“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%

Market
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.

Credit
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.



Economy
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.”

Earnings
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.

Oil
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.

Jaws
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.



Conclusion
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



Ned W. Brines
nbrines@gmail.com
O (562) 430-3232
http://weeklymarketnotes.blogspot.com