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Five Things You Need to Know: Worthless!; Worthlessness Now Spreading to Alt-A?; What Does All This Subprime Stuff Mean for You?; Everything You Need to Know About the Consumer Price Index; Humphrey Hawkins: No News, Is Good News!


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Worthless!

Bear Stearns (BSC) yesterday afternoon told investors in two troubled hedge funds it manages that one fund was worthless and the other had only about nine cents remaining for every dollar invested following bad bets on the US subprime mortgage market.

  • How fast can something like this happen?
  • Snap your fingers. The two Bear Stearns hedge funds, worth an estimated $1.5 billion at the end of last year, were reporting stellar returns even as recently as this spring.
  • Now, the net value of assets in in the High-Grade Structured Credit Strategies Enhanced Leverage Fund are zero, according to the Wall Street Journal.
  • And the net value of assets in its other, larger, less-leveraged fund lost about 91%.
  • The net-asset value represents the value of an investor's holdings after debts have been paid.
  • Meanwhile, Bear Stearns, which last month said it would offer a $1.6 billion loan to shore up the more "conservative" of the two funds and help it sell its assets, nonchalantly reported yesterday that about $1.4 billion of the loan remains untapped, the New York Times said.
  • So, in other words, it appears Bear Sterns was able to either sell or take down internally all the holdings of the funds at a level that wipes out customers, but leaves the firm fairly well covered. Sweet!

2. Worthlessness Now Spreading to Alt-A?

Yesterday Moody's Investor Services said it has put on "negative credit watch" $318 million worth of bonds backed Alt-A mortgages.

  • What is this so-called Alt-A mortgage stuff about?
  • Alt-A mortgages are loans where borrowers lack some of the documentation required by traditional mortgages.
  • For example, if you are a salesperson with somewhat unpredictable income, but you have otherwise good credit, you may not be able to qualify for a traditional prime mortgage, but you're not subprime either.
  • In that case you would fit into the Alt-A category; kind of a gray area between prime and subprime.
  • The potential Moody's downgrades are important because other ratings agencies may follow suit; the result being additional bond downgrades triggering potential sales by funds that own the bonds and aren't allowed by charter or restriction to hold bonds in the portfolio below a certain grade.
  • Oh yeah, and in a related story crossing the Bloomberg wire was this little nugget from Moody's:
    "Moody's Investors Service said it wasn't hired for 75% of the commercial mortgage-backed securities ratings assignments in the past few months because of its requirements for extra credit enhancements."
  • In other words, issuers were and are "rate shopping." How does that work? Well, companies such as Moody's make money by being hired by issuers to rate bonds.
  • Sort of the way some home appraisers develop reputations for being "generous" in their appraisals to help borrowers meet down payment requirements, for example, the ratings agencies are competitive in how they rate the bonds, some being a bit more "generous" in their ratings than others.

3. What Does All This Subprime Stuff Mean for You?

The largest issue (for now) in the subprime (and growing Alt-A) space is leverage employed by hedge funds. The two Bear Stearns funds that blew up were obviously highly-levered. So it doesn't take much of a haircut to produce stunning losses. But what about us normal folks? Is this going to hit my 401k? Are my stock investments at risk?

  • This is all about hedge funds and leverage, right?
  • Mutual funds, bond mutual funds, aren't invested in subprime mortgage-backed securities... are they?
  • Actually, some are. According to the Wall Street Journal, the Franklin Strategic Mortgage Portfolio and the Franklin Total Return Fund are among the mutual funds with subprime-related securities in their portfolios.
  • Fidelity's Intermediate Bond Fund and the Fidelity Total Bond Fund also reportedly have some investments in residential mortgage-backed securities (RMBS) that are subject to ratings downgrades from S&P.
  • And then there are the stocks with subprime-mortgage exposure.
  • Accredited Home Lenders (LEND) and NovaStar Financial (NFI) certainly have exposure; LEND is nearly 50% year-to-date (most of the damage occurring between February and March), while NFI is down nearly 80% year-to-date.
  • In fact, just throw a rock in the Financial sector and you'll likely hit a bad apple or two.
  • Year-to-date the Financial sector is among the worst performers among stocks.
  • The S&P 500 is up a little more than 9% year-to-date, the Dow is up 12%, while the PHLX Bank Sector Index (BKX) is down 1.75% and the iShares Financial Sector ETF (IYF) is off nearly 2%.
  • While financials account for a large percentage - about 19% - of the S&P 500's overall sector weighting, the fact the S&P 500 is up for the year indicates strong outperformance coming from somewhere other than financials.
  • So while the subprime mess may be bad for certain stocks and mutual funds, there are opportunities elsewhere.

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4. Everything You Need to Know About the Consumer Price Index

The Consumer Price Index rose 0.2% in June, the smallest gain in five months according to data released this morning from the Labor Department. But first, what is this so-called Consumer Price Index that the Federal Reserve and economists are so worried about. and why doesn't it ever seem to show what our bank accounts do; namely, higher prices for everything we need - gas, food, healthcare, education - and lower prices for just about anything we might not need but buy anyway - computers, flat screen television sets, consumer electronics?

The Consumer Price Index (CPI for short) is simply an estimate of the changes in prices paid for goods services bought by households each month. Now, you're not really going to believe this, but we'll tell you anyway: The CPI calculation uses price data collected by the Bureau of Labor Services from a sample of retail and service outlets on a sample of goods and services over a sample period from a sample of U.S. households. In other words, it's a sample of a sample of a sample of a sample. The BLS collects the data from 87 urban areas and 23,000 retail and service establishments around the country.

  • OK, so number crunchers crunch numbers and then report some figure that seems meaningless to our bank accounts. So what?
  • Well, the Federal Reserve is very concerned about price stability and the Consumer Price Index is one of the measures the Fed uses to set their interest rate policy.
  • Questions:
    1) For us, in the real world, what do we really need to know about the CPI?
    2) Do we need to know about it for our 401k allocations?
    3) Do we really even need to know about it for trading?
    4) What about for running our businesses and planning for future expenditures?
  • The answer to these questions, as much as it may rub "scientists" the wrong way are:
    1) Not much.
    2) Not really.
    3) Eh, not as much as people think.
    4) Maybe a little bit, but you'd just ignore what the figures are telling you anyway.
  • The reality is that we are not very good at predicting inflation, understanding how it affects stocks price movements, especially over the short term, and even adjusting our lifestyles to follow what our bank accounts and expenditures are telling us about inflation at the household level.
  • So why bother?
  • Well, the illusion of control is a very powerful thing. For example, think about how you feel when you watch a magic trick that you can't figure out.
  • Much of what the Fed does is related to managing (or, attempting to manage) "inflation expectations" and using policy tools to "manage price stability."
  • For that reason, tracking price movements is important for the Fed. As for what we need to know?
  • Well, it's important to be able to present ourselves in social situations as having some modicum of intelligence and a comfortable degree of current event awareness.
  • Note: We said "comfortable." If we seem to know too much, we run the risk of coming across as a jerk.
  • If we know too little - especially if we know too little by pre-meditated intention ("I couldn't care less!), we run the risk of coming across asan arrogant jerk.
  • So, with that in mind, here's what we need to know for this afternoon's happy hour:
    1) The core CPI, which excludes food and energy, was up just 0.2%, and is now running at a 2.2% pace for the year - very close to the Fed's "comfort level."
    2) The year-over-year increase in Core CPI equaled the smallest 12-month gain for core CPI since March 2006.
    3) Everyone is hysterical over Food Inflation, so keep in mind that food inflation rose 0.5% after a 0.3% rise in May.
    4) To make yourself seem more human and warm, relate that tidbit about food inflation as follows:
    "Man, I saw where food inflation was up 0.5% in June and I thought "Ha! No kidding! Get out of the economics department for a minute and buy some milk and eggs!" This will allow someone else to participate in the conversation and feel smart by noting that the food CPI was actually led by the largest increases in poultry and dairy prices since 2004.
    5) Oh yeah, gasoline prices moderated a bit, but are still near a record, which you already knew because you are the one who pays for filling your own car up.

5. Humphrey Hawkins: No News, Is Good News!

Benign inflation and slowing housing. No worries. Today's beginning of the two-day Humphrey-Hawkins testimony from Federal Reserve Chairman Ben Bernanke is just what we've come to expect from the chairman: No news, which is good news, which is just as the Fed anticipated, everything going according to plan and no worries.

  • Federal Reserve Chairman Ben Bernanke this morning predicted economic growth will pick up slightly in 2008 even as inflation gradually recedes.
  • Even the housing slump, which Bernanke said will likely remain "sluggish," will diminish over time. No worries.
  • Looks like everything is going according to Fed script.
  • Still, as Minyanville Professor Jason Goepfert of Sentimentrader noted in an article, there have been some significant market moves - perhaps coincidentally - around past Humphrey Hawkins testimony.
  • Looking at the speech, however, there's not really any "there" there.
  • If there are to be fireworks today it will likely be the result of grandstanding Congress-people making statements that cannot be refuted and asking questions that Bernanke cannot answer.
  • See this article for Minyanville Presents: Great Moment in Humphrey Hawkins History.

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