The latest from Mr. Gross

[giofranchi]

You don't have the same problem here.  Housing is recovering, corporations are generating record profits, banks are the best capitalized they've been in 50 years.  You don't have a credit crunch anymore, but a credit glut...too much capital everywhere and no one wants to use it. Small businesses are still finding it difficult to get funding.  Venture capital is still difficult to find.  M&A's are still slow.  Fear is driving the credit markets right now, not actual fundamentals. 

 

Is there substantial deleveraging still going on...yes, it will continue over the next few years...but there is no real reason why capital markets in North America should remain tight.  It's fear!  And unfortunately, no administration is going to fix that.  It only happens with time as people forget and move forward.  As their lives start to recover.  The U.S. will recover, and it doesn't matter if it's Romney or Obama.  Cheers!

 

I don’t think it is only fear. I also think there is a lack of 15%+ investment opportunities. Quoting Mr. Cumming and Mr. Steinberg:

 

"We continue with the same lamentation as in previous years. There are hordes of private equity and hedge funds chasing low returns. While short term rates are very low, long term rates for non-investment grade borrowers such as Leucadia are quite high relative to expected returns.

As a result, opportunities meeting our investment criteria are few and far between. We would prefer higher interest rates and less availability of money, making acquisitions more attractive. We employ leverage in a careful way and do not intend to fall into the traps of employing too much leverage or borrowing short term and investing long. We will leave that silliness to the hedge funds.

 

Given the above, we have reduced Leucadia’s leverage by calling $511.3 million of long term debt in 2012 and retiring other debt during the last three years in market transactions. With those steps, we have cut Leucadia’s leverage by over 40%. Borrowing money at 7% without a clear path to make 15%+ is not attractive and we don’t see many opportunities to make at least that return. This cautious approach was evident in the purchase of National Beef; although banks were beating down our door to lend us more money, we paid cash.

 

A world-wide recovery in the near future is not a foregone conclusion. Europe and the future of the Euro are far from settled. Growth in China is slowing and the risk of a “Chinese Spring” cannot be ruled out. Iran is a big problem. In an environment of slow growth at home and a dysfunctional government, we believe that less financial leverage is better. We expect many other companies and investors share this view. We emphasize that we are not pessimistic, just cautious. We are enthusiastic about the future of our broad array of operating businesses and investments and have our eyes open for additional acquisitions. Never fear, if a good deal comes along we will find a way."

 

When 15%+ investment opportunities are "few and far between", prices must come down… When prices come down, the economy inevitably slows… I don’t think it is only psychology, I don’t think it is only fear.

 

Now, I know, many of you hate me!! There is a lot of optimism on this board and you must think of me as a joy killer… but, paraphrasing Mr. Cumming and Mr. Steinberg, I am not pessimistic, just cautious.

 

giofranchi

 

"If the dancing has slowed down, then the reason is not

just an overweight partner. It’s that the price of money

(be it in the form of a real interest rate, a quality risk

spread, or both) is too low. Our entire finance-based

monetary system – led by banks but typified by

insurance companies, investment management firms

and hedge funds as well – is based on an acceptable

level of carry and the expectation of earning it. When

credit is priced such that carry is no longer as profitable

at a customary amount of leverage/risk, then the

system will stall, list, or perhaps even tip over."

 

Also Mr. Gross is worried about too little return. Mr. Cumming and Mr. Steinberg may be complaining about too little return on equity, while Mr. Gross may be complaining about too little return on credit (a level of carry that is too low), but the result is the same: they all seem to be very cautious right now.

 

giofranchi

IO_Sept_2012.pdf