November 23, 2009
“A proposal to give banking regulators authority to block accounting standards is “a terrible idea,” Paul A. Volcker
Weekly percentage performance for the major indices
Based on last Friday’s official settlement...
Federal Reserve Chairman Ben Bernanke actually admitted this week that a weak dollar could cause rising commodity prices and inflation, and the dollar responded with a small, but positive move. To my knowledge this is the first time anyone in charge of this country’s currency has admitted what every Econ 101 student already knows-a weak currency is inflationary. While the US dollar caught a slight bid this week, the fed funds futures continue to reduce its belief that he’ll follow words with actions. The odds of a 25 bps rate hike have now been pushed out to Sept 2010.
What is going on with the Treasury market? Yields on the short end are zero (or less), and on the longer end sitting at 3.356% and 4.295% for the 10 and 30 year respectively. The 2-10 spread at 266 basis points (2.66%) is the widest it has been since mid summer, which should help the banks if they ever start lending again.
Merrill put out a piece this week on asset allocation among institutional investors. Based on a survey they conducted with more than 100 institutional investors they found a tremendous strategic desire to move away from US equities, particularly large cap, and toward a more global mandate. Emerging market equities are the most desirable asset class over the next 12 months with 42% looking to add/increase investment. On a percentage basis, nearly as many investors (39%) seek to decrease investment in US large cap equities. This could result in $300-500bn flowing out of US large cap equities over the next 3-5 years from institutional investors.
Actual Consensus Prior
Retail Sales 1.4% 0.9% -2.3%
Retail Sales ex-auto 0.2% 0.4% 0.4%
Business Inventories -0.4% -0.7% -1.6%
Core PPI -0.6% 0.1% -0.1%
PPI 0.3% 0.5% -0.6%
Capacity Utilization 70.7% 70.8% 70.5%
Industrial Production 0.1% 0.4% 0.6%
Housing Starts 529K 600K 592K
Building Permits 552K 580K 575K
CPI 0.3% 0.2% 0.2%
Core CPI 0.2% 0.1% 0.2%
Initial Jobless Claims 505K 504K 505K
Leading Indicators 0.3% 0.4% 1.0%
Philly Fed 16.7 12.2 11.5
The leading economic indictors slowed dramatically in October from 1.0% to 0.3%, slightly less than consensus. Positive contributions from interest rate spreads, stock prices, jobless claims and the average workweek were offset by nondefense capital goods orders, deliveries, consumer expectations and building permits.
Initial unemployment claims rose slightly to 505K. The number of people receiving jobless benefits dropped, as did those getting extended payments.
Housing starts posted their worst decline of the year (-11%), and the lowest absolute number since the spring as the homebuyers credit expired and then was extended. Building permits also dropped by 4%. Mortgage applications just hit a 12 year low, which doesn’t bode well for housing turnover.
October Retail Sales rose 1.4%, .5% more than expected but ex auto’s they were up just 0.2%, 0.2% below forecasts. The Sept headline figure was revised lower by 0.8%, so taken together the Sept/Oct data is a touch light. Motor vehicles/parts sales rose 10.2% in Aug, fell 14.3% in Sept and rose 7.4% in Oct. Sales ex auto’s and gasoline rose 3%, right in line with expectations. Sales rose in the following categories: food/beverages, restaurants, health/personal care, clothing, department stores and online retailers. They fell in furniture, electronics, building materials and sporting goods.
We have been long gold as a hedge against a weak dollar, and the metal has performed as expected, rising to $1163 per ounce. Analysts have been raising their price targets as they tend to do when asset prices go up, and a legitimate question is whether the metal is in a bubble or not. We don’t think so, however, the chart below from The Big Picture shows the metal in relation to US Treasury Bond futures. Today’s ratio is comparable to the prior peak in gold roughly 29 years ago.
Our view is that the commodity won’t turn down until the Fed addresses the ills afflicting the currency. Although Greenspan, whoops, Bernanke (is there a difference other than the beard?) addressed concerns about the dollar’s collapse for the first time this week, with unemployment north of 10% it doesn’t appear the Fed will be acting anytime soon.
Look for a new peak in this chart!
Removing the Stimulus
Bank of Japan Governor Masaaki Shirakawa joined China Banking Regulatory Commission Chairman Liu Mingkang to warn that the loose money policy of the U.S. Federal Reserve could fuel an asset bubble. Shirakawa warned of "new, real and insurmountable risks to the recovery of the global economy" because of the Fed's policy. "The continuous depreciation in the dollar, and the U.S. government's indication that, in order to resume growth and maintain public confidence, it basically won't raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation," Liu said.
European Central Bank President Jean-Claude Trichet said the bank will gradually withdraw the emergency cash it has pumped into the economy in order to ensure it doesn’t fuel inflation. Trichet had previously signaled the ECB is unlikely to renew its offer of 12-month loans to banks after the third tranche in December.
The Chinese Central bank may raise deposit requirements for commercial lenders next year, according to Shanghai Securities News. At a forum in Beijing, former central bank deputy governor Wu Xiaoling said the Peoples Bank of China should be allowed more authority to choose monetary policy tools in 2010 as economic recovery has already become steady. Bank shares eased 1% in the local session overnight on back of the report.
More Accounting Shenanigans by the Banks
An amendment that is strongly supported by the banks is being considered which, in addition to removing mark-to-market accounting, allows a systemic regulator “to order the Securities and Exchange Commission, which now oversees the Financial Accounting Standards Board, to suspend or change any accounting rule that the council thinks is a threat to financial stability.”
“The amendment has been endorsed by the American Bankers Association, which says the SEC’s focus on helping investors is too narrow.”
What!? Reduce transparency even further for a group of zombie banks who almost took this country down as a result of their complete incompetence?
Commercial Real Estate
Goldman Sachs Group Inc. is underwriting $400 million of bonds backed by an Ohio real estate company’s shopping centers, the first sale to tap a U.S. program to unlock lending in the commercial mortgage market. The bond is backed by 28 properties owned by Developers Diversified Realty Corp. The Federal Reserve opened its Term Asset Backed Securities Loan Facility (TALF)in June to newly issued commercial mortgage-backed securities to stimulate lending and avert a wave of foreclosures as borrowers fail to refinance. There have been no new sales of the debt since June 2008, according to data compiled by Bloomberg.
“It would be good for the market psyche to actually see a new deal done,” said Kent Born, senior managing director at PPM America Inc., an investment manager in Chicago. “But as a practical matter it’s not going to get us back to the type of deals that were the bread and butter of the market merely two years ago.” Sales of commercial mortgage-backed debt slumped to $12.2 billion last year from a record $237 billion in 2007, according to JPMorgan.
Deals from JP Morgan and Bank of America are reportedly in the pipeline.
Tax Receipts Remain Weak
The chart below, courtesy the Rockefeller Institute, shows the cumulative changes year over year in income, sales, and property taxes for the US over the past five years. Typically tax rates have little to do with the actual amount of taxes collected, GDP is the primary catalyst to tax receipts. As you can see in the chart below, as of the end of the second quarter the rate of decline in tax receipts hadn’t yet bottomed. This decline is putting severe pressure on state and local governments at a time when the Federal government is attempting to stimulate the economy with massive deficit spending. Since state and local governments need to run balanced budgets, their resulting pullback is having a contra effect on the efforts of the Feds.
The headline in this weekend’s Orange County Register-State Officials Pay to Drop 18%!
An official of the International Energy Agency said the world is much closer to running out of oil than the agency's statistics had shown. Under pressure from the U.S., the IEA distorted statistics to show that more oil would be available, the official said. "The IEA in 2005 was predicting oil supplies could rise as high as 120 million barrels a day by 2030, although it was forced to reduce this gradually to 116 million and then 105 million last year," the official said. "The 120 million figure always was nonsense, but even today's number is much higher than can be justified, and the IEA knows this."
Healthcare and Taxes
According to ISI the proposed health care bill is dangerous for the health of small businesses. Provisions include a payroll tax of 8% of payrolls if small businesses do not offer health care. In addition, high income earners will get hit with a host of new payroll taxes taking marginal federal rates to 44% for the individuals earning more than $500,000.
Add on 11% state income tax in CA, 8.5% sales tax, and miscellaneous other taxes (including capital gains), and for the residents of some states the government is taking well over 60% of the incremental income above $500K.
This certainly seems like a back door way to cap pay without having the authority to explicitly do so.
ISI’s Ed Hyman notes 4 items that are pointing to higher inflation: gold, GSCI, the trade weighted dollar, and import prices ex fuel have begun to move up. The fed's favorite measure the 5-year forward TIP market is also stirring.
According to the Wall Street Journal, after losing billions on single-family residential loans, Fannie Mae and Freddie Mac are bracing for another round of losses, this time on apartment lending. Previous losses already forced the U.S. Treasury to pump more than $110 billion into the companies. Fannie, which has the highest delinquency for multifamily properties, saw apartment loans that were 60 days or more late on payment increase to 0.62% in September, up from 0.16% the same month last year.
A couple of weeks ago I discussed the tax burden in California on the highest wage earners, which generated a number of responses and questions about Federal Taxes. Mint.com (being acquired by Intuit) put out the following statistics regarding income taxes (this is federal income taxes only, and excludes capital gains, etc):
Top 1% (making over $500K) pay 41% of federal income taxes
The top 5% (making over $200k) pay 61% of federal income taxes
The top 10% (making over $100K) pay 71% of federal income taxes
The top 25% (making over $75K) pay 87% of federal income taxes
The bottom 50% (making less than $40K) pay 2.9% of federal income taxes
A full 47% of “tax units” will pay zero. Of 307 million Americans there are 152 million “tax units.”
The median income in the US is just over $50K per year.
I somewhat understand why the homeowner’s tax credit is in place, to somehow reward those willing to take on more risk or trying to get the housing market moving. But why are we providing tax breaks to homebuilders? This just increases supply in the same market where we are providing incentives to people to absorb that supply.
Government continues to amaze me with their basic misunderstanding of supply and demand. If they want home prices to stabilize or go up, and are willing to provide tax credits to accomplish this goal, then why are they also providing tax breaks to those who would increase the supply, thereby putting further pressure on prices?
More Real Estate
The outlook for the home market dimmed this week as residential construction and mortgage applications fell and loan delinquencies reached a record. “I don’t think the housing crisis is over,” Mark Zandi, chief economist with Moody’s Economy.com, said. “I think we’re going to see another leg down.”
New home sales may begin to pick up by the start of the so-called spring selling season, said Toll Brothers Inc., the largest U.S. luxury homebuilder. Existing house sales may take longer. Residential construction and property sales led the way out of the previous seven recessions going back to 1960, said David Berson, chief economist of PMI Group, the mortgage insurer in Walnut Creek, California.
“You don’t pay a mortgage with economic output, you pay a mortgage with a paycheck,” Jay Brinkmann, MBA’s chief economist, said.
The share of all types of home loans with one or more payments overdue climbed to a record seasonally adjusted 9.6% in the third quarter, the Washington-based trade group said in a report yesterday.
There are signs that parts of the U.S. are rebounding. California, among the states where the housing bust started, is one of the few areas that’s beginning to recover. October home prices in Orange County, San Diego and the San Francisco Bay Area increased from a year earlier, MDA DataQuick, a San Diego property information service, said this week. The number of sales also increased in the Bay Area and Southern California.
If the Federal Reserve is content letting the long end of the yield curve rise, it seems as though their goal of lowering mortgage rates may be at risk. The spread between the FHLM 30-year mortgage and 10-year yields is 84 basis points. Currently (data through May 6) the Federal Reserve has bought $366 billion of MBS and has the authority to buy up to $1.25 trillion.
Because of this massive buying, anything is possible with this spread, even inversion. Unless the Federal Reserve plans on driving mortgage rates lower than Treasuries, this spread cannot tighten much more than it already has. Once this spread cannot tighten any further, mortgage rates will be at the mercy of the Treasury market.
Velocity of Money
From Jim Furey of Furey Research Partners:
“Falling money velocity, as has been the case since 1Q08 is accompanied by declining inflation, lower interest rates and small-cap relative outperformance. Current money velocity is at its lowest level since ’81. Examining four key periods of declining money velocity since 1981, we make the following observations: i) core and headline inflation rates have fallen in each period by an average annualized rate of -17% and -14%, respectively; (i) the Fed Funds target rate has been reduced during each period by a -38% average annualized rate; and (iii) small-caps have outperformed large-caps on average by +5% annualized rate.
Implications of rising money velocity. Money velocity at 3Q09 posted a slight uptick from 2Q09, but it is too early to tell if it has begun a cyclical upswing, such as in ’87, ’94 and ’04. We do know that when it does start moving upwards, we can expect rising inflation, higher rates and small-caps to underperform large-caps, if past is prologue.”
Are the data points really that bad? The real estate market is still on life-support without government intervention. Will the stimulus be enough to turn that market, or will the cost associated with re-inflating that bubble be enough to sink us?
The other data is mixed, and that is to be expected at this point in the “recovery”. Anticipate continued mixed results on the economic front, with some deterioration as much of the low hanging fruit has been picked. The preliminary 3rd quarter GDP came in at 3.5%, but it looks like it will get revised down to 2.5%, which many are suggesting is purely due to government intervention. Certainly we have a long way to go.
With the leaders of the market rally (techs, small caps, financials, and inflation trades) pulling back while higher quality and more defensive names move to the forefront, it would appear that at minimum the market may pause into the end of the year. I am net neutral, with a long bias towards higher quality names and a short bias towards lower quality names.
Have a terrific Thanksgiving. Remember that Friday is a shortened trading day and the US markets will be closed on Thursday.
"The baby will talk when he talks, relax. It ain't like he knows the cure for cancer and he just ain't spitting it out."—Justin’s Dad