Mess-o-potemia

Turkey, a NATO ally, has positioned itself to invade Northern Iraq. Their military has been on the move for months now, shuffling around on the border. The activity was mostly ignored by the media because it was explained away as just ‘posturing’. It does NOT look like posturing now. (Iraqi villages on the border came under fire Sunday night from the direction of Turkey.)

Crude Oil Rises to Record on Turkey Border Tensions With Iraq: “Crude oil rose to a record above $85 a barrel as tensions on the Turkey-Iraq border increased concern that supplies may be threatened as global stockpiles decline.

Turkish lawmakers will vote this week on allowing military attacks within a year against Kurdish rebel bases in the north of Iraq, which has the world's third-largest oil reserves. Global fuel inventories fell below a five-year average last month, a period when they typically rise, the International Energy Agency said Oct. 11.”

Gates Accepts U.K. Iraq Drawdown; Marines Mull Shift (Update1): “U.S. Defense Secretary Robert Gates expressed support for the U.K.'s plan to reduce its forces in Iraq to 2,500 by next year while declining to say whether American officials would accept a further British drawdown.

During a joint news conference in London with U.K. Defense Secretary Des Browne, Gates also confirmed that U.S. Marine Corps staffers are “thinking about” a plan to pull all Marines out of Iraq and transfer them to Afghanistan.”

With everybody is abandoning Iraq as swiftly as possible and the US is ‘mulling it over’, Turkey is merely positioning itself to step into the void before other regional powers, such as Iran, can. Mess-o-potemia…

Citigroup Net Falls 57 Percent on Fixed-Income Losses (Update2): “Citigroup Inc., the U.S. bank that shook up top management last week after $6.5 billion of debt- trading and loan losses, said third-quarter earnings fell 57 percent.

Net income declined by the most in three years to $2.38 billion, or 47 cents a share, from $5.51 billion, or $1.10, a year earlier, the New York-based company said today in a statement. Profit exceeded analysts' estimates of 44 cents a share, according to a Bloomberg survey. The company told investors Oct. 1 that third-quarter earnings dropped 60 percent.”

The losses and writedowns are bigger than the company estimated even just two weeks ago.

Citigroup, Bank of America Plan $80 Billion CP Fund (Update2): “Inc., Bank of America Corp. and JPMorgan Chase & Co., the three biggest U.S. banks, agreed to set up a fund of about $80 billion to help revive the asset-backed commercial paper market, according to people familiar with the discussions.

An announcement may come as soon as today, said the people who declined to be named because the decision isn't public. The fund will buy assets from structured investment vehicles, units set up to finance purchases of securities such as bank bonds and mortgage debt.

Other banks may join the fund, which would help SIVs avoid selling their $320 billion in holdings at fire-sale prices, further roiling the credit markets, the people said. The Treasury Department in Washington initiated the talks between the banks after a shutdown of the commercial paper market left SIVs and other sellers unable to borrow, forcing sales of about $75 billion of assets.”

This fund will be called the Master Liquidity Conduit (MLEC). The fund will only buy AAA or AA (Aaa or Aa) rated securities. This is supposed to prevent a credit crunch inspired fire sale of assets in SIVs that no longer are able to roll over their short term financing.

Since investors no longer want to be bagholders, the Treasury department thinks it’s a good idea to organize this bailout. Think long and hard about this: Investors, driven by the profit motive, are no longer willing to finance the SIVs at any price. The banks, such as Citi have refused to honor the guarantees of liquidity they made to those SIVs. Why does nobody want to touch these things AT ALL?

Treasury Sales May Rise 50% as Deficit Suddenly Grows (Update2): “Sales of Treasuries may increase for the first time since 2004 as the U.S. federal budget deficit expands, jeopardizing the biggest bond rally in five years.

Government auctions of bills, notes and bonds in the fiscal year that started this month may rise more than 50 percent to $220 billion, according to UBS Securities LLC, one of the 21 primary dealers that underwrite Treasury auctions. The first decline in corporate tax revenue since 2003 increased the shortfall by 12 percent to $162.8 billion for the year ended in September, from $144.8 billion in the 12 months through April.”

The economy is slowing for real. How do we know? “The First decline in CORPORATE tax revenue since 2003…” Since these numbers lag significantly, you can be assured that this slowdown occurred many months before the August credit crunch. Factor in the recent massive drops in profitably among the largest financial firms that have announced so far this quarter, and tax revenue can only drop further.

As an aside, sales taxes are falling across the U.S. as the housing slump affects sales tax collections.

Meanwhile, over at MarkIt, the ABX indices are taking another dive. The index is defined as follows:

“ABX.HE indexes track credit default swaps (CDS) on subprime mortgage-backed securities. CDS are derivatives that provide insurance against default. Mortgage-backed securities are home loans that have been packaged up together and sold as a single security.”

The BBB and the A are the credit ratings for the instruments that make up the index.

Here is an explanation from MarketWatch (back in February): Subprime mortgage derivatives index plunges

These indices collapsed in February, and then again in July see graphs. The graphs start in July and look like they are about to go into free fall again.

The first chart is the ABX-HE-BBB- 07-2
The second chart is the ABX-HE-A 07-2

Here we go again?

Russian Winter?

In my post Are Things Really This Good? I mentioned that the Russian financial system is experiencing liquidity problems. Well, things are getting worse.

“Russia's central bank lowered the interest rate on roubles used to carry out currency swap transactions to an annual 8 pct from 10 pct, effective today, in an effort to stabilize short-term rates on the currency market, Interfax reported.

The central bank also said the move should help regulate the liquidity of the banking system. Banks actively use currency swaps during unstable periods on currency markets and also when experiencing problems with liquidity.”

Minyanville Professor Sally Limatour had these comments:

“Today the Russian Central Bank revealed widespread liquidity problems for the banking system and announced a package of measures to prevent more trouble - lowering minimum reserve requirements and accepting credit as collateral.

The Kazah banks and companies are big borrowers to the tune of $70 billion or almost 70% of the countries GDP. The bank's 45 billion is about half their assets.

The central bank is lending 10% of the GDP to banks and short term rates are now up to 10% in the last two months.

Liquidity is tight in Moscow and banking problems are also appearing in Lithuania, Latvia and Azerbaijan as well as Romania and Hungary.

Is this important? Not sure, but I did not know the Thai Baht was important until it was. I am keeping an eye on it as the ramifications could roll on.”

Mish from Mish’s Global Economic Trend Analysis covers the developments in great detail in his post Russia Liquidity Problems and Other Warnings Signs. Heads up.

U-TURN!

Sorry for the sloppy posting over the last week, I’m fighting the kind of pestilence only a kindergarten teacher (the wife) could bring home.

Yesterday markets pulled a sudden and significant u-turn. First ‘better’ than expected results from Wal-Mart gave the futures a lift.

Wal-Mart Lifts Profit Forecast After Cutting Expenses (Update5): “Wal-Mart Stores Inc., the world's largest retailer, raised its forecast for third-quarter profit after countering slowing sales growth by reducing packaging and energy costs.

The discounter, which accounts for $1 of every $11 spent at U.S. retailers, rose the most in a month in New York trading, helping drive the Standard & Poor's 500 Index to a record.”

A close look reveals that top sales growth slowed and that it was aggressive discounting that resulted in better numbers. Buried in the numbers was the fact that Wal-Mart significantly reduced expenditures on store improvements.

Target, Nordstrom and JC Penney sales all trailed estimates. That is not a good sign for consumers. (Although it was once again blamed on the weather.)

Foreclosures Doubled in September as Loan Rates Rise (Update6): “U.S. home foreclosures doubled in September from a year earlier as subprime borrowers struggled to make payments on adjustable-rate mortgages, RealtyTrac Inc. said.

There were 223,538 foreclosure filings last month, including default and auction notices and bank repossessions, an 8 percent decline from August. California had the most with 51,259 filings and Florida was second with 33,354. The national foreclosure rate was one for every 557 households.”

No big surprise here. The surprise is that markets keep melting higher, hitting record after record. The worst is still to come as the number of ARMs resetting is going to increase significantly… and we all know what that means:

“Foreclosures are deepening the U.S. housing recession by pushing more homes onto a market where sales and prices are dropping. There's a 10-month supply of unsold homes, the highest in at least eight years. As many as half of the 450,000 subprime borrowers whose mortgages will re-set through December may lose their homes because they can't afford the higher payments, according to data complied by UBS AG and Credit Suisse Group.”

Play with this interactive Subprime Tidal Wave map.

U.K. September House Prices Decline for Second Month (Update3): “U.K. house prices fell in September for a second month, the first back-to-back drop since 2005, after higher interest rates and concern about the economic outlook hurt confidence, the Royal Institution of Chartered Surveyors said.

The number of real-estate agents and surveyors saying prices dropped outnumbered those reporting gains by 15 percent, London- based RICS said today. That compares with 3 percent in August. Among 12 regions surveyed, prices only rose in London and Scotland.”

Just in case you still thought the real estate bubble was only a US problem… (Its easy to dismiss the seriousness of the situation with equity indices making new highs daily.)

“The number of potential homebuyers fell the most since 2003, RICS said. A jump in credit costs led to a run on the deposits of mortgage lender Northern Rock Plc and five interest-rate increases in a year has increased households' record debt burden.”

Winnebago 4th-Quarter Profit Rises 59% on New Models (Update5): “Winnebago Industries Inc., the biggest U.S. motor-home maker, said fourth-quarter profit rose 59 percent, beating estimates, on higher sales of luxury models.”

Foreclosures double. Winnebago sales rise 59%. Got it?

On the road again, I just gotta get on the road again....

Oh and here is a little taste of the consequences:

California Retail Sales and Use Taxes
Sept 2007: $2,038,416,000
Sept 2006: $2,201,717,000

September sales tax revenue was off 7% compared with last year. Can you say massively widening budget deficits?

Beazer to Restate Earnings After Mortgage Unit Probe (Update6): “Beazer Homes USA Inc., the homebuilder under investigation by the Securities and Exchange Commission, will restate earnings going back to 1999 after an internal probe found its mortgage unit violated federal regulations.

The inquiry also found accounting errors in the company's sale-leaseback program. The revisions will affect financial statements from 1999 to 2006 and include parts of this year. A settlement with regulators may cost as much as $15 million, the Atlanta-based company said today in a statement.

Beazer, for the first time, said there was evidence that employees of its mortgage unit violated certain U.S. Department of Housing and Urban Development rules related to the agency's down payment assistance program. Beazer shares fell to a seven- year low this year as the SEC and the FBI started investigations of its accounting and lending practices. Today's disclosures signal the company may be trying to resolve its legal matters.”

Reminds me of the tech bubble days… when that bubble started to deflate more and more aggressive accounting and pure scandals from the boom days started to see daylight. Expect to see more of these. The really juicy ones will come from the financial sector. Level 3 and Level 2 gains. When they start to unravel the real fun will begin.

SLM's Lord Says `Merger Mess' Has Hurt Profit Growth (Update3): “SLM Corp.'s legal fight over J.C. Flowers & Co.'s $25.3 billion buyout offer has distracted the student-loan provider and hurt profits, Chairman Albert Lord said.

“It's costing us earnings momentum,” Lord said today on a conference call with investors after the Reston, Virginia-based company, better known as Sallie Mae, reported a third-quarter loss of $344 million. “The merger mess has gone on too long. We've got to get it sorted out.””

Just think, a private equity firm had been ready to pay $25 billion for the privilege of owning and further LEVERAGING UP a company that just lost $344 million this quarter. WTF? Oh, and the CEO thinks the merger troubles are responsible for reducing ‘earnings momentum’. COME ON. You’re in the student loan business.

Countrywide Says Bad Mortgages Rise, New Loans Fall (Update4): “Countrywide Financial Corp., the largest U.S. mortgage company, said late payments at its servicing unit rose, foreclosures doubled and new loans fell 44 percent as housing sales slowed.

Overdue loans as a percentage of unpaid principal increased to 5.85 percent in September from 4.04 percent a year earlier, the company said in a statement. Foreclosures climbed to 1.27 percent from 0.51 percent. Mortgages funded by the Calabasas, California-based company last month declined to $21 billion.”

FORCLOSURES DOUBLED AND NEW LOANS FELL 44%. Countrywide is a great barometer for the US mortgage market as a whole because their servicing portfolio is almost 15% of total US home loan debt.

All this didn’t matter though. The markets continued to motor higher… UNTIL a monster momo stock, Baidu, was downgraded. That was signal to take profits, hard. THAT was the catalyst that pulled the entire market down. Go figure.

U.S. Producer Price Index Rises, Spurred by Oil Costs (Update2): “Prices paid to U.S. producers rose in September as oil costs climbed, while core inflation was less than forecast.

The 1.1 percent increase in total producer prices followed a 1.4 percent decline in August, the Labor Department said today in Washington. The core measure, which excludes fuel and food costs, rose 0.1 percent after a 0.2 percent gain in August.”

Stronger PPI should add some upside risks to next week’s headline CPI number.

When The Momos Go Parabolic...

Due to time constraints, today's post will be a short one.

I'm throwing up a few of the big momentum (momo) names that have been powering the market higher. Note the chart scale is no longer logarithmic. This helps illustrate just how fast these guys have done a moonshot. Note: the momo names go parabolic at the very end of the Bull market cycle. Unfortunately they can keep running for quite some time, so picking at top isn’t exactly easy… That being said, with all the indices at new record highs on anemic volume, a pullback is in order. The catalyst may very well be a disappointing earnings season. Alcoa started things off with a less than stellar report as did Chevron. Trade cautiously... book some of those profits.

Earnings Season Begins

I hope everybody had a happy (Canadian) thanksgiving weekend.

Northern Rock Wins New Guarantee From U.K. Government (Update4): “Northern Rock Plc, the U.K. mortgage lender bailed out last month by the Bank of England, said the government will guarantee deposits until financial markets become less volatile. The shares rose the most ever.

Chief Executive Officer Adam Applegarth is struggling to keep the company in business as buyout firms including J.C. Flowers & Co. consider bids. A surge in borrowing costs forced the company to seek a rescue from the Bank of England on Sept. 13. Customers withdrew more than 2 billion pounds ($4.1 billion) in the next three days, the first run on a U.K. bank in more than a century.

“This may make Northern Rock easier to sell,” said Philip Shaw, chief European economist at Investec Bank in London.”

Its probably not a good sign when you have to guarantee deposits in order to find a buyer. Keep a close eye on how this turns out. Pricing Northern Rock will illustrate just how good or bad things are for the bank.

Ellington Freezes Withdrawals From Two Mortgage Funds (Update3): “Ellington Management Group LLC, the Old Greenwich, Connecticut-based hedge-fund firm that focuses on mortgage securities, suspended client redemptions from two funds because it's too hard to value their assets.

Investors won't be able to withdraw money from New Ellington Credit Overseas Ltd. and New Ellington Credit Partners LP, according to a copy of the letter posted on the Internet blog nakedshorts.com. There's been little or no trading in some low-rated or unrated securities backed by subprime home loans, making valuations difficult, the Sept. 30 letter said.”

Another hedgie in trouble. Note: “…it’s (still) too hard to value their assets.” Brackets are mine. Even after record liquidity injections and a euphoric rally in equities, certain credit derivative markets are still in a deep freeze. Proceed with caution.

U.S. Stock Market Stumble Presaged by S&P 500 Options (Update3): “Skittishness over the U.S. stock market's record-setting rally is reaching a crescendo among options traders who are preparing for a crash.

Investors are paying the most ever to protect against a drop in the Standard & Poor's 500 Index, data compiled by Morgan Stanley show. The gap between the price of so-called put options on the benchmark for U.S. equity and the cost to wager on further gains has averaged about 8 percentage points since August. That's more than the previous high in July 2001, before the index dropped 34 percent and fell to the lowest this decade.

The widening spread is a warning for OppenheimerFunds Inc. and Harris Private Bank, which oversee more than $300 billion and say the bearish bets indicate stocks may fall. The S&P 500 rebounded 10 percent since Aug. 15 on speculation the worst is over for banks and homebuilders hurt by the collapse of subprime mortgages. Shares in developed markets outside the U.S. have done even better, climbing 14 percent from their trough.”

As I’ve mentioned many at time: The fundamentals have continued to deteriorate and the rate cuts and liquidity injections did not magically fix the most serious of problems. Looking at equity prices at new records highs, ask yourself: Are things really this GOOD?

“Last week's advance hasn't dispelled concern among traders in U.S. options. They are pricing in the highest risk of an equity-market decline since the technology-stock bubble burst at the start of the decade, according to Carl Mason, head of U.S. equity-derivatives strategy at Morgan Stanley in New York.

Mason says implied volatility, a measure that calculates expected price swings of an underlying asset and is used as a barometer for options prices, shows many investors are betting that stocks may fall.

Since Aug. 15, the implied volatility of put options that lock in gains should the S&P 500 drop at least 10 percent in six months has averaged 24.08 percent, according to data from Morgan Stanley, the second-largest U.S. securities firm by market value after New York-based Goldman Sachs Group Inc.

The implied volatility on puts is 8.1 percentage points higher than for call options, enabling investors to profit if the index rises at least 10 percent in the same period. The so-called implied volatility skew climbed as high as 8.53 points since mid- August. That's steeper than 99 percent of all readings since the start of the decade, Morgan Stanley said. The median difference is 5.9 percentage points.

The gap shows there's “an awful lot of nervousness,” said Mason. “A lot of investors don't want to get caught out.”

It looks like the smart money will be selling into rallies to lock in their gains. This kind of option behavior does not suggest investors are looking to put new money to work on dips. Remember, its earnings season. While expectations have been ratcheted down substantially and are therefore most probably ‘beatable’, it is guidance that will make or break the stock.