A Bear’s Eye View
David W. Tice, CFA
Federated Prudent Bear
January 21, 2010
Where are we
Now ?
A Different Kind of Downturn
• Downturns induced by asset deflation +
credit contraction are different vs. gardenvariety recession induced by Fed
tightening & excessive mfg inventories
• As they result in secular shift in behavior
and attitudes towards debt, asset
allocation, savings, discretionary spending
& homeownership.
• David Rosenberg, Gluskin Sheff
It’s Not Great on Main Street
ABC-Washington Post consumer
confidence indicator at yearly low
Govt makes up 40% of recent GDP
Est 7MM homes in delinquency pipeline
13% owners w/mortgage are delinquent
Consumer credit down last 10 mos
1 of 8 Americans are on food stamps
Housing on government life support
85% new mortgages guaranteed by govt
FED buying 80% of mtg-backed sec’s.
Investors Intelligence survey at 6-year
low in terms of “bears”
C
Aug-09
Mar-09
Oct-08
May-08
Dec-07
Jul-07
Feb-07
Sep-06
Apr-06
Nov-05
Jun-05
3
Jan-05
Aug-04
Mar-04
Oct-03
May-03
Dec-02
Jul-02
Feb-02
Sep-01
Apr-01
Nov-00
15
Jun-00
Jan-00
Private sector deleveraging
(% YoY)
11
7
EA 11-16: MFI Loans to Households
US: Loans & Leases in Bank Credit
-1
-5
This Decline is Different
Job Losses in Past Recessions
1973-75
1.45 million
1981-82
2.84
“
1990-91
1.58
“
2000-01
2.68
“
2008-09
8.10
“
Today’s Employment Release
States reported 5,654,544 persons
claiming EUC (Emergency
Unemployment Compensation) benefits for
the week ending Jan. 2, an
increase of 652,364 from the prior week.
A Little Economic
Theory about how
we got in this
predicament
Total U.S. Credit Market Debt as % of GDP
Q
Tot al Cr edit M ar ket Debt as a % of G DP
37
36
36
35
35
34
34
33
33
32
32
31
31
30
30
29
29
28
28
27
27
26
26
25
25
24
24
23
23
22
22
21
21
20
20
19
19
18
18
17
17
16
16
15
15
14
14
13
13
(
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
E 5 0 1 A )1 9 2 5
12 / 3 1/ 2 00De
8 bt
12 / 3 1/ 2 00G
8 DP
= $5 2. 59 3 Tr lio n
= $1 4. 20 0 Tr ilo n
u a r t e r ly
Da t a
1 2 / 3 1 / 1 9 2 2
-
1 2 / 3 1 / 2 0 0 8
= 37 0. 4%
A n n u ina t l e r p o G
la t D
e( P
din c lu d e
in s
g t im pa rt ioet rso1 9 2 9u )s e pd r iot r o1 9 4 6 .
D o m
e s t ic
N o n f in a n c ia l D e b t
u s e d
p r io r
t o
1 9 4 6 .
D o m
e s t ic
N o n f in a n c ia l D e b t
r e p r e s e n t e d
9 9 . 4 %
1 9 3 0
1 9 3 5
1 9 4 0
1 9 4 5
1 9 5 0
1 9 5 5
1 9 6 0
1 9 6 5
1 9 7 0
1 9 7 5
1 9 8 0
1 9 8 5
Source: Ned Davis Research. Institutional Sales Material. Not to be reproduced or shown to the public.
1 9 9 0
1 9 9 5
2 0 0 0
2 0 0 5
37
36
36
35
35
34
34
33
33
32
32
31
31
30
30
29
29
28
28
27
27
26
26
25
25
24
24
23
23
22
22
21
21
20
20
19
19
18
18
17
17
16
16
15
15
14
14
13
A s
o 1
f 3
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
0
5
o
0
T
f
D e c
o t a l C
Austrian School of Economics
GDP growth is not the whole story. Credit is the key.
• Problems occur if money & credit expand vastly in excess
of both savings & GDP growth
• inflation can occur in asset prices rather than goods &
services – even more dangerous
• lower consumer goods inflation keeps monetary policy too
loose, stimulating even more inflation in asset prices
• Credit excesses feed overinvestment & malinvestment &
other excesses & imbalances e.g. current account deficit,
negative savings rate & luxury oriented consumption
• Magnitude of the decline is proportional to the excesses
created during the prior boom
• Best examples: US- 1929 & Japan- 1989
Economy – gotta keep it going !
• Policy makers resorted to even more debt &
“rolling bubbles” to maintain economic growth
• Refinancing boom & bubble R/E represented
the biggest & most dangerous bubble …
• Greenspan even encouraged adjustable rate
mortgages to keep credit growing
• Then, we grew corporate debt, LBO loans,
leveraged loans, private equity loans to keep
credit growing
California Single Family Median Home Prices
Dec. '95 - July '08
$600,000
$550,000
$500,000
$450,000
July:
$350,760
$400,000
$350,000
$300,000
March ’09:
$253,040
$250,000
$200,000
$150,000
Dec-95 Mar-97
Jun-98 Sep-99 Dec-00 Mar-02 Jun-03 Sep-04 Dec-05 Mar-07
Jun-08
Source: California Assoc. of Realtors
$Billions
Total Mortgage Borrowing
1,600.0
1,400.0
1,200.0
1,000.0
800.0
600.0
400.0
200.0
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
Source: Federal Reserve Z-1
GDP Growth w/o Mortgage Equity Withdrawal
PIMCO’s Bill Gross said it so well
“Greenspan is warning that sooner or later foreign
lenders will not be so exuberant in their purchase of
US Treasury bonds…. The US spends too
much; eats too much; drinks too much …
And we pay for it with our debt & 80% of the
world’s excess savings. … On the debtor
side, the US will shop til it drops, … The drop
comes when this comfy cozy current relationship
between giver/taker, consumer/maker for some
reason ends in divorce. The only question is
one of timing.”
Investment Outlook – December 2004
Can you really count on the
government to fix this mess?
Geithner – responsible for supervising the NY
banks
Bernanke – said in 2006 – “The management of
market risk and credit risk has become increasingly
sophisticated. … Banking organizations have made
substantial strides over the past two decades in their
ability to measure and manage risks”
Who’s going to
pay for all of this
???
Unprecedented RED ink
2008 Reported Deficit:
GAAP
“
$0.48 Trillion
$5.1 Trillion
2009 expected rise
in government debt
$2.4 Trillion
Estimated cost to US
taxpayers from bailouts &
guarantees
$23.0 Trillion
(per TARP Investigator General)
Total Federal
Obligations of
US government
(est. Dallas FED)
Source: Congressional Budget office, 2008 Financial Report of the US government
$99.0 Trillion
What’s the Plan, Stan ?
• Administration admitting to $13T
in addt. government debt by 2019
• @ 5% interest, interest expense =
$ 1.25 Trillion
• @10% interest = $2.5 TRILLION
• 2009 US government total
Revenue = $2.1T
“If the problem is an excess of debt,
the cure is not adding more debt,
whether that debt is public or
private”
Giulio Tremonti – Italy’s Finance Ministry
The Eventual Outcome
• There is no means of avoiding the final
collapse of a boom brought about by
credit expansion. The alternative is only
whether the crisis should come sooner as
a result of a voluntary abandonment of
further credit expansion, or later as a final
& total catastrophe of the currency
system involved.
- Ludwig von Mises
•Can You Really
Trust Reported
Earnings, Especially
Financials ?
Chairman FHLBB Office of
Finance Resigns
• “I was not comfortable as an auditcommittee member in signing off on
the financial statements, after I became
aware of the standards and processes
for valuing the mortgage-backed
securities.”
Charles Bowsher
March 2009
Accounting Games in Financials
Cloud EPS Estimates
“Remember that Enron got away with their
illegalities for so long because their financials
were so complicated that even analysts couldn’t
explain how they were making so much
money. After 2 weeks of sifting thru more than
1000 pages of SEC filings of the largest banks, I
have the same concerns.”
Nomi Prins – Ex-Goldman Sachs Managing
Director
There are however lots of
reasons for
…
HOPE
Federated Prudent Bear
Fund
Federated Prudent Global
Income Fund
• Since its inception, BEARX has outperformed the
S&P 500 in every market decline of 10% or more
Cumulative Total Returns (%) - NAV
100
76.91
Cummulative Total Return (%)
80
61.93
64.59
60
36.64
40
20
37.93
29.80
28.12
25.88
21.35
18.17
15.41
13.48
21.12
0
-20
(10.75)
(11.80)
(11.14)
(19.19)
(26.96)
-40
(26.11)
(19.11)
(14.24)
(15.36)
(17.91)
(31.50)
(25.00)
(36.40)
-60
10/7/97 10/27/97
7/17/98 8/31/98
7/16/99 10/15/99
3/24/00 4/14/00
9/1/00 4/4/01
5/21/01 9/21/01
3/19/02 7/23/02
8/22/02 10/9/02
Federated Prudent Bear Fund (NAV)
11/27/02 3/11/03
10/9/07 3/10/08
5/19/08 10/10/08
10/13/08 10/27/08
11/4/08 11/20/08
S&P 500 Index
Performance data quoted represents past performance which is no guarantee of future results. Investment return and principal value fluctuate so that an investor’s shares, when
redeemed may be worth more or less than the original cost. Current performance may be lower or higher than what is stated. For performance current to the most recent month
end, and after-tax returns visit FederatedInvestors.com or call 1-800-341-7400. NAV total returns do not include the effect of the maximum 5.50% sales charge. If reflected,
such charges would reduce the performance quoted.
Source: Ned Davis Research and Bloomberg
Diversification Benefits
Hypothetical Portfolio
Allocation
Compound Annualized Returns (%)
Period Ending September 30, 2009
Standard Deviation (%)
Federated
Prudent Bear
S&P 500
1 Year
3 Years
5 Years
10 Years
3 Years
5 Years
10 Years
0%
100%
-6.91
-5.43
1.02
-0.15
19.68
15.96
16.24
5%
95%
-5.83
-4.52
1.43
0.61
17.88
14.53
14.52
10%
80%
-4.83
-3.64
1.82
1.32
16.11
13.12
12.84
15%
85%
-3.91
-2.79
2.18
2.00
14.36
11.73
11.23
20%
80%
-3.06
-1.96
2.53
2.63
12.63
10.36
9.72
25%
75%
-2.80
-1.33
2.75
3.18
11.03
9.11
8.38
The portfolio returns are based on Net Asset Value and are rebalanced quarterly. This is a hypothetical illustration only as one
cannot invest directly in an index and past performance is not a guarantee of future performance.
Performance figures presented are total returns and include the reinvestment of all dividends and capital gains. Adverse
effects to the portfolio may result from increasing the fund’s allocation or if the Fund is unable to meet its objective. The
asset allocation represented may not be suitable for all investors.
Source: Morningstar, Inc.
34
A Three-Pronged Investment Discipline
Bottom-up
fundamental
company &
industry research
Top-down credit
and market
liquidity analysis
Identify companies with:
•
•
•
•
Deteriorating margins
Weakening earnings trends
Underperforming management
Evidence of accounting
manipulation/attempts to mask poor
earnings quality through in-depth
review of financial statements and
footnotes
• Vulnerable capital structures (i.e., too
much debt)
Risk-based short
side portfolio
management
discipline
Analyze whether conditions are
bearish (or bullish) and potential
impact on individual stocks, sectors as
well as the broad market
• Doug Noland writes weekly “Credit Bubble
Bulletin” on www.prudentbear.com
Actively assess short position daily, utilizing variety
of risk-control techniques to limit down-side
performance:
•
•
•
•
Stop-loss disciplines
Diversification strategies
Use of put options
Adjusts short exposure based on market environment
Federated Prudent Global
Income Fund
Federated Prudent Global Income Fund Historical Returns
Class A Shares at NAV (%)
2001
2002
2003
2004
2005
2006
2007
2008
2009*
2.82
29.60
16.30
3.39
-4.25
11.51
10.66
0.32
6.40
Merrill Lynch 1-3 Year US
Treasury Index
Merrill Lynch Pan-Europe
Government Index
8.30
5.76
1.90
0.91
1.66
3.97
7.32
6.61
0.76
0.26
28.58
26.66
15.83
-8.10
11.70
12.04
0.52
9.96
*YTD as of 9/30/09
Performance data quoted represents past performance which is no guarantee of future results. Investment return and principal value will fluctuate so that
an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than what is stated.
To view performance current to the most recent month-end, and for after tax returns, contact us or visit FederatedInvestors.com. Maximum Offering Price
figures reflect the maximum sales charge of 4.5%.
.
36