Thursday, September 27, 2007
september consumer confidence
This has happened in the face of rising oil prices and the housing problems.
What is the lesson?
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confidence trends may be changing, and i think the trend is more important than the absolute level. present situation is the lowest reading since december 2005 (post-katrina) after building more or less steadily since mid-2003. present situation tends to lag the market at the bottoms but is closer to coincident at the tops.
the differential (future less present) is also possibly breaking trend -- and down from a point (-50) that often marks euphoria.
given the tightening of credit that we're witnessing in europe and the united states -- and what i would suggest is both slowing earnings growth and earnings growth increasingly concentrating in energy -- as well as employment ratio declines -- and poor market performance of consumer discretionary -- a change in confidence trend could be the harbinger of recession.
granted, historically earnings have to coincidentally collapse to push the market way down. so the lesson for the market remains questionable for now.
but i would suggest that the march of ever-increasing gearing has abruptly halted as banks are being forced to hold bridge loans as well as loans previously slotted for securitization, not to mention bringing a lot of commerical paper structured finance back on balance sheet. all this in the face of all-time-low reserves.
if banks cannot increase lending because of balance sheet issues, credit supply -- and therefore money supply -- contracts regardless of what the fed does with fed funds. that may in fact be some of what we're seeing in deteriorating consumer confidence.
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Monday, September 24, 2007
Thursday, September 20, 2007
saudis to follow kuwait and abandon dollar peg?
Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.
"This is a very dangerous situation for the dollar," said Hans Redeker, currency chief at BNP Paribas.
"Saudi Arabia has $800bn (£400bn) in their future generation fund, and the entire region has $3,500bn under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States," he said.
The Saudi central bank said today that it would take "appropriate measures" to halt huge capital inflows into the country, but analysts say this policy is unsustainable and will inevitably lead to the collapse of the dollar peg.
As a close ally of the US, Riyadh has so far tried to stick to the peg, but the link is now destabilising its own economy.
The Fed's dramatic half point cut to 4.75pc yesterday has already caused a plunge in the world dollar index to a fifteen year low, touching with weakest level ever against the mighty euro at just under $1.40.
There is now a growing danger that global investors will start to shun the US bond markets. The latest US government data on foreign holdings released this week show a collapse in purchases of US bonds from $97bn to just $19bn in July, with outright net sales of US Treasuries.
The danger is that this could now accelerate as the yield gap between the United States and the rest of the world narrows rapidly, leaving America starved of foreign capital flows needed to cover its current account deficit - expected to reach $850bn this year, or 6.5pc of GDP.
Mr Redeker said foreign investors have been gradually pulling out of the long-term US debt markets, leaving the dollar dependent on short-term funding. Foreigners have funded 25pc to 30pc of America's credit and short-term paper markets over the last two years.
"They were willing to provide the money when rates were paying nicely, but why bear the risk in these dramatically changed circumstances? We think that a fall in dollar to $1.50 against the euro is not out of the question at all by the first quarter of 2008," he said.
"This is nothing like the situation in 1998 when the crisis was in Asia, but the US was booming. This time the US itself is the problem," he said.
Mr Redeker said the biggest danger for the dollar is that falling US rates will at some point trigger a reversal yen "carry trade", causing massive flows from the US back to Japan.
Jim Rogers, the commodity king and former partner of George Soros, said the Federal Reserve was playing with fire by cutting rates so aggressively at a time when the dollar was already under pressure.
The risk is that flight from US bonds could push up the long-term yields that form the base price of credit for most mortgages, the driving the property market into even deeper crisis.
"If Ben Bernanke starts running those printing presses even faster than he's already doing, we are going to have a serious recession. The dollar's going to collapse, the bond market's going to collapse. There's going to be a lot of problems," he said.
The Federal Reserve, however, clearly calculates the risk of a sudden downturn is now so great that the it outweighs dangers of a dollar slide.
Former Fed chief Alan Greenspan said this week that house prices may fall by "double digits" as the subprime crisis bites harder, prompting households to cut back sharply on spending.
For Saudi Arabia, the dollar peg has clearly become a liability. Inflation has risen to 4pc and the M3 broad money supply is surging at 22pc.
The pressures are even worse in other parts of the Gulf. The United Arab Emirates now faces inflation of 9.3pc, a 20-year high. In Qatar it has reached 13pc.
Kuwait became the first of the oil sheikhdoms to break its dollar peg in May, a move that has begun to rein in rampant money supply growth.
this manner of fallout is potentially one of the unintended consequences of the united states managing its currency and credit in a profoundly irresponsible way. it may end up tantamount to the abandonment of the dollar as the pricing currency of oil, which is one of the primary reasons for the dollar's international status as a reserve currency. that status is under pressure. once oil is priced in other currencies -- say euro, as proposed already by some opec members -- the incentive for foreign central banks to own dollars is greatly reduced. indeed, as menzie chinn notes, the incentives are already deteriorating. the result could be china reiterating the nuclear option in dollar sales.
now, none of this has HAPPENED yet, excepting kuwait's abandonment of the peg. but if it does, the destruction could be swift and bernanke may be forced to backpedal into raising rates to prevent a capital flight from the united states. and -- as paul volcker knows -- even the hint of capital flight would bring disaster.
"I come now to the heart of the problem, as a Nation we are consuming and investing, that is spending, about 6% more than we are producing. What holds it all together? - High consumption - high leverage - government deficits - What holds it all together is a really massive and growing flow of capital from abroad. A flow of capital that today runs to more than $2 Billion per day."
"What I'm really talking about boils down to the oldest lesson of financial policy in Central Banking: A strong sense of monetary and fiscal discipline."
personally, i think the united states would sooner mount an invasion of saudi arabia than see saudi oil priced in euros or yen. so that may be a rather distant prospect.
but even if saudi abandonment of the dollar peg meant only the end of petrodollar recycling, it could have awesome follow-on consequences. indeed, continue to watch for fireworks.
UPDATE: the dollar has taken its cue to tank to new all-time lows against the euro, breaking critical support. the dollar index (shown here) is at new 25-year lows and falling. bond yields are flying higher.
Tuesday, September 18, 2007
bernanke cuts 50bps
it's just more greenspan in the end. the fed is slave to wall street.
UPDATE: i'm really quite angry and upset about this move, so calming down is first priority. but having come down a bit, what can be said about what's happened here?
in the face of all-time highs in commodities and metals, oil, and record lows in the dollar -- the fed cuts rates. and not incrementally, but by 50 bips! what does that say?
either 1) bernanke's fed has set a new low in irresponsibility and government subservience to investment banking; or 2) they have seen deep economic deterioration in the last six weeks (since their last meeting) -- deep enough to make them cut in the face of inflation that has been rising from already discomfiting levels. indeed, nouriel roubini thinks 50bps is too little, too late.
maybe it's both. but what certain is (to overuse a common metaphor) the medicine for the alcoholic with a hangover is apparently going to be a glass of bourbon. the american economy is going to test the limits of foreign investors, who have lost money in the united states since the 2002 market bottom thanks to a steadily depreciating dollar wiping out dollar investment gains. why anyone would invest in the united states just now is totally beyond me.
UPDATE: quantum fund co-founder jim rogers mocks the inflationary american central banking scheme, as does marc faber. both point out that the concept of a central bank is the stability of the currency, a goal that the fed has seemingly abandoned -- and call on investors to sell dollars and treasuries and take shelter in yen and swiss francs.
faber mentioned paul warburg, a fed governor during the early 20th c, and his regret over the permissiveness of the fed (which he helped to create) toward market gearing and engineering in the years leading up to the depression. the suggestion is that such deep deflationary events are a consequence of overleveraging and follow from that, and not policy mistakes in handling the bubble in the aftermath (which may be, after all, essentially unavoidable).
UPDATE: on 'testing the limits of foreign investors' -- who hold a majority of outstanding american debt -- file this ft poll and associated british editorials. i tend to value exterior thinking, as it is normally very difficult to see the shape of the fishbowl when you're inside it. and the exterior thinking is that the federal reserve may be slightly mad.
The Fed’s action comes at a cost. It will cement a perception that the Fed cuts rates in response to market crises and so encourage speculation. It also risks the Fed’s credibility as an inflation fighter. In its statement the Fed says that “it will continue to monitor inflation developments carefully”. The Fed had better hope that bond investors and wage negotiators trust it.
One of the greatest dangers is that loose monetary policy undermines the integrity of the dollar. The US trade deficit is financed by foreign investors who are willing to hold US bonds and assets, and if they fear that inflation will destroy their value, they will sell. The 50bp cut turns a dollar rout from very unlikely to just about possible.
Monday, September 17, 2007
bank run kills northern rock
but that did not stop depositors friday from killing the bank in a massive run (photos via calculated risk).
The run on the bank continued yesterday as police were called in to keep the peace when angry and desperate customers besieged branches across the country despite assurances from the Treasury and Bank of England that their savings were secure.
Branches due to close at midday opened until 2pm, but many hundreds of people were still trying to get their money when the branches closed and minor scuffles and arguments broke out.
The bank, which saw £1 billion taken out by worried savers on Friday and at least £500m removed yesterday, is prepared for a further flood of withdrawals when branches open tomorrow. Many will be by customers with nearly £10 billion in postal accounts, who can only make withdrawals by writing to the bank.
“The question is why wouldn’t you take your money out and put it somewhere else,” said one senior banker, who predicted £12 billion worth of withdrawals from the bank, which has £24 billion in deposits from savers. “Though Northern Rock is solvent, a lot of people have been gripped by the fear that they might lose some of their savings. It is a huge problem.”
One banking analyst warned: “It is not beyond the realms of possibility that they could lose half of their deposit base, if not more.”
“We have not had a decent run on a bank for many, many years. The difference now is the internet and that means you can get your money out very quickly. Banking is about confidence and that has gone from Northern Rock in a spectacular way.”
Michael Fallon, a Tory member of the committee, said: “It seems very odd that Mervyn King was saying there would be no bail-out, then he sets out how to do a bail-out and then he does the bail-out. We need to understand much more clearly how the decision was taken."
the run is devastating northern rock's overlevered balance sheet, and if it survives at all it will be as in pieces.
THIS is why most banks in trouble will not tap the discount window except in the most dire circumstance, regardless of how bernanke's fed tries to make policy with it -- particularly now with northern rock as precedent. once it becomes clear that a bank is in trouble, little can save it. to the extent that the window can be used, it will have to be through "too-big-to-fail" intermediaries -- and i suspect that's exactly what's been happening.
as mish says, expect more of this kind of thing here and there. this is already the second bank run of this affair, the first being countrywide. now alliance & leicester, the uk's seventh-largest bank, is being implicated by the market.
Bradford & Bingley, which makes one in five loans to U.K. landlords, and Alliance & Leicester, another U.K. commercial and consumer bank, were among banks that were downgraded to ``sell'' from ``hold'' at Citigroup.
Citigroup lowered its recommendation on shares of nine European banks and cut earnings forecasts for the industry, citing a drop in credit-market revenue that will bring about ``wide-scale changes.''
Bradford & Bingley sank 15 percent to 279 pence and Alliance & Leicester fell 31 percent to 600.
``The negative macro picture is likely to play out to the detriment of Alliance & Leicester,'' Merrill Lynch analysts Manus Costello and John-Paul Crutchley wrote in a report today.
``We think a takeout is unlikely in the current environment, especially when there is no shortage of cheaper U.K. assets for an interested buyer.'' They cut the recommendation on Alliance & Leicester to ``sell'' from ``neutral.''
the bank of england late today guaranteed all northern rock deposits. we'll have to see if that quells the run.
Thursday, September 13, 2007
setting the stage
If you go through the Petraeus report, the key passages are those that deal with Iran. Petraeus continually points the finger at Tehran as an explanation for the lack of "progress" in Iraq. He claims to have "disrupted Shia militia extremists" – you know, the ones that sit in the Iraqi parliament – and to have captured the leaders of "Iranian-supported Special Groups, along with a senior Lebanese Hezbollah operative supporting Iran's activities in Iraq." Who is this operative, and what are these "Special Groups"? Apparently, they are too special to be named in testimony before Congress. The "ethno-sectarian competition," Petraeus avers, is being pushed toward violence, in part because of "malign actions by Syria and, especially, by Iran."
What actions? No answer is given: not that anyone is asking, at least not in the Congress or among the presidential candidates of either party. Prior accusations that IEDs found in Iraq were manufactured in Iran have proved sketchy, at best, and pure invention, at worst. Yet Petraeus' words are simply taken as gospel, much as Colin Powell's peroration of Scooter Libby-produced lies performed in front of the UN was hailed as a home run. Years from now, will we look back on the Petraeus-Crocker dog-and-pony show with the same bitter regret that nobody – or almost nobody – doubted them?
You can bet the ranch on it.
Refuting this farrago of half-baked fantasies doesn't require any special knowledge, only a basic understanding of the current situation in Iraq and a bit of common sense. For example, why would Shi'ite militias go after the Shi'ite government in Baghdad – when, in reality, they are the armed wings of the parties that make up that government?
Even more egregious is the contention that "it is increasingly apparent to both Coalition and Iraqi leaders" that "Iran seeks to turn the Iraqi Special Groups into a Hezbollah-like force" to "fight a proxy war against the Iraqi state." Is that why Iraqi Prime Minister Nouri al-Maliki traveled to Iran recently, where he walked hand in hand with President Mahmoud Ahmadinejad, then took off for Damascus, where he was warmly greeted by the last of the Mesopotamian Ba'athists?
A proxy war is being fought in Iraq, but it isn't one pitting the Iranians against the Iraqis: the U.S. is the proxy, fighting on behalf of Israel against Iran and Syria.
That's what all this malarkey detailing how the Iranians want to "Hezbollah-ize" the Iranian-run "Special Groups" is about. So now we're fighting Hezbollah, a group that arose because of the Israeli occupation of Lebanon, and is concerned exclusively with ridding their country of Israeli troops and influence.
The "surge," as the escalation of the war is being euphemized, is working, albeit not in the way the hapless Democrats and the American public understand it. "Progress" in Iraq, insofar as this administration is concerned, means we're closer to war with Iran. That has always been our target, and now that we've got the Ba'athists out of the way, we don't mind allying with the "dead-enders" against the real enemy: the Shi'ite mullahs of Tehran.
In answer to questions from the senators, Petraeus gave away the show when he bluntly stated, "We cannot win Iraq solely in Iraq." Oh no, we have to conquer most of the rest of the Middle East, including Iran, Syria, and who-knows-where-else before we can even begin to talk about winning in Iraq.
as raimondo points out, what has seemed apparent for many months to me is now finding read observers among republicans of andrew sullivan and national review. sullivan is finally rightfully appalled at the brazen hubris and the conscienceless engineering of conflict; nro has been, of course, generally eager to broaden the imperial twilight slaughter of endless petrostrategic warfare without victory and maintenance of the israeli beachhead since before i can remember.
that petraeus would fabricate most anything he needed to make the administration case for perpetuating the imperial occupation and (they hope) slow pacification of iraq and its vital energy resources -- all the more valuable in the advancing age of peak oil -- is hardly a revolutionary concept, the undue reverence of jingoistic and economically illiterate americans notwithstanding. moreover, he is certainly in a position to make uncontested and unverifiable statements about conditions on the ground in iraq. it should be well understood that the administration has purged military leadership repeatedly to get the yes-men they want in place, with names like shinseki and abizaid finding even slight dissent impolitic and career-ending. petraeus was never in any danger of being candid before congress; at best, he might rise to the level of 'plausible'.
perhaps worse is his adoption of the casual republican meme that 'things would get worse if we left'. to be sure, they very well might. but they well might if we stay, and they may indeed improve if we leave. what would be sure, however, is that american troops would not be slowly decimated amidst the civil war that the administration so irresponsibly used them to enable. petraeus has utterly no idea how or if continuing the american presence in iraq makes things better or worse, and his pretending that he does undermines his credibility completely and makes him out to be the republican shill he is.
but that his obfuscation points so clearly at the intended next step -- to open a heretofore covert war -- is no less horrifying for his lack of candor and perspective. having lost in iraq, the bush administration would expand a war they can't win, a war that is gradually bankrupting the nation, a war that is tearing the volunteer military asunder, a war that has exposed the united states as just another evil empire, a war that has riven the homeland with fear and political animosity.
there is, moreover, something more subtle but no less sinister. the use of petraeus as an administration salesman is another step back toward the open politicization of the military, a trend in american development that had (previously to the bush administration) largely recessed from the american scene since vietnam and westmoreland, retracing from the perilous high point of eisenhower and macarthur. this must be an unwelcome trend in any democracy, but particularly one committed to a global empire and harboring a monstrous military-industrial-energy complex.
god help us, we're in the hands of an economic model
The MAQS are in charge of the quantitative model of the U.S. economy known as FRB/US or ``Ferbus.'' By adjusting for such things as higher financing rates for American companies or a sharp decline in home prices, the team provides policy makers a glimpse of possible outcomes.
The scenarios -- known at the Fed as ``alt sims'' or alternative simulations -- are especially important at next week's meeting because the vote will likely be cast on the dangers that the forecast is better or worse than reported, former Fed officials said.
``The FOMC will start by looking at the standard calculation'' of how changes in home prices and credit spreads affect the outlook for employment and inflation, said Douglas Elmendorf, an assistant director of the Federal Reserve Board's research and statistics division from 2004 to 2007.
Policy makers will then ask, ```Where do we see the risks arrayed around the baseline?''' said Elmendorf, now a senior fellow at the Brookings Institution in Washington. ``Alternative simulations are quite important, particularly because of the Fed's announced interest in risk management.''
The methodical approach has some pining for the good old rapid-response days of Greenspan, who called six emergency rate meetings between 1992 and 2001. Five of those resulted in reductions as he sought to head off recession or ease gridlock in capital markets.
i applaud any extent to which bernanke gets the data -- doing so is likely to make it harder for the fed to perpetuate the moral hazards that were greenspan's lifeblood and which helped the american economy into the debt trap that may now be closing around it.
but i'm also apprehensive. these economic models are of a kind with all of those which are still giving mainstream economists reason to say that there is no recession coming -- in spite of a credit crunch, declining employment, nascent consumer weakness and a residential housing depression that is now being joined by a commerical real estate downturn. recession, it seems to this lowly observer, is here.
the fed is already holding the funds rate near 5% through liquidity injections, so i would think a quarter-point cut is already baked in to this monday's announcement as a formalizing of extant conditions. but the market is clearly cheering for a half point -- and to some extent has already anticipated as much, with the dollar falling to new lows and some nascent strength returning to financials. and it is doing so against an inflationary background that is not sanguine, though there is certainly credit destruction underway.
what if the data-driven, inflation-concerned, lagging, incrementalist fed of bernanke -- if it really exists, which is a matter of some debate -- gives them a quarter-point and no more? how do markets react?
i have long tended to think the governments of the united states and britain as essentially the same, the latter little more than a division of the former. so it was interesting to hear mervyn king of the bank of england yesterday take a hard line in advance of the fed meeting. is he telegraphing bernanke?
Wednesday, September 12, 2007
In 1981 French philosopher Jean Baudrillard wrote a book attempting to theorize the post-modern, titled "Simulacra and Simulation." Why should you care? Because many of the themes Baudrillard discussed are related to the breakdown in "financial simulation" we are seeing in credit and currency markets.
First, what is "Modernity"?
"Modernity" is most often viewed as the child of the Renaissance and as heralding the development of social and scientific thought; the "modernization" and integration of large-scale societies that had been previously separated by technological, social and even religious boundaries.
In terms of finance, we can characterize "modernity" as a seemingly linear progression of the following:
- increased modes of production
- increased movement of goods and capital backed by some thing, a store of value
- the development of a structural framework in which the movement of goods and capital can interrelate and "grow"
- corresponding division of labor
The reason for bringing up Baudrillard's "Simulacra and Simulation" is to discuss what he called the "successive phases of the image" and the relation to our fiat-based monetary system.
In a fiat-based monetary regime, what is the "price" of a security but an image?
It is a "signifier" of some "thing."
But what? Is it objective? Is price "real"?
Baudrillard's successive phases of the image translate well with the progression of price discovery in markets as money transitions from reality (backed by something physical, a store of value) to image (backed by absolutely nothing).
Baudrillard's Successive Phases of the Image (with price relation in parentheses)
1) it is the reflection of a profound reality (price "means" something profound with respect to the security)
2) it masks and denatures a profound reality (price disguises a profound reality - the value investor's dream)
3) it masks the absence of a profound reality (say, 1999)
4) it has no relation to any reality whatsoever; it is its own pure simulacrum, a copy without a model (the decoupling of fiat money and the continuous supply of liquidity and credit to market participants with no underlying attachment other than the promise of a central bank).
From the standpoint of Baudrillard's final phase of the image (price), we now seem to be witnessing in credit markets objects that have no relation whatsoever to anything - many credit instruments are simply not capable of being valued.
They are now solely existant as a pure simulacrum from which higher and lower are relations to something without meaning; in other words a hyperreal market.
Baudrillard argued in Symbolic Exchange and Death that our society overall has undergone these successive phases of image, from an era of The Original, to The Counterfeit, to the Mechanical Copy, something "Produced" to the "third order of simulacra, where the copy replaces the original.
an excellent metaphysical view on the hubris of financial engineering. and if that wasn't enough....
According to the Wall Street Journal, home builders are putting up fewer supersize homes and offering smaller floor plans to lure buyers by keeping prices low.
The psychology of credit expansion feeds into everything.
Over the past three decades the average size of newly constructed single-family homes expanded by nearly 45%, according to the Journal, even as the size of the average family declined.
According to the Census Bureau, the median size of a newly completed single-family home reached 2,248 square feet, up from 1,560 square feet in 1974.
In the second quarter of this year, however, that expansion abruptly declined, from 2,302 square feet in the first quarter, to 2,241 square feet.
Jeffrey Mezger, chief executive of Los Angeles-based KB Home (KBH), told the Journal that the change has been "driven by data on what our home buyers want and what they can afford in a new home."
Toll Brothers (TOL) chief marketing officer, Kira McCarron, conceded that there "probably is more demand for 3,000- versus 6,000-square-foot," homes, the newspaper said.
Sarah Susanka, author of "The Not-So-Big House," said "I used to be asked all the time why would anybody want to downsize? People thought I was crazy. Now it's becoming much more mainstream."
As deflationary forces grow, the psychology spreads, infecting markets, consumer decisions and attitudes toward tangible goods and consumer goods.
We'll likely see this theme recurring again and again in the coming years.
on being a permabear
Tuesday, September 11, 2007
long the financials? long real estate?
as abysmal as the picture seems from an economic standpoint, i wonder if there isn't a case to be made here to go long the financials -- just the opposite of my current position.
as seen above, the sector has experienced a brilliant washout -- on a par technically with the deepest bear market lows of the 2001-2003 run. 65% of the component stocks in the iyf got within 5% of their 52-week lows. about 40% actually made new 52-week lows. at bottom, just 6% were above their 150-day moving average. that is destruction!
some bullish non-confirmations are mixing in.
but i'd really rather to see some positive leading divergence in new highs to give a greater sense of refuge here. and maybe that will appear before the financials right the ship.
an even better case can be made for real estate.
i still think that a retest of the august 16 low in the indexes is likely -- perhaps not for leading groups like tech, but for the broader market. many of these etfs (including real estate and tech) reached oversold readings on september 4 that could well have marked the end of a bounce and the start of a test lower.
Monday, September 10, 2007
abcp maturity peak: september 17
Banks and companies need to refinance almost $140 billion of commercial paper in Europe by the end of next week and may push up yield premiums on corporate bonds, according to Deutsche Bank AG, Germany's biggest bank.
``This could be a pivotal seven to 10 days,'' Jim Reid, a credit strategist at Deutsche Bank in London, wrote in a note to investors today. ``This will inevitably lead to wider corporate spreads, especially in high yield.''
Almost $60 billion of the commercial paper due this week and next is owed by conduits, firms set up by banks and companies to invest in longer-term assets, according to Reid. The debt is backed by bonds including asset-backed securities, as well as car loans, mortgages and trade receivables. The remaining $80 billion of commercial paper is unsecured.
Yield spreads on corporate bonds are rising in part because banks are more focused on keeping their own conduits afloat than providing finance to other companies. The premium on European high-risk bonds over similar-maturity government debt has increased to 426 basis points from 358 basis points at the beginning of August, Merrill Lynch & Co. indexes show.
Bank of America Corp. estimates that about 59 percent of the $230 billion of asset-backed commercial paper in Europe comes due this month. The peak will be Sept. 17 when the equivalent of $48 billion matures, Bank of America analysts in London led by Raja Visweswaran wrote in a report. The credit markets are likely to remain ``unsettled'' until then, the report said.
Banks' ``increasingly bloated balance sheets will not be good news for overall market liquidity,'' Deutsche Bank's Reid said in the note.
it all leads the market to be very leery of the big banks caught in the structured investment vehicle problem, by which they have sold asset-backed commercial paper (borrowed short) to invest in toxifying mortgaged-backed assets (lent long), all heretofore off balance sheet. the same banks are going to be stuck taking massive wtiredowns on leveraged buyout financing as well.
Lehman Brothers Holdings Inc. faces higher borrowing costs today than it did in June, even after the steepest quarterly drop in U.S. Treasury yields since 2002 pushed interest rates down for everyone from Procter & Gamble Co. to AT&T Inc. Investors are so leery of Bear Stearns Cos. that its 10-year bonds trade at a discount to Colombia, the South American nation that's barely investment grade. Goldman Sachs Group Inc. is being punished with a higher yield than Caterpillar Inc., the heavy-equipment maker.
Bond buyers view the nation's largest securities firms as no safer than taking a flier on subprime mortgages. That's a nightmare scenario for the industry's chief executive officers, who relied on cheap financing for leveraged buyouts, real estate lending and proprietary trading to produce record profits -- and paychecks of $40 million or more for themselves.
The five largest U.S. securities firms -- Goldman, Morgan Stanley, Merrill Lynch & Co., Lehman and Bear Stearns -- will have to fund $75 billion of loan commitments to LBOs at a loss because most investors have stopped buying that kind of debt, Citigroup Inc. analyst Prashant Bhatia estimated last month.
watch for fireworks
the dollar took friday's news as reason to mark its lowest close since 1992 -- some 15 years ago. forecasters today are talking about at least 50 bps of fed funds rate cuts, although comments from some fed governors are not nearly so presumptive of economic action.
starting out on a rate cutting program is likely to compel the dollar yet lower -- particularly in anticipation of other irresponsible fiscal steps in response to the insolvency-driven credit crunch -- and really into unknown and unpredictable territory. letting it slide may have massive unintended consequences. what china feels it must do might become more than what it merely hints at the capacity to do. and there are already hints of a foreign capital flight.
if the dollar collapses in the near term, the damage will be widely felt. keep an eye open.
Friday, September 07, 2007
recession is here
today's non-farm payrolls contracted 4,000 jobs -- against an expectation of creating 110,000 -- crushing some illusions of continuing economic expansion in the face of a burgeoning credit crunch. recent incidents of strong data were emphasized by some, but -- as calculated risk well dissects -- a handful of strong reports are not what they seem. conflicting data are common at turning points. as was previously noted, labor is the last to go -- and one has to see the surprisingly significant weakness here, compounded by a credit crunch that is probably still far from abating, as deep confirmation that all those non-confirms in the equities of consumer and construction sectors were valid indicators of a recession that may well already be here.
the setup for stocks is interesting. financials are being eviscerated, as is the dollar -- but both are set to test lows.
in the financials, the low to watch is 101.50 in the bkx. a fail of that low would probably mean a collapse to the 94 area -- another 8% down. and a fail to hold 94 in the near-term would be unthinkable.
but more important may be the dollar index low of 80 -- it is monumentally important on a multiyear scale. it is being tested on this news. if it breaks against the current credit backdrop, the possibility of a 1987-style cascading failure is distinct -- and will certainly put the fed between a rock and a hard place, as interest rate cuts intended to alleviate leveraged market pain will only weaken the dollar further, sparking inflation. at some point, more debt creation is not the answer to a debt problem.
alan greenspan commented this morning on the identicality of this situation and both 1987 and 1998. but i have to agree more with this comment from minyanville.
Both episodes were liquidity events for sure, but the solution Mr. Greenspan came up with was to create “artificial” liquidity through credit creation. The infusion of debt-stabilized asset prices (more “money” chasing the same volume of assets). But in both cases Mr. Greenspan never had the gumption to mop up that debt and allowed it to grow and grow and grow. Today we have the culmination of that debt. This “liquidity event” is much larger than either of these two previous episodes.
The same solution is being used, but this time it is only slowing down a much bigger problem.
this is an insolvency problem at core, and defaults will ultimately mean serious credit contraction and quite possibly a deflation that the fed simply can not manage even if bernanke dumps money from helicopters.
UPDATE: there is an excellent chart here showing the employment ratio. conclusion: a recession is very probably already underway, and the equities market is -- not for the first time, but probably not for much longer as it has already been doing so for nine months -- lagging the economic reality.
Thursday, September 06, 2007
How this credit crisis works out and what price we end up paying has to be largely unknowable, depending as it does on hundreds of interlocking and often novel factors and how they in turn affect animal spirits. In the end it is, of course, the management of animal spirits that makes and breaks credit crises.
But even if this crisis is contained, we are facing some near certainties that should be understood.
House prices are in genuine bubble territory in the U.S., Britain and many other markets. In Britain and in some critical large cities in the U.S., for example, the multiple of family income has risen to over six times from below four times, and in London last year the percentage of first-time buyers was the lowest since records began.
From these high levels, prices are guaranteed to fall. In doing so, they will reduce consumer borrowing and spending power. They will also increase mortgage defaults, most of which lie ahead, and lower financial profits and confidence.
Second, profit margins are at record levels around the world. They have lifted stock prices directly alongside the rising earnings. They have served to raise P/E multiples as well, for surprisingly, investors on average reward higher margins with higher P/Es. This is fine for an individual stock, but for the entire market, multiplying boom-time profits by high P/Es is horrific double counting and sends markets far too high in good times (and far too low in bad times).
For U.S. and developed foreign markets, fair value (defined as normal P/E times normal profit margins) is about one-third below today's level, and for emerging markets it is about 25 percent lower.
Third, and most important, risk will be repriced. Last year a broad base of risk measures - including volatility (VIX), junk and emerging debt spreads, CD rates, high-quality vs. low-quality stock values - reflected the lowest risk premiums in history. On some data, indeed, investors actually appeared to be paying for the privilege of taking risk.
For fixed income, some spreads widened slowly at first this year and then unexpectedly widened rapidly in recent weeks. For equities, though, the process has hardly started. Junkier stocks continued to outperform into June, even as the subprime woes spread. At the end of the cycle, high-quality blue chips will once again sell at normal premiums or better.
to sum up: margin and multiple contraction to normal should knock over 30% out of equities -- and that's before factoring any possible cyclical contraction in profits that may result from a housing bust that is, he notes, still in the early innings. all in all, he's describing a halving of equity indexes.
here's a better method of applying earnings to valuations that cuts the cyclical earnings peak out.
with conditions in credit and banking markets being negatively compared to 1998, high yield spreads still widening, libor rates stubbornly creeping higher into crisis territory every day as the asset-backed commerical paper unwind takes hold... it's hard for me to imagine that equities have properly priced what is happening. it's often said that the bond guys are a lot smarter than the stock guys, and treasuries have rallied remorselessly since early june.
the ten-year yield in autumn of 1998 fell 23% -- from 5.5% to 4.25% -- from late july to october; the s&p 500 dumped about 20% of its value from peak to trough, though from the point where the decline in treasuries began to the low it lost about 10%.
in the current crisis, the ten-year yield has dropped from 5.2% to 4.5% -- about 13% so far. the s&p is currently only about 5% off its rally high, and is about flat from the point where the treasury gains began (june 12). its maximum intraday loss (to 1378) from june 12 (1492) was 7.5%.
in 1998 by the time treasuries had given up this much and libor spiked as it has, the market was already finding a bottom. is it possible that as much has already happened here?
Wednesday, September 05, 2007
marc faber foresees dollar debasement
Since October 2002, all asset prices have “inflated” in concert. “At the end of a major bubble it is common for the leadership to narrow with just one sector of the market still soaring while the rest of the market falls by the wayside. It is, therefore, conceivable that US stocks could still make a new high while most other assets would no longer appreciate."
that sector looks to be tech, which have been the most disappointing short in the market since july. i've now forsaken them for financials and the russell 2000. he also sees bernanke's fed as utterly slavish to the equities market.
But the Fed is unlikely to “resist supporting the stock market at the expense of a weaker US dollar and higher inflation”, he notes.This would mean that a new high for the stock market in dollar terms is possible. In this context we should not forget that Mr Bernanke’s main thesis – about which he has both repeatedly written and spoken – is that the Great Depression could have been avoided if the Fed had flooded the system with liquidity right away.”
Ben Bernanke, says Faber, “is also the man who suggested that if deflation became a real threat the Fed could always drop money from a helicopter onto the US”. Thus, Faber remains sceptical “that the Fed will refrain from engineering a major monetary bail-out of the system.
The problem with such policy, he warns, “is that the stress in the system is shifted from the lower quality credit market and the stock market to the US dollar, which will continue to be debased (certainly against gold)”.
Another point to consider, says Faber:US mortgage debt as a percent of GDP is now at 70% compared to 40% at the time of the 1998 LTCM crisis…Unless the Fed is prepared to accept a vicious recession it has no other option but to bail out the system no matter how unpleasant the consequences… in the future. The problem is really that in recent years the Fed has never controlled credit growth and that the monster needs now to be fed with even more money and credit growth.
Admittedly, “easy money” may not do the trick for housing, which is likely to continue to deflate in real terms (inflation adjusted), but it is possible that amidst a deteriorating global asset bubble advance/decline line (fewer and fewer assets making new highs) the one or the other asset market will still make a new high. After all, the Shanghai stock market has so far not been affected by the mortgage related credit crisis.
Faber’s point, he says, is simply this:“When emerging markets break down some time in the next nine months, the US stock market is likely to out-perform foreign markets.”
Since I assume that this insight will not have escaped the attention of large global money managers, they are likely to increase their exposure to US equities in future - particularly, if the US dollar weakens further. Therefore, despite being negative about the US economy and its financial market, I am reluctant to be heavily short US equities.
If it’s all a bit confusing - considering Faber’s twin views that new US stock market highs are “unlikely for the rest of the year” and his “relatively positive” view on US equities - blame the Fed, he says.
“The confusion arises because of the market manipulation by the Fed… In fact, the Fed is so driven by asset price changes that one could envision the following scenario: If by the next Fed board meeting on September 18, the S&P 500 is above 1,520, Fed fund rate cuts would unlikely be announced. Conversely, if by then the S&P 500 is around 1,400 or below, Fed fund cuts become highly likely.”
The question, says Faber, is “whether Fed fund cuts will re-ignite the bull market. In two previous instances, stocks rallied repeatedly on Fed fund cuts, but the overall trend was down.”If I look at the investment environment I cannot get excited about participating in the ongoing battle between market fundamentals, which are, in my opinion, a disaster, and the manipulation by the Fed (and possibly at some point also by the government), which could boost US asset prices or at least prevent them from declining as much as the bears (including myself) would like them to do. In military battles, even the victors have a very high casualty rate.
Therefore, concludes Faber, “in the ongoing financial battle between the optimists, who expect a new high shortly, and the pessimists, who expect a new low before the end of October, the best course of action may be to only take small positions and to patiently await better entry points both on the long and the short side.”
the peak is past in real terms but in nominal terms -- thanks to a government that views fiat currency as a means to an end -- anything can happen.
it's been pointed out elsewhere that attempts at dollar debasement -- in the form of interest rate cuts, at least -- is not a slam-dunk for reflation. leverage and lending is the key to increasing the velocity of money, the fed cannot force lenders to lend; it can pump the economy full of dollars, but it cannot direct them to the people in need. indeed this was the core issue of the great depression -- people stuffing matresses with dollars and not spending them -- and one which some believe bernanke simply does not accept or fully understand. time will tell.
Tuesday, September 04, 2007
the markets have squeezed the shorts hard since august 16, but it would seem that the bulk of any reflex rally is now over. the question is: what next?
if august 16 was The Bottom, then the next few days may tell a lot. says the newsletter:
Typically, strong rallies react to overbought readings either with a minor pullback or ignore them completely, as prices continue to rise. A weak rally, though, will frequently react with a substantial decline. Therefore, the next few days should provide a good indication of the strength or weakness of the current rally.
the options market would still seem to consider volatility likely.
Again, options are very high. So the jillion dollar question is whether they are a blazing sale, or are telling us September is going to be pretty interesting.
the s&p closed at its 50dma today, also the top of its 3% envelope. a number of divergences are still apparent from like price levels -- the basis here is august 8. cumulative points, on-balance volume, new highs. similar divergences are also apparent between the august 28 low and the august 3 low. even in the last few days thinning against the percentage over 10dma is noticable.
this has been a price impressive snapback but my expectation still is that it is a snapback and that a retest of the lows is still in order.
if there's considerable strength from here, however, and the sequence of lower highs is violated i'll have been wrong to have expected a retest from august 16.