Monday, 31 March 2008

XAO Declines For 5th Straight Month In March

Against the odds I speculated last month that the XAO would decline in March and low and behold it did. The XAO shed 4.7% in the month of March making it the fifth straight decline in the XAO starting in November 2007. That hasn't happened since the XAO fell for 5 straight months from June to October 1992.

So what will the month of April bring? I have data for the XAO going back 24 years and in that time the XAO has never fallen for 6 consecutive months. I get the distinct feeling that the market wants to have a rally. Especially since the US Federal Reserve is now fully engaged in corporate welfare.

However, I can't help thinking the market is in for a rude shock when 1Q08 earnings season gets underway in the US. Estimates are for about a -6% decline in operating earnings. That was very similar to the forecast going into 4Q07 earnings season and those earnings ended up showing a -32% decline. US banks are in for more pain as writedowns continue and their core businesses come under pressure. Also, expect to hear more tempered protfit outlooks for the rest of 2008 and warnings of a slowing US economy.

On the domestic front, it seems an almost forgone conclusion that the RBA will sit tight on interest rates this week. Economic data will continue to be strong Australia but there are signs that Australia could be headed for marked slowdown over the coming year. A story out today claims that small businesses see a recession coming

Small businesses 'expect recession'

Most small business owners believe the economy will be in recession within three years and, unfortunately, history suggests they may be right.

Click on the link for the full story. By itself that story doesn't mean much but there are increasing signs that business owners are becoming more cautious. Figures from the RBA today showed a slowdown in private sector credit growth in February.

It would seem a tough bet to think that the XAO could pull off something it hasn't in the last 24 years - a sequence of 6 straight monthly declines. However, I've had a lot of success taking the other side of those odds recently so I'll stick my head out and say April will be another down month for the XAO.

Sunday, 30 March 2008

The False Claims and Exaggerations of Permabulls.

There has been a gradual progression in the premabulls line of argument over the last 6 months. Firstly any suggestion that the stockmarket may tank and the economy slide into recession was simply laughed at. Then when negative economic data started coming in the permabulls would counter by pointing at the positive data. Now that there is no positive data they have started to make things up.

Take Don Luskin of Trend Macro and frequent Kudlow & Company contributor. This guy is not stupid, in fact he is articulate and quite often witty. He usually conducts himself in a calm controlled manner, however on occassion he loses it. You can tell when he's on the verge of losing it because he becomes almost hysterical, making wild gesticulations and speaking in a condescending, sarcastic tone.

A great example of that was on Friday 28th March on Kudlow & Company. Luskin, obviously battered from the reality of an ailing economy and stockmarket launched into a tirade about why he is bullish. This is what he managed to spew forth;

"Here's something for your ahhh Kudlow 101 recession watch that I think really tells the story. If we're in recession it probably started in December, if." "We're running you know what, the last payroll jobs report we lost 40 thousand jobs that month and jobless claims are running about 350, 360 thousand." "Normally when you're 3 months into a recession jobless claims are 550 thousand, normally payroll job losses are 250 thousand."

If the above were true I would agree that he has a fair argument in favour of a 'no recession' call. However not only is it not true, it's not even close. Let's take a look at the claim that normally 3 months into a recession intial jobless claims are 550,000 and job losses are -250k.

Luskin's argument rests on the assumption that a recession started in Dec-07 which is not at all clear but let's go along with that assumption for the sake of argument. Below is a table of the last 6 US recessions. Unfortunately I don't have the data on Jobless claims prior to 1980.

The jobless claims number is the 4 week moving average. So for example, the 395,000 number related to the March 2001 recession refers to the 4 week MA of inital jobless claims in June 2001. As you can see the only time it came close to Luskin's claims was in the shallow recession that started in July 1981 with the jobless claims 4 week MA reaching almost 530k 3 months later. The deep recession that started in July 1982 fell just short of the 500k mark whilst the last two recessions in 1991 and 2001 came nowhere near the 550k level Luskin suggests.

Currently the 4 week MA of jobless claims is around 360k so Luskin could have pointed out that jobless claims are running lower than where they normally are at this point in a recession (if it did in fact start in December) but instead he resorted to gross exaggeration.

How about the -250k job loss claim? As you can see from the table above that is not just an exaggeration, it is an outright lie. I've included both the change in non-farm payrolls and the 3 month MA change as the month on month change can be very volatile.

As you can see, in 2 out of 6 recessions shown, payrolls were actually showing gains while in 3 out of 6 the 3 month MA was positive. Payroll losses have never been -200k let alone -250k 3 months into any of the last 6 recessions. Currently payrolls are already in negative territory (Jan -22 Feb -63) and whilst we don't yet have the March non-farm payroll number, the 3 month MA is already negative at -15k.

So whilst jobless claims do look on the low side, changes in non-farm payrolls are bang in the middle of the range of the last 6 recessions. Either Luskin doesn't know the data very well or he is telling outright lies. I suspect it is the latter. He actually remains relatively restrained up to that point but then he really let's go with a very Luskinesque performance. I think I captured it well in the image below.

Funnily enough, after making blatantly false claims, later in the program Luskin accuses John Brown of "throwing numbers around like crazy," more particularly with respect to potential real estate losses. Brown then puts him in his place by pointing out that he got his numbers from the foremost expert on housing, Robert Shiller.

It really is a desperate, sad performance from Luskin. But don't take my word for it. Click on the image below for the entire segment.


Saturday, 29 March 2008

Fifth Consecutive Month of UK Home Price Declines

UK House prices fell -0.6% in March after a -0.5% decline in February. That makes 5 consecutive monthly declines in UK home prices. That has never happened according to the data supplied by Nationwide which began in 1991. From Nationwide:

No bounce in house prices this Easter

• House price growth slows to lowest level in twelve years
• Clear change in consumers’ housing market sentiment
• Outlook more downbeat, but within forecast range
• MPC expected to bring rate cut forward to April

Commenting on the figures Fionnuala Earley, Nationwide's Chief Economist, said:

“House prices fell for the fifth consecutive month in March. The price of a typical house fell by 0.6% during the month, bringing the annual rate of house price growth down to 1.1% - its lowest rate since March 1996. A clear change in sentiment since the late summer has led to the sharp slowing in house price growth, even in the less volatile 3-month on 3-month series. Prices on this measure are now 1.5% lower than three months ago. The price of a typical house in the UK is now £179,110, only £2,027 more than this time last year. However, prices are still 11% higher than two years ago and 47% higher than five years ago - the equivalent of a price rise of more than £30 per day for the last five years.

Last month I said that year over year UK home prices will start to show declines by mid year, that may prove to be overly optimistic. Given the current trend year over year price declines will probably show up next month.

Friday, 28 March 2008

Whitney - A Rude Awakening For US Banks In 1Q08

I've mentioned Meredith Whitey numerous times in recent months. She has been out in front on the problems facing US banks and Brokers. In this interview she says the banks are in for a bad 1Q08 earnings season. Click on the image to watch the interview.

Some points of note, Whitney expects $50 billion in writedowns and $8 billion in additional loan loss reserves for the first quarter from US banks. She believes that Citigroup has to completely eliminate their dividend to preserve capital. Wachovia is also in the same boat. If she's right, and you would be brave to bet against her, you can expect to see some more carnage in the US financial sector in April.

Thursday, 27 March 2008

Another Dose of Comeuppance for US Banks

Another well deserved comeuppance for US Banks came today when a court ruled that the banks involved in providing financing for the Clear Channel Deal have to stump up the cash. From

Judge orders banks to fund Clear Channel buyout

A Texas judge ordered banks to fund the proposed $19 billion buyout of Clear Channel Communications by two private-equity firms, the San Antonio radio broadcaster said in a statement on Thursday.

District Court Judge John D. Gabriel of Bexar County, Texas, granted a temporary restraining order against the banks, Clear Channel (CCU) said.

"He found in favor of Clear Channel's claim that irreparable harm would result if the banks were not immediately enjoined from tortiously interfering with the merger agreement," the company said.

"Accordingly, Judge Gabriel ordered that the banks, among other things, must not 'interfere with or thwart consummation of the merger agreement' by refusing to fund the merger transaction, insisting on terms that are inconsistent with the commitment letter, or refusing to act in good faith in the drafting of definitive loan documents," the company added.

Clear Channel has agreed to be purchased by Thomas H. Lee Partners and Bain Capital. But lenders including Citigroup (C), Morgan Stanley (MS), Deutsche Bank (DB), Credit Suisse (CS), Royal Bank of Scotland (RBS) and Wachovia (WB) have declined to provide the financing that they once said they would issue.

"It seems clear that lenders' remorse set in when credit markets worsened," Bain and Thomas H. Lee said in a statement Wednesday. "Now they are trying to walk away from their commitment letter which clearly states that they bear all the risk that conditions in the debt markets might change."

A spokesman for the consortium of banks wasn't immediately available to comment.
Shares of Clear Channel Communications dropped 17% to $26.92 on Wednesday on concerns the deal wouldn't go through. The offer for Clear Channel is valued at $39.20 a share.

The last thing banks like Citigroup and Wachovia need is to finance deals that no longer make economic sense with capital they don't have. The deal probably never did made any economic sense, as most of them rarely do at the height of LBO mania.

A combination of greed and stupidity made it inevitable that someone was going to be holding the bag when the music stopped. Maybe they should all call the Fed, declare insolvency and get the Fed to pony up the cash, as is the new trend in the United Socialists of America.

Wednesday, 26 March 2008

Whitney Slashes Bank Forecasts Again

Meredith Whitney is taking the knife to her forecasts for bank earnings once again. From

Oppenheimer again cuts estimates on Citigroup, banks

Oppenheimer & Co. analysts led by Meredith Whitney cut their first-quarter profit forecasts for U.S. banks on average by 84%, led by Citigroup Inc. (C) . Whitney increased her first-quarter loss estimate for Citigroup by four times, and expects the company to post a full-year loss of 15 cents a share. She also slashed her outlooks on Bank of America Corp. (BAC) , J.P. Morgan Chase & Co. (JPM) and Wachovia Corp. (WB) to reflect expected write-downs related to mortgages and collateralized debt obligations. "Despite cutting estimates for financials by over 30 times since November, we are confident this will not be our last reduction in 2008," Whitney wrote in a research note. "Rather as key mark-to-market indices trend lower, the housing market worsens, and the U.S. consumer comes under increasing pressure, we anticipate further downside to both estimates and stock prices."

The emphasis in bold is mine. Whilst Whitney may not be done slashing bank earnings forecasts, she is proabably closer to being done than the rest of her industry colleagues.

As I've been saying for months, US bank earnings are going to take a big hit as a fair chunk of their revenue streams have simply dried up. Many are predicting a return to a more normal operating environment for financials in the next 12 months, only problem is, the past 5 years has been anything but normal.

US Home Prices Continue to Tumble

From Standard & Poors:

Record Declines in Home Prices Continued in 2008 According to the S&P/Case-Shiller Home Price Indices

Data through January 2008, released today by Standard & Poor’s for its S&P/Case-Shiller1 Home Price Indices, the leading measure of U.S. home prices, show declines in the prices of existing single family homes across the United States continued into the new year, with 16 of the 20 reporting MSAs posting record low annual declines, of which 10 are in double-digits.

The chart above depicts the annual returns of the 10-City Composite and the 20-City Composite Indices. Both of the composite indices are now reporting annual declines in excess of 10%. The 10-City Composite set yet another new record, with an annual decline of 11.4%. The 20-City Composite recorded an annual decline of 10.7%.

“Unfortunately it does not look like early 2008 is marking any turnaround in the housing market, after the declining year recorded throughout 2007,” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor's. “Home prices continue to fall, decelerate and reach record lows across the nation.

No markets seem to be completely immune from the housing crisis, with 19 of the 20 metro areas reporting annual declines in January and the remaining – Charlotte North Carolina – eking out a benign 1.8% growth rate. Looking deeper into the data, you can see that 16 of the metro areas are also reporting record low annual growth rates. The monthly data show that every one of the MSAs has now declined every month since September 2007, marking five consecutive months. On top of that, the declines have increased through time, in general, as 13 of the 20 MSAs reported their single largest monthly decline in January.”

From their peak, the 10 City index is now off -13.4% whilst the 20 City index is off -12.5%. Whilst that represents the biggest declines in the indexes history, at best, in my humble opinion we are only half way through the full extent of home price declines.

Remember this index is two months old. The latest existing home sales numbers from February released yesterday showed home prices fell sharply, so we can expect to see steeper year over year price declines for at least another month.

What strikes me is that the rate of decline has not slowed. I would have expected the declines to continue but the rate of deterioration to slow. Eventually the year over year declines will slow and ultimately reverse as they did in 1991. However we still have a long way to go before we get to that point.

Tuesday, 25 March 2008

More On The Bottom Callers

Last Friday I posted a piece about, 'bottom callers' siding with comments made by Michael Panzner on Kudlow & Co in which he said;

At bottoms people don't even see them coming and that's the tradition, that's the way markets have worked for hundreds of years. When you have everyone running around now that they see the light at the end of the tunnel it means they see an on-coming freight train.

Barry Ritholtz of the BIG PICTURE picked up on this on Monday.

Bottom Callers Run Rampant

Last week, I questioned the conventional wisdom which claimed that there was Not Enough Bullish Sentiment?

It seemed that there were plenty of Bulls who looked at the 15% pullback in the S&P500 as an ordinary dip-buying opportunity.

In a moderate recession, an 85 day, 15% drop would likely be insufficient to reflect the changes in both growth and earnings -- much less a deeper, more protracted recession.

The counter-argument is that the Fed has flooded so much cash onto the system, the recession no longer would matters.

Looking from a sentiment perspective, its hard to say that the we've seen the sort of fear that typically accompanies a lasting market bottom. There's still plenty of speculative juice around. Consider these headlines from over weekend:

• Barron's: Are You Ready for Dow 20,000 (this year!)
• Vince Farrell on We've Seen Our Bottom
• Barron's cover story: Hitting Bottom? Several Banks and Brokerages Are Ready to Pop Up for Air
• Jim Cramer on An End to the Bear Market? and why this is A Turning Point
Insiders, at Least, See Reason to Smile
• Just about anything at Forbes.

The closest thing to an admonition of caution was Barron's Technical columnist, Michael Kahn, who called this The Market Bottom That Wasn't.

That doesn't mean we can't see a decent bounce here -- there's lots of liquidity, and as we saw last week, the market stopped going down on bad news. That's usually good for a 5-10-15% counter trend rally. We saw that begin last week.

But Dow 20,000 this year? I highly doubt it . . .

Be warned that some of the links above require registration. I highly doubt Dow 20,000 will be reached too. In fact the Dow will be lucky to finish above 12,000 by the end of this year.

Monday, 24 March 2008

One For the Decouplers

Back in November I mentioned the notion of decoupling. Decoupling suggests that the world economy is no longer held hostage to the fortunes of the US economy and therefore would do just fine despite a slowdown in US economic growth. The following article suggests that global grow may not be as healthy as the decoupling theorists anticipated. From

World trade decelerates almost to standstill

Global trade slowed almost to a standstill over the new year, threatening to shrink for the first time since the US economy went into recession in 2001.

An indicator produced by the Bureau for Economic Policy Analysis, a Dutch research institute, showed that in the three months to January world trade in goods rose at annualised rate of 0.2 per cent over the previous three months.

The equivalent growth rate in the three months to October was 6.9 per cent.

"This is a substantial deceleration," the institute said. "World trade volume growth is on a downward trend."

Trade figures tend to be volatile but even on a longer-term smoothed basis, comparing the three-month average with the same period a year earlier, the growth in goods trade is at its lowest since 2003.

The data appear to provide further evidence that global economic activity is slowing, as growth in emerging markets has failed to compensate for weaker demand in the US.

The last time annual growth in trade went negative was in 2001, when the shallow US recession that followed the bursting of the technology bubble and the shock of the September 11 attacks caused global commerce to contract.

Trade growth is consistently higher on average than overall economic growth but it also tends to be more variable, dropping sharply during recessions.

Julian Jessop, chief international economist at the consultancy Capital Economics, said there were one-off factors that might explain the weakness in world trade in recent months, including disruptions to shipping and damage to Chinese trade caused by the winter storms.

However, he added: "Global trade growth tends to do twice whatever global GDP [gross domestic product] is doing, so with the world economy slowing it doesn't surprise me at all that there is a slowdown in trade."

The indicator - which is monitored by economists at the International Monetary Fund and other official bodies - is compiled from official data that are published by both industrialised and emerging market countries.

It covers more than 97 per cent of trade in goods, which itself constitutes more than 80 per cent of total world trade.

The institute said that imports into both the US and European Union fell in the three months to January.

Year-on-year trade growth hit a record high of 9.7 per cent in November 2006, at a time when the US and Chinese economies were both growing briskly.

I'm not suggesting that the US has been solely responsible for bringing global growth to a halt. Europe has been overdue for a pullback as well. However the predominant theme for 2008 will be a recoupling of the rest of the world to that of the US and Europe rather than decoupling.

Friday, 21 March 2008

The Bottom Callers Are Back

One of the biggest contrary indicators that the stockmarket has further to fall is the amount of bottom calling going on in recent days. Maybe I watch too much CNBC but it seems everyone is either saying we have seen the bottom or we are in the process of bottoming. Probably the biggest call recently has been from Dick Bove of Punk Ziegel & Co, from

Bove says financial crisis over, buy banks

The financial crisis is over, giving investors a rare chance to buy bank stocks at attractive valuations, Punk Ziegel & Co. analyst Dick Bove said Thursday. During crises, problems reach a crescendo when even the most optimistic market participants become fearful. That usually prompts government and business to join forces on a big solution that may either work or fail, Bove said.

The collapse and near bankruptcy of Bear Stearns Cos. (BSC) last week was the trigger for the current crisis, pressing President George Bush, Treasury Secretary Hank Paulson, Federal Reserve Chairman Ben Bernanke, President of the Federal Reserve of New York Timothy Geithner and key industry executives into emergency action, the analyst said.

"The actions taken by the Federal Reserve were innovative, dramatic and, in my view, brilliant because they went right to the problem," Bove wrote in a note to clients. "The actions being taken by the Federal Reserve are being mirrored by the Treasury, which now has finally grasped the scope of the problem."

Interest rate reductions and steps to inject more cash directly into the banking system will help banks generate more profit. While most market participants are still worrying about write-downs and falling home prices, investors can now buy bank stocks at their cheapest levels in almost two decades, Bove said.

"The last time an opportunity of this nature existed to buy bank stocks this cheap was in 1990," the analyst wrote. "The next time will be in 20 years. This is a once in a generation opportunity."

I suspect Bove has taken a look at bank stock prices, concluded that they can't go much lower and decided to make a big call. Firstly in an attempt to make a name for himself and secondly to try and repair his reputation after calling Citigroup a buy when it was around $30 (now $22.50) and for repeatedly saying Citigroup didn't need to cut it's dividend. Time will be the ultimate arbiter in deciding whether Bove is a sage or an idiot, I suspect it will be the latter.

Forgive me if I don't share Dick Bove's and CNBC's view of the world. The state of the US mortgage market, where a large part of the problem emanates from, is not getting any better. In fact, according to Fitch ratings (not a very reputable source I know) things are getting worse.

I stole the above slide from a Fitch presentation made yesterday and posted on Minyanville. It shows clearly an acceleration in Alt-A default rates. Let's see what else Fitch had to say:

Fine, but what about the full-court press by government officials to modify loans to prevent foreclosures? Sorry. Glenn Costello, co-head of Fitch Ratings, said on the conference call update that "loan modification programs have been slow to gain traction and have not mitigated foreclosure rates." He added that while the Federal Reserve's aggressive easing policy has eliminated near-term Adjustable Rate Mortgage shock risk, the weakening economy will likely offset this benefit.

Let me add that those rates are going to get worse as we are now in the midst of the biggest wave of resets and as next week's Case-Shiller Home price index will show, house prices are continuing to decline.

The theme here is deflation and as stated before the Fed's attempts to reflate will ultimately fail to prevent deflation across stock prices and commodities as well as housing. Commodities have looked increasingly fragile in recent days prompting Michael Panzer, author of Financial Armageddon to note on Kudlow & Co yesterday, (click the link to see the segment)

I think what you saw in the commodities this week actually marked the end of the year of leveraged speculation and I think it sets in motion the next leg of financial armageddon I'm afraid....I think they (commodities) have been bid up on the back of financial excesses, I think that is now becoming unwound and I think they are going to fall into line with the broader deflationary trends, contrary to what everyone else is arguing about, inflation. The deflationary trends from a bursting credit bubble are going to have their impact on commodities and everything else.

Couldn't have said it better myself Mike. Commodities might have one last gasping leg left in them but I think Panzner is on the money. Unfortunately for Panzner, whenever he appears on Kudlow & Co he is outnumbered by the sneering pollyanas. Yesterday they comprised of Jerry, the big fat idiot, Bowyer and Jeff, could I possibly have a more stupid look on my face? Kleintop.

Compounding the issue was Michelle, everytime I open my mouth I sound even stupider, Caruso-Cabrera, filling in as host in Krudlow the Clown's absence. After Kleintop, (who by the way has been telling people to buy stocks all the way down for the past 6 months) gave his usual clueless views on why the stockmarket has bottomed, Panzner stood his ground and offered what I think is a very sound perspective:
At bottoms people don't even see them coming and that's the tradition, that's the way markets have worked for hundreds of years. When you have everyone running around now that they see the light at the end of the tunnel it means they see an on-coming freight train.

Well put. I suspect the bottom callers will be disappointed as they have been every time the market has rallied in the last few months on false hopes.

Thursday, 20 March 2008

Initial Jobless Claims Inch Higher

The 4-week moving average of initial jobless claims rose to its highest level since February 2004 (excluding the Hurricane Katrina strike)



In the week ending March 15, the advance figure for seasonally adjusted initial claims was 378,000, an increase of 22,000 from the previous week's revised figure of 356,000. The 4-week moving average was 365,250, an increase of 6,000 from the previous week's revised average of 359,250.

The advance seasonally adjusted insured unemployment rate was 2.2 percent for the week ending March 8, an increase of 0.1 percentage point from the prior week's unrevised rate of 2.1 percent.

The advance number for seasonally adjusted insured unemployment during the week ending March 8 was 2,865,000, an increase of 32,000 from the preceding week's revised level of 2,833,000. The 4-week moving average was 2,832,250, an increase of 19,750 from the preceding week's revised average of 2,812,500.

the 4 week MA has yet to push through that 400k level but it continues to inch ever higher. Expect the upward trend to continue in the coming months.

Wednesday, 19 March 2008

Ron Insana on Deflation

Along with the 75bps of heroine the Fed delivered to the junkies on Wall Street yesterday, they also prattled on about the risks of inflation in the Fed statement. This is evidence to me, that depsite all the Fed's moves in recent weeks they still don't fully understand what is going on.

Despite the Fed's best efforts to relfate, a massive deleveraging process is underway. The Fed has predictably demonstrated in recent weeks that they will do anything to prevent that from happening. They have now committed half their balance sheet to addressing the problem and cut the Fed funds rate 300bps.

Deflation across asset classes is the real issue here. House prices are still falling and will continue to do so into next year. Trillions in home equity will be lost, Americans will be forced to save more and consume less (this is a good thing).

However the stockmarket continues stay up on hopes that things are going to be fine with the Fed acting as backstop and business will get back to normal. As mentioned last month Ron Insana is one of the more sane voices on CNBC and summed up the deflation threat perfectly in a CNBC segment yesterday. Click on the image below too watch interview.


If you can't be arsed to watch it, this is the money quote:

I can promise you that if this thing goes farther than it is currently going in terms of the systemic financial risk, we will worry much more about deflation and recession than we worry about consumer price inflation.

Spot on Ronny boy, deflation is the threat. However, I hear you say, currently we have flat or possibly negative economic growth and rising inflation, is that not stagflation? Maybe, but remember that stagflation is just the transition from inflation to deflation. Inflation has a lagging effect, it will eventually come down along with a continued fall in asset prices.

Monday, 17 March 2008

Bear Stearns Gives Itself Away

Back in August last year in "Bear Stearns - a cry for help?" I noted that we were likely to see more dramas unfolding at the company. Then just a month later in "A first look at broker's earnings" I noted:

"A buyout or even Chapter 11 is still very much a possibility for BSC."
Since then I have consistently maintained that should one of the large US brokers go belly up, Bear Stearns would be the most likely candidate. If it sounds like I'm giving you a case of I told you so, that's because I am, from Bloomberg:

JPMorgan Buys Bear Stearns for $240 Million in Fed-Backed Deal

JPMorgan Chase & Co. agreed to buy Bear Stearns Cos. for $240 million, about 90 percent less than its value last week, after a run on the company ended 85 years of independence for Wall Street's fifth-largest securities firm.

Shareholders of New York-based Bear Stearns will get stock in JPMorgan equivalent to about $2 a share, compared with $30 at the close on March 14, the two companies said in a statement today. The U.S. Federal Reserve will provide financing for the transaction, including support for as much as $30 billion of Bear Stearns's ``less-liquid assets.''

JPMorgan Chief Executive Officer Jamie Dimon bought Bear Stearns, once the biggest underwriter of U.S. mortgage bonds, for less than the value of its real estate after clients, alarmed by rumors of a cash shortage, withdrew $17 billion in two days. Faced with the prospect of bankruptcy, Bear Stearns CEO Alan Schwartz was forced to accept the deal as part of an effort by the central bank to stave off a broader market panic.

``Bear Stearns shareholders are at the short end of the stick,'' said CreditSights Inc. analyst David Hendler. ``This was done in the market's best interests. They had to get this done or they would risk runs on other companies.''

Without a resolution this weekend, the company's situation would have continued to deteriorate when markets resumed trading, according to analysts and investors. Yet the value placed on Bear Stearns, which employs about 14,000 people, raised questions about share prices for the rest of Wall Street.

``This is a serious crisis,'' said David Goldman, portfolio strategist at Asteri Capital. ``For Bear's stock price to go to effectively zero, contrary to market expectations, even at the close on Friday, tells us that something is systemically very wrong and we're at a very dangerous moment.''
I highlighted two passages above in bold. Let's deal with the second one first. The much regaled Bear Stearns building is worth more than the $240 million price tag JP Morgan paid for the whole company. So taking the building out of the equation means that Bear Stearns business was worth less than nothing. That is, they gave the business away and the building went for a discount.

The second paragraph is even more disturbing. Whilst JP Morgan paid a paltry $240 million they need up to a possible $30 billion in funding to support the nasty crap that noone wants on the BSC balance sheet. Nasty crap is my interpretation of the term "less-liquid assets"

What does this "support" from the Fed actually mean? From another Bloomberg article:

....In order to strike a deal before the opening of Tokyo trading, the Fed agreed to help JPMorgan finance up to $30 billion of Bear Stearns's ``less liquid assets.''

The Fed is in effect assuming responsibility for managing the assets, a Fed official told reporters in a conference call. The central bank will manage the positions to minimize any market strains and maximize long-term value, said the official, who spoke on condition of anonymity....

So at the end of the day, Bear Stearns was nothing more than one big liability with a nice building which JP Morgan paid $2 a share for. Meanwhile the Fed will stand behind the crappy assets that noone wants. Remember that BSC stock traded at $150 just a year ago.

This raises another question. If Bear Stearns business was worth nothing, then what is Lehman Brothers Worth? How about Merrill Lynch and god forbid the darling of Wall Street Goldman Sachs?

A lot of punditry has centered on the the issue of confidence. Once counter-party confidence is gone they say, your business can vanish into thin air just like BSC's did. However I don't buy it, these guys just totally omitted the concept of risk management from their business model.

Of course they are not the only ones. Lehman Brothers looks very shaky and if another broker falls over I believe it will be them. In addition to watching the brokers keep an eye on Washington Mutual as it is likely to be taken out or file for Chapter 11 at some point.

Sunday, 16 March 2008

The Current State of Play

I was going to write some long winded piece about my current thoughts on the credit crunch, recession, the culprits, the implications and a lot of other stuff. However I came across an article that gives a pretty good summary of the current state of play. So rather than me fumble around with it I'll defer to someone who can actually write. From the Telegraph:

A world addicted to easy credit must go cold turkey

It's only mid-March, but this is one of Wall Street's sweatiest weekends. Traders' shirts are drenched in the perspiration of unpleasant possibilities. The collapse of once-mighty Bear Stearns is another reminder that the unwinding of the Great Debt Delusion still has a long way to go and many more victims to claim.

When, several years from now, economic historians tot up the final casualty list, a trail of destruction will stretch from mobile homes in America's Budweiser belt to the council estates of fish-and-chip Britain. The credit crunch travels with alarming ease.

Alistair Darling's Budget-day boast that Britain is well placed to cope with this turmoil was irrefutable proof of his intellectual bankruptcy. He was either whistling in the dark or wilfully insulting voters' intelligence. Be under no illusion, Friday's dramatic events in New York were neither an aberration nor confined to the surreal world of investment banking. The pain will be lasting and felt by millions who had no idea they were playing with financial fireworks.

When dealers arrive at their desks tomorrow morning, the first question will be: Who's next? Is it just Bear Stearns that has run out of cash, or are other great institutions staring into empty coffers? Investors are already betting that Lehman Brothers, another premier league player, has its financials caught in a mangle.

The US locomotive, for so long the engine of global consumption, is not just grinding to a halt, it is falling apart. The New York Times reports this weekend: "Everything seems to be going wrong… People are buying less, but most things are costing more. Mortgage rates are rising, the dollar is falling and prices of key commodities are leaping from one record high to the next."

Where now are the financiers, regulators and politicians who peddled the inanity, "we mustn't talk ourselves into recession"? Of all the vacuous comments made by officialdom, this one, given the rapid spread of financial disruption, grates more than most. Nobody is talking anyone into anything - it's too late for that. Our jeopardy is very real. Recession, if it comes, will be the result not of idle chatter but a conspiracy of silence. It underpinned the fantasy.

For too long, those who warned that the borrowing bubble would burst with terrible consequences were dismissed as congenital gloomsters. Greedy lenders, their irresponsible customers and incompetent ministers formed an unholy alliance to perpetuate a myth: that consumers, companies and governments could keep spending more than they earned and suffer no penalty.

We heard new and intriguing justifications for excess. Banks seemed able to acquire rubbish and recycle it as triple-A securities. It was a sophisticated version of the second-hand shop that advertises: "We buy unwanted junk and sell valuable antiques." Instruments of financial leverage became so complicated that even those trading them did not fully understand how the system worked. All they cared about was the potency of magic that enabled welfare claimants to borrow five or six times the income they were not earning and still make the numbers add up.

So clever were the designers of this wizardry that, though it failed the common sense test, they were able to fool supervisors, credit committees, external auditors, shareholders and regulators - even themselves! Disbelief was suspended by all concerned.

An important pre-condition for a faith in easy money is a complete disregard for the lessons of history. The bulls at Bear Stearns, it seems, were too busy spending their jackpot bonuses to read how and why boom turned to bust at Barings. Picking through the wreckage of his family's bank, two years after it went under, Peter Baring told a Bank of England inquiry that while Nick Leeson was making extraordinary (and wholly illusory) profits, the company's directors concluded that "it was not actually terribly difficult to make money in the securities business".

For securities in the Nineties, read sub-prime in the Noughties. When it looks too good to be true, it usually is. Bear Stearns has suffered crippling losses on mortgage-linked investments. In the same way that Northern Rock lost the confidence of British savers, Bear Stearns eventually exhausted the trust of hedge funds and its other commercial lenders. For a bank that trades by borrowing 30 times its equity base, this was the kiss of death.

Three years ago, Paul Volcker, a former chairman of the Federal Reserve, warned that the US was "an economy on thin ice". In particular he was worried that Americans had become hooked on living imprudently by using their homes as cash machines. He wrote in The Washington Post: "Personal savings in the United States have practically disappeared… we are buying a lot of housing at rising prices, but home ownership has become a vehicle for borrowing as much as a source of financial security."

Does that sound familiar? I'm afraid so. Here in the United Kingdom we have been living a similar dream. Unable to fund all spending ambitions from income, too many Britons have cashed in part of their bricks and mortar for a blast of instant gratification. Worse still, so has the Government. Unwilling to live within its means, even with revenues of about £600 billion a year, Gordon Brown's Circus and its troupe of performing puppets must borrow more than £40 billion next year to make ends meet. Its budgetary indiscipline makes us all more vulnerable to a sharp downturn.

Credit markets have frozen because it is unclear how many more of the big banks, if any, are bluffing. Nobody wants to be caught out trading with a loser. So cash is being hoarded. At the start of last week, the boss of Bear Stearns told the market that his firm was safe. But when lenders called that bluff, the cupboard was bare.

Central banks are trying to calm jitters by pouring billions of dollars into money markets to increase liquidity. Last week another $200 billion was dropped into the system. That was quickly swallowed up amidst screams for yet more emergency injections. Debt junkies, like heroin addicts, demand ever bigger fixes.

And this brings us to the heart of the matter. The rational response to financial pain is risk reduction. But if the pain is removed, or even suppressed, then so is fear. When individuals or institutions believe they will always be bailed out, they lose the incentive to reform. Delinquency is, in effect, encouraged.

In the end, the patient is so full of painkillers that they become part of the problem. The only way forward is for all palliatives to be washed out of the system. Sooner or later borrowers and lenders must address the real cause of discomfort. For many of Wall Street's finest, it will feel like cold turkey.

Friday, 14 March 2008

1Q08 Forecasts Get More Realistic 4Q Still Delusional

With 99% of companies having reported, 4Q07 operating earnings for S&P500 companies were nothing short of dismal. Year over year quarterly earnings fell -30.8% in the fourth quarter of 2007, the worst since the -35.4% decline in September 2001.

The good news is that analysts are finally getting more realistic on 1Q08 earnings. For the first time 1Q08 operating earnings are now expected to decline, forecasts calling for a -5.5% drop from the same quarter a year earlier. 2Q08 earnings estimates came down slightly but still forecasting a 0.6% gain.

Still, those forecasts will prove to be too optimistic, expect both 1Q08 and 2Q08 earnings to show double digit declines when all is said and done. Again however, the real optimism can be found in the forecasts for the second half of 2008. 3Q08 forecasts are still calling for a 19.6% increase in year over year quarterly earnings whilst 4Q08 are expected to be a ridiculous 73.6% higher.

If you don't see something wrong with the chart above then you need your eyes tested. It may be that analysts just have no idea what 4Q08 earnings are going to look like at the moment so rather than start slashing forecasts they are taking a wait and see approach. Whatever the case they are still in dreamland and need to come down significantly.

Thursday, 13 March 2008

US Retail Sales Retreat in February



The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for February, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $380.2 billion, a decrease of 0.6 percent (±0.5%) from the previous month, but 2.6 percent (±0.7%) above February 2007. Total sales for the December 2007 through February 2008 period were up 3.3 percent (±0.5%) from the same period a year ago. The December 2007 to January 2008 percent change was revised from +0.3 percent (±0.5%)* to +0.4 percent (±0.2%).

Retail trade sales were down 0.6 percent (±0.7%)* from January 2008, but were 2.4 percent (±0.8%) above last year. Gasoline station sales were up 20.2 percent (±1.0%) from February 2007 and sales of sporting goods, hobby, book, and music stores were up 6.3 percent (±2.8%) from last year.

As mentioned last month the unexpected rise in auto sales was not a sustainable trend, auto sales falling -2.0% in February. Downward revisions to total sales were also made to January, -0.1% and December -0.2%. Revisions to December sales now total -0.6% after revsions in January.

As mentioned last month revisions to prior months are a normal part of the process, however it is the trend of those revisions that is important and at the moment that trend is showing signs of weakness. November was revised down twice, so too now December and the first revision to January was also down.

With the rising costs of inflation, higher mortgage costs and the HELOC ATM now removed from homeowners front lawns, it's no wonder consumers are feeling tapped out, and with the continued deterioration in home prices and a weakening labor market it's doubtful the consumers fortunes will turn around anytime soon.

Severe Mortgage Stress to Hit Aussie Households

Whilst the Australian employment picture looks rosy, the position of Australian households is decidedly less so and could get a lot worse according to a report from JP Morgan and Fujitsu Consulting. From the SMH:

Mortgage stress to hit 300,000: report

An alarming 300,000 Australian households will be under severe mortgage stress by mid-2008 and at significant risk of losing their homes, as interest rates and living costs rise, a new report shows.

The worrying finding raises questions about banking sector profitability, which is already under downward pressure due to the global credit crunch and rising funding costs, report authors JPMorgan and Fujitsu Consulting said.

"The banks have passed on nowhere near their increased cost of funding," JPMorgan lead banking analyst Brian Johnson told reporters.

"When you speak to them behind the scenes, they'll tell you that probably they'll have to move another 15 basis points."

The JPMorgan/Fujitsu Australian Mortgage Industry Report for March follows decisions by the major banks to increase their standard variable home loan rates by more than the 25 basis point increase engineered by the central bank on March 4.

ANZ Banking Group Ltd, St George Bank Ltd and Commonwealth Bank of Australia have all raised their rates by 35 basis points. Westpac has approved a 30 basis point increase and National Australia Bank Ltd a 29 basis points rise.

The report, based on the results of telephone interviews with 26,000 Australian households, estimates more than 700,000 households will be experiencing some form of mortgage stress by June this year, a four-fold increase on last year.

It identified mild stress as occurring in households that had prioritised or curtailed spending to pay their mortgages.

But around 300,000 households will be experiencing severe stress, meaning they will have missed repayments, be in the process of refinancing or received a foreclosure notice.

The report also pointed to a rise in `affluent stress' amongst high net worth borrowers suffering from rising rates, school fees and margin calls on shareholdings.

It also called on the banks to review their use of mortgage brokers to win market share and to make mortgage processing more efficient.

Meanwhile, the Australian Securities and Investments Commission (ASIC) released its own report, warning borrowers to be careful of "fringe lenders" offering refinancing services at a high cost.

"The crucial questions are whether the repayments will be lower on the proposed loan, and whether they can afford those repayments over the long run," ASIC acting executive director of consumer protection Delia Rickard said.

"If their broker doesn't talk through this issue with them they should be very careful or consider approaching a different broker."

JPMorgan's Mr Johnson described claims by banks that their home loan books were in good shape as "a bit fanciful".

JPMorgan and Fujitsu believe bank methods testing for financial stress are questionable, given that credit bureaus only collect data on impaired credit records, as opposed to the total amount of debt held by individuals.

There are telltale signs that bank mortgage books are under pressure, Mr Johnson said.

Firstly, the amount of money banks will lend has increased dramatically over the past 15 years.

Secondly, banks have reduced the interest rate safety buffer on their loans to about 100 basis points from over 200 basis points.

"Now the scary thing about that is we've seen 75 basis points of interest rate rises come through," Mr Johnson said.

The Reserve Bank of Australia this month raised the official cash rate to 7.25 per cent, from seven per cent.

It was fourth time it had hiked rates in the current financial year. But banks have added additional, internal hikes of between 20 and 30 basis points since January.

Mr Johnson questioned the banking industry's use of the Henderson Poverty Index to assess a client's risk profile and cited conflicts of interest in the lightly regulated broking industry - where mortgage brokers get more commissions for selling bigger loans.

Additional financial stress was also being hidden by credit card debt, Mr Johnson added, with the average Australian's credit card balance currently equating to about three months of disposable income.

With all the extra stress on borrowers, JPMorgan believes recent, sharp falls in bank share prices are justified.

"Rising interest rates impacting borrowers capacity to repay, coupled with tighter global liquidity forcing lenders to ration credit, likely signals subdued housing growth expectations over the near term," the report said.

Mr Johnson believes Australia's banks are facing their worst operating environment in 16 years.

While he declined to question some banks' forecast for earnings growth of between 10 and 12 per cent in fiscal 2008, he said earnings were likely to fall significantly in fiscal 2009.

"Australian households are still highly geared," he said.

"A 25 basis points increase in interest rates increases the interest burden on home loan borrowers by an estimated $1.7 billion."
No doubt banks earnings are going to come under pressure in fiscal 2009. There seems to be a perception that since bank stock prices have fallen as much as -35% or more over the past 4 months that they can't fall much further. However if earnings take a dive P/E ratios that currently look cheap can get expensive very quickly.

Aussie Employment Picture Still Looks Rosy

The Australian economy continues to add jobs and paints a picture of a healthy economy with the unemployment rate reaching a fresh 33 year low. From the ABS.



* increased by 36,700 to 10,665,500. Full-time employment increased by 47,700 to 7,633,500 and part-time employment decreased by 11,000 to 3,032,100.


* decreased by 16,800 to 440,900. The number of persons looking for full-time work decreased by 5,800 to 293,200 and the number of persons looking for part-time work decreased by 11,000 to 147,700.


* decreased by 0.2 percentage points to 4.0%. The male unemployment rate decreased by 0.1 percentage point to 3.6%, and the female unemployment rate decreased by 0.2 percentage points to 4.4%.


* remained steady at 65.2%.

A strong labour market makes it difficult for the RBA to achieve it's aim of slowing domestic demand and raises the possibility of a further rate hike. However, whilst the SFE 30 Day Interbank Cash Rate Futures contract for April still shows 0% chance of a rate hike in April, according to Credit Suisse, the odds that the RBA will cut interest rates by 25 bps over the next 12 months, fell from 96% before the employment report, to 60% after.

It should be remembered that employment is a lagging indicator as are inflationary pressures. However, you get the sense that despite global credit and growth concerns, that the RBA may raise interest rates again if tight labour markets persist and inflation does not show signs of ameliorating. That could cause more pain for a growing number of stressed Australian households.

UPS Cautions on 1Q08 earnings

UPS stopped short of downgrading their earnings forecast for 1Q08 but are indicating a softening in economic conditions. From Reuters:

UPS says Feb volumes down, could hurt earnings

Citing worsening economic conditions package delivery company United Parcel Service Inc (NYSE:UPS - News) said on Wednesday its U.S. volumes were down in February, which could make it hard to meet its first-quarter earnings outlook.

"If these trends continue through March, our earnings guidance for the first quarter will be difficult to achieve," Chief Financial Officer Kurt Kuehn said in a statement.

UPS has forecast first-quarter earnings per share in a range from 94 cents to 98 cents. Analysts, on average, have predicted EPS for the quarter of 96 cents, according to Reuters Estimates.

Atlanta-based UPS said that while U.S. volumes declined virtually across its "entire customer base" in February, its international volumes, including U.S. export volumes, continued to show strong growth. Kuehn also said that the company's international and supply chain units looked likely to meet first-quarter targets.

Like its main rival FedEx Corp (NYSE:FDX - News), UPS is considered a bellwether of U.S. economic activity, based on the premise that in a robust economy companies and individuals tend to send more packages and that the opposite is true in a downturn.

Despite the present economic challenges, UPS reiterated its full-year forecast of earnings per share within a range from $4.30 to $4.50. Analysts have predicted full-year EPS for the world's largest package delivery company of $4.40.

UPS also reiterated its goals of 6 percent to 8 percent annual revenue growth to 2010, compound annual EPS growth in a range from 9 percent to 14 percent and return on invested capital in a range from 23 percent to 25 percent.

In trade on the New York Stock Exchange, UPS shares were down 40 cents, or 0.6 percent, to $72.39.

It should be noted that despite some strong evidence that the US economy has entered a recession, 50% of Wall Street economists expect the US economy to avoid one. That's an improvement, usually a much greater percentage of economists get it wrong.

Wednesday, 12 March 2008

More Profit Downgrades

Healthcare has been one of those sectors of the US economy that has been recommended by all and sundry on Wall Street as a place to safely park your money during the current/coming recession.

Healthcare is afterall a booming industry in an ageing population expecting an explosion in health care services as the baby boomers start to retire on mass. Sounds like a nice idea, however despite these tail winds it seems some health insurers are having a tough time of it. From

Health insurers take a dive on WellPoint's warning
Carrier cuts full-year outlook by more than 40 cents; brokers cut ratings

Health insurers plunged Tuesday after WellPoint Inc. officials warned the company would have to cut its profit forecast for the first quarter and all of 2008, and then they watched the company's shares lose more than a quarter of their value.

WellPoint (WLP) tumbled by more than 28% to $47.26 at the close after the Indianapolis-based carrier cut its full-year earnings forecast to a range of $5.76 to $6.01 a share, including investment gains of 6 cents, from its previous forecast of $6.41 a share. Its previous forecast was in line with expectations from analysts polled by FactSet Research.

The company also projected a first-quarter profit of $1.16 to $1.26 a share, including 6 cents a share in net realized investment gains. Its prior forecast was for $1.44 a share. Wall Street was looking for earnings of $1.44 a share for the quarter.

"We are making these revisions to our prior earnings guidance due to higher than expected medical costs, lower than expected fully insured enrollment and, to a lesser extent, the changing economic environment in which we are operating," Chief Executive Angela F. Braly said in a press release

WellPoint was hit with a slew of ratings cuts, and the news shook the rest of the health insurance industry. Virtually all other carriers saw double-digit losses.

Interesting that fully insured enrollment numbers are not living up to expectations. Could it be that the ever escalating costs of healthcare in the US have something to do with that? As usual the analysts are behind the curve:

A number of brokers cut their ratings on WellPoint, including JP Morgan, Bear Stearns, Stifel Nicolaus and Goldman Sachs. Goldman Sachs' analyst Matthew Borsch not only cut WellPoint's rating to neutral from buy, it also scaled back its view on managed care to neutral from attractive.

"WellPoint's problems reflect company-specific underwriting error, but also reflect industry-wide pricing pressures that are now combined with upward pressure on underlying medical cost trends, substantially increasing the risk that the current cyclical slowdown in managed care becomes an outright downturn," Borsch wrote in a note to clients.

Other analysts said they were taken aback by the news. "We are shocked by this revision considering the level of confidence with which management spoke as recently as Feb. 13, 2008," Stifel Nicolaus analyst Thomas Carroll said in a note Tuesday. "WellPoint has been exceedingly confident and seemingly conservative in communicating its 2008 outlook in the last three months."

Carroll cut his rating on WellPoint to hold from buy.

While other analysts predicted the rest of the sector would be dragged down, they said WellPoint's problems are not likely to impact other insurers. "The company took responsibility for price inaccuracy and has taken several actions to correct its missteps," David Shove, analyst for BMO Capital Markets, said in a note to clients. "We believe that WellPoint's fumble is company specific, and not indicative of an industry trend."

Phew thanks for that reassurance that it's not an industry wide issue David....wait a minute what's this?

Humana Cuts 1st Quarter, 2008 EPS Views On Higher Claims Volumes

Humana Inc. (HUM) cut its first-quarter and full-year 2008 earnings guidance due to updated projections for its 2008 stand-alone PDP financial performance. News of the guidance revisions sent Humana shares lower by 24% in premarket trading to $36. Humana shares closed down $15.32, or 24%, Tuesday at $47.38, after a reduced earnings estimate by Wellpoint (WLP) dragged the health insurers sector lower. The company cut its first-quarter earnings guidance to a range of 44 cents to 46 cents a share from its prior estimate of 80 cents to 85 cents a share. For 2008, Humana now sees earnings of $4 to $4.25 a share, down from its previous guidance of $5.35 to $5.55 a share. Human cited higher-than-anticipated claims volumes for the company's stand-alone PDPs for the updated projections to its PDP financial performance.

For what it's worth, I agree with Mr Shore, it's not an industry wide issue, it's an economy wide issue.

If I'm starting to sound like a broken record on earnings expectations, it's because it's very important. Earnings are the lifeblood of stock prices over the long term.

A common line we hear these days from mainstream media and Wall Street analysts is that a recession is already priced in to stock prices. However that is doubtful since the forecasts for most sectors do not yet reflect anything approaching recession type earnings.

S&P and Moody's continue ratings scam

An interesting article by naked capitalism on the ratings sham that Moodys and S&P continue to perpetrate.

Moody's and S&P Avoid Cutting Ratings on AAA Subprime

Even after downgrading almost 10,000 subprime-mortgage bonds, Standard & Poor's and Moody's Investors Service haven't cut the ones that matter most: AAA securities that are the mainstays of bank and insurance company investments.

None of the 80 AAA securities in ABX indexes that track subprime bonds meet the criteria S&P had even before it toughened ratings standards in February, according to data compiled by Bloomberg. A bond sold by Deutsche Bank AG in May 2006 is AAA at both companies even though 43 percent of the underlying mortgages are delinquent.

Sticking to the rules would strip at least $120 billion in bonds of their AAA status, extending the pain of a mortgage crisis that's triggered $188 billion in writedowns for the world's largest financial firms. AAA debt fell as low as 61 cents on the dollar after record home foreclosures and a decline to AA may push the value of the debt to 26 cents, according to Credit Suisse Group.

``The fact that they've kept those ratings where they are is laughable,'' said Kyle Bass, chief executive officer of Hayman Capital Partners, a Dallas-based hedge fund that made $500 million last year betting lower-rated subprime-mortgage bonds would decline in value. ``Downgrades of AAA and AA bonds are imminent, and they're going to be significant.''

Bass estimates most of AAA subprime bonds in the ABX indexes will be cut by an average of six or seven levels within six weeks.

The 20 ABX indexes are the only public source of prices on debt tied to home loans that were made to subprime borrowers with poor credit histories. About $650 billion of subprime bonds are still outstanding, according to Deutsche Bank. About 75 percent were rated AAA at issuance.....

S&P and Moody's, the two biggest rating companies, are lagging behind Fitch Ratings, their smaller competitor....

The ratings methods balance estimated losses against so-called credit support, a measure of how likely it is that owners of each piece of the bond will incur losses. For AAA rated debt, credit support needs to be five times the expected losses, according to Sylvain Raynes, author of The Analysis of Structured Securities, a college textbook.

All but six of the 80 AAA ABX bonds failed an S&P test for investment-grade status, which requires credit support to be twice the percentage of troubled collateral. The guideline was one of four tests used by S&P, and a failure to meet the standard wouldn't have automatically resulted in a downgrade. The other companies used similar metrics to grade bonds, Raynes
said. Investment grade refers to all bonds rated above BBB- by S&P and Baa3 by Moody's....

On a $118 million Washington Mutual bond issued in 2007, WMHE 2007-HE2 2A4, 5.6 percent of its loans are in foreclosure
and its safety margin, or the debt available to absorb losses, is less than the combined total of its loans at risk. Both S&P
and Moody's rate it AAA.

Fitch rates that bond B, five levels below investment grade and 15 levels less than its rivals....

The problem extends past the mortgage bonds. Financial firms own high-grade collateralized debt obligations, which package securities such as mortgage bonds and slice them into pieces with varying risk. As the underlying mortgage bonds are downgraded, those securities will also lose their ratings and tumble in value.

A bank would have to increase its capital against $100 million of bonds to $16 million from $1.6 million if a bond was downgraded to below investment grade from AAA, under global accounting rules.....

Bond insurers such as MBIA Inc. and Ambac Financial Group Inc. also have to hold more capital against insurance they write
if the securities' credit quality declines.

The prospect of losses may be holding the ratings companies back, said Frank Partnoy, a University of San Diego law professor and former Morgan Stanley banker who has been writing about the impact of credit ratings companies since 1997.

``If the 800-pound gorilla moves, it's going to crush someone, so it's not going to want to move,'' Partnoy said. ``They know they will trigger a price collapse. They are understandably reluctant.''

We see it time and time again, this attempt to prolong the pain that will inevitably come, the Fed, the ratings agencies and the financial institutions are all trying to suspend reality and hope things get back to normal. The problem is, what was normal 6 months ago was never normal to begin with.

Tuesday, 11 March 2008

There is no containment

An oft repeated platitude by simple minded fools is that outside financials, retail and housing, US corporate earnings are fine. That's like saying outside of my broken leg, the persistent migraine headaches and my diabetic condition, I'm in tip top shape.

No doubt there will be companies that manage to grow right through the current US recession, there are always exceptions. However, as global growth slows in response to a slowing US economy, expect to see more companies revise earnings downward. From Bloomberg:

Texas Instruments Reduces Forecasts; Shares Decline

Texas Instruments Inc., the second- biggest maker of chips that run mobile phones, cut its first- quarter revenue and profit forecasts, a sign that demand for the latest handsets is cooling as the economy slows.

Texas Instruments fell as much as 6.9 percent in extended trading after predicting sales of as little as $3.21 billion, trailing a January forecast for at least $3.27 billion. Profit will be as little as 41 cents a share instead of 43 cents.

Demand for chips used in phones that can download music and access the Internet was lower than expected, Vice President Ron Slaymaker said. Analysts including John Lau at Jefferies & Co. in New York said cutbacks at Nokia Oyj, the world's largest maker of handsets and Texas Instruments's biggest customer, caused the shortfall in wireless orders.

``The speed at which the change in forecast has occurred and its magnitude is worrisome,'' Lau, who rates the shares hold, said in an interview. ``This is definitely something that has to be watched.''

Texas Instruments, based in Dallas, fell as low as $27.60 in extended trading after closing at $29.65 in New York Stock Exchange composite trading. The stock has lost 11 percent this year.

Click on the link for the full story. The part in bold is my emphasis. I expect there will be more abrupt changes in earnings forecasts from a variety of industries as the year wears on. As repeated ad nauseum here, corporate earnings expectations are still way too high.

There is a perception on Wall Street that the second half of 2008 will see a turn around for stocks as a combination of fiscal stimulus and interest rate cuts kick in and spur economic growth. It appears much of Wall Street's earnings expectations are contingent on this outcome.

I would ask those that buy into this scenario to consider previous earnings cycles. For example, S&P500 operating earnings peaked in June 2000. They bottomed a year later in June 2001 and did not recover to previous highs until December 2003, more than 3 years later.

Go back to the recession before that, earnings peaked in June 1989, earnings did not recover to those levels until June 2003, a full 4 years later. In the current earnings cycle corporate earnings peaked in June 2007, currently forecasts expect June 2008 earnings to be setting new records. That would be the fastest earnings recovery in the last 20 years.

As always I don't rule out any possible outcome but simply try to point out what is probable. What is very probable is that earnings will not recover to record levels in 2008 and that forecasts will continue to be slashed as the year wears on.

Minack Sees Aussie Recession

Gerard Minack of Morgan Stanley did some straight talking to clients recently hitting on many key issues that have been discussed on this blog for months. Firstly, earnings expectations are far too high and some type of mean reversion is in order. Secondly much of the boom in recent years has been funded by cheap credit pushing households deeper into debt. That era is now coming to a close. Third China will not save the day. From the Australian:

Australia faces recession: analyst

THE economy is headed for recession next year, with a 50 per cent plunge in share values and a double-digit drop in house prices. Do I have your attention?

While the Reserve Bank takes a largely benign view of the unfolding credit crisis, believing China’s growth will insulate us from its worst consequences, others are less sanguine.

Morgan Stanley’s chief market strategist Gerard Minack introduced a brief to clients last week saying, “I’m bearish - really bearish.”

He argues that Australia will be dragged into recession by a slowing world economy, the tightening grip of the credit crisis, and the effects of the Reserve Bank’s succession of interest rate hikes.

Economists are often trapped by the inertia of the moment, failing to see the magnitude of both booms and busts and being forced into constant revisions of their forecasts.

This makes Minack, who takes a long view, worth listening to.

He argues that the market is coming to the end of its fifth bull run since the beginning of the 20th century.

As the chart (which adjusts the all-ordinaries index for inflation) shows, the bear markets that followed, produced falls in the region of 50 per cent and lasted for two to three years.

The problem is not that the market is overvalued, relative to earnings, but rather that earnings are themselves inflated and headed for a fall.

Based on profit figures back to 1970, earnings are 44 per cent above their long-term trend.

In the three recessions since then, real earnings per share fell by between 36 and 65 per cent from peak to trough.

“You’ve got to argue that earnings do revert to their mean. On almost every measure we’ve got for earnings, be it profit share of GDP, return on assets or margins, it looks unsustainable,” he says.

Earnings have been inflated by spendthrift households running down their savings. While the Reserve Bank has argued that fears about housing debt are without foundation because household balance sheets are strong, Minack says the picture looks a lot worse when you look instead at household cash flow.

The latest annual national accounts show the household sector remains cashflow negative, with the deficit of 3.75 per cent of GDP accounting for half the current- account deficit.

Besides, he says, household balance sheets also looked fantastic in Japan in 1990, before its lost a decade of economic growth.

Minack is not persuaded by the proposition that Australia’s housing market is somehow immune from the excesses of the US.

Australians have more leverage, are as reliant upon equity extraction and base their household balance sheet on a housing stock that is far more expensive than their American equivalents.

The household sector is booming at present, but is vulnerable to any reversal in fortune. The moment unemployment starts to rise, people will start defaulting on their housing loans.

The view that Australia will be saved by China and the resources boom underestimates the magnitude of the forces ranged against us.

China’s growth may continue to require large flows of commodities, but commodity markets at present are being driven by speculative money that can flee as quickly as it came.

Base metals prices could fall by 40 per cent and bulk commodities by 15 per cent without heralding the end of the Chinese driven “super-cycle”.

Commodity markets are facing not only the prospect of a recession in the US, but also the possibility of recessions in Japan and Britain, with a slowdown in Europe.

The long-awaited rise in the volume of mining exports will not save us, with Minack calculating it will raise GDP by, at most, 0.1 or 0.2 percentage points. The terms of trade, by contrast, has lifted GDP by about 9 per cent, while the increase in business investment caused by the resources boom has added about 3.5 percentage points.

“People react as though there is some injustice. Here we are with the market down 20 per cent, when our economy looks strong and China keeps growing,” he says. “People miss the point that we’re hugely wrapped up in the global credit crunch because we are one of the world’s largest issuers of capital, with the most over-priced finance sector in the developed world and a rickety housing sector.

“People think we’re Teflon coated because of links to China. I don’t think that’s true.”

The point of listening to bears is that they have taken hold of the markets. Minack says if you took the spreads on credit-default swaps literally, you would be forecasting financial Armageddon. Based on the latest benchmarks for default spreads, 7.8 per cent of investment grade corporate debt in the US is expected to default, more than double the worst actual default rate in the last 40 years.

Credit markets do not expect Australia to remain immune, with default spreads on corporations here rising in line with those in Europe and the US.

Markets overshoot - and Minack believes they have - but he is not convinced they have yet reached their bottom.

It reverses the overshoot when margins were so unrealistically low that investors took on huge leverage so that they could make a return. The point about the panic in credit markets is that it affects the real economy.

“That’s why there’s no point in asking whether the credit markets or the equity markets have it right,” he says. “Dislocation in credit markets puts a cloud over the economy and over equity.”

It is an unfriendly environment for one of the world’s largest debtor economies.

Monday, 10 March 2008

NFP's confirm Recession

US non-farm payrolls declined -63k in February confirming in my opinion that a recession probably began December 07 or January 08. In addition, December employment growth was revised down to 41k from 82k and January was revised from -17k to -22k.

The chart above shows the change in the 3 month moving average of non-farm payrolls. That has now turned negative. The only times it has ever turned negative is just prior to or at the beginning of a recession. It has never given a false signal of recession. Of course that doesn't mean it can't give a false signal, just that if it walks like a duck and quacks like a duck, then it probably is a duck. Job losses were seen pretty across the board.

  • Manufacturing -52k
  • Construction -39k
  • Retail trade -34k.
Government added 38k jobs so private sector employment actually declined -101k in total,

The unemployment rate miraculously fell to 4.8%. This is explained by the fact that the labor force declined by 644,000. This is not a positive, it shows that a lot of people who were looking for work are no longer looking for work. Not because they found a job but because they gave up looking.

The Birth/Death (B/D) adjustment magically added 135k jobs in February. It's tough to believe that the financial services industry added 10k new jobs, but hey, the B/D adjustment is always hard to believe.

There are really no positives in this report at all. That didn't stop some Wall Street lemming economists from maintaining a recession is still not evident. There is still a huge amount of denial out there, particularly with respect 2008 earnings projections which are forecasting year over year profits to rise more than 17%.

Once market participants embrace recession as reality instead of living in fear and lower their expectations on corporate profits, the quicker they can move on. However that still seems to be a ways off yet.

Friday, 7 March 2008

Initial Claims Ease Continuing Claims Rise

Initial claims eased from an upwardly revised 375k last week whilst continuing claims rose to a more than 3 year high, excluding the hurricane Katrina spike. from the US department of labor:



In the week ending March 1, the advance figure for seasonally adjusted initial claims was 351,000, a decrease of 24,000 from the previous week's revised figure of 375,000. The 4-week moving average was 359,500, a decrease of 1,500 from the previous week's revised average of 361,000.

The advance seasonally adjusted insured unemployment rate was 2.1 percent for the week ending Feb. 23, unchanged from the prior week's unrevised rate of 2.1 percent.

The advance number for seasonally adjusted insured unemployment during the week ending Feb. 23 was 2,831,000, an increase of 29,000 from the preceding week's revised level of 2,802,000. The 4-week moving average was 2,789,000, an increase of 12,750 from the preceding week's revised average of 2,776,250.

A temporary reprieve for intial claims perhaps however the continued upward trend of continuing claims suggests businesses are reluctant to do more hiring.

Thursday, 6 March 2008

AMBAC Underwhelms the Market with Bailout Plan

In one of the biggest anti-climaxes in recent times AMBAC underwhelmed the market with it's proposed recapitalization plans in attempt to keep its fictitious AAA rating alive. From

Ambac to raise $1.5 bln selling stock, equity units

Ambac Financial said Wednesday that it plans to raise at least $1.5 billion selling new common stock and equity units as the troubled bond insurer tries to keep its crucial AAA rating.

Ambac shares dropped 19% to $8.70 after the announcement. Investors worried about being diluted by the offering and about the lack of participation in the deal by banks that are big counterparties to the bond insurer.

Ambac (ABK) is aiming to raise at least $1 billion selling common stock and another $500 million selling equity units. The common stock offering is fully subscribed, according to a person familiar with the situation.

Click on the link for the full story. The banks avoided stumping up capital for the deal and have thus given the plan a big vote of no confidence. The Wall Street Journal summed up the market's reaction well:

Selling Ambac’s News

So that’s it, huh?

Ambac Financial Group let the dogs out, announcing plans to raise $1 billion in common stock and about $500 million in equity units, and, uh, well, that was about it.

The market clearly was expecting more — Ambac shares were up 5.9% prior to getting halted at 1:31 p.m. ET, and when trading in the shares resumed a minute ago, the stock fell sharply, lately down 9%. The Dow Jones Industrial Average, which was up modestly before the news, was lately down 45 points, and other major indexes have dipped into negative territory as well.

“I’m not sure what people were expecting, but it’s definitely why we sold off,” says Todd Leone, head of listed trading at Cowen & Co. “It was at $11, now it’s trading at $9, and the market sold off on it.”

The monoline insurer also plans on getting out of a number of bad businesses that have put the company in the position it currently finds itself in — such as mortgage-backed securities, auto loans and credit-card receivables. But a decision to stop writing insurance for businesses that have already cost the company wasn’t going to assuage investors today, who were looking for more.

Ambac said it doesn’t expect to regain its triple-A rating from Fitch, but hopes to maintain the triple-A ratings garnered by Moody’s and Standard & Poor’s.

And so the charade continues. AAA ratings mean absolutely nothing, although we've known that for a while. Credit spreads show that the credit markets haven't believed AMBAC's rating for months and now the stockmarket is in agreement.

ADP Report Suggests Zero Growth in NFP's

The ADP employment report has been notoriously poor indicator of employment growth in non-farm payrolls in recent months. However it's still worth taking a look at. from

Nonfarm private employment declined 23,000 from January to February 2008 on a seasonally adjusted basis, according to the ADP National Employment Report. The estimated change in employment from December 2007 to January 2008 was revised down 11,000 to 119,000. February’s decline of 23,000 signals a deceleration of employment growth across businesses of all sizes.

Employment in the service-providing sector of the economy grew 47,000, while employment in the goods-producing sector declined 70,000, the fifteenth consecutive monthly decline. Manufacturing employment fell 40,000 in February after declining a revised 3,000 in January, and marked the eighteenth consecutive monthly decline.

Most of the decline in employment during February was accounted for by job losses at large companies, but there was a notable eceleration of employment growth at businesses of all sizes. Employment among small-size businesses, defined as those with fewer than 50 workers, advanced just 15,000 during the month, while employment among medium-size businesses with between 50 and 499 workers dropped 4,000. This was the first outright decline at medium-size businesses since June of 2003, when job growth was still recovering from the last recession. Employment at large businesses with more than 500 workers declined 34,000.

Using the basic rule of thumb, add 25,000 government jobs to the ADP number and you get a forecast for Friday's NFP result of about flat growth in NFP's. If that were to be the case the unemployment rate would probably rise as it would not keep pace with growth in the labor force. However as stated before the ADP report has been a poor predictor of NFP's.

Of more interest in this report was the observation (highlighted in bold above) that employment growth at small businesses slowed substantially and that job growth at medium sized businesses actually declined for the first time since 2003. Why is this important? Because more than 80% of US jobs reside at small and medium sized businesses.

Clearly employment trends are not positive. That said the NFP report is difficult to predict. Although evidence suggests flat growth in employment in February the number could easily be plus or minus 100k. As always watch the revisions data. If January's number is not revised up and February comes in negative, 2 consecutive months of payroll declines will be strong evidence that a recession is already underway.