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A Strong Statement



There is a possibility that I hope you will consider. It is meant with the best intentions. It is made not to change the way you act, but to put just a little caution in your minds. I make it because I truly believe that the hard part is not making money, but keeping it. It is prompted not by today's market action, but by the announcement just made by General Motors(GM:NYSE) that they filed to issue $10 billion in stock and debt.

We have seen over the last several months (and I could argue longer) an unprecedented amount of liquidity injected into the system. The Federal Reserve has made dollars available in floods around the world. This liquidity has found its way into U.S. stocks and bonds. It has certainly drawn the small investor back into the market. Credit spreads have improved, not because companies have less debt, but because investors are starving for yield. Companies are actually accumulating debt, not paying it back. In fact most of this new debt is not being used for new capacity (we have plenty of that), but being used to satisfy other obligations like pension liabilities.

So I want you to just consider and keep in the back of your mind when you invest that risk has increased, not decreased. Many will argue that the level of debt is not what is important, but that the cost of debt service is what matters. This is true as far as the implications to cash flow go, but risk has still increased. If rates rise, perhaps from a collapse in the dollar, the cost of debt service will rise as well.

Liquidity is higher and the markets are higher. But perhaps that is by design to allow desperate companies like GM to issue securities in order to survive. When you buy their stock and the price rises, this allows them to refinance at much better levels. Brian Reynolds has written about this extensively and is one of things he is keying on in measuring the health of the system.

I am not arguing that things will fall apart. Just that when there is so much liquidity, people forget about risk and concentrate on return. Don't forget about risk.

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No positions in stocks mentioned.

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