Leftovers -- Radio Show 5/8/2010

On the 4th of May the stock market went into correction and this meant, if you listen to me, you would have been out of individual stocks and ETFs (which were not part of a well diversified portfolio or fully hedged portfolio) by the end of May 5th.  This would have meant that the wild flash decline and subsequent recovery would not have affected your positions, because all 8% stop-loss or stop-loss limit orders would have been executed by the end of 5 May or sold manually.  The wild crash and recovery on 6 May is from unknown causes but appears to have resulted from several factors starting with a NYSE slow down in trading which caused orders to be sent for execution to electronic markets, a large S&P 500 mini sell order, and algorithmic computer trading programs kicking in and/or defaulting to 1 penny prices as the result of electronic market, with no market makers, sell volume.  Tupperware, which had been a subject of a listener question a few weeks ago, fell 14.8% for the week.

NYSE subsequently decided to cancel orders executed within an approximate 20 minute time period on 6 May if the price was substantially below the immediately prior market prices.

Monthly Jobs report showed an increase of 290,000 jobs minus 66,000 Census temporary jobs equals an increase of 224,000.  Official unemployment increased to 9.9% from 9.7%.  Official discouraged workers is 17.1%, but, if you use the 1994 calculation, discouraged workers are approximately 22%.

U.S. retailer sales were weaker than expected up only .5% at stores open at least a year which was far below the 1.5% expected.  Even discount stores saw a decline in sales.  This continues to show the recovery is too dependent on consumer spending and consumers are not spending with continuing long term high unemployment.

The number of people working part time for economic reasons was unchanged at 9.2 million.  The Employed to population ratio went up to 58.8% from 58.6%.

Tom Duy in his Fed Watch blog said that the inventory drain has become apparent and prices are edging up again.  He doubts that consumer spending can be sustained, because it has been heavily supported by falling savings rate, while income growth less transfer payments remains stagnant.  We have growth but it is growth which leaves the economy limping along and heavily dependent on policies which stimulate consumer spending.  He stated the opinion that outsourcing over the last twenty years has left the U.S. structurally dependent on trade deficits.  Inflationary growth continues in China and other Asian countries like South Korea and Indonesia, while the U.S. needs to decrease imports.  With the Fed is keeping interest rates low , there is not sufficient growth to alleviate unemployment.  He sees a declining value of the dollar as necessary to spur exports, but I have to disagree, because increased exports would require competitive products being sent to countries that are decreasing exports.  I do not see that happening.  A stronger dollar would bring foreign money into the U.S. as a safe haven for investment and would provide more buying power for U. S. businesses abroad..He also cannot understand that the eurozone countries will not benefit from euro devaluation, because the current account balances of each country are not fiscally adjusted within the eurozone.  Rather than internal devaluation (cut wages, raise taxes) those eurozone coutnries with current account balance deficits need targeted investment to stimulate growth and adjust nominal wages and labor units.

The Pragmatic Capitalist noted that the rise in the Libor parallels the spike in Greek sovereign CDS.  It is happening because banks are starting to not trust each other.  It is apparent that the Libor is reacting to counterparty risk.

China raised required bank reserves 50 basis points to 17% for big lenders and the banks were told to reign in credit issuance.  The central bank is stepping up its open market operations in the attempt to drain liquidity.  It wants to reduce new lending this year by 22%.

It appears the bailout of Greece by the EMU and the IMF will encompass approximately 110-115 billion euro available over three years with 80 billion from EMU and 30 billion from the IMF.  The Greek parliament passed an austerity package needed to receive the bailout and Germany approved their first year payment of funds for the bailout.  The money will be in the form of loans at approximately 5%, which is high.  The ECB suspended its minimum credit rating threshhold on sovereign debt to allow Greece to participate in ECB lending programs, even if their debt is further downgraded.  Trichet, the ECB chairman, said Greece is a special case and he is confidant Greece will do what it must do.  French President Sarkozy said the EU needs a mechanism in place to defend the euro.  Germany reiterated there needs to be more rigorous enforcement of the deficit limitation rules and a closer monitoring of sovereign government finances by the EU.  Germany sees speculation against the euro and a repetition of the 1931 currency crisis in its insistence on deficit reduction rather than targeted investment to spur growth in those euro countries with current account balance deficits, because they have non-competitive exchange rates and there is no method for fiscal adjustment within the eurozone.

Hussman sees the Greek problem as a violation of transversality in which there needs to be a well defined  present value of debt in order to credibly pay off debt.  Greece has insufficient economic growth; it is accruing high interest rates payable in a currency it cannot devalue.  Without transversality, the price of a security can be anything the investors like.  Transversality forces the price of an asset to be equal to the discounted cash flow value. He thinks the Maastricht Treaty would have to be changed to allow for larger budget deficits to achieve anything from the bailout other than short term results.  He believes the budget discipline imposed upon Greece will be hostile to GDP and tax revenues making it more difficult for the bailout to succeed.

Martin Wolf, in "A bailout for Greece is just the beginning" published in Financial Times (copy the title and Google search to get past the Financial Times paywall), thinks the 110 billion euro bailout will be enough to take Greece out of the debt market for two years only.  The agreement specifically prohibits any debt restructuring.  The plan sets 2014 as the year in which deficit will be less than 3%.  To get to that Greece will have to endure a cumulative decline in GDP of at least 8%.  He believes Greece may be unable to avoid debt restructuring.  "Given the huge fiscal retrenchment now planned and the absence of exchange rate or monetary policy offsets, Greece is likely to find itself in a prolonged slump."  While Greece needs to fiscally adjust nominal wages, the debt burden will actually become worse.  In his opinion more money will be needed is restructuring is ruled out.  In my opinion, the bailout should be closer to 140 billion euro and Greece should be allowed to restructure debt by extending the maturity dates of all debt by five years.  Wolf sees the bailout as rescuing European banks and not Greece.  Wolf believes the eurozone must either allow sovereign default or create a true fiscal union and funds sufficient to provide fiscal adjustment when needed.

The eurozone has a single central bank tied to disparate national fiscal policies and there is no mechanism within the EU to respond to fiscal adjustment needs of individual countries.  There are no EU taxes, no EU distributed spending, and no EU bonds or debt.  Some would like a common tax policy and EU review of sovereign budgets.  I believe there should be a Euro bond and, rather than being tax based, guaranteed by the sovereign nations of the eurozone combined with a Fiscal Adjustment Fund to respond to the special needs of individual countries in need of GDP growth and fiscal adjustment of nominal wages and labor units or in need of more internal consumption like Germany.

Spain sold 3.09 billion euro of 5 year bonds with a yield of 3.6% up from 2.8% from the issue sold in March.  The bid-to-cover was 2.4 up from 1.5.  The spread between Spanish bonds and German bonds has grown from 80 basis points to 160 basis points in two weeks.

Bullard, the St. Louis Fed President, said a sovereign default in Europe could threaten the continuing recovery in the U.S.  However, Greece cannot default without totally withdrawing from the EU, which would be a potentially greater bombshell than default in my opinion.  Rather than a debt crisis, this is, in my opinion, a credit crisis and the risk is that interbank lending may become frozen in Europe and create a global crisis.

Nomi Prins had an excellent article on how proposed financial reforms are basically not touching hedge funds, private equity and trading abuses of banks, and the lack of proper risk management in the financial banking system.

The Consumer Metrics Institute had an very good article on how the collection and time period of GDP numbers are ancient history by the time the quarter of record is completed and shifts of just two weeks in either direction could have profound effects using their sampling during Q4 2009 and actual Q4 2009 results.  In their opinion demand side numbers are continuing to contract indicating a possible double dip.

Roubini had a strange fear inspiring article in which he fears U.S. debt will result in either inflation or default, but it is not true, in my opinion, that debt equals inflation.  Inflation expectations are high and may be growing although we are presently in a deflationary situation.  However, in my opinion, there is the risk of inflation as the Fed exits from its $2.3 trillion balance sheet by selling mortgage backed assets after all liquidity programs have ceased.  It has tried very hard to increase U.S. banks capital ratios and liquidity at the expense of long term continued high unemployment.  This will be a very difficult balancing and timing act that may go in spurts as the Fed adjusts to market response.  As long as the Fed continues low rates, it cannot begin an exit and sell assets.  I think Bill Mitchell would agree with me.

Bank analyst Meredith Whitney is steadfast in her opinion there will be a double dip in housing and that banks are "under-reserved".

AIG Q1 profit was $1.21 per share or $1.45 billion net.  Just one week ago it drew down another $2.2 billion from the New York Fed loan facility for a total net loan of $21.6 billion plua $5.8 billion in interest and fees.

According to the Fed, banks have tightened credit card terms and loan standards for small businesses which is tightening credit and restraining the economy, although consumer and business demand for laons has declined.

Consumer spending is up as savings is going down.  Savings are being spent.  U. S. personal income was up .3% in March, but spending was up .6%.  This is not sustainable without jobs and income growth.

ISM U.S. service sector index was flat at 55.4 for April and march; employment was down to 49.5 from 49.8.

ISM manufacturing index was up to 60.4 from 59.6; new orders were up to 65.7 from 61.5; inventory was down to 49.4 from 55.3; production was up to 66.9 from 61.1; customer inventory was down to 33.0 from 39.0; prices were up to 78.0 from 75.0.

U.S. factory orders were up 1.3% in March and February was revised up to 1.3% from .6%.

GM sales were up 6.4% April vs year ago.
Ford  was up 24.7%.
Toyota was up 24.4%.
Hyundai was up 30%.
Chrysler was up 25%.

According to a Hewitt study, retirees will need 15.7 times final annual salary with 4.7 times coming from Social Security and only 18% will have that.  On average workers accumulate 13.3 times annual salary leaving 2.4 times as a shortage.  Defined Benefit participants are likely to have 74% of needs.

Consumer borrowing was up 1% annualized for March ($1.95 billion).

Canada's finance minister, Jim Flaherty, said high unemployment and fears of a renewed credit crunch could harm economic recovery and there is need to be cautious.

German retail sales were down 2.4% in March but up 2.7% vs year ago.

Producer prices in the eurozone were up .6% in March and up .9% vs year ago.

Brazil's industrial output was up 2.8% in March.

China's National Bureau of Statistics sees 9% growth and a 4% increase in consumer prices.

Indian consumer prices are projected to rise 7.5%.

Australian retail sales were up .3% in March (expected .8%) after dropping 1.2% in February.

German industrial output was up 4% in March for its biggest gain in ten months.

The Federal reserve FOMC policy makers have agreed to sell some of its $1.1 trillion MBS assets but remain divided on timing and extent as too soon and/or too much too fast will hurt recovery.

Australia increase interest rates by 25 basis points to 4.5% for the sixth time in seven months.

Moody's placed Portugal on review pending a credit downgrade.

ECB held its interest rate to 1%.

Spanish GDP was up .1% in Q1 (first in six quarters) and it is seen as exit from recession by some.  I prefer to see two successive quarters and, if Spain adopts a EU austerity program, it will go back into recession.

Vanguard ETFs are now commission free at Vanguard.

GMAC changed its name to Ally Financial.  2010 Q1 profit is $162 million vs <$675 million> year ago.  Its troubled mortgage unit --- Residential Capital --- had a $110 million profit.

Two money losing airlines (United and Continental) will merge.

Pending U.S. existing home sales were up 5.3% in March and February was revised up to 8.3%.

U.S. personal bankruptcies were up 15% in April.

Freddie Mac Q1 was <$6.7 billion> and wants another $10.6 billion from the U. S. Treasury.



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