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.

Financial Headlines

Defaults to increase while GDP rebounds, S&P says
Standard & Poor's forecast an increase in the corporate default rate from 5.5% to more than 14% in the next year, even as it predicted that the economy will start to rebound in the third quarter. Like unemployment numbers, defaults lag behind GDP, meaning a high level of bond defaults will continue into 2010 and beyond, said Dianne Vazza, head of fixed-income research at S&P. Forbes (06 Apr.)

More economists see U.S. starting recovery this summer
With stocks rallying and some economic indicators turning positive, increasingly more economists are predicting that a U.S. recovery is not far away. Some even suggested that growth will be robust when it returns rather than a feeble upturn. Lakshman Achuthan, managing director of the Economic Cycle Research Institute, said recovery could be as little as four months away. CNNMoney.com (07 Apr.)

U.S. plan to tighten regulations could present hazards
The Obama administration's plan to increase oversight of the financial system will likely have severe unintended consequences that do the opposite of the plan's intent, experts said. Some firms might grow dangerously large and take on greater risk because of a perception that the government will step in to prevent certain losses, they said. Others said increased regulation of some securities could fuel questionable investments in lightly regulated areas around the world. The Washington Post (07 Apr.)

Analysis: FDIC bends its own rules to insure debt
Columnist Andrew Ross Sorkin explains how mission creep prompted the Federal Deposit Insurance Corp. to go from insuring bank deposits to becoming "an enabler of enormous leverage" at the center of the financial crisis. U.S. Treasury Secretary Timothy Geithner's plan to help private investors buy banks' troubled assets includes details of how the FDIC is working to stabilize the financial system by adding risk rather than reducing it and how the agency is reinterpreting its own rules to do so. The New York Times (06 Apr.)

Investors appear wary of participating in Fed's TALF
The Federal Reserve's Term Asset-Backed Securities Loan Facility has attracted only two issuers as the deadline nears, suggesting that investors are still concerned about participating in the program. The lack of participation could undermine efforts to shore up banks' balance sheets. Although the Fed's financing terms are attractive, the program presents challenges and issues, including concerns about legislative interference, limits on hiring foreign workers and tedious paperwork. The Wall Street Journal (06 Apr.)

Change opens U.S. troubled-asset plan to smaller funds
Responding to arguments that the U.S. government's plan to finance the purchase of banks' illiquid assets unfairly favors the big funds that helped write it, the Treasury changed its rules to allow small funds and hedge funds to participate. Financial Times (06 Apr.)

IMF predicts troubled assets could spiral to $4 trillion
The International Monetary Fund is forecasting that financial institutions have racked up $4 trillion in troubled debt. In its upcoming assessment of the global economy, the IMF is expected to raise its estimate of the deterioration of assets originated in the U.S. from $2.2 trillion to $3.1 trillion by the end of 2010. Meanwhile, troubled assets originated in Asia and Europe are expected to total $900 billion. The Times (London) (07 Apr.)

Mark To Market (MTM) Rule Change

April 2: FASB agreed to ease Mark-To-Market accounting rules for illiquid assets with uncertain market value. Question arises if that undermines Geithner's PPPIP plan unless banks are forced to participate. If participation remains voluntary, banks might prefer to hold on to particularly toxic assets and in particular loans for which the auction price could potentially lead to large writedown at the sales price.

Key points: 1) Rules effective Q1 2009. 2) FASB says the objective of mark-to-market accounting is to set a price that would be received by a bank in an "orderly" transaction in the current, inactive market. It says an "orderly" transaction for accounting purposes does not include the forced liquidation or a distressed sale of an asset. 3) FASB agrees to drop the presumption in mark-to-market accounting that all transactions in an inactive market are distressed unless proven otherwise. 4) FASB clarifies when banks are required to take write downs on impaired assets, letting them record smaller losses on their income statements.(Reuters)

Economy Sheds 663,000 Jobs

In line with Street expectations, the U.S. economy eliminated 663,000 nonfarm payroll jobs last month, while the unemployment rate leapt to 8.5% — the highest level since November 1983. The U.S. economy has now lost over two million jobs in the last three months, and 5.13 million since January 2008, the beginning of the recession. In no surprise, the greatest losses came from manufacturing (-161,000), construction (-126,000) and temporary help services (-72,000). Retail’s slide continued, with a loss of 48,000 employees in March – a 16th consecutive monthly decline. This report is as miserable as any can get, and we expect at least two more of the same. The stimulus
package won’t stem the rampant job loss until much later in the year. We expect a peak in the unemployment rate in October of around 9.5%.

Initial job claims are viewed as a leading indicator, employment as a coinciding indicator, and unemployment as a lagging indicator.

Historical Perspective on Dividend Yields

Investors seeking income from the stock market – given that growth has been difficult to achieve for the past seven quarters and yields from bonds are historically low – have the best opportunity in almost 20 years. The current yield on the Dow Jones Industrial Average is 3.6%, the highest it has been since 1990. Yields have been climbing since 1999, when the DJIA yield bottomed at 1.5%. Changes in the U.S. tax code to favor dividends have helped drive the trend. The post-War high for yields was 6.85% in 1952, and then 6.5% in 1981. If yields are to reach that level again, the stock market would be poised for several more challenging years. Of course, when investors seek dividends, they need to focus on more than just the percentage yield. Argus analysts are continuously assessing the safety of those yields. We rate the Financial Strength of each company in our Universe. A simple screen for income investors on our website could be to seek BUY-rated stocks with yields higher than 3.6% and Financial Strength ratings of Medium-High or High.

Source Argus Research - Market Watch 4-2-09