Apr 27, 2009

“Although perfectly legal, this move is also perfectly delusional, because some day soon these assets will be written down to their fair value, and it won’t be pretty.”-Steven Roth, professor of management at the Tuck School of Business at Dartmouth College, on Bank of America’s earnings fraud

April 26, 2009

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: -0.7%
SPX: -0.4%
COMPQ: 1.3%
RUT: -0.1%

The market closed slightly down for the week, breaking a six week streak of positive performance. The market was actually able to close up from Monday, as the week began with a stiff correction following the Bank of America quarter. Additionally, credit card companies are once again talking about rising delinquencies and defaults, further spooking a market that seems to believe a recovery is eminent.

I mentioned the rout on Monday, as financials were smoked as the EPS issues became clear. BofA reported improved and better than expected earnings, but added an additional $6.4 billion to their reserves to cover increased losses on consumer, credit-card, and commercial real estate loans. After cheering for Wells and other big banks who also obfuscated their real earnings with accounting gimmickry, the market finally woke up when they realized that BofA’s numbers were completely make-believe.

From Bespoke (re: Monday) “ the 50 stocks that were up the most from March 9th through April 17th are down an average of 10.4% today, while the S&P 500 itself is down 3.65%. As you go down the list of deciles from the best performers during the rally to the worst, the performance today gets better. Clearly, investors are selling the big winners over the past few weeks, while the stocks that haven't participated on the upside are down the least today.”

The table below, courtesy of Briefing.com, shows that materials, industrials and consumer discretionary were the leading sectors last week. More importantly, the market continued to be led by low priced, small cap stocks. The Russell 2000 is now up 39% during this rally versus 28% for the S&P 500.

Look Out Fed
Paul Volcker came out during the week and said the Fed has massively overstepped its mandate and that the doubling of the Fed’s balance sheet not only ensures renewed inflation but also threatens the Feds independence from the government.

That’s comforting.

It’s no secret that credit is still tight, but definitely improved over the fall. The TED spread below is representative of a number of credit measures, which have improved but are still much higher than historical levels. The Fed continues to print money (by purchasing Treasury and other debt) in an effort to lower borrowing rates. Jumbo mortgages have finally nudged lower, although the spread between jumbos and conforming rates still sits at a record high.

The Index of Leading Economic Indicators (see chart below) were reported Monday and came in slightly under consensus at -0.3% versus -0.2% consensus. Once again the biggest positive data points were M2 and interest rate spreads, which contributed 0.34% and 0.26% to the index. Consumer expectations added 0.08%, and consumer goods orders were flat. All other components were negative, led by building permits (0.26%).

The Federal Housing Finance Agency reported that home prices rose 0.7% in February versus January, the second consecutive increase in that measure. Existing home sales were down 3% to an annualized rate of 4.57 million, less than the 4.65 million estimate and lower than the prior period of 4.7 million. Interestingly, over 50% of the transactions were attributed to first time buyers, many of which are receiving a federal subsidy of $8000. The affordability index is rising; however, employment concerns may overwhelm the improving affordability. The ever bullish National Association of Realtors feels the market has already turned in California.

Initial jobless claims increased once again from last week’s revised 613K to 640K.

The headline number for March durable orders was better than expected, down -0.8% versus a consensus estimate of -1.5%. Excluding transportation, orders declined -0.6%, which was also better than expected (consensus -1.2%). There were downward revisions for the February data for both components. Orders were shown to be up 2.1% versus an originally reported increase of 3.4%, while the ex-transportation number was up 2.0% versus an originally reported increase of 3.9%. Looking within the March report, shipments were down -1.7% after a -0.8% decline in February. Meanwhile, the continued weakness in business investment was evident with a -1.7% drop in nondefense capital goods, excluding aircraft. That followed a 0.1% increase in February and a -9.4% decline in January.

More Quant Problems
According to Bloomberg, funds relying on quant/momentum strategies have been slaughtered in the recent rally. These funds speculate that the stocks which have performed the worst over the prior twelve months will continue that underperformance. The result has been a reported decline of 27% in the past month alone.

It’s not a true bear market until everyone gets wiped out, even the shorts.

Responsibility Abdicated
According to the Wall Street Journal Ken Lewis, Bank of America’s CEO, is claiming that Hank Paulson and Ben Bernanke encouraged him not to say anything about the pending losses at Merrill Lynch when he was acquiring the firm. Hey Ken, that’s illegal! Bloomberg reports securities regulators are now investigating all three.

As I mentioned a few weeks ago, this bank has already abandoned its customers, and now apparently they also abdicated their fiduciary responsibility to their shareholders. Slide over Rick Wagoner, Ken Lewis needs a seat on your bus.

The Dollar
From the CFA daily briefing: China wants closer surveillance of major reserve currencies. Reforms to the international financial system should include "strengthened surveillance" of the economic policies of nations that issue the most important reserve currencies used in global trade, said Wen Jiabao, China's premier. The U.S. was not mentioned by name, but Chinese officials recently expressed concern about the nation's assets held in U.S. dollars.

More Glass Houses
Ever the populist, Nancy Pelosi has called for a probe of Wall Street patterned after the Senate Banking hearings in 1933 led by Ferdinand Pecora. Members of Congress may be reluctant to tackle the recommendations of such an inquiry because of financial industry donations to political campaigns, said Wall Street historian Charles Geisst.

Financial services has been the biggest contributor in every U.S. election cycle in the last 20 years, according to the Center for Responsive Politics, a Washington research group that tracks campaign money. Its individual and political action committee donations in 2007 and 2008 totaled $463.5 million, compared with $163.8 million from the health-care industry and $75.6 million from energy companies.

Individual and PAC donations from Goldman Sachs Group Inc. which totaled $30.9 million, and Citigroup Inc., at $25.8 million, were higher than those from any other company except AT&T’s $40.9 million over the last 20 years, the center’s compilation of Federal Election Commission data shows.

More Jobs I Could Do in Four Hours per Week

The IMF has announced that the world economy will shrink 1.3% this year. Their prior estimate, made in January, was for an increase of 0.5%.

I need to be careful because if I commit to taking on too many of these useless functions, I may not have time to write this note.

Miscellaneous Bank Comment

“Instead of receivership and liquidation, we rewarded these cretins with your grandchildren’s lunch money. It is idiocy on a grand scale, beyond my feeble imagination.”-Barry Ritholtz

Billions Later, Defaults Still Rising

Prime borrowers at least 60 days behind on mortgages rose from 497,131 in December to 743,686 in January, according to the Federal Housing Finance Agency. This is almost double the total for October.

From Bloomberg: “Fannie Mae and Freddie Mac mortgage delinquencies among the most creditworthy homeowners rose 50 percent in a month as borrowers said drops in income or too much debt caused them to fall behind, according to data from federal regulators. Of all borrowers who ended up in default, 34 percent told Fannie and Freddie they were earning less money, about 20 percent cited excessive debt as a reason for missing mortgage payments, and 8.1 percent blamed unemployment, FHFA said.”

Hickey and Walters (Bespoke) submit:
“A fifth of the companies in the S&P 500 have reported earnings for the first quarter, and so far earnings are down 16.6% versus the first quarter of 2008. While down, this is much better than the -37.3% expected at the start of earnings season. When comparing actual earnings versus estimates, Consumer Discretionary, Financials, and Energy are leading the way. Consumer Discretionary was expected to see a year over year decline of 103.4% at the start of earnings season, but the companies that have reported in the sector have only seen earnings decline 22.2% so far. And Financials are actually showing earnings growth with 26.3% of the reports in.

From Ned Davis Research- “Crude oil inventories continued to climb, rising by 3.9 million barrels last week, its seventh consecutive increase, to 370.6 million barrels, the most since September 1990, even as refineries began coming back on line after routine maintenance. Analysts were expecting an increase of 2.5 million barrels. On a days’ supply basis, crude oil is at its highest level in over 15 years. All major categories posted stock increases and inventory levels remain above average for this time of year, as demand destruction for all products continues.”

Global Economy
From NDR- The OECD Composite Leading Indicator (CLI) for OECD countries plus key non-member economies, a proxy for global growth, decreased for a 14th straight month, falling 0.8 points. The monthly decline in the index, however, was the smallest since last June, indicating a slowdown in the rate of deterioration. A quarter of the countries, including South Korea and France, even saw an increase in their CLIs. Nonetheless, all of the leading indicators remained below their long-term averages, indicating continued economic slowdown. Although it is still too early to tell, we may be seeing signs that the worst of the global downturn has passed.

Big 2? How about Big 1?
The New York Times is reporting that Chrysler is preparing for bankruptcy. The company announced that they had reached an agreement with the UAW, although a union vote still needs to occur. A portion of the deal calls for the UAW health-care trust fund for their retirees to take a 20% ownership stake in Chrysler.

Ford reported Friday, cutting $1.9 billion in costs, paying down debt, and still focused on avoiding taking government aid. Ford said it lost substantially less than analysts had expected during the first quarter.

The Fed’s Shell Game
According to disclosures by the Fed they had unrealized losses of $9.6 billion at year end on the $74 billion in subprime mortgages, leases and other assets from Bear Stearns and AIG. The US taxpayer will have to reimburse the central bank for those losses through TARP. This could be the tip of the iceberg as the Fed has loaned roughly $2 trillion to various financial institutions.

Let me get this straight-first the Fed is effectively printing money to buy government IOUs and other garbage securities, then they lose billions on those securities, then the same government that borrowed money from them is going to have to give them a loan?

Attention Ben!! If anyone else took federal money and then lost it while engaging in a fraudulent transaction would end up in jail, fired from their private sector job by the government, or certainly on the front page of the NY Times.

Even More Fed
Not content with the pending losses on their many investments, The Federal Reserve began buying Treasuries maturing between May 2012 and August 2013 as part of the central bank’s efforts to reduce lending rates and lift the world’s largest economy out of recession.

From Doug Tengler at Bloomberg: Why couldn’t former Treasury Secretary Hank Paulson solve this problem? And why does it seem as though his successor, Tim Geithner, won’t even look us in the eye and spell out his strategy? Is it because they don’t get it? No. It is because they know—like Roy Scheider in the movie “Jaws,” when he first saw the great white shark—that “we’re gonna need a bigger boat,” and they’re too afraid to tell us just how big.

Have a great week. As always, please let me know if you’d like to be removed from this list. Thank you for all of the referrals, which have driven the list up to around 700.

Old notes and links to related websites can be found at http://weeklymarketnotes.blogspot.com.


Ned W. Brines
O (562) 430-3232

Apr 20, 2009

Less Bad is the New Good

Less Bad is the New Good

April 19, 2009

“Everybody’s talking smack, but nobody’s got anything on the table.”-Bill Zabowski, GM bondholder

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: 0.6%
SPX: 1.5%%
NDX: 1.0%
COMPQ: 1.2%
RUT: 2.4%

The S&P 500 closed the week at 869, marking the sixth consecutive week of gains. Whether this ends up being a bear market rally (I’m still in this camp, although my perseverance is being tested) or a new bull market, this rally has proven that the “pain” is to the upside. Short sellers, who until now have been relatively unscathed in this bear market, are finally paying the piper as this rally takes the market ever closer to its 200 day moving average. The rally is being led by those stocks with the biggest short positions.

According to State Street bank, institutional investors are driving the stock market's recent rise. The firm, which monitors the buying and selling of $12 trillion in assets it holds as custodian, says monthly cash flows into equities are in the 98th percentile - close to a 12-year high!

The financials have soared during the rally, contributing roughly 25% of the gain S&P 500 (see chart below, blue). The red portion of the chart shows that on a weighted basis, the financials have really outperformed, contributing nearly twice their weight in the index. As I have been discussing the past few weeks, you can see that the more economically sensitive, early cycle groups have led this rally while the defensive groups (i.e. healthcare and consumer staples) have lagged.

The market certainly seems overbought given the S&P 500 now sits 28.5% above its 50 day moving average. This is the highest level since 1990 (and probably earlier), as shown in the chart below from Bespoke.

Economy Improving?
Personally I’m a bit concerned that many of the same people who missed the entire financial crisis until we were in the middle of it are now proclaiming things are better (sorry to call you out, Mr. Bernanke). I fall in the camp that the rate of decline may have slowed, but the economy is still going down at a rapid pace. Corporate earnings estimates are still too high for 2009 unless, of course, there are more accounting rule changes on the way.

The International Energy Agency is predicting 2009 demand for oil to fall to its lowest levels in five years as factories continue to slump. They are predicting demand of 83.4 million barrels per day vs. 85.8 million per day in 2008. US crude supplies are now at their highest level since July 2003.

March retail sales posted the first under-consensus economic data point in quite some time, declining 1.1% versus an expected increase of 0.3%. Sales excluding autos fell 0.9% versus flat expectations. Food and beverage stores were up 0.5% and health and personal care were up 0.4%. All other categories were down, led by electronics and appliances down almost 6%.

The most entertaining portion of the soft retail report was the talking heads on CNBC, who seemed shocked that sales were down. Are they living in the same economy as the rest of us?

The jobless numbers were slightly better than the expected increase of 9,000 to 663,000, although the prior week’s claims were upwardly revised by 9,000. It should be noted that the majority of last week’s drop occurred in states that posted sizable gains in prior weeks and that the start of the new quarter may have posed some seasonal adjustment issues. Nonetheless, the four-week moving average fell for the first time in 13 weeks to 651,000. Continuing claims in the prior week increased by 172,000 to a record high 6.022 million. As a result, the insured jobless rate inched up 0.1 point to 4.5%, the highest level in over 26 years.

Exports from the Port of Long Beach jumped nearly 27%, the most since October 2003, and more than the typical seasonal gain. Imports climbed almost 25%, the most in nearly four years. These are encouraging
signs that the trade freeze is thawing.

PPI was anticipated to be flat, but fell 1.2%, pulled down by a 5.5% drop in energy. The core PPI (ex food and energy) was flat after 0.4% and 0.2% increases in January and February.

March Core CPI came in at +1.8% vs. the +1.7% consensus. March reported CPI was -0.4% vs. -0.1% consensus.

Housing starts fell 10.8% and building permits fell 9% in March, both well short of estimates. Existing home sales seem to be benefiting from low mortgage rates while foreclosure and forced sales at depressed prices are accounting for a bulk of the activity. As lenders end the moratorium on foreclosures, filings have increased by 24% to 800K in the first quarter. Interestingly, mortgage applications declined last week for the first time in a month.

Industrial production was down 1.5% in March, the 5th consecutive decline. Expectations were for a 0.9% decline. Capacity utilization (see below from Bill King) dropped to an all time low of 69.3% (record keeping started in 1948).

The Michigan Consumer Sentiment Index came in at 61.9 versus a consensus of 58.5. This is an improvement over 57.3 the prior month.

The Philadelphia Fed Index went the way of the Empire Manufacturing Index and surprised the market with a better-than-expected reading. Specifically, the index checked in at -24.4 (consensus -32.0) for April versus -35.0 for March. The April reading still connotes contraction, but it suggests the pace of decline has slowed. The most notable component within the report perhaps is the jump in the six-month outlook for general business activity, which rose to 36.2 from 14.5. That was the fourth consecutive monthly improvement and leaves the reading well above the -10.4 level registered in December. As for the April report, the new orders index went to -24.3 from -40.7; inventories went to -40.2 from -55.6; prices paid held pretty steady at -31.5; prices received went to -41.4 from -32.6; shipments slipped to -35.7 from -26.5; unfilled orders moved to -19.5 from -22.8; and delivery time went to -17.1 from -30.8.

Shared Sacrifice
While the Obama administration has espoused a philosophy of “shared sacrifice”, and has been extremely critical of any corporation lavishing perks on its employees, apparently the walls of the White House are made of glass. In the first 60 days occupying the White House, the Obama’s hosted 50 social events. According to Dee Dee Myers, the former press secretary for Bill Clinton, the Obama social event calendar is twice the number of events held by the Bush administration and even surpasses the number held in the ‘party-loving’ Clinton White House.

I remember an adage about people who live in glass houses and wonder if it extends to those living in white houses?

From Karl Denninger: “Makes you wonder if having a Treasury Secretary who was a former CEO of Goldman Sachs had anything to do with this. Indeed, not only was Hank Paulson Goldie’s boy, but he was the same gentleman who so vociferously lobbied the SEC to allow the 5 largest investment banks to drop the net capital rule and leverage up 40 to 1. So not only did he help set up the disaster, but he then oversaw the greatest transfer of wealth in the planets history — several trillion dollars from taxpayers to the management and shareholders of inept, incompetent, wildly irresponsible companies.”

Note that Goldman reported a huge 1st quarter profit (see More Goldman below) this past week and many are attributing their quarterly success to the double dip gains on the AIG trade. Speculation is that they were hedged on their AIG exposure (possibly even short AIG stock), then collected 100 cents on the dollar when the government made all of AIG’s counterparties whole. Interestingly, they also announced they would be cutting their dividend as well as raising $5 billion in new equity to pay down their TARP loan.

More Goldman
GS reported a $1.8 billion gain in the first quarter, but there was some sleight of hand in those numbers. The company changed its fiscal year end from November to December, which means the month of December results became orphaned (the company reported the quarter ended November, and last week the quarter ended March, which meant that December results magically disappeared into the footnotes). Among some of the results for the month of December were $2.7 billion in “fair value losses”, in other words write downs of bad loans.

I wonder how much of the stronger bank earnings (see Citi below) gracing the headlines the past two weeks were due to more AIG Tomfoolery?

Citi reported full EPS this week (remember they pre-announced a couple of weeks ago), and a portion of their smallest loss since 2007 was directly attributable to the deterioration in their own credit quality. It seems that they were able to book a $2.7 billion gain from their own credit default swaps.

The continued deterioration in Citi’s credit quality actually resulted in a gain for the company!

Fair Value Accounting
Fair value accounting requires financial institutions to mark their holdings to market value. As I discussed in the April 5th note (http://weeklymarketnotes.blogspot.com) under “mark to imagination”, FASB (the accounting rules makers) recently announced a plan to eliminate fair value accounting. The FASB plan has recently been opposed by the CFA Institute for Financial Integrity (disclaimer, I am a member). The institute represents financial services professionals who have achieved the Charted Financial Analyst designation. In their letter to members, they stated “We also have undertaken considerable outreach to regulators, legislators, other organizations, and the media to represent investors and convey the negative implications of such hasty and damaging modifications to the transparency and accuracy of fair value reporting.”

Corporate Debt
According to Bloomberg, spreads on high-yield bonds have narrowed to their lowest point in over six months. The gap now sits at 15.85% over treasuries, down about 3% since the beginning of March. Issuance of high-yield debt is up over 15% from this point last year with $14 billion issued YTD.

California Taxes
From Mike Shedlock: “Like the proverbial frog in a gradually boiling pot of water, Californians apparently didn't notice taxes being elevated incrementally until they now have the highest income tax rate in the nation, the highest sales tax rate and the sixth-highest overall tax burden among the 50 states. Incredibly, tax-happy state legislators now want taxpayers to add another $16 billion in taxes to their burden by approving an initiative the lawmakers put on a May 19 special election ballot, on the heels of $12.9 billion in new taxes the Legislature itself imposed only two months ago.”

Oil to China
A deal to build a branch of the Eastern Siberia-Pacific Ocean pipeline toward China received final approval from the Russian government, the Itar-Tass news agency reported. At a meeting of the Russian Cabinet, Prime Minister Vladimir Putin said the branch will "create a stable and reliable sales market for oil" to be delivered to Russia's eastern customers.

China is continuing to use their dollar surplus to ensure a stable energy supply while we avoid any attempts to become energy independent.

Thank Goodness that’s settled

The U.S. and Chinese economies are so closely aligned that “China would not consider dumping Treasuries or other actions that would disrupt U.S. interests” said Richard Fisher, president of the Federal Reserve Bank of Dallas. "China cannot succeed if the U.S. does not succeed," he said.

Alternative Energy
US consumers pay average of $.11 per kilowatt-hour (kWh) for power derived from coal, natural gas, nuclear and hydroelectric. The proposed $10 per ton carbon tax would increase the price of coal-fired electricity by $.01 per kWh or 9%. In an effort to help the environment, the new administration is pushing renewable energy sources hard, regardless of the economic impact. Below I have shown some alternative energy sources, their costs, and some of the benefits/drawbacks of each. The pricing estimates are from Scientific American, and are estimates at full deployment (current pricing is much higher).

Solar-Thermal-At a cost of $.20-$.28 per kWh, this technology is expected to cost three times current sources. The advantage is that it may be one of the only renewable sources which allows for the storage of energy to meet peak demand. The drawbacks are the need to locate in deserts, far from existing transmission lines and available water for cooling.

Ocean Wave Power-The price is unknown at this point as the technology is still in its design phase. The advantage is that most of the population is located near the coasts. A major drawback will be designing a building that can withstand 50-75 years of heavy waves.

Geothermal-At a cost of $.062-$.076 per kWh, geothermal is actually cheaper than the existing technology. The advantage is that the supply is very reliable, and can generate to meet daily demand patterns. The downside is the pollution given off by the steam from underground water can be highly toxic and corrosive.

Solar-Photovoltaic-Right now this technology is one of the furthest along in commercial deployment; however, it is heavily subsidized by governments due to its high cost, $.47-$.71 per kWh. The major advantage is the ability to overlay the technology in heavily populated areas to save the cost of new distribution lines. The drawback-cost!

Wind-The US is undergoing a major wind generation deployment program over the next 12 years. The advantages include no cooling water requirements and its low cost of $.06-$.085 per kWh. The disadvantages are location (typically far from population centers) and most generation occurs at night, which doesn’t match the demand requirement patterns. There are also issues with birds and bats flying through the turbines.

Personal Credit
Capital One disclosed their March card metrics; reporting US a card net charge-off rate of 9.33% and 30 day delinquency rate of 5.08%.

According to Business Week: “Credit card defaults, which have risen dramatically in recent months, might be stabilizing, according to data from American Express. The company's disclosed that default rates rose only 0.2% to 8.8% in March. "We haven't solved all of the problems yet, but the market likes these little indications that maybe some of the worst has passed," said Darin Newsom, a senior analyst at DTN.”

Auto Subsidies
Congress is discussing a “cash for clunkers” program which would provide buyers of new autos manufactured in North America $5000 if they were trading in a car from model years 2001 or older. Does it make sense to encourage people to borrow more money during a major economic slowdown? Once again it seems to me that the government is pushing the solution of “more borrowing, more spending” to correct an economic slowdown caused by too much borrowing and too much spending.

TARP Fraud
ABC is reporting that former Treasury Secretary Paul O’Neill said that the heads of the major U.S. banks were summoned to Washington and told they were required to take the money “So that those who needed it would not be stigmatized.” What was the purpose of this policy? “To deceive the people so that the public would not know which banks were in danger of failing. Why didn't any of the CEO's, claiming not to need the money, have the courage to refuse?" O'Neill said in an e-mail to ABC News. "If banks now claim they want to return the money because they don't need it, why do they have to raise new capital to replace the money from we the people in order to repay the government?"

Last month JP Morgan Chase CEO Jamie Dimon told ABC News that banks should return the money only if they are strong enough to do so, rather than simply to increase their executive compensation payments. "When it gets returned, it shouldn't get returned so you can pay people. That is not why anyone wants to or should return the TARP money," Dimon told ABC.

The Fed to the Rescue
This comment came from Ben Bernanke, the same Fed Chairman who in 2007 said things were fine and in mid-2008 that the financial crisis would be limited to a few hundred billion in mortgage backed securities. Recent favorable data on auto sales, home construction and consumer spending are "tentative signs that the sharp decline in economic activity may be slowing." The Fed will raise interest rates and use other policy tools to "drain excess liquidity" when the time comes to turn from economic stimulus to heading off inflation, he said.

I feel confident, how about you?

From Jack McHugh: “trying to foster sustained growth in an economy weighed down by too much debt is like trying to start a sustainable fire using wet logs. The matches and gasoline (some stimulus and a low funds rate) didn’t work on our debt-soaked economy, so Mr. Bernanke is resorting to the blowtorches and rocket fuel (a lot of stimulus and quantitative easing). I don’t know enough about the chemistry of combustion to accurately predict what will happen next. But my advice would be to stand well back and wait to see what happens next.”

New Administration, Same Graft
Steven Rattner, head of the government's auto task force, disclosed that he was under investigation in an alleged kickback scheme involving New York State’s pension fund. The Wall Street Journal reported the probe last week.

According to RealtyTrac, foreclosure filings were reported on 803,489 U.S. properties in the first quarter, a 9 percent increase from the previous quarter and an increase of nearly 24 percent from Q1 2008.

Monday Morning Quarterback
From a speech by Barry Ritholtz: “If only the Fed let the 2000-2002 cap ex led recession run its course, I wouldn’t be here talking about monetary policy and political science. We have B52 Ben carpet bombing us with money and he won’t stop until we have completely inflated our way out of our massive debt that ironically, as I previously mentioned, is a hangover from the last period of easy money. So Ben wants us to drink more and more to somehow cure our hangover. He and Tim Geithner are trying to put Humpty Dumpty back together again. Humpty Dumpty was a consumer that borrowed too much, spent too much and saved too little. Their new creation, the TALF, is trying to jump start the securitization market so consumers can get access to easy credit again. Huh? What’s so bad about a recession if not allowing one to happen, gets us into this mess? Why can’t we just allow Mother Nature to run its course? Also, this whole talk about once the banking system gets fixed, everything will be fine, is a fallacy. Problems in the banking system are just the symptoms. The disease is the overleveraged consumer and implosion in the housing sector. When house prices stop going down, Voila! The banking system is fixed. I’ve never seen a period of history where one can print, borrow and spend their way to prosperity and without nasty unintended consequences as a result.”

Well said.

What does that mean?
Further regulation of the credit card industry is expected after an NBC weekend interview with presidential economic adviser Larry Summers indicated the White House will focus on credit card abuses.

What is credit card abuse anyway? Is it running multiple cards up to their limits and then defaulting on them? Somehow I don’t think that is what Mr. Summers has in mind.

WSJ reports the Obama administration said Medicare will use competitive bidding to buy wheelchairs, walkers and other medical products, but seniors won't be affected until 2011. The Centers for Medicare and Medicaid Services, the agency that manages the federal insurance program for the elderly and disabled, has said the prices it pays are too high. It sometimes pays several thousand dollars more than prices charged by Web vendors.

I’m a big proponent of improved stewardship with our tax dollars by our government, however, shouldn’t the administration be focused on the bigger picture items (i.e. trillions spent on bailing out the banks)?

From a Reader

Sorry about the tardiness of the note this week as Sunday was my youngest son’s first communion, and the celebration lasted a bit longer than we anticipated. If you have a complaint, please feel free to call the customer service hot line on the website (http://weeklymarketnotes.blogspot.com), leave a credit card number, and we’ll process your complaint quickly.
Just kidding, have a great week.

The market has opened weaker this morning on a weak Leading Economic Indicator release.


“The people who designed the plans are either in the pocket of the banks or they’re incompetent.”-Joseph Stiglitz, Nobel Prize Winner discussing TARP

Apr 12, 2009

Did I Get Bullish?

Did I Get Bullish?

April 12, 2009

“The key to long-term profits on Wall Street is not making big killings, it’s not getting killed.”-Daniel Turov

Weekly percentage performance for the major indices
Based on last Thursday’s official settlement...

INDU: 0.8%
SPX: 1.7%%
NDX: 1.8%
COMPQ: 1.9%
RUT: 2.6%

A big rally Thursday pulled the market into the black for the fifth consecutive week. For the S&P 500, which closed at 856, the move put the index down just over 5% for the year and near the levels of early February. As I posited in my first letter of the year (http://weeklymarketnotes.blogspot.com), and have reiterated throughout the first quarter, I still anticipate a range bound market for the foreseeable future. While there has been improvement on the credit side of the economy (see below), and some indicators have slowed their rate of decline (see Leading Economic Indicators below), the economy is still dropping and I’m not seeing the bottoming signs necessary to sustain a new bull market.

Last week I wrote that the groups moving in the market made me more inclined to believe that this latest rally could have some legs to it. In response to the many emails I received asking if I had suddenly become bullish, the answer is no. Please note, however, that the market deserves to be listened to, and the prior market rallies were screaming ‘bear market rally’ by their constituent leaders, which were the same stocks that led the prior bull. In my studies, it is rare that a new bull is led by the prior bull’s leaders. This recent rally, which has been right on queue with my outlook, has been led by more of the early cyclical groups, which I have maintained would be the leaders coming out of this bear (see More Market below for an argument against that view). My more positive comments last week merely reflected that view, but I still feel the markets will be range bound, potentially for many years. If you recall from my previous notes I expected this rally to peak in the 830-850 range, and we are slightly over that upper level. A continued move to the upside will require an obvious reassessment of those levels, and you’ll be the second to know (right after my trader).

Leading Economic Indicators
The ECRI leading economic indicators are still negative, but less so than at the end of 2008. Remember that at the present level of -20 the measure is still lower than at any time in the 40+ years that the index has been maintained. The prior low was near the end of 1974.

Defense Cuts
Defense Secretary Gates announced major cuts in defense systems which approached $500 billion. The cuts targeted major programs such as the C-17 transport and F-22 fighter. Raytheon, Northrup Grumman, and Lockheed Martin would be directly impacted, potentially impacting over 200K jobs. Gates announced a new focus on less sophisticated enemies and away from these major systems.

Let’s hope that China doesn’t decide to attack us when we devalue their $1 trillion in US dollar holdings, since I doubt they would be considered a “less sophisticated enemy.”

From a reader: “Quietly last week Fannie and Freddie lifted their moratorium on foreclosures and that is not good for housing prices. It is interesting that when they initially announced the moratorium on foreclosures it received a lot of publicity, but this announcement is scarcely receiving any press.”

More from the same reader “A few years ago FHA loans were a small part of most lenders originations but 2009 has brought them to the head of the pack but BIG trouble is coming soon and a government bailout may not be far behind. 20.7% of all FHA loans issued in 2008 are at least 60 days late whereas only 14.1% of subprime loans that were issued in 2007 are 60 days late. This should not be surprising to anyone as a 3.5% down payment is lost almost immediately with home prices falling every month. We are not even close to the end of the housing crises but the government is too busy wrestling with Congress over AIG, the banks and more regulations to see what is so clear to anyone outside of Washington.

The Comptroller of the Currency released a report Friday that showed re-default rates for modified mortgages continued to rise at the end of 2008. 41% of modified loans in the first quarter of 2008 were 60 days or more late by the third quarter and 46% for loans modified in the second quarter. If house prices continue to fall (and they will) every modified loan will be delinquent within months because homeowners won’t make payments on a house loan when the amount due is more than the value of the house. Add a rising unemployment rate and it’s a recipe for many more years of the U.S. recession/depression.”

Corporate Debt

According to Moody’s 35 high yield companies defaulted in March, the highest number in single month since the 1930’s. The default rate jumped from 4.1% to 7% in Q4, and appears poised to move higher in Q1.

Government Debt
According to the CBO, the budget deficit reached nearly $1T during the first half of FY '09 and receipts fell around $160B, or 14% Y/Y. Nearly half the drop was from a fall in corporate income tax receipts, the largest such fall in more than three decades.

Automotive Debt

Not satisfied at making horrendous loans that have contributed to driving them close to bankruptcy and into the waiting arms of the government, GMAC has announced they will make an additional $5 billion available for dealer and consumer loans. Among some of the perks are guaranteed payments if the borrower loses his job.

Didn’t the housing crisis start with similar poor lending standards?

Another Top of the Market Call
In what has to be a sign the market is topping, Goldman Sachs is preparing to repay their $10 billion TARP loan (remember they announced plans to do so when the government announced they would cap recipients pay at $250K) by issuing new common stock. GS has been very adept at issuance of debt, equity and preferred at very favorable times (ask Warren Buffet).

Retail same store sales came in last week slightly better than anticipated, which helped really fuel stocks in the sector. Surprisingly, Wal-Mart stood out as one of the few retailers to miss on their comps. Of course, Wal-Mart was also one of the only retailers posting positive comps last year, so they had a tougher year over year comparison than the others.

According to Liz Sonders at Charles Schwab, “retail March same-store-sales came in mixed, but many consumer-related stocks were higher, as traders viewed the results as stabilizing.”

Retail sales improved in the April 4 week, up 0.6 percent from the prior week, but remain weak at a year-on-year pace of -0.3 percent. ICSC-Goldman reports some pullback at discount chains but strength at ultra-discount dollar stores. The report expects sales for the full month of March flat to 1 percent lower.

Wholesale inventories dropped 1.5%, the largest decline since 1992 as sales at US wholesalers rose in February for the first time since June, up 0.6%. Additionally, factory inventories dropped 1.2%. Wholesale inventories (25%) and factory inventories (33%) make up approximately 58% of US inventories, with the rest residing at retailers.

These continued inventory declines suggest that, if demand has stabilized, we may experience an increase in manufacturing activity in coming months to replace the depleted wares. Personally, my data points suggest we are already seeing some pickup in manufacturing.

The trade deficit dropped on a huge drop in imports, coming in at a deficit of $26 billion versus expectations of -$36 billion. Lower oil prices and slowing consumer spending contributed heavily to this decline.

The pundits have stopped being shocked over the 600K (+) job losses each week. In an obvious case of becoming numb to the magnitude of the problem, there no longer seems to be shock value attached to over 1 million people losing their jobs every other week. The chart below shows the rate of new claims (gray line) and also the 4 week moving average (red line). I guess that you could say there has been some moderation in the rate of job losses as indicated by the small flattening of the moving average, but that seems like a reach to me. Remember that employment is a lagging indicator.

Toxic Debt
According to the London Times, the International Monetary Fund is forecasting that financial institutions have racked up $4 trillion in troubled debt. In its upcoming assessment of the global economy, the IMF is expected to raise its estimate of the deterioration of assets originated in the U.S. from $2.2 trillion to $3.1 trillion by the end of 2010. Meanwhile, troubled assets originated in Asia and Europe are expected to total $900 billion.

Thank goodness the new proposed regulations from Congress won’t require banks to mark these assets to market.

Welcome Back Mike
Bank analyst Mike Mayo recently left Deutsche Bank to join a Calyon division. His first report was filled with gloomy forecasts, including a prediction that loan losses because of the financial crisis will exceed levels seen during the Great Depression. Of the 11 banks under his coverage, he rated them all either underperform or sell.

More Market
David Rosenberg, the soon-to-be former Economist for Merrill Lynch, had this to say about the recent 25% rally:

“As for this 25% rally in three weeks – the consensus has swung to the view that this is a real inflection point. One warning. We saw this happen in late 2001 and early 2002 too … big, big rally; early cyclicals flew; the markets thought we were in for a V-shaped recovery … it was longer away than many at the time believed and many were burnt as a result. And keep in mind that the ‘second derivative’ on growth began to improve in the fourth quarter of 2001, and the S&P 500 still did not bottom for another year.

Currently, the equity market is priced for $70 on earnings on a going-forward basis, or a 75% rebound. And with retailing stocks up 30%, leisure/accommodation up 35%, and the homebuilders up 40%, the market is priced, amazingly, for a revival that is led by the consumer! (in fact, the only S&P sector that is now trading at P/E multiples that are at post-2001 highs is the consumer cyclical group). If we see that in the next year, we will be the first to hang up our Hewlett Packards. Being up 25% in a year and staying bearish … well, shame. Achieving that in less than a month – come on. Too flashy for our liking.

In fact, let’s learn from history. The only times we have ever seen the stock market surge close to this much in such a short time frame were:

* December 1929
* June 1931
* August 1932
* May 1933
* July 1938
* September 1982

Only in September 1982 and in May 1933 was the equity market embarking on a new bull phase. But guess what? By the time the S&P 500 surged 25%, it had already crossed above its 200-day moving average. So call us when the S&P 500 crosses the 1,000 mark – another 20% to go. That is how deeply entrenched this particular bear market has been – that even after this massive rally, the onus is still on the bulls! Consider as well that on 4 of the 6 occasions that the equity market staged such a huge rally over such a short time period, it relapsed. So we are going to wait this out, acknowledging that we could be late to the party. We still feel the downside risks are too high to be involved.”

Thanks David-I’m going to miss your voice of reason.

The VIX finally broke below the 40 level, for the first time since spiking through that level in October (see chart below). Could this be indicating the market is finally relaxing somewhat from the frenetic activity over the past six months? Certainly a downward move is bullish, however, the level is still extraordinarily high when compared to virtually any time period except the past six months.

Spring Training and Opening Day
Now that baseball season is back, it seems only appropriate that the Pirates are back in action. Not the Pittsburgh variety, but the Somalian ones. Once again they have been extremely active this past week, probably in an effort to divert media time from their National League East namesakes. Over the course of three days the pirates managed to nab five ships, the most recent a Danish ship with an American crew. In an effort to maintain their neutrality and demonstrate their displeasure with the recent G-20 meetings, they have also hijacked British, French, German and Taiwanese ships in this latest spree.

During 2008 the pirates batted a mere .261, hijacking 43 of the 165 vessels they attacked. After some intensive off-season training, it appears they are on a mission to exceed last season’s tepid results. Although difficult to confirm, rumors are swirling that many of the Pirates are in the last year of their contracts, which would suggest a bumper crop of free-agents this fall. Stay tuned.

Ever the optimist, Pulte Homes CEO Richard Dugas feels the February sales jump in housing sales may signal stabilization in the housing market. In a sign of his renewed optimism, Dugas and Pulte agreed to buy Centex Corp for $1.3 billion in an all stock deal. The deal was done at a 38% premium to Centex’s closing price the prior day, which is 87% lower than its peak. Many analysts are hailing this as a transaction that will save both companies in the face of a 75% decline in new home sales. The combined companies now have $3.4 billion in cash and $1.8 billion in debt. Management feels they will save $250 million in overhead and $100 million in debt service per year. There are, of course, opportunities (however unlikely) to pull inventory from the market, which could help ease some of the pressure on the new housing market.

More Earnings
The market appears prepared for a bad spate of Q1 earnings. This is only a small sample, but I noticed that companies which pre-announced in-line to better numbers really sailed, typically up 10-15%. Interestingly, even companies pre-announcing weaker than expected numbers showed some positive returns. While many are talking about the disaster the Q1 earnings reports will be and the negative impact on the market, these early reports would suggest that much of the bad news may already be expected. Could we see an upward bias to the market during earnings? If so, it would be the first time in over a year.

Even More Earnings
According to www.chartoftheday.com the drop in S&P 500 earnings during this recession is greater than the average recession. While this represents the obvious severity of the economic crisis we are facing, in my opinion it also is indicative of two other items. First, earnings of financial stocks were overstated for much of this decade and their downfall has been a significant contributor to the decline in S&P 500 earnings. Second, earnings in general were overstated leading into this recession as corporate profit margins were at record levels, partially due to efficiency improvements, accounting games, and outsourcing to foreign manufacturing, which allowed companies to import deflation from countries with lower labor costs.

Stress Testing the Banks

Is anyone else dubious of the government’s intentions in their stress tests of the banks? It seems to me this is a rubber stamp for bad management teams to remain in place and is designed as cover to protect those banks deemed “too big to fail.” The bank stress tests currently underway are “a complete sham,” says William Black, a former senior bank regulator and S&L prosecutor. I continue to support the alternative view that “too big to fail means to big to survive.” Break up the big guys!

Bank of America
Continuing to defy the odds, Bank of America somehow remains in business despite crapping all over their customers and running their bank like a bunch of morons. This past week I was notified they intended to raise the rate on my Visa card from 8.5% to 14.9% on purchases and 25.99% on other transactions. I have been a customer for years without incident or change in my credit rating. Meanwhile, these imbeciles have seen their cost of capital drop as a result of MY TAX DOLLARS bailing out their lack of lending standards. Additionally, their credit rating has declined, not mine, yet for some reason they feel they want to gouge me for an additional 650bps on a card we barely use. I’ve also had friends attempt to draw on committed home equity lines of credit, only to be blocked by this same institution.

I’m changing banks, and if anyone has any suggestions for a decent bank catering to small businesses and individuals, please let me know. Note to Ken Lewis-I hope you gag on Countrywide and Merrill. What makes you think you can operate those businesses when you have ZERO idea how to operate the business you grew up in?

OK, I’m done ranting.

TED spread chart
Earlier I mentioned the credit situation has improved slightly. The chart below shows the TED spread, which has improved from its death defying heights of the fall, but is still stubbornly hanging around the 100bps level. I’d like to see it cut in half to really get things moving.

Short Selling and the Uptick Rule

Repeal of the uptick rule has been broadly condemned as causing the market downturn. According to Peter Boockvar, “short sellers didn’t get people to buy homes with no money down, didn’t convince people to buy homes with teaser rates, didn’t encourage people to lie about their income on mortgage applications, didn’t tell banks and brokers to lever up to huge levels, didn’t tell Greespan to cut rates to 1% and leave it there, didn’t invent Freddie Mac and Fannie Mae, didn’t tell the OTS, OCC, FDIC, Fed, SEC, FFIEC, FTC, FHFA, and all the state regulators to twiddle their thumbs all day, didn’t tell the rating agencies to rate AAA on anything that moved, didn’t tell banks to lend to commercial real estate investors on a property where the rent didn’t cover the mortgage payment, and didn’t tell the average consumer to spend more money than they make and borrow the difference.”

And you thought I was ranting?

In my view what the SEC needs to do is enforce the law against naked short selling, which is illegal. Naked short selling (not as fun as it sounds since its rarely done without clothes) occurs when a short seller sells a stock short but hasn’t borrowed the shares. This effectively allows short sellers to pile onto stocks even when the supply doesn’t exist to borrow. Congress and the SEC messing around with the uptick rule only diverts attention from their long-standing failure to adequately enforce existing naked short selling laws.

Bull vs. Bear Market

From Barry Ritholtz: “The smart investor’s playbook is very different in bear markets than bull markets. In a Bull Market, you buy the dips. Lower prices are an opportunity to buy into equities at cheaper valuations. Most sales are disappointing, as prices eventually go higher. Buy & hold is the simplest, most cost effective investment strategy.

Bear markets call for a very different set of plays: You sell the rallies; higher prices are opportunities to sell equities at premium valuations. Most buys are disappointing, as prices eventually go lower. Buy & hold is a losing strategy – trading what the market presents to you is the best risk management strategy.

The goal during bull markets is to grow your capital; the goal during bear markets is to protect your capital.”

Asian stocks continued their run after Japanese Prime Minister Taro Aso more than doubled his intended stimulus spending package. The announcement, which came on April 10, was the third plan since he took office and will total 57 trillion yen ($566 billion).

In China lending activity rose by a record to 1.9 trillion Yuan ($277 billion), as their M2 rose almost 26%. The People’s Bank of China “will implement moderately loose monetary policy and maintain the continuity and stability of policy” while pledging “ample liquidity” to ensure loan growth and money supply remain sufficient. In a warning that sounds eerily similar to those describing the US situation a couple of years ago, Jian Zhenghua, the former vice chairman of China’s parliamentary committee said “the biggest of these hidden dangers is the degree of bad loans in China.”

Angel Baseball
God Bless N.A.

I have heard from many of you, and appreciate your continued support and hopefully enjoyment of these letters. I encourage you to visit the website (http://weeklymarketnotes.blogspot.com) as eventually I hope to move the distribution over to the site directly. Feel free to support my advertisers by visiting those that present interesting ads on the site.

Have a great week and good luck as earnings season begins.


“The best minds are not in government. If any were, business would hire them away.”-Ronald Reagan

Apr 6, 2009

April 5, 2009

The problem with socialism is eventually you run out of other peoples’ money.” – Margaret Thatcher

Weekly percentage performance for the major indices
Based on last Friday's official settlement...

INDU: 3.1%
SPX: 3.3%
NDX: 5.2%
COMPQ: 4.9%
RUT: 6.3 %

The market continued its upward march with the S&P 500 moving to 842, slightly above its 100 day moving average (green line on chart below). The index has now moved an impressive 26% off its March 6th bottom, and is just 8 points short of the area where I felt this rebound would get tested. There are certainly valid arguments to be made for the market to continue its upward path, not the least of which is the improvement in the capital markets as evidenced by the positive change in the Bloomberg Financial Conditions Index (second chart below)

The G-20 meeting resulted in a pledge of $1 trillion in emergency aid, stricter limits on hedge funds, executive pay, credit rating companies, and bank risk-taking. And in what is sure to be another sinkhole for capital, they offered more than $750 billion to the International Monetary Fund (IMF), one of the worst run financial organizations in the world. In summary, bowing to German and French demands, the G-20 has agreed to rewrite the rules of capitalism. Some of the new rules involve limits on excessive leverage- I wonder if the US will qualify?

The end result of these meetings will be a more global regulatory and financial system that de-emphasizes the US. Instead of celebrating this as a victory, we should mourn the loss, or more accurately the give-away of yet one more industry in which we were the global leader. I guess now we can be the global leader in bankruptcy attorneys.

The markets celebrated with a rally on Thursday, but for what? The #1 priority for team Obama was to get hard commitments for stimulus from other countries, yet was blocked by the Germans and French. The $1 trillion pledge was a PR number while the actual commitment was to “do what we can.”

Did you notice?
Did you notice that as the market roared off the G-20 meeting, the movement clearly favored the inflation play (with the exception of gold)? Bonds and the dollar fell while oil and materials rose. In the S&P 500, the groups I have been saying need to lead for a real rally were leading the rally-transports, consumer discretionary, financials, and energy (although that one hasn’t been one of my target groups). Could this rally be for real?

Junk Bounce
Jim Furey of Furey Research Partners feels that “the typical manager is lagging off the March 9th bottom. Why? Low priced (+48%), micro-cap (+43%) and loss making (+45%) R2000 firms are outperforming sharply since the March 9th bottom. Few managers own these shares. These returns compare to the average R2000 stock, which has risen +34% since March 9th. Consumer Discretionary and Financial sector low priced, micro-cap, loss making firms have been the strongest and are likely under owned.”

To me this is reminiscent of the 2003 rally, in which sub $5 and micro caps led a monstrous rally. Small caps were up over 40% that year, staging a rally that began around the Iraq invasion in March 2003.

Much has been made about the rising unemployment rate. According to Liz Sonders at Charles Schwab, unemployment typically peaks near the end of a recession. The chart below seems to confirm this thought, and also confirms employments’ status as a lagging economic indicator.

More Problems from California
From Art Laffer: “the problem is that California has the most “progressive” (ah, what a deceptive term!) income tax code in the country. Tax progressivity exaggerates the normal ups-and-downs of the overall economy, and explains why income tax receipts in California are among the most volatile of all the 50 states. When times are good, California citizens earn more, pushing many of them into a higher tax bracket, thereby giving the state a larger fraction of a bigger pie. But then the opposite holds true during recession. People earn less income in general, thereby shrinking the tax base, as many fall into lower tax brackets and pay a smaller fraction of smaller paychecks. This one-two punch explains why hard times seem to hit California harder than other states.”

These comments follow reports that the state is looking for federal backing for additional borrowing.

Commercial Real Estate
Commercial real estate delinquency rates have jumped. The Real Estate Roundtable, a trade group, estimates that commercial real estate in the U.S. is worth $6.5 trillion and financed by about $3.1 trillion in debt.

Deutsche Bank estimates the default rates on the $700 billion of commercial-mortgage-backed securities outstanding could hit at least 30%, and loss rates, which figure in the amounts recovered by lenders, could reach more than 10%, the peak seen in the early 1990s.

California reported 80,775 properties with foreclosure filings in February, a 5% increase from the previous month, according to the latest RealtyTrac® U.S. Foreclosure Market Report. The CaseShiller Home price index was down 19% year over year, roughly in line with consensus.

The Chicago Purchasing Manager survey was under the consensus, posting 31.4 vs. the 34.3 expectation and 34.2 in the prior period.

The ISM manufacturing index measured 36.3 vs. a 36.0 consensus and 29.0 in the prior period. The ISM prices paid was 31 vs. the 33 expectation.

Payrolls were inline, with another 663K job losses announced and the unemployment rate up to 8.5% from 8.1%, a new 25 year high. Manufacturing payrolls were down 161K.

ISM lows and the Market
From Deutsche Bank: A very interesting chart on the ISM, which hit the low 30's in '49, '74 and '80 and snapped back above 50 within 7months, 7months, and 4months respectively.

February of '49 Low at 32 on the ISM - the market declined another 5.5% by May. However, that was the low - from there the market rallied 30% by Feb of 50. Also, that represented the beginning of a 10 year Bull Market as the market was up 3-fold during the 50's.

December of '74 at 31 on the ISM - the market rallied roughly 30% from end of Dec 74 to March 75. The market was up roughly 40% by Dec of 75. Sept 74 was the low - Dec 74 was a retest, but we never broke that Sept 74 low. From there we did not experience a raging bull market, but we were up over 70% by the end of the 70's from the 74 low.

May of '80 at 30 on the ISM - the market rallied roughly 12% from May 80 to Aug 80. The low in the market had already formed in March of 80 and by May of 81 the market was up about 18%. The 80's represented another good bull market - the market was up over 200% by the end of '89 from the May of 80 level.

The Fed
From Bloomberg: Bernanke noted that "credit spreads are much wider and credit market more dysfunctional in the United States today than was the case during the Japanese experiment with quantitative easing." Because the U.S. financial system has seized up more than the Japanese financial system did during its crisis, the Federal Reserve has chosen to tackle the U.S. financial crisis in a different way. Rather than simply expanding the quantity of banks' excess reserves as the Bank of Japan did, with the hope of boosting bank lending, Bernanke indicated that the Fed has chosen instead to "focus its policies on reducing [key credit] spreads and improving the functioning of private credit markets more generally."

GM Conspiracy
President Obama, who has no business experience whatsoever, has determined in his inestimable wisdom that GM needs to go through a prepackaged bankruptcy. Personally, I don’t disagree with the President, but think it’s tantamount to Richard Nixon announcing that Charles Manson was guilty during the Tate-LaBianca murder trials.

Some of my more cynical readers (I swear it’s not me) are suggesting that Obama’s attempt at taking over GM is solely to promote the production of smart cars. The President has often indicated he is looking towards a US future with no carbon emissions, so their suggestions certainly have some validity.

It appears Japan will be hitting their economy with another enormous stimulus package. I don’t have an exact count, but I believe that this is their 5th or 6th attempt at big stimulus packages, all of which have been funded by printing paper. Japan’s total debt is close to 2x their GDP, and yet the economy hasn’t rebounded at all. Maybe the people crafting our stimulus packages should take note that printing money to foster consumer spending and lending has never succeeded.

The ECB cut rates by 25bps, sparking a rally as investors had anticipated a cut of 100bps. In a refreshing piece of common sense from a Central Bank, the ECB feels that easy money won’t cure a hangover from a period of easy money. Comments were also made that the economy didn’t “need to stimulus” right now.

Mark to Imagination
Changes to FASB 157 will allow banks to mark the loans in their portfolios to some imaginary value. So let me get this straight-the banker who made a bad loan that is now worth 40% of face value has the leeway to mark this same loan back to 80%, 90%, or 100% because he feels it has more value than the free market ascribes to that loan? If nothing else, this should boost bank earnings by the second half of the year and once and for all kill any need for banks to participate in the PPIP.

Things are getting more bizarre by the day! Next thing you know the Czar of the United States will start firing the CEOs of major corporations.

Courtesy of Chart of the Day, the length of US recessions is shown below.

On April 3rd I published a short and somewhat entertaining note which walks through the steps of creating a derivative security. Click on http://weeklymarketnotes.blogspot.com and look in the right hand column under “the old stuff”, 2009, April, Derivatives Explained to view this quick read.

I have discussed the potential fall of the US dollar many times due to reckless stewardship and the resultant loss of desire to hold our currency by foreign trading partners. The chart below shows what appears to be the first drop in dollar holdings in the past decade. Should this trend continue, then hello inflation and goodbye dollar.

The chart below shows the massive drop in US rig counts since late 2008, from over 2000 to just over 1000. Global rig counts have taken a similar plunge, falling from 3500 to 2700 since September. While oil inventories have been rising, it would appear that any increase in demand could quickly bump the price of oil.

This week should give us a sense as to whether this bounce will continue or lose steam. The market is approaching levels that suggest it should hit some resistance, however, if it moves through these levels it is certainly feasible that the S&P 500 could move well above the 900 level. Stay tuned.

Please have a wonderful week and a Happy Easter.


"The market can stay irrational longer than you can stay solvent." - John Maynard Keynes

Apr 3, 2009

Deriviatives Explained

I try not to post jokes, however, outside of the obvious light hearted nature of this post, I think it does a good job of explaining the creation of a derivative security. Enjoy.

Heidi is the proprietor of a bar in Detroit. In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around about Heidi's drink now pay later marketing strategy and as a result, increasing numbers of customers flood into Heidi's bar and soon she has the largest sale volume for any bar in Detroit. By providing her customers' freedom from immediate payment demands, Heidi gets no resistance when she substantially increases her prices for wine and beer, the most consumed beverages. Her sales volume increases massively.

A young and dynamic vice-president at the local bank recognizes these customer debts as valuable future assets and increases Heidi's borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral. At the bank's corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then traded on security markets worldwide. Naive investors don't really understand that the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, their prices continuously climb, and the securities become the top-selling items for some of the nation's leading brokerage houses who collect enormous fees on their sales, pay extravagant bonuses to their sales force, and who in turn purchase exotic sports cars and multimillion dollar condominiums.

One day, although the bond prices are still climbing, a risk manager at the bank (subsequently fired due his negativity), decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar. Heidi demands payment from her alcoholic patrons, but being unemployed they cannot pay back their drinking debts. Therefore, Heidi cannot fulfill her loan obligations and claims bankruptcy. DRINKBOND and ALKIBOND drop in price by 90 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %. The decreased bond asset value destroys the bank's liquidity and prevents it from issuing new loans.

The suppliers of Heidi's bar, having granted her generous payment extensions and having invested in the securities are faced with writing off her debt and losing over 80% on her bonds. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 50 workers. The bank and brokerage houses are saved by the Government following dramatic round-the-clock negotiations by leaders from both political parties. The funds required for this bailout are obtained by a tax levied on employed middle-class non-drinkers.