Nov 10, 2008

Now that the election is over, maybe we can get on with the recession

President-elect Obama just spent $600+ million to win the Presidency, which I believe is a $400K per year job. I’m having a bit of trouble with the math, but that doesn’t look like a good ROI to me.

Weekly performance for the major stock indices
Based on the last Friday, Oct 31st official settlement

INDU: -4.2%
SPX: -3.9%
COMPQ: -4.2%
NDX: -4.8%
RUT: -5.8%

The Market and Earnings
A 4% down week is nothing to sneeze at, but when the week includes the largest gain ever on an election day (up 4%) and then follows that with the worst two day performance since 1987 (down 10%), sneezing could be down right dangerous. The economic releases were dismal, and the earning releases continued to limp in. Quoting the populists, now that the recession has spread from Wall Street to Main Street, corporate earnings are going to be challenging as both consumer and corporate spending hit the skids.

Over 90% of the S&P 500 constituents have reported so far, with 3Q earnings down 10%, especially weak given that at the beginning of 2008 analyst estimates for this quarter were an increase of almost 20%. The weakness is broad and appears to be getting worse. Estimates for the 4th Quarter and 2009 are probably much too high, and will need to come in significantly. Top down strategists have begun lowering their estimates, but the bottoms up numbers are much too high.

As if things weren’t bad enough for retailers, with retail comps negative for October, we are starting to experience significant bankruptcy filings (or companies on the verge). The retailers are starting to look like General Motors, who announced this week that not only would they not be buying Chrysler, but that they would run out of cash this week without an injection of capital.


The economic reports last week were flat out rotten. The ISM data came in weaker than expected, plunging below 40 for the first time since 1974. In an especially dour comment from a government agency, one of the quotes accompanying the release stated “it appears that manufacturing is experiencing significant demand destruction as a result of recent events”. Export orders in the ISM dropped for the first time in 70 months, which coincidently coincided with the great boom in industrial and commodity demand. If this trend has truly turned, it could spell more trouble for the small cap value indices, which was so robust for the bulk of this decade. Unemployment is really starting to hum as we lost 157K jobs a week ago, and the unemployment rate is now 6.5% and rising like an internet stock in 1999.

The upcoming week is a bit light on economic releases. The big one is Thursday’s University of Michigan Consumer Confidence. We highlighted that chart a few weeks ago, but have reproduced it again as this week’s estimate may should take it to a new low over the past 20 years.

Market Prophets

This year’s Elaine Garzarelli award goes to the author of “Black Swan”, Nassim Taleb . Professor Taleb is on a rapid rise to stardom after predicting some of the recent events with precision timing (his book came out just as the financial markets were beginning their demise). Professor Taleb, who is definitely not a fan of quantitative analysis, recently said that “quant models and business school curriculum is all wrong. They must abandon equations and look with the naked eye, emphasizing empirical vs. quantitative analysis”. I imagine that when the bloodletting on Wall Street subsides, there will be fewer PhD’s running those models and Professor Taleb will still be on the talk show circuit. I haven’t read the book yet, but am waiting for the Cliff notes.


Some very interesting comments this week as it relates to Europe. This week the BOE cut rates 150bps to 3%, the lowest rate since 1955, to help shore up their slumping economy. The EC came out last week and said Eurozone is now in a recession. Arcelor Mittal announced they would be cutting production by 35% due to weakness in Europe-quite a change from 12 months ago when they were running full tilt and trying to acquire major producers all over the world.

Europeans have not been shy in their support of President-elect Obama, and their hatred of everything US. Now that they have weighed in on our political system, I wonder how they’ll view the placement of 200 ICBMs in their backyard? Little noticed in the post-election hoopla was a statement by Russian Deputy Foreign Minister Alexander Grushko that they would be deploying missiles in Kaliningrad, a region wedged between Poland and Lithuania, but purely placed there to deter the US from deploying their own missile defense system. This situation should test the resolve of the Euro-support for President Obama, as well as his much bandied about diplomacy skills. The Europeans had better hope their multi-decade free ride on the tails of the US Department of Defense doesn’t end. Building a military is costly, and with the state of the Eurozone economy, they can’t afford to divert resources into building or leasing a military presence. Hopefully the French understand the word “comrade”, they may be hearing it a lot.


I try to keep politics out of this note as much as possible, but this week is a bit of an exception because there is a plethora of great material to carp on. Nancy Pelosi, has a penchant for making statements so outlandish they are often dismissed as the ramblings of a, well, a liberal democrat. Three weeks ago I joked about the new administration solving the budget crisis by confiscating private pensions ala Argentina. I didn’t realize that Speaker Pelosi already had that plan in the works. When the Dems took over Congress in 2006, evidently Speaker Pelosi made some comments about “nationalizing 401K plans” and raising capital gains rates to 80% to “help the 12 million illegal immigrants in this country achieve the standard of living that they wanted” as residents of the US. I can’t even comment here except to say that this is great material that even I couldn’t make up-no one would believe it.


When the market closed on Friday, I anticipated writing about China, where the market is down 70% from its highs, and the impact of the financial crisis on China’s growth is starting to take its toll. The funding drought has slammed the country’s factories as banks have spurned a state plan to lend. Exports are drying up, and GDP is estimated to grow at its lowest level since 1990. However, this evening (Monday morning in China), the government announced a $586 billion spending plan focused on infrastructure. The CSI 300 Index is up 5.2% as I write this, with copper rising 7% and the old regulars (primarily commodities) jumping as well. The Chinese plan to pursue a “moderately loose” monetary policy to goose growth. Personally, I think the world will be facing significant inflation by 2012, but until then let’s party like its 1999 on cheap and plentiful capital. If the Chinese can reinvigorate their economy, I may be forced to move from my negative (and very profitable) position on the IME stocks.

Miscellaneous Comments

1. I saw a report estimating CDS exposure worldwide at over $30 trillion.

2. JP Morgan announced they would be eliminating their proprietary trading desk.

3. I’m hearing the government is considering a bailout of credit card issuer Capital One.

4. Quote heard on Wall Street “This is worse than divorce, I’ve lost half my assets and I still have my wife.”

Miscellaneous Responses

Wow! The counter party risk is still enormous and I’m expecting more skeletons popping out of someone’s closet.
A good idea to get back to the business of banking and let the clients engage in higher risk activities. I’m sure some clients will be attracted to a lower risk business model, one which isn’t in direct competition with the customer.
Why? How is Capital One critical to the survival of the US financial markets and thus deserving of taxpayer money? These are the guys sending credit card applications to my kids and dog, they deserve to be out of business.
I don’t know if that’s a true quote, but it made me smile.

Good luck this week. As always, if you would like to be dropped from the list, please let me know.


Ned W. Brines

Office (562) 430-3232

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