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Friday, September 7, 2007

Just Like 1987

Today could be a big day.

Apple Offers $100 Credit, Apology to IPhone Buyers (Update3): “Apple Inc. Chief Executive Officer Steve Jobs apologized to customers who paid full price for the iPhone before he cut the cost by $200 yesterday.”

Like I said yesterday in the post The Stupid Tax, the price cut was not going to sit well, even with fanatically loyal Apple customers.

Countrywide Drops Below Bank of America's Deal Price (Update3): “Countrywide Financial Corp. shares briefly dropped below $18, erasing the $700 million paper profit Bank of America Corp. made when it invested $2 billion in the nation's biggest mortgage lender two weeks ago.”

Although not a good sign in general, I am pretty confident Bank of America managed to snap off a good hedge on this position while the getting was good.

U.S. Home Foreclosures, Delinquencies at Record High (Update4): “The number of Americans who may lose their homes to foreclosure reached a record in the second quarter as late payments by subprime borrowers surged to one out of every seven loans.”

ONE out of every SEVEN or 14% are late DURING an economic EXPANSION. What happens when things slow down further and when the US economy finally contracts ever so slightly? What happens when job losses accelerate even a little bit?

Deutsche Bank May Be Worst Hit by Rout, JPMorgan Says (Update3): “Deutsche Bank AG, Germany's biggest bank, will probably be the European securities firm most affected by fallout from rising U.S. subprime mortgage defaults, according to JPMorgan Chase & Co. analysts.”

Deutsche is wounded, that much we know. But how deep are the cuts? How long will they take to heal?

““Ackermann yesterday said banks should mark-to-market their assets “to restore confidence and credibility in the system.” Deutsche Bank said last month that it took a “not insignificant” charge in the second quarter, marking down the value of some outstanding leveraged-finance loans.

Marking-to-market leveraged loan commitments, assuming about half have been hedged, would result in a 625 million-euro ($853 million) charge for Deutsche Bank in the third quarter and charges of 1 billion Swiss francs ($831 million) for Credit Suisse and 375 million francs for UBS, JPMorgan estimated.”

Lower sustainable revenues in securitizations, leveraged finance, hedge funds and proprietary trading will impact 2008 and 2009 results.

Yen Advances as Carry Trades Reverse on Stock-Market Declines: “The yen headed for second week of gains and almost erased this year's losses as declines in stock markets prompted investors to shun the risk of trades funded with loans in Japan.”

Its either voluntary or forced, but risk reduction is the name of the game right now.

Greenspan Sees Echoes of 1987, 1998 in Current Market Turmoil: “Alan Greenspan, former chairman of the U.S. Federal Reserve, said forces behind current market turmoil are “identical” to previous economic upheavals, including the 1987 stock-market crash.

“The behavior in what we are observing in the last seven weeks is identical in many respects to what we saw in 1998, what we saw in the stock-market crash of 1987,” Greenspan said yesterday in a speech in Washington, the Wall Street Journal reported today.”

Wait, it could actually be WORSE than 1987:

““There are some parallels I think with '87, but this is worse because the economy starts off from a weaker footing, whereas the tightening factor was just beginning then,” Mortimer-Lee said in an interview today. “The stock sell-off in '87 was a bit of a financial panic. This is much more imbedded in the weakness in the housing sector, and that's why it's more worrying.””

I believe Mortimer-Lee is on the right track. The bursting of this credit bubble will pillage the middle class in America. Falling home prices result in falling home equity values. This is particularly painful considering Americans have long lived beyond their means and have relied heavily upon MEW. This will also lead to falling financial equity prices. This is the other major store of wealth for the middle class. Factor in some demographic trends and you’ve got an aging middle class that should have piled up enough equity to ease into retirement over the next several years. These dreams will now be dashed for most…

U.S. Payrolls Unexpectedly Drop First Time Since 2003 (Update1): “The U.S. economy unexpectedly lost jobs in August for the first time in four years, raising the risk the economy may stall in the second half and serving as a warning for the Federal Reserve to lower interest rates.

Employers cut 4,000 workers from payrolls, compared with a revised gain of 68,000 in July that was smaller than previously reported, the Labor Department said today in Washington. The unemployment rate held at 4.6 percent as almost 600,000 people left the workforce.”

Watch for the Bulltards out there. They will spin this Bullish with the argument that rate cuts are now guaranteed. Let me say it again: Bernanke is NOT Greenspan. First, a rate cut is far from guaranteed. Commodity prices have stayed elevated. The dollar is so weak it is almost dead and this is only the first seriously weak unemployment number. Second, it won’t help. Not even a little bit. The financial system is re-pricing risk and de-levering. Most of these crazy subprime products will no longer be offered at ANY price. Expiring teaser rates will result in massive rate jumps even if there IS a whole series of rate cuts. Lenders are lending less and with far more scrutiny at new, higher, risk-adjusted rates.

There is no quick fix. Such is the economic cycle. Past excesses will ALWAYS be purged at some point. This process can only be DELAYED but never PREVENTED and the FED has ALWAYS increased the amplitude of this process. Such is the nature of capitalism.

Thursday, September 6, 2007

The Stupid Tax

Yesterday North American, European and most Asian equity indices dropped. This I liked because it had to happen to keep the Bear case alive. However, the volume was ridiculously low and I am therefore less than impressed.

Apple's Jobs Cuts IPhone Price by $200, Updates IPods (Update4): “Apple Inc. Chief Executive Officer Steve Jobs cut the price of the iPhone by $200 and unveiled new iPod media players with touch screens and video games to entice holiday shoppers.”

Apple cut prices significantly yesterday. I mention it here today because I find it very interesting. Basically the original iPhone price of $599 was a stupid tax on early adopters. This is price discrimination, or more specifically the strategy of price skimming where price varies over time. While this is practiced by most market participants to some degree, tech companies are notorious for it. However, a $200 drop from $599 in two months is unusually rapid and steep. While Apple customers are fanatically devoted to the brand, this still has to sting a little with most of them. Apple spins this as a holiday shopping strategy. I am wondering if maybe Apple noticed that the number of US consumers with that kind of discretionary spending power wasn’t as large as they had first anticipated. Could this be a sign of a weakening consumer? Time will tell.

ECB Leaves Interest Rates Unchanged, Shelving Plan for Increase: “The European Central Bank left interest rates unchanged today, shelving plans for an increase as the U.S. housing slump threatens to curb economic growth.”

I can’t say that was unexpected given the recent turmoil. They did toss in some more liquidity… again… Which has me thinking the banks are in pretty bad shape.

“The collapse of the U.S. subprime-mortgage market has made banks reluctant to lend, pushing up the cost of credit and causing turmoil on world financial markets. The ECB earlier today added 42.2 billion euros ($57.7 billion) in emergency cash to ease a credit drought that had pushed overnight deposit rates to a six-year high.”

Wal-Mart Says August Same-Store Sales Increased 3.1% (Update1): “Wal-Mart Stores Inc., the world's largest retailer, said August same-store sales rose 3.1 percent as customers stocked up on backpacks and computer laptops for the school year.”

That’s actually not that bad. However, Wal-Mart did cut prices on 16 000 items to get those numbers.

China Curbs Bank Lending to Cool Economy, Inflation (Update2): “China ordered banks to put aside more money as reserves for the seventh time this year to cool lending and investment after inflation accelerated to a 10-year high.

Lenders must park 12.5 percent of deposits with the central bank from Sept. 25, up from 12 percent, the People's Bank of China said today. The ratio is the highest in almost 10 years.”
The Chinese are still trying (unsuccessfully) to put on the brakes.

CPDOs Rated AAA May Risk Default, CreditSights Says (Update1): “Credit derivatives awarded the top ratings by Moody's Investors Service and Standard & Poor's may be as vulnerable to default as high-risk, high-yield bonds, according to independent research firm CreditSights Inc.”

Re-read that please. Basically AAA = high-risk junk. Shocking. Can you say, “Sudden forced liquidation from portfolios that aren’t allowed to hold shit?”

Constant proportion debt obligations (CPDOs) were created last year and use credit-default swaps to speculate that a group of companies with investment- grade ratings will be able to repay their debt. An increase in credit rating downgrades for investment-grade companies may cause losses that CPDOs would struggle to recoup.

German July Factory Orders Drop Most in 16 Years (Update3): “German manufacturing orders dropped the most in at least 16 years in July after a decline in sales of ships, trains and airplanes.”

Big ticket items the world over are starting to exhibit serious weakness. Big ticket items also require plenty of financing both on the production and the consumption side of the equation. What did you think would happen when a global credit bubble bursts?

U.S. Total Jobless Benefit Rolls Rose to Highest in Six Months: “The total number of Americans receiving unemployment benefits rose to a six-month high even as new applications fell more than forecast last week, suggesting hiring has cooled.

Benefit rolls swelled to 2.598 million in the week ended Aug. 25, the highest since February, the Labor Department reported today in Washington. Initial unemployment claims fell by 19,000 to 318,000 in the week that ended Sept. 1.”

The big number is Friday’s Non-Farm Payrolls, but with a weak ADP yesterday at 38 000 and now this as well, things don’t look so promising.

U.S. Productivity Rose 2.6% in Second Quarter; Labor Costs Cool: “Worker productivity in the U.S. accelerated more than forecast in the second quarter and labor costs cooled, lowering the risk of a pickup in inflation as the Federal Reserve weighs cutting interest rates.”

At least that’s a decent number.

Wednesday, September 5, 2007

Now Or Never

I’m short now. I used the strength of Friday and Tuesday to build my positions. For a while there we got into ‘oh shit’ territory yesterday but prices backed off. I did not want to see a close above 1490 on the S&P, and when it looked like we might tag 1500 I started to squirm a little. Today we need to turn south or the Bear case becomes almost impossible to defend. As it stands the charts aren’t so pretty. Downtrends have been violated and possible Inverted Head and Shoulder formations have been spotted in most indices. It is now or never.

Good thing then that we’ve got a few problems brewing:

BOE Eases Overnight Rate, Doesn't Aid 3-Month Costs (Update1): “The Bank of England offered to provide additional cash to reduce “unusually high” overnight interest rates and said it shouldn't be expected to take additional action to reduce three-month borrowing costs.”

Basically banks in the U.K. have refused or are unable to lend to each other, sending overnight rates screaming higher.

“This is the first time the U.K. central bank has taken steps to ease a squeeze in credit markets after the collapse of the U.S. subprime mortgage market made banks reluctant to lend to each other.

““They've done the minimum to make sure markets keep functioning without creating moral hazard,” said Tom Vosa, director of economic research at National Australia Bank in London, who used to work at the Bank of England. “They've essentially told banks that three-month rates aren't something they have to deal with. Those will return to normal when banks decide there aren't any more dead bodies out there.””

Moral hazard is a huge problem and the man to blame is Greenspan. The BOE is really trying to eliminate this problem and has therefore taken a pretty tough stance. I personally believe Bernanke is doing the same. He worked with Greenspan and learned the same lessons. Unlike Greenspan he currently has a clean slate. Take these issues into consideration and good lagging economic numbers and it becomes far less likely that Bernanke will cut rates in September than the market currently thinks…

MGIC, Radian Cancel Merger, Citing Market Conditions (Update1): “MGIC Investment Corp. and Radian Group Inc. ended merger talks, saying “market conditions” had scuttled a deal that would have combined two of the three biggest U.S. mortgage insurers.

“Both MGIC and Radian believe it is in their best interests to remain independent companies at this time,'' the insurers said today in a joint statement.””

Translation: We can’t raise cheap bling to finance this ridiculously priced merger.

Lehman Sees `Material Hit' to Europe Investment Banks (Update1): “European investment banks will take a “material hit” to earnings from writedowns associated with securities related to U.S. subprime loans, Lehman Brothers Holdings Inc. analysts said in a report.

The analysts are predicting post-tax writedowns of at least 15 percent to 25 percent of banks' “annualized level of first-half 2007 net profit,” they said in a report. Disclosure by European investment banks about their subprime-related assets, collateralized debt obligations, leveraged lending obligations and asset-backed commercial-paper conduits “ranges from the bad to the non-existent,” the analysts wrote.

Investment-banking divisions may see a 40 percent revenue decline in the second half, compared with the first six months of the year, as income from credit fixed-income trading drops and debt issuance and merger and acquisition activity slows, they said in the report.”

Read that carefully. We are talking double whammy here. First, we can expect serious declines in revenues. Second, we can expect serious losses on current investments and commitments.

Commercial Real Estate in U.S. Poised for 15 Percent Price Drop: “U.S. commercial real estate prices may fall as much as 15 percent over the next year in the broadest decline since the 2001 recession as rising borrowing costs force property owners to accept less or postpone sales.

“People aren't willing to do deals right now,” said Howard Michaels, the New York-based chairman of Carlton Advisory Services Inc., which has arranged financing for real estate purchases including the Lipstick Building in midtown Manhattan. “The expectation is that prices will come down.””

Pay attention to this. The credit contagion is spreading…

“Commercial mortgage rates have climbed as defaults rose in the subprime part of the residential real estate market. About six months ago, a 30-year commercial loan with 5 to 10 years of interest-only payments would have cost the borrower about 120 basis points more than the yield of the 10-year Treasury note. A similar loan would now cost about 160 to 200 basis points more than the 10-year Treasury's yield of 4.6 percent, data compiled by New York-based Cushman & Wakefield Sonnenblick Goldman show.”

What does that mean? What are the consequences? Well, foreclosure signs aren’t just for houses…

“The slump has ensnared New York developer Harry Macklowe, who may have to sell assets to pay back $3.4 billion of short- term debt. Macklowe bought seven Manhattan office towers from Equity Office in February for $6.7 billion concurrent with Blackstone's takeover of Zell's Equity Office.”

Simply put: This is a global margin call on EVERYTHING. This is how credit bubbles unravel.

ADP Employer Services Says U.S. Added 38,000 Jobs (Update1): “Companies in the U.S. added the fewest jobs in August since June 2003, a private report based on payroll data showed today.

The 38,000 increase was less than forecast and followed a revised gain of 41,000 for the prior month that was smaller than previously estimated, ADP Employer Services said.”

The most important number will be Octobers Non-Farm Payrolls report because that will include the first effects of the credit crunch that really got into full gear in August.

Global Economic Prospects `Less Buoyant,' OECD Says (Update3): “The Organization for Economic Cooperation and Development lowered its forecasts for economic growth and said they may be reduced further as borrowing costs rise following the collapse of U.S. subprime mortgages.

“Downside risks have become more ominous,” Jean-Philippe Cotis, the OECD's chief economist, said today in Paris.”

The damage is starting to become undeniable. Come to think of it, I haven’t heard the word ‘contained’ in while…

ABN Amro's Moute Cuts Stock Holdings on `Tip of Iceberg' Fears: “ABN Amro Asset Management's Francois Moute, one of Europe's best investors in U.S. stocks, started preparing for hard times more than a year before markets slumped in July.

Since early 2006 he has slashed his net holdings of shares from 85 percent of assets to 60 percent, the lowest he's allowed. Almost one-quarter of his $343 million U.S. Opportunities fund now bets against indexes. The only equities he is buying are those of U.S. commodity companies selling in emerging markets, such as oil-service provider Schlumberger Ltd.”

Some of the more nimble Financial Ninjas out there aren’t exactly surprised by the current turmoil and have long been positioned to benefit.

Nepal rocks: Airline sacrifices goats to appease sky god.
“The snag in the plane has now been fixed…”

Tuesday, September 4, 2007

Confusion Reigns

Confusion reigns. How bad is it really right now? How bad will things get? Was this a correction and is it over now? Will there be a Recession? The Bulls and Bears are at war.

BIS, S&P Disagree Over Severity of Credit Market Rout (Update1): “The market fallout from the subprime mortgage slump is less severe than in 1998 after Russia's default and the collapse of Long-Term Capital Management LP, the Bank for International Settlements said.

The assessment from the BIS, which monitors financial markets for central banks and regulates lenders, contrasts with analysis from Standard & Poor's, which last week said the outlook for securities firms is worse than in 1998.”

I believe that the guys at S&P have a better grasp of the situation and that their analysis of the consequences is more accurate than that of BIS:

“S&P, based in New York, last week said revenue from investment banking and trading may fall 47 percent in the final six months of this year, compared with a 31 percent decline nine years ago. Moody's Investors Service on Aug. 16 said a hedge fund collapse on the same scale as LTCM was possible.

Investment banks face larger losses than in 1998 as they write down high-risk, high-yield loans and asset-backed securities they can't sell amid the slump in global credit markets, according to Nick Hill, an analyst at Standard & Poor's in London.”

Fed, Blamed for Asset-Price Inaction, Is Told `Tide Is Turning': “Federal Reserve officials, wrestling with a housing recession that jeopardizes U.S. growth, got an earful from critics at a weekend retreat arguing they should use regulation and interest rates to prevent asset-price bubbles.”

Bernanke is stuck with the mess that Greenspan made. Cleaning it up won’t be easy. After all, Greenspan too was stuck with somebody else’s mess…

“Controversy on how to handle asset prices has been stoked by two crashes in the past decade. Some economists blame former Fed Chairman Alan Greenspan for not raising rates enough to curb the Internet-stock boom in the late 1990s. That soured in 2000, contributing to a U.S. recession the next year.

By cutting rates to a four-decade low in 2003, the Fed inflated property values, Ed Leamer, head of an economic forecasting group at the University of California at Los Angeles, said at the conference. The ensuing housing slump, the worst since 1991, and the credit-market turmoil that followed, threaten to undo the six-year economic expansion.”

I have noticed a peculiar trend: When dotdumb stocks were flying high, speculators were telling anybody who would listen how super smart they were and how they were really really skilled traders. When housing prices were jumping 10% a month, speculators were telling everybody how they were real estate ninjas climbing the property ladder to great wealth. BUT, when the bubbles finally burst, and these novice speculators get pwn’d it was NEVER their FAULT.

Cheapest Stocks in 12 Years Greet Investors After Summer Swoon: “U.S. investors are returning from summer vacation to the cheapest stock market in almost 12 years, and some of the biggest fund managers say they're ready to load up on shares of technology, energy and industrial companies.”

Sounds very interesting. A no brainer basically. Or is it?

“Estimated profits at companies in the S&P 500 represent a yield of 6.46 percent of share prices, or 1.93 percentage points more than the yield on 10-year Treasuries, Bloomberg data show.”

Aaah. Stocks are cheap based on FORWARD earnings ESTIMATES. Considering analysts DOWNGRADED most home builders, mortgage originators and other financial firms long AFTER they had been destroyed by the market, could it be that these estimates are a little optimistic? Have these estimates been adjusted already to account for the effects of this recent liquidity crunch? Can the effects even be measured and estimated with any confidence?

“Catching falling knives is a dangerous art and not one I have perfected,” said Edwards, the firm's managing director. “They're only cheap if the earnings hold up, and there's not a lot of confidence with the E portion of their P/E ratios.”

Yen Gains as Carry Trades Pared, Qatar Plans to Invest in Asia: “The yen rose against the 16 most- active currencies as a decline in stocks prompted investors to pare purchases of riskier assets, and after Qatar said it will reduce dollar holdings and invest in Asia.”

The appetite for risk has been curbed severely and does not yet show any sign of returning. This is ultimately both dollar bearish and equity bearish.

Treasury Market Volatility Rises to Most in 3 Years (Update1): “The global flight to the safety of government debt is causing the widest price swings in Treasuries in three years, driving away traders who rely on computer models to guide their strategies and raising costs for investors.”

As long as the flight to quality is in force, equities can’t make sustained runs.

Recession Risk Rises as Consumers Feel Pain of Tighter Credit: “The pain from higher borrowing costs may be spreading as consumers and businesses follow investors in shying away from risk, increasing the odds of a recession.”

Now, two areas of the economy that have held up well so far, jobs and consumer spending, no longer appear immune as cheap credit dries up all over the globe…