capital or selling stake in companies they hold some stake to pay off their debt at-least provide a comfort with respect to involvement of private capital into these banking giants, which is the need of the hour. Thanking You, Warm Personal Regards, Vinit Tulsyan http://vinittulsyan.wordpress.com March 23, 2009 Vinit Tulsyan http://vinittulsyan.wordpress.com
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