10/01/14   Your Beef Is With Congress

Editor’s Corner

Ron Rowland

The Federal National Mortgage Association (FNMA), better known as Fannie Mae, and the Federal Home Loan Mortgage Corporation (FMCC), better known as Freddie Mac, are Government Sponsored Enterprises (“GSEs”).  Although they are not actual government entities, they have historically enjoyed a public perception of being so.  Many investors treated their bonds as though they were backed by the full faith and credit of the U.S. government.  In fact, the media usually portrayed the securities of Fannie Mae and Freddie Mac as having an implicit government guarantee.

As their names imply, these firms are in the mortgage business, and the financial crisis of 2007 and 2008 brought their survivability into question.  They were on the brink of bankruptcy in 2008.  At one point, the government was thinking it might take over the firms.  Alternatively, it was considering making their “implicit” guarantee an “explicit” one with a $5 trillion backing.

In September 2008, both Fannie Mae and Freddie Mac were placed into conservatorship, which was viewed as one of the most sweeping government interventions to ever be undertaken in the financial markets.  The firms issued new senior preferred stock and common stock warrants to the Treasury, essentially making the Treasury 80% owners, and dividends on previously issued securities were suspended indefinitely.

Despite the dire outlook for those prior securities, many fund managers decided to gamble and loaded up at discount prices.  In 2012, Congress amended the terms of the bailout.  Referred to as the Third Amendment, it allowed Treasury to have nearly all future profits from the two firms.

Meanwhile, fund managers decided to file various lawsuits (about 20 in all) against Fannie and Freddie, charging breach of contract in regards to dividends, liquidation preferences, and future profits.  Today, U.S. District Court Judge Roy Lamberth rejected the claims on the first of those lawsuits, stating the 2012 amendment “requires Fannie Mae and Freddie Mac to pay a quarterly dividend to Treasury equal to the entire net worth of each” entity, minus a small reserve that shrinks to zero over time.

In other words, the Judge told investors their lawsuits (and anger) are misdirected.  Instead of suing Fannie Mae and Freddie Mac for following the Third Amendment, they should be suing Congress for passing the law.  Stay tuned.  This one is not over.  Stock prices of both firms were about 35% lower in today’s trading.

Investor Heat Map: 10/1/14


Sector categories continue to weaken with five more moving into the red this week.  The newcomers’ momentum scores went from being slightly positive to slightly negative.  Although the changes were small, it was enough to reverse the direction of their momentum.  Health Care kept its top ranking, a position it has now held for five weeks.  Technology maintained its second-place ranking, although its momentum score dropped down to single digits.  Consumer Staples and Financials swapped positions, with the defensive nature of Consumer Staples giving that sector the edge.  The Financials sector is barely clinging to a positive trend and will likely be the next to turn negative.  The five categories that moved to the red occupy the fifth through ninth places and consist of Materials, Telecom, Utilities, Consumer Discretionary, and Industrials.  Real Estate was the only sector to not lose momentum over the past week, although it didn’t gain any either and will have to be content with its “unchanged” status.  Energy continued to weaken and fell further into negative territory.


The relative strength ordering of the style categories is unchanged from a week ago and continues to indicate a defensive posture.  Capitalization is the predominate characteristic determining relative strength, with the largest stocks showing the most resilience in this market.  Growth has an edge over Value within each capitalization strata.  Mega Cap is on top, followed by Large Cap Growth, Large Cap Blend, and Large Cap Value.  They are the only four style categories able to avoid negative momentum scores this week.  The three Mid Cap categories were in the green a week ago, but they now find themselves on the red side of the ledger.  The four categories representing the smallest capitalization stocks were the only ones in the red last week, and they have now moved into deeper downward trends.  Small Cap Value is on the bottom.


Once again, the U.S. is the only global category with positive momentum, although it is in jeopardy of joining the other regions in negative territory.  The cap-weighted benchmarks used in our rankings allow the U.S. to post a positive score despite the fact the majority of its sectors and styles are in negative trends.  Japan held relatively steady in a volatile week, which allowed it to move up a notch to second place.  World Equity fell to third due to weakness outside of U.S. markets.  China, Canada, EAFE, and the U.K. maintained their third through seventh place rankings, although they all increased the magnitude of their negative trends.  Europe had a bad week, but it’s not immediately obvious from its two-position climb in the rankings.  Sometimes relative strength just means “less weak” than the others.  Emerging Markets and Latin America are two such “others” that dropped in the rankings with Latin America feeling the most pain.  Pacific ex-Japan is on the bottom for a second week


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


[The Third Amendment may] “raise eyebrows, or even engender a feeling of discomfort, but any sense of unease over the defendants’ conduct is not enough to overcome the plain meaning” [of the language of the law].

From Judge Roy Lamberth’s decision to reject the claims of lawsuits against Fannie Mae and Freddie Mac


© 2014 AllStarInvestor.com All Rights Reserved. Protected by copyright laws of the United States and international treaties. Nothing in this e-mail should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. Any investments recommended in this letter should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company. All Star Investor employees, its affiliates, and clients may hold positions in the recommended securities.

Distribution is encouraged. Please do not alter content.