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HomeFirst Pacific Advisor’s Atteberry and Rodriguez Provide Macro Perspective
Posted by Larry Doyle on June 7th, 2009 2:29 PM |
Hat tip to MC for sharing this brief but rich interview our Economic All-Stars Tom Atteberry and Bob Rodriguez gave at last week’s Morningstar Investment Conference. Atteberry and Rodriguez take a macro perspective. In my opinion, their experience, wisdom, and long term focus are not only a pleasure but also a necessity as we move forward slowly but steadily in the Brave New World of the Uncle Sam Economy.
LD
Join Me Tonight at 8PM for NoQuarter Radio’s Sense on Cents with Larry Doyle
Posted by Larry Doyle on June 7th, 2009 7:32 AM |
UPDATE: The show has concluded, but you can listen to a recording in its entirety by clicking the Play button on the audio player below. Once the playback has started, you can fast forward or rewind to any portion of the show by clicking at any point along the play bar.
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Please join me Sunday evening from 8-9 p.m. ET for NoQuarter Radio’s Sense on Cents with Larry Doyle. I believe we are now entering the next stage of the Brave New World of the Uncle Sam Economy. As we navigate the trails in this leg of our journey, our primary focus will be on interest rates. We experienced a dramatic spike in global rates over the course of the last few weeks. What do these spikes mean? Will they persist? Do we need to “lighten the weight of our packs” to successfully traverse these hills and valleys? Do the moves in rates indicate that “inflation” is just around the bend?
Listen to NQR’s Sense on Cents with Larry Doyle tonight from 8-9PM as I address all of these angles. Additionally, I am thrilled to have Luke Fry of 12th Street Capital join me to address these topics and developments in and around the world of mortgage-backed securities. Luke is a senior salesman at 12th Street Capital, a leading broker-dealer with untold expertise in the mortgage business. Prior to 12th Street, Mr. Fry was a Managing Director at Knight Libertas, LLC where he was responsible for providing market insight and analysis in mortgage and asset-backed structured products to a wide range of clients that included hedge funds, money managers, insurance companies and banks. Mr. Fry was hired as the first salesperson on the ABS/MBS desk at Libertas Partners and helped expand the group to over 12 salespeople while seeing the company through a merger in July 2008 with Knight Capital Group, the largest U.S. equity market maker. (more…)
About Those Interest Rates
Posted by Larry Doyle on June 6th, 2009 9:49 AM |
A sharp move higher in interest rates has received a lot of attention lately. In fact, I now believe the focus on interest rates will move to center stage in our Brave New World of the Uncle Sam Economy. Allow me to comment.
I spent my entire career on Wall Street within the bond market, so my professional life has been consumed by interest rates. I don’t know if that is necessarily a good thing, but that’s for another day.
What are interest rates?
Very simply, the interest rate – for whatever financial product – is the “price of money.”
What are the components of interest rates for respective financial products?
Interest rates are determined by three factors:
1. a general level of rates of return in the economy and market: this level is typically viewed by focusing on the shorter maturity U.S. government securities. Uncle Sam is viewed as the benchmark from which all other interest rates are compared. Uncle Sam’s own creditworthiness is coming into question, but that can be a topic for a separate post.
2. a risk component: this factor addresses the creditworthiness of the borrower (be it a global government, a corporation, a municipality, or an individual). Additionally, while most bonds focus on the risk component as being a function of creditworthiness, there are other risk factors as well, including prepayment risk for mortgages.
3. inflation/deflation: this factor addresses how fixed future returns on bonds are impacted by the general change of prices in the economy. The presence of inflation (a rising level of prices) erodes the value of fixed future returns. In a similar fashion, the presence of deflation (a declining level of prices) increases the value of fixed future returns.
Utilizing these three factors, one is prepared to more effectively understand the nature of interest rates, both from a static standpoint and in a dynamic environment.
Utilizing these components, how and why do interest rates change in a dynamic economy?
Let’s recall that the valuation of any financial product (a stock, bond, currency, commodity) is determined in a dynamic market setting by buyers and sellers assessing three variables:
1. fundamental analysis: from our trusty Investing primer (right sidebar), we see this variable defined as:
an investor can perform fundamental analysis on a bond’s value by looking at economic factors, such as interest rates and the overall state of the economy, and information about the bond issuer, such as potential changes in credit ratings.
2. technical analysis: again using our Investing primer:
A method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.
3. market psychology: the Investing primer educates us on this variable as well:
The overall sentiment or feeling that the market is experiencing at any particular time. Greed, fear, expectations and circumstances are all factors that contribute to the group’s overall investing mentality or sentiment.
While conventional financial theory describes situations in which all the players in the market behave rationally, not accounting for the emotional aspect of the market can sometimes lead to unexpected outcomes that can’t be predicted by simply looking at the fundamentals.
Utilizing these tools, let’s review the prevailing level of interest rates in our economy from a chart provided on a daily basis at the WSJ Market Data page linked here at Sense on Cents.
We can assess how all the short term interest rates have come down over the last three years in response to the recession. We are now faced, though, with a move higher in rates given the increased risks of inflation, along with massive demand by global governments, corporations, municipalities, and individuals for credit. That demand, like any demand, is driving the price of money (the interest rate) higher. Is this demand being generated by improvements in the economy, the need to refinance existing debt, or a combination of the two?
Welcome to the word of interest rate analysis for fixed income investments (bonds).
Please share your thoughts, questions and concerns so we can all most effectively navigate the economic landscape.
For more on this topic:
Is The Government Bond Bubble Getting Ready to Burst?
May 21, 2009
Mortgage Refi Activity Is Driving Rates Higher
May 26, 2009
The Wheels Have Come Off Barack’s Bond Bus
May 27, 2009
I will also address the dynamics driving interest rates extensively during my NQR Sense on Cents radio show Sunday evening June 7th from 8-9pm.
LD
P.S. If you like what you see here at Sense on Cents, please add the site to your favorites, share with your friends, and visit/comment often!! Thanks!!
Front End Springs a Leak
Posted by Larry Doyle on June 5th, 2009 4:57 PM |
In a manner of speaking, the management of our economy has been nothing short of a major overhaul of a tired old ship. When the tide went out, the base of our ship was exposed as being filled with holes.
Little did we know at the time, but through many of those holes a number of “pirates” were running off with a whole lot of booty. In the process, many market participants riding along on the main deck were thrown overboard by the economic storm that hit our economy and markets over the last two years.
We do not have the luxury of bringing our ship into port for an overhaul. We have had to continue to sail this ship while trying to repair it. In that spirit, by necessity we have had to add significant ballast (liquidity) in our hull. In so doing, we need to recognize that the ballast can itself be inflammatory if the engine generates a spark.
In purely economic terms, this morning’s non-farm payroll number of -345k jobs was a hint of a spark. While various sectors of the market gyrated today, the front end of our ship, that is the front end of our yield curve, sprung a serious leak. How so? Interest rates on short term Treasury notes increased a DRAMATIC 35 basis points. Why?
Traders are already pricing in an expectation that the Federal Reserve will be forced to increase the Fed Funds rate prior to any hint of inflation or even the expectation of inflation gains a foothold. Bloomberg sheds color on this likelihood, Traders Begin to Speculate Fed Will Need to Tighten:
Traders are beginning to price in expectations the Federal Reserve will raise interest rates this year as the recession shows signs of abating.
Federal-funds futures contracts on the Chicago Board of Trade show a 70 percent probability the central bank will lift its target rate for overnight bank borrowing to at least 0.5 percent by November after a report today showed the U.S. economy shed the fewest jobs in May in eight months. Rate-increase odds were 27 percent yesterday.
The Fed cut the target rate to the record low range of zero to 0.25 percent in December as the economy lapsed into the worst recession in decades. President Barack Obama and Fed Chairman Ben S. Bernanke have committed $12.8 trillion to thaw frozen credit markets and ramped up government spending to revive growth. The Fed last raised borrowing costs in June 2006, when policy makers pushed the rate to 5.25 percent.
Fed governors and Fed chair Bernanke now face a serious quandary. Economic data will remain decidedly weak. Unemployment will continue to increase. Consumers are going to remain strapped. Corporations will face challenges. Municipalities will encounter an ongoing decline in tax revenues. Nobody is going to truly feel like the economy is improving to the point that the Fed should even think about increasing interest rates. Then why is the market starting to price that reality into the market? Let’s go back into the hull.
The bowels of our ship are flush with liquidity and given any sort of traction in the economy, the velocity and growth in the money supply will drive inflation.
What is Big Ben and team to do? The market is raising interest rates on him rather than his raising interest rates on the market. In the process, a very fragile economy will now be forced to deal with higher interest costs along with anemic growth.
What do I see on our economic horizon? In my opinion, today’s price action took us in the direction of the island known as Stagflation.
Please share your thoughts and comments.
LD
Sense on Cents Navigates the Markets
Posted by Larry Doyle on June 5th, 2009 12:41 PM |
Navigating the markets on the day in which the employment report is released is always fascinating. Why? Typically the release of new and meaningful information generates very heavy volume; as such, the market moves can be measured with greater weight. Let’s take our equipment and head out along the trail . . .
Equities: major market equity averages opened very firm after the positive tone embedded in the non-farm payroll component of this morning’s report.
As the day has moved along, though, these indices have all faded. The DJIA is up approximately .4% as of this writing. The S&P 500 and tech heavy Nasdaq are unchanged relative to Thursday’s closing levels.
Particular industry groups that have had outsized moves are mortgage finance (-2.2%) and industrials (+.93%). What’s going on here? The mortgage finance companies are negatively impacted by higher interest rates (more on that in a moment). The industrials are likely benefitting from the perception that the economy may be slowly turning the corner.
Bonds: this is where the real action is occuring!! Various sectors of the bond market are down anywhere from .25% to 1%. It appears the only bond sector improving on the day is the high yield space (+1-1.5%) as it is benefitting from the perception of lessened credit risk.
The biggest loser on the day is the front end of the U.S. Treasury market which has backed up an EYE-POPPING 25 basis points. The intermediate to long end of the Treasury yield curve has backed off by 5 to 15 basis points.
Bonds are faced with 3 major hurdles:
1. massive supply: as global governments, corporations, municipalities, and individuals all look for credit.
2. inflation : as much as analysts will point to the lack of any wage pressures, the fact is that the U.S. has so much liquidity in the system that any hint of an economic spark will be akin to dropping a match on dry hay. The Fed can only dampen the “hay field” by withdrawing liquidity from the economy. How? Increase the Fed Funds rate or sell Treasury or mortgage assets currently on its books. What would that mean? Push interest rates even higher, especially on the front end of the yield curve. What would that do? Slow the economy.
3. the Fed: Big Ben, (Turbo-Tim as well) and team may find themselves between the proverbial rock (a fragile economy) and a hard place (fears of increasing inflation) sooner than they think.
Currencies: the greenback is doing better on the day. This seems counterintuitive to an economy regaining its footing with investors taking on a greater risk appetite. What’s happening? In my opinion, the greenback is anticipating that Bernanke and the Fed may have to “think” about increasing the Fed Funds rate.
Commodities: slightly weaker on the day.
Other news of note . . . Bloomberg releases a story highlighting the charade being played by banks in “generating” earnings. The fact is banks have benefitted tremendously by “accounting” maneuvers and as such are “masking” sizable losses. Regular readers of Sense on Cents have witnessed my addressing these issues. That said, I recommend: Bank Profits From Accounting Rules Mask Looming Loan Losses.
In summary, we are clearly entering the next stage of the Brave New World of the Uncle Sam Economy. The key attribute of this phase will be higher interest rates.
LD
Unemployment Report June 5, 2009 >> UPDATE
Posted by Larry Doyle on June 5th, 2009 5:45 AM |
UPDATED AS OF 9:15AM
The report was surprisingly strong on one front but with reason for caution as well!! Let’s dive right in.
Before this morning’s numbers were released:
The widely anticipated June Unemployment Report covering the month of May is due out this morning at 8:30 am (EST). Will this report show signs of improving trends in the pace of layoffs? I remain quite skeptical about the data connoting ongoing improvements while simultaneous negative revisions receive limited focus. We have experienced ongoing layoffs within the private sector with some pickup in government hiring. I believe we will likely see a pickup in layoffs at the state and local levels as tax receipts continue to disappoint.
In regard to revisions versus the actual report, let’s revisit what I wrote a month ago in my commentary for the May Unemployment Report:
On the face, the report appears better than expected but given the additional job losses in the revised numbers for February (an additional 18k jobs) and March (an additional 48k jobs) we are still in the 600k average job loss for the month. Private sector lost 611k jobs while government added 72k jobs with a lot of those people being temporary workers employed by the Census Bureau. The fact that temporary government workers are factored into overall employment, in my opinion, is stretching the integrity of the report. Health care added 17k jobs, manufacturing lost 149k jobs, construction lost 110k jobs, financial services lost 40k jobs.
Expectations for this morning’s report, as well as previous months’ data, are as follows:
(Note: please check back shortly after 8:30am when I will post the actual for June unemployment statistics, along with my post-report commentary.)
Unemployment Rate
April 8.5%
May 8.9%
Expectation for June: 9.2% (recall how the base case for the Bank Stress Tests was 8.9%. Here we are in June and have exceeded 9%. I think it is a lock that we hit 10% and not inconceivable that we push 11% by year end.)
Actual for June: 9.4%
Post report comment: this rate is substantially higher than the expectation of 9.2% and implies that we will almost certainly get to 10% sooner than expected.
Non-Farm Payroll (click here for definition of this term)
April: loss of 663k
May: loss of 539k
Expectation for June: loss of 520k
Actual June report: loss of 345k
Revisions: April and May combined gained 82k jobs
Post report comment: a much better than expected number with positive revisions to prior months. May was revised from -539k to -504k.
Average Hourly Earnings
April: +.2
May : +.1
Expectation for June: +.1%
Actual June report: +.1%
Post report comment: as expected. No surprise that wages are under control with slack employment. This number does not support any expectation of a pickup in consumer demand and retail sales.
Average Hourly Workweek
April : 33.2 hours
May: 33.2 hours
Expectation for June:33.2 hours
Actual June report: 33.1 hours
Post report comment: this number is weaker than expected. It does not support any expectation of a pickup in new orders driving a rebuilding of inventories.
7am: equity index futures are higher by.4%. The 10yr Treasury is trading at 3.74%. The 2yr Treasury is trading at .97%.
Post report market reaction: equity index futures jumped from .4 to 1.4% while bonds have sold off. The 10yr initially moved higher to 3.87% but is now at 3.82%. The biggest move in the bond market, though, is on the front end of the curve. The 2yr has increased by 25 basis points to 1.22%!!! Of all the numbers and moves, this should attract the most attention. Why?
The market is telling the Fed the following: if in fact the economy has bottomed in terms of a slowing in job losses, then a degree of economic traction will lead to inflation (even without a pickup in wages). The Fed may need to revisit the idea of leaving the Fed Funds rate at 0-.25% for the foreseeable future.
The “patient” is stabilizing, but still faces numerous side effects from all the procedures!!
If you like what you read and see here, please put Sense on Cents (www.senseoncents.com) in your favorites, and visit and comment often. Thanks!
LD
Banks Cooking a Second Course
Posted by Larry Doyle on June 4th, 2009 2:15 PM |
I am of the strong opinion that the relaxation of the FASB’s mark-to-market accounting standard is nothing short of an allowance for banks to “cook their books.” Well, it now appears that the banking chefs are whipping up a “second course.” The Wall Street Journal opens the door to the kitchen and reports, Banks Try to Stiff-Arm New Rule:
The financial-services industry is taking steps to delay an accounting rule that would force banks and others to bring some of their off-balance-sheet vehicles back onto their books next year, which could force some to raise additional capital.
A group that includes the Chamber of Commerce, the Mortgage Bankers Association, and the American Council of Life Insurers and others sent a letter on June 1 to Treasury Secretary Timothy Geithner, regarding the off-balance-sheet accounting-rule change, saying it should be adopted “cautiously and seek to minimize any chilling effect on our frozen credit markets.”
The letter was signed by 16 industry associations, many of which were part of a group known as the “Fair Value Coalition,” which was formed earlier this year with the goal of changing mark-to-market accounting rules. Mark-to-market accounting rules set guidelines for banks on when they are required to reflect market prices in the values they assign to hard-to-value securities and other assets.
Please recall that the massive leverage within the banking industry was largely housed within these off-balance sheet vehicles (SPVs, special purpose vehicles). The lack of transparency of these vehicles allowed banks to leverage their assets to greater than a 30:1 ratio. Regulators and rating agencies were totally remiss in fully exposing these vehicles and protecting investors. We have all paid for it.
The banks and Washington jointly conspired to pressure FASB to relax the mark-to-market accounting rule so the industry could alleviate the pressure of raising capital. I detailed that “course” just yesterday in writing Wall Street-Washington: “Pay to Play.”
We hardly had time to digest that “inedible” piece of meat and now understand our chefs are working to continue the lack of transparency within the industry. Regrettably, our Congressional watchdogs have been more than happy to accept perfunctory campaign contributions and lobbying dollars to facilitate this charade.
The WSJ takes a whiff of what is simmering and reports:
Some accounting experts say they aren’t surprised by the banking industry’s latest effort. “Here we go again. They will get out their checkbooks and go to the Hill,” says Lynn Turner, the Securities and Exchange Commission’s former chief accountant.
At what point do the patrons get some representation, drop these meals in the garbage, fire the chefs and staff, and hang out the “Condemned: Department of Health” sign?
LD
How Courageous Is Mary Schapiro?
Posted by Larry Doyle on June 4th, 2009 11:57 AM |
Does SEC chair Mary Schapiro have the personal courage to lead a new and emboldened financial regulatory regime?
Ms. Schapiro has always been viewed as being far too cozy with the financial industry. Sense on Cents first crossed paths with current SEC chair Mary Schapiro this past January at the time of her exceptionally easy confirmation hearing. At that point and since, the Wall Street Journal, Bloomberg and others have weighed in that Ms. Schapiro is “no regulatory heavyweight.”
Let’s check back and see if Ms. Schapiro is breaking off the Wall Street shackles. The Washington Post does us the favor of reporting this morning, SEC Chief Strives to Rebuild Regulator:
Schapiro is working to step up enforcement efforts, pushing cases linked to the financial crisis and freeing investigators to more vigorously pursue financial wrongdoing. She is also pursuing regulations to govern hedge funds, derivatives, short-selling, money managers, corporate disclosures and governance.
I am heartened by Ms. Schapiro’s aggressive posture. That said, I am not about to accept purely on face value that Ms. Schapiro is “changing her game.”
On the heels of the financial fiasco on Wall Street, there is doubtless lots to clean up. However, Ms. Schapiro has to appreciate that many question her courage in taking on this task. Why? Very simply, her track record as head of Finra saw an unprecedented drop in sanctions and fines. As the WSJ highlighted this past January:
Fines collected and sanctions assessed by Finra under Ms. Schapiro’s leadership dropped by 73% (in 2005, prior to Ms. Schapiro assuming leadership, Finra collected $150 million in fines. In 2006, Schapiro assumed the leadership reins and that number moved to $75mm. It dropped further to $50mm in 2007, and $35-40mm in 2008).
Against that backdrop, Ms. Schapiro has a lot of work to do to change her own image along with that of the SEC. The WaPo reports that Schapiro is aware of this fact. Schapiro states as much:
“I wanted to be very clear almost from my first day — not just with words, which are pretty easy to string together, but with actions — that this is a new SEC that is moving in a decidedly different direction and at a decidedly different pace,”
Additionally, Schapiro comments,
“Our markets are vulnerable if we’re not able to restore confidence,” Schapiro said. What investors “need to see is that the rules that are in place and will be in the future are enforced and aggressively enforced. If they don’t see that, their reluctance to engage the capital markets will be pretty significant.”
The media continues to rail on Schapiro, the SEC, and Finra for having missed the Madoff scam. Those protests are totally justified. It has been almost 7 months since Bernie turned himself in to authorities and little progress is provided to the public on the investigation.
In my opinion, though, Ms. Schapiro has other dirty laundry that needs a full and public airing.
The U.S. attorney in Brooklyn along with the SEC are currently investigating former executives from Lehman for potentially front running the Auction Rate Securities market in 2007. I call upon Ms. Schapiro to release information regarding Finra’s liquidation of its own Auction Rate Securities holdings in the same time period. Full details on this story are included in U.S. Attorney and SEC Investigate Lehman’s Auction Rate Securities Sales; They Should Also Investigate FINRA’s.
Ms. Schapiro may have to recuse herself in the process of a full and thorough investigation of Finra and its ARS sale. As with any real leader, if she has absolutely nothing to hide, then she should have no problem recusing herself. As she herself said, “our markets are vulnerable if we’re not able to restore confidence.”
Does Ms. Schapiro have the courage to investigate Finra and her own tenure in an attempt to restore that confidence?
LD
Sheila Bair and the PPIPs Tour: Cancelled
Posted by Larry Doyle on June 4th, 2009 7:56 AM |
What is going on with the PPIPs?
The Public Private Investment Program was “scheduled” to play a grand national tour in helping the banking industry cleanse itself of toxic assets. Did the “lead singer,” Sheila Bair, lose her voice? Did the “backup” in the form of the banks and investors lose their rhythm? Let’s “boogie” on over and check it out.
The FT reports, FDIC Stalls Sale of Toxic Loans:
Details of the Treasury’s toxic asset plan are in doubt after the Federal Deposit Insurance Corporation on Wednesday said it was suspending a test run of the legacy loans programme.
Sheila Bair, chairman of the FDIC, said development of the programme – designed to encourage investors to buy toxic, or legacy, loans from banks in order to restart the flow of credit – would continue but a pilot sale of assets was on hold.
“Banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor confidence in our banking system,” Ms Bair said in a statement.
Is this all that it appears to be or is there more of a smokescreen on the stage inhibiting all parties – Uncle Sam, the banks, and investors – from “giving it their all”? Let’s dive into the mosh pit.
Sense on Cents views the situation as follows:
1. Impetus for banks to liquidate toxic assets (now called legacy assets by the Obama administration) is dramatically lessened. Why? Are they now less toxic? No, anything but that. With the relaxation of the mark-to-market accounting standard, banks can now “mark to model.” As such, banks are not forced to write the asset value down. In so doing, banks are now not compelled to sell it at a price which would incentivize an investor to purchase.
2. What about all of the equity capital raised by banks over the last few weeks after results of the Bank Stress Tests? Has that had an influence on banks need to raise capital via the PPIP?
Yes, but remember that the Bank Stress Tests only covered the largest 19 banks in our nation. These banks have been largely successful in raising new capital. That said, the toxic legacy assets remain on their books. Do not forget, though, that many small to medium sized banks and thrifts have a sizable amount of underperforming loans (residential mortgages, commercial real estate, corporate loans) on their books. These banking institutions were neither put through a “stress test” nor are they in a position to raise capital as easily as the large banks.
A successful PPIP program would have helped these institutions.
3. Hints of potential self-dealing by banks involved in the PPIP, both as seller of assets and buyer of assets, would have created a firestorm. I addressed this problem in writing, Putting “The Fix” in the PPIP.
4. With all due respect to the lead singer, Sheila Bair, all indications are that her handler – an individual named “Uncle Sam” – can not be trusted. Potential investors have been very reluctant to get overly involved with Sam. Why? In other performances, Sam has “strip searched” individuals upon entry and also played various iterations of “bait and switch.”
As the FT reports:
Banks and investors, meanwhile, had misgivings over taking part in the PPIP amid fears the politically charged climate could prompt Congress to change rules on issues such as executive compensation for those firms that participated in the programme.
While this tour is being cancelled, don’t get overly despondent. I am sure our Summer concert series will be able to provide plenty of entertainment going forward!!
LD
