GalaTime

• Mint: World steel demand to fall most since World War-II

World Steel Association (Worldsteel), whose members produce around 85% of the world’s steel, expects the apparent steel demand to fall by 14.9% to 1,019 million tonnes (mt) this year, compared with 1,197mt last year.

India is one of the few countries that the association projected to buck the trend, predicting 2 percent growth in steel demand for the Asian nation this year. Figures confirmed Christmas’s view of the picture worsening in developed nations. Demand for the metal, used in construction and automotive industries, is seen down 36.6% in the US and 28.8% in the European Union.

• Bullion Vault: China & the Fed: Blowing Bubbles

• Bloomberg: Simon Tried to Buy General Growth Malls

Simon Property Group Inc., the largest U.S. shopping-mall owner by stock-market value, tried to buy real estate from rival General Growth Properties Inc. before it filed for bankruptcy, Chief Executive David E. Simon said. “They didn’t realize they were a distressed seller,” Simon said in a panel discussion at the Milken Institute Global Conference today in Beverly Hills, California.

“You have a scenario today where you have very few ‘03 to ‘07 financings that are above water,” he said. “You have more debt than you have value.” Such owners have no incentive to sell as long as they owe more than their properties are worth, Zell said. Investors will buy distressed debt for “the next two to three years” as those properties go into foreclosure, he said.

• Zero Hedge: The One Trillion Commercial Real Estate Time Bomb

I focus on some additional facts about why the unprecedented economic deterioration and the resulting epic drop in commercial real estate values could result in over $1 trillion in upcoming headaches for financial institutions, investors and the administration.

Combining all sources of CRE asset holdings demonstrates the true magnitude of this problem. The period of 2010-2013 will be one of unprecedented stress in the CRE market, and a time in which banks will continue taking massive losses not only on residential mortgage portfolios but also on construction loan portfolios, the last one being a possible powder keg: Foresight Analytics estimates C&L loan losses at a staggering 11.4% in Q4 2008.

… nearly 68% of loans in the next 4 years will not qualify for a refinancing at maturity putting the whole plan to merely delay the day of reckoning indefinitely at risk of massive failure.

• China Financial Markets: The death of the Asian development model

… if the explosion in new lending (loans are up 15% in the first quarter of this year) leads, as it almost certainly will, to a subsequent explosion in non-performing loans, in the next few years just as China is expanding its production and struggling with US reluctance to absorb its rising excess capacity, the resolution of the NPLs will itself constrain Chinese consumption.

If the Asian development model is dead, China will need domestic consumption growth more than ever, and this is cannot be the best time for China to try to revive the production-enhancing model in a way that may limit future domestic consumption growth. 

• NY Times: Recession, Far From Over, Already Setting Records

• BCA Research: From Economic Free-Fall To Sliding

• A VC: A Second Market Is Emerging

Claire Cain Miller has a story in today’s NY Times about Second Market, a NYC based company that makes markets in illiquid securities. She reports that they will shortly be launching a marketplace for private company stock.

Entrepreneurs won’t start companies and investors won’t invest in them if there is no path to liquidity on the company stock. A secondary market for private company stock can fill the gap that the lack of an I.P.O. market has created…. it represents a tier in the market that is missing between venture capital and the public equity markets. There are about a half dozen other startups working on creating markets of this kind and I expect we’ll see all of them launching in the next six months.

• The Atlantic: Why I Fired My Broker

I took a random walk down Wall Street and got hit by a bus. How am I sure it’s goodbye? The signs are rampant, but one has become stuck in my mind: a video of Richard Bernstein, the chief investment strategist for Merrill Lynch (sorry, I mean the Merrill Lynch division of Bank of America, which, by the time you read this, may be the Bank of America division of the United States Government), advising Merrill clients such as myself that one of the best financial strategies to adopt now would be to extend my “investment time horizon.”

“If the head of Merrill Lynch and every other investment firm had their way,” he continued, “no individual broker would ever recommend an individual stock or bond to a retail client again. They have essentially gotten out of the brokering-and-advising business and gone all in on the ‘wealth management’ business. The new model is to gather assets from wealthy people and then place those assets with a whole bunch of managers who will manage different pieces of it in diversified styles so you don’t lose it all at once. And by the way, people with less than $10 million need not apply.

Long but good piece. See the section on Seth Klarman, towards the end.

• Calculated Risk: IMF: Global Synchronized Cliff Diving
  

• Reuters: An emerging opportunity in U.S. housing
  

… historically cheap long-term fixed-rate financing (less than 5 percent on a 30-year mortgage) and the prospect of some nasty inflation a year or two out, both courtesy of current Federal Reserve and government policies, make owning a real asset that is debt financed a lot more attractive than would have been the case just three or six months ago.

… while housing won’t exactly thrive in a period of high inflation and low growth, it may perform reasonably well compared to the alternatives. Government bonds will get whacked by inflation and stocks may do a bit better than bonds over the medium term though they will suffer as the quality of earnings declines.

Rise in mortgage rates to offset further price declines? Maybe 6 months too early.

• Bloomberg: Bill Miller Not Dead Yet as Value Funds Bury Quants

Investors using so-called quantitative momentum strategies — which speculate that the worst stocks in the past 12 months will continue to decline — have become this year’s biggest losers after banks and companies that rely on consumer spending surged. Quant momentum techniques may have lost 27 percent this month in the U.S., the most since at least 1993.

While momentum investors have suffered in 2009, last year’s worst performers, Miller’s Legg Mason Value Trust and Harry Lange of the Fidelity Magellan Fund, are making comebacks with bets on technology companies. Both lost more client money than 98 percent of their rivals in 2008 by clinging to or doubling down on shares of financials. Now, Miller is outperforming 68 percent of his peers with a 1.2 percent gain in 2009 after boosting his stake in Hopkinton, Massachusetts-based EMC Corp. in the fourth quarter.

• WSJ: Why Capital Structure Matters

With financial institutions weakened by the recession, public and private markets began displacing banks as the source of most corporate financing. Bonds rallied strongly in 1975-76, providing underpinning for the stock market, which rose 75%. Some high-yield funds achieved unleveraged, two-year rates of return approaching 100%.

Just as in the 1974 recession, investment-grade companies have started to reliquify. Once that happens, the market begins to open for lower-rated bonds. Thus BB- and B-rated corporations are now raising capital through new issues of equity, debt and convertibles. This cyclical process today appears to be where it was in early 1975, when balance sheets began to improve and corporations with strong capital structures started acquiring others.

• Hussman Funds: Trading Volume Separates Bull Markets from Bear Rallies

If March 6th proves to be the bottom of the market, Anatomy of the Bear author Russell Napier can put off his next edition for awhile because the most recent bear market won’t qualify as a great bottom. That’s because even though the market’s decline since 2007 has been one of the largest on record, it didn’t bring the market to truly great values. In his analysis of the stock market bottoms of 1921, 1932, 1949, and 1982 Mr. Napier chose to use two measures to gauge the valuation of the market. One was Robert Shiller’s PE ratio based on trailing earnings. As I noted in Market Valuations During U.S. Recessions , this ratio has fallen to the mid-single digits during periods of extreme undervalution. It’s currently 15. The second valuation tool Mr. Napier used was the q-ratio, a measure of market valuation relative to the replacement cost of assets. Deep undervaluation for this measure tends to be when market prices are roughly 35 percent of replacement costs. According to the most recent data the q ratio is about twice that.

An important observation that Mr. Napier makes in his studies of the most damaging bear markets is that even if the initial move off of the bottom is lacking volume, once a new higher level is reached, the market should begin to attract buying interest. In each of the bottoms he studied, volume expanded noticeably after the intial rally. This idea also holds up for the majority of bear-market bottoms. In the graph below the axes are the same as the graph immediately above. The vertical axis shows the percent change in the S&P 500 while the horizontal axis shows the percent change in volume. But this time the period is 6 months from each bear-market bottom.

• Business Week: The Biofuel Bubble

Yet behind the very real innovations and investments, the brash claims and the breathless headlines, lies an inconvenient truth. Replacing petroleum with biofuels is a tough business. Even as the industry develops, many of the companies—probably most—will not survive. “We’ve seen a venture capital-led bubble,” …

These difficulties don’t mean advanced biofuels aren’t coming, or that they won’t play a crucial role in fighting climate change. But everything will happen more slowly than many venture capitalists say. And the probable winners will be those with deep pockets and patience, such as Royal Dutch Shell (RDS), BP (BP), DuPont, agriculture giant Archer Daniels Midland (ADM), or the rare startup with revenues from another business, such as making drugs. For the rest, the demonstration biorefineries now being built are more like high-stakes auditions than a step in the process of becoming commercial biofuels producers. “The business model that makes sense for most of us is demonstrating the technology and getting it into the hands of those who have balance sheets.“

• Wealth Bulletin: Charities fear their funding crisis can only get worse

Super-wealthy families and corporate donors are tightening their purse strings after years of generous giving. The three virtues – faith, hope and charity – are mutually inclusive. Where faith and hope are in short supply, charity takes a knock. If past recessions are anything to go by, there is a lag of a year from the onset of recession before charity starts to dry up. Bang on time, the process has begun.

Swiss and US foundations were devastated by the fraudulent activities of Bernard Madoff, with many forced to close their doors to the needy or trim donation packages. The Picower Foundation, America’s seventh largest philanthropic organisation, told beneficiaries in December that its grant-making would cease without delay after it lost millions with Madoff.

• Haaretz: Irrational everything

From Kahneman’s point of view, the most important moment of the recent economic crisis came when Alan Greenspan admitted at a congressional hearing that his theory of the world had been mistaken. “Greenspan expected financial firms to protect their interests, because they are rational companies and the market is rational, so they would not take risks that would threaten their very existence,” Kahneman says.

“Where did he go wrong? Because he did not distinguish between the firms and their ‘agents’ [their managers]. There is a huge gulf between the companies and their agents. Firms take the long view, while agents have short perspectives and take the short view. The compensation models of the corporation and their agents are different. The executives did not commit suicide when they took risks; it was the corporations managed by these agents that committed suicide.

• Alpha Magazine: The Power of Six (Masterminds of D. E. Shaw & Co.)

In a series of recent interviews, these six executives — managing directors Anne Dinning, Julius Gaudio, Louis Salkind, Stuart Steckler, Max Stone and Eric Wepsic — have given Alpha an unprecedented look at the people and processes that lie behind the company’s success.

“David, like [Caxton Associates founder] Bruce Kovner, approaches the business from a risk management perspective — you may not know how to make money at times, but you had better know how not to lose it,” explains Paloma’s Sussman, whose funds were down only 3 percent last year. “And that’s a very critical difference between what they do and what most people in this business do. First they decide how to size positions and how much risk they can take based on projections. The difference between the people who survive for long periods of time and have good records and those who don’t is risk management.”

Long - must read - piece.

• WSJ: Venture Capital Under Attack

America has now gone two straight quarters without a venture-backed company completing an IPO - the first time that’s happened since we started keeping records in the 1970s.

The second most pressing problem facing VC is pension funds, endowments and other buy-side investors running out of patience with small growing companies. Historically, buy-siders have understood and accepted that most economic value isn’t created until five years after a company’s IPO. But now, a focus on unfavorable current EBITDA multiples is displacing long term predictors of success such as market size, growth rate, technology and management experience.Finally, we have counterproductive regulations such as Sarbanes-Oxley, and could see two more regulatory measures that will end up undermining the already tenuous value proposition for venture capitalists and their limited partners.

• Morgan Stanley: Ready to Cope with the New Global Environment?

Just as during 2005-07 when strong positive global factors supported India’s growth above its then-sustainable growth trend, negative global factors are now pulling its growth below potential. Apart from adverse global factors, India faces the payback from the excesses of its own credit cycle and unusually high level of fiscal deficit.

Typically, the cost of a high fiscal deficit would have been higher real interest rates. However, India witnessed an unusually low real interest rate environment right at the time when its fiscal policy had been loose, as reflected in rising public debt to GDP. The key to lower-than-warranted real interest rates was the large capital inflows. Almost 85.6% of the total US$207 billion capital flows that India received over the four years ending March 2008 were in the form of non-FDI flows. However, in the era of global deleveraging and significantly lower capital inflows, the high level of deficit issue should remain in the form of higher real interest rates for the private sector.