No End In Sight

This looks like an interesting documentary on the criminal incompetence of the Bush Administration. Anyone seen it yet?

Rising Credit Default Risks Sound Alarm Bells

Australia Bond Risk Rises to Record as Banks Lift Mortgage Rate

The risk of Australian companies defaulting rose to a record as two of the nation's biggest banks increased mortgage rates after the collapse of the U.S. subprime market drove up funding costs.

National Australia Bank Ltd. and Australia & New Zealand Banking Group Ltd. lifted home-loan charges without the central bank changing benchmark rates, the first time that's happened in a decade. Losses in the U.S. caused Centro Properties Group in Melbourne to put itself up for sale, triggered the collapse of Sydney-based hedge fund Basis Capital Fund Management Ltd. and contributed to the highest bank borrowing costs in 11 years.

Credit-default swaps on the Markit iTraxx Australia Series 8 Index of 25 companies, including the nation's five largest lenders, jumped 2 basis points to 70.5 today, according to Citigroup Inc. The index, a benchmark for the cost of protecting bonds against default, rises when perceptions of credit quality deteriorate.

"Risk sentiment will remain high,'' said Annisa Lee, a credit analyst at Lehman Brothers Holdings Inc. in Hong Kong. "The woes of the housing sector in the U.S. may be starting to spread into the broader economy.''

Oh Really Annisa? Thanks for the tip.

National Australia, the country's second-biggest provider of mortgages, raised the interest it charges for floating-rate home loans by 12 basis points to 8.69 percent. Credit-default swaps on the Melbourne-based bank rose 10 basis points to 42.8 this week, according to prices on Bloomberg.

ANZ, which funds 40 percent of its assets in the wholesale debt market, raised borrowing charges by 25 basis points to as much as 8.54 percent. Credit-default swaps on the Melbourne- based lender increased 10 basis points to 42.83 this week.

The fact this article focuses on Australian corporates is not the main point. Credit markets are clearly spooked and despite the smoke and mirrors liquidity magic tricks played by the Fed and the ECB that have bought LIBOR rates down credit default swap rates continue to rise. The credit markets are telling us something important here. The problem is not one of liquidity but insolvency.



Above is the the North American High Yield Credit Default swap index. Note the spread (red line) has climbed back to the highs of November. This in an environment of relative calm in credit markets over recent weeks.

US Unemployment rate climbs in December

Nonfarm payroll growth came in at a very weak 18k in December, total revisions to previous months amounted to an addition of 10k. Before we get carried away we should point out that these numbers are subject to large revisions. In August nonfarm payroll growth was initially estimated at -4k and ended up after subsequent revisions at 93k.


Still the report shows broad weakness. Private-sector payrolls actually fell -13k, the biggest decline in more than four years. The 31k jobs added by the government sector pushing the total number into positive territory. However that is only after the magical birth death adjustment contributed 66k to the final number.


Looking closer at the details construction lost -49k, manufacturing -31k, retail suprisingly lost -24k whilst the service industry continued to add jobs growing by 93k in December. Hourly wages rose more than expected at 0.4% for the month and the real kicker was a 0.3% jump in the unemployment rate to a 2 year high of 5.0%.


The chart below illustrates why the unemployment rate is important. Since 1960, every time the unemployment rate has risen 0.5% or more the US economy has gone into recession. The unemployment rate bottomed at 4.4% in October 2006 and is now according to the latest data 0.6% above that level.

That is not meant to imply that this single data point means a recession is a certainty but the case is certainly gaining momentum alongside slowing consumer spending and weak ISM manufacturing data. I've been calling for US recession in 2008 since August 2007 and this latest piece of data on the employment front only serves to strengthen my view.

ABCP market gains $26.2 billion in latest week

The market for Asset Backed Commercial Paper broke a 20 week losing streak in the week to January 2nd as the amount of ABCP outstanding increased by $26.2 billion. Naturally the bottom callers have come out and announced that the ABCP market has stabiized. From Bloomberg:

"The market is stabilizing," said Neal Neilinger, managing director and co-founder at NSM Capital Management LLC in Greenwich, Connecticut. "I don't think we'll see another drop, unless there's another headline that hits."

OK so a 1 week hiatus in a 20 week downtrend signals stabilization. No doubt this quote will be revisited this quote in the weeks to come.

ADP report suggests slow job growth in December

After a period of reasonable correlation with the BLS nonfarm payroll numbers the ADP report lost it's credibility as a good predictor of nonfarm payroll job growth last month estimating more than twice the number (189,000) of new jobs as the BLS report (94,000). So should we put any stock in today's numbers? From adpemploymentreport.com:

Nonfarm private employment grew 40,000 from November to December of 2007 on a seasonally adjusted basis, according to the ADP National Employment Report. The estimated change in employment from October to November was revised down 16,000 to 173,000. December’s increase of 40,000 marked a slowing of nonfarm private employment growth that averaged 118,000 during the three-month period from September through November.

Employment in the service-providing sector of the economy grew 71,000, while employment in the goods-producing sector declined 31,000, the thirteenth consecutive monthly decline. Manufacturing employment experienced its eighteenth consecutive monthly decline, falling 16,000...

...Two sectors of the economy hit hardest by recent problems in mortgage markets have been residential construction and financial activities related to home sales and mortgage lending. Today’s data suggest that in these two crucial sectors employment is still falling. In December, construction employment fell 17,000. This is the thirteenth consecutive monthly decline, bringing the total decline in construction jobs since the peak in August 2006 to 199,000. Employment in financial activities fell 5,000, which is the third decline during the last five months.

So according to ADP 40,000 new private sector jobs were created in December. If we add the customary 25 - 30k government jobs not captured by the ADP report that suggests we could expect 65 -70k new jobs for the month of December from the BLS report tomorrow which is about what consensus is expecting.

However as suggested above the ADP report has to be taken with a grain of salt. Last month's job growth was revised own 16,000 to 173,000 however that is still well above the BLS estimate of 94,000.

Whilst tomorrow's headline number for nonfarm payroll growth in December is much anticipated, the revisions are much more reliable than the headline number. Coupled with the usual controversy surrounding the Birth / Death adjustment tommorrow's report will be an interesting one to dissect.

Also on the employment front, weekly jobless claims fell to 336,000 however last week's claims were revised upward to 357,000 from 349,000 reported previously.

The 3 month moving average continues to hover just under 350,000. As can be seen in the chart below, the last two recessions began when claims reached a 4 week moving average of 360 - 370k and then accelerated to almost 500k by the time the recessions had run their course.

That Was The Year That Was

The above chart shows the performance of some of the major indices in 2007. I didn't include the Shanghai Composite because it would have been off the chart with a 96.7% return for 2007. Also not included above was the German DAX returning 27.9% for the year.

Just for fun here are some predictions for this year:

• The All Ords will not do as well in 2008 as it did in 2007.
• The Nikkei will do better.
• The Hang Seng will do worse.
  
• Shanghai will do worse.
  
• The US indices will put in negative returns.
  

Anyone else want to have a stab? Feel free to leave a prediction in the comments section.

Santa Takes a Holiday in December

Last month I threw caution to the wind and speculated that the All Ords would finish down in the month of December and low and behold it did falling -2.6%. Santa failed to show in November or December and I believe he'll stay home in January. In fact over the last 24 years (yes that's right I discovered more data on Yahoo Finance, I'm a bit slow you see) the month of December has only produced negative returns on 6 occasions as shown below.


So what will January bring? Probably the first economic data point of note will be the US nonfarm payroll report next Friday. With the steady rise in initial unemployment claims in recent weeks the number could come in to the low side. If that happens, no doubt the stockmarket will go into schizophrenic mode between 'this is bad news because it might mean recession' and 'this is good news because it means the Fed will have to continue to cut the Fed funds rate'.

Also in the US, 4th quarter earnings season will get underway in earnest. Earnigns are forecast to come in negative. Expect some more large writedowns from Merrill Lynch and Citibank and no doubt some more equity injections. Also the ratings agencies may be forced to end the charade surrounding the AAA ratings of the large bond insurers like Ambac and MBIA. That event could have some serious repercussions.

However at the end of month the Fed may ride to the rescue and save the day. Although their last rescue attempt didn't fare too well. Stockmarkets usually have a decent correction before recessions get underway and thus if the US is moving into recession we could see some rather large moves downward. That said stockmarket corrections are characterized by a series of sharp upward movements that fail to move the market higher over the medium term (sucker rallies).

So as always the choice is not an easy one but being the glass is half empty kind of guy I am when it comes to the current economic environment I'm betting the All Ords will continue to slide in January. incidentally the last time the All Ords fell for 3 consecutive months was Dec 2002 - Feb 2003.