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“We’re Going to Have to Pay . . .”

Posted by Larry Doyle on January 22, 2009 1:02 PM |

MARKET UPDATE** Equity markets broadly speaking are down between 3-4% led down by banks and insurance companies. Bonds are not providing a safe haven as across most sectors of the bond market are down anywhere from .25-1%. We are not surprized by the downward move in the equity markets nor in the government bond sector.  We discuss in depth in this piece the global demand for funding driving interest rates …UP!

MARKET NEWS: Senators Schumer and Shelby are proposing $110 million in increased funding for staff at SEC and FBI to oversee fraud on Wall Street especially given the unregulated hedge fund industry. We have highlighted that one of the investors in the hedge fund industry and the fund of funds industry is FINRA, the largest non-governmental regulatory authority for financial services business.

John Thain resigns from Bank of America. Culture clash amidst massive losses will get you every time.

Microsoft announces 5000 layoffs.


In the midst of an interview, Alice Rivlin — former head of the OMB (Office of Management and Budget) under President Clinton — was asked about the prospects for the ballooning deficit. She responded that unless we are somehow able to control the deficit, “We’re going to have to pay much higher interest rates and face a rapid fall in the dollar.” I concur.

I do not want to throw cold water on a day when we had a 4% upward move in the equity market, but we need to take a step back and assess the market and economy from a wide angle as we try to make sense of it all. To that end, allow me to provide year-to-date changes across sectors with some general commentary as well.

Equities: on average -6% with major concerns about earnings potential for 2009. I do believe we will retest market lows seen on November 20th. Those lows are approximately 9% below today’s closing levels.

Government Bonds: 10yr rates have backed up 30 basis points (rates higher, government bond prices lower)!!! This development is a major issue and we will address why shortly.

Municipal Bonds: on average down 1% . . . be careful about general obligation bonds in the face of potential ratings downgrades.

High Yield Bonds: +7% . . . the big winner!! Investment managers clearly view this sector as having been much cheaper than equities, which are only one rung below them in priority of being paid back.

Mortgage Bonds: unchanged given the Fed and Treasury have been buying a lot of these bonds. IMO, I think mortgage rates may ratchet back up as government rates move higher. If you are thinking about refinancing (if you can get approved), I would do it sooner rather than later.

Commodities: oil is +4% while gold is down 4%

Last week we spanned the globe and saw that trade has slowed dramatically. We know of the massive deficit spending going on here in the U.S., but we need to appreciate the same phenomena is occurring around the world.  Many countries have much less access to liquidity than we do. They are facing the prospects of not only an economic slowdown and increased borrowing needs, but also the perils of having their sovereign credit rating being downgraded. What does all that mean? Higher borrowing costs!!! This scenario is playing out in so many countries that it is not worth mentioning them all. Our friends at Bloomberg highlighted a few for us:

I’d rather be in the Greek Isles, but in lieu of that check out the fiscal problems in Greece.

A trip to the coast of Portugal might be nice, but again in lieu of that how about a peek into its financial difficulties.

You say you’d like a trip to the Far East, well this might not be much fun, but the best I can do is give you a whiff of Japanese borrowing needs.

In regards to China, I found a fascinating read on the challenges the Chinese economy may face with a major drop-off in exports. I know you’re thinking a walk along the Great Wall sounds much more appealing. Sorry. Here is a somewhat challenging and technical read by Professor Michael Pettis of China Financial Markets. Developments in China have MAJOR implications for global markets!!

To this point, many may be wondering what these global issues have to do with us here in the United States. We have plenty of our own issues and can’t save the world this time. That’s not the point. The point is that we finance our deficit to a significant extent from foreign lenders. As they have much greater cash needs at home, the cash that has previously worked its way to the U.S. may only get here if our interest rates move higher in order to attract that money. This scenario is a very simple supply/demand equation. Greater global government demand for money along with increased U.S. needs will drive the price of that money . . . UP!

While these other parts of the world may seem distant and foreign, from a financial standpoint they are right around the corner.

Other Points of Interest . . .

1. The state of California is facing an imminent downgrade in its credit rating. This development will drive its borrowing costs higher.

2. Jamie Dimon, CEO of JP Morgan, put his money where his mouth is as he purchased 500,000 shares of JPM today. While many CEOs will tell you things are positive, Dimon’s purchase is a strong vote of confidence in JPM.

3. eBay’s earnings disappointed, while Apple’s earnings far exceeded expectations.

4. Prospective Secretary of Treasury Tim Geithner’s hearing was devoid of any major developments. He offered a mea culpa on his tax “mistake.” Senator Bunning was relentless on questioning him on that topic. Senator Cantwell (D-WA) was exemplary in questioning Geithner about the failures that occurred by FINRA (Financial Industry Regulatory Authority) in the Madoff debacle. I do think that bank stocks rallied today because Geithner was not harping on the topic of nationalization, but emphasized the idea of more capital injections and buying toxic assets into an aggregated bad bank. I honestly view that as a quasi-Japanese approach and forestalling the ultimate reality of recognizing losses. I did like the fact that Geithner indicated more funds should be directed to community banks so that these institutions can lend more freely.

When things do settle, perhaps we can take a real trip around the world.


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