December 28, 2008
I hope that you and your family had a wonderful Christmas, and best wishes for a Happy New Year.
Weekly percentage performance for the major stock averages
Based on last Friday's official settlement...
I have discussed capital movement and pricing quite a bit over the past few months. One of the indicators I have been watching is the TED spread, the spread between US treasuries and LIBOR. The spread has dropped significantly since it peaked in early October, a sign that capital pricing is improving. The absolute level is still quite high, reflecting the concern which still exists regarding the capital markets, but the direction is a positive which should be viewed as positive for the markets.
In general the economic data was soft once again as poor housing data led the way. Existing home sales were down almost 9% and new home sales hit a 17 year low. The median resale price showed the biggest decline since record keeping began in 1968 and was probably the biggest drop since the 1930s, down 13%.
Mortgage applications showed a big jump last week, up 48% as refinancing activity picked up due to a drop in conforming 30 year rates to 5.1%. Jumbo loans, which typically are priced at a 25bps premium to conforming mortgages, are now roughly 215bps above that rate. The difference can be attributed to government support of the conforming market. That gap will need to close, with either jumbo rates coming down or conforming rates moving back up.
Personal consumption was down 3.8%, which the overly optimistic are spinning as a renewed focus on savings. Real consumption was up for the first time in six months, posting a 0.6% increase.
Everyone has been expecting a weak holiday shopping season, and while the final numbers are certainly not in yet, some preliminary numbers have been coming in over the past couple of days. Bloomberg reports that consumer spending on women’s clothing, electronics and jewelry during November and December were down 20%, the biggest drop in four decades. The CEO of retail advisory firm Financo said “It’s been difficult, much more difficult than anyone expected.” Macy’s, among many others, has been offering up to 70% off. Additionally, more than a dozen retailers have filed chapter 11 or chapter 7, including Circuit City, Linens & Things, and Mervyn’s. Like I said a few weeks ago, wait until after Christmas to buy those big screen TVs, they may just be giving them away.
Bucking the soft retail trend, Amazon.com announced Friday that they had posted their “best ever” holiday season. This may have been helped by the weather, which was pretty rough across the entire country for the past few weeks, keeping shoppers indoors. Amazon appears to have been bucking the online trend as ComScore reported that e-commerce spending (ex-travel) fell 17% year over year in the month of November. Although this is not surprising given the weak economy and five fewer post-Thanksgiving shopping days this year, this is weaker than we expected. (ComScore data courtesy of Credit Suisse).
Wanna Be A Bank?
The Federal Reserve approved GMAC LLC (the financing arm of General Motors, which happens to be 51% owned by Cerberus, the owners of Chrysler) to become a bank holding company. The Fed used their “emergency powers”, as opposed to their everyday powers, to approve the GMAC conversion to a bank. The Fed feels this move will help GMAC fund vehicle sales by GM (I didn’t realize those finance guys could actually help GM to make better products, but I’ll leave that alone for now).
A spokesman for GM’s National Dealer Council said that GMAC financing has been down 90% since they have been unable to access the debt market, and the banks won’t make auto loans either. He felt that a GMAC default might force 40% of GM’s dealers to close. While I never want to see a business go under and people lose their jobs, if you’ve followed my thoughts on the Big 3, one of my recommendations has been to streamline their dealership structure, and this may have been their chance.
GMAC was unable to tap the credit markets of late (like everyone else) because they had almost $8 billion in losses! Hmm, let’s see, the free market won’t lend them money because they managed to lose $8 billion making loans, yet the government is willing to let them become a bank. Now it makes sense, it was obviously just a classification issue. As an auto lender, your primary job is to make money on your loans, but as a US bank you only need to make the loans, and then our government will bail you out of the bad ones. GMAC certainly fits the description.
I’m going to use my emergency powers to turn myself into a bank. Please send your deposits to my home address.
ISI, which in my view is one of the better macro economic research firms, reported on Friday that their sales to China survey had fallen to 45.3 versus the high 60’s in the middle of the year and the 70’s in late ’07. While a bit late, they are now calling this the most severe global recession since the 1930s. The data fro China continues to be concerning, and I will continue to keep you posted.
I find it somewhat interesting to note the very strong correlation between the US and the Emerging Markets (EM). Economic activity in the emerging markets had been quite robust while US growth was somewhat anemic during this decade. Common portfolio wisdom has dictated investing in emerging markets as a way of diversifying away from the US, however, as this global slowdown (and in fact virtually every US recession) matures, it is quite obvious that the diversification benefits of holding emerging markets in your portfolio is greatly exaggerated. While the emerging economies may add additional performance to your portfolio during an expansion, in my view this should not be considered portfolio diversification, but instead should be viewed as adding additional risk to the portfolio with the goal of somewhat higher returns on the equity portion of your portfolio.
Obviously I’m skeptical that there is actually a “diversification” benefit from the emerging markets. In my view diversification into another asset should provide downside protection when one or more of your other assets declines. In this case, the emerging market assets tend to drop more, not less than the US. So where is the diversification benefit?
I’m sure that this view is probably put a good percentage of readers into overdrive, I’d love to hear your comments on this topic.
After staging an impressive rally since July, the dollar has stalled against the Euro. Much of the strengthening in the dollar was due to the unwinding of the high risk strategies involving the dollar and partially due to a flight to quality. As the dust begins to settle somewhat on the global financial crisis, the dollar is evolving as anything but quality. The fed has printed and committed to print dollars quite liberally over the past six months, and now the dollar is weakening once again. There are many economists concerned about deflation; however, I continue to beat the drum that says we will be battling inflation, more than likely sometime in 2010 or 2011.
According to the NY Times, courtesy of the Big Picture, there are presently $11.3 trillion in US mortgages outstanding. Of that total, $750 billion, or 7%, are option ARMs, which of course contributed to the current mortgage problem. Remember that the option ARM is a mortgage that starts with a low rate which later can, and usually does, spike up a couple years after funding. The NYT reports that of the $750 billion still outstanding, $119 billion (16%) was originated by Wachovia.
California vs. Chile
The question we must ask is who is smarter, the people running the state of California or those running Chile? Today in California we are some $48 billion under water with no viable way of raising the capital required to balance our budget. How did we get here? A large chunk of California’s tax base is dependent upon capital gains taxes. I don’t know about you, but I would view this as a variable revenue stream, not one that I would depend upon year in and year out. For some reason, those rocket scientists running California not only assumed the capital gains taxes would be a stable source of income, they also projected annual growth to fuel an ever increasing socialized experiment in spending. Now that these tax receipts have fallen to nearly zero, as well as a whole host of other taxes due to the economic collapse, what does our legislature prescribe as the cure? Of course, more taxes (actually, they are defining them as user fees, but that is another story). Did any of them take Economics 101? Raising taxes during an economic crisis is a sure-fire way to ensure the crisis lasts a lot longer. Is it any wonder that even during the boom jobs fled this state in record numbers?
What about Chile? Their economy was very dependent upon copper exports, the price of which has fallen 68% since its record high in May. Disaster? You’d think so, especially if the legislature of California had their hands on this bounty. President Michelle Bachelet instead held back on the spending while this windfall came in, and managed to stash away $28 billion to protect their state run services. How did they do that? By basing their expenditures on copper at $1.37 per pound, less than 50% of this year’s average. Chile isn’t going to completely avoid this crisis, but they should come out smelling better than California, and certainly at this point their government has proven to be more fiscally responsible than that of the Golden State.
The impact has been a huge jump in California’s borrowing costs as yields are now at a four year high on the state’s tax backed debt. This jump has come without a downgrade, which in my view should be coming soon. Of course, the ratings agencies do tend to be late in their actions (see last week’s note), so let’s just say I’m downgrading California to a B rating. I’m sure the agencies will follow suit, say in 2011. Right now California general obligation bonds maturing in 2038 and carrying an interest rate of 5.25% are trading around 82 and yielding 6.7%, up 1.6% from September. I’m certainly not a muni-bond expert, however, in my view the yields will continue to rise on these bonds, and at some point the US government may have to step in to help the state. When the press coverage on this issue hits a crescendo, and cocktail party chatter moves from Bernie Madoff to California, it will be a good time to step in and buy those bonds, especially if you live in California and qualify for the tax exemption.
What Did You Say?
Joseph Stiglitz, a Columbia University economist and Nobel winner, said “there are many cases all over the world where Wall Street banks have made loans that were beyond countries’ ability to pay. The bankers are to blame because they enabled reckless lending at high interest rates”. What? Isn’t that what they are supposed to do, lend at higher rates to lower quality credits as opposed to the subprime crisis where they recklessly lent at low rates? The smart people in this world keep making stupid comments, which keeps me very busy.
Bad All Over
Thaker Proffitt & Wood, 160 year old NY law firm, closing down. You know things must be bad if even the lawyers can’t keep their doors open.
Also from ISI, their Quant report charts the performance of the ISI Risk-Preference Index which tracks the performance of aggressive stocks (high foreign exposure, high P/E, smaller market cap, etc) versus more defensive names (low foreign exposure, lower P/E, larger market cap, etc). Though the performance of this index has been choppy, since the start of the year more defensive names have been relative outperformers. In other words, investors have been reducing their exposure to risky assets, but interestingly, since the middle of November investors have once again began purchasing risky assets.
Happy New Year to all of you, and here is to a successful 2009. I haven’t finished loading charts onto my blog site, so that won’t be up for a week or so. I’ve found I’m really not very technologically savvy, so I’m hacking my way through that one.