Tuesday, 30 September 2008

XAO Crashes in September

Well what a month. September turned out to be the second worst month for the All Ords since October 1987, January of this year just edging it out of first place. The XAO fell -11.2% in September and defied my expectations of a rise - again confirming my inability to pick short term movements in the market.

However, my longer term view continues to play out and despite today's new low in the XAO, I expect the market to continue to make new lows. Credit markets are under severe stress (take a look at the TED spread below) and with a bailout plan of any kind in doubt, it's difficult to see confidence returning anytime soon.

But with such a steep drop surely we should expect some kind of bounce in October? I think that is probably true but if it there ever a time when it was hard to identify a catalyst for a bounce other than that the market had a steep sell off, it is now. It could come with a revote of the bailout package in a couple of days or it might not. Either I still think that the market has still not priced in the full effect of earnigns downgrades and the full extent of a recession.

In Australia, the economy is still holding in there, retail sales for August rose 0.3% and employment remains reasonably robust. However I feel there is still some denial about Australia's ability to sail through a global slowdown relatively unscathed and I still don't think we've heard the worst of the news from our major financial instituitions.

On that cheery note I'm going to say that October will finish lower than Septmeber although I wouldn't be surprised to see a bounce from current levels either. Also don't forget to have your say in this month's poll.

Citi Picks the Eyes out of Wachovia

Wachovia has been teetering on the brink for a while so it was hardly surprising to see them finally topple over. Although they are not entirely out of business....at least not yet, they are still left with a brokerage and funds management outfit. From Bloomberg:

Citigroup Agrees to Buy Wachovia's Banking Business

Citigroup Inc., the biggest U.S. bank by assets, will acquire banking operations of Wachovia Corp. for about $2.16 billion after shares of the North Carolina lender collapsed under the weight of overdue mortgages.

The all-stock deal equals about $1 a share for the Charlotte-based bank, ranked sixth by assets in the U.S. All depositors will be protected, according to the Federal Deposit Insurance Corp., which helped broker the takeover by Citigroup. The New York-based bank plans to cut its own dividend in half and raise $10 billion in capital as it takes on Wachovia's senior and subordinated debt.

Citigroup will absorb as much as $42 billion of losses on Wachovia's $312 billion pool of loans, the FDIC said in a statement. The regulator will take on losses beyond that amount in exchange for $12 billion in preferred stock and warrants.

"This is a compelling deal," said Citigroup CEO Vikram Pandit, 51, on a conference call with analysts and investors. "This is one of those rare high-return acquisitions in which we have contained the risks."

Well Pandit would say that wouldn't he? However Meredith Whitney was a little more skeptical.

"Of course they are going to raise capital,'' Oppenheimer & Co. analyst Meredith Whitney said in an interview on CNBC. "I don't know how they absorb $42 billion on the income basis they have."

That's what I don't understand. Citigroup are up to their necks in the brown stuff themselves and I bet they weren't counting on the bailout plan being rejected today.

....Wachovia is the largest holder of option ARMs, ahead of Washington Mutual, the Seattle-based lender that collapsed last week. The loans are prone to default because they allow borrowers to skip some interest payments and add them to the principal. The terms backfired when housing markets weakened, leaving borrowers with loans bigger than the value of their home. Prices in California during August fell 41percent from year-earlier levels....

....Analysts at Fitch Ratings predict default rates on such loans packaged as securities may reach percent.

Was Citi hoping to dump some of these assets into the governemnt bailout plan? Pandit probably won;t be sleeping well tonight. So who's next? Keep an eye on National City (NCC)

Sunday, 28 September 2008

Thoughts on the Bailout and Other Things

By now you've probably read umpteen articles about the proposed bailout of US financial institutions. Rather than waste time on the political sideshow playing out on Capital Hill, I would rather talk about the viability of the plan and what it means for investors.

Put simply, the plan proposed by Hank 'containment' Paulson and 'Helicopter' Ben Bernanke, is for the US government to buy troubled assets from banks and then resell them at auction.

The $700 billion amount you see floated about in the media is just the amount that can be held at any one time. Thus it could be significantly more than that, expectially if as proposed, they start buying up commercial real estate loans, credit card debt, auto and student loans.

There is understandably much opposition from the US taxpayers to such a huge amount of their tax dollars being used to pay for problems created largely by Wall Street. I know there are plenty of other parties who share some of the blame but lets avoid playing the blame game for now.

Also working against the plan was the poor attempt at marketing it by Paulson and Bernanke who basically asked for a blank check. Their excuse being that financial armageddon was imminent. There is something eerily similar about the fear-mongering of this event and that of the need to invade Iraq because of the WMD's that turned out not to exist.

In fact, in the little over a week since the prediction of worldwide financial meltdown, we have Goldman Sachs get private equity infusions and Washington Mutual get taken out by JP Morgan who was then able to get a $10 billion dollar equity raising away to pay for it.

So it seems the private sector is not as moribund as some would have us believe. However, we also should not ignore the severe stresses in the credit markets. As mentioned on Wednesday the credit markets are a better gauge of financial distress than the equity markets.

    The chart above comes courtesy fo John Maudlin and shows the TED SPREAD in the last week has hit levels not seen since just prior to the equity market crash of 1987. According to Bennet Sedacca at Minyanville, the credit markets are virtually closed:

    Welcome to the credit market, folks - it's officially closed. After Lehman, Fannie Mae (FNM), Freddie Mac (FRE), AIG (AIG) and Washington Mutual (WM) debt and preferred holders have been unmercifully tossed under the bus so Jamie Dimon can be given banks, do you really think many want to get in front of this train wreck?

    Me thinks not.

    • For what it's worth, I was just offered Wachovia (WB) 5.8% hybrids at $0.10 on the dollar, and I passed. A block of 30-year Wachovia paper just traded at $0.35 on the dollar. This is not preferred stock or hybrid, folks, this is subordinated debt.

    • Washington Mutual sub paper? $0.01 on the dollar. This is what a credit rout looks like. And until this ship is righted, watch out.

    • There are others trading similarly, like Morgan Stanley (MS) and, while I have no positions, it's quite interesting to watch.

    • So the few that can raise capital, like JPMorgan (JPM) and Goldman Sachs (GS) will survive, but many failures lie directly in front of us.

    • Many regional banks are likely next.

    So there are very legitimate causes for concern but there are also signs that the market is sorting itself out. As usual, choices are rarely a simple case of black or white, there are various shades of grey. However, whether the bailout plan is needed seems to be a moot point. As I write it seems an agreement, at least in principle, has been reached.

    So what does it mean? US taxpayers should understand that whatver the final amount to be spent, that it is not going directly down the drain, the government will recoup some, if not the majority (and some even say more than) the intial outlay. However that still doesn't make it any more palatable.

    The theory behind the plan is that by removing bad assets from banks' balance sheets, it will free them up to resume lending again. That sounds good in theory but will it work? Will banks just resume lending to one another? This is my biggest doubt about the plan.

    I think a lot depends on what price the government pays for the assets. It's clear from Bernanke's discussion of what he called 'hold to maturity price' and 'firesale price' that the government will pay somewhere in between.

    However it also depends on the specific institution. If a bank is on the verge of bankruptcy, has not been writing down the assets to firesale prices and the price paid by the government is less than that on the company's books, the subsequent capital hit the company takes may be enough to tip them into bankruptcy.

    Conversely, if some institutions have been aggressive with their marks (and I doubt there has been many of those), they may not have to write off any capital. The problem is that the government will auction these securiites and whilst the price eventually realised may be good for one company, it may be lethal for another.

    Thus uncertainty remains around who can be trusted to lend to, or put another way, who is solvent. Hence why back in January I said the bigger issue was solvency not liquiditiy. If financial institutions are unsure of who is going to make it, they will continue to be reluctant to lend and thus the credit markets will remain under stress.

    If instead the government identifed those institutions who they would put capital into and support, and then those they think will go belly-up, then that would remove some of the uncertainty. Then there is the question of how exactly do you value these assets. A bunch of mortgage backed securities might not be too much trouble but how about a CDO squared?

    From the latest read the bailout plan seems to have attracted a few additions such as limits on executive pay and equity participation by the taxpayer. Still there are scores of financial commentators who think the plan is a dud. Time will tell. But it seems it will be passed in one form or another.

    Assuming that it goes ahead in its current form, what does it mean for equity investors? Initially we can expect equity markets to rebound sharply as confidence returns, credit spreads should narrow but still remain elevated.However as time goes on, I think the difficulties as outlined above in implementing the plan will become evident.

    Also, A few themes that I identified almost a year ago continue to play out. The economic backdrop continues to deteriorate. There is only a few permabulls left now that would claim the US is not in recession. Also growth is slowing considerably in Europe and now even in asia.

    Corporate profit margins are contracting from record levels and earnings estimates are being revised lower. Research in Motion (RIMM) being the latest market darling to disappoint on their outlook for the fourth quarter, causing the stock to plunge -27% on Friday.

    My take is that the intial euphoria over the bailout plan could push the equity markets sharply higher, it could last a few days, weeks or even months. However the economic fundamentals coupled with gloomier corporate profit outlooks and the realization that the bailout plan is not a panacea for all that ails the US economy and global financial markets, will reassert itself and the stockmarket will eventually find new lows.

    Friday, 26 September 2008

    WaMu Goes Belly Up Who Would Have Thought?

    Back in July went IndyMac went bankrupt, I asked the question "Who's Next?" At that time I put forward Washington Mutual as the most likely candidate. More recently I argued that WaMu's future was "beyond question" and labelled them as a "Dead Man Walking" . Lo and behold, today the FDIC and the Office of Thrift Supervision (OTS) put WaMu out of it's misery by facilitating a sale of JP Morgan.

    On September 25, 2008, the banking operations of Washington Mutual, Inc - Washington Mutual Bank, Henderson, NV and Washington Mutual Bank, FSB, Park City, UT (Washington Mutual Bank) were sold in a transaction facilitated by the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation (FDIC).

    In brief, The details of the deal are as follows;

    JPMorgan Buys WaMu Deposits; Regulators Seize

    JPMorgan Chase & Co. became the biggest U.S. bank by deposits, acquiring Washington Mutual Inc.'s branch network for $1.9 billion after the thrift was seized in the largest U.S. bank failure in history.

    Customers of WaMu withdrew $16.7 billion from accounts since Sept. 16, leaving the Seattle-based bank ``unsound,'' the Office of Thrift Supervision said late yesterday. WaMu's branches will open today and depositors will have full access to all their accounts, Sheila Bair, chairman of the Federal Deposit Insurance Corp., said on a conference call.

    So they paid $1.9 billion but what about the assumptions underlying WaMu's toxic mortgage assets?

    JPMorgan is taking on $176 billion in mortgage-related assets and writing down the value of it and other portfolios by about $31 billion, the company said. The bank will make a one- time payment of $1.9 billion to the FDIC as part of the deal.

    Not mentioned in the Bloomberg story is that JP Morgan said they have been very aggressive in their assumptions. To arrive at the numbers quoted above they have assumed a further -8% fall in US home prices and a 7% unemployment rate.

    JP Morgan can call it aggressive if they like, but the fact is US home prices could fall a lot more than another -8% as a lot of pundits, like Nouriel Roubini and Meredith Whitney expect. In addition, given current economic conditions a 7% unemployment rate is not a stretch and could easily prove too conservative.

    So who's next big bank to fail? Keep your eye on Wachovia (WB)

    Still No Bottom in Sight for US New Home Sales

    The bottom-callers continue to be disappointed today as new homes sales plunged in August to a 17 year low on a seasonally adjusted basis. From the census bureau:

    Sales of new one-family houses in August 2008 were at a seasonally adjusted annual rate of 460,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development.

    This is 11.5 percent below the revised July rate of 520,000 and is 34.5 percent below the August 2007 estimate of 702,000. The median sales price of new houses sold in August 2008 was $221,900; the average sales price was $263,900. The seasonally adjusted estimate of new houses for sale at the end of August was 408,000. This represents a supply of 10.9 months at the current sales rate.

    On a non seasonally adjusted basis August sales were the lowest since August 1982. On the positive side the number of homes for sale is continuing to drop, although it should be noted that those numbers don't include cancellations which are still close to record levels.

    Thursday, 25 September 2008

    Weekly Jobless Claims Hit 7 Year High

    The US Department of Labor reported on Thursday that initial unemployment claims rose to their highest level in 7 years. As you can see on the graph above, all that is missing is a light grey line on the right hand side representing the current recession.

    Also in the news, a much bigger than expected -4.5% drop in durable goods orders for August and New Home sales plummeted to a 17 year low but the market is rallying on a the new socialist plan from the USSA government. Yep, it all makes sense.

    Jim Awad Makes a Complete Fool of Himself

    I doubt by now that anyone needs to another reason to doubt the opinions of so-called experts when it comes to the stockmarket. But just in case you were beginning to think that you need some guidance, here is a reason to think again.

    Stocks Watch Washington, Pt. 2
    Stocks Watch Washington, Pt. 2

    Jim Awad appeared on Kudlow & Company on Wednesday night and let out this pearl of wisdom when asked about one stock market pick for investors:

    “One pick, well you want long term international growth and a current dividend and exposure to a turnaround in financials I gotta tell ya, if GE doesn’t work nothing works.”

    Then less than 12 hours later GE drops this little bombshell.

    GE Cuts Forecast, Suspends Buyback on Market Weakness
    Sept. 25 (Bloomberg) -- General Electric Co. reduced its annual profit forecast for the second time this year and suspended its stock buyback because of ``unprecedented weakness and volatility'' in financial markets.

    Full-year earnings will be $1.95 to $2.10 a share instead of the earlier projection of $2.20 to $2.30, Fairfield, Connecticut- based GE said today in a statement. The world's fourth-largest company by market value fell in early New York trading.

    So I guess Jim Awad is now thinking nothing will work. Nice one Jim, made a fool of yourself on national TV. However, in anindustry with no accountability, he will be invited back next week to espouse more of his 'expert' views.

    Wednesday, 24 September 2008

    Buffet Extracts A Pound of Flesh from Goldman

    The headlines since the US market closed on Tuesday were full of praise for Warren Buffets deal to sink $5 billion dollars into the former golden boy of Wall Street, Goldman Sachs. However, behind the cheery headlines the details are much less favourable for Goldman.

    Buffet is an opportunist, he lives for times like the present. Just look at the deal he got today. First up he bought $5 billion of preferred stock paying a dividend of 10%, great for Buffet but a big ouch for Goldman as they now have to pay out $500 million to Buffet every year. On top of that, if they want to buy back those preferreds, they have to pay a 10% premium.

    In addition, Buffet is getting warrants on approximately 43.5 million shares at a strike price of $115 per share (about $5 billion worth) with 5 years in which to exercise them. As Barry Ritholtz of the BIG PICTURE points out:

    If Buffett were to go to the Street earlier today to buy 44 million calls with a $115 strike price (circa 2010), they would have cost him about $1.5 billion dollars. With GS now trading at $135, Buffett’s $5 billion investment is more like $3.5B, in terms of net cost to him. Hence, the 10% interest is more like 14%.

    So it pays to have a look beyond the headlines, no doubt Buffet got a great deal, but it was a very expensive one for Goldman Sachs.

    Pay Attention to the Credit Markets

    Whilst it may be entertainting to watch stock prices fluctuate up and down. If you want an indication of the level of financial market stresses, it's a good idea to take notice of events playing out in the credit markets.

    Yesterday Caterpillar raised $1.3 billion in a bond offering. It's a positive that they were able to get that offering away but take a look at the terms:

    Caterpillar Raises $1.3 Billion in Biggest Bond Sale in 2 Weeks

    The sale, Caterpillar's biggest, was split between $750 million of 6.2 percent, five-year notes that priced to yield 320 basis points more than U.S. Treasuries of similar maturity and $550 million of 7.05 percent, 10-year bonds at a spread of 325 basis points, according to data compiled by Bloomberg.

    Caterpillar, the biggest maker of earthmoving equipment, last issued five-year notes on Aug. 7, selling $300 million of 4.9 percent senior unsecured debt that paid a spread of 175 basis points, Bloomberg data show.

    Peoria, Illinois-based Caterpillar sold 5.45 percent, 10- year notes on March 19 with a spread of 205 basis points, Bloomberg data show.

    So even for an investment grade company like Caterpillar that is posting record profits, credit is proving much tougher to get. Another measure of credit market distress is the so-called TED spread. In brief the TED spread is a measure of how willing banks are to lend money to one another. The wider the spread the higher the level of distress.

    You can see above that huge spike that occurred last Thursday when the world supposedly looked into the abyss. That quickly came down on the news of the latest socialist plan from the U.S.S.A government. However, as you can see above, it has failed to return to more normalised levels.

    What the above show are severe levels of distress in credit markets and an unwillingness of financial institutions to extend credit. If those persist or get worse, the equity market is in for tough times.

    Tuesday, 23 September 2008

    Earnings Estimates Continue to Fall

    As you know by now, stock market analysts are a bit on the slow side but they are starting come round to reality, although they still have a long way to go. After months of rosy forecasts for 3Q08 earnings, analysts have finally succumbed to the idea that it they won't be much good now expecting a -0.6% decine in operating earnings.

    Remember that the third quarter last year is when the proverbial started hitting the fan making this years comparisons a little easier. That said I expect earnings to eventually show a double digit decline beofore the quarter is out.

    Also of note is that FY08 earnings are now anticipated to be down -5.7%, well down from the lofty predictions of more than +19% back in February.

    Analysts have also pushed back the timeframe for when they expect earnings will surpass their former peak. Previsouly anaylsts had expected S&P500 operating earnings to surpass the record set in 2Q07 by 4Q08 - just 6 quarters later. Now they have pushed that out until 2Q09 a full 2 years or 8 quarters later.

    However, as noted previously, it took 20 quarters after peak earnings in 1989 and 14 quarters after the peak in 2000 for earnings to regain their former highs. Expect those behind the curve analysts to keep pushing their forecasts out as the months progress.

    Sunday, 21 September 2008

    Watching a Train Wreck in Slow Motion.

    It was difficult not to get caught up in the events of the last week. Stockmarkets around the world were yanked violently in both directions as The United Soviet States of America took another step toward socialism by banning short selling on financial companies. Not only that, the latest news is that the Federal Government is going to take hundreds of billions (Probably trillions) in mortgage related assets onto their balance sheet.

    We should not underestimate the gravity of the situation. The financial world is in turmoil and understandably so, as the biggest credit bubble in history, 25 years in the making, continues to implode. However this is no ordinary implosion, this is not a stockmarket correction or an economic slowdown. This is a once in a lifetime event, a train wreck in slow motion.

    The train has been off the rails for a while but all the passengers had the illusion of safety. More recently a couple of the dare devil passengers fell out the window, or were they thrown? However, the train driver (the US government and the Federal Reserve) is soothing the rest of the passengers nerves with reassuring bromides like "the US financial system is fundmentally sound". Of course they would say that wouldn't they?

    But the financial system is not fundamentally sound, in fact it is fundamentally unsound. How sound is a financial system where one small broker dealer called Bear Stearns could threaten to bring down the entire system and lead the Federal Reserve to step in and guarnatee $30 billion in liabilites?

    Some of the passengers have woken up to this fact and have begun short selling financial companies. They realise that the broker dealer model built on ridiculous leverage and worthless mortgage paper is dead and that certain banks will be writing off foreclosed homes for years. However, before they could really get going the train driver gave them all an anesthetic and threw them under the wheels.

    However the train keeps moving on, gaining speed, so the train driver looks around for something else. US taxpayers! That'll do the trick and out the window they go, but the train ploughs on. They could pull on the brake but noone wants to do that, there is no political will, anyone with the power to pull on the brake has too much at stake. And so the maintenance of the gravy train must go on.

    Do I have an unhealthy obsession with trains? No, I just got carried away with the analogies. I apologise for that. Hopefully you didn't get lost. The point is, the US government has now reached desperation stages and is now pulling out all the stops. How and when will it all end? I won't even pretend to know the answer. All I know is, it will get worse before it gets better, much worse.

    The actions to prevent short sellers repricing financial stocks closer to fair value doesn't mean a floor has been put under stock prices. It just means the revaluing of asset prices will take longer and be more drawn out.

    In the space of 4 trading days, MQG shares fell more than -40% and then bounced back almost 38% the very next day. What the true value of MQG shares is a question I don't purport to answer, but the point is that the market clearly doesn't either.

    So don't get caught up in the day to day noise, except when stocks with good economic fundamentals, get absolutely punished to the point where they represent good buying opportunites.

    Thursday, 18 September 2008

    Roubini on why Broker Dealers are Doomed.

    Brilliant interview with Nouriel Roubini. You have to take your hat off to this guy, he said months ago that the independent broker dealers were ultimately doomed.

    Amongst other things he discusses:

    • The nonsense that short sellers and mark to market accounting are to blame.
    • the reasons why broker dealers business models are broken and cannot survive as independent entities.
    • The ridiculous asymetric approach to monetary policy that leads to asset bubbles on the way up and trying to prevent them on the way down.
    • The overblown fears of inflation.

    I wholeheartedly agree, excellent stuff!

    Credit Market Pressure
    Credit Market Pressure

    Impaired Assets Rising But Not Yet Alarming

    The Reserve Bank released it's monthly bulletin today along with certain financial statistics. Regular readers will recognize the chart above. It is the total dollar amount of of impaired assets at Australian financial institutions and also those assets as a percentage of total assets.

    Whilst impaired assets are rising sharply, as noted before they are still far from alarming levels. You nwould need to see impaired assets rise above 1.0% of total assets to get worried. However, given the current trend and the events of recent weeks, you should expect impaired assets to continue rising over the next 18 months.

    Whilst the globe is currently roiling from the worst economic crisis in recent memory, large corporate failures and home foreclosures in Australia are still relatively tame. However, it is dangerous to think that becasue we dig up rocks and send them to China that we will somehow come out of the current turmoil relatively unscathed. Expect corporate failures to ramp up over the next 12 months and for the major Australian banks to make frequent visits to the confessional.

    US Housing Bottom-Callers Still Early

    Regular readers may have detected a note of sarcasm and contempt in my comments regarding the constant brigade of cheerleaders suggesting that both housing sales and prices have bottomed in the US.

    Data released today from the Commerce Department showed that the bottom is definitely not in yet. From marketwatch.com:

    Home building weakens further in August
    Single-family building permits fall to 26-year low

    Home building tumbled again in August, with the number of new building permits for single-family homes dropping to a 26-year low, the Commerce Department estimated Wednesday.

    Starts of new homes fell 6.2% to a seasonally adjusted annual rate of 895,000, the lowest in 17 years, and much weaker than the 955,000 rate expected by economists surveyed by MarketWatch. See Economic Calendar.

    Starts of single-family homes fell 1.9% to a 17-year low of 630,000 annualized units.

    Building permits for single- and multiple-family dwellings fell 8.9% to a 26-year low of 854,000 annualized units, with permits for single-family homes dropping 5.1% to 554,000, also a 26-year low. Permits for single-family homes fell to the lowest levels in at least 20 years in the Midwest and West.

    "Starts will almost surely fall below the 1-million-unit mark this year" for the first time since 1945, said Patrick Newport, an economist for Global Insight. "In the fourth quarter, we currently project that starts will drop to an annualized 813,000 units, which would also be a record post-war low."

    Click on the link for the full story.

    We were getting used to seeing new 26 year lows in various housing statistics but thats the first time I've seen talk of a 60 year low. If you want a silver lining in these numbers it is that at least builders are building less houses. Still, with record numbers of inventory, both home construction and prices will continue to fall.

    Wednesday, 17 September 2008

    Time for the Big 4 to Show Their Cards

    Yesterday we learned the extent of the big Aussie 4 banks exposure to Lehman Brothers. Commonwealth Bank has an exposure of less than $150m, ANZ appoximately $120m NAB less than $100m and WBC less than $10m. Those amounts are not necessarily what will be lost but the banks will proabably need to take some kind of specific provision against them.

    Expect this game to continue. The banks are 'all in', they have placed their bets and now it is time to show their hands. The difference in this game though is that noone wins, some just lose less than the others. Stay tuned, their are plenty of hands yet to be played.

    Tuesday, 16 September 2008

    Whitney on Wall Street Meltdown

    Amidst all the hyperbole that passes for finanical journalism, sometimes something worth listening to, actually gets through. As noted here previously, Meredith Whitney has been ahead of the curve for some time when it comes to US financial companies. In an interview today, in her usual straight forward style, she pulled no punches on the outlook for US financial companies.

    Future Of Wall Street
    Future Of Wall Street

    Forget the Broker Dealers, Bigger Problems Loom

    Away from the noise of Wall Street, ordinary citizens are going about their business as usual. However if you are in any way connected to or interested in financial markets, these are indeed interesting times.

    6 months ago there were five large independent broker dealers in the US. Today there are only two. How many will there be in another 6 months? Nouriel Roubini thinks none of them will independent.

    Does it really matter? Do we really need them? I would argue not. What benefit have these institutions brought to the economy? They have proved themselves incompetent by losing every dollar they have ever made. And this is not the first time.

    What good are institutions that leverage themselves to the hilt, slice and dice dubious pieces of paper in the name of financial innovation and then infect all corners of the financial markets with their toxicity? Absolutely nothing and good riddance to them.

    Besides, there are bigger problems out there in the form of AIG, Washington Mutual and Wachovia - and they are just the ones we know about. Citigroup itself is hardly out of the woods and it is doubtful if they survive in their current form.

    The latest on AIG and WaMu is that their ratings have taken another hit. From marketwatch.com:

    WaMu, AIG downgraded

    Washington Mutual shares (WM) stumbled 9.4% to $1.82 after Standard & Poor's late Monday cut its ratings on the company and its Washington Mutual Bank unit because of increased market turmoil. S&P cut the counterparty credit rating on Washington Mutual Inc. to BB-/B from BBB-/A-3 and the rating on Washington Mutual Bank to BBB-/A-3 from BBB/A-2. The outlook is negative....

    ....Fitch on Monday evening downgraded AIG's rating to A from AA-, and said the company has an "extremely limited" ability to raise capital for its holding company

    That doesn't sound good for AIG. from Bloomberg:

    AIG's Ratings Cut by S&P, Moody's, Threatening Quest for Funds

    American International Group Inc.'s credit ratings were downgraded by Standard & Poor's and Moody's Investors Service, threatening efforts to raise emergency funds to keep the company afloat.

    The ratings reductions occurred after two people familiar with the situation said that the biggest U.S. insurer by assets is seeking $70 billion to $75 billion in loans arranged by Goldman Sachs Group Inc. and JPMorgan Chase & Co. to replenish capital.

    $70-$75 billion, jaysus! On the weekend it was $40 billion. Also an AIG failure would not be good for anyone it seems:

    "I don't know of a major bank that doesn't have some significant exposure to AIG," said Kenneth Lewis, chief executive officer of Bank of America Corp., in a CNBC interview. An AIG collapse would "be a much bigger problem than most that we've looked at," he said.

    Why is that?

    "The bigger problem here is that AIG is a bigger balance sheet, the tentacles go further and we don't have the same relationship between the Fed and an insurance company as we do with some of the others," said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. in a Bloomberg Television interview.

    That's about it in a nutshell. Isn't this wonderful world of interconnected global financial markets marvelous? Hank containment Paulson was careful not to rule out government intervention. My bet is that AIG will qualify for the 'too big to fail' doctrine if it does indeed come to that.

    How about Australia? There seems to be almost eerie silence form our banks and other financial institutions. It would be wishful thinking to assume our banks will be unscathed. We already know ANZ has CDS exposure to some major US corporate names. I think it's safe to say that BNB and all it's satellite companies are toast. MQG will find it tough to stay in one piece and there have been some rumblings about SUN's portfolio of assets.

    But forget about the sideshow surrounding the Broker Dealers. The main event is the main street banks and insurers. If a couple of these go belly up in short order, we could be in for some real fireworks.

    Saturday, 13 September 2008

    US Financial Crisis Goes from Bad to Worse

    Let's have a look at the main stories on Friday from the US. I could link any number of articles on Lehman butwhat is the point? They're gone, whether that is being bought out, or selling off assets or bankruptcy remains to be seen but they're gone.

    Also, Washington Mutual's problems are being compounded by those ever behind the curve ratings agencies.

    Fitch Downgrades Washington Mutual to 'BBB-'; Outlook Negative

    Fitch Ratings has downgraded the long- and short-term Issuer Default Ratings (IDRs) of Washington Mutual, Inc. (WaMu) as follows:

    --Long-term IDR to 'BBB-' from 'BBB';

    --Short-term IDR to 'F3' from 'F2'

    Fitch has also taken the following rating actions on Washington Mutual Bank (WMB):

    --Long-term IDR affirmed at 'BBB''

    --Short-term IDR downgraded to 'F3'
    from 'F2'.

    The Rating Outlook is Negative.

    Today's actions reflect Fitch's expectation for continuing asset quality challenges amidst market conditions that are considered the most difficult in several decades for U.S. retail banks, particularly those with a concentration in residential mortgage assets.

    Washington Mutual is adamant that they are OK and do not think the downgrade is justified. If that were the case, you have to wonder why they are in 'advanced talks' with JP Morgan.

    JPMorgan Chase in Advanced Talks to Buy Wamu: Sources

    JPMorgan Chase is in advanced discussions to buy Wamu, sources said Friday. While a deal has not been struck, and could fall apart, talks are ongoing at the highest levels ...

    Whilst the media seems to be obsessing about Lehman, I think WaMu is much more important. If WaMu were to go down the toilet, it would be by far the biggest bank failure in history. A failure of this company alone would force the FDIC to go hat in hand to the Tresaury for more money to cover the insured deposits at WaMu.

    At the end of 2Q08 WaMu had $25 billion in capital, that might sound like a a lot but with potentially $40 billion in losses coming down the pike over the next few years it's just a matter of time before these guys fold.

    The good news is that there are suitors circling. I think the balance of probabilities suggests that neither Lehman nor WaMu file for bankruptcy, they both have assets that other financial companies want. However, there is no doubt that these institutions will not exist in the current form in the near future.

    But we are not done yet. Also on Friday, AIG, formerly the largest insurance company in the world by market value fell -31% as the cost of their credit default swaps rose to record levels, prompting them to hold a conference call this coming Monday:

    AIG May Hold Analyst Call As S&P Threatens Downgrade

    On Friday, credit-ratings firm Standard & Poor's threatened to downgrade American International Group Inc., citing the significant decline in the company's share price and the increase in credit spreads on the company's debt. Meanwhile, AIG will likely hold an analyst call Monday morning and could announce a series of steps aimed at reassuring investors, including possible asset sales, a person familiar with the matter said.

    And last but not least, Merrill Lynch stock fell -38% this week. As Lehman gets taken out the market has decided that it's next victim is Merrill.

    We have consistently heard over the last 6 - 9 months that the worst is over and the botom is in but things continue to deteriorate. As I said back in August, this will not be resolved in a year, it will be several. The real question that everyone would like to know the answer to is 'when does the stockmarket price it all in?' I wish I knew, but from where I sit there still seems to be too much denial and complacency out there to signal a bottom just yet.

    Thursday, 11 September 2008

    Australian Labour Market Resilient in August

    The Australian labour market added a net 14,600 jobs in August, well ahead of market expectations. Before we start popping champagne corks and declaring the possibility of an Australian recession dead in the water, we should remind oursleves of what labour market data tells us.

    Firstly employment is a lagging indicator. From the graph above you can see that the moving average was still positve at the beginning of the last two sessions. By the time the employment numbers confirmed the recession, it was half over.

    In a recession you would expect to see several consecutive months of job losses exceeding -20k. However as stated above if you wait for those kind of numbers you will have missed the boat.

    So job ads remain the best forward looking indicator for the job market and although they have weakened considerably over the last six months they would need to worsen a lot more to get near recessionary levels. If we do get several consecutive monthly eclines in payrolls it's likely not to be until the first half of 2009.

    As stated above the Australian economy need to creat between 15 -20k jobs a month just to keep the unemployment rate constant. However, the unemloyment rate dropped from 4.3% to 4.1% in August. This simply reflects the fact that the number of people looking for work fell in the month of August as shown in the fall in the particpation rate.

    WaMu Dead Man Walking

    Whilst a lot of focus in the last few days has been on Lehman Brothers (LEH) and the new wave of socialism gripping the United Satates, Washington Mutual (WM) has been quietly making a march toward bankruptcy.

    Back in July of this year when IndyMac Bankcorp went belly up, I asked the question "Who's Next?" At that time I suggested Washington Mutual would be the most likely candidate. The stockmarket now seems to think the same. WM stock tumbled -28% yesterday after a -22% fall the previous day.

    On Monday Wahington Mutual's CEO resigned and the company entered into an agreement with the Office of Thrift Supervision (OTS):

    WaMu replaces CEO, signs agreement with regulator

    WaMu also announced that it has entered into a Memorandum of Understanding (MOU) with the Office of Thrift Supervision (OTS) concerning aspects of the bank's operations, principally in several areas of its risk management and compliance functions, including its Bank Secrecy Act compliance program. In addition, WaMu has committed to provide the OTS an updated, multi-year business plan and forecast for its earnings, asset quality, capital and business segment performance. The business plan will not require the company to raise capital, increase liquidity or make changes to the products and services it provides to customers.

    So what does that actually mean? Well basically Washington Mutual is in such a state that they can't be trusted to run their business by themselves. It's kind of like telling an 18 year old he can't be trusted to stay home by himself and therefore needs a baby sitter.

    Dick Bove of Ladenburg Thalmann & Co. Inc. chimed in late Monday and summarised the situation well;

    "The problem is very simple. They made a lot of bad loans and they are absorbing high levels of loan losses. The solution for their problem is to find some mechanism for reducing the bad loans. That can't be done by a new CEO."

    How many bad loans did they make? From the same WSJ article we find:

    WaMu has $53 billion in option adjustable-rate mortgages ... Of the $53 billion in option ARMs, $14 billion of these are to the riskiest segment in mortgage lending, subprime borrowers.

    WaMu also has $62 billion in home-equity loans ...

    Mr. Bove predicts that WaMu will lose $40 billion over the next three years on its loan portfolio. If the economy weakens further and losses are even higher, he said, "the future of the company is questionable."

    Then on Tuesday, the ever behind the curve ratings agencies cut WaMu's outlook to negative.

    I've been talking about the problems at WM for more than a year. For a recap check out:

    WM Loan Losses to reach $2.2 Billion in 2007
    WM ups loan loss reserves again
    WM to Bleed Red Ink in 2008
    WaMu's Great Dilution
    Nothing but Red Ink for Wamu

    Unlike Bove I don't think the company's future is questionable, it's beyond question, this company is a dead man walking.

    Tuesday, 9 September 2008

    The Spring Selling Season That Will Not Be

    The title above is meant to a prediciton about the upcoming Spring home selling season in Australia. The bull case is that with an RBA rate cut and more on the way, homebuyers will be encouraged to go looking for homes.

    The bear case, or as I like to call it - reality is that this Spring selling season will fail to eventuate because of tighter lending standards and an already an embattled consumer up to theri eyeballs in debt and facing the prospect of falling equity in their homes for the first time in many years.

    Today the ABS released data on housing finance commitments. Both the number and value of commitements excluding refinancings are off -30% from their highs.

    Also today the abs released retail sales data for July showing a tepid rise in retail sales. It should be noted that the abs has reduced its smaple size for the retail sales data and therefore they now recommned that the trend data be used rather than the seasonally adjusted data and that is what is shown below.

    As you can see, even in the recession of 91, retail sales never went negative on a year over year basis. Whilst retail sales are clearly weak, on the positive side, tax cuts in July in concert with lower petrol prices may give consumers some support, however I believe that will be offset to some extent by rising unemployment in the months ahead.

    Monday, 8 September 2008

    Bailout Nation to the Rescue

    I'm sure by now you've heard that the United Soviets of America have decided to throw taxpayer money behind the nations biggest hedge funds Fannie Mae and Freddie Mac. There is a multitude of article onlines if you wish to dig through the details. I'll just offer a couple paragraphs from John Hussman who sums up well my feelings on the subject.

    With that January 2009 “sunset” provision now gone, I expect that U.S. taxpayers will be on the hook for about $250 billion in losses. Look – 9.16% of U.S. mortgages are already delinquent or in foreclosure, with the likelihood of further delinquencies and foreclosures in the coming quarters. On a $5.2 trillion book of mortgage loans between Fannie and Freddie, and a prevailing recovery rate of 50% on foreclosed properties, an overall loss of about 5% of this book, or about $250 billion, is a fairly conservative expectation.

    It's likely that the market will take some initial comfort from this transaction, on the notion that the government has provided a “safety net” under the U.S. financial system. The problem with that interpretation, however, is that Fannie and Freddie always had the implicit backing of the government, and the government is now being forced to save these institutions because private investors have increasingly refused to provide additional capital. Unfortunately, what is true of Fannie and Freddie is most likely also true of other financial institutions that do not enjoy the implicit backing of the government. The prospect of a government bailout of those other institutions isn't at all clear. So by essentially capitulating that Fannie and Freddie have to be taken over, the government is also sending a signal that other financial institutions (particularly investment banks with high gross leverage multiples) may be vulnerable to failure. For that reason, any “knee jerk” enthusiasm about this transaction will probably be misplaced.

    Job Ads Signal Warning for Labour Market

    ANZ released their monthly job add series today which showed job advertisements fell a seasonally adjusted -4.9% in August after a -0.3% decrease in July. The total number of advertisements in August was -0.3% lower than 12 months ago. How good a predictor of employment growth is this series? According to the ANZ website:

    It has historically proved to be a very good indicator of future labour market conditions and thus, is extensively relied upon for forecasting employment growth.

    But lets not take ANZ's word for it, what does the ABS say about it? The ABS found that:
    ANZ (newspaper) Job Advertisement Series leads peaks in employment growth by one to three quarters, and troughs in employment by zero to two quarters. The ABS analysis finds that the ANZ Job Advertisements Series has a correlation coefficient of 0.75 with employment growth at a lead period of three quarters.

    And here is a pretty graph to prove it.

    Note that the correlation relates to Newspaper based ads, and since a little thing called the internet caught on a few years back that is no longer as reliable. Looking at the internet data shows that it is not a good predictor of future labour market growth.

    However the trend is clear, job ads whether Newspaper or Internet based have fallen sharply over the last 6 months. Taken together with recent layoff announcements and a general slowing in the economy is all the evidence I need to draw the conclusion that we can expect a softer labour market in the coming months.

    Sunday, 7 September 2008

    Wesbury Gets His Ass Handed to him..... AGAIN

    Frequent readers of this blog will know the utter contempt I have for Brian Wesbury. If you would like to refresh your memory, please see the following posts:

    Behind the Curve or on Another Planet?
    Permabulls in a State of Desperation
    Joe B. Rips Brian Wesbury a New Asshole

    That Wesbury is incompetent is clear. However it's comical the kind of stuff he is now sprouting. 12 months ago he could actualy point to real data to support his case, now he just making things up. Friday was a perfect case in point.

    In relation to Friday's dismal jobs report, Wesbury made the claim that the unemployment rate jumped significantly not because a huge amount of jobs are being lost but because there has been a surge in the labor force, or in other words the amount of people looking for work has increased dramatically in the last 6 months.

    Then John Ryding of RDQ Economics absolutely bitch slaps Wesbury by pointing out that the labor force participation rate, that is the percentage of people of working age in the labor force has remained steady since March and quotes the exact numbers whihc anyone who read the report would know.

    You can clearly see from the expression on Wesbury's face that he knows he's been caught out in a lie, he's absolutely lost for words and stutters his way though some insignificant point. Then to prove that he is still in denial he drops this doozy to finish the show;

    “….between December and June, gasoline prices went up 17 cents a month, it was a killer, people were shocked, and I believe that’s what we’re seeing here, it’s just a shock to the system, we’re now bouncing back, auto sales soared and truck sales soared in August, I think this economy is nowhere near a recession."
    Thanks for clearing that up Brian, it's just the shock of oil prices, the economy is doing just fine. The only shock going on is the realization from Wesbury that he has gotten it so horribly wrong. Click on the image below to watch the clip.

    Is America Working?
    Is America Working?

    Saturday, 6 September 2008

    US Employment Continues to Deteriorate

    On Friday, the US Bureau of Labor Statistics released the monthly non-farm payroll report which showed a net -84,000 jobs were lost in the month of August. That makes the 8th straight month of job losses for the US economy. Below are the main job loss and gain catergories;

    construction -8,000
    manufacturing -61,000
    retail trade -20,000
    service -27,000
    prof & bus services -53,000
    leisure & hospitality -4000
    education & health services +55,000
    government jobs +17,000

    Also of importance were the revisons to prior months. And here is why they are important. Back in July, on the eve of the NFP report I noted that we could see triple digit declines (more than -100k) in NFP's for June. The report subsequently showed job losses of only -62k. Then last month it was revised to a loss of -51k . Yesterday June was revised to a loss of -100k. So it pays to look at the revisions. Total revisions caused an extra -60k in job losses to be recognized for the preceeding two months.

    The unemployment rate soared to 6.1%. Of course the permabulls said this was an aberration caused by more people staying on the recently extended unemployment benefits. Remember that the permabulls said the spike in the unemployment rate from 5.0% - 5.5% from April to May was due to teenage workers entering the workforce. Interestingly, that aberation has stayed.

    Debate still rages at whether the US is in a recession. The above chart says quite clearly the US is in recession. The only time you see sharp upward spikes in the unemployment rate are during recessions.

    Lastly it wouldn't be a NFP report without talking about the infamous birth death adjustment. Just to recap, the B/D adustment tries to estimate the number of jobs lost as a result of businesses going under and the number of jobs added as a result of new businesses being created. Incredulously, the BLS claims that a net 125k jobs were created in August. Yeah right.

    Friday, 5 September 2008

    Robert Shiller on Home Prices

    Robert Shiller is a leading expert on US Home prices and is the co-creator of the widely cited Case-Shiller Home Price Indices. Here is the most interesting quote from the interview for mine;

    "There's a lot of misconceptions about home prices, people think that there is a strong historical uptrend to them. In fact by my data there is not. In fact home prices in the United Sates if you correct for inflation, in 1990 were about the same as they were in 1890."

    Well worth a watch.

    Thursday, 4 September 2008

    ADP Report Suggests Modest Declines in NFP's

    Yes it's that time again when we get probably the most watched yet most unreliable economic data of the month. The ADP employment report released today is seen as a proxy for tomorrow's non-farm payroll report from the bureau of labor statistics.

    Today's ADP report for August saw a decline of -33,000 in private sector payrolls. Remember the NFP report includes government jobs. The general rule of thumb is to add 25k -30k. That would suggests the BLS report should show a flat reading for August.

    However as mentioned many times here before, the ADP report is notoriously unreliable in predicting non-farm payrolls from month to month and has been fairly consistently on the high side compared to the BLS number.

    So basically you can forget about the ADP report. You might as well pick a random number anywhere between -150 and +50k for tomorrow's NFP number and you'll have as much chance as any economist of getting it right. And don't forget to pay attention to the previous months revisions.

    Wednesday, 3 September 2008

    Aussie Growth Sluggish in Second Quarter

    Australian GDP grew 0.3% in the second quarter according to a report released by the abs today, lower then forecasts of 0.4% by economists. That represents the lowest quarterly growth rate since the fourth quarter of 2004. The major highlight for me was that Household Consumption Expenditures were down for the first time in 15 years, dropping -0.1% in the June quarter.

    Also this week we've seen separate reports on the manufactuing and services sectors. The Performance of Manufacturing Index registered a reading of 47 in August making it the third straight month of contraction.

    Meanwhile, the Performance of Services Index fell to its lowest level since inception five and half years ago and has now been in contraction mode for 5 straight months.

    On the back of today's data the Australian dollar continued to decline against other major currencies and the SFE futures market increased the likelihood of another 25 bps rate cut by the RBA in October to 88% up from 83% yesterday. The data continues to come in on the weak side and if that continues over the next few weeks another rate cut in October is looking more and more likely.

    Tuesday, 2 September 2008

    RBA Waffles, Markets Disappointed

    Well, if you thought an RBA rate cut might spark a rally in equities you would have been wrong. While there was no surprise the RBA didn't go 50 bps, the decision at today's meeting to cut 25 bps was accompanied by less than inspiring commentary about the likelihood of further cuts. Thus the stockmarket abruptly gave up the gains made earlier in the day.

    I rarely comment on the reasons the stockmarket goes up or down on any given day but the reason for today's afternoon reversal was clear. Basically the RBA waffled on about the "opposing forces at work" as it has done for the last several months. Sure, inflation has not gone away as yesterday's TD securities, Institute of Melbourne inflation gauge reminded us, showing inflation at a 4.2% annual rate, however as mentioned before inflation is a lagging indicator and it will prove not be the problem the RBA thinks it is in the coming months as we transition towards a more deflationary environment.

    At the end of the day the language used in the RBA's statement, whilst not closing the door on further rate cuts, left some doubt as to if and when more cuts would be forthcoming. The RBA made clear that any further decisions will be data dependent. As one economist put it;

    "It's not as dovish as we thought. The guidance...is quite clear that they're looking month to month and meeting to meeting, and it just depends on how things evolve with the economic data, the currency and the global financial conditions,'' Stephen Walters, chief economist with JP Morgan, told Reuters.

    And so we will continue to monitor the data as it comes in. Currently the cash rate futures market is pricing in an 83% chance of a 25 bps cut in October. I think we can expect to see more weak data in coming months that will lead the RBA to cut at least once more before the year is out.

    Click on this link for the full RBA statement.