Five Things You Need to Know: Money Market Fund Hysteria; PPI; Retail Sales; Painting All Credit Products With the Same Brush?; On Herding Behavior
What you need to know (and what it means)!
Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
1. Money Market Fund Hysteria
The hysteria over money market funds is now beginning. The New York Times today is looking at money market funds. And so far today I have seen a handful of stories in my Bloomberg Alerts questioning the safety of money market funds.
See yesterday's Five Things for a primer on money market funds and the real story on money market fund safety issues.
Good news, they say, producer prices rose less than forecast in October, paving the way for the Federal Reserve to formally be able to justify additional interest rate cuts with a straight face.
- The Producer Price Index rose 0.1% in October, according to the Labor Department.
- Core producer prices, which exclude fuel and food costs, were unchanged.
- A Bloomberg survey of economists showed core prices were expected to have increased 0.2%.
- One of the more amazing aspects of the report was that finished good prices were led by food, not energy as one would expect.
- Prices for consumer foods moved up 1.0% in October, while energy actually showed a 0.8% decrease.
- According to the BLS, gasoline prices fell 3.1% in October, following September's 8.1% rise.
- How this occurred is something of a mystery to us, mostly because when we look at statistics from the Energy Information Administration, an organization that presumably follows energy information and then administers it to people like us... but apparently not the Bureau of Labor Statistics... we see that from October 1 to October 29, average retail gasoline prices rose across all categories - regular, conventional and reformulated.
- The consumer food increase is also interesting because price for crude foodstuffs and feedstuffs actually decreased by 1.8% in October.
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3. Retail Sales
Also good news, retail sales increased at a slower pace in October, but at a slower pace that was less slow than expected, if that makes any sense, which of course it does not.
- Once we read past the headline - Retail Sales Increased More Than Expected in October - everything else in the report loses a bit of luster.
- The most important component in the report is "retail trade sales."
- Why, because this is where the real action is in terms of consumption since it excludes autos, building materials and gasoline.
- Retail trade sales rose an anemic 0.1% in October.
- The weak categories were precisely the ones you would expect to be weak; sporting goods, hobby book & music stores (-0.4%), general merchandise stores (-0.1%), department stores (-0.5%), miscellaneous store retailers (-0.6%), nonstore retailers (-1%).
4. Painting All Credit Products With the Same Brush?
On Monday we looked at one of the ways the credit repricing crisis has slowly spread and is now threatening to pull in companies in industries with absolutely no exposure to mortgages; iliquidity in the formally highly-liquid auction rate securities market.
Minyan Mike Gill provided us some additional insight into auction rate securities worth passing on:
Regarding your "5 Things You Need to Know" Nov. 12 on auction rate securities (ARS), I don't have any particular information on the specific company you pulled out as an illustration, Northgate Minerals (NXG), but I have a couple of insights to share.
First, take a look at New America High Income Fund (HYB). That's a high yield bond fund that has some leverage.
Specifically it has two-thirds equity and one-third Auction Trust Preferred. All of its underlying assets are reasonably good quality junk bonds for which there is ample market pricing sources. They have a 2:1 leverage ratio, which is very mild.
They had some problems rolling over their ATP in early September, as the panic engulfed them too, but I think it would be hard to argue that the paper isn't worth par, at least from a collateral perspective. Here's the only press release I've seen on the topic.
I have been watching the growing iliquidity in the Asset-Backed Commercial Paper (ABCP) market with fascination (like watching a train wreck in slow motion), and there's always some new twist that I haven't heard of (despite over 20 years on Wall Street), like Auction Rate Securities (SIVs and Conduits were new to me in July).
My point is that I've found both bad surprises and good surprises in this liquidity meltdown, and when I find an anomaly like the HYB ATP-which is unfairly painted with the same negative brush as all ABCP-I think it is worth pointing out. Other than this particular anecdote, I'm not particularly knowledgeable on ARS, which just seems to be a sub-sector of the commercial paper market.
Minyan Mike Gill
5. On Herding Behavior
If there is anything to be learned from the unwinding of this credit bubble it is this simple reminder: the amount we do not know about our instinctual motivations to herd and swarm - even in situations where such behavior is seemingly at odds with what is in our best interests - dwarfs what we do know about the "power" of individual human decision-making.
Yesterday we ran across a fascinating article in the New York Times science section on swarming behavior, specifically in ant colonies and among locusts. Dr. Iain D. Couzin, a mathematical biologist at Princeton University and the University of Oxford, observed that army ants are particularly good at moving in swarms; if they have to travel over a depression in the ground, they erect bridges so that they can proceed as quickly as possible. Compare that to the 3.7 billion hours a year American spend congested in traffic.
According to the Times, what Dr. Couzin wanted to know, however, was why army ants do not move to and from their colony in a mad, disorganized scramble. With the power of computers he was able to model their behavior and discover some of the feedback the ants rely on in organizing and swarming successfully. As the Times points out, however, "Understanding how animals swarm and why they do are two separate questions."
Dr. Couzin learned while studying locust swarms that even when two "swarm leaders" present conflicting views to the group, the swarm was still able to decide which leaders to follow to preserve the swarm. "As we increased the difference of opinion between the informed individuals, the group would spontaneously come to a consensus and move in the direction chosen by the majority," Dr. Couzin said. "They can make these decisions without mathematics, without even recognizing each other or knowing that a decision has been made."
And this is where we return to human decision-making abilities. Dr. Couzin teamed up with researchers at the University of Leeds to also study human behavior. Given a set of rules, and even presented with hidden conflicts information, the human swarm made a quick, unconscious decisions about which way to go.
The experiment is unique, and you can read more about it in the Times, but the observation that humans tend toward herding, and even follow unconscious decisions about crowding and swarming is not particularly new. A remarkable book about crowds and the power they afford individuals is presented in Elias Canetti's book Crowds and Power, a must read for any market participant.
The larger takeaway from the Times article, especially in light of credit market behavior, is that in spite all of our computer pricing models and the new, scientific-sounding nomenclature that has spawned a wide variety of acronyms - SIV, ABCP, ARS, CDO, CMO, ETC.... - we are still human beings governed by herding impulses that aren't quite as removed from irrationality and misunderstanding as we presume.
This is your brain on quantitative risk models in June, 2007.
And this is your brain on the banks of the Rhine River a couple of hundred thousand years ago having just caught a fish with your bare hands.
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