A Decade for International Stock, A Lost Decade for the US Market

Stock markets of emerging economies win as decade closes. This decade is nearly over, and results are in for equity markets. While the stock market in the U.S. stumbled, markets in developing economies enjoyed an avalanche of investment and handed back to investors huge returns. Brazil, Russia, India and China delivered returns in double -- occasionally triple -- digits as the broad U.S. market lost about a fifth of its value. The New York Times (29 Dec.)

Article link below, copy and paste to your browser. http://www.nytimes.com/2009/12/30/business/global/30emerge.html?hpw

Fed Turning Off The Liquidity Faucet

Fed aims to create tool for drying up excess liquidity. Preparing for a day it would need to put the brakes on the U.S. economy, the Federal Reserve is looking to launch a program for withdrawing excess liquidity from the financial system. The central bank would pay financial institutions interest on term deposits, probably ranging from one to six months. The Fed pays interest on banks' overnight deposits. "Term deposits would be one of several tools that the Federal Reserve could employ to drain reserves to support the effective implementation of monetary policy," the central bank said. Reuters (28 Dec.)

Why Stocks and the USD Are Now Moving Together

Historically, the USD and stocks have moved together. However, over the past two years, the dollar has in fact moved opposite stocks. Why?

The Good News Wasn’t Good For the USD

The very low USD interest rates meant that traders had no reason to want dollars when there was optimism/risk appetite, because there were much better yielding alternative currencies like the AUD or even EUR that would also benefit from growth. This buying of high yield currencies and selling low yield ones to fund these purchases is called carry trade.

Moreover the "good news" we’ve seen for the US economy over the past years DID NOT help unemployment and consumer spending, the very issues that were forcing the fed to keep stimulus flowing, rates low, and thus the USD a sell relative to other currencies. The "good news" was of the "less bad than expected" unemployment, spending, or corporate earnings data. Good for stocks, but not for the USD. Thus stocks would rise, investors would buy other FX and sell the USD to fund these purchases

What Has Changed?

As we’ve noted repeatedly, at least 1 of 3 things had to happen to stop the USD slide:

* A panic event, which bids up demand for low yield currencies like the USD as carry trades unwind with rising fear.
* Improvement in US economic fundamentals that improves expectations for interest rate increases (i.e. in employment and consumer spending)
* A decline in EUR fundamentals that weakens the EUR and thus causes the USD to rise, because these currencies move in opposite directions due to the EUR/USD comprising nearly a third of all FX trade by itself. That means for every 3 EUR bought a USD is sold and vice versa.

Recently, we’ve had all three. Most importantly, the ‘good news’ for the US economy was improving employment and spending conditions. Not only has the unemployment rate and rate of new job losses almost stopped, there is a surge in temporary hiring, which is believed to indicate employers are moving closer to hiring full time staff. Consumer spending has also risen.

This news suggests not only higher earnings, which are good for stocks, but also sooner than previously expected stimulus reduction and interest rate increases for the US. Rising US treasury yields have also fed this expectation, as rising stocks draw capital away from US government bonds, which forces their price down and thus their yield up.

Will this traditional relationship continue?

Whether this traditional relationship continues will depend on whether the US continues to see overall improvement in jobs and spending data, which is good for both stocks and the USD. (source: http://seekingalpha.com/article/179551-why-stocks-and-the-usd-are-now-moving-together)

Mortgage Payments Fall Behind

More homeowners fall behind. The number of borrowers that fell behind on their mortgages - including the most creditworthy - rose in Q3 as the percentage of current and performing mortgages dropped for the sixth consecutive quarter, a regulatory report said. Those that fell behind on their prime mortgage payments more-than doubled to 3.6% from a year ago. Such troubles could mount as banks and thrifts remain unable to match modifications with the number of struggling borrowers who need help. (source - SeekingAlpha.com, Wall Street Breakfast - Must Know News, 12-22-2009)

Fed Keeps Rates Low, Despite Rising Inflation

While the Federal Reserve's Open Market Committee (FMOC) met last Tuesday and Wednesday, both major U.S. inflation indexes were released. First, on Tuesday, the Labor Department announced that the November Producer Price Index (PPI) rose 1.8% (nearly a 24% annualized rate), due to an 8.7% increase in vegetables and 6.9% increase in energy prices, including a shocking 14.2% increase in gasoline prices.

The price of raw materials, known as "crude goods," rose 5.7%, which illustrates the inflationary impact of a weak U.S. dollar. Meanwhile, the core PPI, excluding food and energy, rose just 0.5% (6% annual rate), but economists were expecting only a 0.2% rise in the core PPI and a 1% rise in the overall PPI, so the November report was clearly a big surprise to those who wish the Fed to leave interest rates alone.

Then, on Wednesday, the Labor Department reported that Consumer Price Inflation (CPI) rose 0.4% in November, due largely to a 4.1% increase in energy prices. Excluding food and energy, the core CPI was flat. However, the "Owner's Equivalent Rent," which accounts for nearly 40% of the core CPI, will keep future CPI gains relatively muted, due to weak hotel rates, plus the ongoing housing and rental glut.

In the past 12 months, the CPI is now up 1.8% (and the core CPI is up 1.7%). As the CPI 12-month rate nears 2%, the Fed is going to come under increasing pressure to raise key interest rates in early 2010. But despite all this news of strongly-rising prices, the FOMC left rates alone on Wednesday, adding only that it intends to wind down its quantitative easing operations by February 1, 2010. The Fed also affirmed that it plans to terminate most of its domestic liquidity programs on that date, and others a few months later.

The Fed also said it was sticking to its existing plan to taper off and complete its scheduled $1.25 trillion purchase of mortgage-backed securities issued by Fannie Mae and Freddie Mac by March 31. Despite the Fed's intention to exit quantitative easing, the FOMC also made clear that it expects to keep interest rates at "exceptionally low levels" for an "extended period" and did not make any reference to rising inflation!

Some dovish members of the FOMC believe inflation is likely to remain so low that rate increases might not be needed until 2011. Others will want to move more quickly because interest rates are starting from such a low point. Financial markets anticipate the Fed will boost rates to 0.5% after mid-2010, based on federal funds futures. The Fed also acknowledged that the U.S. economy is picking up. I suspect that the faster the U.S. economy grows, the earlier the FOMC will raise key interest rates in the months ahead. (Navellier & Associates, 12-21-2009)

Here comes the late 70's and early 80's.

Cash is King

Pimco makes major shift from government debt to cash. Pacific Investment Management Co.'s Total Return Fund made a big move from government debt to cash, signaling to analysts that the fund's managers anticipate interest rate hikes as the U.S. economy strengthens. The fund has increased its cash position to its highest level since the Lehman Brothers bankruptcy in September 2008. A company spokesman said the firm does not comment on its holdings. However, Pimco chief Bill Gross said recently that Treasuries are overvalued when weighed against the potential for inflation. Bloomberg (17 Dec.)

What Recovery?

Howard Davidowitz shares his view and more importantly his wisdom.

"The consumer is in worse shape since I was here last" in August, Davidowitz says, citing the following:

* Unemployment has exploded: "We've lost a ton of jobs since I was here last," Davidowitz says, noting the "real" unemployment rate is 17.5%. "That's an astounding number."
* Housing continues to sink: "The consumers' biggest asset is down trillions" in value while "foreclosures are exploding" and a huge percentage have negative equity -- 23% according to CoreLogic.
* Record numbers of consumer bankruptcies: The American consumer has "never been further behind...never defaulted more" on mortgages, student loans, auto loans, and credit card bills, he says.
* Poverty on the Rise: One in eight Americans and one in four children are receiving food stamps, as The NYT reported this weekend.

Link to webpage: (copy and paste to browser)
http://finance.yahoo.com/tech-ticker/article/381625/What-Recovery-U.S.-Consumers-Getting-%22Dramatically-Worse%22-Howard-Davidowitz-Says?tickers=RTH,XLP,XLY,WMT,TGT,HD%20,^DJI

The Credit Foundation is Still in Question

UAE officials try to counter concern regarding Dubai World. The United Arab Emirates' central bank said it "stands behind" the country's banks as they face losses from a possible default by Dubai World. The central bank eased credit to banks with an emergency liquidity facility and aimed to curtail potential capital flight. "This is a timely pre-emptive move from the central bank," said Goldman Sachs economist Ahmet Akarli. Financial Times (tiered subscription model) (29 Nov.), Bloomberg (30 Nov.)

Analysis: $1 trillion in U.S. bank reserves raise concern. U.S. bank reserves exceed the minimum required by the Federal Reserve by $1 trillion, raising questions and concern about inflation and banks' willingness to lend. Banks could activate the funds to support new loans, which could spur demand and inflation. Or the excessive reserves could indicate that bankers remain nervous about making new loans and would rather hang onto the funds. "If they don't make a loan, they can't make a bad one," said Pennsylvania State University associate professor John Mason. Others said the excess is to be expected. The Wall Street Journal (30 Nov.)

Is The Bank Crisis Over?

U.S. bank lending posts biggest decline in 25 years. Banks in the U.S. cut back the amount of money loaned to customers by $210.4 billion in the third quarter, the Federal Deposit Insurance Corp. said. The 2.8% reduction marks the sharpest drop since at least 1984. The biggest banks, which received billions of dollars in taxpayer bailouts, accounted for a disproportionately large part of the drop. "We need to see banks making more loans to their business customers," said Sheila Bair, the FDIC's chairwoman. The Washington Post (25 Nov.)

What is the reason for the drop? Do banks need capital? Does this mean the banking crisis is over?

All great questions.

US Homes Underwater - Negative Equity Expected to Rise

Nearly a quarter of U.S. homeowners are "underwater". About 23% of U.S. homes have a higher mortgage balance than the property is worth, according to First American CoreLogic. The nearly 10.7 million households with negative equity present a huge obstacle to residential-housing recovery. Homeowners with an "underwater" mortgage are more likely to allow their property to go into foreclosure. The Wall Street Journal (24 Nov.)

In one of my previous post I wrote how this number is forecasted to be 50% by 2011. Which means for this to come true home values must continue to fall. Headlines lead readers to believe otherwise; but the headlines speak to the "second derivative" the rate of change slowing not the general direction. Which is continuing to decline.

Precursor to the Second Stimulus Package?

Obama warns of double dip. The U.S. is flirting with a double-dip recession if it doesn't act to contain rising U.S. deficits, President Barack Obama warned Wednesday in an interview with Fox TV. The government is challenged in trying to boost the economy and spur job creation while setting a path toward long-term deficit reduction. Obama said the administration is considering tax measures to spur companies to hire.

The Fed Governors Don't All Agree.

Fed officials disagree on recovery. Top Fed officials gave different points-of-view on Tuesday about the pace of recovery. Inflation hawk Jeffrey Lacker, president of the Richmond Fed, said that recovery is solidly under way, and he expects the economy to grow at a reasonable pace next year, though there could be "patches of lingering weakness." Cleveland Fed President Sandra Pianalto and San Francisco Fed chief Janet Yellen disagreed, saying that the economic recovery will be sluggish. Yellen warned that the Fed could not maintain its loose money stance for too long, regardless of the pace of recovery. "It is a core responsibility of the Federal Reserve to preserve price stability," she said.

Fed Chairman Comments on the Econmy, Market....

Bernanke gives mixed signals. The recent pickup in the economy "reflects more than purely temporary factors" and continued moderate growth is likely, Fed Chairman Ben Bernanke said in a speech Monday, though constrained lending and weak labor market remain headwinds to robust growth. Inflation expectations haven't responded to upward or downward pressures, he said, noting plenty of resource slack. Bernanke pledged that low-interest, loose monetary policies would continue for an extended period. In a follow-up Q&A, Bernanke said it's "not obvious" that asset prices are out of line, at least inside the U.S., and that "we can never say never" on using interest rates to deflate bubbles, adding we won't have a "real market-based financial system until it's safe to let a financial firm fail."

Fed’s Kohn sees no asset bubbles. Fed Vice Chairman Donald Kohn said in a speech Monday that there was no sign of an asset bubble being caused by the low interest-rate policies the central bank was pursuing. Kohn pointed out that the central bank's loose monetary policies were intended to help investors move into riskier assets.

Or should he say "force" them in to riskier assets????

Hoenig - "Let The Fail" - Freemarkets Work

Hoenig on big banks: Let them fail. The U.S. economy still faces "significant weaknesses," KC Fed president Thomas Hoenig said Monday, "and coupled with a rapidly rising level debt and enormous moral hazard issues, we have a great deal of work ahead of us." Speaking at a central banking event in Abu Dhabi, Hoenig also urged policymakers to allow large financial institutions to fail if needed: "Our institutions must be allowed to fail no matter what their size or political influence."

Not a New Bull Market

We are still in a Multi-Year Bear Market that began in October 2007, led lower by financials.

The Bear Market Rally is based mainly on the Dollar Carry trade not on economic fundamentals. You can not have a New Bull Market when ValuEngine shows seven of eleven sectors overvalued.

Year to date the S&P 500 is up by 21.6% with community banks down 24.9% and regional banks flat. Where's the leadership?

Copy and paste the following to your browser:

http://seekingalpha.com/article/172980-not-a-new-bull-market-for-stocks?source

Retirement Risk Index

The Center for Retirement Research at Boston College just released an article pointing out that the recession has made retirement at age 65 more difficult. The article found that 51% of Americans have a high risk of not being able to maintain their current lifestyle in retirement, which is up from 44% in 2007. Americans at risk have two options - postpone retirement or lower their standard of living.

The article gives four reasons for the increased risk:

1) Housing Market Decline: which was considered the big factor for the increased risk.

2) Stock Market Slump: From 2007 to through Q2 2009 stock holdings declined by $7 Trillion.

3) Lower Interest Rates: Retirees will earn less on their investments

4) Reduced Social Security: Full SS benefits are no longer available at age 65 for those born after 1937. It is extended by months based on year of birth. For those born in 1960 or later full SS benefits occur at age 67. One can still get reduced benefits at age 62.

Link to the article: http://crr.bc.edu/images/stories/Briefs/ib_9-22.pdf

Wall Street Journal - Historical Quote On The Stock Market

Mr. Buffett's approach to investment often seems to parallel the Commodore's. Vanderbilt accepted no salary as an executive, but took only the dividends on his personal stock. (In his era, investors expected steady dividends, not rising share prices.)

To prosper, he had to make his corporations profitable, year after year. He bought lines with permanent advantages—those that ran through developed regions that provided local traffic, for example, and that had low grades, which reduced operating expenses. So, too, does Mr. Buffett look to the long term.

Will The Real GDP - Come On Down!

What was the real GDP for Q3 - 2009?

Economists say U.S. GDP is miscalculated
The calculation of U.S. GDP is not correct, a group of economists said. Imports priced at their point of origin at a certain amount are being accounted for at U.S. prices when GDP is calculated. The problem appears to have swelled GDP reporting, the economists said. While last quarter's GDP was reported at an annual growth rate of 3.5%, the number was actually 3.3%, they said. The New York Times (08 Nov.)

In addition to the above, Cash for Clunkers artificially added to GDP by 1.7%. Of which 3/4 of those buyers were going to buy anyway. If we reduce GDP by Cash for Clunkers and First Time Homer Buyer Credit it looks as though GDP was negative.

Oh the lies Washington tells.

Stock Price - Detachement From Reality

The current value of the stock market has detached from reality. Looking or listening to headlines one would conclude that companies are exceeding growth expectations. And so they are, because of overly conservative analyst estimates and easy comparison.

Of companies that have reported 74% have beat expectations, this percentage is unheard of. Of addition concern is the amount by which the earnings have beat expectation - 7.5%, the average is 3%. As we dig deeper one quickly realizes that the headlines are misleading. Of the companies that have reported, only 27% reported increased revenue. The earnings expansion was due to cost cutting which lead to margin expansion. The 15 year average margin is 6.6% versus the recent average of 7.8%. This highlights that margin expansion and cost cutting is leading too much of the bottom line growth, not revenue growth. Revenue growth is a must to recover.

Stock investors needs to be cautious.

Roubini Sounds the Alarm

Nouriel Roubini is back at it, delivering the latest battle call in his war against complacent optimism. This time, Dr Doom is concerned about "the mother of all carry trades", where investors are borrowing dollars at negative interest rates (due to low nominal rates, and an ever-depreciating dollar), and investing them in anything that is risky and from emerging markets. Hence the disparity between real economic growth and financial market growth.

This new carry trade is quite dangerous, as it is based on the assumption that the dollar will continue to plunge and emerging market investments will continue to pay off handsomely. Should it unwind, due to a rising dollar or emerging market crisis, markets would become dangerously volatile, which would then hamper the real economy (sound familiar?):

But while the US and global economy have begun a modest recovery, asset prices have gone through the roof since March in a major and synchronised rally.

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fueling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades.

The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.

In effect, it has become one big common trade- you short the dollar to buy any (Roubini's emphasis) global risky assets.

source: SeekingAlpha.com

Investment Asset Values

Cumulatively, asset values have risen twice as fast as GDP over the 50 year period. As Gross writes "you would have been far better off investing in paper than factories or machinery or the requisite components of an educated workforce."

Bernanke Speaks

Bernanke warns U.S., Asia to mind the gap. Fed chairman Ben Bernanke called on U.S. and Asian leaders to "avoid ever-increasing and unsustainable imbalances in trade and capital flows," saying the U.S. financial system is currently "overwhelmed" by an inflow of capital. Speaking Monday at a San Fran. Fed conference on Asia, Bernanke warned that while the U.S. trade deficits with developing countries are not as onerous as they were two years ago, they are still a threat to the global economy. World leaders believe global economic growth must begin to depend less on the U.S. consumer.

Fed tests exit tool... As global central banks begin to weigh inflation risks, the Fed confirmed Monday it has begun experimenting with "triparty" reverse repo agreements, but says their actual use is not imminent. In a reverse repo, the Fed pledges mortgage-backed securities and Treasurys it bought as collateral for short-term loans, thereby draining cash from the financial system. Reverse repos are normally the domain of the 18 primary dealers; the experiment involves extending that to deals with the $2.5T money-market mutual fund business.

Foreclosures Increase in Q3 - 2010 Foreclosure Projected to Increase

U.S. residential foreclosures hit record high in Q3. During the third quarter, home foreclosures in the U.S. reached a record high. "They were the worst three months of all time," RealtyTrac spokesman Rick Sharga said. The firm said 937,840 homeowners received some form of foreclosure notice. The number is 23% higher than that of last year's third quarter, RealtyTrac said. CNNMoney.com (15 Oct.)

It is projected that 50% of all homes with a mortgage will be underwater, i.e. the mortgage greater than the homes value by 2011. Therefore, the drop in home prices has not stopped, as headlines have indicated. The rate of drop as just has slowed down.

Dow Is The Talk - But Bonds Get The Money ($$$)

Bonds are the real deal. Although the Dow sailed past 10,000 on Wednesday, bonds continue to steal the show. U.S. fixed-income funds have been a cash magnet this year – attracting 18 times more money than stocks in 2009, despite the Dow surging 53% after hitting a 12-year low in March. Americans are deploying money they put in money-market accounts during the credit crisis back into the markets. And there's more ammo on the sidelines: almost $3.45T remains in U.S. money-market accounts.

Where Do Interest Rates Go From Here?

click to enlarge image

Bond investors are filling the same squeeze that stock investor have been facing - what to do with cash? Based the chart below prices are up and yields are near or at there low. Wisdom would have one stay relatively short and in high quality.

Financial Tidbits

Office rents plunge. Office rents fell 8.5% Y/Y in Q3, the biggest drop since 1995, according to research firm Reis. The decline came as renters returned a net 19.6M square feet to landlords; YTD they've given back 64.2M square feet - the highest negative absorption rate on record. The vacancy rate of 16.5% is a five-year high. With more job losses still predicted, many say it's too soon to look for a bottom: "If employers are still shedding jobs, they are also going to shed space."

Better economy doesn't inspire spending. Consumers are feeling an improvement in the U.S. economy, but concerns about their personal finances are limiting their spending plans. Only 19% of respondents in Discover's U.S. Spending Monitor said they expect to spend more in the next month, even though 33% now feel an improvement in economic conditions. "There appears to be no indication consumers are willing to increase their spending," Discover's Julie Loeger said.

Source: SeekingAlpha.com, "Wall Street Breakfast: Must-Know News", 10-7-2009

Quote:

For those still in equities, we believe Tyler Durdern at Zero Hedge said it best,

Go long here at your peril.

Roubini Interview - "Too Much, Too Soon, Too Fast"

“Markets have gone up too much, too soon, too fast,” Roubini said in an interview in Istanbul on Oct. 3. “I see the risk of a correction, especially when the markets now realize that the recovery is not rapid and V-shaped, but more like U- shaped. That might be in the fourth quarter or the first quarter of next year.”

‘Growing Gap’

“The real economy is barely recovering while markets are going this way,” Roubini said. If growth doesn’t rebound rapidly, “eventually markets are going to flatten out and correct to valuations that are justified. I see a growing gap between what markets are doing and the weaker real economic activities.”

source:Bloomberg.com, http://www.bloomberg.com/apps/news?pid=20601087&sid=aM2YCVc3cUOI

A Must View - Fox New Clip

Copy & Paste the following link into your browser:

http://video.foxbusiness.com/10261104/dollars-impact-on-markets/?category_id=1292d14d0e3afdcf0b31500afefb92724c08f046

Research Edge's Keith McCullough highlights potential issues we face in our economy and stock market.

As I have told all of my clients, the current market rebound is due to liquidity expansion (excess cash) than fundamentals (earnings growth and/or P/E expansion). Granted comparison earnings will look better year over year (yoy), just because last year looked so bad. But when you smooth out the earnings over multiply we still have a long way to go.

This is not the time to chase the market.

Recent Home Prices Data and The Rest of The Story - It's Not Rosey

The ongoing decline in U.S. home prices continued to abate, with prices down 12.8% and 13.3% for S&P/Case-Shiller's 10- and 20-city home price indexes, a 1.7% improvement from a month ago (i.e. the decline is slowing, but not ended). The group said figures continue to support the stabilization story, "but we do need to be cautious in coming months to assess whether the housing market will weather the expiration of the Federal First-Time Buyer’s Tax Credit in November, anticipated higher unemployment rates and a possible increase in foreclosures." Source: SeekingAlpha, Wall Street Breakfast: Must Know News, Sept. 30, 2009

For the rest of the story watch the following Youtube Link (copy and paste to your browser). It highlights future impending problems that lead to future price declines, though we are near the bottom. More importantly, the analysis points to a long basing period to recovery, i.e. an extended U-shape recovery in home prices.

http://www.youtube.com/watch?v=stVgR0SeiQo&feature=player_embedded

Strange to Strained Banking

Bank bailout with a twist. Regulators are seriously considering a plan to have healthy banks lend billions of dollars to the FDIC's bank insurance fund, which is rapidly running out of cash amid a wave of bank failures. The plan appeals to banks, because it would forestall yet another across-the-board emergency assessment on them, which could erode $5-10B of their profits. And it appeals to FDIC head Sheila Bair, who bankers say "would take bamboo shoots under her nails" before turning to the Treasury to tap the FDIC's $100B emergency credit line. (Source Seeking Alpha, Wall Street Breakfast, New's You Must Know. Sept. 22, 2009)

Does this point to pending/continued problems with banks? I'd say yes. There is a push by bank and consumers to clean-up their balance sheets. The government can only extend itself for a finite period of time. The current market is a bull rally in a bear secular market. Be very careful.

But Cash Is Earning Zero

The idea of cash earning zero comes up every so often in interviews, in the context of managers needing to put cash to work because of the low yield, or "you don't get paid to sit in cash" or managers needing to get invested ahead of the quarter (window dressing).

This is entirely the wrong context. If you knew that stocks would double over the next year, then a money market yield of zero is bad. If you knew that stocks would be cut in half over the next year, then a money market yield of zero is fantastic.

Obviously no one knows whether stocks will go up 100% (unlikely), down 50% (unlikely) or something in between (likely). People who actively manage portfolios (for themselves or others) probably have an opinion about direction and tilt to that opinion in some magnitude. In this context, cash becomes a tactical tool regardless of the yield. As a tool, it is used in correct proportion for a given period or it isn't, but the idea of "too much cash" is not complete without context.

During the worst of the recent (current?) bear market I met with my firm's primary point of contact at Schwab and he mentioned something about our cash level being high - this, as the market was puking down. To put it in Hussmanesque terms, if risks favor the downside, then having cash - regardless of the yield - becomes the correct tactical decision.

Unfortunately, much of what we see in the media asks the wrong questions or more correctly frames the context incorrectly. "I see you don't like financials" is one example. Actively (so not passive) navigating market cycles can be made much easier (not easy, easier) by weighing risks and rewards of various things you invest in, either broad asset classes, investing at the sector level, country level or however narrow you go.

In too many interviews in the media, maybe as a function of time, the questions asked do not necessarily seek the correct context and the person being interviewed may or may not realize this and add in that context. Anytime you read or hear anyone speak, it is important to realize there could be more context as not every one tells you everything he is thinking, like Jimmy Rogers.

By: Roger Nusbaum, SeekingAlpha.com, http://seekingalpha.com/article/161830-but-cash-is-earning-zero

Investing and Inflation

Most of us think of the return on our investments in nominal terms, or the stated return on an investment. In periods of low inflation, if you expect a corporate bond fund to yield 5 percent, thinking of this as a 5 percent return may not be particularly harmful.

When inflation increases, however, thinking in nominal terms can be very detrimental, especially to your long-term investment planning. Given recent events, it may be prudent to consider the next stage of the economy. The government has aggressively increased spending, and the Federal Reserve, the U.S. central bank, has increased the money supply. If inflation results from these measures, thinking in nominal terms may reduce the probability of satisfying your needs and goals. Now may be a good time to think about your portfolio return above the rate of inflation, or in real terms, and to prepare for the risk of higher inflation.

Inflation reduces investment returns and needs to be considered in constructing portfolios for different stages of investors’ lives. Most investors want their investment portfolio to preserve and enhance purchasing power. Preserving purchasing power means that investment returns must clear the inflation hurdle.

Investment insight

Nominal return: The stated return on an investment. If you invest $100 and get $102 in a year, that is a 2 percent nominal return.

Real return: The return on an investment adjusted for inflation (or deflation). A 2 percent nominal return in a 2 percent inflationary environment will leave you exactly where you started in terms of purchasing power, unless you are paying taxes on the interest, in which case you are worse off after a year. Your goal should include maintaining purchasing power, or your ability to pay for your future.

Let’s look at different securities in your portfolio to determine whether they are likely to meet the inflation hurdle.

Cash/short-term bond fund

Cash investments, such as savings accounts and money market funds, will often yield less than the inflation rate, reducing your portfolio’s real return. While cash serves a useful purpose, it may be beneficial to consider a high-quality short-term bond fund for some of your liquidity needs.
The somewhat higher yield in a short-maturity bond fund can help to keep pace with inflation. Remember, however, that returns that seem too good to be true often entail unexpected risks, so proceed with caution. Review the latest prospectus to understand the fund manager’s strategy and recent holdings. You may choose to skip a fund that contains securities with unfamiliar characteristics.

Bonds

Medium- and longer-term bonds typically do poorly in periods of higher-than-expected inflation for two reasons. Inflation erodes the purchasing power of a bond’s fixed income stream. In addition, unexpected increases in inflation typically result in rising interest rates, which lower nominal bond prices.

Inflation-protected bonds are an important exception to the behavior of most bond investments in inflationary periods. These bonds protect investors against unanticipated inflation explicitly, because they promise to pay a real rate of return plus actual inflation. In the United States, they are called TIPS (Treasury inflation-protected securities) and can be purchased individually to a target maturity date or within a fund that holds a diverse basket of maturities. Their special properties make them useful for investors who place paramount importance on maintaining purchasing power and desire the safety of a government-guaranteed bond.

While TIPS offer protection against unexpected inflation, they share with conventional bonds the sensitivity to changes in interest rates and market sentiment. Note, however, that hold-to-maturity investors would still receive the payments, including adjustments for inflation, for which they bargained when they bought the security (regardless of changes in the quoted value of the bond). Work with your financial adviser to evaluate the role that TIPS can play within your portfolio.

Investment insight

Treasury inflation-protected securities (TIPS): Treasury inflation-protected securities, or TIPS, protect against inflation. The principal of TIPS increases with inflation (and decreases with deflation) as measured by the Consumer Price Index (CPI). When TIPS mature, you are paid the adjusted principal or original principal, whichever is greater. Speak with your investment adviser about the tax treatment of the annual principal adjustment.

Stocks

Stocks are generally thought of as good inflation hedges over the long run because companies are able to charge higher prices to offset rising costs. Stock returns, however, may lag inflation, especially over shorter horizons. The recent decline in the stock market should underscore that equity investing is not for everyone or for every investment need. Match your goals and risk tolerance with an appropriate mix of investments.

Commodity funds

Sophisticated investors may address concerns about inflation by investing in commodity funds, which have value that fluctuates with prices of physical goods such as agricultural products, metals, and oil. Actively managed funds within this category tend to concentrate on a narrow range of positions, and consequently can experience more volatile results than other fund types. Additionally, some funds invest in companies that produce commodities, while others invest directly in the underlying commodity, which generally offers better diversification benefits. In general, commodity funds may serve the interests of longer-term sophisticated investors, often representing a small percentage of their portfolio.

Investing amid uncertainty

Recent market developments underscore the importance of following the evergreen Scouting principle of “being prepared.” Prudent investment planning suggests constructing a portfolio that will meet your needs and goals over a range of possible scenarios. While it is impossible to know with certainty how damaging inflation will be in your investment future, being prepared for the full range of possibilities, including a period of inflation, can make sense.

Why choose a CFA charterholder wealth manager?

Many investors use specialists for the complex matters of life, and portfolio construction is a good example. Consider using a financial adviser who is a CFA charterholder to assist you in constructing a portfolio that will meet your needs and goals.

Today’s financial markets demonstrate just how important it is to have reliable evidence of your financial adviser’s integrity, experience, and commitment.

No credential is as widely regarded in the global financial industry for its rigorous focus on current investment knowledge, analytical skill, and fiduciary responsibility as the Chartered Financial Analyst (CFA) designation.

A CFA charterholder is:

Credible. Adherence to a code of ethics that puts the client’s interest first and mastery of a comprehensive body of investment knowledge

Committed. Demonstrated professional experience and perseverance to undergo 18 hours of examination

Current. Exams updated with the latest and most relevant knowledge and access to world-class lifelong learning resources

Connected. Membership in a network of more than 100,000 investment professionals in 131 countries

source: CFA Institute Newsletter

Quote of the Day

"The ability to ask the right question is more than half the battle of finding the answer."

Thomas J. Watson

Investors should focus their time on the right question. A rare few do. Hence, the reason for a Coach.

Louis Navellier's Thoughts on the Market

On the anniversary of 9/11, the Dow closed Friday at 9605.41, ironically just 0.1 below its 9605.51 close on September 10, 2001, the day before the attack on America. In terms of the broader S&P 500, the U.S. market is well below where it was last year and in most of the mid-September marks of the last 10 years (except 2002-03). While some analysts talk about an “overbought” stock market that has risen “too far, too fast,” we are still trading well below where we were a decade ago, with near-record amounts of cash still on the sidelines, pondering the “buy” decision. From a contrarian viewpoint, this is encouraging…

Stock versus Bonds

Treasury prices rallied through the summer, but so did stock prices. Can we really have it both ways? In 2008, Treasuries outperformed the S&P 500 by an impressive 53%. From 1900 to 2008, equities have outperformed bonds by an average of 4.2%, but only an average of 2.7% from 1821 to 2008. This suggests the long-term average equity risk premium is in the vicinity of three to four percent.

Source: RGE Monitor, 9-8-09

Bill Gross - Possible Double Dip

Bill Gross, chief investment officer of Pacific Investment Management Co., said a double-dip recession might result in opportunities to invest in longer-term U.S. government debt. "To the extent that we have had a trillion dollars worth of stimulus, from the standpoint of deficits, and more, the government basically has to continue to do that and to add to that in order to keep the economy chugging along," he said. "To the extent that that's limited, to the extent that they pull back on some of those stimulus programs -- 'Cash for Clunkers' and those types of things -- then the double dip moves into the realm of possibility." CNBC (02 Sep.)

Video link: http://www.cnbc.com/id/15840232?video=1237349639&play=1

What a Wild Ride the Past 12 Months Have Been

About a year has passed since the financial crisis hit with full force, and investors could learn a few things from the experience. First and foremost, diversification is still a useful concept, but markets are so interconnected that there are limits to the level of security one can achieve from it. Now and then, trends are so powerful that diversification will not work. The Wall Street Journal (30 Aug.)

Full Article: http://online.wsj.com/article/SB125158349559369687.html?mod=dist_smartbrief

Consumer Spending/Savings

The following is from RGE Monitor (Nouriel Roubini):

Personal income fell less than 0.1% in July 2009 after falling 1.1% in June 2009, while disposable personal income fell less than 0.1%. Real disposable income fell 0.1% in July after falling 1.6% in June. Personal spending rose 0.2% in July after rising 0.6% in June, while inflation-adjusted spending rose 0.2% after rising 0.1% in June. Real spending on durable goods rose 1.8% in July after rising 0.8% in June, led by purchases of motors vehicles under the "cash for clunkers" program. The saving rate fell to 4.2% in July from 4.5% in May. (U.S. Bureau of Economic Analysis)

The IRS Is Thinking About Cutting 401(k) Contribution limits

Because of the low inflation rate in the U.S., the Internal Revenue Service likely will reduce the $16,500 limit on 401(k) contributions to $16,000 for next year. The limit is based on a formula tied to inflation that the IRS is required by law to follow, according to an analysis by human resources consultant Mercer. Unless Congress changes the law, the IRS probably will have no choice, said Bill McClain, a senior consultant at Mercer. USA TODAY (26 Aug.)

A Wild Ride A-coming

Are we in for a wild stock market ride? If the past is any kind of an example - then yes.

From seekingalpha.com

John Mauldin's most recent weekly missive (registration required and highly recommended) contained the following graphic depiction via Ed Easterling of the ups and downs seen in the last secular bear market in stocks during the period from 1966 to 1982.

That gives the nearly 50 percent rally since March a whole new perspective, particularly given the fact that we are only nine years into a cycle that typically runs much longer.

Some parallels to the 1972 peak are cited in the analysis, but a repeat of the 1975 peak would surely disappoint recent stock buyers as well.

CCM Comments:
Well let's look at recent history. On 10/10/2007 the S&P 500 was (1562) from there we declined to (676) on 3/09/2009, a return of -57%. Or what I call "negative compounding". From 3/09/2009 the S&P 500 has increased to (1028) a return of 52%. In less than two years we have experience one "wide ride". If history is any indication of the future then get ready for a more wide rides to come.

Banks Continue Tighten Lending Practice

The Federal Reserve’s latest Senior Loan Officer Survey of 55 domestic banks and 23 U.S. branches and agencies of foreign banks revealed a continued tightening in lending standards amid weak demand for all types of loans during the second quarter. According to the Fed’s survey, about 30% of domestic respondents, on net, reported tighter standards on commercial & industrial (C&I) loans to large firms, and about 35% claimed to have tightened lending standards to small firms. The household lending situation continues to be restrictive as 35% of those polled tightened standards to consumers. Loans and conditions on credit card and other consumer loans were also tighter, though not as tight as in April. This just doesn’t seem like an environment that will result in greater organic economic activity. As low as rates are, the lending channel remains clogged and there’s currently no incentive to lend or borrow.

Source: Argus Research, 8-25-09

Double-Dip Warning

Roubini: Double-dip recession risk is rising. In an op-ed in the Financial Times, economist Nouriel Roubini warned there is a growing risk of a double-dip recession. Lawmakers are "damned if they do and damned if they don't," since unwinding stimulus policies too soon could undermine a recovery but running large deficits could push up borrowing rates and cut off economic growth as well. The economy also runs the risk of a contractionary shock if speculation drives oil back over $100, and energy, food and oil prices are rising faster than fundamentals warrant.

Foreclosure Rates and Negative Home Equity

The linked articles paint a continuing negative picture for home values in the US. Karen Weave of Deutsche Bank is forecasting that approximately half of all homes with a mortgage will have negative equity by 2011. Currently 14 million home mortgages are said to have negative equity. Karen is projecting this to rise to 25 million by 2011.

The biggest question is will the negative equity have a transforming behavior change for the US consumer. Crew thinks so, with a potential for long lasting impact.

If you'd like additional insight give us a call.

http://finance.yahoo.com/tech-ticker/article/307793/One-In-Three-Chance-You%27ll-Soon-Owe-More-Than-Your-House-Is-Worth?tickers=xhb,tol,len,kbh,dhi,phm

http://www.businessinsider.com/henry-blodget-half-of-us-homeowners-underwater-by-2011-2009-8

US Recovery "V", "L", "W" or "Q"

The link below is a great article. It provide a very compelling argument for the shape of US Recovery going forward. It's one that I happen to agree has a strong probability of occurring.

http://seekingalpha.com/article/156736-understanding-the-q-recovery

Please forward for others to consider.

Is China Tightenting it's Credit??

China is not tightening credit, economists say. Although loan growth in China cooled during the past month, economists said the slowdown should not hinder the country's economy. "We do not think that the rapid credit expansion since early 2009 is sustainable and expect normalization for the remainder of the year," said Qing Wang, China economist at Morgan Stanley. "This slowdown in loan growth, therefore, should not be interpreted as policy tightening." FinanceAsia.com (12 Aug.)

Please make sure to review yesterday's post.

Other important items:

Statistics signal U.S. recovery with no new jobs nor pay hikes
Economic indicators suggesting the U.S. recession is ending are increasing by the day, but those same indicators point to the likelihood that recovery will not mean good times for many Americans. The statistics indicate a recovery with no new jobs, no pay increases, and no growth in tax receipts for cash-strapped state and local governments. "It's going to be a recovery only a statistician can love," said Mark Vitner, senior economist at Wells Fargo. The Washington Post (12 Aug.)

Geithner Asks Congress for Higher U.S. Debt Limit

As reported on SeekingAlpha.com 8-10-09.

Now does that sound like everything is moving in the right direction??? If the US were a corporation the bankers would call the loans. Hopefully China doesn't.

US Promoting Consumer Spending - a Ponzi Scheme?

The link below provides an interesting dialogue on the subject. This article is a continuation on my theme this week: The US Economy needs the consumer to grow. The US Consumer needs confidence to get back in the game to spend. The US Government and the media is doing just about everything it can to supply and support consumer confidence. Some economic data is turning positive or at least slowing its negative descent. But the US Consumer JUST ISN'T BITING. I think being Madoff'd is fresh in their memory.

http://seekingalpha.com/article/154621-confidence-games-and-ponzi-schemes-no-way-to-run-the-world-s-largest-economy?

In summary the US Consumer has had one big party and now it's time to pay the tab and get down to business. That being said the recent stock market recovery looks over extended. The largest agreeing percentage group (30%) of the economist attending the annual economic summit at Leen's Lake this week believe we will face a "W" recession. And based on this and the last two post I Agree.

Continuation on Consumer Spending, Savings and Disposable Income

Please read the link below from SeekingAlpha.com. It extends the discussion from yesterday. If the trends continue we will be heading back to a period very similar to the post Great Depression Era and therefore a "reset" of US consumer behavior.

Given the reset, the US Stock Market may be a head of itself.

http://seekingalpha.com/article/154253-investing-implications-of-higher-consumer-savings-rate?

Consumer Spending Reset - Linchpin to Recover

Below is a to a good interview regarding consumer spending "reset" habits with Andy Bond, ASDA (a European Division of Wal-Mart). Just copy and paste it to your browser.

http://seekingalpha.com/article/153918-will-consumers-ever-revert-to-pre-recession-spending-levels?

It is important because "Consumer Spending" is the linchpin to economic recover. Consumer spending habits after the "Great Depression" slowed the economic recover with the shifted to savings from consuming. This transition behavior is replicating its self again. The degree of replication is the big question to be answered and the linchpin to the economy and investing. As personal evidence, just recall how your own parents and grandparents consumed and saved.

First Half 2009 Federal Government Tax Receipts in a Free Fall

This morning Fox News reported that Federal Government Tax Receipts are down $338 Billion. Individuals represented a little over $170 Billion of the total with corporate tax receipts being the residual. On a percentage bases individual are down 22% and corporations are down 57% for the first half of 2009.

Tax Hikes A-Coming

Here come the Tax Hike!

Though it is contrary to President Obama's campaign rhetoric, he sent his economic staff out over the weekend to float the idea of a middle class tax hike. Come on, you didn't believe him during the campaign, did you? If so, just remember, if a politician is moving his/her lips they are lying. OK, that is a little strong, but there is a foundation to that comment. Note I didn't favor any political party, I said politician.

We have just gone through one of the the biggest parties in economic history, call it the "Roaring 90's", remember the "Roaring 20's" from history class? What followed? So now it's time to pay the tab. An it's a big one. So look to slow to no economic growth. Because we are faced with higher taxes and no leverage.

But in the end this might be a good lesson for us all to learn, though it will be a little painful.

Double-Dip or W-shaped Recession

The following link is a great read from RGE Monitor, regarding the Outlook for the US Economy. It points to the potential for a Double-Dip or W-Shaped Recession.

http://www.rgemonitor.com/economonitor-monitor/257243/rge_monitor__us_economic_outlook_q2_2009_update

Copy and paste it into your browser window.

New Home Sales

New home sales came in at 384K in June, up 11% from May, vs. consensus of 350K. Sales were down 21.3% vs. the previous year. The median home price of $206,200 was down from May's $221,600. Inventory of 281K homes represents an 8.8 month supply, down from 10.2 months in May.

Bernanke Defends Fed.

In a PBS Town Hall forum that taped on Sunday and will be aired this week, Bernanke defended the Federal Reserve's actions of the past year, telling participants "I was not going to be the Federal Reserve chairman who presided over the second Great Depression." Bernanke said he was 'disgusted' by the circumstances leading up to the rescue of some large firms and called for new legislation to allow non-bank financial firms to fail without going into bankruptcy. SeekingAlpha.com

In a move to keep with his idea of transparency, Mr. Bernanke held a "town hall" meeting in St. Louis. In addition to his comments above he noted that there is no current need to increase rates, i.e. no inflation concerns.

Martin Feldstein on a Double Dip

As reported on seekingalpha.com:

More and more are converting to our view - Martin Feldstein has been a reasonable voice through much of this mess, unlike the traditional punditry (including the economists class) normally sourced. [Apr 2, 2009: Martin Feldstein - Economic Recovery Has Long Way to Go]

On my end, I just call this one big Great Recession, already by multiples longer than anything we've faced post World War II, that most likely will "technically" be classified as double dip due to the massive amount of government spending that will buffet official government statistics and paper over damage for a few quarters. So after we clap and cheer about the GDP turning positive perhaps in Q3, we'll see much of it was due to a massive drop in imports combined with massive government transfer payments. Yee haw.

Unless I am completely wrong and the engine of the world (the US consumer) acts very differently than I anticipate, unless we are going to do multiple $500-$750B type stimuli each year, we're just going back to having a stagnant situation. A year from now we'll have to ask - what bone are we going to cut to prop up earnings now that all the muscle has been chopped, and in China we'll be asking what the outcomes of all the loan growth have been; their property and stock markets are flying as government money is sprouting in all directions. The misallocation of said loans should begin to be an "issue" 12-24 months out.

Further, we've been discussing the state budget disasters coming for 2 years now - many states used this year's stimulus as a "stop gap" to plug holes in their budget. What for next year? This is why I believe a new stimulus will be upon us again by next winter.

We keep trying to get around the fact that Americans need to rebuild their savings, and we are content to hide this fact by stealing more and more from future generations to create false demand for homes, cars, et al. We just keep repeating the same errors and burdening grandkids with ever increasing bills. All we have is paper printing prosperity. [May 19, 2009: Paper Printing Prosperity Defined]

Via Bloomberg:

The U.S. recession may not be coming to an end and there is a risk the economy may experience a “double-dip” contraction, said Martin Feldstein, a professor of economics at Harvard University.
“There is a real danger this is going to be a double dip and that after six months or so we’ll have some more bad news,” Feldstein, the former head of the National Bureau of Economic Research and Reagan administration adviser, said today in an interview on Bloomberg Television. “We could slide down again in the fourth quarter.”
The economy could “flatten out” or “even be positive” in the third quarter, and then it’s likely to contract again in the last three months of the year as the effects of the federal stimulus program wear off and companies finish rebuilding inventories, he said. “There isn’t going to be enough to sustain a really solid recovery,” he said, even though recent data has provided some “good news” on the economy.

The Fed's Next Tool - The Dollar

Below is a great article from SeekingAlpha.com, http://seekingalpha.com/article/149817-is-the-u-s-dollar-the-fed-s-next-weapon?source=email

The second anniversary of the credit crisis has arrived and, in the light of the plethora of fiscal and monetary policy initiatives, it makes for interesting reading to reflect upon how the U.S. economic landscape has changed since the start of the crunch.

• Fed funds rate: down from 5.25% to zero

• Fiscal deficit: up from 2% to 13%

• Mortgage rates: down from 6.5% to 4.7%

• Home affordability: 70% improvement

• Fed’s balance sheet: up from $850 billion to $2 trillion

Yes, the Fed has tried just about everything, and yet real GDP growth is negative at about 5% and the unemployment rate has doubled to almost 10% over the past two years.

David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, points out that there is one policy tool that is practically unchanged since two years ago … the U.S. dollar:

It is the only policy tool that has not budged one iota since the crisis erupted two years ago. But we are sure that as the unemployment rate makes new highs and increasingly poses a political hurdle in a mid-term election year, it would make perfect sense for a country that always operates in its best interest - even if it may not be in everyone’s best interest - to sanction a U.S. dollar devaluation as a means to stimulate the domestic economy.

It follows that Rosenberg is of the opinion the greenback has significant downside potential. He therefore suggests that investors should start thinking about protecting their portfolios against a declining dollar by taking positions in commodities, gold, the Canadian dollar, resource stocks and U.S. sectors that have high foreign exposure (materials, industrials, staples, health care).

Historical Perspective of the Bull-Bear Market Cycles

Below is part of an article from Louis Navellier. He points out that we are in the midst of a 17 year Bear Market Cycle, for which I agree. Please don't take me wrong - History doesn't repeat but it sure does rhyme.

As you will note the Bull Markets are founded on low taxes less government with the opposite occurring for Bears. Bear Markets are marked with high taxes and an oppressive government.

Navellier writes:
The Five (and a half) 17-Year Bull and Bear Markets since the Birth of the Fed
Market cycles are not locked in stone for any demographic or mystical reason, but in the 95 years since the birth of the Federal Reserve, the stock market has swung in very wide bull and bear market trends.

In shorthand terms, the government has played a major hand in each of these wide market swings:

(1) The 1920s bull market (over 500%) was fueled mostly by tax cuts and credit expansion
(2) The 1929-42 bear market (-75%) was exacerbated by high tariffs and credit contraction
(3) The 1949-66 bull market (over 500%) was created by free trade policies under GATT
(4) The 1966-82 bear market (-22%) was deepened by profligate fiscal and monetary policy
(5) The 1982-99 bull market (over 1400%) was inspired by tax cuts and a war on inflation.
(6) The current bear market (-30% so far) is due to deregulation, plus a revival of Guns & Butter

The Market’s Wide 17-Year Swings
Since the Birth of the Federal Reserve

1914 to 1929 Bull market +617%
1929 to 1947 Bear market -57%
1949 to 1966 Bull market +516%
1966 to 1982 Bear market -22%
1982 to 1999 Bull market +1409%
Since 1999 (Bear market) -30% *

* All figures based on the Dow Jones Industrial Average, which does not account for dividends or inflation. The declines in 1966-82 (and since 1999) would be much worse after inflation, which rose faster than dividend yields.

How Government Policies Caused the Major Bull and Bear Market Inflection Points

1930: Smoot-Hawley tariffs and the Fed’s deflationary policies killed the market recovery. Six months after the 1929 crash, in April, 1930, the Dow had climbed all the way back to 294, about 50% above its mid-November 1929 panic low. But then the Smoot-Hawley trade bill was signed into law on June 17. That day, the Dow Jones index fell by a massive 19.64 points (-8%), from nearly 250 to 230. The world retaliated against Smoot-Hawley by passing their own tariffs, leading to isolationism and World War II.

1947: GATT and the Marshall Plan rescued global economies and our stock market. In a mirror image of the protectionist Smoot-Hawley trade bill of 1930, the birth of the General Agreement on Tariffs and Trade (GATT) in 1947 created postwar prosperity. Politically, in a mirror image of the punitive Treaty of Versailles, the world helped rebuild Germany and Japan with the Marshall Plan and other temporary relief measures. The Dow rose six-fold from 163 in mid-1947 (and 161 in mid-1949) to nearly 1,000 in 1966.

1966: Fiscal (Guns & Butter) policies and profligate monetary policies doomed the stock market. LBJ escalated the war in Vietnam while launching multiple new domestic programs. He also took silver out of U.S. coins and enlisted the Federal Reserve to inflate money to fuel a phony prosperity. Nixon followed suit, closing the gold window and instituting wage and price controls, while fighting wars and launching new welfare programs. The result was a decade of “stagflation” (inflation and no growth) in the 1970s.

1982: The worst postwar recession included unemployment, interest rates and inflation in double-digits. The economy had declined in eight of the previous 12 quarters, since Fed Chairman Paul Volcker had spent three years choking off the money supply to kill the inflationary beast. But that medicine worked. In August 1982, he stopped the punishment and began easing the Discount Rate dramatically, while the President and Congress were cutting taxes to fuel a strong economic recovery and stock bull market.

1999: Fears of Y2K caused the Fed to expand liquidity way too fast in late 1999 (and then they raked in that money too rapidly in early 2000), adding to the tech bubble and making its “pop” bigger. In addition, the Gramm-Leach-Bliley Financial Services Modernization Act (passed overwhelmingly by Congress) was signed by President Clinton on November 12, 1999, right before the stock market’s peak. It allowed the creation of mortgage-backed securities, collateralized debt obligations (CDOs) and Structured Investment Vehicles (SIVs) – all those names which have become infamous by now – but there is more:

2007: The market decline of 2007-09 was also caused by massive government spending (Guns and Butter II) under President George W. Bush and a Republican Congress. Trying to fight two wars while also trying to solve a variety of social ills – and never vetoing a bill – Bush’s administration was a reflection of the same kind of hubris which destroyed Johnson’s first Guns and Butter efforts back in the late 1960s.

What’s Next? The bottom line of this brief history lesson is that specific financial blunders in 1930, 1965 and 1999 led to deep and long market declines, while enlightened policies in 1948 and 1982 led to long, powerful market surges. What will be the government’s next big mistake – or enlightened breakthrough?

The future is not locked in stone. The decisions that President Obama, Congress and the Fed make in the next year will determine if we have 7 to 10 more bad years or maybe only one more flat year before the next bull market. Voters also have a say: The mid-term elections of 2010 may help rescue our portfolios.

Cap and Trade

What Does it Mean?
A regulatory system that is meant to reduce certain kinds of emissions and pollution and to provide companies with a profit incentive to reduce their pollution levels faster than their peers. Under a cap-and-trade program, a limit (or "cap") on certain types of emissions or pollutions is set, and companies are permitted to sell (or "trade") the unused potion of their limits to other companies that are struggling to comply.

So it's an informal TAX. Or better yet a redistribution of wealth.

Where is the Dow Heading

Click on the attached link for additional perspective.

In summary, it looks like we are in for a pullback. The video presentation attached has us pulling back to around 7,600 on the Dow. I see a potential for a great decline.

http://broadcast.ino.com/education/dow_update_200907/?campaignid=3

U.S. Needs Plan for More Stimulus, Obama Adviser Says...

The $787 billion economic stimulus might not be enough to bring the U.S. out of recession, and the government should start planning for a second round in case it is needed, said Laura D'Andrea Tyson, a member of a group advising President Barack Obama on the economic downturn. "We should be planning, on a contingency basis, for a second round of stimulus," she said. Reuters (07 Jul.)

That's because the spending of the money doesn't occur until 2010 and 2012. I wonder what happens in those years...ELECTIONS. Talk about try to stack the deck.

S&P/Case-Shiller Housing Price Update

The S&P/Case-Shiller 20-City Composite Index fell 18.1% y/y in April 2009 after declining 18.7% y/y in March. The m/m pace of decline in April was slower than in March for 19 cities, while 13 of 20 cities covered in the survey showed an improvement in the y/y returns in April (Standard and Poor's)

As of April 2009, average home prices are at similar levels to what they were in mid-2003. From the peak in mid-2006, the 10-City Composite is down 33.6% and the 20-City Composite is down 32.6%.

Residential R/E is bottoming.

Commercial R/E is the next shoe to drop. It lags Residential R/E by about 18 months. Rubin has recently reported that NYC commercial rents are down by 30 to 45%. Commercial R/E is prices are calculated using discounted cash flows. Therefore, NYC Commercial R/E should drop proportionately.

Housing Stabiliizing

The National Association of Realtors reported a 2.4% increase in the level of existing home sales — the best bellwether of U.S. home sales as existing home sales outnumber new home sales by more than a 10-to-1 ratio. During May, home resales totaled 4.77 million units — up from 4.66 million in April and a notable increase form the current trough of 4.49 million units in January. The total monthly supply fell to 9.6 months from 10.1 months in April. Meanwhile, new home sales slipped 0.6% to 342,000 units in May and the associated level of inventories fell to 10.2 months. We view the May home sales data as positive and indicative of an industry that is finally stabilizing. We caution that there are still some hurdles to overcome, including rising mortgage rates, the expiration of the $8,000 first-time home-buying credit and rising unemployment. Also, sales generally pick-up during the summer since families attempt to avoid school disruptions.

Source: Argus Research - Market Outlook June 30, 2009

Soaring US Debt

U.S. debt is soaring, given the Federal Reserve’s quantitative stimulus program as well as the Obama Administration’s fiscal stimulus program. The weakened U.S. balance sheet has caused the dollar to decline, and interest rates have recently risen as global investors have demanded extra return to shoulder the increased risk. Many other nations are in a similar situation. International Monetary Fund economists do not believe that these debt-fueled government spending trends can continue indefinitely. The IMF argues that a 60% gross debt ratio (government debt/GDP) is sustainable. Given current spending patterns, this will take years to achieve. For example, to reach the 60% level in 2014, the proposed budget surplus would have to be increased by 3.5% of GDP. That’s almost $400 billion of extra revenue (higher taxes?) or reduced spending. In the meantime, expect investors to continue to demand a premium for buying government bonds.

Source: Argus Research, Market Watch 6-25-2009

Q2 Earnings Outlook

Many companies are in a quiet period, as the second quarter draws to a close and the EPS reporting season draws near. Assuming another EPS decline for the period, earnings will have declined for eight consecutive quarters. Currently, Wall Street is expecting a 16% decline in profits, according to Standard & Poor’s; we are a bit more conservative, with an estimated 25% drop for the period. But the outlook is starting to improve. In Q3, the consensus is expecting only a 5%-6% decline and then a strong rebound to profitability in Q4 (when comparisons will be easier as the market cycles the worst of the bank write-offs). Investors may get an early sense of 2Q EPS this week as Consumer Staples companies such as Kroger and Walgreen will likely report modest growth, while Tech companies such as Oracle and Jabil Circuit may report more substantial profit declines.However, investors will be closely attuned to comments from the Tech companies on the outlook for the IT business, which has been improving.

Source Argus Research - Market Watch, June 22, 2009

Headline Financial News

Fed unlikely to substantially boost bond purchases:
When officials at the Federal Reserve meet later this month, they are not expected to significantly increase purchases of mortgage-backed securities and U.S. Treasuries. However, other adjustments are possible as bond yields rise and the economy appears to be improving. While some Fed officials are more confident that the economy is stabilizing, divisions are emerging over the next step. The Wall Street Journal (12 Jun.)

Mountain of public debt could force overdue actions:
Policymakers will have to follow a tricky and difficult path to cope with government debt accumulated from stimulus spending. That is not necessarily a bad thing. They might be forced to make decisions that have been delayed far too long, such as raising the retirement age or reforming the health care system in the U.S. The Economist (11 Jun.)

U.S. sees 19 weeks of record unemployment claims:
The number of U.S. workers continuing to claim unemployment benefits set another record for the 19th consecutive week, at more than 6.8 million, according to the Labor Department. Last month, joblessness rose to 9.4%, the highest in 25 years. The New York Times/The Associated Press (11 Jun.)

FBI: Recession reveals record number of Ponzi schemes:
Hit by the same financial nightmares as legitimate businesses, Ponzi schemes are being forced into the open by the recession in record numbers, investigators said. "We have more open Ponzi scheme cases than at any time in FBI history," said Special Agent David G. Nanz, chief of the FBI's economic-crimes unit. The Washington Post (12 Jun.)

VIX - Update

After a rocky ride during which the VIX Volatility Index shot up toward 80 and has averaged 45 over the past 10 months, the popular measure of market volatility has moved back below 30 (barely) for the first time since the bankruptcy of Lehman Brothers. The markets have reacted positively to the monetary and fiscal stimulus plans enacted across the globe. The trend is pointing toward a quiet summer in terms of volatility, but investors would be wise to monitor their portfolios closely. One of the side effects of the numerous stimulus plans is likely to be an increase in pricing pressure over the next two-three years. We think hardasset based sectors such as Energy and Materials may be poised to benefit, as well as the Tech sector, which works to keep productivity high and costs low. We expect to see the VIX volatility index move within a range of 25-35 over the next several months as the market works to conclude that the recent rally is a secular move, not a cyclical swing in a long-term bear market.

I'm not sure I agree with the last sentence. I think this is more of a cyclical (short-term) rally in a secular (long-term) bear. I am very concerned that the US Bank are moving the way of the Japanese Banks in the 90's, which create "Zombie" Banks. For the US to have growth capital MOST be invested, currently the bank are not investing.

Source Argus Research, Market Watch, 6-8-2009

Bernanke Prolonged Deficit Will Choke Economic Growth

A large budget deficit will result in a sustained economic crisis, Federal Reserve Chairman Ben Bernanke said in congressional testimony. While acknowledging that Congress and the Obama administration were using the deficit to address short-term problems, Bernanke warned that "unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth." The deficit is expected to double to more than 82% of the U.S. economy by the end of the next decade. The Washington Post (04 Jun.)

Rig Count Slumps

The total number of crude oil and natural gas rigs currently operating in North America slumped 1.1% to 918 during the week ended May 15. This was the lowest level since February 2003. The total number of rigs now stands some 60% lower than the 2008 highs. When energy prices rocketed to record levels last year, the number of operating rigs soared – as drillers simply couldn’t keep up with escalating global demand. Now that the global economic activity has cooled, with most of the world in recession, energy prices have collapsed from year-ago levels — forcing producers to shutter rigs. Natural gas prices are currently about 70% of year-ago levels at $4.098/million Btus. The record high was registered on July 2, 2008, at $13.694/million Btus. We suspect that depressed gas prices will continue to dampen drilling activity and the number of rigs in operation.

Source: Argus Research - Market Watch 5-22-09

Theory of Decoupling Not Discredited After All

Evidence is starting to pile up that points to an economic rebound in the near future among the biggest emerging nations, even if the U.S. continues to struggle. Naysayers who rejected the theory of decoupling -- emerging economies going their own way opposed to depending on richer nations -- might have been a bit hasty. The Economist (21 May.)

Headline Financial News

Foreclosures, inventories to delay housing recovery to 2010:
Falling prices, rising foreclosures and a huge inventory of unsold homes suggest a broad recovery in the housing market is unlikely until next spring, possibly later. The construction of homes and apartments dropped 12.8% in April to 458,000 units, the fewest in 50 years, the U.S. Commerce Department reported. InvestmentNews/The Associated Press (19 May.)

Royal Dutch Shell's stockholders reject executive-pay plan:
Nearly 60% of shareholders attending Royal Dutch Shell's annual meeting voted to reject the company's executive-pay plan and demanded that members of the committee that proposed it resign. The proposal called for awarding bonuses to executives despite the fact that the company's performance has repeatedly fallen short of targets set in 2005. The Times (London) (20 May.)

China subtly diminishes exposure to U.S. Treasuries:
China, long the biggest foreign buyer of U.S. Treasuries, is implementing a subtle shift in its investment in response to the large amount of debt the U.S. has put on the market since the economic crisis began. Anticipating that the U.S. will be forced to push up interest rates at some point to cope with inflation, China is shifting its Treasury buying from long-term debt to shorter maturities. Reuters (19 May.)

Obama administration considers all-new financial regulator:
The creation of a financial watchdog responsible for protecting consumers when they use a wide variety of financial products, ranging from mutual funds and credit cards to mortgages, savings accounts and college loans, is being seriously considered by the Obama administration. Officials think the action is necessary because existing federal regulators put a low priority on consumer protection, and some financial products are totally unregulated. The Washington Post (20 May.) , The Wall Street Journal (20 May.)

Financial Headlines

Warrants become key issue as banks look to repay TARP:
Banks are eager to repay the U.S. government for money they received through the Troubled Asset Relief Program and to do so as quickly and inexpensively as possible. The government received warrants from the banks when the financial system was poised for disaster, and those warrants are becoming a sticking point. The New York Times (18 May.)

Hedge fund clients of Madoff sued by liquidating trustee:
The trustee liquidating the investment firm of Bernard Madoff sued hedge funds managed by Fairfield Greenwich Group, demanding the return of $3.2 billion that the funds withdrew from their Madoff accounts. The lawsuit states that the funds received annual returns ranging from 10% to 21% from Madoff, figures that the trustee described as "unrealistically high." The trustee also found evidence of 280 stock trades for the funds that are "clearly fictional," according to court papers. The New York Times (18 May.)

U.S. could struggle 5 years after recovery, Krugman says:
Rising unemployment, which is expected continue after the recession ends, could lock the U.S. into a "depressed economy" for as long as five years, Nobel Prize-winning economist Paul Krugman said at a financial conference in Seoul, South Korea. He said it is possible the U.S. economy will return to GDP growth this summer, with Europe following "a little bit later." Forbes/The Associated Press (19 May.)

Libor indicates credit crunch is over, economists say:
For the first time since May 2007, Libor returned to a normal level, prompting economists to say the credit crunch has ended. "This marks a return to normal territory and gives us hope that we can cope with anything that comes now," said Peter Chatwell, an interest-rate strategist at Credit Agricole's Calyon. "It indicates that the banks are well capitalized, with no more surprises. It gives us hope that we have a functioning banking system and that we can now go about the job of running the broader economy." The Times (London) (19 May.)

Unemployment to linger as recovery begins, Geithner says:
Joblessness will continue to increase, even as evidence emerges that the U.S. economy is stabilizing, Treasury Secretary Timothy Geithner said. Millions of Americans will continue to suffer from the effects of the downturn because hiring lags behind rising economic growth, he said. The Sun (Baltimore)/The Associated Press (18 May.)

Financial News Headlines

New taxes for life insurers? The Obama administration wants to tag life insurers with $12.8B in new taxes over the next decade, even as the sector recently garnered approval to receive TARP bailout funds. New proposals would restrict some tax breaks received by purchasers of insurance or insurance companies themselves. Industry followers say the changes could hit sales of corporate-owned life insurance. The Wall Steet Journal May 18.

ECB hopes it's done with easing. European Central Bank governing council member Axel Weber said it's unlikely the ECB will take further action to address the financial crisis. "Unless circumstances worsen considerably, previous measures are adequate, in my view," Weber said, adding, "We would come to reassess our strategy only in the case of a dysfunctional banking system." Late last week, Eurostat reported euro-area GDP fell a record 2.5% in Q1 from Q4, sparking speculation of further rate cuts from the current 1% benchmark. easybourse.com May 15.

Changes to Fed's powers likely on horizon
The U.S. Federal Reserve is at a turning point. The financial crisis is expected to result in the Fed gaining the authority to supervise large, systemically important financial institutions. However, the Fed could lose its emergency-lending power or its regulatory authority over consumer-finance activities. The Wall Street Journal (18 May.)

U.S. economy weak but not in free fall, official says
The latest data suggest the U.S. came through the worst of the recession and the economy should start recovering before the end of the year, said Peter Orszag, the White House budget director. The nation's record-high budget deficit should start coming down once the economic recovery gets under way, he said. Reuters (17 May.)

Paulson Demanded That Banks Accept Government Aid

Former U.S. Treasury Secretary Henry Paulson told the CEOs of the nation's largest banks that they needed to either accept billions of dollars in government aid or regulators would force them to accept the taxpayer money. "If a capital infusion is not appealing, you should be aware that your regulator will require it in any circumstance," according to Paulson's talking points for a meeting with the executives. "We don't believe it is tenable to opt out because doing so would leave you vulnerable and exposed." Bloomberg (14 May.) , Reuters (14 May.)

Can the World Absorb $33 Trillion of New Bonds?

The twelve most industrialized of the world's G20 countries will have to issue about $10 trillion worth of new bonds to cover the cost of the current crisis. However, Reinhart and Rogoff estimate the true cost at $15 trillion in the best case scenario and a whopping $33 trillion - 1/3 of total global savings - in the worst case. Issuing governments may have to inflate away their debt or pay drastically higher yields if deflation does not materialize (Niels Jensen et al)

In the early part of 2009, government bond yields are likely to remain low in the face of the sharp slowdown in global growth. Against this background, deflationary fears and talk of zero official interest rates will continue to outweigh worries about the additional supply of government bonds (Dresdner Bank)

Source: RGE Monitor 5-13-09

Financial Headlines

Survey: Growth to return to U.S. economy in second half
Leading forecasters said in a survey that they expect the U.S. economy to start growing in the third quarter of this year. They also predicted that the unemployment rate will peak in the first three months of next year. "The past month provided fresh evidence the decline in business activity is starting to moderate, buttressing consensus expectations that the economy will emerge from recession in the second half of this year," according to the Blue Chip Economic Indicators newsletter in which the survey was published. Reuters (10 May.)

Obama administration to get tough with antitrust rules
Reversing the Bush administration's approach that favored big corporations, the Obama administration is preparing to aggressively enforce antitrust laws. Christine Varney, head of the U.S. Justice Department's antitrust division, is scheduled to announce policy changes in a speech Monday. The New York Times (11 May.)

Ed Yardeni Follow-Up

“Commanding Heights” is a book by Daniel Yergin and Joseph Stanislaw first published in 1998. It traces the rise of free markets during the last century, as well as the process of globalization. It takes its title from a speech by Vladimir Lenin, who used the phrase "commanding heights" to refer to the segments and industries in an economy that effectively control and support the others, such as oil, railroads, banking and steel. Today, governments around the world are taking power back from free markets, particularly financial markets, under the pretext that they have failed. In fact, the markets were hobbled by a combination of anti-market regulations and the lack of enforcement of regulations that leveled the competitive playing fields. In the US, the power grab is spreading to banking, autos, energy, and health care. Here is a brief chronology of recent developments around the world in this epic power struggle:

(1) It started with TARP, which was proposed by Hank Paulson and Ben Bernanke and enacted by Congress on October 3, 2008. This politicized the financial rescue program in the US. It gave the government the power to dictate how recipients must manage their companies. On October 13, Paulson forced nine major banks to take some of the TARP money even though most of them didn’t need it or want it.
(2) In December, Ken Lewis, the CEO of Bank of America, had buyer’s remorse after having agreed to purchase Merrill Lynch in mid-September. Mr. Lewis contends that Paulson and Bernanke also advised him not to share his second thoughts with BofA shareholders who were about to approve the deal.
(3) On February 26, the Obama administration unveiled its budget, which includes significant increases in spending on social welfare, especially health care. The resulting deficits are projected to total more than $9tn over the next 10 years.
(4) On March 30, 2009, the White House fired Rick Wagoner, the head of General Motors. The Obama administration is orchestrating the restructuring of the auto industry. President Obama declared that the US government stands behind GM's warranties.
(5) The government is pushing legislation aimed at bringing down credit card fees.
(6) The Obama administration is pushing to have student loans made by the government rather than private lenders.
(7) Democrats in Congress are moving to make the Obama administration’s health care proposals filibuster proof by pushing the proposed legislation as part of the budget reconciliation process.
(8) In Russia, the government is in effect nationalizing the industries that were once controlled by the oligarchs, who borrowed too much and must now be rescued by their comrades in the Kremlin.
(9) In China, the government is pumping large sums of money into infrastructure projects aimed at stimulating economic growth to offset the shuttering of thousands of manufacturers as a result of the plunge in exports.
(10) Governments are raising taxes, especially on high income earners. The Bush tax cuts will be allowed to expire at the end of 2010. States from New York to California are raising income tax rates and user fees. Prime Minister Gordon Brown’s government laid out plans on Wednesday for more than $1tn in deficit spending over the next five years, a scale of public debt that critics say is without precedent in Britain. In addition, his government now plans to hike the top marginal income tax rate from 40% to 50%, rather than to 45%.

U.S. Consumers on a Tightrope as They Face Increasing Financial Headwinds

Personal income fell 0.3% in March 2009, after falling 0.2% in February 2009, while disposable personal income grew less than 0.1% in March. Personal spending fell 0.2%, while inflation adjusted spending declined by 0.2% in March after rising 0.1% in February. The savings rate rose to 4.2% in March from 4.0% in February

Weakness in the labor markets continued to drive down personal income while government transfers remained the main source of personal income in March (BNP Paribas)

Financial Headlines

The U.S. economy contracted by 6.1% in the first quarter, the Commerce Department reported, a much sharper downturn than the 5% drop projected by many economists. The latest figure is nearly as poor as the 6.3% decline posted for the last quarter of 2008. The economy has not suffered a six-month downturn this severe since 1958. The New York Times (29 Apr.) , The Economist (29 Apr.)

The U.S. government stepped into the financial crisis and made itself the consumer, investor and lender of last resort. Of the $11.3 trillion authorized to rescue the economy, slightly more than $3 trillion has been put to work. The companies that received the biggest direct investments or loans are American International Group, Freddie Mac, Citigroup, Bank of America and JPMorgan Chase, in that order. The Christian Science Monitor (26 Apr.) Would it have been better to give the money to each American Family, which amounts to approximately $1 million/family?

Ed Yardeni's Take on The Heavy Hand of The Government

Below is Ed Yardeni's summary of the TARP - What a Very Scary Mess:

"Why would anyone, who can avoid it, do business with the US government? It’s like doing business with the Godfather. At first, he only wants a small piece of your action in exchange for some help and protection. Then he tells you how to run your business. Before you know it, he owns you, your business, and your family. Once you join his mob, you can’t leave it--not alive."

"The administration is threatening to convert the government’s preferred shares into common equity in some of the bigger banks. So much for the October 13 promise reported by the NYT. This “backdoor” nationalization may be the consequence of Geithner’s stress test. The conversion would create an extra $100bn of tangible common equity, thanks to the magic of accounting--a sum that would be nearly impossible to extort from Congress. Why would anyone want to participate in TALF and PPIP, given the government’s mob-like behavior?"

Ed wrote a great piece outlining the TARP, it's well worth the read, www.yardeni.com. Food for thought.

Fed Interest Rate Model Suggest -5%

Fed research suggests -5% interest rate. According to an internal analysis prepared for the Federal Reserve's last policy meeting, the ideal interest for the U.S. economy right now would be -5.0%. The analysis is based on the Taylor-rule approach, which estimates appropriate interest rates based on unemployment and inflation. Though a central bank cannot cut interest rates below zero, the research suggests the Fed should use unconventional policies to create the equivalent of a minus 5 percent interest rate.

Financial Headlines

Federal Reserve officials are giving preliminary results of the stress tests to banks Friday, and the Fed is also releasing the tests' methodology to the public. The banks might find it hard to raise funds because their troubled assets have soared during the past year. "We're really hesitant to put money into financials," said Douglas Ciocca, a managing director at Renaissance Financial. "The ambiguity is still engulfing the opportunity." Bloomberg (24 Apr.)

The Chinese government owns a substantial portion of U.S. Treasuries, making it the country's biggest creditor. As the U.S. looks to sell huge sums of debt to pay for its economic stimulus, signs are emerging that China might not be as interested as it used to be. Also, People's Bank of China Governor Zhou Xiaochuan recently suggested changing the reserve currency, sparking concerns that the Asian giant is turning its back on the U.S. dollar. The Economist (23 Apr.)

In a desperate attempt to cope with vanishing tax revenue, U.S. states have made broad and deep cuts in spending for public safety, health care, education and social services, throwing police officers and teachers out of work and cutting off the elderly and the poor from benefits. Despite these efforts, states must cut $27.6 billion from their budgets this fiscal year and $67.5 billion from next year's budgets. CNNMoney.com (23 Apr.)

With technology giants such as Apple, Google and IBM beating analysts' earnings estimates, the tech sector is gaining respect for its ability cut costs and hang onto profitability through a serious downturn. Analyst Rob Enderle said high-tech is positioned to respond to changing conditions, and "tech might very well lead us out of the recession." Reuters (23 Apr.)

Experts are divided on whether the recovery of the U.S. economy is headed toward inflation, deflation or stagflation. Analysts said these scenarios call for investment strategies that are quite different from one another. BusinessWeek (23 Apr.)

The U.S. Labor Department said the nation experienced 2,933 more mass layoffs, defined as those impacting 50 or more people, in March compared with February. Since the official start of the recession in December 2007, there have been 31,414 mass layoffs, causing 3.2 million people to lose their jobs. Reuters (23 Apr.)

An unexpected, sharp rise in the European purchasing-managers index, widely followed as a leading economic indicator, points to the possibility that the eurozone has already gone through the worst of the recession and is poised to move in the direction of growth. The composite purchasing-managers index posted its biggest improvement this month since the survey began in 1998. Financial Times (23 Apr.)

The historically high number of vacant houses in the U.S. might give the Federal Reserve some flexibility in deciding when to start pulling liquidity out of the economy, analysts said. "There's just so much slack in the economy, including the high level of vacancies, that the Fed doesn't need to worry about inflation for a while and will have loads of time to remove all the stimulus," said Jim O'Sullivan, senior economist at UBS Securities. Bloomberg (23 Apr.)

U.S. More Than Quadruples Borrowing

U.S. more than quadruples borrowing as tax revenue drops
Driven by unemployment, which turns taxpayers into benefit applicants, the U.S. budget deficit is headed toward a figure that is more than four times last year's record. "Tax receipts are just collapsing," said Chris Ahrens, head of interest-rate strategy at UBS Securities. The government must sell more debt, and "the surging budget deficit is the primary cause." Bloomberg (22 Apr.)

Spending Orgy = Future Inflation

The Fed is already priming the pump, i.e. setting the stage for inflation.

Fed braces for criticism that comes with raising rates
Policymakers at the Federal Reserve know they will have to stand up to political pressure when it comes time to raise interest rates, said Donald Kohn, the central bank's vice chairman. "I am sure that when we get ready to raise interest rates, there will be a lot of criticism. There always has been," he said. Reuters (20 Apr.)

Banks & Reported Earnings

Earnings for banks are going to look "great".

Don't believe them - the use of the same accounting rules (tricks) that helped ENRON during the late 90's have returned.

Nouriel Roubini's view:
A look below the surface reveals some caveats to this positive picture. “In brief, banks are benefitting from close to zero borrowing costs and fewer competitors; they are benefitting from a massive transfer of wealth from savers to borrowers given a dozen different government bailout and subsidy programs for the financial system; they are not properly provisioning/reserving for massive future loan losses; they are not properly marking down current losses from loans in delinquency; they are using the recent mark-to-market accounting changes by FASB to inflate the value of many assets; they are using a number of accounting tricks to minimize reported losses and maximize reported earnings; the Treasury is using a stress scenario for the stress tests that is not a true stress scenario as actual data are already running worse than the worst case scenario.”

Accounting change makes Goldman's December losses vanish. Goldman Sachs suffered a painful $780 million loss in December, but it does not show up on the bank's bottom line for the first quarter of 2009 or the last quarter of 2008. When the former investment bank became a bank holding company, it switched from a fiscal year ending in November to a fiscal year beginning in January. The December losses do not show up in either. The Washington Post (15 Apr.)

Am I dreaming???

Financial Headlines

ICBC becomes world's largest lender by deposits
Industrial and Commercial Bank of China is the world's largest lender by deposits and by market capitalization. The development underscores how well Chinese banks have weathered the financial crisis compared with many of their rivals. ICBC overtook JPMorgan Chase and Mitsubishi UFJ Financial Group of Japan. Financial Times (13 Apr.) , Reuters (14 Apr.)

S&P: Leveraged buyouts to boost corporate defaults in Europe
Standard & Poor's predicted that as many as 112 speculative-grade European companies will default this year. The credit-rating agency said defaults among companies bought in leveraged buyouts in which the targets are loaded with debt will be "materially higher." "We see the risk to currently vulnerable companies being that their lenders have neither the appetite nor the capacity to provide new financing to help them through the downturn," S&P analysts wrote in a report. Bloomberg (14 Apr.)

Sources: U.S. might accept equity in GM for some debt
The U.S. government is looking at the possibility of taking an equity stake in a restructured General Motors as payment for some of its $13.4 billion in loans to the troubled automaker, said people familiar with the proposal. Bondholders who own $27.5 billion in GM debt also would be offered an equity-for-debt swap, the sources said. Reuters (14 Apr.)

Lenders lash out at proposals to overhaul student loans
The Obama administration's proposed changes to the student-loan program would deliver poor service to borrowers, cause thousands of industry workers to lose their jobs and unnecessarily expand the national debt by billions of dollars, said representatives of the student-loan industry. The government said the changes would save taxpayers $94 billion and better target the help toward students who need it most. The Washington Post (14 Apr.)

China won't undercut U.S., Fed official says
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. Reuters (14 Apr.)

Workers worry more in downturn about retirement savings
Workers are the most pessimistic in nearly 20 years about their ability to save enough money for a comfortable retirement, the nonpartisan Employee Benefit Research Institute found in a survey. One of the survey's authors, Jack VanDerhei, said the good news is that "this will be a wake-up call for many people who had false optimism in the past." The New York Times/The Associated Press (14 Apr.)

1) Corporate Bond Woes: Moody's Predicts Junk Default Rate of Over 15% in U.S., 21% in Europe

In the U.S., the default rate at the end of the first quarter of 2009 was 7.4%, up from 4.5% at the end of 2008, and in Europe it jumped to 4.8% from 2% at the end of the final quarter of 2008 (Moody's via Bloomberg on April 7, 2009)

About 53% of U.S. companies that issued high-risk, high-yield bonds will default over the next five years (Deutsche Bank analyst Jim Reid on April 6, 2009)

2) Russian Inflation Dynamics: Rouble Depreciation Boosting Inflationary Pressures?

Russian inflation rose to a five-month high of 14% in March 2009 as the weak rouble boosted import prices. Food prices gained an annual 15.8%. Inflation rose 13.4% in January 2009 from 13.3% in December 2008 (Bloomberg)

Despite the sharp slowdown in growth, consumer price disinflation is unlikely in 2009; the main inflationary factors are the recent rouble devaluation and the massive injection of Reserve Fund money into the economy (ING)

3) Small towns hurt by complex municipal-bond derivatives
Throughout the U.S., hundreds of small towns and counties find themselves in serious financial trouble because they were persuaded to participate in complex, and often risky, transactions of municipal-bond derivatives that they never truly understood. Officials of Lewisburg, Tenn., were stunned to learn in January that annual interest payments on its bond had quadrupled to $1 million. The New York Times (07 Apr.)

CCM Commentary: Is this Orange County, CA all over again. This is what happens when elected officials with NO experience in these matters make UNEDUCATED decisions and rely on a broker, who doesn't have a fiduciary responsibility for the client.