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Economic/Market Highlights 11/12/08

Posted by Larry Doyle on November 13, 2008 1:31 PM |

Markets trade down another 5% and close within spitting distance of October’s closing lows seen on Oct 10. I remain decidedly negative on the market and the economy despite every effort made by global governments. In fact, the pace of the economic slowdown is quickening. It’s all about delevering and liquidity.

We have much to address, so let’s get after it.

1. Best Buy comments that they see a “seismic slowdown” in 4th quarter projected sales. Expect to see significant sales and price cuts on electronics going into the holiday season.

2. Survey of credit card holders indicates the following: 53% have more debt than they are comfortable handling. Of that group 73% indicate that they will likely spend less this holiday season….lots of regifting….

1. Julian Robertson, one of the most highly regarded money managers of the last 40 yrs, indicates that “we have not seen the capitulation in our economy and that the foreseeable future will be a long, tough period for the American people. He also offered that Nancy Pelosi wants to throw money down the toilet to save the automotive industry. (more on this later)

2. Moody’s ratings expects defaults on distressed debt situations to almost quadruple in the next year to north of 10%. This expected level of defaults is why high yield debt is trading near a 20% yield level. Lots of RISK! Companies will be severely challenged to refinance their debt.

3. Jamie Dimon, CEO of JP Morgan, indicates that the economic recession will be worse than the credit crisis.

Auto Situation
1. Pelosi, Frank, Obama and team clearly want to see a bailout for the automotive industry with GWB’s signature. The package being discussed is $25bln but with no specifics highlighted as of yet. Expect hearings next week in Washington on this issue. From the standpoint that Uncle Sam has already committed north of a trillion dollars to the financial system, a 25bln capital injection is a drop in the bucket but it goes a lot deeper than that. First off, the cash burn rate for the Big 3 at the anemic pace of auto sales is currently 5+bln per month, so 25bln gets us to next March. Big deal.

IMO, I would not give this industry $20 without an agreement to restructure. Very simply I would propose that these automotive corporations duplicate the business model of Toyota and Honda which have domestic plants throughout the South. Not trying to be punitive but a business is not a business unless it can sustain itself.

These companies including the UAW have no choice but to accede to the demand to restructure. If they do not want to accept that model, then ….they have no other choice. The idea that we would give them a taxpayer rescue package with equity warrants and restrictions on executive compensation is a joke, or as Julian Robertson said, “throwing money down the toilet”. The UAW will kick and scream and believe me I empathize but we live in a dynamic world in which markets change. As a nation we need to accept and understand that principle if we want to compete in the global marketplace. This restructuring should have occurred years ago!!

I will say as I listen to Mr. Frank discuss this situation, he does not inspire confidence.

Housing/Wall St.
1. Hank Paulson indicated today that Treasury will not look to use any of the 700bln authorized by Congress to buy up distressed mortgage assets but would in turn utilize money not already committed to bring liquidity into the consumer asset space.

What does this mean and how did the market take this news?
Wall St. banks and investment banks are pissed because they thought they would be able to sell distressed mortgage assets into Uncle Sam at elevated prices.

Paulson now knows that by buying distressed mortgage assets, much like by making direct capital injections into the banks, consumer credit will not flow. WHY?? As we have been saying here at NQ, the losses embedded in the banking system likely run upwards of 1 trillion over and above the 500bln already acknowledged. Thus, any capital that goes into the banks will be used to recapitalize not to be lent out. The market took Paulson’s message as an indication that future (already embedded) losses must be greater than initially thought and thus the market sold off hard today.

Paulson wants to target bringing liquidity into the Asset Backed Market, (remember the one where volume is down 75-80% year over year) so that credit for consumers loosens. I commend Hank for his herculean effort but I do not see this working unless the government set up a separate entity to issue loans. Will Uncle Sam run individual credit checks as well and effectively go into business vs the banks? Doubtful.

Speaking of credit crunch, I heard a statistic today that I find hard to believe but it came from a credible source. He shared that Bank of America wrote a total of 7 Jumbo mortgages in the entire country in the month of October. (Jumbos are greater than 415k) Is that possible??

2. Why does Paulson want to target the consumer credit space? He knows that that is the next shoe to drop in terms of losses by AMEX, Visa, Master Card, Capital One, et al…

He is hoping and praying that the Asset Backed Market can restart so that these companies and other credit companies can sell loans currently on their books. We tried to cover this in our other piece as to why investors are not willing to buy these loans.

Simply put, credit cards taken out by a large number of borrowers over the last three to four years using their house as a piggy bank and now in the face of a rapidly rising unemployment rate will have severe defaults. No bid for assets like that anywhere close to where they may want to sell them.

3. Transparency
I had an exchange with a reader as to why the government is not revealing which banks have been participating in certain specific programs launched over the last few months. I made the case that the government is trying to protect the participating banks and in turn the taxpayers by not revealing the names.

The reader responded as to why and how could he ever invest in a bank. That is a very good point, investing in banks now is a much higher risk proposition because one does not know just how deep losses are in individual banks. Who does know?? Hank Paulson knows and he does not want to reveal those figures because they would further spook the markets. We got a whiff of that today.

4. Citigroup is expected to lay off 25-30% of its capital markets staff next week. The depth of this cut is truly draconian and indicates that they do not view this market downturn as merely a normal recessionary move but rather a significant fundamental shift in the Wall St. model. You know it’s broken as we highlighted in our earlier piece. Citi’s cuts confirm this.

Global Governments
1. Russia allows the ruble to move outside a trading band. The ruble gets hit hard as do Russian equities.

Read more as to “Russia Weakens Ruble to Fight Drain on Cash Reserves.”

It was the devaluing of the Russian currency back in 1998 that sparked the global financial crisis back then.

2. Could the U.S. ever lose its implicit AAA rating? There is a better chance now than a few months ago given the enormous debt that we are accruing.

Read more, as to how the “US May Lose its AAA Rating.”

1. Oil and copper had a one-day bounce on Monday after the Chinese stimulus package was announced but they have quickly reversed course and are back down to new lows for this move. Oil closed at $55.78. Commodities are pricing in a protracted economic slowdown. I still believe that hard assets will outperform when the economy stabilizes due to a global currency devaluation.

Government Bonds
1. In a flight to quality move, government bonds rallied and rates were lower by .10 (rates down, prices up)

2. Riskier bonds are more closely tracking the equity markets given the likely increase in defaults.

3. Hearing more and more rumblings about municipal defaults. Name I heard today was City of Philadelphia.

1. GE gets its debt guaranteed by FDIC insurance. GE much like other entities that rely on short term funding will be hard pressed going forward. They are completely dependent on Uncle Sam’s backstopping short term facilities. What happens when Uncle Sam does not show up for work one day??

2. Intel cuts its 4th quarter forecast across all divisions and all geographic areas. This put pressure on the market after the close.

3. Insurance companies along with the credit finance companies have been under increased pressure and it will likely continue. Various research reports have highlighted (I should say lowlighted) Hartford Financial , Protective Life, Principal Financial, and Prudential (check with your agents if you have policies with these outfits…)

The constraints on the incoming administration get tighter each and every day. The markets want discipline. In fact, I firmly believe that the market is getting tired of more and more talk of bailout packages. These packages may bring a cushion but they prolong and exacerbate the situation over the long haul. Private capital does not want to invest alongside the government.

Stimulus Package
There is little doubt that we will receive a package either before or after inauguration. The standard package that we saw last Spring is nothing more than giving a shot of whiskey to a drunk. I read the ideas proposed by HRC. There is a lot to discuss on this topic. I am all for funding projects in which the government can contract with private industry for capital improvements and infrastructure. I am not supportive of creating more government bureaucracy to manage projects.

I will save another few ideas I have for a separate article.


My 4th grader received a 30/31 on his recent Math test.

Boston Red Sox “freeze” ticket prices at 2008 levels.

Hedge funds on the “hot seat” today as a number of them go in front of Congress. I would like to see some Congressman have the courage to truly get after Soros for activities and influence of

All the best.


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