So if you've been reading the financial press over the last couple months, you've inevitably heard about sovereign wealth funds and their impact on the American and world economy. Many of the pundits have decried the influx of these SWFs into the American economy. In essence, SWFs are state-owned entities that manage the savings of a country or the country's pension fund. In recent months, SWFs from all over the world have been investing in American companies. Most notable amongst these are the American financial institutions that have been forced to take billions of dollars in writedowns on the balance sheet.
Now, you might ask... so what? Well, there is more of a connection between subprime and Singapore than you think. You see, all of these banks and financial institutions have to keep their capital ratios intact. That is, they must keep a certain amount of Tier 1 Capital (common stock, preferred shares, and retained earnings) on the balance sheet relative to certain assets like cash and other short-term securities (can you say ABCP, CDOs and other subprime-tainted instruments?) So, as the capital ratios of these banks and financial institutions have fallen with the steep drop in the value of these assets. Thus, these banks have been forced to seek capital to make sure they meet the requirements.
Morgan Stanley, Merrill Lynch, Citigroup, and UBS - amongst others - have all sought capital from SWFs. Citigroup (C) got $7 billion from Singapore Investment Corp and $3 billion from the Kuwait Investment Authority, on top of $7.5 billion from Abu Dhabi. In December, Morgan Stanley (MS) received a $5 billion injection of capital by selling almost 10% of itself to China Investment Corp. Merrill Lynch (MER) received a $6.6 billion investment from Kuwait, Korea and Japan.
Now, you may think that SWFs are sort of a foreign innovation, you know, created out of the oil-rich countries in the Middle East, or the U.S. dollar rich exporting countries like China. However, Canada has our very own SWF - the Canada Pension Plan Investment Board (CPPIB). The CPPIB has over $121 billion in assets, and invests around the world. Basically, it takes the money from the pension plan and invests it, earning a greater return on the investment than would otherwise have been achieved if the money had just sat around in low-yielding investments. The CPPIB operates like a private equity firm in some respects, and you might have read about its struggle to purchase a stake in Auckland International Airport.
So, SWFs have become the 'in-thing' for the past while, and I'm sure you'll hear about them more in the future. Keep your eyes out for political bias and posturing as well, as many people are concerned about the backlash that may occur due to the optics of foreign companies snapping up large stakes in American companies (read up on the Dubai ports deal for more).
Sunday, January 27, 2008
Friday, January 25, 2008
Most interesting story of the week
So one of the most intriguing stories this week was that of the 'rogue trader' at Societe Generale that racked up a massive $7 billion loss for the French bank. The scandal has been making waves across the world all week, as investors have been marveled at how one trader could fly so low under the radar while sustaining such massive losses. The clear breakdown on internal controls is frankly stunning, and has dominated the press over the last week. Now, although it's interesting that one guy could pull off such a feat, I found the most interesting part of the story surfaced today. I first read it in the Wall Street Journal, and later in the day it was all over CNBC. The part of the story I'm talking about is: was the Federal Reserve duped into cutting interest rates by a 75 basis points (one of the largest single cuts in history). Many people now believe that the Fed was tricked into cutting rates on Tuesday, one day after European and Asian stocks were pummeled (U.S. markets were closed on Monday). Now, I'm over here in Sweden on exchange, and I was watching CNBC and BloombergTV via some amazing computer technology (hello Slingbox), and I can tell you that from 5 am until the Fed announced its rate cuts just before the markets opened, most people were saying that we were about to witness a drop in stocks of massive proportions.
All of a sudden, the Fed cuts rates, and the drop isn't nearly as severe. Yet, now people are beginning to think that Monday's losses were linked to the yet-to-fully-break SocGen story. Thus, the rare emergency rate cut (first since 9/11), might have been made on somewhat false pretenses, and might have been reactionary for the wrong reasons. Now, maybe your sense of humour isn't as skewed as mine (and I'm sure the people at SocGen aren't laughing), but does anyone else not find this just the least bit funny? For months, the Fed has been assailed from all sides for not reacting quickly enough to the credit crisis. Now, all of a sudden, they jump the gun and may have pulled the trigger unnecessarily.
Somewhat ironically, this theory actually helped the markets rebound late in the week, as investors revised their estimates of how far the Fed will go in its easing policy (some say 2% to 2.5% eventually). Moreover, adding to the upbeat sentiment was the $150 billion economic stimulus plan that was reached Thursday by President Bush and congressional leaders. So here we stand, the sentiment turned from "the-sky-is-falling" on MLK Jr. Day and the morning after to a "we might, maybe, just maybe could get through this with a soft landing".
One thing is for sure, this is a fascinating time to be following the markets. So, to you QCTC competitors out there who are reading this, keep on trading, because if one thing is for sure, the volatility in the market (see the 600 point swing on the Dow the other day) is sure to remain for the foreseeable future.
All of a sudden, the Fed cuts rates, and the drop isn't nearly as severe. Yet, now people are beginning to think that Monday's losses were linked to the yet-to-fully-break SocGen story. Thus, the rare emergency rate cut (first since 9/11), might have been made on somewhat false pretenses, and might have been reactionary for the wrong reasons. Now, maybe your sense of humour isn't as skewed as mine (and I'm sure the people at SocGen aren't laughing), but does anyone else not find this just the least bit funny? For months, the Fed has been assailed from all sides for not reacting quickly enough to the credit crisis. Now, all of a sudden, they jump the gun and may have pulled the trigger unnecessarily.
Somewhat ironically, this theory actually helped the markets rebound late in the week, as investors revised their estimates of how far the Fed will go in its easing policy (some say 2% to 2.5% eventually). Moreover, adding to the upbeat sentiment was the $150 billion economic stimulus plan that was reached Thursday by President Bush and congressional leaders. So here we stand, the sentiment turned from "the-sky-is-falling" on MLK Jr. Day and the morning after to a "we might, maybe, just maybe could get through this with a soft landing".
One thing is for sure, this is a fascinating time to be following the markets. So, to you QCTC competitors out there who are reading this, keep on trading, because if one thing is for sure, the volatility in the market (see the 600 point swing on the Dow the other day) is sure to remain for the foreseeable future.
Wednesday, January 23, 2008
A brief overview of the past few months
Subprime. Subprime. Subprime. Mostly everything going on in the markets today can be traced to the subprime situation developing in the U.S. The whole fiasco has spawned talk of a recession in the U.S. In fact, many people believe we're in a recession (defined as two consecutive quarters of negative real GDP growth).
So how did we get here? Well, if you came out to our meetings in the fall, you got a pretty good answer (we hope). However, I'll give a quick general summary as to what got us here.
If you remember way back when in 2001/2002, the U.S. was reeling from 9/11 and the bursting of the technology bubble. Alan Greenspan, then Fed chief, cut rates to historic lows - for a time they were as low as 1%. These phenomenally low interest rates jumpstarted the economy, and sent the markets on a torrid bull run. The availability of cheap credit fuelled the LBO boom, as companies could borrow large sums of money at a low cost, and then use this money to snap up these firms.
However, the bull run that followed the low interest rates also spawned another industry in the U.S. The subprime mortgage industry. Typically, a prime mortgage is awarded to people with good credit scores (usually above 700). A subprime mortgage, however, is awarded to borrowers with below-average credit scores - hence subprime. These subprime borrowers could afford these mortgages, as interest rates were so low. Moreover, many of the companies that were handing out these subprime mortgages were playing fast and loose with the regulations, so people who really shouldn't have been getting loans were getting them by the boatload.
However, as is the case with a quickly growing economy, inflation and other factors associated with rapid growth forced Greenspan to raise interest rates 17 times. Rates hit 5.25% by 2006, and stayed that way until September of 2007. Now, unfortunately for many of the subprime borrowers, as rates rose, their ARMs (adjustable-rate mortgages) began to 'reset' or adjust to the new higher rates. All of a sudden, the payments that seemed reasonable and affordable to these borrowers were now much higher, and in many cases, unaffordable. Worse yet, a recession in the southern U.S. housing market began to impact the loans awarded to new borrowers, and the quality of loans already made (due to the deteriorating value of the homes - the collateral).
So here we sat, many of these subprime mortgages were set to go into default. Many in the markets began to realize this through 2007, but the scope of the problem wasn't really felt. The markets continued to climb through May, June, and July. The Dow closed above 14,000 for the first time ever on July 19th 2007. However, shortly thereafter, the markets began to discover the extent of the burgeoning subprime problem.
Now, common sense would dictate that a problem mostly in the southern U.S. However, in the global search for yield, many firms took these high-yielding subprime mortgages, and sliced and diced them up. They took bits and pieces of subprime loans and packaged them up into CDOs (collateralized debt obligations) and ABCP (asset-backed commerical paper). These investments were sold throughout the world: to mining companies in Alberta, school trusts in Florida, banks in Dublin, and to investors in Singapore. It got so complicated, that no one really knew what they were holding. As the market began to digest possibility of a large number of defaulting loans, panic began to grip investors. August saw rapidly eroding stock values, worst among them: the homebuilders and the financials. However, since this was such a widespread problem, almost every stock took a hit (save for tech stocks like Apple and RIM). No one exactly knew what they were holding; that is, no one could really know if they had acquired a slice of the subprime pie.
Many Canadian companies were particularly hard hit by the credit crisis. A lot of these companies held ABCP on their balance sheets. ABCP, which is typically rolled over after 90 days, allows companies to capture a higher yield that cash, and is generally a liquid investment. However, as questions began to arise about just what was 'backing' this paper, the liquidity dried up. Suddenly, companies like Redcorp and Transat AT were left in a serious cash crunch. (As an aside, the fact that much of this paper was highly leveraged added to a lot of the fear and headache in the markets). A subtle distinction that is often overlooked, is that it was the non-bank ABCP that seized up, not the bank-sponsored ABCP, as liquidity provisions were contained in the latter. These provisions allowed the banks to step in and provide liquidity. The non-bank commercial paper was a different story. The market completely froze, and a committee was formed to develop an action plan known as the Montreal Proposal. Only after months of debate and study (and several extensions of the freeze in the market) did the group come up with a solution. Basically, the solution involves turning the short-term notes into longer-term paper maturing in 5 to 8 years. The committee has ensured that investors will get most, if not all, of the face value back within this time period.
So all of this news began to hammer away at stocks. Specifically, many financials were hard hit, as rumours of massive write-downs dominated the news for months. Financial stalwarts like Merrill Lynch, Citigroup, Morgan Stanley, UBS, Credit Suisse, CIBC, HSBC, Bank of America and many others were forced to writedown billions of dollars in assets, as these assets had lost a substantial portion of their value. Stocks gained and lost 5% simply on rumours of financial writedowns, and this trend continues today.
The Federal Reserve and Uncle Ben Bernanke had long parroted that inflation remained the primary threat to the economy. Even throughout the dark days of August, the Fed refused to cut interest rates, much to the chagrin of many investors. They did provide liquidity through other open market operations, but most felt it wasn't enough. Finally, at the September meeting, the Fed cut rates by 50 basis points to 4.75%. They cut rates at the next two meetings, taking the overnight rate to 4.25%. Finally, just a couple days ago, the Fed cut rates further by 75 basis points to 3.5%. Now, even though the Fed has been criticized by many for its slow response, it should be noted that they have had to battle conflicting data suggesting slowing economic growth and rising prices, which could lead to stagflation.
So there is a Coles notes version of what's gone on the last few months. Of course, there have been a tonne of other subplots and sidestories, which we hope to get to in subsequent blog postings.
So how did we get here? Well, if you came out to our meetings in the fall, you got a pretty good answer (we hope). However, I'll give a quick general summary as to what got us here.
If you remember way back when in 2001/2002, the U.S. was reeling from 9/11 and the bursting of the technology bubble. Alan Greenspan, then Fed chief, cut rates to historic lows - for a time they were as low as 1%. These phenomenally low interest rates jumpstarted the economy, and sent the markets on a torrid bull run. The availability of cheap credit fuelled the LBO boom, as companies could borrow large sums of money at a low cost, and then use this money to snap up these firms.
However, the bull run that followed the low interest rates also spawned another industry in the U.S. The subprime mortgage industry. Typically, a prime mortgage is awarded to people with good credit scores (usually above 700). A subprime mortgage, however, is awarded to borrowers with below-average credit scores - hence subprime. These subprime borrowers could afford these mortgages, as interest rates were so low. Moreover, many of the companies that were handing out these subprime mortgages were playing fast and loose with the regulations, so people who really shouldn't have been getting loans were getting them by the boatload.
However, as is the case with a quickly growing economy, inflation and other factors associated with rapid growth forced Greenspan to raise interest rates 17 times. Rates hit 5.25% by 2006, and stayed that way until September of 2007. Now, unfortunately for many of the subprime borrowers, as rates rose, their ARMs (adjustable-rate mortgages) began to 'reset' or adjust to the new higher rates. All of a sudden, the payments that seemed reasonable and affordable to these borrowers were now much higher, and in many cases, unaffordable. Worse yet, a recession in the southern U.S. housing market began to impact the loans awarded to new borrowers, and the quality of loans already made (due to the deteriorating value of the homes - the collateral).
So here we sat, many of these subprime mortgages were set to go into default. Many in the markets began to realize this through 2007, but the scope of the problem wasn't really felt. The markets continued to climb through May, June, and July. The Dow closed above 14,000 for the first time ever on July 19th 2007. However, shortly thereafter, the markets began to discover the extent of the burgeoning subprime problem.
Now, common sense would dictate that a problem mostly in the southern U.S. However, in the global search for yield, many firms took these high-yielding subprime mortgages, and sliced and diced them up. They took bits and pieces of subprime loans and packaged them up into CDOs (collateralized debt obligations) and ABCP (asset-backed commerical paper). These investments were sold throughout the world: to mining companies in Alberta, school trusts in Florida, banks in Dublin, and to investors in Singapore. It got so complicated, that no one really knew what they were holding. As the market began to digest possibility of a large number of defaulting loans, panic began to grip investors. August saw rapidly eroding stock values, worst among them: the homebuilders and the financials. However, since this was such a widespread problem, almost every stock took a hit (save for tech stocks like Apple and RIM). No one exactly knew what they were holding; that is, no one could really know if they had acquired a slice of the subprime pie.
Many Canadian companies were particularly hard hit by the credit crisis. A lot of these companies held ABCP on their balance sheets. ABCP, which is typically rolled over after 90 days, allows companies to capture a higher yield that cash, and is generally a liquid investment. However, as questions began to arise about just what was 'backing' this paper, the liquidity dried up. Suddenly, companies like Redcorp and Transat AT were left in a serious cash crunch. (As an aside, the fact that much of this paper was highly leveraged added to a lot of the fear and headache in the markets). A subtle distinction that is often overlooked, is that it was the non-bank ABCP that seized up, not the bank-sponsored ABCP, as liquidity provisions were contained in the latter. These provisions allowed the banks to step in and provide liquidity. The non-bank commercial paper was a different story. The market completely froze, and a committee was formed to develop an action plan known as the Montreal Proposal. Only after months of debate and study (and several extensions of the freeze in the market) did the group come up with a solution. Basically, the solution involves turning the short-term notes into longer-term paper maturing in 5 to 8 years. The committee has ensured that investors will get most, if not all, of the face value back within this time period.
So all of this news began to hammer away at stocks. Specifically, many financials were hard hit, as rumours of massive write-downs dominated the news for months. Financial stalwarts like Merrill Lynch, Citigroup, Morgan Stanley, UBS, Credit Suisse, CIBC, HSBC, Bank of America and many others were forced to writedown billions of dollars in assets, as these assets had lost a substantial portion of their value. Stocks gained and lost 5% simply on rumours of financial writedowns, and this trend continues today.
The Federal Reserve and Uncle Ben Bernanke had long parroted that inflation remained the primary threat to the economy. Even throughout the dark days of August, the Fed refused to cut interest rates, much to the chagrin of many investors. They did provide liquidity through other open market operations, but most felt it wasn't enough. Finally, at the September meeting, the Fed cut rates by 50 basis points to 4.75%. They cut rates at the next two meetings, taking the overnight rate to 4.25%. Finally, just a couple days ago, the Fed cut rates further by 75 basis points to 3.5%. Now, even though the Fed has been criticized by many for its slow response, it should be noted that they have had to battle conflicting data suggesting slowing economic growth and rising prices, which could lead to stagflation.
So there is a Coles notes version of what's gone on the last few months. Of course, there have been a tonne of other subplots and sidestories, which we hope to get to in subsequent blog postings.
Thursday, January 10, 2008
Welcome
Hello Everyone,
Welcome to the Queen's Commerce Trading Competition (QCTC) blog. We had a very successful start to the competition last semester, and we look forward to continuing the competition this semester and next year. The five co-founders of the group are all away on exchange agreements with various universities this semester; thus, this blog - and perhaps an occasional e-mail - will be the primary method of communication with the competitors.
This blog will collate information from the investing world, and we'll add a lot of our own insight. This will augment and, for this winter semester, replace the bimonthly meetings that were so successful in the fall. Each of us (Ryan, James, Justin, John, and Scott) will post regularly with interesting news items and stories related to the investing world. If you have any questions or comments, don't hesitate to email us at theqctc@gmail.com
Thanks so much,
The QCTC Team
Welcome to the Queen's Commerce Trading Competition (QCTC) blog. We had a very successful start to the competition last semester, and we look forward to continuing the competition this semester and next year. The five co-founders of the group are all away on exchange agreements with various universities this semester; thus, this blog - and perhaps an occasional e-mail - will be the primary method of communication with the competitors.
This blog will collate information from the investing world, and we'll add a lot of our own insight. This will augment and, for this winter semester, replace the bimonthly meetings that were so successful in the fall. Each of us (Ryan, James, Justin, John, and Scott) will post regularly with interesting news items and stories related to the investing world. If you have any questions or comments, don't hesitate to email us at theqctc@gmail.com
Thanks so much,
The QCTC Team
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