“A mind always employed is always happy. This is the true secret, the grand recipe, for felicity." -Thomas Jefferson

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Hindsight
Major market indices were higher last week. The DJIA gained 2.93%, the S&P 500 jumped 3.75%, and the Nasdaq added 3.72%. Value stocks outperformed growth stocks. The small cap index leapt 4.31%. The 10-Treasury yield gained 7 basis points, closing at 2.71%.
Last week, Fed Chairman Bernanke admitted that the central bank and other regulators could have done a better job tackling mortgage and banking risks that helped precipitate the worst financial crisis in seven decades.
Bernanke explained that the Fed was slow to identify and address abuses in lending, and that regulators could have done more to identify risks to the broader financial system.
The chairman also appeared to absolve some of his predecessor’s culpability for having kept rates so low for so long, which many have blamed as a major contributing factor for the housing bubble and the proceeding turmoil.
So, Bernanke admits that regulators largely failed to see, slowdown or prevent the financial meltdown. However, we’ve recently witnessed the largest wholesale rewrite of the financial regulatory statutes since the great depression. Within those new laws, the very regulators who failed us have been granted farther reaching regulatory powers. Also, per the complaints of many of the bills’ critics, nothing was done regarding two of the calamity’s top protagonists, Fannie Mae and Freddie Mac. You might analogize this to a healthcare overhaul without tort reform.
Daniel Loeb, surfer turned money manager extraordinaire, had much to say in a recent letter to clients concerning recent government actions towards much of the private sector. And he says it very astutely. To read Loeb’s comments, click here.
Milton Friedman said, “Nothing is so permanent as a temporary government program.” We have recently witnessed a huge expansion in government powers and oversight. Such expansions tend to rob citizens, gradually, of the ability to pick, choose and navigate their own lives. I am raising my sons to be captains, not passengers. And I am oft finding that to be at odds with my government’s intentions. Stay tuned…
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Economically Speaking
- Obama called on Congress to approve a six-year public works program that would spend $50B upfront on upgrades to roads, rail lines and airport runways in an effort to combat unemployment. The administration said it will work with Congress to fund the plan without adding to the deficit, perhaps by cutting subsidies on oil and gas exploration and production. However, lawmakers preparing for the midterm elections may not provide the zippy approval Obama is hoping for. Obama is also expected to announce this week an expanded tax incentive to encourage business investment.
- Manufacturing in the U.S. expanded at a faster pace than forecast in August as factories added workers and increased production. The ISM’s factory index rose to a three-month high of 56.3 from 55.5 in July. The forecast had been for the index to drop to 52.8. Readings greater than 50 signal growth.
- Jobless claims fell last week by 6,000 to 472,000, in line with economists’ forecasts. The data shows that, while the economy has expanded, and unemployment is not worsening, it is not yet improving.
- Pending home sales unexpectedly grew 5.2% in July. The jump was seen as a sign that the market may be starting to stabilize after the expiration of a homebuyer tax credit.
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Foreign Observations
- India's gross domestic product grew 8.8 percent in the second quarter, according to an Aug. 31 statement released by the Indian Ministry of Statistics and Program Implementation, Xinhua reported.
- German employment increased to 40.2 million in July, an increase of 141,000 or 0.4 percent from July 2009, Destatis reported on Aug. 31. Seasonally adjusted figures show an increase of 9,000 over the previous month.
- Israeli Prime Minister Benjamin Netanyahu arrived in Washington, D.C., on Aug. 31, Haaretz reported. Netanyahu was briefed on the deadly attack that killed four Israelis near Hebron in the West Bank. Members of Netanyahu's entourage said Israeli is preparing for the possibility that militants will attempt to launch attacks or fire rockets at Israel ahead of peace negotiations, according to Ynet. Netanyahu is expected to tell U.S. Secretary of State Hillary Clinton that the attack shows the need to be uncompromising regarding Israel's security.
- Drug cartel violence reduces Mexico's gross domestic product (GDP) by about 1.2 percentage points, Mexican Finance Secretary Ernesto Cordero said at a Sept. 1 press conference, Reuters reported.
- The European Union may limit naked short sales of equity and government debt, attributing the maneuver to the “disorderly market and possible systemic risks.” (Bloomberg)
- Unemployment in Spain increased by 61,083 people in August, up 1.5 percent compared to July, Spain's Ministry of Labor and Immigration reported on Sept. 2.
- The second quarter unemployment rate in France was 9.3 percent in metropolitan areas with 2.6 million people out of work, DPA reported on Sept. 2. Finance Minister Christine Lagarde said the figures represented a turnaround for France's labor market.
- Iranian speaker of parliament Ali Larijani said at a rally in Qom that direct talks with the United States are currently impossible, Mehr News Agency reported Sept. 3. Larijani said Iranian Supreme Leader Ayatollah Ali Khamenei's guidelines state that Iranian policy is negotiation, but not with Washington.
- Tehrik-i-Taliban Pakistan (TTP) threatened to attack the United States and Europe "very soon" and dismissed Washington's move to place the group on its terrorism blacklist, Reuters reported Sept. 3. Senior TTP leader Qari Hussain Mehsud said the blacklisting showed the United States fears TTP.
- China offered a rare glimpse today into its foreign exchange reserves, the largest stockpile in the world at $2.45T. A report in the China Securities Journal, an official newspaper, cited unnamed reserve managers who said the holdings are roughly in line with global averages, with 65% allocated to dollars, 26% to euros, 5% to pounds and 3% to yen. China also reiterated its discomfort at a global financial system dominated by the dollar, warning that "once a reserve currency's value becomes unstable, there will be quite large depreciation risks for assets."
- Russian Prime Minister Putin extended his country's grain-export ban through at least Nov. 2011, after announcing last month that Russia would suspend grain exports until the end of this year. Wheat prices rose only slightly, as some had already anticipated a prolonged export freeze from the world's former no. 3 wheat exporter, but the announcement added to growing fears about the possibility of a global food crisis.
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Weekly Sector Review
The sectors of the U.S. economy, as well as the S&P 500, have performed as follows:
Last Week’s Returns:
Information Technology... 3.50%
Materials... 4.17
Consumer Staples... 2.20
Utilities... 1.63
Consumer Discretionary... 5.03
Financials... 5.67
S&P 500... 3.75
Industrials... 4.67
Healthcare... 2.21
Telecommunications... 2.02
Energy... 3.68
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Equity Markets Review
- Exelon agreed to buy Deere's wind energy business in a deal worth a total of $900M (a purchase price of $860M with a provision for up to $40M upon commencement of construction on the advanced development projects). In its statement, Exelon said "not only does this acquisition add value for Exelon shareholders, providing incremental earnings in 2012 and cash flows in 2013, but it also is one more way to implement a clean energy future."
- JPMorgan Chase & Co. announced that it is shutting down all proprietary trading operations, in compliance with the financial reform bill’s Volcker Rule. The rule may cost the bank as much as $1.4 billion in annual profit, estimated Barclays Capital.
- Oracle weekend rumors that Mark Hurd, the ousted CEO of H-P, will join the company as co-president and a member of the board of directors. Analysts said the move is a coup for Oracle as the company is aggressively branching out and increasingly coming into competition with firms like H-P and IBM.
- The Basel Committee will require global banks to hold Tier 1 capital of 9%, according to a draft proposal obtained by German weekly Die Zeit, and will be able to demand banks accumulate an "anti-cyclical buffer" of 3% so that Tier 1 capital requirements can rise to 12% in boom times. This is a significant jump from the present requirements, under which banks are required to have a Tier 1 ratio of no less than 4%. Regulators and central bank officials are meeting today to finalize the Basel III package.
- HP won the heated bidding war for 3Par with an offer of $2.4B, or $33/share, that 3Par's board approved Thursday evening.
- Goldcorp agreed to pay C$3.6B ($3.4B) for all the outstanding shares of Australia's Andean Resources, representing a 35% premium to Andean's closing price yesterday in Toronto. The boards of both companies have approved the deal, which now must be approved by 75% of Andean's shareholders.
- Blockbuster said it missed another interest payment on its bonds, disclosing in a regulatory filing that it was unable to make a semiannual payment to junior note holders because it still hadn't made a payment to senior bondholders that was due in July. The company has already said it may have to liquidate if it can't restructure its $1B-plus of debt.
- HSBC made its clearest warning yet that it may move its headquarters abroad if U.K. regulators ultimately decide that banks need to split their high street banking from their riskier investment banking activities.
- Brazil’s state-controlled Petrobras agreed to pay the federal government $42.5B in stock in exchange for five billion barrels of deepwater reserves. The deal is a controversial one, as investors say Petrobras is paying more than the oil is actually worth, and shares of Petrobras have already fallen significantly this year as investors worried just such a scenario would occur. Petrobras also plans to sell new shares to the public to raise an additional $25B as part of the plan.
- General Electric could spend up to $30B on takeovers in the next two to three years, said John Rice, one of the company's four vice chairmen, but would do so in a way that's compatible with plans to boost its dividend and buy back shares. The comments signal GE is pulling away from the defensive position it took during the recession, with one analyst calling it a "sea change" in the company's thinking.
- Heinz’s fiscal first-quarter earnings rose 13%, helped by strong sales of ketchup and staples such as Classico pasta sauces. During a conference call to announce its results, the Pittsburgh-based company again signaled its interest in making acquisitions in emerging markets.
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Sports, Culture & Politics
- The Environmental Protection Agency and the Transportation Department jointly proposed new rules that would require passenger cars to be labeled with a grade from A to D depending on the vehicle's fuel efficiency and emissions. Electric cars and plug-in hybrids, for example, would be the only vehicles that could receive an A-minus, A or A-plus, while SUVs would get a C or C-minus. It would be the largest shake-up to car labeling rules in the last 30 years, and has left critics disgruntled that the government is trying to legislate its own value judgments about vehicles.
- As many as 2,000 additional troops, including a number of U.S. forces, may be headed to Afghanistan in the coming weeks under a plan being proposed by Gen. David Petraeus, CNN reported Sept. 6. The proposal, which calls for an additional 2,000 troops including at least 750 personnel to serve as trainers for Afghan forces, has been briefed to NATO officials behind closed doors. Another NATO official said it was highly unlikely that many of the additional forces will be U.S. troops.
- U.S. President Barack Obama announced the end to Operation Iraqi Freedom and the end of the U.S. combat mission in Iraq, in a television address Aug. 31. Remaining U.S. troops in Iraq will give support to Iraqi troops and will be gone by the end of 2011, according to Obama.
- The assistant to U.S. Middle East envoy George Mitchell conducted a secret visit to Damascus on Sept. 1, Asharq al-Awsat reported Sept. 3. Frederic Hof discussed peace process developments with Syrian Foreign Minister Walid al-Moallem. Syrian sources said Hof wanted to know Syria's position on the U.S. vision for the region and on the resumption of negotiations.
- Comedian Robert Schimmel, died at age 60 on Friday from injuries suffered in an August 26 car accident.
- College football kicked off its 2010 campaign with wins from Ohio State, Florida, Alabama, Oklahoma and LSU. Ole Miss was upset. And Boise State commanded respect in beating Virginia Tech 33-30 in V Tech’s backyard.
- America’s new Tennis darling, Caroline Wozniacki, continues to win and charm at the U.S. Open, entering the quarterfinals by beating Sharapova. Nadal, Federer and Djokovic also won.
- The unsung Charlie Hoffman won the PGA’s Deutsche Bank Championship.
The weekend’s top-five box office performers as reported by Cinemablend.com were:
1) The American, Focus Features, $16,400,000
2) Machete, 20th Century Fox, $14,000,000
3) Takers, Sony Pictures, $13,500,000
4) The Last Exorcism, Lionsgate, $8,780,000
5) Going the Distance, Warner Bros., $8,610,000
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Goldman Sachs and the Winds of Change.
by Bloomberg on September 3, 2010 at 4:25pm
10 percent of Goldman Sach's revenues have been derived from their proprietary trading practice. Now, in compliance with the new Volcker rule, Goldman appears to be closing the group down.
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Daniel Loeb Comments on Governments' Policies.
by Daniel Loeb, founder, Third Point LLC on September 2, 2010 at 11:45am
Daniel Loeb, founder of the $3.3 billion Third Point fund, is a registered democrat and supporter of the current administration--for which he personally raised a lot of money. However, Loeb recently said in his letter to clients that the U.S. administrations' policies appear intent on "redistribution rather than growth," and should send chills through those who believe in free markets...
Review and Outlook
As we entered the second quarter of 2010, many measures of confidence and economic activity were showing consistent improvement, leading us to increase our exposures in select undervalued companies that we thought would benefit from a favorable economic environment. Most pundits initially attributed the subsequent turn in the markets and investor sentiment to the Greek crisis, concern over the Euro, the Oil Spill in the Gulf, and vague rumors concerning faltering Chinese growth. However, it is apparent to us that the turning point in both investor and consumer confidence came on April 16th, with the filing of the government's suit against Goldman Sachs over its mortgage CDO activities.
This politically-laced lawsuit was a tipping point for shaky investor confidence against an increasingly worrisome landscape of new laws and proposed regulations that are perceived by many market participants to promote "redistribution" rather than growth, and are contrary to free market ideals.
As every student of American history knows, this country's core founding principles included non-punitive taxation, Constitutionally- guaranteed protections against persecution of the minority, and an inexorable right of self-determination. Washington has taken actions over the past months like the Goldman suit that seem designed to fracture the populace by pulling capital and power from the hands of some and putting it in the hands of others.
For example, a well-intentioned government program gone awry is the new CARD Act that restricts banks from repricing interest rates on borrowers who fail to meet their revolving credit obligations. The effect of this legal prohibition has been to force the banks to raise the interest rate paid by all borrowers, to compensate for losses they are now being forced to take on delinquent borrowers. The effect is a redistribution of wealth from people who pay their debts on time to those who do not.
Laws and regulations such as these justifiably raise questions about this government's commitment to free-market capitalism and the articulated rule of law. Arguably unconstitutional Bills of Attainder, such as the special "Enterprise Tax" proposed to be levied on hedge fund managers and other managers of private partnerships who wish to sell their management companies (ostensibly in order to extend unemployment benefits beyond the current 99 weeks) send a vivid message that this Administration is operating from a playbook quite different from the one we are used to as American business people; a thought that chills all participants in these free markets.
On the other hand, it is not hard to understand the source of the popular distrust in capitalism today. Many people see the collapse of the sub-prime markets, along with the failure and subsequent rescue of many banks, as failures of capitalism rather than a result of a vile stew of inept management, unaccountable boards of directors, and overmatched regulators not just asleep, but comatose, at the proverbial switch. When we hear the chorus of former executives and regulators exclaim that the crisis was "impossible to see coming", while at the same time walking away with millions or going on to greater levels of responsibility in government, it is both puzzling and demoralizing. It is easy to see why so many people have concluded that the entire system is rigged.
This crisis of trust in our system is not limited to inept executives in regulated financial institutions that bury their shareholders and then walk away with ill-gotten sacks of loot. Having analyzed hundreds of proxy statements from the outside and having had the "pleasure" of sitting on several corporate boards, giving me a chance to walk the sausage factory floor, I have personally witnessed the incompetence of many boards of directors. One can only conclude that the incentive systems put in place for directors reward luck and station more than they do talent, skill or creation of shareholder value.
Not all boards are bad, of course. Private equity firms have a terrific model of appointing energetic members of their firms and outside experts to oversee the affairs of the companies they govern. They tend to have real "skin in the game", spend days reviewing strategy and other matters, and have their own staffs to analyze numbers produced by the company. Board fees tend to be irrelevant to the members of such firms as they are keenly focused on strategies to deleverage and to create long/medium term shareholder value.
Even some public companies have similarly engaged corporate boards.
However, individuals who rely on the stipends they receive from numerous corporate boards and thus appear motivated primarily to ensure continuing board fees, first-class air travel and accommodations, and a steady diet of free corned beef sandwiches until they reach their mandatory retirement age populate many of the boards we have come across.
All of the above leads us to conclude that America faces not only a crisis of confidence among consumers unwilling to spend and businesspeople unwilling to invest, but also a crisis of leadership. So long as our leaders tell us that we must trust them to regulate and redistribute our way back to prosperity, we will not break out of this economic quagmire.
As capital allocators, it is important to remain dispassionate amid the volatility. We have given a great deal of thought about the impact that public policy has on individual companies, industries, and the economy generally. It was this decision framework that led us to shed our investments in large cap US banks in January due to concerns over increasing regulatory headwinds (in advance of the announcement of the Volcker Rule). We have also sold other regulated industries and eliminated our position in Wellpoint, an HMO that is a statistically cheap stock owned by several hedge funds, but which we saw as being overly exposed to unpredictable government regulation.
On the other hand, our perspective on the government's increased willingness to use its regulatory muscle enhanced our short positions in the for-profit education space. Indeed, this summer certain government actions taken regarding these companies served to accelerate the unfolding of our thesis on these names.
As we discussed in June's letter and on our Quarterly Investor Call a few weeks ago, we began to bring our gross and net exposures down significantly throughout May, primarily in our equities portfolio. We continued this process through the remainder of the Second Quarter, carving out most positions without definitive hard catalysts on the equity side, also reducing positions in Europe, and avoiding sectors entirely where US government intervention remains likely. Gross and net exposures in our portfolio today are at their lowest levels since March 2009, and have been decreasing all summer in accordance with our political and economic framework.
One can hope only that this Administration, composed of brilliant academics that have had experience in creating the very regulation and overseeing the very institutions that have failed, has learned from its mistakes and will set us down the right path. Perhaps our leaders will awaken to the fact that free market capitalism is the best system to allocate resources and create innovation, growth and jobs. Perhaps they will see the folly of generating greater deficits by "investing" in programs that lead to corruption and distortions of the system. Perhaps too, a cloven-hoofed, bristly haired mammal will become airborne and the rosette-like marking of a certain breed of ferocious feline will become altered. In other words, we are not holding our breath and are focused instead on navigating these murky waters for the benefit of our funds.
[Ed. Note: Third Point LLC is a registered investment adviser based in New York, with approximately $3.4 billion of assets under management. The firm was founded in 1995 by Daniel S. Loeb, who is CEO and oversees all investment activity. Third Point employs an event driven, value oriented investment style.]