Hackett Advisors in the News

Could Jackson Hole Be a Turning Point for Homebuilders?

Justin Rohrlich August 22, 2011 2:55PM

    "The Fed actually has one lever left in its bag of tricks: the reverse repo market," says money manager Shawn Hackett.

As we near the annual Fed hoedown in Jackson Hole, predicting what might transpire has become a parlor game of sorts.

Neal Soss, chief economist at Credit Suisse Holdings USA and a former economist at the New York Fed, says, “The chairman knows the whole world is watching, so if he chooses not to say very much, the markets and the economy in some broader sense would be disappointed. It's absolutely critical that the Federal Reserve portray itself as having some relevance to the economic problems the society faces.”

Stevyn Schutzman of RBC Capital Markets tells the FT, “While it’s possible the chairman may shed some light on additional easing, we think the news out of Jackson Hole will be about getting a better feel for the Fed’s opinion about its easing options and less about it actually choosing one of the options.”

And Nigel Gault, chief US economist at IHS Global Insight, says, “Unfortunately, the Fed doesn’t have any rabbits to pull out of the hat to magically reignite economic growth. It is doing what it can, and despite the dissent, that will probably mean a QE3 program at some point, but its prime ammunition has already been used.”

However, money manager Shawn Hackett, founder and CEO of Hackett Financial Advisors, believes Ben Bernanke and his merry band of central bankers have one more trick left up its collective sleeve.

“The Fed actually has one lever left in its bag of tricks: the reverse repo market,” Hackett tells me.

As he explains in his most recent client letter:

The definition of a reverse repo transaction is as follows: A purchase of securities with an agreement to resell them at a higher price at a specific future date. This is essentially just a loan of the security at a specific rate also called reverse repurchase agreement. Through QE-1 and QE-2 the Federal Reserve has helped re-liquify the banks and helped support runaway government borrowing at rates far below the true market rate by printing money. What quantitative easing did not do was get the fractional banking system going through the typical money multiplier effect. Banks are afraid to lend, borrowers are afraid to borrow and zombie loans remain in decay. This has kept the key housing asset market stuck in reverse.

The result is that the banks have deposited at the Federal Reserve 1.8 trillion dollars of unlevered capital better known as NBR’s (Non Borrowed Reserves). This is a massive amount of capital that it sitting there idle doing nothing and earning next to nothing. The Federal Reserve and the U.S government want this money to move into the system to help roll current government debt coming up for maturity and for future borrowings as well as for other bond asset purchases for states and municipalities and to help supply and expansion cheap mortgage loans.

These NBR’s can be levered 10:1 in the fractional banking system that we have today. This opens the possibility of extending bank credit by up to 18 trillion dollars without printing any more money or reserves by the Federal Reserve. That is a lot of money and a huge expansion of money supply.

“The Federal Reserve put together a list of approved counterparties called the Reverse Repo Counter Party List,” Hackett says.

(The full list can be found HERE)

Writes Hackett:

The NBRs would be loaned by the banks to the entities on the approved counterpart list. The entities on the approved counter party list would then take the money and buy short duration government bonds which have the highest quality and lowest risk. The government would guarantee to buy these securities back from these entities at an agreed to premium thereby generating a guaranteed return for the counterparty and the bank that loaned these counterparties the money. Even though rates on short duration government bonds out to 5 years are very low when you gear up 10:1 then the return on capital becomes very exciting indeed.

This then would allow for maturing government debt and new government debt to finance at ultra low interest rates thereby kicking the can down the road by minimizing the accelerating interest expense as a percentage of tax revenue. It would also allow for the Federal Reserve to say publicly that they are no longer printing money like they did with QE1 and QE2 which everyone would be against and to say that this is simply a normal expansion of bank credit that should have already happened but did not due to unusual extraneous conditions. It would also remove the worry about near term government funding and allow politicians to avoid taking any major austerity measures during a time of economic weakness.

It is an ingenious plan for sure. The public is very aware at the inflationary implications of printing money like quantitative easing. They may not be as aware that expanding bank credit is even more inflationary. This could allow for the current Ponzi scheme to go on longer before the public becomes fully aware of the dilutive effects of such a massive expansion of monetary policy.

“They’ve created this counterparty list on purpose -- it’s not by accident,” Hackett notes. “They’ve been conducting transactions to test the system since the spring, the money’s already been printed, so why would they be talking about these reverse repos, why would they be doing all this if they weren’t going to follow through?”

Hackett points out that “nobody wants another QE3, politically it’s just not viable. I don’t really see what else they could do that would have the effect of improving housing and jobs in time for them to get reelected a year from now.”

If Hackett’s prediction is accurate, it would launch “an even greater asset inflationary boom to hard assets than we have already seen and provide huge opportunities to reenter the long side of commodity markets and commodity related equities.”

Specifically, Hackett believes opportunity will likely present itself in homebuilder stocks such as DR Horton (DHI) or Pulte (PHM), but appears more enthusiastic about the timber companies that would benefit.

“I’d be looking at names like Rayonier (RYN), Plum Creek (PCL), which is a timber REIT, and PRT Forest Regeneration (PFSRF.PK), which is a company that produces the seedlings timber producers need for future harvests,” Hackett says. “You could also play it with an ETF like the Guggenheim Timber ETF (CUT).”

Hackett describes his view as “the quintessential contrarian play.”

“We’ll find out soon enough if I’m right about this,” he says.

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