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Archive for August, 2009

August 2009 Market Review

Posted by Larry Doyle on August 31st, 2009 9:28 PM |

monthly-market-review2August represents the sixth month in a row in which the equity markets have posted positive returns. Has the rally been built upon a solid economic foundation? Does the rally have even further to run? Is it too late to get in? Should investors be more cautious at these levels?

What do the numbers on Wall Street mean for people on Main Street? How are the powers that be in Washington responding to the markets? What do we learn from international and emerging markets?

Let’s review the monthly performance, look beyond the numbers, and project what may lie ahead.


Unlike the explosive performance in July (equities up 8-10%), the market had a much more subdued performance in August. Be mindful that August is the heaviest vacation month for market participants. Over and above that, total volume in the equity markets has been rather light. A large percentage of market volume has centered on those stocks in which Uncle Sam is heavily involved (Citi, AIG, BofA, Freddie, Fannie). I view these particular stocks as very speculative in nature. That said, there are large short bases in these stocks. The shorts were punished during the month. The stocks did trade off significantly on the last day of the month.

Are we supposed to make assessments of our future economic health and overall market performance based upon stocks in which Uncle Sam holds anywhere from a 40-80% equity stake? I think not. I view trading these stocks as pure gambling, not investing. I challenge any analyst who would say otherwise.

I am concerned about the equity markets going forward. Why? What sector has led the equity markets overall? Emerging markets, specifically China. What is happening in those market segments? China sold off close to 6% on the last day of the month and is down over 20% from its high. That decline is technically termed a ‘bear market.’ Analysts I respect view China’s market as an asset bubble. Emerging markets overall have had an unbelievable run but appear to be losing momentum as both the U.S. markets and developed markets outperformed the emerging markets this month. What drives the emerging markets? Primarily the exporting of commodities. Let’s review that segment.


The DJ-UBS Commodity Index is also showing signs of losing momentum. In fact, the index was down -.6% for the month while it is off a full 4-5% from the highs seen in July. While oil is approximately 7% off its highs, natural gas had a significant decline this month (down approximately 30%) and corn also sold off hard early in the month (down approximately 10%) before stabilizing.

The Baltic Dry Index is a good indicator of activity in the commodity space and as a link to activity in the emerging markets, especially China. What does the trend line on the BDI look like? Not very good. The BDI closed today at 2686, down approximately 20% from the highs seen in July.

Interest Rates/Bonds

Ben Bernanke announced in August that the Fed will leave the Fed Funds rate unchanged at a range of 0-.25% for an extended period. There is little doubt that Ben knows there remain major hurdles on the economic landscape. Clearly, both Bernanke and Geithner view improved financial markets and an improved financial industry as a pre-condition to a healthy economic recovery. Against this backdrop, U.S. Treasury debt rallied while other sectors of the bond market added marginally positive returns.

Does it make sense that both equities and bonds would rally in sync? No, but equity and bond markets both continue to trade more on technicals (that is, excess liquidity provided by Big Ben and his friend Uncle Sam) than pure fundamental value.

U.S. Dollar

The U.S. dollar continues to gradually erode in value. Is this any surprise? Many major trading partners of the U.S., from China to Japan to France, are calling for lessened dependence on the greenback as the international reserve currency.


While the industrial segment of our economy appears to be stabilizing, from my perspective the consumer (remember 70% of our economy is tied to the consumer) remains severely stressed. Delinquencies and defaults continue to run at a record pace across almost every form of debt (mortgages, credit cards).

The next shoe to drop is in the commercial real estate space.

I particularly like Sense on Cents‘ Economic All-Star Bob Rodriguez’s characterization of our economy. Bob views our economic landscape not as a “V,” or a “U”, or a “W” but rather as a caterpillar. What does he mean? He believes the economy will slowly move up and down for the foreseeable future. I concur.


While it has been foolhardy and painful to fight the Fed and the massive liquidity pumped into the system, I see some real signals in a variety of sectors that this rally is running out of steam. The markets have not truly had a meaningful correction in the last 6 months. Are we due for one? I personally think it would be very beneficial. Why? The disconnect between Wall Street and Main Street has never been greater. I do not view that gap as healthy.

Call me crazy, but I project September will have a 5-7% retraction across the major equity market averages based on reading the tea leaves as highlighted in this review.

What do you think?


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Custom Derivatives are the Darkest Corner of the Wall Street Casino

Posted by Larry Doyle on August 31st, 2009 4:16 PM |

Why is it that Wall Street is lobbying VERY heavily to delay and dilute expected reforms for the derivatives market? Well, given that Wall Street is making multiple billions in this space, it is not difficult to understand that the industry will spend millions to protect the franchise. In fact, the industry has been aggressively lobbying to maintain the veil of secrecy on this segment of the market.

The profits generated in this space are centered on 5 banks:  JP Morgan, Goldman Sachs, Citigroup, Morgan Stanley, and BofA. Bloomberg takes a peek into the highly profitable but excessively opaque world of derivatives in writing, Wall Street Stealth Lobby Defends $35 Billion Derivatives Haul:

Wall Street is suiting up for a battle to protect one of its richest fiefdoms, the $592 trillion over-the-counter derivatives market that is facing the biggest overhaul since its creation 30 years ago.

The Washington fight, conducted mostly behind closed doors, has been overshadowed by the noisy debate over health care. That’s fine with investment bankers, who for years quietly wielded their financial and lobbying clout on Capitol Hill to kill efforts to regulate derivatives. This time could be different. The reason: widespread public and Congressional anger over the role derivatives such as credit-default swaps played in the worst financial crisis since the Great Depression.

Wall Street would clearly like to keep the derivatives enterprise running in a ‘business as usual’ format. How might some light shine into this corner of the casino? Require the banks to report trading activity. I detailed this topic in July when writing, “Can We TRACE JP Morgan’s Business?”:

There is little to no transparency in the world of customized derivatives and as a result the bid-ask spreads are very wide. Cha-ching, cha-ching. Jamie and his friends on Wall Street are working extremely hard to keep it this way.

In their defense, it is likely not functionally feasible to move many customized derivatives to an exchange. What should regulators compel them to do? JP Morgan and every other financial firm on Wall Street should have to report every derivatives transaction to a system known as TRACE, which stands for Trade Reporting and Compliance Engine.  This system currently only covers transactions within the cash markets and not derivatives.  What does that mean for investors? No transparency and price discovery for investors in the customized derivatives space. As such, Jamie and friends can keep those bid-ask spreads nice and wide and ring up huge profits in the process.

I won’t make many friends on Wall Street, and perhaps lose some of my current friends, but TRACE should be implemented across all product lines. For those involved in the markets, please access the TRACE system to gain a wealth of pricing data while keeping your brokers and financial planners honest!!

Bloomberg offers a similar sentiment today in writing:

“Part of the pull and tug is that the banks are trying to prevent more and more of the product from being commoditized in the sense of being exchange-traded,” said Charles Peabody, an analyst at Portales Partners LLC in New York, which provides institutional equity research. “Like anything that starts to get commoditized — we’ve seen that with Trace on the bond side — it’s obviously going to pressure margins.”

Trace, shorthand for the Trade Reporting and Compliance Engine, was created in 2002 to post prices on all registered corporate bonds 15 minutes after trades occur. The public disclosure meant bond dealers no longer had better price data than clients, and profit margins in the business shrank by more than 50 percent, according to a Bloomberg News review of trades and a study published by the Rochester, New York-based Journal of Financial Economics.

If derivatives were required to be reported via TRACE and also had to be settled via a clearance system, would AIG have been able to take such massive systemic risk? Doubtful. Yet, Wall Street wants to keep the lights dimmed in this corner of the casino. Will they ever learn?


Pinnacle Receives Auction-Rate Securities Settlement; What about Every Other ARS Investor?

Posted by Larry Doyle on August 31st, 2009 12:34 PM |

How can auction-rate securities investors receive liquidity from the remaining $165 BILLION in frozen ARS securities?

Let’s review a recently announced settlement that Pinnacle Airlines negotiated with Citigroup. Bloomberg reported this morning, Pinnacle Airlines Flight From Auction Rate Costs $16 Million. Pinnacle is under severe cash constraints with a $109 million note maturing in early 2010. Bloomberg provides details how Pinnacle received liquidity along with a call option to repurchase the ARS from Citigroup at the same price it is selling the ARS. What does it all mean? Bloomberg highlights:

Pinnacle received $112 million from Citigroup Global Markets Inc. for its $128 million auction-rate portfolio, according to Williams. The $16 million loss amounted to a 12.5 percent discount. The deal allows Pinnacle to buy the securities back at the same discount anytime during the next three years, Williams said.

“We are pleased to have been able to provide a liquidity solution to our client,” said an e-mailed statement from Danielle Romero-Apsilos, a spokeswoman for Citigroup, which sold Pinnacle the auction-rate securities.

Sense on Cents asks the following questions:

1. Would Citigroup offer this settlement to every other investor to which it sold ARS?

2. What do ARS investors who are regular readers of Sense on Cents think of this settlement?

3. Does this settlement preclude investors from participating in a larger settlement that may include penalties?

4. Why shouldn’t other banks, brokers, and money managers who sold and marketed ARS in a fraudulent fashion be mandated by the courts to provide a temporary liquidity facility similar to this? If these entities, which engaged in the fraud, maintain they can not ‘afford’ this settlement, isn’t that a de facto admission of guilt and an ongoing perpetuation of the fraud?

When will ALL investors in auction-rate securities receive an expedited settlement which leads to full and total restitution? The feet dragging on behalf of issuers, banks, regulators, and the courts is a gross injustice of massive proportions.

Perhaps the claim embedded in the Amerivet Securities complaint against FINRA can help to unlock the ARS mess and expose the incestuous relationship between the financial self-regulator and Wall Street. At that point, perhaps ARS investors may move closer to receiving their funds and some justice from this fraud.


United States and Japanese ‘Forests’ Appear as Mirror Images

Posted by Larry Doyle on August 31st, 2009 8:57 AM |

Japan’s election results yesterday, in which the Japanese LDP party was routed, is a clear case of resoundingly ‘throwing the bums out’ in an attempt to ‘clean house’ and set the nation on a new track. What direction is that track headed? East, as in measures of increased protectionism within Japan itself and a closer relationship with the BRIC nations, primarily China.

Sense on Cents provided a hint of this on July 13th in writing, “Will Japan Take a Samurai to the U.S. Dollar?”:

Is the economic influence of the BRIC nations (Brazil, Russia, India, and China) gaining momentum and a huge ally in the assault on the U.S. dollar? It would appear so. What country is also questioning the validity of the greenback as the international reserve currency? Our second largest creditor, that being Japan.

Japan remains mired in a longstanding run of economic stagnation. This stagnation not only encompassed The Lost Decade of the 1990s, but to a large extent continues today. Japan, much like China, has largely been an export based economy dependent on American consumers. With the American consumer now pulling in his purse strings, what does the future hold for Japan? Let’s review the platform of the victorious Democratic Party of Japan (DPJ). The Wall Street Journal provides insightful analysis this morning, The Audacity of Yuai, in detailing the DPJ’s premise and platform, which includes the following:

> Yesterday’s election represents only the second time that the LDP has lost office in 54 years, and Mr. Hatoyama succeeded brilliantly by campaigning on the audacity of ambiguous “change.”

Interesting . . . “change,” sound familiar?

> Like the LDP, the DPJ wants to protect the politically powerful agricultural lobby, reshuffle public handouts, raise taxes in the name of environmentalism, and protect workers and small- and medium-sized businesses from competition. On the campaign trial, Mr. Hatoyama sold these old ideas as a new vision of government focused on yuai, or friendship and love.

Could we categorize these components as ‘the more things change, the more they stay the same?’ Are we experiencing much of this in Washington as well?

> Japan’s public-debt-to-GDP is about 180% and the fiscal deficit is projected to approach 8% by year end. Mr. Hatoyama promises to trim the budget to pay for his 16.8 trillion yen ($177 billion) in spending promises. But that ignores the gaping debt hole that must be serviced eventually.

What other country has a massive debt problem and is going into deeper debt to dig its way out?

> He suggests that China’s rise to economic dominance in Asia is inevitable and that Japan should do more to redistribute the wealth it currently has.

Redistribute? Sound familiar?

> On foreign affairs, Mr. Hatoyama wants the U.S. to remain the main guarantor of Japan’s security, but with fewer troops and bases in Japan. He is strong on human rights but supports international institutions like the United Nations that coddle rogue regimes.

How gracious of them. We get to protect them with a lessened physical presence. Might he also dare to negotiate with certain ‘rogue regimes?’

The simple fact is the Japanese public is fed up with economic stagnation. However, the Japanese may care to review the foundations of that stagnation. Within that foundation is a culture which has never been willing to recognize losses within its banking institutions. That unwillingness to acknowledge losses has left an overhang of bad debt on its economy.

If you see many similarities in the platform of the newly elected DPJ, look beyond the trees and I think you may see a forest in the United States which, in many respects, is the mirror image of that in Japan.


Recommended Reading

Posted by Larry Doyle on August 30th, 2009 6:09 AM |

In the midst of doing some reading today, I came across several articles which made me pause and wonder just how far we’ve come and just how much further we have to go in terms of getting beyond our current economic issues.

I hope you also find these articles enlightening:

1. It’s Time to Admit That Money Funds Involve Risk
by Joe Nocera
The New York Times; August 28, 2009

2. Wall Street Fox Beds Down in Taxpayer Henhouse
by David Reilly
Bloomberg; August 26, 2009

3. Banking Crisis of Historic Proportions
by John Lounsbury
Seeking Alpha; August 16, 2009
***Reminder: John Lounsbury will be my guest tonight on No Quarter Radio’s Sense on Cents with Larry Doyle

4. Local Governments Expect Big Jump in Pension Costs
by Joseph Spector
Star Gazette; August 28, 2009

5.The End of the Line for California Automaking
by Martin Zimmerman and Maura Dolan
Los Angeles Times; August 28, 2009

The real world impact of the issues highlighted in these stories is an indication that we have miles to go and numerous hills to climb as we navigate our economic landscape.


NoQuarter Radio’s Sense on Cents with Larry Doyle, Sunday Night at 8PM

Posted by Larry Doyle on August 29th, 2009 1:07 PM |

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 forward or rewind to any portion of the show by clicking at any point along the play bar.


Many analysts would promote the performance and developments on Wall Street as the clear indicator of future developments on Main Street. The divide between these two great thoroughfares has never been greater. In fact, The Wall Street Journal’s lead article on Saturday morning, Halting Recovery Divides America in Two, highlights this very point.  What is the name of the street trying to bridge this divide? Pennsylvania Avenue.

Please join me Sunday evening, August 30th from 8-9pm as I traverse the economic landscape along these three distinct avenues. I will be joined by an individual, John Lounsbury, who is a student, professor, and practitioner on a wide array of topics played out on these streets.

John Lounsbury provides comprehensive financial planning and investment advisory services to a small number of families. He has a background which includes 34 years with a major international corporation, 25 years in R&D management, and corporate staff positions. More recently he was a Series 6, 7, and 63 licensed representative with a major insurance company brokerage from 1992 to 2001.  Since 2002 he has operated his own sole proprietorship business. John’s specific interests include political and economic history and investment strategy analysis.

John is also a featured contributor at Real Money and has his own blog, PiedmontHudson.

Please join me Sunday night as I chat with John Lounsbury. We will hold nothing back in dispensing a healthy dose of wisdom and riveting analysis as we collectively navigate the economic landscape. Share your questions and thoughts by calling in to (347) 677-0792, and also join our live chat room, which I’ll start up about 10 minutes before the show begins.

As a reminder, all of my radio shows are archived and can be listened to right here at Sense on Cents by clicking on the NoQuarter Radio tab located under the page header. (FYI, I keep an audio player of my most recent episode in the right sidebar). In addition, all NoQuarter Radio programming is available as a free podcast on iTunes. From the iTunes Store page, type “NQR podcasts” in the search window.

Many thanks to Larry Johnson and the rest of the team at NoQuarterUSA blog for providing such a vibrant vehicle as NoQuarter Radio. I look forward to having you join me Sunday evening as we collectively navigate the economic landscape!!


Mary Schapiro Comments on Examining Books and Records

Posted by Larry Doyle on August 29th, 2009 6:51 AM |

If hedge funds and other financial firms are to be regulated for purposes of reviewing business practices, doesn’t it go without question that a financial self-regulatory organization which has invested in hedge funds should also be required to open its books and records?

In a recent interview, SEC chair Mary Schapiro was asked about the regulation of hedge funds. Wall Street Pit captured the entire interview, SEC Chair Schapiro: The Agency Lacks the Tools to Get the Job Done. This interview is very comprehensive and covers market structures, high frequency trading, derivatives, the Federal Reserve, systemic risk, the future of the SEC, and more.

The segment that jumped out at me was the following:

CLAMAN: How would you regulate a hedge fund?

SCHAPIRO: First of all, we need to have them registered, so we understand who is in the space and what they’re doing. We need information so that, to the extent they could be engaging in manipulative activities, insider trading, we can constrict. Reconstruct trading practices and patterns so that we can bring those cases and enforce the rules against manipulation and insider trading.

So we really need reporting. We need registration. We need the ability to examining their books and records, and understand how they’re conducting business. (LD’s highlight)

My point of this commentary is not hedge funds specifically but that Ms. Schapiro raises the topic of examining books and records and understanding how an entity conducts business.

Just as Ms. Schapiro feels hedge funds should be regulated for these purposes, who in their right mind would not want the same exposure and transparency required of the Wall Street self-regulatory organization, FINRA? That exposure and transparency is the basis for the complaint filed by Amerivet Securities vs. FINRA (Amerivet Complaint Against FINRA Alleges Madoff Investment).

Ms. Schapiro may have to recuse herself from any review of FINRA given her position as head of FINRA prior to heading the SEC.

In fact, given the questionable nature of FINRA’s activities (investment, regulatory oversight, compensation practices), the review of FINRA should be undertaken by an independent investigator.

Although FINRA itself does not want to provide transparency into its activities, transparency for a financial regulatory organization must happen without question.


Auctions Across America

Posted by Larry Doyle on August 28th, 2009 4:07 PM |

How does an entity sell a massive amount of assets? Individual sales are too time consuming. Personal negotiations would be too onerous. How about utilizing the internet and engaging a wider audience? That is, in fact, exactly what is happening as America goes on sale via auctions. That’s right, folks.

From the state of California to small banks and all points in between, there are and will be ongoing liquidations via auctions for the foreseeable future.

How does one receive a list of items for sale? Check out the following to start:

>> Great California Garage Sale held by the California Department of General Services.

>> Auctions for U.S. Treasury, FDIC, Personal Property, Real Estate, and Services by Rick Levin and Associates, Inc.

I have two rhetorical questions:

1. What will these auctions mean for consumer spending and retail sales going forward?

2. What will these auctions mean for the pace of inventory buildup?

All part of the new dynamic within the Uncle Sam economy.

Have fun shopping.


How Will Bank Failures Impact Economy?

Posted by Larry Doyle on August 28th, 2009 1:04 PM |

Will the failure of a small bank in a small community truly impact America?

Analysts discount the impact that the expected massive number of bank failures will have on the U.S. economy.

Additionally, analysts also discount the fact that the FDIC fund to cover depositors of failed institutions is close to zero. This fund can be replenished by the FDIC imposing an assessment on remaining banks or, if need be, tapping an emergency line of credit at the U.S. Treasury.

What will be the real impact of bank failures? In my opinion, American consumer confidence and small business owners will bear the brunt of the pain from the bank failures. Why?

>> The reality of further job losses at these banks and those they support within local economies.

>> The psychological impact of seeing small and community banks fail.

>> The lack of credit availability to consumers and small business owners in communities across America.

What are the plans to stem the tide and plug the holes created by bank failures?

1. Have larger banks take over these institutions. What are the risks in this transition? Many of these banks are already filled with underperforming and delinquent loans. The acquiring banks typically want the cheap deposit base of the failed banks and little more.

2. Private equity buyers will have the opportunity to purchase failed banks. What are the risks in this process? The private equity buyers will have to maintain higher capital ratios. Another risk is that the private equity buyers may utilize the cheap deposit base as a pool of liquidity and capital for higher return undertakings than traditional lending in the local communities.

In my opinion, the gap dividing Wall Street and Main Street is only going to grow wider in the midst of these bank failures. The party on Wall Street has little appreciation for this reality on Main Street.

John Kanas, the former chairman and CEO of North Fork Bank, and his private equity firm purchased BankUnited in Florida this past May. Kanas addresses these topics in an interview on CNBC.


Related Commentary:
   Halting Recovery Divides America in Two
   by Cari Tuna, Liz Rappaport, and Julie Jargon
   The Wall Street Journal (August 29, 2009)

Wall Street ARS Betrayal Brings Losses and Sleepless Nights

Posted by Larry Doyle on August 28th, 2009 9:19 AM |

Those who would betray the trust and integrity of a market and investment must be held to account.

Such is the current dynamic within Wall Street’s greatest fraud that encompasses Auction-Rate Securities.

At times, I wonder if I focus too much on the ARS debacle. Then, when I read of the depths of despair experienced by ARS investors, both institutions and individuals, I personally seethe at the injustice of it all.

Bloomberg provides a wide ranging review of institutional investors who were defrauded by Wall Street in purchasing auction-rate securities. Bloomberg writes Wall Street Betrayal Seen in $4.8 Billion Company Debt Losses. The highlights in this article are almost too numerous to single out, but suffice it to say this fraud has likely touched almost every investor in either a direct or indirect fashion.

I am heartened that the fraud is finally receiving significant focus. That said, how will Wall Street be held accountable and how will investors be made whole? Let’s address some specific details as highlighted by Bloomberg:

Bristol-Myers Squibb Co. the New York-based pharmaceutical company, took an 82 percent loss in 2008 when it sold a portion of its auction-rate debt with a $642 million face value.

The maker of Plavix, the world’s second best-selling medicine behind Pfizer Inc.’s Lipitor, continues to hold $169 million worth of auction-rate bonds. It wrote them down by $75 million in the second quarter, according to regulatory filings.

An 82% loss on a supposed cash surrogate! A 44% writedown on cash! (more…)

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