XAO posts biggest monthly gain in almost 6 years

Last month I speculated that the market would finish up in September and I wasn't disappointed. The All Ordinaries Index (XAO) posted it's biggest monthly gain in almost 6 years rising 5.3% from the August 31st close and set a new record high of 6580.9.

In October 2001 the XAO rose 6.6% and went on to rise a further 6.7% over November December and January. Then the XAO plunged 18.4% between January 31st 2002 and the end of February 2003.

So what will October 2007 bring? Will we see a rally into the new year on the coattails of the Bernanke put? The markets have definitely climbed the wall of worry in September shrugging off awful US housing data and a tight credit market environment.

There are signs of life in the LBO market with KKR putting away a chunk of debt for the First Data deal. The Commercial paper market disappearing act is slowing, LIBOR has come down and the yield curve has returned to it's normal shape.

Apart from Housing the Australian economy remains robust with corporate profits and investment ticking over nicely. Of most interest next week will be US employment numbers to see if August's figures were just a one off.

So what does all that mean? Who knows? I certainly don't but just for kicks I'm going to say that October will finish on the downside for equities as data out of the US on housing, employment and consumer spending will be mostly negative.

New Home Sales & KB Home's shocker

Sales of new homes dropped 8.3% in August to a seasonally adjusted annual rate of 795,000, the slowest sales pace since June 2000, the Commerce Department estimated Thursday.

The median sales price fell 7.5% to $225,700 compared with a year earlier, the largest year-over-year decline in 37 years.

The inventory of unsold homes fell by 1.5% to 529,000, the fifth straight decline as builders struggle to bring their inventories down. The inventory represents an 8.2-month supply at the August sales pace, the highest since March. A few comments from the esteemed legion of economists:

"This is just hideous," "Sales have further to fall," "people don't like borrowing to buy depreciating assets, and lenders don't like to lend on them either." Ian Shepherdson, chief U.S. economist for High Frequency Economics.

"This is more evidence that it's going to be a long and -- for a lot of people -- a painful process," "the soft housing market will be with us for a long time, at least 18 months." Mike Schenk, economist for the Credit Union National Association.

"The bad news is that the August data only partially reflect tighter mortgage credit conditions," Richard Moody, chief economist for Mission Residential.

While both existing and new home sales are subject to large revisions you'd have to blind not to see the trend emerging. New home sales are a better proxy for current conditions as they reflect sales in the month of August whereas existing home sales includes homes purchased in July and in some cases June.

The reaction from the market suggests investors are getting used to bad housing data as they continues to climb the wall of worry. That's good because there will be plenty of bad news to come.


KB Home's shocker
Home builder KB Home (KBH) had a shocker of a third quarter posting a loss of $478.6 million, or $6.19 a share from continuing operations, compared with income of $129.3 million, or $1.60 a share the previous year.

During the quarter the company sold its 49% stake in French subsidiary, Kaufman & Broad SA, for an after-tax gain of $438.1 million. Including the French discontinued operations, KB Home said it posted a 3Q07 net loss of $35.6 million, or $0.46 cents a share. Total revenue fell 32% from a year earlier to $1.54 billion.

KB Home said it booked pretax charges of $690.1 million related to inventory and joint-venture impairments and land options it's walking away from. It also took a $107.9 million charge related to goodwill impairment. CEO Jeffrey Mezger had this to say:

The results "reflect the seriously challenging market conditions that prevail for home builders across most of the nation." "The oversupply of unsold new and resale homes and downward pressure on new home values have worsened in many of our markets as tighter lending standards, low affordability and greater buyer caution suppress demand."

"At this time, we see no signs that the housing market is stabilizing and believe it will be some time before a recovery begins." "We expect housing industry conditions to continue to worsen through the end of the year and into 2008."

Pretty grim stuff. It may prove 'seriously challenging' just to stay afloat in 2008.

Ever wonder how money is created?

The following video and short review comes from Google video. Very interesting and at times unnerving. Click on the image to watch.

Money As Debt

47 min 7 sec - Feb 12, 2007
Average rating: (2121 ratings)
Description: Paul Grignon's 47-minute animated presentation of "Money as Debt" tells in very simple and effective graphic terms what money is and how it is being created. It is an entertaining way to get the message out. The Cowichan Citizens Coalition and its "Duncan Initiative" received high praise from those who previewed it. I recommend it as a painless but hard-hitting educational tool and encourage the widest distribution and use by all groups concerned with the present unsustainable monetary system in Canada and the United States.

Marc Faber & Jim Rogers interviews

I finally figured out how to link to individual Bloomberg videos so expect more to come. Both of the interviews below took place on September 18th prior to the Fed meeting.

I decided to post Marc Faber and Jim Rogers because unlike the other cardboard cut-outs on Wall Street they are not afraid to go against the crowd and say what they think. Click on the images to see the interviews.

Bloomberg interview with Marc Faber

Bloomberg interview with Jim Rogers

Discount Condo Shopping in Miami

Click on the video below to check out the state of the Miami Condo market. Up to 50% price reductions on all types of condos. A lot of these condo complexes are still being built which in the short term will just add to already record inventory levels.

Housing & Consumer Confidence slide in August

From marketwatch.com

With sales of existing homes falling 4.3% to a five-year low seasonally adjusted annual rate of 5.50 million in August, inventories of unsold single-family homes rose to an 18-year high.

Meanwhile, a separate gauge of home prices fell for the 12th straight month in July, with prices falling in 15 of 20 major cities over the past year. Prices in 10 major cities are falling at the fastest pace in 16 years.

Consumers are getting more worried about the economy. The consumer confidence index fell sharply for a second straight month, hitting depths not seen since Hurricane Katrina struck two years ago, the Conference Board reported in yet another report. The consumer confidence index fell to 99.8 in September from a revised 105.6 in August

A point to remember about existing home sales is that the numbers are based on closings, so the decision to buy could have been made as far back as June. Thus we can expect existing sales to tank further as the numbers catch up with current market conditions.

To hear why Robert Shiller - the co-creator of the Case-Shiller Home price index, thinks that the worst in the Housing recession is yet to come click on the this link.

Homebuilders - who'll be the first to go?

As the US Housing market slumps further homebuilders continue to do it tough. The only thing missing from the scenario so far is a major player going belly-up. The last 24 hours have thrust a couple of candidates to the fore for that honor:

Fitch Rates Standard Debt As "Junk"
Monday September 24, 6:00 pm ET Fitch Issues "B" Rating for Standard Pacific Debt Offering Amid Challenging Housing Market

NEW YORK (AP) -- Fitch Ratings assigned a "junk" rating to homebuilder Standard Pacific Corp.'s proposed $100 million convertible debt offering.

The ratings agency assigned a "B" rating, which means the debt is speculative and subject to very high credit risk. The non-investment grade rating also means Standard Pacific will have less favorable borrowing terms than if the debt received an investment grade rating.

Fitch also noted its "Negative" outlook for the company, due to "a more challenging outlook for homebuilders during the balance of calendar 2007 ... and probable future weakening in the housing market in 2008."

In aftermarket trading shares of Standard Pacific shares fell 1 cent to $7.04, after falling $1.05, or 13 percent, during Monday's trading session.

On the positive side at least Standard Pacific was able to get funding. However, will it be enough to sustain them through what could be a very prolonged housing downturn or are they just putting off the inevitable? The company also announced that they will eliminate the quarterly cash dividend. Desperate times call for desperate measures. In other news just out today:

Lennar posts big quarterly loss on write-offs, adjustments

WASHINGTON (MarketWatch) -- Lennar Corp. (LEN) reported a net loss of $513.9 million, or $3.25 a share, for the third quarter ended Aug. 31, a reversal from the prior year's net earnings of $206.7 million, or $1.30 a share.

The Miami-based home builder's quarterly revenue plunged to $2.34 billion from $4.18 billion in the third quarter of fiscal 2006. Analysts, on average, had been looking for revenue of $2.39 billion, according to estimates compiled by Thomson Financial.

Valuation adjustments and write-offs of option deposits and pre-acquisition costs, goodwill and financial-services notes receivable totaled $856.8 million in the latest quarter, equating to $3.33 a share, Lennar said.

On an adjusted basis, gross margins on home sales narrowed to 14.0% from 19.5%, primarily reflecting higher incentives. Home deliveries dropped 41% in the latest quarter, with the average sales price of homes delivered off 6%.

CEO Stuart Miller said Lennar's cut the size of its work force by 35% and expects to make further reductions during the fourth quarter

In short, very ugly stuff, the company will probably cut back half it's workforce before it's done. Considering that housing is going to get worse before it gets better how long can these guys weather the storm? I'm convinced we'll see a major homebuilder go under before the storm passes.

Homebuilders have been doing it tough and they are going to do it tougher. With Existing Home Sales and home prices today. New Home Sales and a shocker earnings report expected on Thursday from KB home (KBH) it's shaping up as a nasty week for homebuilders.

Retailers sound profit warnings

Last week it was transports, yesterday it was retailers with profit warnings.

Firstly Lowe's Companies Inc. (LOW) warned on Monday that full-year profit could trail its prior forecast, saying dry conditions in some parts of the United States were hurting sales. Analyst Colin McGranahan of Sanford Bernstein noted that:

"Lowe's sales trends have reversed the apparent improvement seen" in the second quarter.... "while part of the weakness is weather related, Lowe's cautious outlook on 2008 suggests underlying trends are weaker than the company expected against easy compares,"

"easy compares" means comparable sales from last year that were not great and thus expected that this year's comparable period would easily be better. The company said it now expects profit for the year ending in February to be at the low end or below a forecast of $1.97 to $2.01 a share it gave in August.

Target Corp. (TGT) said after the close on Monday that it now expects same-store sales to rise 1.5% to 2.5% for the month, down from its previous forecast of 4% to 6% citing particularly weak sales in the northeast. Analyst Edward Weller of ThinkEquity Partners had this to say:

"This is a little bit surprising," "It seems to be a setback." It's not clear why traffic fell during the month, but he said that a quick recovery should be in store for Target. "It's not like these guys don't know how to adjust and adapt to the environment,"

It seems to be a setback? I'd say that was a fairly significant revision given the relatively short time frame. It's not clear why traffic fell but they should recover. Gees, some top class analysis there. ThinkEquity Partners need to think a little harder.

Transports signal slowing US economy

Transport companies are usually a fair gauge of how the economy is traveling. A couple of US transports gave earnings guidance last week suggesting the US economy is definitely slowing.

Last Thursday FedEx Corp. (FDX) posted 1Q07 earnings of $1.58 a share 4% higher than the same period a year ago and ahead of analyst estimates of $1.54 a share. Not a bad result given a slowing economy however the company issued a profit warning for the second-quarter. The company now expects to earn net income of $1.60 to $1.75 a share, below the Wall Street target of $1.97 a share.

Knight Transportation Inc. (KNX) issued a profit warning last Tuesday stating that their 3Q07 results would likely come in below expectations. Knight forecast earnings for the three months ending Sept. 30 in a range of 18 cents to 21 cents a share, compared with analysts expectations of 23 cents a share. The company cited an industry-wide drop in freight and excess truckload capacity for the weaker results.

Knight's statement is particularly telling, "an industry-wide drop in freight and excess truckload capacity" quite simply it means more people moving less stuff around the country. Just another sign that the US economy is getting weaker.

A first look at broker's earnings

This week saw 4 US broker's report 3Q07 earnings . Let's have a look at how they fared:

Lehman Brothers (LEH)
Earnings declined 1.9% to $1.54 a share, in 3Q07 from $1.57 a share a year earlier, beating analysts average forecast of $1.48 a share.

While fixed-income trading revenue fell 47% to $1.06 billion in the quarter, Lehman reported gains of at least 33% in equity trading, investment banking and money management.

Lehman took a one-time charge of $44m for restructuring the mortgage business after cutting about 2,000 mortgage- related jobs. They still have some $6.3 billion of subprime-mortgage assets on their books and by some estimates Lehman may have to fund around $16 billion of loan commitments to leveraged buyouts at a loss because investors are reluctant to buy that type of debt.

Richard Bove of Punk Zeigel pointed out that Lehman achieved the better than expected result after cutting compensation costs by $500m and reducing tax expense by about $75m. Bove argues the latter is unsustainable going forward.

Kevin Depew at Minyanville noted that LEH didn't reveal the split among trading asset levels. That is between level 1 assets, which are highly liquid and therefore have easily observable market prices, level 2 assets which are kind of liquid and level 3 assets which aren't very liquid at all. Still confused? Read point 2 and associated links here. Nor did they adjust any of their loan commitments to reflect potential credit market issues.

So what can we say about Lehman's 3Q07? I think Kevin Depew put it best:

Bottom Line: The standoff continues as Lehman pulls back the curtain to reveal the fact that there's a curtain hiding the earnings wizard. Thanks!

Morgan Stanley (MS)
On to Morgan Stanley - the company's earnings dropped 17% to $1.44 a share, compared to $1.75 a share in the year-ago period. Analysts polled by Thomson Financial had expected the firm to earn $1.54 a share in the quarter. Revenue at the firm rose 13% however loan write-downs in the quarter cost it $940 million. The company stated that:

losses of approximately $940 million (were) due to the marking-to-market of loans as well as closed and pipeline commitments. These losses reduced third-quarter earnings per share from continuing operations by approximately 33 cents a share. The markdowns reflect the illiquidity created by current market conditions."

A little more transparency here. Morgan Stanley also noted that the current difficulties in credit markets will take a couple of quarters to work through.


Bear Stearns (BSC)
Earnings slumped 61% to $1.16 a share, down from $3.02 a share, earned in the same period a year earlier. Net revenue declined 37% to $1.33 billion. On average, analysts polled by Thomson Financial had been looking for the company to generate earnings of $1.78 a share on revenue of $1.64 billion. Bear Stearns said fixed-income net revenue plummeted 88% to $118 million in the latest quarter.

Roughly $450 million of Bear's $700 million write-down came from cuts in the value of mortgage assets such as MBS and collateralized debt obligations (CDOs), with the other $250 million of Bear's write-down was related to commitments that the bank made to finance leveraged buyouts and other debt-fueled acquisitions.

The company still had $7.6 billion of leverage finance commitments at the end of August, down from $20.8 billion at the end of May.

Like all the other brokers Bear experienced strong growth in trading income as expected given the volatility in financial markets. The company also said it had upped it's share-repurchase program from $2 billion to $2.5 billion.

In other news Bear Stearns sought a stay of proceedings to appeal the bankruptcy ruling that went against them on Aug. 30. Remember Bear tried to claim bankruptcy in the Caymans as a foreign entity thereby gaining exemption from US creditors.

Thankfully the judge recognized the brazenly fraudulent act and ruled against them. Bear must file for bankruptcy before the end of this month but will get a hearing on September 24th to appeal the decision. Hopefully the judge throws it out with the contempt it deserves.

Then the lawsuits can begin. How much are they liable for? A number totaling in the billions of dollars no doubt. Such lawsuits could present far bigger problems than faltering earnings. A buyout or even Chapter 11 is still very much a possibility for BSC.


Goldman Sachs (GS)
The market darling didn't disappoint posting earnings of $6.13 a share for 3Q07, up 88% from $3.26 a share in the year ago period. Analysts polled by Thomson Financial had, on average, expected Goldman to earn $4.35 a share. The result including a $900m gain from the disposal of Horizon Wind Energy.

Goldman said in its earnings commentary that "significant losses" on subprime loans and securities were more than offset by gains on short mortgage positions. Credit products included a loss of $1.71 billion, or $1.48 billion net of hedges, related to non-investment grade origination activities.

The firm said it wrote down about $1.5 billion of leveraged buyout loans, net of hedges and fees.

The firm also said it wrote down some mortgages, but that was offset by gains from short positions, or bets that the value of mortgages would fall.

The bank said that at the end of the third quarter it had about $42 billion in unfunded leveraged loan commitments on its books, and about $10 billion of unfunded commitments.

Goldman said revenues from its financial advisory business grew 64% in the quarter, and helped generate record revenue of $2.15 billion in its investment-banking unit whilst the company commented that merger and acquisition activity remained strong.

In othe news on Friday Goldman and KKR abandoned their $8 billion takeover of Harman International Industries Inc., maker of Infinity and JBL audio equipment, citing a decline in the firm's performance.

The sale agreement would require the buyers to pay the company a so-called break-up fee of $225m should they refuse to proceed with the transaction, unless they can show a severe decline in the company's business. Obviously Goldman and KKR are trying to weasle their way out of this one on that basis. Expect more of this type of behaviour as more deals fall over.

What does it all mean?
Two companies were worse than expectations while the other two were better. A couple of points to bear in mind. Whilst MS gave the most candid assessment of the medium term outlook no-one was willing to give any solid guidance going forward.

It may have sounded strange that Goldman announced strong M&A activity given that LBO activity has all but dried up. However remember that the fiscal 3rd quarter for these companies covers June, July and August. Two of those months saw business as usual. Problems didn't really kick until August.

4Q07 results will be more interesting to see how these companies do in a more subdued M&A and structured credit environment. Also of note is that whilst GS earnings growth looks impressive, their 3Q06 number was quite low at $3.46 which subsequently jumped to $7.01 per share in 4Q07. I suspect it will be a lot tougher for GS to post earnings growth of any kind in 4Q07.

Last week I posed the question "Is the Commercial paper purge over?" The answer would seem to be, not quite. Whilst not reaching the same levels of the month of August where an average of more than $70 billion per week of Commercial paper disappeared. A still size-able $48 billion was not rolled over in the week to September 19th.

The biggest move was in Financial paper which lost -$32 billion, Asset backed paper lost a further -$15.6 billion while Non- Finanical paper was virtually unchanged losing -$0.9 billion.

Since the peak at the end of July a total of $356 billion had been wiped from the Commercial paper market. To put this in perspective the market for Commercial paper has been reduced to the levels of September 2006. Not a disaster by any means.

Of more interest is where the weaker players that have been forced out of the market go to get funding? Wherever they go you can bet that they won't receive as attractive terms that they have enjoyed in recent times.

Building permits & Housing starts still tumbling

Starts of new homes fell by 2.6% to a seasonally adjusted annual rate of 1.331 million, which was the lowest since June 1995. Authorized building permits, meanwhile, fell by 5.9% to a seasonally adjusted annual rate of 1.307 million, also the lowest since June 1995.

Remember that these numbers are volatile and subject to large sampling and other statistical errors. In most months, the government can't be sure whether starts increased or decreased. Large revisions are common.

Permits are generally considered a better indicator of building fundamentals than starts, which can be heavily influenced by weather conditions. The sampling error on permits is also lower.

These numbers coupled with yesterdays figures on foreclosures and builders sentiment simply confirm that there is more pain to come in the housing market.

Housing outlook continues to look grim

In case you missed it amongst the euphoria of helicopter Ben's antics, homebuilders confidence fell to it's lowest level ever.

The NAHB/Wells Fargo housing market index fell two points in September to 20, matching the all-time low for the index set in January 1991. The index, which gauges builder sentiment, dates back to 1985.

Numbers over 50 indicate more builders think conditions are good than think they are bad. So at 20, approximately one fifth of the builders say the housing market is good. As I expressed last month I'm surprised anyone thinks the housing market is good.

If that wasn't enough to dampen your enthusiasm, how about the fact that nearly a quarter of a million foreclosure filings were reported in August, up 115% from a year ago and up 36% from July. James Saccacio, chief executive for RealtyTrac had this to say:

"The jump in foreclosure filings this month might be the beginning of the next wave of increased foreclosure activity, as a large number of subprime adjustable-rate loans are beginning to reset,"

You better believe it is James. If you'd like to hear a not very upbeat interview with Rick Sharga of RealtyTrac click here.

Bernanke put invoked

Ben Bernanke rode to the rescue in his shiny federal reserve helicopter lobbing cheap money at idiots who don't deserve it. If there was any doubt about Bernanke's priorities there isn't now. Save Wall street not Main street.

The stock market rallied more than 2% while the ass fell out of the dollar. The dollar index, which tracks the greenback against a basket of six major currencies broke below a 15-year low and dropped to 79.170, down from 79.645 before the announcement.

Years of academic study and tutelage under easy Al has led Bernanke to decide that the solution to the problem of an excess of cheap money is more of the same.

Again the Fed's decision highlights just how far behind the curve they are. From less than 2 months ago where the chief concern was inflation to a 50 bp cut in the fed funds rate to prop up an ailing economy.

The short term rally in the stock market was to be expected. However that will be short-lived. Housing continues to tank, employment is in doubt and corporate earnings are slowing. None of this has changed. If the consumer wasn't stretched enough already now they will have to contend with higher prices as the dollar sinks.

Greedscam passes the buck

From marketwatch.com:

Greenspan: Efforts to get mortgage rates up failed Ex-Fed chief says he's not to blame for subprime mess

WASHINGTON (MarketWatch) -- Former Federal Reserve Board chairman Alan Greenspan says he tried to raise mortgage rates to head off a housing bubble, but the effort came to naught because of "global forces" that had the effect of keeping long-term interest rates low.

In an interview early Monday with NBC News's "Today Show," Greenspan said he does not accept blame for the nation's housing bubble.

He noted that 20 to 30 other countries have experienced housing bubbles, adding that these were "all caused by the same thing, this global sharp decline in long-term interest rates, specifically mortgage rates.

"We tried to get mortgage rates up. We failed. The reason we failed is global forces are overwhelming," he said.

Less than 2 years out of office and already Greedscam has turned into a revisionist. I doubt reasonable people would lay the blame for the housing bubble squarely at Greenspan's feet but you would expect him to at least acknowledge his role in the process.

Mysterious global forces were to blame, not central banks facilitating massive doses of cheap credit via a prolonged period of artificially low interest rates. Well I'm glad that's been solved, now we can all sleep better knowing the truth.

Will the Fed cut? By how much?, Will it matter?

In short, Yes, 0.25% and No.

The consensus seems to have moved from "Will they cut?" To "How much?" Bernanke wants to carve out a different image than easy Al and he still has one eye on inflation so a 0.25% cut leaving the door open for more is the most likely scenario IMHO.

As to the question of will it matter, an unequivocal 'NO' apart from a short term effect on market sentiment. As mentioned before the Fed will prove how irrelevant they are.

I'm becoming addicted to John Hussman's Monday scribblings. Absolutely great stuff, not because I agree with most of what he says but because he talks common sense and backs it up with well researched evidence. In today's column he succinctly spells out why a Fed rate cut matters:

The Fed: Magical Fairies and Pixie Dust

Wall Street continues to hold its breath about the upcoming decision by the Federal Reserve. There's no question that the Fed's decision will have a market impact. This is not because Federal Reserve operations matter, but because investors believe they matter.

The Fed is, at best, a square-dance caller - the guy who by mutual consent gets to holler out when to swing your partner and when to do-si-do. The Fed provides coordination, but it is a mistake to think it has power. When the barn is on fire and people no longer find it in their best interests to follow along, you can bet they'll dance to their own tune (as we're starting to see in the Eurocurrency market, where LIBOR has significantly diverged from the Fed Funds rate being "called out"). The Fed can provide a modest amount of liquidity to the banking system, but it can't provide solvency to the mortgage market. It's dangerous to believe that a reduction in the Fed Funds rate or the Discount Rate will materially change credit conditions here.

Still, we'll all be gathered there under Ben's helicopter on Tuesday, hoping for a sprinkling of magical pixie dust.

Off to Neverland!

Now that may not seem to be backed up by a lot of well researched evidence. For that you need to click on the heading for the full article. The reason I haven't reproduced the whole article is because Hussman has a reprint policy whereby only a couple of paragraphs can be re-printed and I've decided to respect that.

In a nutshell the Fed funds rate is the overnight rate at which banks lend their excess reserves to each other. This amounts to a few billion dollars, then add a few billion more for funds the Fed lends at the discount window. Then compare those few billions to the $13.8 trillion US economy with $6.3 trillion in loans of which $3.4 trillion are real estate loans and you'll see why the Fed is largely irrelevant.

Retail Sales sluggish but not yet recessionary

From marketwatch.com:

Retail sales rose 0.3% in August, led by a 2.8% increase in auto sales, the Commerce Department said Friday. Excluding motor vehicles, sales fell 0.4%, the biggest decline since last September.

Sales were slightly weaker than expected, but an upward revision to July's figures to a 0.5% increase put the level of sales closer to expectations.

In a nutshell strong auto sales carried August retail sales. The number is not terrible but neither does it instill confidence. Why were auto sales so strong?

Heavy discounting seems to have been at work. This would also account for the contradiction between the strong same store sales growth at big chain retailers and the surprising weakness in categories like apparel which fell 0.1% in August according to today's report. For more info on discounting see this post over at THE BIG PICTURE.

Also of note yesterday was the first decline in manufacturing output in 6 months. Manufacturing fell 0.3% driven by - surprise, surprise, a 2.6% decline in automotive production. What does that tell you? Obviously auto makers had pent up inventory which they successfully shifted in August via heavy discounting.

How long can retailers continue to discount heavily? Who knows, however the longer they continue to do so the more it will affect margins and therefore earnings. In other news consumer sentiment was virtually unchanged from a month ago rising slightly to 83.8 from 83.4.

The consumer spending shoe has not dropped but it is definitely experiencing some slippage. It will be interesting to see what effect Fed rate cuts will have on consumer confidence as they contend with a worsening housing market, an increase in mortgage resets and looming higher gas prices with oil piercing $80 a barrel.

CFC - just another $12 billion to tide us over

So that brings the grand total to $25.5 billion in extra funding that CFC has secured in the last 4 weeks. There was the existing credit facility of $11.5 billion, then the paltry $2 billion from BAC and now another $12 billion.

No doubt CFC has now been banished from the exclusive club of commercial paper issuers and has had to look elsewhere for funding. Will this be enough? Who knows but things must be tough.

In Another sign of the times CFC announced that August mortgage loan fundings fell 17% from a year earlier with average daily applications dropping 12% to $2.3 billion. However the following was the most interesting of CFC's recent revelations:

While Countrywide's residential lending business is retrenching - also seen by its plan to cut up to 12,000 jobs, or 20% of its work force - the firm's commercial segment isn't. The company said commercial real estate funding volume nearly tripled in August from a year earlier to $757 million.

Banking on the continued strength of the Commercial Real estate market is a risky prospect given that it usually follows the residential real estate market. Why would a market that has been fueled by easy credit and an absence of risk considerations be immune to a repricing of risk and tighter credit? The short answer is, it wont be.

Commercial Paper purge over?

The evaporation of Commercial paper seems to have subsided with the latest figures released by the Federal Reserve showing that during the week to September 12th the total value of Commercial paper outstanding fell just -$8.2 billion. That compares to an average of more than $70 billion per week for the previous 4 weeks.

Financial Paper rose actually rose $11.1 billion whilst Non-Financial paper rose $2.2 billion. However Asset Backed paper dropped -$21.6 billion. Still that compares favorably to the previous 4 weeks that saw an average of $54 billion per week wiped from the Asset Backed paper market.

Tony Crescenzi - a very knowledgeable guy, noted that investors have already pushed out the weakest issuers by refusing to roll over their paper and that the commercial paper that remains is from a relatively more respected crop of issuers.

He also noted that the latest figures may ease pressure on banks, which have been funding companies that can't sell commercial paper. That may also reduce interbank lending rates such as the London interbank offered rate, which last week rose to the highest since January 2001.

Beginning of the end for Commercial Real Estate?

Michael Shedlock has an interesting post over at MGETA containing a series of articles on the state of the Commercial Real Estate market. As noted before Commercial Real Estate along with Consumer Spending will be last shoes to drop signaling a recession. Click on the link below for the full post.

Global Real Estate Abyss

Economists hedge their bets

When it comes to forecasting economists have a woeful track record. If economists were held to the same standards as physicians they would be mired in malpractice suits. To be fair we shouldn't expect much of such a speculative area of investigation. However the primacy Economics is given in our society today leads us to expect more from the profession.

Now that little rant is out of the way The Wall Street Journal did an article on economists views on the likelihood of a US recession. If you click on the above link you can also watch Kelsey Hubbard of marketwatch.com interview David Wessel, global economics editor for the WSJ.

The 50 or so market forecasters surveyed put the percentage chance of a US recession at 36% up from 28% a month ago. 11 of the 50 put the chance of a recession at 50% or more whilst 9 put it at less than 30%. The forecast ranged from 5% to 90%.

I have a question. What happens if the US economy goes into recession and someone had forecast a 40% probability that it would occur, does that make them 40% right and 60% wrong? How about if you gave recession a 10% chance 6 months out from it happening but a 90% chance 6 weeks before it started? Do we take a weighted average over time?

I enjoy most of what Barry Ritholtz at THE BIG PICTURE has to say but I had to chuckle the other day when he announced, like he was a market maverick, that he'd upped his chance of recession to 65%. Oooh go out on limb why don't ya Barry.

An economy either goes into recession or it doesn't. It's never 40% in a recession and 60% not in one. If you haven't made a definitive call at least 6 months out from the official start of a recession you are sitting on the fence in my book and can't be credited with a correct call even if you had it pegged at say 65%.

Optimistic Chuckle-heads at the NAR

The National Association of Realtors (NAR) issued their 7th straight downward revision to existing home sales yesterday. NAR now see existing home sales in 2007 at 5.92 million units. Remember Goldman Sachs (GS) just downgraded their estimates for 2007 to approximately 5.77 million units.

However this is the real kicker, the NAR is predicting existing home sales to rebound in 2008 by 5.8% to 6.28 million units. In contrast GS sees 2008 existing home sales falling to around 4.9 million units - a rather large difference of 22%.

In addition the NAR optimistically sees median house prices rising 2.2% next year whilst just about everyone else in the market is expecting outright price declines across most of the country. Absolute chuckle-heads.

Calculated risk had an amusing post comparing the headlines of NAR's monthly reports since December 2006. If the NAR were to come clean and be honest next month's headline would read something like, "Actually we haven't got a clue."

Moody's, tell us something we don't know

A stunning revelation by Moody's, from marketwatch.com:

Corporate defaults to surge, Moody's says
Credit crunch cuts off access to borrowing for weaker companies

SAN FRANCISCO (MarketWatch) -- The credit crunch has cut off access to borrowing for many weak companies, which will trigger a surge in corporate defaults, rating agency Moody's Investors Service said Tuesday.

What began as a subprime mortgage problem earlier this year has spread across other credit markets. Investors are still willing to lend money to financially stronger companies, but demand for new debt issued by less creditworthy firms has been "largely wiped out," Moody's said in a report.

Few companies have struggled to repay debt in recent years, mainly because booming credit markets allowed weak businesses to get rescue financing to avoid bankruptcy. However, this summer's credit crunch has changed all that, Moody's said.

"Going forward ... many more weak companies will be unable to obtain new financing and will default either when debt maturities come due or when they run out of cash," the agency said.

The default rate among U.S. speculative-grade companies will more than double to 4% during the next year, Moody's predicted.

Homebuilders, auto makers, retailers and consumer durable companies may be most affected, Moody's said. Many companies in these industries have been acquired in leveraged buyouts in recent years and have borrowed a lot of money in the process, the agency said.

"The bumper crop of highly leveraged new issuance in 2006 and 2007 expanded the number of these low-rated, highly leveraged issuers to a record level," Moody's said. "We expect defaults to rise substantially among the large population of companies that have been aggressively financed with less than two times EBITDA/interest coverage and little or no free cash flow."

True to form the ratings agencies are well behind the curve pointing out the obvious well after the fact. Of course companies that need to continually borrow just to stay afloat are going to implode in the current environment and rightly so. A quick look at the Mortgage Lender Implode-O-meter is all you need to confirm that.

Is it any surprise that companies can't roll over their short term paper with corporate credit spreads widening and a complete aversion by market participants to riskier issues?. No, and besides, any business that needs to continually borrow just to stay afloat is not a business worth being in - as more will find out in the months ahead.

How low can CFC go?

The geniuses at Bank of America (BAC) who negotiated and $18 conversion price for the CFC stake must be feeling a little silly as CFC plunged to an intra-day low of $16.18 before closing at $16.88.

At least they have their 7.25% return on the investment, or do they? Of more concern to BAC would be the ability of CFC to pay the $145m of interest on BAC's $2 billion injection after yesterday's revelation that CFC is seeking more funding.

Countrywide Financial Corp. is putting together another multi-billion dollar bailout plan as the nation's largest home lender continues to struggle amid the global credit crunch and declines in the housing market, The Post has learned.

Sources familiar with Countrywide's plans said the lender continues to work with Goldman Sachs and law firm Wachtell Lipton Rosen & Katz to structure another strategic investment similar to the deal Bank of America struck last month.

It's unclear at this point who exactly is involved in the investment, but sources said a group that could include J.P. Morgan and Citigroup as well as several hedge funds has expressed interest in Countrywide.

A final deal could be announced by the end of the month, sources said.

Last month, Bank of America paid $2 billion for a new series of non-voting preferred stock in Countrywide, which provides an annual dividend of 7.25 percent and can be converted into common stock at $18 per share. As part of the deal, Countrywide left the door open to issue additional preferred stock or convertible preferred stock.

"Countrywide is in desperate need of cash right now to continue funding mortgages and the credit markets are still largely closed to them," said one source familiar with the company.

Countrywide's chief executive Angelo Mozilo, who announced plans last week to eliminate as many as 12,000 jobs, said recently that interest rate cuts by the U.S. Federal Reserve won't be enough to revive home sales and warned that the U.S. economy is headed for a recession.

"The issues the economy is facing are worse than most people believe," Mozilo said in an interview last Friday with Bloomberg News. Mozilo has been pushing for the government to allow Fannie Mae and Freddie Mac to finance bigger home loans.

Countrywide, which handles one of every five new U.S. mortgages, has been hurt by falling home prices and record foreclosures. The company has billions in medium-term debt coming due in about 90 days and needs to cash to continue operating.

Countrywide's stock plunged by over 5 percent yesterday after analysts at Merrill Lynch and UBS cut their profit estimates on worries over the company's ability to make new loans. The stock, which has fallen over 59 percent this year, closed at a four-year low of $17.21 yesterday.

Making matters worse, Alliance Capital Management, which is owned by giant French insurance company Axa SA, disclosed that it has sold about 31 million shares of Countrywide in the last month. Barclays Global Investors has also sold nearly 25 million shares.

"We think the stock will continue to drift down, as investors lose hope of a near-term recovery," said Merrill analyst Kenneth Bruce. He estimates that the job cuts could save Countrywide roughly $1 billion a year, but that will only offset lower revenues.

A few weeks back I posed the question, How much is enough? It seems that an $11.5 billion credit facility plus an additional $2 billion from BAC isn't enough.

Surely without Wall Street's help CFC would be well on it's way to filing for Chapter 11. Wall Street doesn't want to see the country's biggest mortgage lender go down as that would be an enormous blow to confidence which is hanging on by a thread as it is. It would also be an admission of how bad things really are.

So how far is Wall Street willing to go to prop up CFC? It seems they'll go as far as it takes. However at some point Wall Street may realize that catching knives is a dangerous business. Given Wall Street's commitment we probably won't get there but expect CFC stock to get cheaper before things get better.

WM loan losses to reach $2.2 billion in 2007

From Marektwatch:

NEW YORK (Dow Jones)--Washington Mutual Inc. (WM) Chief Executive Kerry Killinger warned Monday that the company anticipates a continued rise in bad loans, which will take a toll on WaMu's earnings.

Killinger, speaking at a financial-services conference, said the Seattle-based thrift will set aside as much as $2.2 billion this year to cover potential loan losses. That is $500 million more than WaMu predicted as recently as July.

Killinger also cautioned that WaMu will book lower gain-on-sale income from selling mortgage loans instead of keeping them on the company's balance sheet.

Killinger offered a bleak outlook for the state of the housing industry nationwide. "Most housing markets appear to be weakening to us," he said, adding that there could be declines in housing prices around the country over the next few quarters.

Amid weakening housing prices and other factors, Killinger said, WaMu could face "a higher level of charge-offs for the foreseeable future." Nonetheless, Killinger said the company has opportunities to profit from the mortgage-industry wreckage by, among other things, boosting its market share

How does that compare to WM's loan loss provisions over the past few years? Take a look at the chart below. This can only be described as a massive increase in loan loss provisions. Consider that the provision for FY06 was 2 1/2 times that in FY05 and that FY07 is going to be another 2.7 times 2006 levels.

What impact will this have on earnings? For 1H07 WM posted Net Income of $1,612m, with $606m set aside for loan losses. That leaves $1,600m of loan losses to be provided for in the second half - a full $1 billion more than 1H07. Using 1H07 Net Income as a proxy for 2H07 that would mean Net Income of approximately $600m or a FY07 total of approximately $2,200m.

Given the state of housing market and the comment from Killinger about booking lower gain-on-sale income from selling mortgage loans instead of keeping them on the company's balance sheet, 2H07 could be substantially lower than that estimated above.

Still, giving the company the benefit of the doubt of a $2,200m bottom line for FY07 below is what WM's Net Income profile will look like.

Ouch! Looking further ahead, given that housing is expected to drag in FY08 and comments from WM's CEO that WaMu could face "a higher level of charge-offs for the foreseeable future," FY08 is shaping up as another year of profits well below those recorded in the years between 2003 - 2006.

Again, this is another example of a company that has enjoyed a period of abnormally high profits and is about to undergo a step change downward in earnings over the medium term. The only thing missing from this picture is an announcement of job cuts, expect that to be forthcoming over the next few months.

B of A's bargain is no bargain

A couple of weeks ago I posted on Countrywide Financial (CFC) expressing the belief that Bank of America Corp's (BAC) $18 a share redemption price for CFC stock was not the bargain it appeared to be. Just two weeks after that shrewd investment it seems anyone can pick up CFC stock for $18 a share and I suspect in the coming months you'll be able to get a better deal than BAC did.

Last Friday CFC announced job cuts of between 10,000 - 12,000 equating to approximately 20% of their workforce and in addition announced that origination volumes would fall 25% in 2008 from 2007. Remember 2007 profit is going to be significantly lower than 2006 before any asset write-downs and now we can expect 2008 to be lower still.

Just a couple of weeks ago CEO Angelo Mozillo stated that there was significant opportunity for Countrywide to gain market share in the consolidating prime mortgage space. However the point is that it will be a larger market share of a much smaller market.

I've said it before but it's worth reiterating, CFC's earnings in recent years are an aberration brought about by the housing bubble. They are not sustainable or even normal and may not return to these levels for a long time if at all. Whilst CFC may be the extreme case other companies in the financial sector are in the same boat.

The mistake investors make will be to think that post the current credit and housing crisis profits will return to previous levels and continue their upward march. However like all bubbles the earnings bubble needs to be deflated - that process is already underway. What hasn't been deflated yet are investors expectations and the longer they continue to ignore the signs the nastier the surprise will be.

The Employment shoe drops

From the Bureau of Labor Statistics (BLS):

Nonfarm payroll employment was essentially unchanged (-4,000) in August, and the unemployment rate remained at 4.6%, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Over the last 3 months, total payroll employment changes have averaged 44,000 per month and private sector employment changes have averaged 72,000 per month (as revised). In August, employment in manufacturing, construction, and local government education declined, while job growth continued in health care and food services.

Well that took everyone by surprise. Wednesday's weak ADP report suggested Non-farm payroll growth of around 60 - 65k and with the controversial birth/death adjustment who really knew where the number would be?

However not even the B/D adjustment could make the overall number look good with NFP's dropping for the first time in 4 years. Some sizeable revisions to June and July have had a meaningful impact on the employment trend.

As shown below the June figure was basically halved whilst one quarter of the jobs originally estimated in July were also revised away. As the opening paragraph to the BLS report states the running 3 month average stands at 44,000 jobs per month. Prior to this report the monthly average for this year was running between 130 -135k per month. Last year job creation averaged about 190k per month.


Are we seeing a downward step change in job growth? I believe we are. The ADP report was pointing the way last month with private sector growth of 48k and backed it up with 38k this month. Clearly the BLS data was behind the curve but now that revisions have come through the trend change is clearly visible.

I heard the perma-bulls on CNBC suggesting that the August number could be revised back up towards 100k. Well anything is possible but how likely is it? I'd suggest that a revision downward for August is probably more likely next month. Why? Take a look at the chart below which shows the monthly Birth/Death adjustment.

(click on the chart for a larger image)

The B/D adjustment added 120k to job creation in August. Surprising where some of that came from - 15k in construction, must be on the commercial side since the residential side as you may have noticed is not traveling too well. then there is the 11k in Financial activities - this goes in the wtf? category.

Yesterday I mentioned that record numbers of jobs in the financial industry were lost in August. September is not shaping up to be much better with Countrywide announcing between 10 -12k in job cuts yesterday undoubtedly with more to come from others in the industry. Not to mention the small matter of the 150 mortgage business that have gone belly-up in the last 12 months. Expect some downward revisions to financial services jobs in the months ahead.

The employment shoe is a big one and it has now dropped. The retail shoe has been looking a bit worn but has yet to fall off. When that happens, and it will, the dirty 'r' word will be back it vogue.

If the Fed needed an excuse to cut interest rates it definitely has one now. The question seems to be by how much will they cut? It don't think it matters, what the Fed does from here won't stop the forces that are already in motion.

Commercial paper market continues to evaporate

(click on chart for a sharper view)

The above graph courtesy of Federal Reserve website shows that a large portion of the Commerical paper market is disappearing. It the week to Sepetember 5th another $54 billion of Commerical paper was wiped away, $31 billion of that paper was of the Asset Backed variety.

The total amount of Commercial paper outstanding peaked late July at $2,225 billion, the total outstanding now stands 13.5% lower at $1,925 billion.

Asset Backed Commercial Paper (ABCP) represents around half the total however that percentage is diminishing. Total outstanding ABCP peaked early August at $1,183 billion, as at September 5th total ABCP outstanding stood at $967 billion, an 18.3% decrease.

This is one of the reasons why Nouriel Roubini of RGE monitor argues that what we have seen since early August is more than a straightforward liquidity crisis. Roubini argues that what we are seeing is an insolvency crisis. This following is an excerpt from Roubini's blog on August 9th:

Today we do not have only a liquidity crisis like in 1998; we also have a insolvency/debt crisis among a variety of borrowers that overborrowed excessively during the boom phase of the latest Minsky credit bubble.


First, you have hundreds of thousands of US households who are insolvent on their mortgages. And this is not just a subprime problem: the same reckless lending practices used in subprime – no downpayment, no verification of income and assets, interest rate only loans, negative amortization, teaser rates – were used for near prime, Alt-A loans, hybrid prime ARMs, home equity loans, piggyback loans. More than 50% of all mortgage originations in 2005 and 2006 had this toxic waste characteristics. That is why you will have hundreds of thousands – perhaps over a million - of subprime, near prime and prime borrowers who will end up in delinquency, default and foreclosure. Lots of insolvent borrowers.


You also have lots of insolvent mortgage lenders – not just the 60 plus subprime ones who have already gone out of business – but also plenty of near prime and prime ones. AHM – that went bankrupt last week – was not exposed mostly to subprime; it was exposed to near prime and prime. Countrywide has reported sharp losses not only on subprime lending but also on prime ones. So on top of insolvent households/mortgage borrowers you have plenty of insolvent mortgage lenders, subprime and - soon enough - near prime and prime.


You will also have – soon enough – plenty of insolvent home builders. Many small ones have gone out of business; now it is likely that some of the larger ones will follow in the next few months. Beazer Homes – a major home builder - last week had to refute rumors of its impending insolvency; but so did AHM a few weeks before its insolvency. With orders for home builders falling 30-40% and cancellation rates above 30% more than a few home builders will become insolvent over the next year or so.


We also have insolvent hedge funds and other funds exposed to subprime and other mortgages. A few – at Bear Stearns, in Australia, in Germany, in France – have already gone bankrupt or are near bankrupt. You can be sure that with at least of $100 billion of subprime alone losses – and most losses are still hidden given the reckless practice of mark-to-model rather than mark-to-market - many more will go belly up. In the meanwhile the CDO, CLO and LBO market have completed closed down - a “constipated owl” where “absolutely nothing moves” the way Bill Gross of Pimco put it. This is for now a liquidity crisis in these credit markets; but credit events will occur given that the underlying problem was not of of liquidity but rather one of insolvency: if you take a bunch of to-be-defaulted subprime and near prime mortgages and you repackage them into RMBS and then these RMBS are repackaged into various tranches of CDOs, the rating agencies may be using magic voodoo to turn those junk BBB- mortgages into AAA tranches of CDOs; but this is only voodoo as the underlying assets are going to be defaulted on.


Moreover, the recent sharp widening in corporate credit spreads is not just a sign of a liquidity crunch; it is a sign that investors are realizing that there are serious credit/solvency problems in some parts of the corporate system. Ed Altman, a colleague of mine at Stern, is recognized as the leading world academic expert on corporate defaults and distress. He has argued that we have observed in the last few years record low default rates for corporations in the U.S. and other advanced economies (1.4% for the G7 countries this year). The historical average default rate for US corporations is 3% per year; and given current economic and corporate fundamentals the default rate should be – in his view - 2.5%. But last year such corporate default rates were only 0.6%, i.e. only one fifth of what they should be given firms' and economic fundamentals. He also noted that recovery rates - given default - have been high relative to historical standards.


These low default rates are driven in part by solid corporate profitability and improved balance sheets. In Altman’s view, however, they have also been crucially driven - among other factors - by the unprecedented growth in liquidity from non traditional lenders, such as hedge fund and private equity. Until recently, their demand for corporate bonds kept risk spreads low, reduced the cost of debt financing for corporations and reduced the rate of defaults. Earlier this year Altman argued that this year "hot money" from non traditional lenders could move to other uses for a number of reasons, including a repricing of risk. If that were to occur, he argued that the historical patterns of default rates - based on firms’ fundamentals - would reassert itself. I.e. we are not in a new brave world of permanently low default rates. He said: "If we observe disappointing returns to highly leveraged and rescue financing packages, some of the hedge funds may find it difficult to cover their own loan requirements as well as the likely fund withdrawals. And broker-dealers who are not only providing the leverage to the hedge funds but whom are also investing in similar strategy deals will recede from these activities." The same could be said of the consequences of the unraveling of some leveraged buyouts. Altman suggested that triggers of the repricing of credit risk could also be "disappointing returns to highly leveraged and rescue financing packages". So he argued that the unraveling of the low spreads in the corporate bond market could occur even in the absence of changes in US and/or global liquidity conditions.


Thus, until recently the insolvent firms in the corporate sectors included corporations that could service their debt only by refinancing such debt payments at very low interest rates and financially favorable conditions. Many firms, under normal liquidity conditions, would have been forced into distress and debt default (either of the Chapter 7 liquidation form or Chapter 11 debt restructuring form) but were instead able to obtain out-of-court rescue and refinancing packages because of the most easy credit and liquidity conditions in bubbly markets. Now that we are observing a liquidity and credit crunch and a vast widening of credit spread you will observe a sharp increase in corporate defaults and a further risk in corporate risk spreads.


Insolvent and bankrupt households, mortgage lenders, home builders, leveraged hedge funds and asset managers, and non-financial corporations. This is not just a liquidity crisis like in the 1998 LTCM episode. This is rather a liquidity crisis that signals a more fundamental debt, credit and insolvency crisis among many economic agents in the US and global economy. Liquidity runs can be resolved by the liquidity injections by a lender of last resort: in the cases of the liquidity crises of Mexico, Korea, Turkey, Brazil that international lender of last resort was the IMF; but in the insolvency crises of Russia, Argentina, and Ecudaor the provision of the liquidity by the lender of last resort – the IMF – only postponed the inevitable default and made the eventual crisis deeper and uglier. And provision of liquidity during an insolvency crisis causes moral hazard as it creates expectations of investors’ bailout. Thus, while the Fed and the ECB had no option today but to provide massive liquidity in the presence of a most severe liquidity crunch and run, they should not delude themselves that this liquidity injections can resolve the deep insolvency problems of many overstretched borrowers: households, financial institutions, corporates. Insolvency/credit crises lead to financial and economic distress – hard landing of economies – and cannot be resolved with liquidity injections by a lender of last resort. And now the vicious circle of a weakening US economy – with a housing recession getting worse and a fatigued consumer being at the tipping point - and a generalized credit crunch sharply has increased the probability that the US economy will experience a hard landing. We are indeed at a "Minsky Moment" and this recent financial turmoil is the beginning of a much more serious and protracted US and global credit crunch. The risks of a systemic crisis are rising: liquidity injections and lender of last resort bail out of insolvent borrowers - however necessary and unavoidable during a liquidity panic- will not work; they will only pospone and exacerbate the eventual and unavoidable insolvencies.

This is why I believe the Fed will prove how irrelevant they really are in the coming months despite whatever they do to prop up a slowing economy.

US consumer shows resilience in August

I've mentioned a number of times that US consumers are a resilient bunch and that is just what August retail sales show.

U.S. retailers posted a 3.1% gain in same-store sales, better than an original estimate of a 2.5% increase. That compared against a 3.9% advance a year earlier, according to Thomson Financial.

August is the biggest selling month of the back-to-school period, which covers sales from July to September and represents the No. 2 shopping season after the crucial holiday period, said Michael Niemira, chief economist of International Council of Shopping Centers.

Teen retailers posted a 6.5% increase, leading the gain among retail sectors, according to Thomson Financial. More than two-thirds of retailers posted better-than-predicted results, while the rest missed, according to Thomson, which surveyed 45 retailers.

Even Walmart (WMT) beat estimates posting 3% same stores sales growth as opposed to the 1.5% expected by analysts.

Although growth was slightly lower that August last year for the retail industry the numbers are still robust. What is not evident is the extent to which sales were driven by discounts, which can cut into profit. Remember Wal-Mart had cut prices on about 16,000 back-to-school items to drive sales. Gap Inc (GPS) whilst beating forecasts noted that profit margins declined.

"Although merchandise margins were below last year, we're pleased with the progress we're making across our brands," Sabrina Simmons, executive vice president of Gap Inc. finance, said in a statement.

Still it looks as though it's going to take a lot more buffeting from housing and employment to dent the US consumer's enthusiasm.

More on Employment

While everyone will be watching the non-farm payrolls tomorrow, an interesting number came out of the Institute for Supply Management index for August.

The ISM non-manufacturing index was unchanged at 55.8% in August, slightly stronger than the 55.0% expected by economists and indicates expansion in the non-manufacturing sectors of the economy.

The interesting part was the The ISM employment index which dropped to 47.9% from 51.7%, the lowest since February 2003 and the first decline in hiring since July 2004. Only 3 of 18 industries were hiring whilst 8 industries were reducing their workforce.

Any correlation between this number and the news that layoffs jumped 85% in August? I think there could be.

Announced lay-offs surged 85 percent to 79,459 in August from 42,897 in July, according to Challenger, Gray & Christmas Inc, an employment consulting firm. August's job cuts were the highest since February, when they totaled 84,014.

"Nearly half of the August cuts came from the financial sector, as dozens of mortgage and subprime lenders caved under the pressure of a sinking housing market," Challenger, Gray & Christmas said in a statement.

Financial job cuts totaled 35,752 in August, the highest monthly total for the industry since Challenger, Gray & Christmas began tracking in 1993, the firm said.

Now remember what Bernanke said about the Fed looking at the 'timeliest indicators.'

First-time claims for state unemployment benefits fell by 19,000 to 318,000 for the week ending Sept. 1. The drop in claims is down from a revised 337,000 in the prior week, the Labor Department said.

This was the first drop in jobless claims after five straight weeks of increases. Initial claims are at the lowest since the week ended Aug. 4.

Sounds reassuring, or if you aren't convinced that employment growth is not under threat maybe the Fed PR department can help ease your mind.

Federal Reserve officials said Thursday that current economic conditions are good and the financial turmoil hasn't hurt Main Street.

In a luncheon speech to the Atlanta Press Club, Atlanta Federal Reserve President Dennis Lockhart said there are no signs of spillover from the housing and mortgage market woes into other sectors of the economy such as consumer spending.

Lockhart said his comment relied on real-time information from business contacts around the South because much of the new government indicators are "backward looking."

"So far, I have not seen hard or soft data that provide conclusive signs that housing problems are spilling over into the broad economy," Lockhart said.

His remarks echo the sentiment in the Fed's Beige Book report on current economic conditions that found that growth continued across the country at a moderate pace through August with little sign that the credit crunch and financial turmoil have slowed activity.

But in an earlier statement to reporters following a speech in London, St. Louis Fed President William Poole said the risks of recession have risen as a result of the market turmoil. But Poole said, "I don't think we should take for granted that the economy is going to nosedive."
Later in the afternoon, Dallas Fed President Richard Fisher was upbeat about current conditions.

In answer to a question after a speech in El Paso, Fisher said recent economic data has been "rather positive," and pointed specifically to the August ISM services index, which was unchanged at 55.8%.

Fisher said anecdotal reports from throughout his district and across the country point to "a labor shortage." "People are having trouble finding everything from day workers to bank tellers," he said. "The good news is the financial turmoil that we have recently seen came against a background of a very strong economy. I don't see the dynamics of that growth changing overnight."

Well if there is a shortage of mortgage origination specialists maybe they could give Lehman Bros. a call since they have now cut over 2,000 jobs in past two weeks.

Lehman Brothers Holdings Inc. (LEH) announced a restructuring in its residential mortgage operations that will entail cutting 850 jobs and shuttering its Korean operations.

The move comes as the Wall Street brokerage - along with numerous other mortgage lenders, underwriters and investors - adjusts to the ongoing turmoil in the credit markets, caused by sharp climbs in subprime mortgage delinquencies and foreclosures. That has caused a sharp curtailment in investor demand for mortgages and mortgage-backed securities.

Lehman, a leader in Wall Street firms' push to have their own home-lending business, said it is cutting back its U.S. and U.K. operations "due to market conditions and product revisions." Two weeks ago, Lehman shut down its subprime-lending division, resulting in a loss of 1,200 jobs, or 4.2% of the company's total work force.

Whatever the BLS plucks out of the air for it's birth death adjustment tomorrow I doubt it will be enough to disguise the downward growth trend in employment.