1-2 Knockout

Mugabe? Mugabyou! (worst title ever)

By 1-2 & TheUnrepentantGunner

This Saturday Zimbabwe will be holding a much more exciting election than the ones we hold. How can it be more exciting than the Obama v. Hillary fight Sunday Sunday Sunday?  Well, we at 1-2 will be holding a contest of sorts to up the ante.

Zimbabwe, as you have no doubt read by now, has launched a revolutionary economic policy.  It is so revolutionary that no one has ever implemented it before; certainly not in Germany, Chile, or Venezuela (although Chavez’s “Nuevo Bolivar” concept is brilliant, to cure hyperinflation all you have to do is remove the ‘0’s from the end of your currency). As a quick refresher you should read Long or Short Capital’s fine analysis on President Mugabe’s economic stimulus plan here.

These are troubled times for the bold pioneer of such a policy that Helicopter Ben can hardly dream of–not only helicopters dropping money, but rickshaws and horses too. You see, Mugabe is in potential danger of not getting to see his vision through to completion. He is being challenged by two candidates who lack the foresight to just print infinite amounts of money. As a result, Mugabe may have to get creative, and possibly print an infinite amount of ballots with his name already marked on them.

Whoever can come closet to the percentage of votes Mugabe will receive will win a prize. You can go to the nearest tenth of a percent, and Bobby Barker rules always apply, you cant ever ever go over.  It should be noted that your prize will be valued at 50USD on April 1.  The prize will then be tied to Zimbabwe’s inflation rate, and distributed on June 1st. We’re actually serious about both the prize and inflation-link.

Put your guesses in the comment fields; we will contact the winner. Keep in mind that the results may take a few days, as most of Zimbabwe's computing power is being occupied trying to find deserving Westerners a chance to hold onto $50 million dollars, and store it for them in exchange for a small one time fee of $10,000.

For those who don't trust their gut about the Mugabe efficiency theory, you can read a contrarian guide to handicapping the elections here (The Economist).

Retail Financial Business, a Hedge? Not Exactly

By TheUnrepentantGunner

So let’s start with a fun question. Going into this morning, how much were the S&P and Dow (I know, I know, no one uses it) down for the year?  Answer at the bottom.

So, now to address my earlier point about the retail business being fine. As the Hertz commercial says: "nottttt exacttttly". In fact, Retail business may well end up a decent LOSER for a lot of firms.

A really crude 3 minute read of the retail business as it stands today looks as follows (these numbers are made up, but the concept holds):

Profit: Take the assets for some random boutique firm to make the numbers easy: Let’s call it $1b. Let’s say their average fee is 1.2% per annum. So each year they will rake in $12m from their retail arm–assuming it's all fee-based–or $1m a month.

They probably pay their brokers half of that let’s say, so now they have $500k per month to cover their expenses. This includes all non-producing administrative costs, which are mostly fixed salary if they are unlicensed. This includes the office rents, also fixed. Non-producing rookie brokers, unless you fire them, are often on salary as well. And if you do fire them, their 5 or 6 clients may well leave you, which will partially offset your savings there. Costs also include compliance costs, fixed. In short, while some things can be cut back on (supplies, perhaps educational programs, etc), many of the costs to run a retail arm are FIXED.

Now here is the beautiful part, of that $500k per month that doesn't get paid out, maybe $300k goes out the window for fixed costs, and another 100k in incentive costs for the managers and licensed administrators leaving $100k in profit for 20% profit margin.

For bigger firms, there are much bigger fixed costs that boutique firms don't have (1-800 numbers and the people who staff them, an ongoing technology bill for service), etc. But I digress. We have $100k in profit a month for our mythical boutique firm with an annuitized book. Now let’s assume the firm's assets under management drop by 10%. Instead of $1m a month in gross income, $900k is coming in monthly.  $450k still goes to the brokers, but instead of 100k profit, its now only $50k profit. Maybe some of the bonuses get scaled back for management, maybe some people get fired, maybe that awards trip is to Des Moines next year instead of Honolulu, but still, a 10% drop is in many cases a 30-40% drop in profits, if not an outright loss for bigger firms running on thin profit margins.

In the old days, if the market fell, that wasn't great, but wasn't horrible. If anything the extra volatility and volume meant more orders processed on a per share basis, more people jammed into high commission annuities, and out of b-shares (another commission hit) into CD's or such. Now, with firms mostly preaching annualized recurring profits on a planning basis (not a bad strategy by the way), the firms will be the big losers. They made their bed, and they will sleep in it more than ever. Sure the Eddie Jones's of the world still use largely A-Shares, and no firm is fee-basis only, but the trend has been strongly that way the last 5-10 years.

Some producers might see a slightly smaller paycheck, but shareholders might see a much smaller dividend, and for the firms out there that are counting their retail arm to bail them out of the subprime debacle, a big drop in the markets is not so great.

Now what's the silver lining? That's right: the markets aren't all that bad... yet.

Some huge retail bond funds have made out like bandits (PTTAX on course for 14% for a bond fund, after 11% last year!!!), and the S&P is only down 9.5% as of close on Friday, with the Dow down 7%ish, but factor in today and the recent rally and things aren't that bad, not as good as the 5% growth that the planners probably budget in, but not horrible.

Bear's Magically Levitating Share Price--and Other Musings

ByTheUnrepentantGunner

Hello there! For my opening post I would like to point out two things going on that have been underreported in the Bear Stearns Fiasco that are worth noting and investigating.

1) With the BSC share price moving to upward and onward towards $11, many reporters are hypothesizing that bondholders have been buying shares in an effort hold enough voting shares to protect their institutional investments. Because Barry said it I sort of accepted the theory without the requisite skepticism. Still, it’s an absurd argument. There are what, 140 million shares of bear outstanding? Volume has been at least half that every day for 6 of the last 7 trading days. That alone tells you it wasn't buyers and holders snapping up the stock.

I understand a lot of that volume is day traders playing it by the minute picking up pennies. Still, the bondholders would buy and hold through the shareholder vote, and if they really wanted to they could have held. This was speculation, and the speculators won out with this morning’s announcement.

2) More importantly:

Lost among all the discussion from the fallout, I feel like I should get something off my chest.

So, what was the main reason that Lehman saw a 40% drop on the day of the BSC? LEH sold-off 40% on the day of the BSC announcement–far higher than the other financial institutions caught in the subprime quagmire.  Many analysts say it was because they don't really have the same retail arm, and thus were more exposed as an entity.  Without the recurring revenues retail/private banking produce LEH is far more susceptible to weakening based on capital market seizure–and the resulting loss in revenues. I must suppose that the undiversified business mix puts the firm at increased risk, but at no point did Lehman acknowledge any of the same mistakes Bear made, and didn't have any large hedge funds bet the farm on their demise. Would it be totally crazy to suggest that if Lehman was run better and managed better, that maybe their exposure wouldn't be bad as Bear’s?

Furthermore, and this is what really aggravates me. Everyone suggesting that those with a big retail business would emerge unscathed is absolutely crazy...

More to come on that in a second article.