Prop Trading

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Now, on to what I read…




1. Markets

The market rose 118 points. The ISM and strong earnings led the way.




Let the last be first. Last year’s laggards (AXP, KFT, MCD and PG) are leading the Dow this year.  Last year’s winners (AXP, MSFT and IBM) are lagging.




Loads of municipal debt being issued. Municipalities issued $31.8 billion of debt in January, a 37% increase YOY and a new record for January.  This is slightly misleading because the jump comes from taxable debt (Build America Bonds).  Taxable bonds accounted for 34.8% of the total.




Investors have preferred bonds over stocks. Since the recovery started, $24 billion has gone into equity funds and $178 billion has gone into bond funds.




Warnings from the boy who didn’t cry wolf. Moody’s warned that investment grade corporations may have a more difficult time refinancing in the future.  There is approximately $500 billion of corporate investment grade debt coming due in the next five years.  Approximately 25% of that was issued by the tech / telecom / media companies.  Another 18% was issued by energy / natural resources / chemicals companies.




Asset-based lending. Asset-based lending grew 8.3% (to $600 billion) in 2008.  It is expected that there was a double digit gain in 2009.  This crushes syndicated lending, which dropped 39% in 2009.




I hope they merge and fire themselves. More than 80% of private equity managers expect the private equity industry to experience more mergers.  There are difficulties in raising funds.  Mid-market transactions are expected to grow while large transactions will be difficult.  Private equity funds raised $35 billion in Q4, the lowest quarter since 2003.




2. The Economy

Manufacturing improvement. The ISM Index of Manufacturing hit its best reading since August 2004.  The index reached 58.4 after reading 54.9 in December.  This indicates recovery in the manufacturing sector.




Weak-to-moderate spending. Personal income rose .4% in December and personal spending rose .2%.  The core price index for personal consumption expenditures is up 1.5% YOY.  If you include food and energy, it’s up 2.1%.




Ugly construction spending. Construction spending fell 1.2% for December!  It fell a similar amount in November.  For all of 2009, spending fell 12.4%.  This is largest drop on record since this index has been recorded (1964).   For the month, private construction spending fell 1.1% and public spending fell 1.2%.  (Even though federal spending increased, state spending decreased.)




California’s uneven growth. The WSJ reports that coastal regions are beginning to stabilize while inland areas are not doing well.  Overall, California is weak with 12.4% unemployment.  This reminds me of a recent academic paper that I read which argued that we saw the housing market expand in inland areas (leading to problems), but there was nowhere to build in coastal areas.  The bottom line is that I wouldn’t expect prices to fall as much at the coastal area.




Greece promises…Greece revealed a plan that would bring their deficit down to 3% of GDP by 2012.  It’s currently at 12.7%.  The goal is 8.7% this year, then 5.6% and finally 3%.  If they do not do this, it could cause risks for their bondholders, as well as the euro and possibly Portugal and Spain.  The WSJ states that Greece has a problem with companies and individuals who cheat on their taxes.




Poor, poor China. China’s Ministry of Commerce said that the US has been increasingly engaging in protectionism since the financial crisis started.  It’s hard to listen to this from a country that doesn’t let their currency float.

3. The Budget

The future is ugly. The President’s 2011 budget will result in $8.5 trillion more debt over the next decade.  The next fiscal year is supposed to have a $1.6 trillion deficit.  You really should read some of the comments from the members of Congress.  They all say things like, “we need to balance the budget, but the President unfairly is hurting my constituents.”  (Jenny frequently says that we need to reduce our spending as long as it doesn’t affect her or the kids.)  Our political process is completely broken.  (My house is actually much more efficient because I don’t have a false belief that there is a democracy.  I remember feeling some guilty happiness when our dog passed last year because I moved from 6^th to 5^th in the pecking order.)




You can’t handle the truth! As always, the WSJ mistakenly says that we have $7.5 trillion of debt right now.  It’s amazing that we have to raise the debt ceiling to $14 trillion when we only have $7.5 trillion of debt…




Good luck. Apparently, the budget is based on the assumption of 4.3% growth in 2011.  They expect unemployment to be 9.2% in 2011 and 8.2% in 2012.  Income tax brackets will rise from 33% and 35% to 36% and 39.6%.  Jenny has also submitted a budget under the assumption that I’m going to become an investment banker in 2011.




Higher taxes. The new budget proposes an additional $1 trillion of taxes (over the next ten years) on families making more than $250K.  Banks and multinational companies would pay more and energy companies would lose their tax break.

4. Limits on Proprietary Trading

Paul Volker wrote a really important / interesting piece in Saturday’s NY Times. In it, he made the following key points:

1. We have had the most serious crisis in 75 years and we can see this in lost production and jobs.






2. The government acted because it had to act.  Now the discussion is focused on appropriate capital requirements, better supervision, improved risk management, better board oversight and accounting principles.






3. A long line of decisions has protected creditors and (sometimes) shareholders.  This leads to a belief that some institutions are “too big to fail.”  (He didn’t mention that Lehman caused us to temporarily suspend this belief and that caused a problem or two…)






4. The government protection leads to moral hazard.  There are enhanced incentives to take risk and use excess leverage.






5. In the past, moral hazard was offset by close regulation and supervision.  Now, we’re also thinking about capital requirements.






6. Recently, the President suggested banning the banks from engaging in proprietary trading.  The idea is that commercial banks serve an important function and there is risk inherent in their work.  But, we don’t need extra layers of unnecessary risk (such as proprietary trading).  This is better suited for other parts of the market.






7. Bank capital should be used to respond to customer needs, not to chase speculative profit.






8. Aside from the risk, these pursuits also cause conflict of interest in banks.  In addition, there is no reason that proprietary trading (or hedge funds or private equity) needs to be housed within a bank.






9. We also need an agency to identify and limit systemic risk.  They would be allowed to step in when an institution is on the brink of failure.

10. Institutions would have a “living will” and shareholders and creditors would not be protected.




11. We need to make structural changes.  Otherwise, we are failing to learn from our past and failing to anticipate the needs of the future.




More hearings. Senate hearings begin today to discuss the Administration’s proposed ban on banks conducting proprietary trading.  Possibly the most important issue is to figure out what would fall under proprietary trading as opposed to trading for a customer.




How’s this for fear about the ban on prop trading? Morgan Stanley’s new CEO says that they will hire hundreds of new traders in the next few years.  MS had cut most of its trading operations after suffering losses in 2007.




5. Random

Chips demand was weak last year. Global semiconductor chip sales fell 1.2% in December.  But, they were still 29% higher than last December.  Overall, sales were down 9% in 2009.




Just what we need…more car ads.  Media companies are being helped by a recovery of car advertising (which can generate half of their revenue).  I hope Toyota starts advertising that their cars have great acceleration, even in traffic jams.
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