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Posts Tagged ‘equity market rally’

We Still Have To Pay The Bill

Posted by Larry Doyle on May 5th, 2009 4:16 PM |

Equity markets have rallied back to unchanged on the year. Libor is back to 1%. Housing is showing signs of life. Other economic indicators are declining at a less rapid rate. Fed chair Bernanke provides a cautiously optimistic tone in his testimony today. So why am I as concerned as ever?

Perhaps I do not fully appreciate the benefits of the massive government injections of capital into our economy. Why? I view any short term benefit from the capital injections as merely covering for losses which are still embedded in the system. The bills associated with those losses, in terms of increased interest costs and principal writedowns, are yet to be paid. 

Where are the losses? Well, the results of the Bank Stress Tests have been leaked and 10 of 19 banks will supposedly need more capital. The commercial real estate market is totally dependent on the government committing to 5 yr loans via the TALF.  I view the rebound in the residential real estate market as mortgage mayhem, not mortgage magic.  None other than the IMF continues to highlight that our economy has another $1 trillion plus in losses.     

I will grant Obama and Bush and their respective administrations credit for succeeding to this point in what they were trying to accomplish. However, that success, in my opinion, only means that longer term costs will be steeper and longer term benefits will be further off as a result.

Nouriel Roubini and Matthew Richardson address these points in today’s WSJ, We Can’t Subsidize The Banks Forever.   

From my perch, I view Obama and team as indiscriminately allocating capital across too many programs. I am becoming somewhat concerned that Bernanke is wondering if they have put too many chips on the table.

Roubini and Richardson offer:

. . . stress tests aside, it is highly likely that some of these large banks will be insolvent, given the various estimates of aggregate losses. The government has got to come up with a plan to deal with these institutions that does not involve a bottomless pit of taxpayer money. This means it will have the unenviable tasks of managing the systemic risk resulting from the failure of these institutions and then managing it in receivership. But it will also mean transferring risk from taxpayers to creditors. This is fair: Metaphorically speaking, these are the guys who served alcohol to the banks just before they took off down the highway. 

While the tone feels better, there is no doubt we still have challenges. Private enterprise’s  interaction with Uncle Sam is one of the biggest challenges.

All this said, the government had a choice between immediate losses with excruciating pain or buying time with long term underperformance. They chose the latter.

We still have to pay the bill.


April 2009 Market Review: Brave New World

Posted by Larry Doyle on May 1st, 2009 5:00 AM |

Does the economic activity in April 2009 represent a turning point in the recession which started in December 2007? Does the continuing rebound in the equity markets represent a bright light at the end of the tunnel or merely a rebound from a very oversold market? Have global risks abated or are they being masked by massive government intervention? Let’s get after it.


In my opinion, we are in the early stages of transition to a new global economic dynamic. That process includes:

1. Strict discipline in underwriting. Banks are forced to underwrite to own as opposed to underwrite to sell. The shadow banking system (loans originated to be securitized and sold) is dead as we knew it. Banks have certain assets marked way too cheaply while also carrying plenty of fraudulently underwritten loans worth far less than their mark. Growth potential for the economy as a whole will remain constricted by a lessened flow of credit. There will be a clear distinction in companies which are winners and losers in this process.  

2. Lessened consumer demand on a going forward basis.   

3. Challenges for companies relying on debt financing and opportunities for companies generating free cash flow. The model based on leveraged finance is dead and not soon to return. Automotive companies need a 13 million rate of unit sales to break even. Without a shadow banking system, I don’t see this happening.

4. Opportunities for consumers buying homes. Don’t expect a rebound in home price appreciation as foreclosures, which were forestalled by banks and Freddie and Fannie, will add supply to the housing market. Housing may stabilize, but I do not think it will improve given the glut of unsold homes. 

5. Continued increase in unemployment will keep consumers cautious.

6. Many analysts focused on inventory drawdown in the latest GDP report as being a positive for future growth. Why didn’t analysts highlight the fact that consumer spending was actually a positive 2.2%?  Does that statistic represent a return of the consumer? In my opinion, NO. The positive consumer spending was primarily focused on massive price discounts offered in January and February to move product after anemic holiday sales. Personal spending for March was released yesterday morning and came in at -.2%. March retail sales were a surprisingly weak -1.1%.

7. Government intervention in markets may be viewed as necessary in the short term, but a persistent government presence in markets and industries comes with unknown, and in my opinion, very high costs. We are seeing heightened challenges in banking, insurance, automotive, and soon health care, energy, and education. Companies, consumers, and investors will be forced to adapt to a regular presence of Uncle Sam. He is not a good business partner. 

8. There is a very distinct shift in economic power towards China and with it a shift in political power, as well. I believe it is a question of when – not if – in terms of a major European country defaulting on its debt and requiring a rescue from the EU and/or  IMF.

9.  I still see a steady dose of analysts and economists forecasting future economic activity based on past models. I think they are missing the big picture.  I believe we need to forecast economic activity based upon traditional bank lending. If the government persists in trying to fill a void which naturally is not there, the risk involved in that undertaking is hyperinflation. 

Again, I am happy the markets have rebounded from the lows of early March but in looking forward I see a dramatically different economic landscape than our recent past. People who are able to adjust to that will do fine. People who are trying to maintain a lifestyle predicated on the economy of 2003-2007 will be very frustrated.

As far as my market call, I remain very concerned about the prevailing level of interest rates. I think the market will test the resolve of the Fed to continue to effectively overpay for mortgage and government securities.

In regard to the equity market, we are only 3-7% away from the S&P and DJIA being unchanged on the year. If we do get there, I think it would be a good opportunity to sell positions. I believe the next 10% move will be to lower prices.

In short, I think the delevering process has been given a significant breather due to Uncle Sam’s checkbook but that it is not yet over.

What do you think? There is plenty here for everybody. Please share your thoughts.


St. Patrick Smiles on the Market!

Posted by Larry Doyle on March 17th, 2009 5:34 PM |

When trading bonds, I used a rule that Tuesday’s price action often reversed Monday’s. While that rule of trading was strictly a quirk based upon years of experience, I found it happen so regularly that I never discounted it. 

Supported by a surprisingly strong housing starts number (+22% to 583K) and a relatively mild increase in PPI (producer price index) of .1%, the market opened relatively flat today but firmed all day right into the close. The major stock market averages closed up 2.5%-4%!! (more…)

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