Does a Troubled President Equal a Troubled Market?
August 22, 2013
Quote number 1. â€œThe National Security Agencyâ€”which possesses only limited legal authority to spy on U.S. citizensâ€”has built a surveillance network that covers more Americansâ€™ Internet communications than officials have publicly disclosed, current and former officials say.
The system has the capacity to reach roughly 75% of all U.S. Internet traffic in the hunt for foreign intelligence. In some cases, it retains the written content of emails sent between citizens within the U.S. and also filters domestic phone calls made with Internet technology.â€
(Wall Street Journal, August 20, 2013)
Quote number 2. â€œThe Obama administration on Wednesday declassified opinions from a secret court that oversees government surveillance showing the National Security Agency was broadly collecting domestic Internet communications of Americans and misrepresenting the scope of that effort to the court.
The three opinions include one from October 2011 by U.S. District Judge John Bates, who scolded government lawyers that the NSA had, for the third time in less than three years, belatedly acknowledged it was collecting more data than it was legally allowed to.â€
(CNN, August 21, 2013)
Quote number 3. â€œPresident Obama proved himself a great segue artist Friday, as he smoothly glided from his previously unassailable position on the matter of surveillance to his new unassailable position on the matter of surveillance.â€
(Maureen Dowd, Sunday New York Times, August 11, 2013)
In addition to the uncertainty about the Federal Reserve, we have a growing uncertainty about the second term of our president. History demonstrates trouble for markets when a president is weakened by events outside his control or by events within his administration. Egypt is outside of President Obamaâ€™s control. The NSA behavior is within his administration.
This president is at risk of becoming one of the earliest lame duck presidents in American history. As that evolves, we worry about trouble for markets. A young whistleblower is sinking the American presidency and rendering it immobile. At the same time, we are awaiting the presidential appointment of a new Fed chair and, with it, the announcement and a clarification of Fed policy. Is it any wonder that markets are troubled?
Three times in the past, we have changed Fed chairs while a president was near the end of his term and when global risks were high. Volcker came into the Fed chairmanship when inflation had approached double digits and when President Carter was in serious trouble over the Iran hostages. Volcker attacked inflation with higher interest rates. My personal market memories recall the viciousness of the sell off in both stocks and bonds.
Greenspan followed Volcker, and took his chairmanship at a time that the dollar weakened. He attacked the dollarâ€™s weakness with rising interest rates and sank the stock market into the crash of 1987. That was at the end of Ronald Reaganâ€™s second term.
Bernanke became Fed chair in early 2006 and pronounced the housing issues â€œcontainedâ€ when he testified before the US Senate. Well, we know what happened in 2007-2009.
We now have a second-term president, global political risk rising in the Middle East, and a new Fed chair in the wings. Yellen and Summers and two mystery candidates are the current inventory of possible chairs. And our president is facing a succession of scandals. The overreaching of the NSA is the latest and the worst.
How does all this play in the real world?
We have clients who are directing us not to email because they believe that the government is reading their email. They are reluctant to talk on the cell phone because they think that the government is listening.
They do not trust their government. Who can blame them? They are disconcerted about markets. Who can blame them? They are watching their portfolios bleed in spite of hedges that dampen volatility and in spite of cash raised. They are bewildered by events and revelations. And they are watching their government operate in continuing dysfunctional ways.
Meanwhile, the Fed is obfuscating. We do not know what the Fed policy is, and we do not know who will be leading the Fed while making the policy. That is the unfortunate condition of the most important central bank in the world.
This has created massive market pricing anomalies in some markets. For example, why should the NJ Turnpike tax-free bond pay a yield of 100 basis points higher than a taxable US government obligation of the same maturity? Muni-treasury spreads are at enormously wide levels.
Why should an issuer of taxable and tax-free debt have the tax-free debt trade at a yield that is higher than the taxable debt? Here is an example of that from Morgan Stanley Matrix.
Marathon Oil (MRO) is one of the largest issuers of tax-exempt debt among all US corporations, with $1 billion outstanding, issued through the Parish of St. John the Baptist in Louisiana in 2007. The bonds were authorized by the Gulf Opportunity Zone Act of 2005, following Hurricane Katrina. The issue was structured as an installment sale, and the obligation to make payments is absolute and unconditional. Pursuant to the terms of the Installment Sale Agreement, Marathon Oil Corporation retained the obligation following the spinoff of downstream businesses to Marathon Petroleum in 2011. The tax-exempts carry the same ratings as Marathon Oilâ€™s senior unsecured debt (Baa1/BBB/BBB); the Munis and corporates were upgraded in lockstep by Moodyâ€™s on July 31â€¦. Tax-exempt 5.125% due 6/1/37, callable 06/1/17 at par. (CUSIP 79020FAM8) offered at 5.35%.
In a crazily priced market there are many opportunities. We are seizing them. In the stock market we are maintaining a high cash reserve as events run their course. In the bond market we want long-maturity credits in the spread arena. Tax-free yields are well above taxable yields in the long end of the muni market.
Let me end this note with this offer. Many readers have emailed over the years and asked how do I get to Leenâ€™s Lodge? Well it is easy, and there are a small number of rooms available for some nice and well-meaning folks on Labor Day weekend â€“ not a lot of rooms, but some. Call Leenâ€™s Lodge owner, Charles Driza, 207-796-2929. He will know if he still has any space. It is best if you have a companion as a fishing partner.
David R. Kotok, Chairman and Chief Investment Officer
Category: Markets and Trading