Leftovers --- Radio Show 4/24/2010

Seven banks failed, all in Illinois, including Broadway Bank owned by the Giannoulias family and in which the U.S. Senatorial candidate Alex Giannoulias was a former officer.  It will cost the FDIC $394.3 million and does not affect the family's holding company.  The unofficial problem bank list at www.calculateddriskblog.com is up to 694.

We followed up on a question about Tupperware stock from some weeks ago, because it reported earnings which were up 69% and sales up 20%.  We reiterated that has mixed fundamental and technical information; that it had gone through its buy point on April 5th and immediately fallen back.  On last Monday it went through its 50 day line and came back above during the trading day establishing a secondary buy point as low as $47.08, if one wanted to take the risk by buying 25-50% of planned investment and waiting until next day to see how it performed before investing more if it went up.  With its earnings report it did go through its primary buy point of $50.73.  This stock has shown weakness and low volume.  As with all individual stock purchases, an 8% stop loss order should always be placed to limit losses.  If one had done proper research and looked at similar market sector groups, one might have found BTH, Blyth, which broke out on April 5th and proceeded to go up 88%.

Vanguard Total Stock Market Index mutual fund has long term results and short term risks.  As we explained in prior weeks, it might have a place in a well diversified portfolio with a horizon of 8-10 years, but should not be owned by someone whose investment time horizon cannot absorb and recoup the short term losses as it follows the market down as it did in 2008.  A less expensive alternative would be the Vanguard ETF (VTI) with a cost of only 9 basis points.

We urged the caller from the prior week to determine what percentage of the total retirement portfolio was put into individual Ford bonds (the comment by the caller was we now own a lot of Ford bonds).  This would be key in determining if it was inappropriate.  The spouse had followed a stock broker adviser to another brokerage and the stock broker redid the spouse's retirement account.  Individual bonds constitute all at risk investment just like individual stock.  Individual company bonds are generally not appropriate for the common investor as they may difficult to sell, may have maturity problems with respect to the actual premium/discount investment returns, and require more analysis with respect to risk.  I urged them f they were listening to go back to the stock broker and ask for a complete accounting of all commissions and fees received by the stock broker.  While I said I have no problem with Ford bonds, one should remember that two years ago Lehman was too big to fail and no portfolio should have a significant exposure to one company.

We also commented on the Malcolm Berko newspaper column in which a local individual had asked for help in making selections in their Bunn-o-Matic 401(k) program, because J. P Morgan, which administers the plan said they could not provide advice.  Rather than help he went into a tirade on how awful the choices were and that the choices were only J. P Morgan mutual funds and how he could get no information from Bunn-o-Matic or J. P. Morgan.  He did not help the individual and his advice to complain to the employer is not useful.  J.P. Morgan cannot give advice to the participant because their client is the employer.  The fact that the employer chose a plan which lacks proper diversified choices from a variety of fund families based on performance and expenses speaks to the plan administrator being chosen because somebody knew somebody rather than due diligence and duty to the retirement plan participants.

I help retirement plan participants make the best choices available to them based on their individual retirement needs with in their retirement plan offerings all the time.  It is often not very pleasant given very poor choices or choices from only one mutual fund company.  It is also not unusual to see only choices from one company, including tailored sub accounts with additional management expenses in a variable annuity retirement vehicle.

The March 26.9% increase in new housing sales is an aberration due to the tax credit which expires at the end of April.  We will see a similar aberration in April.  Schiller indicated the housing recovery could be on shaky ground and we may be at risk to another bubble.

I followed up on reports and speculation that some funds, such as IAU, which are supposed to hold physical gold, may be holding paper from banks (fractional reserves) rather than physical gold consistent with shareholder purchases.  One person had gone to ScttiaMocatta, which holds some of the IAU gold and only about 19.5% (all of the gold in the vault) of what was supposed to be there for IAU.  Some are asking if this means they are keeping only enough on hand to meet daily redemptions and is this only one-tenth or one-hundredth of what is supposed to be physically held.  Others are also speculating about whether there is enough physical gold and silver to cover physical demand.

We talked about how preferred stock has the worst of two worlds in that to a common equity holder it is fixed obligation and, hence, looks like some kind of debt, while to a bondholder or a bank or some other creditor it looks like equity, because they lie between bondholders and common shareholders.  You do not have the contractual claim of a bondholder and you do not have any way to grow as you would with common stock.  They are inherently flawed securities with the worst of both worlds.  You have credit risk (is the yield worth the risk?) and extension risk (will they ever be redeemed, will they just sit there at a very low nominal rate of return?).  As interest rates go up, the value of any preferred stock is going to go down.  Investors often do not consider that inflation my erase yield over time.  It could potentially destroy a whole lot of value in your portfolio over time.

John Hussman in his weekly commentary talked about how delinquent mortgages are 21.3% higher than the same period last year.  February's foreclosure rate of 3.31% was a 51.1% increase over a year ago.  In January distressed sales accounted for 29% percent of all sales.  He also dissected bank earnings reports to show that those favorable earnings reports do not reflect discretionary charges and the bank earnings have been boosted by reduced loss provisions (about $1 billion for Bank of America alone) while actual charge offs are increasing.  He believes investors should not be surprised by another wave of credit strains.  The stock market remains strenuously over bought and over valued.

Besides the Goldman Sachs dubious derivatives being investigated, there is also a Chicago company called Megnetar which put together a variety of deal of which 96% were in default by the end of 2008.  Of interest is the way in which Magnetar took these CDOs to an industrial level and the involvement of Rahm Emmanuel.
Yves Smith of naked capitalism has written extensively about Magnetar.  It is an example of hedge fund excess.

The SEC has issued subpoenas to Goldman Sachs, Credit Suisse, Citigroup, Bank of America/Merrill Lynch, Deutsche Bank, UBS, Morgan Stanley, and Barclays Capital seeking information about the sale and marketing of CDOs.

The Countrywide grand jury continues after two years.

The U. S. Senate has finally discovered that the ratings agencies were besieged with conflicts of interest in their "issuer pay" business model.  We have been talking about this buy the rating conflict for over two years.

According to a Quinnipac University poll, 60% of Americans favor raising taxes on those who make more than $250,000 and 64% of those who make over $250,000 agree.  Since 1960, the top 1% pay 50% less taxes while the middle class are paying the same percentage in taxes and the top 400 households pay 2/3rds less taxes.  The tax cuts for the top 400 households cost the United States $48 billion in 2007, $700 billion as the result of the Bush tax cuts, and if the those tax cuts were retain another $826 billion over the next ten years.  Those tax cuts for the wealthiest families all contributed to the growth in the national debt.

The health care tax credit is available for small businesses with 25 FTE or less.  They are not limited to 25 employees but to the equivalent of 25 full time employees and the average salary must be no more than $50,000.  The full amount of the credit is only available to employers with 10 or less FTE with an average salary of less than $25,000.  To be eligible the employer must make a non-elective contribution on behalf of each employee for qualifying health insurance in an amount equal to not less than 50% of the premium cost of the qualifying health plan.  The credit is equal to the applicable percentage of the small business employer's contribution to the health insurance premium for each employee.

Moody's cut Greek credit rating one notch to A3.  Weber, president of the German central bank, indicated Greece will need more aid and disparaged Greek citizens for not caring or appreciating the seriousness of the debt problem.  Evidently, Weber is under the false impression that citizens exist to support government rather than government exists to support individual liberties.  In that Greece will need more than 45 billion euro over three years, Weber is correct that it should be closer to 115 billion euro.  I would go so far as to say it should be 140 billion euro over three years.  Some discussion has also broached the subject of any EU loans have some type of super senior status to other creditors.  There have been public comments that the EU loans should be given in tranches and tied to deficit goals.

The basic problem with the proposed bailout is that it concentrates on deficit reduction and has no program for structural reforms to increase economic growth.  These structural reforms are not only necessary in Greece but they are necessary in the structure of the euro, current account balances, and fiscal flexibility of the EU to the fiscal policy needs of any member nation.  In the meantime, the perception this is a short term solution means Greek bond spreads continue to increase.  Taxes will be raised and wages cut, which will only aggravate the economic situation putting Greece into long term recession and deflation with the possibility of price inflation.

The external deficits, loss of competitiveness, and anemic economic growth aggravated by the appreciation of the euro from 2002 to 2008 has only intensified the "original sin" of the euro which failed to address the divergent nominal labor units and wages of each eurozone country.  These eurozone countries no longer have the foreign currency reserves needed to prevent the equivalent of a bank run on its short term liabilities and the ECB does not have the authority to act as a lender of last resort as a central bank of a country with its own currency would have.  Despite continued arguments that Greece would be better off defaulting or must eventually default, default is not an option as it would require a complete withdrawal not just from the eurozone but from the European Union.  This European debt crisis is actually a credit crisis in which the structural weaknesses of the euro are being exploited by speculators and a crisis in confidence inflated, because no eurozone country, unlike any country with its own currency, can exert monetary policy and each has relinquished full fiscal policy options under the Stability and Growth pact. 

Mary Schapiro of the SEC continues to talk reform but always within the constraints of the investment community she sees as her true constituents.  Her failure to recognize the need to serve the American public and defend the public against fraud and the risky self-serving conduct of investment managers and investment advisers, puts her at odds with Sheila Bair of the FDIC and Elizabeth Warren of the TARP Congressional Oversight Committee.

Many investors are confused by or do not understand bond fund duration.  Bond funds do not always respond predictably to Treasury market shifts, because duration, or interest rate duration, works best for bonds which are similar.  The further away you get from investment grade bonds, the typical duration calculation begins to lose its predictive value as the gauge of how bonds will improve in relation to Treasuries.  Rather than gain or loss, the spread duration will describe how much a bond's price will move if there is a change in the gap between its yield  and a comparable Treasury..  This is yet another reason why common individual investors need to be wary of investing in bonds and have trouble evaluating bond funds.  Duration is an estimate and normal conditions do not always prevail.  Portfolio durations are just a weighted average of the durations of its underlying bonds and funds with the same duration average could perform very differently.  You need to read the fine print and figure out what it holds.

Greece sold 1.95 billion euro of 3 month bills at 3.65%, which was twice the January auction rate of 1.67%.

India raised its interest rate for the second straight month.

The Bank of Canada removed its pledge to keep interest rates low until the second half of 2010.

The Bank of Japan rebuffed government calls to target 1-2% inflation saying inflation short term focus on prices could lead to excessively low interest rates and fuel a credit bubble.

US consumer prices were up 3.4% in March vs year ago with higher energy prices.

Chrysler has lost $4 billion since bankruptcy in June 2009.  It has a Q1 loss of $197 million (improvement) with a "operating" profit of $143 million.  Q1 sales were $9.7 billion.  Fiat thinks combining its auto unit with Chrysler will save $4.9 billion over four years.

On Thursday, the market bull/bear contrarian index went over bull exceed bear by 35.9%.  The last time it was over 35% was January 13th just prior to the 9% Nasdaq correction.

French consumer spending on manufactured goods was up 1.2% in March.

UK March inflation was 3.4%

UK GDP Q1 2010 grew only .2% (expected .4%) and now expect 1-1.5% for year if the stimulus is maintained as the recovery is "fragile" according to the Chancellor of the Exchequer.

Canadian annual inflation rate slowed to 1.4% in March from 1.6%.  Retail sales up .5% in February, but economists expected 1%.

US wholesale prices were up .7% in March (expected .4%) with 70% of increase due to 2.4% jump in consumer foods.  Gas was up 2.1%.

US existing home sales were up 6.8% in March with 8 months of inventory left.  New home sales were up 26.9% in March, which is an aberration due to the tax credit.  New home inventory was down to 6.7 months from 8.6 months.

 US durable goods total orders were down 1.3% in March (67.1% drop in non-defense aircraft).  Excluding cars and aircraft, orders were up 2.8%.  Non-defense capital goods orders were up 4%.  Inventories were up for the fourth month.

US producer prices finished goods were up 6.6% annualized in March unadjusted.  Adjusted March total was down .8% and finished goods were down 3.4%.

According to Moody's, CRE (commercial real estate) prices are down 2.6% in February.

Vehicle miles driven in February were down 2.9% (6.3 billion miles) vs year ago and 2010 YTD is down 2.3%.

GM repaid US and Canadian loans of $8.1 billion implying they use profits when in fact they used TARP money held in reserve.  The US and Canada continue to own Chrysler.

AIG is "considering" if it should take action against Goldman Sachs for $2 billion CDO insurance loss.

FASB "may" review repo 105 and 108 guidelines, which have been used by banks to hide debt and loss reserves as quarterly reporting dates approach and then put them back on their books after reporting financial data.

Wells Fargo profits fell to 45 cents per share from 56 cents year ago on 25% decline in mortgage originations.

Proctor & Gamble dividend increased 9.5% to 48.18 cents per share.

Evans (President of Chicago Fed) said the Fed will keep near zero interest rate for quite some time --- at least six months.  He sees high unemployment keeping policy accommodative and there is a need to keep an eye on price stability.  In my opinion high unemployment is being used to keep inflation down while the Fed is focused on increasing the capital ratios and liquidity of banks, which are allowed to keep toxic assets on their balance sheets at fraudulent values by special legal dispensation.

As many as 6 members of the Fed FOMC (open market committee that sets rate and policy) favor selling some of the Fed's mortgage backed assets if the economy keeps improving.




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