Friday, May 28, 2010

Leftovers -- Radio Show 5/1/2010

During this show we discussed a customer's encounter with Chase personal bankers in Texas, when Chase refused to allow the individual to transfer more than $2000 per day from her Texas unemployment Chase debit card (she had allowed the balance to grow unused as she used savings) amounts to her community bank account and insisted she should open a Chase account.  The personal bankers also made a variety of other claims including that, if she transferred her retirement account to Chase, she could get 30% yields, which was an amounted repeated several times without any reference to time period.  To make such a yield statement is a securities violation.  The woman was very impressed with the extreme pressure she was put under as a small, unemployed.

The Fed Open Market Committee April meeting press release stated household spending remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit but they see improvement.  Employers remain reluctant to add to payrolls.  With substantial resource slack (interpret that as high unemployment) continuing to restrain cost pressures, inflation is likely to remain subdued.  With low rates of resource utilization and stable inflation expectations, the economic conditions warrant exceptionally low levels of the federal funds rate for an extended period.   In Fed speak, "extended period" equals at least six months.  Hoenig was the lone dissenting vote and voiced the belief that continued expression of exceptionally low levels of the federal funds rate for an extended period was not warranted and would lead to a build-up of future imbalances and increase risks of longer run macroeconomic and financial stability, while limiting the Fed's flexibility in raising rates modestly.

U.S. Q1 GDP is estimated to have grown 3.2% annualized.  This is not large enough to sustain a recovery.  In past recoveries, GDP growth rates of 7% or more for several quarters were not unusual.  Of the 3.2%, 1.7% was from slower inventory reduction (it comprised 4.4% of the Q4 5.6%) and 1.6%was from sales which is an anemic number..  Personal consumption expenditures were up 3.6%.  Weekly unemployment insurance claims remain elevated well above 400,000 indicating more jobs are still being lost than created.

John Hussman's weekly commentary noted the price-to-normalized earnings multiple of 19.1 exceeded the peaks of August 1987 and December 1973 and the only market valuation exceeding the current level was 20.1 just prior to the 1929 crash.  Still market valuations have never been used as an indicator of near-term market fluctuations.  He then discussed two looking forward models of a typical post-war recession or a period of credit strains.  The current situation has attributes of both.  Any increase in credit strain could consequently move markets negatively with the most damaging declines occurring when reality departs materially from expectations.  These two data sets have distinct differences in how the market responds to valuations and market action with "post-war" being positive and "credit strains" being negative.  He still finds the market overvalued and overbought with no reprieve in interest pressures.

Following up on a prior week question regarding owning individual bonds, I stressed that owning individual bonds with concentrated risk exposure just like owning stocks is usually not advisable for the common investor.  Additionally, they are not as liquid as other investments and, if you have an emergency and you have to sell them before they have matured, you may have to sell them at a steep loss, depending on the maturity of the bond at the time.  You probably could not build a large enough portfolio of different company and municipal/state bonds to offset default exposure. The credit risks associated with municipal bonds are particularly hard for a common investor to determine. You have to buy them and sell them through a bond sales person.  Bonds could have call options which reduce the yield which could have been realized if held to maturity.  You could buy Treasury bonds directly from the government,  You could also buy iBonds which have a fixed interest rate and an inflation rate with the fixed rate set every May and November for the life of the iBond while the inflation rate changes every May and November.  The May 2010 iBond has a fixed rate of .20% and a current inflation rate of .77%.  Most common investors are better off with well managed mutual fund bond funds or selected ETFs or ETNs.  There is also the possibility of exchanged traded bonds (just like stocks) in face values of $25 to $100 with no minimum purchase.

FDIC is concerned that if derivatives trading is removed from banks in the financial reform bill that the trading activity will end up in unregulated entities.

Bullard, St. Louis Fed President, said the Senate financial reform bill would result in "blatant politicization" of the central bank and questioned the proposed system to wind down biggest banks.  He opposes an audit of the Fed.  He thinks a consumer protection agency within the Fed blurs responsibilities and would prefer it be either completely under Fed control or spun off independently.  The biggest banks are too complex to put through a resolution process.  I have long maintained that if there was another financial crisis like 2008, systemically dangerous, without respect to size, financial institutions might have to be resolved in parallel by stripping toxic assets from balance sheets as well as some being singularly resolved by liquidation or reorganization.  I have also long argued that the Consumer Financial Protection Agency should be independent.  It was placed within the Fed to insure it does not do anything which upsets the financial system.

Former Fed governor Mishkin said controlling $1 trillion in mortgages was a huge difficulty for the Fed which acted in bravery to prevent depression but now is faced with cleaning up the mess.  The top priority of the Fed should be selling these mortgaged backed assets.  In my opinion, there is a relatively large discussion within the Fed with substantial disagreement about when they can start selling assets, particularly since the Fed is just ceasing its special liquidity programs.  I have been particularly concerned that the Fed has shown no interest in how monetary policy is affecting jobs and high unemployment.  Lacker, Richmond Fed President, said low rates are appropriate while economic slack is taken up in coming years.  Again, in my opinion, the concern is increasing the liquidity and capital ratios of the banks while it is ok for unemployment to be continued in order to keep inflation down.

The Fed this week authorized offering term deposits for lenders who are eligible to collect earnings on their balances at the Fed's Reserve Banks to drain liquidity as a prudent plan with no near-term implications.

The TARP Special Inspector General, Barofsky, indicated their may be possible criminal charges with respect to the SEC, Treasury, and New York Fed (from when Geithner was the Fed President) cover-up of AIG counterparty payments and has fought several attempts by Treasury to reduce his authority and overview.

I indicated that if a EU/IMF bailout of Greece was not agreed upon by Monday, it would hit the fan and the market ride could get wild.  It would increase credit pressures not just on Portugal but also Spain, which has a much larger economy.  If it gets to Spain, it could very well go global given German banks heavy exposure to Spain and weak regional saving banks (caja) with substantial real estate mortgages on their balance sheets.  The emphasis on deficit cuts will be counter productive as it will put Greece in recession with deflation and possible price inflation from tax hikes resulting in years of stagnate growth.  The emphasis should be on efficiency cuts and increased targeted investment to increase domestic consumption of domestic products and to increase price competitive exports.

Greek bond yields continued to rise, bank stocks are falling, and there is a growing fear of contagion within Europe.  Some in Greece are calling for EU common budget  policy to help create a fiscal policy which addresses the weaknesses of the euro exposed by the Greek crisis.  The IMF indicated the final package may be as high as 120 billion euro.  Key to any bailout is agreement by Germany in which many Germans blame speculators and Greek fiscal incompetence rather than this being the ultimate result of Germany's refusal to allow current account balance inequalities and exchange rates to be resolved when the euro was created, because it was to its benefit and economic advantage over the other EMU countries.  This helped create a pseudo gold currency which did not provide for any fiscal adjustment between countries while depriving member countries of any monetary policy to help adjust individual member country's economy.

S&P cut Greek bonds to junk and Portugal to A-.  On Monday, trading pressure on Greek bonds had pushed yield on ten year to 6.2%, 2 year to 12%, and the spread between Greek and German bonds were at 5.63%.  By Wednesday, 2 year Greek bonds had passed 23% yield.  Greece banned short selling for net two months.  Spain's credit rating was cut one notch to AA with negative outlook.  By Thursday, 2 year Greek bonds were down to 13% and 10 year to 9.4% with prospect of bailout.  The Greek bailout may be 120 billion euro over 3 years with drastic austerity cuts and tax hikes.  Greece warned that default was not option, but many commentators keep wanting to bet on it.  I have questioned why a restructuring of debt is not done by increasing maturity dates by five years.  One Greek economist proposed a similar process this week. This would avoid a haircut and default.  Default is not possible unless Greece withdraws completely from the EU and that is not going to happen even if Germany would try to kick them out.

Rogoff stated his opinion that if Greece gets a bailout than at least one other country will get one within one to two years.  He is overly optimistic, because the austerity measures he has endorsed as necessary to cut debt will drive other countries into recession and stagnate European growth as well as run the risk of significantly aggravating citizens within those countries to the point of social action.  Portugal credit swaps hit a record 318 basis points as it suffers from contagion pressure on bonds.  Portugal's problem is not necessary public sector debt which is on a par with France but it has an economy which is not growing.

IRS guidance has been provided in Notice 2010-38 on tax-free health insurance for children under the age of 27 years.  Detailed regulations have not yet been issued providing guidance on how employer health plans can avoid penalties for providing health coverage deemed unaffordable to lower paid employees.

Spanish unemployment is at 20.1%

South Korean GDP is up 1.8% Q1 and 7.8% vs a year ago.

IBM will buy $8 billion of its shares in second buyback.  Is IBM upbeat or does it not have better options for its cash?

Caterpillar earnings were up and beat expectations but sales were down everywhere except in the AsianPacific.

Ford beat Q1 earnings expectations with $2.1 billion revenue, which was up 15%, and pretax profit of  46 cents per share vs <75 cents> last year.  However, Ford shareholders do not believe it can continue and the stock went down 6% the same day.

HP will buy Palm for 41.2 billion.

Russia's central bank cut interest rate 25 basis points to a record low 8% as the recovery remains unstable.

Brazil's central bank hiked interest rate 75 basis points to 9.5% to curb inflation fears; it was the first hike in two years.

Eurozone inflation is up 1.5% April vs year ago (1.4% in March).

Japan's unemployment is up .1% to 5%.

Chicago Fed National Activity Index is up to <.07> from <.44>.

U.S. Treasury Auctions:

5 year TIPS, $11 billion, yield .55% (high), bid-to-cover 3.21, foreign 23.1%, direct 13.0%.
2 Year Treasury, $44 billion, yield 1.024%, bid-to-cover 3.05, foreign 31.04%, direct 21.4%.
5 year Treasury, $42 billion, yield 2.54%, bid-to-cover 2,75, foreign 48.9%, direct 24.3%.
7 year Treasury, $32 billion, yield 3.21%, bid-to-cover 2,82, foreign 59.5%, direct 12.2%.  The 7 year was a strong auction.


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