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Anyone intertested in exposure to Polish & Hungarian mortgages that are denominated in Swiss Francs with a yield of only 7.5%? I didn't think so. / So long Cap & Trade?

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April 13, 2009 – Comments (3) | RELATED TICKERS: GE , EXC

I wrote a post bashing a Barron's article that recommended buying GE Capital bonds a month or so ago (see post: Barron's is pumping the heck out of GE Capital bonds, but I'm not buying it). 

Since then, GE Cap has provided investors with more transparency on its portfolio of "assets" (to use the term loosely).  Steve Eisman of FrontPoint Partners recently gave a fantastic presentation on the mess at GE Capital at Jim Grant's (who is great BTW) annual conference last week.  Here are a few slides from the presentation that contain some eye-popping information (courtesy of Clusterstock).

Eisman estimates that GE Capital's portfolio of investments contains $41 to $46 billion in likely losses that it has not accounted for yet.

These messed up assets have the potential to force General Electric to take a huge charge against its earnings in the future.

The GE Capital's securities are currently on its books at $5 billion more than their actual current market value.

Then there's those beautiful Polish, Hungarian, and UK mortgages that it has on the books.

Lastly, there's all of the commercial real estate that GE Capital owns.  Many analysts believe that this is the next big looming problem for banks and the economy.  Eisman estimates that GE Cap's commercial real estate may currently be worth 40% less than it is carrying it on its books at.

When the Barron's piece pumping GE Cap bonds was published the bonds that it mentioned sported the following yields. 

GE Capital 5.625% 2018: Yield to Maturity (YTM) 7.59%

GE Capital 6.45% 2046: 8.82% YTM

GE Capital 6.05% 2047: 9.14% YTM

Yuck.  So the choice here is either to purchase nine year bonds in a seriously messed up company at 7.6% or lock up my money for the rest of my life at a point to a point and a half more than that and cross my fingers that interest rates never rise again.  No thanks.  There are so many amazing investment opportunities out there right now that I can't fathom who in their right mind would buy GE Cap bonds.

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Around a month and a half ago I wrote about the potential passage of cap and trade legislation and how it would be beneficial for two companies in my personal portfolio if it did pass (see post: Cap and Trade: Will it happen and what does it mean for the economy?)

According to a piece in today's New York Times, the momentum for some sort of Cap & Trade law may be stalling, (see article: Obama, Who Vowed Rapid Action on Climate Change, Turns More Cautious ). 

Obama ran for office on a platform of change.  One of the big changes that promised was swift action to tackle global warming (I'm not here to debate whether it exists or not, I'm just looking at how it would affect investments).  As promised, the first draft of Obama's budget plan contained approximately $650 billion in revenue over decade 10 years from a cap and trade plan.

However, in an effort to protect the health care reform that Obama and friends evidently value more, the administration has eased off its insistence that cap and trade be included in the budget.  It was not included in either budget resolution that the Senate or Congress passed last week.

Cap and trade may have been moved to the back burner, but it's far from dead.  Even if it never comes to fruition, I still like the companies that I invested in to take advantage of the potential passage of this sort of legislation.  I have waxed poetically about FPL Group (FPL) a number of times in the past, but I have not elaborated as to why I like my other play Exelon Corp. (EXC) so much.

Exelon is a huge player in the nuclear power arena.  It currently sports a fairly safe dividend of around 4.5%.  I downgraded the word "fairly" in the previous sentence from "extremely" because there's always the potential for the company to make a large acquisition and revisit its dividend policy...see Pfizer.  Still, Exelon's current payout amounts to only 2.8% of its current operating earnings and it has a solid $1.4 billion in cash on its books.

If cap and trade happens, clean power companies like EXC will be amazing investments.  Even if it doesn't this is a very solid company with a great dividend.

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Interesting chart and article: China Slows Purchases of U.S. and Other Bonds

Deej

3 Comments – Post Your Own

#1) On April 13, 2009 at 2:02 PM, TMFDeej (99.25) wrote:

According to the wise folks at Stratfor (which is a fascinating site BTW), Chinese exports fell by a whopping 25.7% year-over-year in Feb. This is even worse than the 17.5% drop in exports that it reported a month earlier.

Clearly the main driver of Chinese exports, American consumers...or over-consumers one could say, is slowing. Despite calls by many analysts that the world is decoupling as late as a year ago, clearly the old axiom "When the U.S. sneezes, the rest of the world catches a cold." is true. With consumer confidence low, savings rates rising, and scared Baby Boomers reducing their level of spending...perhaps permanently, the U.S. consumer may not be riding to the rescue any time soon.

So how can China turn around its economy? It needs to wean itself off of its reliance upon exports, they currently account for approximately 40% of Chinese GDP, and stimulate domestic demand. It needs to do so ASAP to avoid possible civil unrest amongst its migrant workers. The Chinese government certainly seems to be trying. It rolled out a massive 4 trillion yuan ($586 billion) stimulus package well before we did so here in the United States.

So what does all of this mean for U.S. investors? Obviously, anyone here can purchase Chinese stocks. While I have been optimistic for some time that Chinese stocks would outperform the U.S. markets in 2009, as of right now I see very little evidence of an economic recovery in China. Focusing on the purchasing manager's index while ignoring the elephant in the room, a massive drop in exports, seems foolish to me. Doing so is like the U.S. investors who have been focusing on the better than expected (perhaps less worse is a better, yet grammatically incorrect description) retail sales numbers and boosting U.S. stocks over the past several days.

Less obvious than its impact upon Chinese companies and their stock prices, the country's massive drop in exports could ultimately affect its appetite for U.S. Treasuries. The Chinese government has generated large trade surpluses and built up massive and reserves over the past several years. It has been using much of this money to buy Treasuries. Without China's massive appetite for our debt, interest rates would likely have to head much higher.

China prefers to use its trade surplus to buy bonds rather than tapping into its reserves to do so. If its exports, and in turn its trade surplus, continue to fall it will have less money to buy our debt. Its February trade surplus fell to a paltry $4.84 billion, down from $39.1 billion in January. This is definitely a number to keep an eye on. The lower it gets, the more difficult it will be for China to finance U.S. spending.

For now, the demand for U.S. Treasures continues to be robust (see article: Investors are still gobbling up Treasuries). There is absolutely no physical evidence that China will stop buying Treasuries, but it continues to make threats that it might do so in the future. Just yesterday Chinese Premier Wen Jiabao said "We have made a huge amount of loans to the United States. Of course we are concerned about the safety of our assets. To be honest, I'm a little bit worried. I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets."

The amount of our debt that China holds gives it a lot of power. Analysts estimate that China currently holds approximately $1 trillion in U.S. Treasuries and similar notes issued by government-affiliated agencies. If it becomes apparent that the Chinese are unwilling or unable to continue buying Treasuries at the current rate, interest rates would likely begin to rise, something that we can ill afford during an economic downturn.

I see China doing a whole lot of talking and not a lot of walking on this front right now. I suspect that it will continue to buy massive amounts of Treasures for as long as it can, well into 2010. Fixed income investors definitely need to keep an eye on China. It is probably best to avoid super long-term debt at this point and to instead focus on issues that will mature over the next several years. I'm not worried about a spike in interest rates in the near term, but long-term it is going to be difficult for the U.S. continue to issue debt at this rate and expect foreigners to keep gobbling it up.

The NYT published an excellent article on the subject of China and its purchases of Treasuries today. The following graphic alone is worth the price of admission:

http://graphics8.nytimes.com/images/2009/04/13/bus...

Of note, the Chinese government actually sold bonds heavily in January and February before resuming purchases in March.

China’s foreign reserves grew by only $7.7 billion in Q1, the lowest number in almost eight years. This compares with a record $153.9 billion rise in foreign reserves dueing the same quarter a year ago. Even if China continues to have the desire to purchase treasuries...it may not have the money to do so.

Deej

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#2) On April 13, 2009 at 2:17 PM, tonylogan1 (28.22) wrote:

I suscribe to the stratfor email, which typically scares me once or twice a month.

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#3) On April 13, 2009 at 2:20 PM, Cherryz (32.35) wrote:

I hold nrg, sold out of everything else as i think we'll go down a bit, as my only long term hold.  I hope they don't get acquired by exc =/.  All utilities are fairly cheap in my opinion.

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