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Value Dilution Shows No Sign of Stopping


Corporate, high-yield spreads indicate recovery is still a long way off.

Let me first take a moment to thank Todd and those at Minyanville for all their efforts and their dedication to a greater cause than most can imagine. I'm flattered to have been offered the opportunity to be a part of something that will forever change the landscape of financial education and information. I always figured there would be a time when I'd have the opportunity to "pay it forward." However, I must admit that I never imagined it would manifest itself quite this way.

Now, onto the business at hand.

I've been (and continue to be) of the opinion that the best visual depiction of the current and future economic landscape is that of a hockey stick. While I respect the possibility that we may have arrived at the elbow of the blade; the inflection point, the tangent of the slope or whatever you want to call it. I also know that defining where that elbow starts to form can be a tricky business. While I agree that focusing on the second derivative of numbers (rate of change of the rate of change, or better said, we're decreasing at a decreasing rate) is prudent, what one also must focus on is that of consumer psychology.

Corporate -- and, more importantly, consumer -- psychological and physical balance sheets are still in the process of healing. You don't have triple bypass surgery, then get up the next day and go back to work. These things take time, and lots of it.

The Fed and Treasury have essentially provided a tourniquet to a massively hemorrhaging artery. The patient, however, is still in triage with numerous doctors circling around the stretcher, armed with instruments of cauterization in hand. This ultimate healing process won't be a quick one, thus the Fed and Treasury are going to have to be patient in their expectations of individual consumers consuming large ticket goods and services -- financed with leverage -- anytime soon. This will be represented by the horizontal blade of the stick.

As I'm sure you've noticed, there have been a plethora of secondary equity offerings over the last 2 months. This issuance has been most prominently seen in the REIT space, and has just now started to broaden out into other sectors (e.g. steel, solar and *cough, cough* banking). The reason for this is simple. It's cheaper to dilute your common than to roll or issue new debt - especially when you own commercial property that's painfully underwater and virtually un-refinancable, even at the most usurious of rates. I'll have more on that later...

Back in December, I was speaking with an analyst at a large fund, and I made an off-the-cuff comment that "Pretty soon, the word "dilution" is going to be used by more than just chemists."

Well, ladies and gentlemen, the corporate chemists are busy diluting, and until the (non-government influenced) credit markets loosen up substantially from here, you can expect to see this trend continue. Corporate and high-yield spreads have definitely come in, but are still very wide, versus what are seen in "distressed but recovering" economic conditions.

Yesterday, the Federal Reserve chose not to announce any additional bond manipulation purchases than are already on the docket. This is either analogous to a wild-haired mad scientist leaning over his beakers and rubbing his hands together while concocting his next wicked brew, or a sign that the Fed may in fact have realized that in the end, they're not bigger than the market, and trying to be can have severe repercussions.

I'll let you decide for yourself.
No positions in stocks mentioned.
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