Sense on Cents

December 5, 2009: Month to Date Economic and Market Review

Posted by Larry Doyle on December 5th, 2009 10:41 AM |

Is our economy stabilizing? Is yesterday’s surprisingly strong employment report a harbinger of a trend toward better days? While I am not going to indiscriminately pooh-pooh economic reports which may be overly sanguine, I am also not going to blindly buy into them either.

Let’s return to the surprisingly weak employment report produced in November, combine that with the report released yesterday and realize that the economic road in front of us remains long, steep, and challenging.

Prudence dictates we neither get overly ebullient nor despondent as we manage our finances and navigate the economic landscape. In that context, I will caution readers here at Sense on Cents that news deemed positive for the economy may very likely generate negative returns across a wide array of asset classes. Why is that?

The fuel that has been driving the markets all year is provided by the Fed and Treasury. That excess liquidity has served to punish the value of the greenback while supporting virtually all asset classes via the dollar carry trade. If the economy shows signs of stabilizing and the fuel source is restricted via a Fed-tightening of credit, the U.S. dollar should rise and hedge funds, speculators, and selected investors will be forced to exit positions across these asset classes. That very phenomena played out to a small extent just yesterday. Will it continue? Watch the U.S. Dollar Index and expect that it will continue to be negatively correlated with the markets.

Let’s navigate. Prior to reviewing the month to date market returns, I’ll address economic data released this week.

ECONOMIC DATA

Unemployment Report: The only data that was truly meaningful. Rather than regurgitating my analysis of this report, I submit my comprehensive review from yesterday “Unemployment Report: December 4, 2009.”

Let’s move along to market performance. The figures I provide are the weekly close and the month-to-date returns on a percentage basis:

U.S. DOLLAR

$/Yen: 90.51 versus 86.38, +4.8%
Euro/Dollar: 1.4856 versus 1.5007, -1.0%
U.S. Dollar Index: 75.75 versus 74.80, +1.3%

Commentary: the overall U.S. Dollar Index rebounded strongly after the surprisingly strong Unemployment Report. Why? Very simply, if the economy is starting to stabilize then the Fed will be faced with tightening its easy money policy much sooner than forecast. In fact, that is exactly what happened. While prior to yesterday’s release of the employment report, most market participants believed the Fed would be on hold for all of 2010. Now, however, the market is projecting the Fed may very well be forced to raise rates by mid-2010. If that occurs, the dollar will continue to firm. See that U.S. Dollar Index I linked to above?Watch it like a hawk. As the dollar goes one way, look for the markets to go the other.

I continue to reiterate my points from previous weeks: while I think Washington is not disappointed in a relatively weak dollar, although they should be (“Dollar Devaluation Is a Dangerous Game”), other countries are not overly keen about further dollar weakness. Why? A weak dollar puts those countries in a marginally less competitive position in international trade.

I also would like to reiterate that although Fed officials play up the lack of inflation as a positive and an overriding reason for its easy money policy, they provide little to no commentary on deflationary pressures at work in large segments of the economy. I firmly believe these deflationary pressures are the Fed’s gravest concerns and they hope the weak dollar creates hints of inflation to offset these deflationary pressures. Can rising asset valuations support underlying economic fundamentals which provide little to no pricing power for many companies?

COMMODITIES

Oil: $75.78/barrel versus $77.33, -2.0%
Gold: $1162.1/oz. versus $1180, -1.5%….
DJ-UBS Commodity Index: 134.79 versus 136.49, -1.2%

Commentary: the red ink in this sector is directly correlated with the improvement in the dollar. A lot of hedge funds had sold the dollar, given the fact that it could be borrowed for next to nothing, and used the proceeds to buy commodities. As the dollar rallies, that part of these trades loses, and thus as entities cover their dollar shorts, they sell out their long positions in commodities, especially gold.

EQUITIES

DJIA: 10,389 versus 10,345, +.4%
Nasdaq: 2194 versus 2145, +2.3%
S&P 500: 1106 versus 1096, +.9%
MSCI Emerging Mkt Index: 986 versus 941, +4.8%
DJ Global ex U.S.: 202.0 versus 197.04, +2.5%

Commentary: I am overall fairly impressed with the the equity market performance this week. There were conflicting forces at work. Supporting the market, the situation in Dubai was somewhat alleviated by support from the UAE, and the employment report conveyed a sense of an improving economy. Pressuring the market, interest rates moved sharply higher and the dollar rallied. How will this play out going forward? For now, I remain fixated on the value of the dollar as the primary factor influencing equities.

I reiterate from last week, I think we are beginning to enter into a blowoff phase in which investors who have missed the market move to get in while those who are outright short the market are forced to cover. I view the current price action more akin to gambling than anything else.

BONDS/INTEREST RATES

2yr Treasury: .85% versus .67%, +18 basis points or .18% (rates up, prices down)
10yr Treasury: 3.48% versus 3.20%, +28 basis points or .28% (rates up, prices down)

COY (High Yield ETF): 6.58 versus 6.46, +1.8%
FMY (Mortgage ETF): 17.57 versus 17.79, -1.2%
ITE (Government ETF): 57.95 versus 58.52, –1.0%
NXR (Municipal ETF): 14.61 versus 14.80, -1.3%

Commentary: lots of red ink in this sector as questions about the Fed raising rates comes back into play. The fact is the deficit remains a MAJOR problem both economically and politically. The markets are also faced with a sizable amount of Treasury supply in the coming week. Can the economy improve if rates move higher? It will be a real challenge.

Summary/Conclusion

We live in a very fragile world, economically and politically. Our global economic risks remain deeply embedded in the debt burdens of nations, corporations, and consumers. These debts are disguised and covered by central bank liquidity. The water may appear fine, but it remains shark-filled. Remain on guard.

Our economy is so large and so complex that it is not possible to turn on a dime as some may like to project. When hotel rooms in prime Las Vegas hotels are offered at $49 a night, we are a long way from a stable economy.

Please join me tomorrow evening as we discuss any and all of the above on Open Mike Night from 8-9pm on No Quarter Radio’s Sense on Cents with Larry Doyle.

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Have a great day and weekend.

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Dollar Carry Trade Remains in Vogue

Posted by Larry Doyle on December 4th, 2009 3:47 PM |

Today’s price action in the markets is very telling. What is it telling us? The dollar carry trade remains in vogue and technicals continue to dominate overall flows much more than fundamentals. Let’s navigate.

Recall that the weakness in the U.S. dollar has facilitated a large number of hedge funds, market speculators, and to a less extent investors to borrow dollars and buy a variety of risk based assets. What assets? Equities, a wide array of bonds, a basket of commodities, primarily gold. How are these sectors performing?

After an initial spike of 1-1.5% across the equity markets, these major market averages have retraced and are now effectively unchanged to slightly better on the day. Is that a sign of investors not believing in the details of the employment report? No, anything but. In fact, I believe the equity performance today is quite strong given the fact that the dollar has increased by 1.6%.

Bonds have traded in a very narrow range. Interest rates moved higher by approximately 12 basis points (.12%) and have sat there almost all day. The question that now comes back front and center is when the Fed will decide to raise rates. While most analysts had written off the possibility of an increase in rates prior to 2011, now analysts are projecting that the Fed may raise rates by mid-2010.

If rates do rise here, what does that do for our greenback? It will do better and it is doing just that today. As I referenced the U.S. Dollar Index has increased by 1.6%. Read the rest »

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UPDATE: FASB 166 and 167

Posted by Larry Doyle on December 4th, 2009 11:27 AM |

Is Wall Street getting a reprieve from the capital constraints that would be effected by the implementation of FASB 166 and 167? I first broached this topic a month ago in writing, “12th Street Capital Reviews FASB 166 and 167 and Tells Us Why Wall Street Will Need More Capital”:

In brief, FASB 166 and 167 will require hundreds of billions in assets to be moved from off-balance sheet vehicles onto the balance sheets of the financial institutions. As those assets, which are embedded in an array of securitization transactions, come on balance sheet, the banks and non-banks alike will have to raise more capital to support the growth in their balance sheets. Best guesstimate is that the institutions will need to raise capital in the tens of billions.

12th Street Capital provides us updated developments on this very important topic with the following release: Read the rest »

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Unemployment Report: December 4, 2009

Posted by Larry Doyle on December 4th, 2009 8:57 AM |

The widely anticipated December Unemployment Report covering the month of November was just released. Let’s dive right in and take a look at the numbers . . .

I. UNEMPLOYMENT RATE
August: 9.4%
September: 9.7%
October: 9.8%
November: 10.2%
– December Consensus Expectation: 10.2%
– December Actual: 10.0% !!

>> LD’s comments: Discouraged workers did increase and exit the labor pool. That fact supported this improvement. Initial reaction to the report remains one of disbelief and skepticism. The underemployment rate (U-6 rate) improved to an overall level of 17.2%.

II. NON-FARM PAYROLL (click here for definition of this term)
July: loss of 463k
August: loss of 304k
September: loss of 154k
October: loss of 219k
November: loss of 190k
– December Consensus Expectation: loss of 100k to 125k
– December Actual: loss of 11k!!

>> LD’s comments: positive revisions to the previous two months of 159k. A major surprise. Along with the positive revisions, do not be surprised to see many analysts tout this as the turn in the economy and the fact that government programs are working. We will need more than one month’s report to confirm that. Read the rest »

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Time to Reinstitute Glass-Steagall

Posted by Larry Doyle on December 3rd, 2009 3:16 PM |

A car needs gas to run. An engine needs steam. A factory needs power. The fact is without a steady source of energy nothing can operate. Welcome to the Uncle Sam economy circa 2009.

You may be thinking, wait a second LD . . . the Federal Reserve is flushing the system with liquidity. Money is easy and it is propping the markets. While availability of credit may be tight, the demand for credit is also weak. So what am I talking about?

Thanks to RM for providing the FDIC Third Quarter 2009 Banking Profile (a link to the full document is provided at the end of this commentary). For those who care to rip apart the inner workings of our banking system, this report is the owner’s manual. The report highlights the following:

> Industry Posts Net Profit of $2.8 Billion
> Increased Revenues, Lower Securities Losses Offset Higher Loan-Loss Provisions
> Net Interest Margins Improve at Most Institutions
> Troubled Loans Continue to Rise, But Rate of Growth Slows
> Loan balances Decline by 2.8% in the Quarter

Based on this overview, it would appear that the banking industry is slowly recovering. In aggregate, perhaps that may be the case. But what doesn’t this report tell us? Read the rest »

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The Market’s Greatest Risk

Posted by Larry Doyle on December 3rd, 2009 12:26 PM |

What is the greatest risk in the market currently? Is it the fact that the American consumer remains strapped? Unemployment showing no signs of improvement? Is it the continuation of problems within housing? While all of these issues are significant, I would maintain they are not anywhere close to being the greatest risk in the market. Why? Let’s navigate.

Each of the previously raised points is an economic factor, but the market is trading to a much greater extent based on technicals and excessive liquidity provided by the Fed than any individual or group of fundamental economic statistics.

Thus, let’s return to my original question. What is the greatest risk in the market currently? If the market is being supported by easy money provided by the Fed and that easy money is pressuring the dollar ever lower, then the greatest risk is that the dollar stops its decline. What might precipitate the dollar to increase in value? Coordinated intervention by international trade partners who are disadvantaged by a weak dollar. Could this happen? Without a doubt. In fact, our friends in Japan just started intervening in the currency markets to weaken the yen against the dollar.

The Wall Street Journal highlights this development in the brief video clip, Calls Increase for Japanese Intervention More Acute:

The yen has moved up to a current valuation of 88.14 versus the U.S. dollar from a month end level of 86.38 just this past Monday.

While I have no doubt that our political leaders in Washington are not unhappy with the weakening of our greenback, our international trade partners, such as Japan, are less thrilled. To the extent that these partners fashioned a coordinated response to strengthen the dollar and weaken their own currencies in an attempt to support their own exports, that coordinated effort is ‘the market’s greatest risk.’

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I’ll Gladly Pay You Tuesday…

Posted by Larry Doyle on December 3rd, 2009 9:26 AM |

Postponing losses in hopes that one can trade out of them is a game very rarely won. In similar fashion, not acknowledging losses in hopes that the situation improves and the loss is mitigated is also a recipe for disaster. All one needs to do is look eastward to Japan to realize that. Ultimately, a loss not only must be realized, but paid. “I’ll gladly pay you Tuesday for a hamburger today …” may be cute in cartoons, but in the real world that approach never works. That said, this ‘delay to pay’ is the exact approach being utilized by Uncle Sam and, in large measure, by private industry.

Bloomberg’s Jonathan Weil once again distinguishes himself and provides great insight on this dynamic in writing, Fudging Losses is Easy When the FDIC Does It Too:

No wonder so many banks are delaying their losses. The Federal Deposit Insurance Corp. keeps showing them how, by doing the same thing with its own.

Last week the FDIC, led by Chairman Sheila Bair since 2006, said its insurance fund’s liabilities exceeded assets by $8.2 billion as of Sept. 30. That marked the first time since 1992 that the industry-financed fund had shown a deficit. There’s plenty of reason to believe its financial health is much worse.

How much worse? Read the rest »

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Federal Reserve Says “One More Drink”

Posted by Larry Doyle on December 2nd, 2009 2:31 PM |

Illustration by Zhou Tao

I have to admit, I chuckled upon reading the news today that the Federal Reserve is debating whether and how it may fight the prospects of asset bubbles developing. The Wall Street Journal addresses this story in writing,
Fed Debates New Role: Bubble Fighter:

Not so long ago, Federal Reserve officials were confident they knew what to do when they saw bubbles building in prices of stocks, houses or other assets: Nothing.

Now, as Fed Chairman Ben Bernanke faces a confirmation hearing Thursday on a second four-year term, he and others at the central bank are rethinking the hands-off approach they’ve followed over the past decade. On the heels of a burst housing-and-credit bubble, Mr. Bernanke now calls financial booms “perhaps the most difficult problem for monetary policy this decade.”

With Asian property prices soaring and gold prices busting records almost daily, the debate comes at a critical time. Mr. Bernanke wants to use his powers as a bank regulator to stamp out bubbles, but the Senate Banking Committee, which will grill him later this week, is considering stripping the Fed of its regulatory power.

At the same time, pending legislation in the House could leave Mr. Bernanke running a less independent institution. The House Financial Services Committee has passed a measure that would subject the Fed’s interest-rate decisions to scrutiny by the Government Accountability Office, an investigative arm of Congress. Mr. Bernanke and others at the Fed fear that with Congress looking over their shoulders, any decision they make about interest rates would be subjected to the winds of politics — making it harder to control inflation or financial bubbles.

My immediate thought upon reading this article is to think of the bartender who is happy to push one more drink upon an overlubricated patron. Or perhaps a junkie who is willing to sell a down and out addict one more fix in order to ease the pain. Read the rest »

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FHA: Go Broke First, Tighten Standards Later

Posted by Larry Doyle on December 2nd, 2009 11:09 AM |

When will those charged with spending taxpayer money treat associated responsibilities with the seriousness they deserve? Indiscriminately and wastefully allocating taxpayer funds is not merely a question of competence but, in my opinion, a question of patriotism.

The Obama administration’s support of our nation’s housing market has been overwhelming. Taxpayer funds have been directed towards Freddie, Fannie, the FHA (Federal Housing Administration), and a wide number of banks. Although government spending and waste go hand in hand, the American taxpayer deserves so much better.

With the recent news that the FHA insurance fund is depleted, now the FHA decides to tighten standards. Spend money first, ask questions later? Where and when will this madness end? A recent release from the Federal Register/Department of Housing and Urban Development highlights new initiatives by Housing and Urban Development (HUD) which oversees the FHA. The FHA Summary reads as follows: Read the rest »

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FINRA Defense: Exhaustion and Immunity

Posted by Larry Doyle on December 2nd, 2009 9:24 AM |

Let’s revisit the case of Standard Investment Chartered v. FINRA. While I have written extensively on a host of issues related to FINRA, I believe the issues embedded in this specific case drive to the very core of our financial regulatory system. For those unaware of this case, a recent memorandum (link provided at end of this commentary) filed on behalf of the plaintiff highlights:

At the core of the case is the FINRA Defendants’ issuance of a proxy statement on December 14, 2006 (the “Proxy Statement”), which contained out-and-out material falsehoods and omitted essential facts bearing on the Transaction and on a proposed “Special Member Payment” that was to be made upon its completion. The most important false representation was that federal tax authorities limited a payment to NASD Members to $35,000. Second Amended Complaint (“SAC” or the “Complaint”) ¶ 13. The FINRA Defendants magnified the falsehood that the Internal Revenue Service (“IRS”) limited NASD Member payments to $35,000 in many different forms, over and over, as if saying it enough times and wishing it to be true would somehow make it come true.

A claim of out-and-out material falsehoods against defendants, including then FINRA head and current SEC chief Mary Schapiro, is where the rubber meets the road. How have the defendants responded? Are they willing to embrace the virtues of transparency and integrity so badly needed to restore investor confidence? No, I don’t think so.

The defendants have filed a motion to dismiss this complaint. On what grounds do the defendants make their motion? The memorandum highlights: Read the rest »

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