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No Inflation Problem – Analyst Blog

Dirk Van Dijk — Mon, 09 Nov 2009 17:43:37 +0000

Analytically, there are three components to an interest rate. The first is the risk that the money will not be paid back. This is a very big factor when dealing with corporate bonds, especially junk bonds. For the U.S. government's obligations, as the owner of a nice shiny printing press that can always be turned on to pay back any obligation denominated in dollars, that part is assumed to be zero.

The second part is expected inflation. After all, if you decide that you want to consume something later, rather than today, and thus decide to save and invest your money, you want to be sure the dollar you put away today buys at least as much in, say, ten years that it does today. If you expect that it will buy less bread, gasoline and clothing in ten years, then you would demand a higher interest rate to offset the diminution in purchasing power.

Finally, most people would rather enjoy themselves today rather than put off that enjoyment until some time in the future. As a result they demand a real interest rate, over and above the rate of inflation, to reward them for their delayed gratification, even if there is no risk that they will not be paid back.

Since 2003, the government has been selling bonds where the amount of the principal that gets paid back when the bond matures rises with the rate of inflation over the life of the bond, called TIPS. Aside from the fact that it is a much smaller and illiquid market than that of regular T-notes, TIPS make a great vehicle for tracking the real rate of interest that investors want in return for consuming later, rather than today.

Well, if repayment risk is assumed to be zero, and we know what the real rate is, then the difference between a regular T-note and the TIPS of the same maturity is what the market expects inflation to be over the life of the bonds. The yield on regular 10-year T-notes is shown in blue in the graph below, while the rate on 10-year TIPS is in pink, and the difference is shown in yellow.

Since TIPS were introduced, the average difference has been 2.17%. As of last week, the difference was 2.12%. In other words, the market does not expect inflation to be more of a problem over the next ten years than it has feared about inflation since 2003.

Aside from the price of oil and some other commodities, the last six or seven years have not been a particularly high inflation time (well, they have been for Health Care and Education, too, but overall inflation has been pretty well contained). Aside from the dislocations last year, which were arguably as much about the relative lack of liquidity in the TIPS market, this market-based measure of expected inflation has been remarkably stable -- much more stable than the yield on either regular T-notes or of TIPS.

While it is true that the implied inflation has been climbing since it almost hit zero last year, it is not at levels that suggest inflation is going to skyrocket.

This means that the Fed should be far more concerned about getting the economy moving again. Any move to tighten up monetary policy by raising interest rates would be a serious mistake. Historically, the Fed has not started to increase the Fed Funds rate until well after the unemployment rate has peaked -- more than a year, in the case of the last two cycles. Those unemployment peaks looked more like the Catskills versus the Andes sized peaks we have today, and unemployment is still rising.

Keep in mind that the unemployment rate will most likely continue to rise, even after the economy starts to, on balance, create new jobs. That is because there are probably a huge number of people who have become discouraged about their chances of getting a job and have stopped looking. Others have gone back to school or done other things that take them out of the formal labor force. As soon as it looks like companies are hiring again, they are likely to flood back into the labor market.

How, then, does one explain the recent move in the price of gold to over $1,100 an ounce? Historically, gold has been seen as the ultimate inflation hedge. Its rise over the past year to record nominal levels (it would have to roughly double to match its inflation-adjusted high’s set back in 1979) would seem to indicate that the market is afraid of inflation. How do we square this with data from the TIPS market, which indicates the market sees no real problem with inflation?

One reason might be the rise of India, although that would not explain the day-to-day moves. Historically and culturally, Indian’s have a far higher propensity to store their wealth in the form of gold, specifically in jewelry, not bullion, than the rest of the world does. That said, I don’t think that the 200 metric tons recently bought by the Reserve Bank of India is about to be turned into necklaces and earrings anytime soon.

Still, as millions and millions of Indians become more middle class, the demand for gold has gone up. To a lesser extent, this holds true for China as well. Even more Chinese are becoming wealthy or at least middle class than are Indians, although the cultural propensity to hold gold is not quite as strong.

Part of it might just be that we have not found that many new gold mines recently, and the ore grades in places like South Africa have been going down. That, combined with rising demand, is a classic recipe for rising prices -- even if people are not expecting a return of 1970’s-style inflation.

The second graph, from Goldnews.billionvault.com, shows that total world gold production has been falling over the last five years following steady growth in the over 20 years preceding that. That would mean good things for the gold miners who have large reserves of gold in the ground, especially if they are able to increase production when the rest of the world is seeing production decline. Freeport McMoRan (FCX) and Barrick Gold Corp. (ABX) are good examples of such companies.

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The Fed Stays on Easy Street – Analyst Blog

Dirk Van Dijk — Wed, 04 Nov 2009 20:43:26 +0000

The Federal Reserve decided to keep the Federal Funds rate unchanged at the meeting it concluded today, as expected. Below is the current Fed Statement along with the one from their September meeting in paragraph-by-paragraph format, with my translation and commentary interspersed.

As the graph below shows, the market is expecting the Fed to remain on hold, with Fed Funds between 0 and 25 basis points for an extended period. The graph shows the expected outcomes for the January meeting (before today’s announcement) from the Cleveland Fed. The market set the odds of anything other than standing pat at either today’s meeting or the December meeting effectively at zero.

Reading off the chart, it looks like about a 95% probability of no action in January as well. I doubt we will see the Fed raise rates before the third quarter of 2010.

The Fed is playing out exactly the script that Ben Bernanke suggested in his academic work prior to joining the Fed: keep rates near zero, promise to keep them there for an extended period of time to help bring intermediate term rates low, and if needed use quantitative easing to increase the money supply in the event of a liquidity trap.

The Fed will first stop the quantitative easing (the buying of long-term treasuries and mortgage paper) before it considers raising rates. It is done with its program of buying $300 billion of long-term T-notes, and will finish up its $1.25 billion MBS buying program by the end of the first quarter. It slightly reduced its plan to buy agency debt from $200 billion to $175 billion.

"Information received since the Federal Open Market Committee met in September suggests that economic activity has continued to pick up. Conditions in financial markets were roughly unchanged, on balance, over the intermeeting period.

"Activity in the housing sector has increased over recent months. Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.

"Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability."

"Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased.

"Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.

"Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability."

The Fed sees more improvement in the economy. Most notably, it points out that household spending is increasing, rather than stabilizing as it saw in the last meeting -- although due to the all the factors it pointed to last time, it is going to be a rather sluggish pick up.

Conditions in the Financial markets, by which they mean things like the rates that banks charge each other in the overnight funding market (the TED spread) had already returned to pre-crisis levels by the time of the last meeting, so there was not a lot of room for further improvement. Business investment is still sluggish, which is not a surprise given that capacity utilization is still around 70%, well below the lowest point reached in any recession since they started tracking capacity utilization in 1967, but up a bit from its low of near 67% in June.

The Fed thinks its policies are working, but that growth is going to be slow for the foreseeable future. I have to agree with them on that. Historically, capacity utilization of 80% is normal, and of 75% represents a deep recession. Capacity utilization of 85% or more represents a boom and signs that the economy is overheating, and needs to be reigned back in by higher interest rates. We are a long way from there.

"With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time."

"With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time."

Not a syllable changed from last time. Inflation is not a problem, and it will not be for some time to come. The reason is that with high unemployment, there is no way for the wage side of a wage price spiral to gain any traction. With almost 30% of the country’s factories, mines and power plants sitting idle, businesses do not want to risk losing market share by raising prices aggressively.

"In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions -- including low rates of resource utilization, subdued inflation trends and stable inflation expectations -- are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

"To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt.

"In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities, and anticipates that these transactions will be executed by the end of the first quarter of 2010. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."

"In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

"To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010.

"As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet, and will make adjustments to its credit and liquidity programs as warranted."

The same basic idea in both statements, although the Fed did elaborate more on why they will keep rates low for an extended period. In other words: "Mr. Market, we mean it when we say we are not going to raise rates any time soon."

The Fed did back off its quantitative easing program slightly. It is done with the program of buying $300 billion of longer-term T-notes, and is continuing its program of buying $1.25 trillion of mortgaged-backed securities. It did, however, slightly reduce its planned purchases of Fannie (FNM) and Freddie (FRE) debt, from $200 billion down to $175 billion. In the overall context of the quantitative easing program, the reduction is trivial. It is, however, a sign that the program will not be expanded, nor is it likely to be renewed after the current program is completed by the end of the first quarter.

"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen."

"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen."

Everyone agreed at both meetings. There had been a few Fed types who had been making speeches about the need to bring things back to normal sooner rather than later, but when the rubber hit the road, they are still on board with the program.

Overall, the Fed seems to understand that the weak economy is the overriding problem. Yes, things are getting better, but given the sluggish pace of improvement, this is not the time to be taking away the punch bowl.

This would be in keeping with historical precedent as I pointed out here. Following the end of the 2001 recession, the Fed waited 32 months before it started to raise rates, and then it did so at a very gradual 25 basis points at a time. Following the 1991 recession it waited 35 months.

So assuming that the NBER eventually determines that the recession ended in July 2009, history suggests that the Fed will not begin to raise rates until the first quarter of 2012. The last two recessions were far milder than this one, which would argue that the Fed should stay on easy street for even longer this time around.

The problem is that keeping rates so low for so long the last time was a key factor in allowing the housing bubble to form. Still, the balance of risks seems to be on the side of an economic relapse, not of an overheating that causes inflation to soar.

Keeping rates low means that we will have a steep yield curve. A steep yield curve allows banks to make a lot of money, since their economic function is to borrow short term, and lend long term. The idea is that if the curve is kept steep enough long enough, even basket-cases like Citigroup (C) and Bank of America (BAC) will be come solvent again.

The promise of keeping rates low for a long time should also put more pressure on the dollar, which would be good for improving our trade deficit -- although at the risk of higher inflation, particularly headline inflation -- since oil prices will go up at the dollar goes down. However, given the low inflation pressures elsewhere in the economy, it really is not that big of a risk.
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Housing Prices Up Again – Analyst Blog

Dirk Van Dijk — Tue, 27 Oct 2009 16:47:33 +0000

Helped by the "first-time home buyer" tax credit and other forms of government assistance, home prices -- as measured by the Case Schiller Composite 20 index -- rose for the third straight month, up 0.97%, but still down 11.36% on a year-over-year basis, and off 29.89% from its May 2006 peak (note below when I reference peak levels they are from May 2006, not from the individual city peaks, which might have been a few months before or after the national peak).

Since home prices do exhibit a fair amount of seasonality, I am working with the seasonally adjusted numbers. Most of the press has a habit of tracking the unadjusted numbers, which I feel is a mistake. So realize that the numbers presented here might be different from what you read in the newspaper tomorrow.

A total of 16 of the 20 cities registered price increases, so the gains were widespread. The older Composite 10 index registered a similar 1.03% gain for the month and is down 10.67% on a year-over-year basis, and off 30.85% from the peak.

The first graph below (from http://www.calculatedriskblog.com/) shows the history of both the Composite 10 and the Composite 20 indexes. The first-time homebuyer tax credit provides up to $8,000 to buyers of houses, but is scheduled to expire at the end of November. To claim the credit, the closing must be by that date, so any house that is going to qualify pretty much had to be under contract by now, and even in August (the data is released with a 2-month delay) people were scrambling to make the deals in time to qualify.

When a subsidy is given for a purchase, it is very much of an open question as to how much of that subsidy goes to the buyer, and how much goes to the seller. To the extent any of it goes to the seller, then what the Federal government is doing is using tax dollars to prop up housing asset values.

One would expect that a large portion of the subsidy ended up in the hands of the sellers. The acid test will be what happens to housing prices once that subsidy is removed. The Fed is also helping by its purchase of $1.25 Trillion in Fannie Mae (FNM)- and Freddie Mac (FRE)-backed mortgages, which is artificially holding down mortgage rates.

What happens to mortgage rates when they stop in March? Or will they continue to just keep the printing presses turned on and continue to buy every mortgage out there? The HAMP mortgage modification program is helping to keep the number of foreclosures down, even as delinquency rates continue to skyrocket. This keeps the supply of distressed houses for sale down. However, many of these mortgage modifications are likely to eventually fail, especially if the principal left on the mortgage remains higher than the value of the house. It is a game of "extend and pretend."

Geographically, some of the best gains came from California, which has been among the states hardest hit by the collapse of the housing bubble. San Fransciso saw prices rise by 2.59% for the month, although prices are still down 12.49% on a year-over-year basis and off 40.00% from the peak. San Diego rose 1.52% for the month and is now down just 8.86% for the year and down 39.33% from the peak. Los Angeles saw a 1.27% rise for the month, bringing the decline since last year to 12.00% and is 39.70% below peak levels.

There were also two winners in the Midwest, with Minneapolis seeing a 2.32% gain for the month, but down 13.83% year-over-year and down 30.00% from the peak, and Chicago saw a 1.22% monthly gain. Windy City housing prices are down 12.72% from a year ago and off 22.74% from the peak.

The second graph has a somewhat different way of presenting the city performance information. It shows the declines through different dates on a cumulative basis. Thus, if the final red bar is shorter on the down side than the yellow middle bar it means that prices in that city are actually up year-to-date. It shows that many of the cities that were hit hardest early in the downturn (large blue bars) continued to suffer even bigger declines in 2008, and are for the most part still suffering declines on a year-to-date basis.

Meanwhile, cities that largely sidestepped the bubble on the way up, and which held up well as the national housing market started to turn south, such as Dallas and Denver, suffered only minor losses in 2008 and have already started to see housing prices rebound on a year-to-date basis.

While enormously expensive, the government support of the housing market is working. If housing prices continue to fall, it means more and more people will end up underwater on their homes, and being underwater is the single best predictor if a house will end up being foreclosed upon. This is already a huge problem as illustrated by an analysis by First American Core Logic.

"More than 15.2 million U.S. mortgages, or 32.2 percent of all mortgaged properties, were in negative equity position as of June 30, 2009... June’s negative equity share was slightly lower than the 32.5 percent as of the end of March 2009 and it reflects the recent flattening of monthly home price changes. As of June 2009, there were an additional 2.5 million mortgaged properties that were approaching negative equity. Negative equity and near negative equity mortgages combined account for nearly 38 percent of all residential properties with a mortgage nationwide."

As housing prices rebound, it means that some people who were underwater are able to catch a breath, and many who were on the cusp of going underwater will stay above the waves -- at least for now. The actions have served to slow the trainwreck, and that is a good thing since it gives people time to adjust and for banks to try to earn their way out of the mess (the extremely steep yield curve that is a consequence of the Fed Funds rate near zero is a very big part of that).

However, I am not convinced that the housing market has turned for real, that it will not start to fall again after the supports are removed. Prices are still above normal when measured relative to both incomes and rents, although not nearly as out of whack as they were a few years ago.

But rents are now falling, which will put additional pressure on the price to rent ratio, and with the official (U-3) unemployment rate at 9.8% and rising, with the underemployment rate (U-6) at 17.0% the income side of the price to income ratio is not looking so hot either.

Still, this is a welcome report, I just worry that it will not be sustained. I hope I am wrong about that.
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Inflation Under Control – Analyst Blog

Dirk Van Dijk — Thu, 15 Oct 2009 16:55:54 +0000

The Consumer Price Index, or CPI rose 0.2% in September, down from a 0.4% increase in August and down 1.3% from a year ago. If food and energy prices are stripped out to get to core inflation, prices also rose 0.2%, up from 0.1% in August. Core inflation is up 1.5% from a year ago. On a year-over-year basis, those numbers are likely to flip in the coming months.

Food prices actually declined slightly for the month, with a 0.1% decline in September reversing a 0.1% increase in August, and unchanged from a year ago. In particular, the price for food at home fell 0.3% in September after being unchanged in August. On a year-over-year basis, prices at the grocery stores are down 2.5%. This is not good news for firms like Kroger's (KR) and Supervalu (SVU).

It is energy that is the big difference between core and total inflation. Overall energy prices rose by 0.6% in September following a 4.6% surge in August. However, a year ago energy prices were collapsing, and on a year-over-year basis they are down 21.6%. The low price for oil was in December, and as we reach the aniversary of that low, year-over-year headline inflation will start looking much higher.

However, both rent and owners-equivalent rent, which is how the government tracks housing inflation for homeowners (esentially assuming you rent your house to yourself), both fell by 0.1% in September. Those were the first declines measured for those catagories since 1992. This is extremely important, since together rent and owners-equivalent rent makeup almost 30% of the total CPI and almost 40% of the Core CPI. With the supply of rental housing far outstripping demand and vacancies surging, both types of rent could be falling for a long time to come.

The decline in rents were partially offset by a surge in hotel costs (also considered part of housing), which looked very strange to me given the other data from the hotel industry -- showing that both occupancy and the average daily rate are falling. Given the huge weight of housing on the index, it means that inflation -- particularly core inflation -- is going to stay under control for the foreseeable future.

Part of the increase in core inflation was a side effect of the Cash for Clunkers program, which cleared up the excess inventories of new cars and reduced the supply of used cars. The price of new cars rose by 0.4% in September, after falling 1.6% in August. Used car prices rose by 1.6% following a 1.9% rise in August. This would correspond to news from automakers like Ford (F) that the levels of rebates and other incentives are down sharply from earlier in the year.

As always, the other problem area was health care. The cost of medical goods such as drugs and replacement parts (a.k.a. medical devices) rose by 0.6% on the month, following a 0.5% increase in August and are up 4.1% year over year -- once again far outpacing the overall rise in both core and headline inflation. If inflation in health care is not brought under control soon, it will bankrupt the country.

This data suggests that the focus of the Federal Reserve right now should be on stimulating the economy and not to worry about inflation too much. This means that they should keep the Fed Funds rate near zero and keep the quantitative easing programs in place.
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Zacks Bull and Bear of the Day Highlights: Guess?, Washington Federal, J.P. Morgan, Citigroup and Costco Wholesale Corporation – Press Releases

Zacks Market Commentaries — Thu, 08 Oct 2009 12:55:18 +0000

For Immediate Release

Chicago, IL – October 8, 2009 – Zacks Equity Research highlights Guess? (GES) as the Bull of the Day and Washington Federal (WFSL) the Bear of the Day. In addition, Zacks Equity Research provides analysis on J.P. Morgan (JPM), Citigroup (C) and Costco Wholesale Corporation (COST).

Full analysis of all these stocks is available at http://at.zacks.com/?id=2676

Here is a synopsis of all five stocks:

Bull of the Day:

Guess? (GES) reported better-than-expected results for the first half of 2010, thanks to strong North American sales, operating cost controls and smart inventory management. In addition, the company's strong cost-control efforts helped it maintain a lower operating cost structure, which in turn helped it navigate through the difficult economic conditions.

Management also issued optimistic guidance for the third quarter, although it declined to provide guidance for fiscal year 2010. For the third quarter, Guess expects revenue of $465-$485 million and EPS of 46-49 cents.

Given the company's positive outlook and strong control mechanisms, we upgrade the shares of Guess Inc. from Neutral to Outperform.

Bear of the Day:

Washington Federal’s (WFSL) third quarter earnings were in line with the Zacks Consensus Estimate. However, the results significantly deteriorated from the prior-year quarter due to a huge increase in provision for loan losses, primarily in response to a deteriorating residential land and construction portfolio.

Credit quality drastically worsened during the quarter. However, declining deposit rates helped improve funding concerns to a great extent and capital position remained strong.

Though margin expansion and increased market share through acquisitions will be a great support going forward, we are concerned about the company's significant exposure to real estate markets and suspect that it will continue to experience credit quality deterioration. Therefore, we recommend the shares as Underperform.

Fed to Be On Hold a Long Time – Analyst Blog

Dirk Van Dijk — Wed, 07 Oct 2009 14:12:21 +0000

The table below from the Federal Reserve of Atlanta is interesting. It looks at all the recessions since 1970, and how long it took for unemployment to peak after the recession technically ended, and how much longer after that that the Fed actually started to tighten up. The short 1980 recession, which was really the first part of a double-dip recession, is excluded.

Note that unemployment always peaks after the recession is over. However, in earlier recessions the time lag between the end of the recession and the peak of unemployment was brief. This sort of holds for the 1970 recession as well, since there was a double peak in unemployment (6.1%) in both December of 1970 and in August of 1971. If the first peak were used, the time from the end of the recession to the unemployment peak would have been just one month, and to the start of the tightening by the Fed would have been 15 months.

The last two recessions were very different, with unemployment continuing to rise for more than a year after the end of the recession. Both were very mild recessions.

In all cases, the Fed waited a significant time (a minimum of six months) after the recession was over before they took their foot off the accelerator.

If we assume that the recession technically ended in July, something that would be indicated by the rise in Industrial Production and Capacity Utilization that started then, and we followed the same path as the 1991 recession, then we would not see unemployment peak until October 2010 -- and not until February 2011 if we were to follow the path of the 2001 recession.

If anything, the dynamics of this downturn are going to argue for an even much slower recovery this time around than we had in the last two recessions. For starters, the amount of wealth that has been destroyed in this downturn dwarfs that of the previous two. The consumer was much more deeply in debt, and the decline in the value of his assets have left him even more leveraged today than he was before the recession started.

Also, the savings rates going into the previous recessions were much higher. While the banking system was wounded in the 1991 recession (S&L crisis), it was but a mere scratch when compared to the crisis of a year ago.

Given the historical precedents, if we followed the path of the 1991 downturn, the Fed Funds rate would not rise until June of 2012, and if we followed the 2001 precedent, the Fed Funds rate would not rise until May of 2012. Even if we were to follow the earlier precedents, it would be February of 2010 (1982), September of 2010 (1974-75), or October of 2010. Well, we are more than a month passed July, and we know that we have not hit the unemployment peak yet, so I think it is safe to throw that one out.

The problem with the Fed leaving interest rates too low for too long is it tends to help create bubbles. An overly easy monetary policy also can let inflation get out of hand. The ultra-low interest rates in the early part of this decade played a key role in allowing the housing bubble to form.

I really don’t see much evidence of any current bubbles. Yes, the stock market does seem to be pricing in a much stronger recovery than I foresee, but it is not really at a bubble stage. Oil and other commodity prices are well off their lows of last winter, but also well below the highs seen in the summer of 2008. Real estate is clearly not in a bubble anymore.

One could make a case for bonds being in a bubble -- certainly prices are high and yields are very low by historical standards. However, over the past year, the CPI is actually negative, and hence real rates are higher than nominal rates. At the headline level that will not last, the decline in oil prices is going to anniversary, so year-over-year headline inflation will head up.

However, excluding food and energy, prices are likely to stay very well contained. The most important component of the CPI, especially core CPI, is housing prices. No, not the price of your house, but what the government figures you are paying yourself for the privilege of sleeping in your own bed, otherwise known as Owners Equivalent Rent. Together with the regular rent that renters pay their landlords, that makes up about 30% of the overall CPI and about 40% of core CPI. Vacancy rates are rising and rents across the country are under pressure. This means that overall inflation, particularly core inflation, will stay low.

There is a chance, however, that this policy could start to develop a bubble in stocks. There is a lot of money that has been pushed into the system. There is not that much demand by corporations -- especially the solvent ones that the banks would like to lend to -- to borrow lots of money to build new plants, or even take on more inventory. That money will try to find a home, and if it can't find it in the real economy, it will gravitate to the financial economy.

Thus, while keeping rates low does pose a risk, that risk looks mostly theoretical at this point. The very low Fed Funds rate means that there will also be a very steep yield curve.

This is good news for the banks, since their core economic function is to borrow short term -- for example by taking in checking deposits -- and to lend long term, for example making commercial and industrial loans. This will help big banks like J.P. Morgan (JPM) and Citigroup (C) earn enough from their current loans to help offset the massive losses they have hidden on other books of previous loans that have gone bad.

Historical lag between end of recession, unemployment rate peak, and beginning of funds rate tightening cycle

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Fed: Growth, No Near-Term Inflation – Analyst Blog

Dirk Van Dijk — Wed, 23 Sep 2009 20:17:40 +0000

The Federal Reserve decided to keep the Fed Funds rate at its historically low level, and noted that growth was starting to pick up and there was very little threat of near-term inflation. The current statement and the one from the previous meeting (8/12) are presented below, along with my analysis of the statements and the differences between them.

"Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.

"Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability."

"Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out. Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing but are making progress in bringing inventory stocks into better alignment with sales.

"Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability."

The key difference is that the Fed sees the economy picking up rather than merely leveling out. They note the continued improvement in the financial markets. This is true not only for the stock market, which is up almost 7% since the last meeting, but also in things like credit spreads.

They note the upturn in the housing market, which they did not do last time around. They note that fixed investment is going down, but at a much slower rate, which is the first step towards a turnaround. Most of the rest of the first paragraph is the same. This is the most upbeat Fed statement in a long time.

"With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time."

"The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time."

The Fed seems ever less worried about near-term inflation than last time around. While I think that we will still see upward movement of commodity and energy prices (well obviously not today, with oil down hard following higher-than-expected inventory levels). This could lead to higher headline inflation, but low core inflation.

There is simply too much slack in the economy to see inflation rocket higher. There is no way for the wage side of a wage price spiral to take hold. Also keep in mind that rent and owners equivalent rent make up almost 40% of core CPI, and it seems more likely that rents will fall than rise over the next year or so.

"In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

"To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010.

"As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."

"In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

"As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities.

"To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions, and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."

Fed Funds are not going up -- not now, not next meeting, or the meeting after that. I would be greatly surprised if they were to raise them at any time before the fourth quarter of 2010, and then only gradually and cautiously.

Historically, the Fed does not raise rates until well after the unemployment rate has peaked, even in a shallow recession. This one has been anything but shallow. It is likely that the unemployment rate will not peak until well into next year and will be well over 10% when it does. It would be very irresponsible for the Fed to strangle the recovery by moving too soon.

The size of the asset buying programs was maintained, but they decided to stretch out the mortgage-backed and agency paper buy until the end of the first quarter, rather than by the end of the year. This would prevent a disruption in the market from the Fed no longer being in the market.

The slowdown is a bit of a concession to those who think that the Fed has been going overboard on its easy money policy, but not much of one. By the end of the program, the Fed will own almost 25% of all the Fannie (FNM) and Freddie (FRE)-backed paper outstanding.

The big question for next year is: what are they going to do with all that paper. At what point do they start feeding it back out into the market, or do they just plan to sit on it forever? Stretching out the program will also help the housing market so that the end of the artificial price support for mortgage backed paper, and thus artificially low mortgage rates, does not come right at the same time as the end of the "first time" home buyer tax credit.

"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen."

"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen."

Everyone agreed.

Overall this was a very upbeat Fed statement. Growth is coming back, no near-term threat of inflation and the financial markets are improving. Low interest rates for as far as the eye can see. I suspect that the market should like it.

The foreign exchange market might have been looking for some evidence that the Fed was going to reverse course and start to tighten up, but they didn’t get it. Pressure on the dollar is more likely to cause headline inflation to go up than core inflation to rise. I think the Fed is more concerned with core inflation.
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Fed Staying on Hold, Housing Up – Analyst Blog

Dirk Van Dijk — Tue, 22 Sep 2009 16:00:06 +0000

Tomorrow afternoon all eyes will be on the Federal Reserve, which is currently holding one of its every-six-weeks get togethers. I and probably the rest of the world expect no change in the Fed Funds rate. It is currently near zero, so there is no room for further cuts, and it is extremely premature for them to raise rates again.

The real interest will be in deciphering the policy statement. I would expect a more upbeat tone about the pace of economic growth and continued confidence that they have inflation under control. There is about a mile of economic slack in the system, and while there are some indications that it is starting to be reeled in (for example, capacity utilization up two months in a row) we are a long, long way from any tension on the line.

As the graph below (from http://www.calculatedriskblog.com/) shows, historically the Fed has waited until well after unemployment peaks to start tightening up interest rates. After the 1991 recession they waited 18 months after unemployment peaked to start raising rates, and after the 2001 recession they waited a full year. Keep in mind, in both cases unemployment peaked well after the recession was over.

Currently unemployment is still rising, and is already at much higher levels than in either of the last two peaks. The earliest the Fed is likely to increase rates is probably the end of 2010.

Tomorrow afternoon, we will publish a paragraph-by-paragraph comparison and interpretation of the new Fed statement versus the pervious statement.

One of the key things to look for will be if they are going to end their quantitative easing programs soon. They have just about filled up their previously announced quota of buying Treasuries, so they may announce that they are done there. Through mid-September, they had bought $285 billion of the $300 billion of longer-term treasuries they planned to buy through the end of October.

On the Fannie Mae (FNM)- and Freddie Mac (FRE)-backed securities front they have already bought $840 billion of the $1.25 Trillion planned by the end of the year. That far exceeds the total amount of GSE-backed paper issued this year (about $440 billion), and when completed will represent almost 25% of all outstanding paper. The buying of MBS paper is a substantial deviation from classic central banking practice.

This has been a huge prop to the mortgage (and by extension, the housing) market. But what happens when the program is completed? The timing will roughly coincide with the expiration of the first-time buyer tax credit (11/30).

So far this year we have seen some stabilization and even signs of recovery in the housing market. For example, existing home sales were 15.2% higher in July than they were in March. The August data on used homes is due out on Thursday morning.

Even on the pricing front there are some signs that things are turning around. This morning the FHFA housing index, which tracks the prices of repeat sales of houses backed by the GSEs, showed a month-to-month gain of 0.3%. While that was less than the 0.5% consensus expectation, it was still up. On the other hand, prices were still down 4.2% year over year.

The FHFA index has a bigger weight on lower-priced homes than does the Case Schiller index, which is due out early next week, and which through June had shown a 15.4% year-over-year decline. The CS index is generally considered the gold standard of house price indexes.

There is a very real risk that the housing could slip back after these artificial supports are removed. That would be bad news, since historically housing is one of the key locomotives pulling the economy out of recessions. While absolute housing inventories (both new and used) are now relatively low, relative to sales they are still very high -- if not as awful as earlier in the year.

I still fear a big second wave of foreclosures will add to those inventory levels. Mortgage delinquencies are still rising, and unemployed people in houses that are worth less than the amount of the mortgage have every incentive in the world to simply walk away from their house, or simply live rent and mortgage free until the sheriff shows up at the door. This is one of the key reasons that I expect the economic recovery to be very anemic, especially after a short-term inventory bounce is out of the way.

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Leading Indicators Higher – Analyst Blog

Dirk Van Dijk — Mon, 21 Sep 2009 17:42:47 +0000

In August, the Conference Board’s Index of Leading Economic Indicators (LEI) rose 0.6%, following gains of 0.9% in July and 0.8% in June. This was slightly below the 0.7% consensus expectation, but on the other hand, the July number was revised up from 0.6%, so the gain was coming off a higher base.

Five of the ten indicators were up on the month, three were down and two were unchanged. This marks the fifth month in a row that the index has been up since it bottomed out in March. Prior to that, it had fallen for 20 straight months -- one of the longest negative strings on record.

The five components that were up, in order of their impact on the index, were: the vendor performance index, which rose to 57.1 from 52.0; the spread on 10-year Treasuries versus Fed Funds, which rose to 3.43% from 3.40%; stock prices at 1009.72 versus 935.82; building permits at 579 versus 564; and the index of consumer expectations at 65.0 versus 63.2. Barring any major crash in the next few days, stock prices should be a nice positive influence on the September index.

The biggest drag on the index by far was the real money supply (M2 in chained 2005 prices), which was as big a drag as the interest rate spread was a boost to the index. New claims for unemployment insurance rose to 573,000 from 556,500, but since that data is released weekly, we know that it has since improved to around the 550,000 level and should be a positive contributor to the September numbers.

A decline in new orders for non-defense capital goods also weighed on the index. While capacity utilization has recently started to inch up, it remains extremely depressed, so it is not a big surprise that businesses are not spending money to expand capacity. The decline in the money supply indicates that banks are still holding back on lending, rather than the Fed being restrictive in its monetary policies.

Rather than get too caught in the weeds of the index, it is worth stepping back and looking at the big picture. The trend in the index has turned and it is accelerating. The six-month change in the index is now up 4.4%, while it was up just 3.3% in July, 2.1% in June. Back in March, the six month trend was down 2.7%.

These numbers seem to indicate a much-stronger-than-expected economic recovery in the making. I’m not sure I quite buy it, but the combination of the sweet spot of the economic stimulus package hitting and a stopping of inventory liquidation (even perhaps some rebuilding) could give us a few very nice quarters -- it's the sustainability of them that is the issue.

The U.S., however, does not seem to be alone in starting to recover, and if other countries are recovering, it will also aid in ours. They will be more likely to buy our exports if they are growing.

A world-wide recovery would, however, mean much higher commodity prices, particularly for base metals and energy. This would be good news for the miners like Freeport McMoran (FCX), Rio Tinto (RTP) and Vale (VALE).
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Global Stocks Retreat

Contrarian Profits — Mon, 21 Sep 2009 17:30:55 +0000

pWorld stocks retreated further from last week#8217;s 11-month high on Monday as lower energy and commodity prices and caution ahead of a Federal Reserve meeting and G20 summit prompted investors to trim risky trades./p pLeaders of the Group of 20 meet on Thursday and Friday in Pittsburgh and U.S. President Barack Obama said on Sunday he would push world leaders for a reshaping of the global economy in response to the crisis./p pWorld stocks, measured by MSCI have risen over 26 percent this year, recouping more than half of last year#8217;s losses, underpinned by repeated pledges by G20 policymakers to keep emergency support for the economy in place./p p#8220;The market might look slightly overbought near term, but the economy is definitely improving, corporate#8230;/p

Key Indicators Point to a Rough September for U.S. Stocks

William Patalon lll — Tue, 01 Sep 2009 18:13:46 +0000

[Editor's Note: The global economic recovery will create an estimated $300 trillion worth of global-investing-profit opportunities. To find out how to capitalize and profit, you just need to know where to look. And for that, you need a guide. As part of a new report, Money Morning Investment Director Keith Fitz-Gerald details " the [...]

Obama Backs Big Ben – Analyst Blog

Dirk Van Dijk — Tue, 25 Aug 2009 16:05:16 +0000

President Obama has decided to reappoint Fed Chairman Ben Bernanke to a second term. On balance, I think this is the right move. In many ways, his reappointment makes more sense than his original appointment.

The worst marks against Bernanke’s record come from when he was serving on the Fed board under Alan Greenspan, did nothing to stop the bubble forming and was almost willfully blind in seeing it coming. While as Chairman, he was a little slow off the mark in addressing the crisis, once engaged he took the needed steps to pull the world back from the brink of the abyss.

The role of Fed Chairman has two major components. First and foremost, he (along with the board of Governors) is responsible for monetary policy. This is the raising and lowering of the Fed Funds rate and regulating the overall money supply.

On that front, I think he has done an excellent job under the most trying of circumstances. He faced a raging wildfire of deleveraging in the financial system after the demise of Lehman Brothers and the near collapse of several other major financial institutions, including American International Group (AIG), Fannie Mae (FNM), Freddie Mac (FRE), Merrill Lynch -- now part of Bank of America (BAC) and Citigroup (C).

He responded by quickly lowering the Fed Funds rate to almost zero, and then going a few steps further by engaging in quantitative easing, or buying mortgage-backed securities and long-term T-notes. These actions dramatically increased the size of the Fed balance sheet and with it the size of the monetary base. He responded with a slew of innovative alphabet soup programs, such as the TALF program, to stabilize the system.

At the core of the problem is that deleveraging dramatically slows the velocity of money, or the rate at which it moves from one hand to another. Banks want to hold onto as much cash as possible and do not want to lend it out.

Since nominal GDP can be defined as the supply of money times the rate at which it turns over, if the money supply is not increased, then GDP will fall precipitously. This comes from the basic monetarists equation of M*V = P*Q, where M is the money supply, V is the velocity, P is the price level (inflation) and Q is the quantity produced (real output).

Once engaged, Bernanke saw the scope of the problem and unleashed a fire hose of liquidity on the problem. While the economy is clearly not in good shape, I shudder to think about the condition we would be in had he not taken these actions. Most people fail to appreciate just how close we came to financial Armageddon last fall. It was the economic equivalent of the Cuban Missile Crisis.

Sopping up all that liquidity is going to be extremely tricky, and the timing is going to have to be just right. If it is removed too soon, then the economy will slip right back into its downward trajectory.

The actions of the Fed prevented a second Great Depression, but that does not mean the threat has totally disappeared, just that the medicine is working. Stopping the medicine too soon would cause a relapse.

The best example of this in history was in the 1930’s. Few people realize that the greatest growth in GDP and industrial production in U.S. peacetime history was from 1933 through 1936. Unfortunately, worried about the potential for inflation and unprecedented budget deficits, both Monetary and Fiscal policy turned concretionary in 1937, resulting in a very nasty recession, a relapse that took WWII to cure.

On the other hand, if velocity starts to pick up and all that monetary base is still out there, then the movement on the other side of the equation will be as much or more from the P, inflation, as it is from the Q, a pick up in real economic activity. If Bernanke does not act quickly enough, inflation could easily return to mid-1970’s levels or worse.

Bernanke is betting that right now real activity is depressed enough that when V starts to pick up, the bulk of the adjustment will be in real output, or Q. With capacity utilization at near record lows, there is a very good justification for this view.

Certainly recent inflation reports have been not been on the too-hot side. Heck, we just saw the biggest year-over-year drop in producer prices on record! Changing horses in midstream is not a good idea, and until this river of liquidity is removed, we will not get to the other side.

The other major role of the Fed Chairman is to be one of the most important bank regulators. Here I would give him much weaker marks. The banks acted outrageously leading up to the crisis. They used taxpayer-backed deposits and effectively went to Las Vegas with them. Their casino of choice was highly leveraged bets on exotic forms of mortgage-backed securities.

Another favorite table game were derivatives, most notably Credit Default Swaps (CDS) which were essentially life insurance contracts on companies. When they were winning the bets, they paid out bonuses that were beyond lavish. They did not set aside sufficient reserves for when the bets turned bad.

The Fed, along with the Treasury, simply threw money at the banks with very few strings attached. The taxpayer got very little in return. This was one of the greatest transfers of wealth -- welfare, if you will -- in human history. It did not go to the poor or the sick; it went to the wealthy and the powerful. In the process, it set up a moral hazard problem of epic proportions.

Bankers now know that they can make huge bets, and if they lose, the taxpayer will cover them. If they win, they get to keep it all. This will encourage banks and other financial institutions to be even more irresponsible in the future.

An overhaul of the financial regulatory structure would help, and the recent proposals by the Obama Administration are a decent first step in that regard. Unfortunately, the proposals are more likely to be watered down in Congress than strengthened. This is exactly the sort of issue where lobbyists hold the most sway -- dry and complicated issues where a very powerful group has a huge interest in the outcome.

The net result is that down the road -- not next year or the year after, but maybe in a decade -- we will face another massive crisis in the financial system. And where the actions of the last administration with regard to the banks were beyond scandalous, the actions of the current administration towards the banks have been a huge disappointment. "Change we can believe in" has, at best, become change around the edges.

In his second term, Bernanke will have to become a much tougher regulator. Part of the regulatory reform would put even more power in the hands of the Fed as a systemic risk regulator. I agree that such a regulator is needed, and the Fed is one of the two obvious candidates for the job (the other being the FDIC).

The opposition the Fed has shown in giving up part of its regulatory power -- the consumer protection part -- is extremely disappointing, and smacks of more interest in bureaucratic turf than the interests of the American people or the economy. The Fed has done a lousy job in protecting the consumer from predatory practices at the banks, and a separate agency is desperately needed.

The experience of Alan Greenspan should warn us loudly about the lionization of a Fed Chairman. For most of his tenure, Greenspan was lionized as the “Maestro." Now it is clear that he truly was a failure whose actions led to the near total collapse of the entire world economy.

Thus, I have no desire to lift Ben Bernanke up to Mount Olympus. Still, given his excellent handling of monetary policy during the most difficult of times, Bernanke deserves to finish the job he started, and Obama is making the right move in reappointing him.
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Why the Obama Stimulus Has Us on a Collision Course with Inflation

William Patalon lll — Mon, 03 Aug 2009 16:59:11 +0000

Has the massive Obama stimulus plan put us on a collision course with virulent inflation? It sure looks that way. Let me explain … When the U.S. Commerce Department on Friday said the U.S. economy contracted at a 1% annual pace in the second quarter, the report was actually seen as good news: It was a slower decline [...]

Risk Aversion Disappears Again

Contrarian Profits — Mon, 20 Jul 2009 14:00:35 +0000

pRisk aversion has left the building#8230; CIT survives without Fed help#8230; SNB tries to fight the markets#8230; Light week for US data#8230; And Now#8230; Today#8217;s Pfennig!/p pGood day#8230; We had just an amazing weekend of weather here in St. Louis, and this morning is shaping up to be another beautiful day. Friday turned out to be a beautiful day for those who have taken our advice and diversified their holdings out of the dollar. Risk aversion was placed on the back burner again, and investors moved money back out of the dollar into higher yielding currencies. The dollar and yen got sold but all other currencies rallied, and investors also turned back toward gold pushing the metal above $950 for the first time in over#8230;/p

The PPI Roller Coaster Ride – Analyst Blog

Dirk Van Dijk — Tue, 14 Jul 2009 19:24:52 +0000

The Producer Price Index rose a shockingly high 1.8% in June, far higher than the tame readings of 0.2% in May and 0.3% in April. It was also much higher than the 0.9% consensus expectation.

To be sure, most of the acceleration had to do with the rise in energy prices, which rose 6.6% on the month on top of a 2.9% rise in May. In May, the rise in energy prices was largely offset by a 1.6% decline in food prices. That left the May change in Core PPI at a slightly negative 0.1%.

That was not the case this time around, as finished food prices jumped 1.1% to help fuel the increase in the headline number to its highest level in over a year. However, even if we take out food and energy to get the Core PPI, the increase came in at 0.5%, well above expectations of a 0.1% increase.

The PPI is released at three levels, with the index for finished goods being the one that gets the most attention (i.e. what I talked about first). It also looks further up the production chain to see what is happening to prices at the Intermediate and crude stages of production. The easy way to conceptualize the differences is to think Wheat, Flour and Bread to represent Crude, Intermediate and Finished goods.

Prices are starting to accelerate up the production chain as well. To some extent this is a good thing, since the early stages of production had been showing serious signs of deflation. On a year-over-year basis, intermediate goods prices are down 12.5% and crude goods are down a whopping 40.0%. However this month both staged large increases with intermediate goods rising by 1.9% and crude goods jumping by 4.6%.

Energy was the principal reason at both levels, rising 8.9% at the intermediate, and 10.9% at the crude level, following increases of 2.0% and 5.3%, respectively in May. The fact that energy prices are rising much more in the early stages of production than at the finished level is bad news for refiners like Valero (VLO) and Tesoro (TSO). For the integrated giants like Exxon (XOM) and Chevron (CVX) the effect is likely to be a wash.

The year-over-year numbers are a bit deceptive. If we break the year into the last half of 2008 and the first half of 2009, the difference in the behavior of the PPI numbers is startling. Looking just at the finished goods numbers, in the last half of 2008, overall finished goods prices plunged at an annual rate of 12.1%, but in the first half of this year they are up at a 4.2% pace (annualized the June rise would be at a 23.9% pace). However, that was almost all a function of energy, which plunged at a 52.9% rate in the last half of last year, but are climbing at a 18.8% rate so far this year.

On a core basis, PPI has actually be going up at a relatively tame 2.9% rate, well below the 4.6% rate it was rising late last year. The core rate is significant because the Fed tends to look at it more than the headline rate in setting monetary policy. To the consumer it is less significant, since most people have to consume both food and energy.

The traditional rationale for the focus on the core rather than on headline is that over the long term, food and energy price changes will tend to match the overall price level, but they can be very volatile in the short term and are vulnerable to exogenous shocks. Thus they could cause the Fed to “over-steer" in setting monetary policy. The rise in the core rate has to be a bit disconcerting to the Fed, especially if it is matched by a similar report on Consumer Prices tomorrow.

The traditional medicine for fighting incipient inflation is to raise the Fed Funds rate. However, with unemployment at 9.5% and rising, such a move seems ill-advised. It is hard to see how the wage side of a wage price spiral can get underway in these conditions, so any rise in inflation simply means a reduction in the real standard of living for the vast majority of Americans.

Still, the aggressive policy moves by the Fed -- reducing Fed Funds to almost zero and engaging in quantitative easing (a.k.a. turning on the printing press) -- are inflationary by their nature. They were put in place to fight off the deflationary effects of the private sector attempting to deleverage.

Getting the balance right, and sopping up the liquidity used to fight that deflationary fire, is going to be tricky. I’m sure that the Fed does not want to have to do that yet.

I have long thought that the current problem was deflation but that inflation was a very big risk for late 2010. If that switch-over comes early, before the economy has had a chance to at least stop the rise in unemployment, the Fed is going to be in a serious bind.
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Is Another Huge Bank Failure Brewing?

Contrarian Profits — Thu, 02 Jul 2009 21:14:59 +0000

pA large “mystery” bank is scrambling for late night cash. At the close of the quarter, an unnamed bank paid 7% for overnight money from the Fed. The mainstream and the Fed claim this to be normal behavior at the end of the quarter, but don’t believe it for a second./p pHere’s Karl Denniger at the Market Ticker on why you should be concerned:/p blockquotepLet#8217;s put this in plain language: strongThe discount window is open for any bank that has good collateral at less than 1/10th of that interest rate./strong/p pTherefore strongthere is absolutely no reason for any institution to go into the Fed Funds market for overnight money at 7% unless they have no good collateral to post against it and thus cannot go to#8230;/strong/p/blockquote

Will Week of Controversy Undermine Financial System Overhaul That Calls for Broad Expansion of Central Bank’s Power?

Contrarian Profits — Mon, 29 Jun 2009 17:45:17 +0000

div class="entry" pDocuments brought to light by key by congressional investigators hightlight real disagreement between top-level U.S. Federal Reserve officials about how it should address the strongBank of America Corp.(NYSE:a href="http://www.google.com/finance?q=NYSE%3ABAC" target="_blank"BAC/a)/strong acquisition of strongMerrill Lynch #38; Co. Inc/strong. are almost certain to fuel the ongoing congressional debate over a href="http://www.moneymorning.com/2009/06/18/obamas-financial-system/" target="_blank"the central bank’s push to expand its authority over the U.S. financial system/a./p pThis a href="http://online.wsj.com/article/SB124606477050863921.html" target="_blank"growing concern/a manifested itself Thursday, when Fed Chairman Ben S. Bernanke; was grilled by Capitol Hill lawmakers during a congressional hearing looking into the central bank’s conduct in BofA’s buyout of Merrill Lynch. Bernanke’s failure to resolve some of the most-pointed questions posed by congressional leaders – (especially Republicans) who wanted to discover whether the Fed overstepped its authority and interfered with merger-related decisions – may undermine a#8230;/p/div

Will Week of Controversy Undermine Financial System Overhaul That Calls for Broad Expansion of Central Bank’s Power?

Contrarian Profits — Mon, 29 Jun 2009 17:45:17 +0000

G8 Finance Chiefs Express Cautious Optimism About the State of the World Economy

Contrarian Profits — Mon, 15 Jun 2009 14:20:15 +0000

div class="entry" h4Top financial officials from the a href="http://encarta.msn.com/encyclopedia_761589420/Group_of_Eight.html" target="_blank"Group of Eight/a (G8) industrialized nations on Friday issued an upbeat evaluation of the global financial crisis, describing signs that markets were stabilizing around the world and warning that it was necessary to devise “exit strategies” to disengage from stimulus programs that have been put in place.br / /h4 pThe G8 met for two days in Lecce, Italy. Eight world finance ministers – including U.S. Treasury Secretary Timothy F. Geithner, and his global counterparts from Britain, Canada, France, Germany, Italy, Japan and Russia – also agreed to create #8220;a href="http://www.washingtonpost.com/wp-dyn/content/article/2009/06/13/AR2009061301479.html?hpid=sec-business" target="_blank"a set of common principles and standards/a governing the conduct of international business and finance,#8221;strongemThe Washington Post/em/strong reported./p pIn a communiqué called #8220;the Lecce Framework#8221; – which described the strategy for obtaining those goals –#8230;/p/div

History Hints that Current Stock Market Rally May Be the Leading Edge of a New Bull Market

Contrarian Profits — Mon, 08 Jun 2009 12:48:29 +0000

div class="entry" pIf history is our guide, then the rally we’ve seen in U.S. stocks in recent weeks is more than just a periodic run-up in share prices – it’s the initial stage of a prolonged bull market./p pThe 13-week rally the stronga href="http://www.google.com/finance?q=INDEXDJX:.DJI" target="_blank"Dow/a a href="http://www.google.com/finance?q=INDEXDJX:.DJI" target="_blank"Jones Industrial Average/a/strong has experienced off its March lows is the most powerful surge that index has seen since the Great Depression. If we look to history, stocks should continue to rally over the next three months./p p#8220;I say this with the utmost confidence and my fingers tightly crossed: This is the start of a new bull run,#8221; Hugh Johnson, chairman of Johnson Illington Advisors, told strongemMarketWatch.com/em/strong./p pThe 13-week stretch from March 9 through May 29, which saw the Dow soar 28.3%, has been bested only#8230;/p/div

As GM Cruises Toward Government Deadline, U.S. Automakers Must Learn to Deal With a Permanently Smaller Market

Contrarian Profits — Tue, 26 May 2009 12:30:52 +0000

pstrongGeneral Motors Corp. (NYSE: a href="http://www.google.com/finance?q=gm" target="_blank"GM/a) /strongis closing in quickly on its June 1 deadline to finish overhauling its operations, or opt for Chapter 11 bankruptcy. Because that deadline is actually one week from yesterday (Monday), analysts and investors will be watching GM closely this week./p pNo matter which path GM chooses – conventional restructuring or bankruptcy – the U.S. Big Three of GM,strong Ford Motor Co. (NYSE: a href="http://www.google.com/finance?q=f" target="_blank"F/a) /strongandstrong a href="http://www.google.com/finance?cid=4090940" target="_blank"Chrysler LLC/a/strong will have to adjust to the U.S. auto market’s post-financial-crisis “new reality.” Automakers will sell only 10 million cars and trucks in the U.S. market this year, the worst in at least 30 decades – and roughly 38% less than the 16 million vehicles that were sold in the United States annually in#8230;/p

History Will Show That Alan Greenspan Played a Key Role in Creating the U.S. Housing Bubble

Peter D. Schiff — Wed, 20 May 2009 16:27:57 +0000

By Peter D. Schiff Guest Columnist Money Morning [Editor's Note: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a well-known author and commentator, and is a periodic contributor to Money Morning. Schiff is the author of two New York Times best sellers: "The Little Book of Bull Moves in Bear [...]

Chrysler, GM Dealer Cuts Point to More Rough Times Ahead for U.S. Automakers

William Patalon lll — Wed, 20 May 2009 11:59:46 +0000

By William Patalon III Executive Editor Money Morning/Money Map Report [Editor's Note: When it comes to banking or global economics, there's literally no one better than Money Morning Contributing Editor Martin Hutchinson - a former investment banker with more than a 25 years experience. Hutchinson has proven himself to be a market maven and he is [...]

Chrysler, GM Dealer Cuts Point to More Rough Times Ahead for U.S. Automakers

Contrarian Profits — Mon, 18 May 2009 15:30:46 +0000

pJust days after stronga href="http://www.google.com/finance?cid=4090940"Chrysler LLC/a/strong said it would be cutting one quarter of its auto dealerships, 1,100 strongGeneral Motors Corp. (NYSE: a href="http://www.google.com/finance?q=gm"GM/a)/strong dealerships have reportedly been told not to expect a relationship with the embattled U.S. carmaker after October 2010./p pGM dealers targeted for separation a href="http://www.reuters.com/article/bigMoney/idUS197637279320090516"were informed by letter/a over the weekend, strongemReuters/em/strong reported./p pThe eradication of hundreds of hundreds of American auto dealerships is merely the latest development in the ongoing dismantling of the so-called U.S. “Big Three’’ – a process that seems likely to leave strongFord Motor Co. /strongstrong(NYSE: a href="http://www.google.com/finance?q=f" target="_blank"F/a) /strongas a href="http://www.moneymorning.com/2009/05/12/ford-share-offering/"the last American automaker standing/a./p p“These companies are making up for now for what they have avoided doing for years, if not decades,” industry analyst stronga href="http://www.casesashapiro.com/johncasesa.html"John A. Casesa/a/strong, managing partner of consultantcy stronga href="http://www.casesashapiro.com/"Casesa Shapiro#8230;/a/strong/p

The Emerging Global Financial Architecture

Menzie Chinn — Wed, 06 May 2009 15:45:22 +0000

Events, particularly these days, tend to outrun the best laid plans to anticipate research trends. And it might seem that this was true in the case of this conference, sponsored by UCSC's Santa Cruz Center for International Economics, the Journal of International Money and Finance, and the Federal Reserve Bank of San Francisco. The conference was planned last year, at a time when most academic researchers were aware and concerned about the incipient economic slowdown, and whether the major economies would "de-couple", and in turn how these factors would impact the constellation of global imbalances.

As it turns out, the papers were all, in my opinion, remarkably germane to issues we're concerned about right now: how the composition of debt determines vulnerability to crises, the effect of capital controls on capital flows, the role of the IMF, and the usefulness of macroeconometric models to predict exchange rates even during periods of financial disorder. That's a testament to the organizer's (Joshua Aizenman) skill (plus a bit of luck), but also a reflection of the fact, some outsider views notwithstanding, that academics do often incorporate real-world driven questions and concerns into their research (e.g., see this silly debate in the blogosphere in the wake of the last AEA meetings).

First off was Bob Flood (IMF/Notre Dame) and Andy Rose's (UC Berkeley) paper, entitled "Inflation Targeting and Business Cycle Synchronization":

Inflation targeting seems to have a small but positive effect on the synchronization of business cycles; countries that target inflation seem to have cycles that move slightly more closely with foreign cycles. Thus the advent of inflation targeting does not explain the decoupling of global business cycles, for two reasons. Indeed business cycles have not in fact become less synchronized across countries.

The authors use as their primary measure of business cycle synchronization the (contemporaneous) correlation of output gaps defined using Hodrick-Prescott filters, Baxter-King filters, linear detrending, and growth rates (on quarterly data, since 1980) (see this post for a discussion of detrending techniques applied to US data.

The discussant, James Lothian (Fordham), among other things, suggested that the use of "correlations" might be problematic to the extent that there were mean shifts in the relationships between the measures of the business cycle.

"Controlling Capital? Legal Restrictions and the Asset Composition of International Financial Flows" by Mahir Binici (UCSC), Michael Hutchison (UCSC), and Martin Schindler (IMF):

Legal restrictions on international capital movements are imposed in many countries in an attempt to (partially) insulate their economies from abroad and pursue some degree of domestic policy independence. But is the imposition of capital controls effective in achieving these goals? We investigate this issue from a new angle by linking de jure restrictions on three specific asset categories of outflows and inflows with the corresponding component of capital flows. The analysis is based on a novel panel data set of capital controls data, disaggregated by asset class and by inflows/outflows, and covering 74 countries during 1995-2005. Using panel LSDV regressions, and including a host of well-known determinants of capital flows, we estimate a model of capital flows with four categories: equity-like flows (including FDI) and debt for both capital inflows and capital outflows. The estimated effects of capital controls vary markedly with the type of controls imposed: they are binding on capital outflows (debt, equity and FDI); have no apparent effect on capital inflows of various types; and are less effective in low and middle-income countries. Moreover, there are no apparent substitution effects so that controls on debt and equity outflows change the volume and composition of capital flows as well as the net flow of capital in each asset class. The large differences across asset categories in the effects of capital controls suggest that the common use of aggregate capital control indicators can be misleading.

Next up was a paper entitled "The Emerging Global Financial Architecture: Tracing and Evaluating the New Patterns of the Trilemma's Configurations", by Joshua Aizenman (UCSC), myself, and Hiro Ito (Portland State). This paper was described in this post from last month.

Figure 2 from Aizenman, Chinn, Ito (2009): "The Trilemma and International Reserves Configurations over Time: Regional Patterns for Developing Countries"

Using the indexes we developed (Aizenman, Chinn, and Ito (2008)) to measure the degree of the three policy choices countries make with respect to the trilemma: exchange rate stability, monetary independence, and capital account openness, we investigate the normative questions pertaining to the trilemma, that is, how the policy choices among the three trilemma policies affect output growth volatility, inflation rates, and the volatility of inflation, with focus on developing economies. Some key findings for developing countries include: (i) greater monetary independence can dampen output volatility while greater exchange rate stability implies greater output volatility, which can be mitigated by reserve accumulation; (ii) greater monetary autonomy is associated with a higher level of inflation while greater exchange rate stability and greater financial openness could lower the inflation level; (iii) a policy pursuit of stable exchange rate while financial development is at the medium level can increase output volatility, and while greater financial openness with a high level of financial development can reduce output volatility, greater financial openness with a low level of financial development can be volatility increasing; (iv) net inflow of portfolio investment and bank lending can increase output volatility and higher levels of short-term debt or total debt services can increase both the level and the volatility of inflation.

The discussant, Helen Popper (Santa Clara U.) made a number of observations. Two salient ones were (i) countries choose the tradeoffs between monetary independence, exchange rate stability, financial integration and reserve accumulation as a consequence of characteristics and experiences of those countries, and so estimating macro outcomes as a consequence of policy choices might be subject to endogeneity; and (ii) the measure of monetary independence in some cases yielded counterintuitive categorizations (e.g., Canada). She suggested that a more economic approach, such as the extent to which Canadian policy rates could be described by US variables.

Michael Bordo (Rutgers) and Harold James's (Princeton) paper, entitled "The Long Running Quest for Economic Reform":

This paper examines changes in the role of the IMF since its inception in 1944, in response to the breakdown of the par value system, the liberalization of capital movements, and financial deregulation. In the 2000s, as IMF lending contracted, the role of the Fund has become less controversial but also less important; with the eruption of a global financial crisis in 2008, IMF lending again assumed a major importance. A need for public goods provision arises out of the major new problems of the twenty-first century: controversies over exchange rates, over the management of reserve assets, the politicized debate over sovereign wealth funds (SWFs), and the management of financial globalization. The paper examines ways in which the new demand for a role of the Fund could be met, and its implications for governance reform.

The discussant, Barry Eichengreen (UC Berkeley) was largely in agreement, spending some time arguing that it would be indeed better for the world economy if somehow countries could diversify out of the dollar as the key reserve asset, perhaps using the SDR as a substitute. For more on this idea, see here.

In "The International Transmission of Interest Rate Shocks: The Federal Reserve and Emerging Markets in Latin America and Asia", Sebastian Edwards (UCLA) examined linkages mostly before the onset of the crisis:

In this paper I use high frequency data to investigate the extent to which interest rate changes originated in the United States are transmitted to a group of emerging countries. More specifically, I am interested in understanding the effects of changes in the Federal Reserve Federal Fund's interest rates on differential between (short term) local currency interest rates. I also investigate how changes in the U.S. term structure affects short term rates in and international interest rates, properly adjusted by currency and country risk. Other shocks considered in the analysis include changes in the US dollar-Euro exchange rate, changes in the international price of oil, risk ratings, and the degree of capital mobility. The results indicate that there is a strong and fairly rapid transmission of changes in the Federal Funds rate into interest rates differentials in the Latin American countries in the sample. This effect is equally large in the Asian nations in the long run. The adjustment path is different across the two regions, however. Adjustment is very fast and cyclical in Latin America; it is gradual and slower in East Asia.

The discussant, Reuven Glick (SF Fed), observed that while the short run dynamics of propagation differed, the implied long run elasticities were quite similar. In addition, he observed that not all Fed Funds rate changes were (are) created equal -- and anticipated changes probably differ in effect from unanticipated.

The keynote address was given by Maurice Obstfeld (UC Berkeley). I thought this wide ranging survey, entitled "The Immoderate World Economy" was very insightful. I can't summarize the entire presentation (and it's not online), but I can highlight what I thought were the important parts.

First, he enumerated "Myths We Lived by through 2007":

Efficient capital markets will smoothly finance and absorb large global imbalances.
Housing losses will be limited and the wealth effects offset by central bank interest rate cuts.
Central banks are firmly in control of inflation.
A new era of stability in emerging markets may make the IMF redundant. There is no systemic global threat because emerging markets are small players, rich countries have robust institutions.

The end of these myths set the stage for the two main components of his talk, namely (1) the relation of global imbalances and the US financial collapse, and (2) the major lesson of this episode, namely that we need to take a systemic view of the global financial architecture.

On the first point, Obstfeld notes gross international imbalances (large gross asset and liability positions) helped create pyramids of counterparties, and could have occurred without current account deficits. "But world's willingness to finance US deficit kept US spending high, interest low, and the dollar strong." If I am reading his comments correctly, there are large roles for monetary policy and adverse incentives in this story of boom and bust.

In terms of the lessons, Obstfeld observes that there is a fallacy of composition in thinking that micro-prudential regulation that is aimed at mitigating idiosyncratic risk might exacerbate macro-level risk. The challenges associated with dealing with such risk is highlighted by Obstfelds concluding points:

Assets that melt down only when everything else does may carry high excess returns (cf. rare disasters and the equity premium).
Some who invest in them, however, may place insufficient weight on the risks of rare disasters.
This may make the financial system as a whole more vulnerable.
Systemic risks are likely to be associated with large "overvaluations" (as in housing) or large borrowing flows (current account deficits, term mismatches).
The macro-prudential perspective requires that such imbalances be monitored and addressed.

And, so (from my view), one can see how we have come full circle -- the end of the myths laid out by Obstfeld raises enormous challenges for managing the world economy. But the first step in progress is to dispense with those myths, that even now, some people adhere to.

On the second day, Chris Messner (UC Davis) presented his paper with Michael Bordo (Rutgers) entitled "Foreign Currency Debt, Financial Crises and Economic Growth: A Long Run View".

What are the costs of hard currency liabilities? After being implicated in the global financial instability of the late 1990s, the costs are widely believed to be large, and as a result many emerging markets have pushed to minimize currency mismatches. We study the growth effects of exposure to foreign currency debt using data from two periods of international financial integration (1880-1913 and 1973-2002) for over 45 countries. Hard currency debt is associated with increased risks of currency and debt crises in both periods, especially when a country's macroeconomic financial fundamentals are weak. We find the risk of financial crisis associated with hard currency debts translated into significantly diminished growth rates. However, we also find evidence that strong financial development and policy credibility attenuate the crisis risks associated with high exposure to hard currency debt, which has implications for eastern European countries where large current account deficits and high levels of hard currency debt are believed to pose financial risks. In this region some countries have adopted flexible exchange rates and avoided foreign currency debt. Several others have built up large net foreign currency liabilities and are exposed to a significant likelihood of a financial crisis in the near future.

The discussant, Mark Spiegel (SF Fed), pointed out that one key assumption of the paper is that the model assumes the debtors make the decision. But in fact, creditors and debtors joint come to make the decision regarding borrowing and lending. Hence, one has to be careful not to take the results to mean that countries can mitigate the likelihood and costs of a crisis by reducing hard currency debt. The alternative to lots of hard currency debt might be no debt at all.

Oscar Jorda presented his paper with Alan Taylor (both UC Davis) entitled "The Carry Trade and the Real Exchange Rate: Nothing to Fear but FEER Itself".

The carry trade refers to the investment strategy of going long in high-yield target currencies and short in low-yield funding currencies. In recent years this naive trade has seen very high returns for long periods, followed by crashes where large depreciations of the high-yield currencies cause large losses. Based on low Sharpe ratios and negative skew, these trades may therefore appear unattractive, even when diversified across many currencies. But more sophisticated conditional trading strategies exhibit more favorable payoffs. We develop these strategies based on the simplest equal-weighted portfolios analyzed in the literature, and apply novel (within economics) statistical binary-outcome classification tests to show that our directional trading forecasts outperform their rivals. The critical conditioning variable, we argue, is the fundamental equilibrium exchange rate (FEER). Expected returns are lower, all else equal, when the target currency is overvalued. Like traders, academic researchers should incorporate this information when evaluating trading strategies. When we do so, some questions are resolved: negative skewness is purged, and market volatility (VIX) is uncorrelated with returns; other puzzles remain: the more sophisticated strategy has a very high Sharpe ratio, suggesting market inefficiency.

The discussant,Eric Fisher (CSU Polytechnic), observed that while the procedure seems to do very well, it -- like many other seemingly profitable algorithms -- may disappear once the procedure becomes well known in the practitioner community.

I'll note that the FEER used in this model is not like a typical FEER; rather it is better to characterize the equilibrium exchange rate concept as PPP.

The final paper, by Shang-jin Wei (Columbia) and Zhiwei Zhang (IMF), was "Does the Global Fireman Inadvertently Add Fuel to the Fire? New Evidence from Institutional Investors' Response to IMF Program Announcements":

Fighting global financial crises is a primary charge of the International Monetary Fund (IMF). Yet it has often been criticized to have hindered rather than helped the recovery of many countries in a crisis by demanding policy changes that may not be appropriate for them in that particular moment. Such actions would tend to damage investor confidence. Using monthly data on investment in 94 developing countries by 168 institutional investors during 1996-2005, this paper re-assesses this important question. We find that international investors tend to revise upward an economy's outlook after an IMF program is announced, and increase their investment in the country. Patterns of concurrent asset price movement suggest that it is unlikely due to a bailout/moral hazard effect. Based on this evidence, we conclude that the IMF has typically restored rather than reduced investor confidence.

I unfortunately did not get a chance to see this paper presented, which was discussed by Michael Melvin (BGI).

Market Moves Will Remain on Hold Until Bank Stress Test Results Are Released Thursday

Contrarian Profits — Mon, 04 May 2009 18:27:37 +0000

pBarring some dramatic – and unforeseen – news this week, expect investors to tread water until Thursday, when the government is expected to release the results of the bank stress tests it conducted on the 19 largest U.S. banks./p pThe stress-test results are expected to show that the 19 banks may have to raise between $100 billion to $150 billion – or even more – in new capital. Investors will cause the shares of the strong players to zoom northward, and will likely savage the shares of the weakest players./p p#8220;I can’t think of a time since I’ve been watching banks when there’s been so much uncertainty about the true value of a key set of assets,#8221; Douglas Elliott, a fellow at#8230;/p

Controversial Stress Tests Reveal Only One Bank Needs Capital, but Worries Remain

Contrarian Profits — Mon, 27 Apr 2009 18:18:54 +0000

pOnly one of the 19 financial institutions that received a bank stress test would require additional capital, the controversial government initiative has reportedly concluded./p pThe identity of the bank that is alleged to have failed the bank stress test was not revealed./p pThe bank-stress-test findings were reported yesterday (Sunday) by strongemCNBC.com/em/strong, which said it obtained the information from a source that it did not identify. The source did not identify the company, strongemCNBC.com/em/strong reported./p p“At least one firm – under the [bank] stress test assumptions – will require more capital,” the source said./p pThe bank-stress-test results were contained in a two-dozen-page report that the government released Friday. But the results had already been “conveyed” to the firms, a href="http://www.cnbc.com/id/30406330" target="_blank"meaning the bank in question is aware of#8230;/a/p

Earnings Reports Will Play a Key Role This Week

Contrarian Profits — Mon, 20 Apr 2009 15:05:54 +0000

pWhen it comes to the U.S. stock market right now, the story continues to be about earnings. And this week will be no exception./p pstrongBank of America/strong strongCorp. (a href="http://www.google.com/finance?q=NYSE:BAC" target="_blank"BAC/a), /strongwhich reports today (Monday),strong /strongremains among the last financials of note that has yet to announce its first-quarter performance, and the big bank figures to get a lot of attention as investors look to see how well stronga href="http://www.google.com/finance?cid=6586550" target="_blank"Merrill Lynch #38; Co. Inc/a./strong (formerly known as “The Bull”) and stronga href="http://www.google.com/finance?cid=9180917" target="_blank"Countrywide Financial Corp/a/strong. have fit into the BofA family fold./p pstrongInternational Business Machines Corp. (a href="http://www.google.com/finance?q=NYSE:IBM" target="_blank"IBM/a) /strong(today) andstrong Apple Inc. (a href="http://www.google.com/finance?q=NASDAQ:AAPL" target="_blank"AAPL/a) /strong(Wednesday) will give investors a better idea of just how well the tech sector – which up to now has been quite hot – is really doing. strongAmazon.com/strong strongInc./strong (stronga href="http://www.google.com/finance?q=NASDAQ:AMZN" target="_blank"AMZN/a/strong) (Thursday)#8230;/p

As Earnings Season Heats Up, U.S. Banks Will Make or Break the Stock-Market Rally

Contrarian Profits — Mon, 13 Apr 2009 13:03:21 +0000

pCorporate earnings will take center stage again this week as certain financials hope to follow last week’s upbeat announcement by banking giant strongWells Fargo/strong strong#38; Co. (a href="http://www.google.com/finance?q=wfc" target="_blank"WFC/a)/strong with some decent earnings reports of their own. /p pGstrongoldman Sachs/strong strongGroup Inc. (a href="http://www.google.com/finance?q=gs" target="_blank"GS/a)/strong reports tomorrow (Tuesday), while strongJPMorgan Chase/strong strong#38; Co. (a href="http://www.google.com/finance?q=jpm" target="_blank"JPM/a)/strong reports Thursday, and strongCitigroup/strong strongInc (a href="http://www.google.com/finance?q=c" target="_blank"C/a)/strong reports on Friday./p pWhile the chief executives of several of the largest U.S. banks a href="http://www.moneymorning.com/2009/03/10/citigroup-profit/" target="_blank"were quick to announce favorable showings for the first two months of the year/a, analysts are concerned that the strong showings may not have carried over into March, and that the performances of some of these money-centered banks may disappoint./p pContradictions hit the financials last week as diverse reports about strongMorgan Stanley (a href="http://www.google.com/finance?q=ms" target="_blank"MS/a)/strong and Wells Fargo brought even more confusion to a#8230;/p

Fed Minutes Tick Down – Analyst Blog

Dirk Van Dijk — Wed, 08 Apr 2009 22:25:36 +0000

Highlights include General Motors Corp. (GM), Lear Corp. (LEA), TRW Automotive Holdings, Inc. (TRW), Wells Fargo & Co. (WFC) and Fifth Third Bancorp (FITB).

The Federal Reserve released the minutes from its meeting of March 17th and 18th. At the meeting, there was no changer in the Fed Funds rate (it is already effectively at zero and the LAST thing they would consider doing now is raising it), but they did decide to get more aggressive on buying long-term T-notes to expand the money supply (quantitative easing, or as Bernanke is now calling it, "credit easing").

The key "news" was that the staff economic forecasts are more downbeat than they were at the January meeting. Here is a key excerpt from the report:

"In the forecast prepared for the meeting, the staff revised down its outlook for economic activity. The deterioration in labor market conditions was rapid in recent months, with steep job losses across nearly all sectors. Industrial production continued to contract rapidly as firms responded to the falloff in demand and the buildup of some inventory overhangs.

"The incoming data on business spending suggested that business investment in equipment and structures continued to decline. Single-family housing starts had fallen to a post-World War II low in January, and demand for new homes remained weak.

"Both exports and imports retreated significantly in the fourth quarter of last year and appeared headed for comparable declines this quarter. Consumer outlays showed some signs of stabilizing at a low level, with real outlays for goods outside of motor vehicles recording gains in January and February...

"The staff's projections for real GDP in the second half of 2009 and in 2010 were revised down, with real GDP expected to flatten out gradually over the second half of this year and then to expand slowly next year as the stresses in financial markets ease, the effects of fiscal stimulus take hold, inventory adjustments are worked through, and the correction in housing activity comes to an end.

"The weaker trajectory of real output resulted in the projected path of the unemployment rate rising more steeply into early next year before flattening out at a high level over the rest of the year. The staff forecast for overall and core personal consumption expenditures (PCE) inflation over the next two years was revised down slightly. Both core and overall PCE price inflation were expected to be damped by low rates of resource utilization, falling import prices, and easing cost pressures as a result of the sharp net declines in oil and other raw materials prices since last summer."

They don't put a lot of numbers in, but this is the general scenario that I have been writing about for awhile now. We get a very shallow recovery starting in the fourth quarter, but it will still feel very much like a recession. That anemic recovery persists through 2010. Deflation is a bigger immediate threat than inflation (but inflation could be a big problem further out). Unemployment will likely continue rising through at least the middle of 2010, and will most likely hit double digits (on a U-3 or headline basis).

If General Motors (GM) goes bankrupt, it will drag under a slew of suppliers with it, companies like Lear (LEA) and TRW (TRW). This would greatly exacerbate the economic weakness and probably cause unemployment to top 12% -- the highest level of headline unemployment since the Great Depression. When those who can only find part time work or become discouraged are thrown in to the mix, unemployment (U-6) could rise from its current 15.3% to well over 20% in such a scenario.

It seems unlikely that U-3 unemployment will fall below 7% before early 2012. This is both a plausible scenario, and one that is far worse than the "Adverse Case" that the big bank stress tests are based on. The baseline case for the stress tests should be ignored entirely. A worsening economy will only mean more defaults and foreclosures, and more headaches for banks like Wells Fargo (WFC) and Fifth Third (FITB).

Read the full analyst report on "GM"
Read the full analyst report on "LEA"
Read the full analyst report on "TRW"
Read the full analyst report on "WFC"
Read the full analyst report on "FITB"
Zacks Investment Research

As the Economy Worsens, Experts Call for Obama to Focus on the Fundamentals

Contrarian Profits — Mon, 09 Mar 2009 11:30:46 +0000

pIn sports, championship-caliber teams all have at least one characteristic in common: They’re able to focus on the fundamentals. /p pWith the U.S. unemployment rate jumping to its highest level in a quarter century in February, it’s become abundantly clear that that the U.S. recession is much deeper than President Barack Obama anticipated, meaning it’s likely that additional measures will be undertaken to arrest the slide and restart growth./p pMany experts are now calling for the Obama administration to focus on the fundamentals – fundamental economics, that is. They want him to drop some of its ancillary pet projects – such as healthcare reform – and are telling President Obama to focus all his time and the government’s resources on three things:/p ul liArresting#8230;/li/ul

As the Economy Worsens, Experts Call for Obama to Focus on the Fundamentals

William Patalon lll — Mon, 09 Mar 2009 09:41:42 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report In sports, championship-caliber teams all have at least one characteristic in common: They’re able to focus... Money Morning is here to help investors profit h...

Soros, Latest to Predict the Worst is Yet to Come

Contrarian Profits — Mon, 23 Feb 2009 11:30:27 +0000

pRenowned investor a href="http://www.reuters.com/article/newsOne/idUSTRE51K0A920090221" target="_blank"George Soros said Friday the world financial system has effectively disintegrated/a, and there’s no near-term bottom to this financial crisis in sight./p pSpeaking at a dinner at Columbia University, Soros actually compared the current situation to the breakup of the Soviet Union, and said that the whipsaw effects of the crisis are actually more severe than the Great Depression./p p#8220;We witnessed the collapse of the financial system,#8221; Soros told his audience. “It was placed on life support, and it’s still on life support. There’s no sign that we are anywhere near a bottom.#8221;/p pHe said the bankruptcy of. strongLehman Brothers Holdings Inc. (OTC: a href="http://www.google.com/finance?q=OTC%3ALEHMQ" target="_blank"LEHMQ/a)/strong in September marked a turning point in the functioning of the market system./p pHis comments echoed those made earlier#8230;/p

Obama Administration Kicks the “Car Czar” to the Curb

Contrarian Profits — Tue, 17 Feb 2009 14:32:48 +0000

pU.S. President Barack Obama has decided against naming a #8220;car czar,#8221; and is instead asking U.S. Treasury Secretary Timothy F. Geithner and White House economic adviser a href="http://en.wikipedia.org/wiki/Lawrence_Summers" target="_blank"Lawrence H. #8220;Larry#8221; Summers/a to head a task force on revamping the U.S. auto industry, strongemBloomberg News/em/strong reported yesterday (Monday)./p pThe president was under pressure to say who would handle the issue before tomorrow, when strongGeneral Motors Corp. (a href="http://www.google.com/finance?q=NYSE:GM" target="_blank"GM/a)/strong and stronga href="http://www.google.com/finance?cid=4090940" target="_blank"Chrysler LLC/a/strong must give progress reports on plans to restructure as a condition of $17.4 billion in U.S. Treasury loans. The so-called car czar - an approach that had some support in the American auto industry - was viewed as a a href="http://www.moneymorning.com/2008/12/08/big-three-bailout-2/" target="_blank"key move in the federal government’s push to revamp the U.S. auto industry/a. The task force puts an#8230;/p

New-Look Bank Bailout Plan Set to Debut this Week

Contrarian Profits — Mon, 09 Feb 2009 18:22:52 +0000

pAs the worst financial crisis since the Great Depression continues to worsen, decades of deregulation and the growing independence at the state level are being reversed as a deteriorating national economy forces the federal government to increasingly take on responsibilities that no other institution has the power or resources to handle./p pThis dismantling of the so-called “a href="http://en.wikipedia.org/wiki/New_Federalism" target="_blank"New Federalism/a” will be readily apparent again this week as the federal government is once again at the forefront of the most-closely watched crisis-fighting initiatives at hand: With Congress pushing forward on an $827 billion stimulus plan and the Treasury Department a href="http://www.bloomberg.com/apps/news?pid=20601103#38;sid=ag2bBDsXHd0M#38;refer=us" target="_blank"planning to unveil its new banking bailout blueprint on Tuesday/a, economists and other experts say the federal government is taking its biggest role in#8230;/p

Is Washington Replacing Wall Street as the City That Drives America?

Contrarian Profits — Mon, 02 Feb 2009 18:21:12 +0000

pIs Washington replacing New York – and more specifically, Wall Street – as the city that drives America?/p pThe question, a href="http://www.reuters.com/article/newsOne/idUSTRE50T6R820090130" target="_blank"raised in a new strongemReuters/em/strong piece/a, is certainly a good one – and a fair one./p pAs the United States suffers through perhaps its worst financial crisis ever – a crisis caused by the combination of rampant greed and some ill-conceived financial engineering – Wall Street’s reputation has been badly tarnished, perhaps forever./p pMoving forward, two results will be a tightening of financial regulation and an increase in government control of the financial markets. We’ll also end up with a federal government that more closely controls – and in some cases owns stakes in – banks and other financial institutions, a move that some#8230;/p

Fed: Rates Unchanged, Lacker Dissents – Analyst Blog

Charles Rotblut — Wed, 28 Jan 2009 14:42:31 +0000

Highlighted stocks include (FITB), Zions Bancorp (ZION), S&P 500 (SPX), Abbott Laboratories (ABT) and Wells Fargo (WFC).

Though the target for the Fed Funds rate was unchanged, there was a surprise in today's statement - Richmond Fed President Jeffery Lacker's dissenting vote.

The Fed voted to expand its program to buy debt-related securities. Rather than just buy agency debt and mortgage-backed securities, the central bank is also prepared to purchase longer-term treasuries. The expansion of the central bank's balance sheet was widely expected.

Jeffrey Lacker dissented from the majority by expressing his preference to directly purchase U.S. Treasury securities rather than rely on targeted credit programs.

Lacker's dissent shows that though Bernanke is clearly trying to stabilize the credit markets, he clearly does not have all the answers. To be fair, some of Bernanke's earlier actions have been muddled by the mishandling of TARP.

There was also deflation talk: "The Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term."

Stocks rallied strongly ahead of the meeting and seem to be holding onto their gains in the minutes after the statement was released. Some of the upward move is no doubt the result of short-covering.

Though Fifth Third Bancorp (FITB) and Zions Bancorp (ZION) are among the best-performing stocks within the S&P 500 (SPX) today, optimism that the government will come to a company's rescue is never a good reason for buying a stock.

Prudent investors would better to remain conservative and look for stocks that are likely to raise their dividends in the future, not merely maintain it. Think Abbott Laboratories (ABT), not Wells Fargo (WFC).

Today's statement is can be viewed on the Federal Reserve's web site: http://www.federalreserve.gov/newsevents/press/monetary/20090128a.htm

Read the full analyst report on FITB

Read the full analyst report on ZION

Read the full analyst report on ABT

Read the full analyst report on WFC

"FITB" Free Stock Analysis: Buy? Sell? Hold?
"ZION" Free Stock Analysis: Buy? Sell? Hold?
"SPX" Free Stock Analysis: Buy? Sell? Hold?
"ABT" Free Stock Analysis: Buy? Sell? Hold?
"WFC" Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

Fed Counts Bullets, Earnings Dominate Calendar

Christian Hill — Mon, 26 Jan 2009 18:11:02 +0000

pThere is a full economic calendar this week, but all eyes will be on the two-day FOMC meeting and the rate decision on Wednesday./p pIt will be interesting to see how the FOMC approaches this meeting. The current Fed Funds target rate is 0-0.25%, which in and of itself is rather strange. It is a moving target, not a fixed rate. Who determines which rate is used? My guess is this meeting will be used to clarify what the rate is. The Fed will either officially reduce it to 0% in a continued effort to resuscitate the economy, or lock it in at 0.25%. This would at least leave the Fed with one perceived bullet in the gun./p pThe rest of the#8230;/p

Financial Crisis Challenges Escalate as Republicans Announce Plans to Oppose $825 Billion Obama Stimulus

William Patalon lll — Mon, 26 Jan 2009 10:30:23 +0000

William Patalon III Executive Editor Money Morning/The Money Map Report President Barack Obama’s $825 billion stimulus plan heads to the floor of the House of Representatives this... Money Morning is here to help investors profit han...

Could Tax Problems Trip up the Confirmation of the Best Candidate for Treasury Secretary?

Contrarian Profits — Mon, 19 Jan 2009 16:45:08 +0000

pAfter a two-day “holiday” to start the week–Martin Luther King Day today (Monday) and Inauguration Day tomorrow (Tuesday)–it’ll be back to business on Wednesday as Congress begins to grill U.S. Treasury Secretary nominee Timothy Geithner – the appointment many observers believe to be the most important of the new Barack Obama administration./p pa href="http://www.moneymorning.com/2008/11/24/timothy-f-geithner/" target="_blank"Geithner/a, currently the president of the Federal Reserve Bank of New York, is viewed by Democrats and Republicans alike as probably the most qualified candidate to succeed current Treasury Secretary a href="http://en.wikipedia.org/wiki/Henry_Paulson" target="_blank"Henry M. “Hank” Paulson Jr.,/a since whoever fills this post will have to be able to step right in and make whatever moves are needed to fix a financial system that seems to get worse by the week. Geithner is#8230;/p

Deflation? – Analyst Blog

Dirk Van Dijk — Thu, 15 Jan 2009 10:33:03 +0000

This morning's Producer Price Index (PPI) release is additional evidence that we are on the cusp of deflation. This is a remarkable turnaround from just a few months ago. In December the Producer Price index fell by 1.9%, following a 2.2% decline in November. It was the fifth straight month of declines.

On a year-over-year basis, producer prices are now down 0.9%, a dramatic decline from its up 9.9% peak in July. Things are not quite so dramatic once you strip out food and energy prices to get to the core PPI. It rose 0.2% in December after a 0.1% rise in November. In December, Food prices were down 1.5%. However, the real story was the continuing decline in energy prices, which fell 9.3% in December following declines of 11.2% in November and 12.8% in October.

All of these numbers refer to the prices of finished goods, but the numbers are released for three levels, Finished (bread), Intermediate (flour) and Crude (wheat). The price declines get more dramatic as you go farther back in the production chain. Intermediate goods prices fell 4.2% in December following declines of 4.3% in November and a 3.9% decline in October.

Crude goods fell even further, but the rate of decline is slowing markedly, down 5.3% in December vs. a 12.5% decline in November and a 18.6% decline in October. Trends in the lower levels of production do eventually tend to bleed through to the finished goods level, but they are almost always more volatile.

Tomorrow we will see if deflation has yet reared its head at the Consumer Price (CPI) level. Most Central Bankers and Economists really do not like deflation, and see the ideal situation to be very low and stable positive inflation, between 1% and 2%.

Since interest rates can not decline below zero (at least for any significant amount of time -- we have actually seen negative rates on the 3 month T-bill recently, but that is just plain weird and a sign of extreme distress in the financial markets) falling prices raises real interest rates and the traditional tools of Central bankers (changing short term interest rates) do not work very well.

Deflation also tends to slow economic activity. Think about is as a bear market in the market for goods and services. When the markets are falling fast, many investors don't want to "catch falling knives." They say, "Sure XYZ Corp. looks cheap here, but why should I buy it at $20 a share when it looks like it could go much lower?"

Falling prices in the real economy tends to induce the same sort of behavior. Why buy a car now if you think that the car companies are going to come out with even bigger rebates in the near future?

This further slows the velocity of money. Remember, nominal GDP is equal to the money supply times the velocity of money. Falling velocity is a VERY serious problem. Central banks then have to offset this by increasing the money supply, but the traditional way of doing that involves cutting short-term rates, like the Fed Funds rate.

However, it is impossible to cut rates if they are already at zero. Thus, Central Banks have to resort to more "creative" ways of increasing the money supply, and that usually involves the Central Bank taking on more risk, either buying non-government paper or buying longer dated securities.

The Fed has already started going down that path.

Zacks Investment Research

The Dollar Swings A Mighty Hammer!

Contrarian Profits — Wed, 14 Jan 2009 16:12:35 +0000

pAnother dollar rally#8230;. Rumors in Ireland#8230; Trade Deficit narrows#8230; Retail Sales to disappoint? And Now#8230; Today#8217;s Pfennig!br / The dollar ripped through the 1.32 handle of the euro yesterday, like a hot knife goes through butter! There was little to no resistance in that 1.32 handle, and before you could tell one of the many people on the desk here that sneeze all day, God Bless you, we were trading with a 1.31 handle in euros. The talk about a European Central Bank (ECB) rate cut has really ramped up this week, and taken its toll on the single unit. No one is mentioning that even if the ECB cuts 75 BPS this week, they#8217;ll still have a an interest rate /#8230;/p

Obama Stimulus Will be Topic of Debate Through Inauguration

Contrarian Profits — Mon, 12 Jan 2009 14:00:08 +0000

pPresident-elect Barack Obama said Saturday that an analysis of his stimulus proposal found that the capital infusion could save or create as many as 4 million U.S. jobs by 2010, nearly 90% of them in the private sector. /p pObama previously estimated that his estimated $800 billion strategy for winching the American economy out of its year-long recession could save or create 3 million jobs, but the new study has found that the actual number would range between 3 million and 4 million./p pThe analysis was submitted by Christina Romer, head of Obama’s council of economic advisors, and Jared Bernstein, the economic advisor to Vice President-elect Joe Biden. The analysis directly follows an official government report showing that U.S. employers slashed more#8230;/p

The U.S. Dollar: A Federal Reserve Thingy

Contrarian Profits — Thu, 08 Jan 2009 19:15:32 +0000

pAnd this, together with the economic disaster that is already out there, only proves the utter, utter failure of the Federal Reserve to #8216;preserve the value of the dollar#8217;, which is their freaking mission in life. Morons!/p pThe front of a recent issue of Barron#8217;s asks, #8220;Are Treasury Bonds Safe?#8221; which is actually a really stupid question since every doofus knows that Treasury bonds are perfectly safe because a fiat currency and a lapdog Federal Reserve means that they can print up all the money the Treasury needs with which to pay bondholders!/p pSo… Safe? Hell yes they are safe! You#8217;d think that Barron#8217;s would know that! Jeez! If I had been there at Barron#8217;s, I would have suggested using this week#8217;s#8230;/p

Obama Stimulus and January Effect, this Week’s Top Stories

Contrarian Profits — Mon, 05 Jan 2009 16:20:48 +0000

pPresident-elect Barack Obama’s transition team is reportedly putting the finishing touches on an economic recovery plan that could run from $675 billion to $1 trillion, though many experts believe the program will most like range between $700 billion and $800 billion./p pBriefings for top congressional Democrats were to start either over the weekend or today (Monday), a senior transition-team official told strongemThe Associated Press/em/strong late last week. President-elect Obama is slated to meet today with House Speaker Nancy Pelosi, D-Calif., and Senate Majority Leader Harry Reid, D-Nev., in a Democratic strategy session that is likely to focus on the a href="http://www.moneymorning.com/2008/12/18/economic-stimulus/" target="_blank"economic recovery package/a./p pIt’s time to look forward, not back.strongem /em/strongThe 111th Congress meets tomorrow (Tuesday), and a comprehensive economic stimulus package is at the#8230;/p

U.S. Economy in 2009, Pain Will Precede the Promise

Shah Gilani — Mon, 29 Dec 2008 15:15:51 +0000

pIf there’s a proverb that captures the outlook for the U.S. economy in the New Year, it’s the one that says: “It’s always darkest before the dawn.”/p pRegardless of any formal announcement of whether or not the United States drops into an actual recession, the ongoing credit crisis guarantees a contraction of the American economy by virtually every measure we know. That period of darkness will be marked by a dramatic slowdown in economic activity, as well as by rising unemployment, additional declines in U.S. stock prices, and constant volatility. It could last as long as 12-18 months./p pBut when the dawn does come, it will be one to remember. If U.S. President-elect Barack Obama gets it right - and I have#8230;/p

Why Shorting Treasury Bonds Might Just Be Too Obvious

Justice Litle — Tue, 23 Dec 2008 18:49:37 +0000

pUS Treasuries are in a bubble, making them ripe for shorting. But that trade is too obvious, saysstrong Justice Litle/strong. And the situation is more complex now that the Fed is getting involved. Bernanke #38; Co could support T-Bills in the medium term, but that will only increase the odds of an epic decline after./p pThis from a href="http://www.taipanpublishing.com" class="alinks_links"Taipan/a Daily:/p blockquotepU.S. Treasuries look so lousy here that shorting them has become the “obvious” trade. But there is more to this mystery than meets the eye, as Justice explores#8230;/p pJim Grant nailed it in a recent emFinancial Times/em piece. Known for their “risk-free return” in more normal times, Grant observes that U.S. Treasuries (or USTs for short) now offer “return-free risk.”/p pTreasury buyers, in other words, choose to lend#8230;/p/blockquote

House Prices, Stocks and Inflation

Matt Hougan — Fri, 19 Dec 2008 00:06:10 +0000

I'm glad you've seen the light, Jim.

It takes a big man to admit when he is wrong, and to yield to the wisdom of a younger generation.

Since you asked so nicely what I see in my great crystal ball, I'll tell you. But first, a clarification:

I didn't say that oil would fall to $25/barrel. I said that it could, and that it was nearly as likely to fall to $25/barrel as it was to go back to $100/barrel. I still think that's true, and with oil trading at $38.77/barrel, the market seems to agree.

Looking forward, I'll reiterate my other comment from before: I think the Dow will see 10,000 before it sees 6,000. I think that the direction and size of the fiscal stimulus is overwhelming right now, and that Helicopter Ben and his compadres at other central banks around the world will succeed in restarting economic growth in 2009.

Speaking of which ... you mentioned the stunning fact that the Federal Reserve has cut interest rates to a range of 0%-0.25%, which of course brings to mind the eerie parallel of Japan and its lost decade. Bob Eisenbeis over at Cumberland Advisors has the best analysis of the Fed's maneuver that I've seen. Eisenbeis points out that the Fed's action merely brings official policy in line with what was already happening in the market, noting that the effective Fed Funds rate hasn't been above 20 basis points since December 4. He has some great thoughts on what the rate cut really means for Fed policy in coming months and years, and how the Fed will control liquidity now that its rate-cutting quiver is out of arrows.

Of course, there is a piper who must be paid for all this liquidity, eventually. That payment may come in the form of inflation, a continued deterioration of the dollar or weaker economic growth ... it may come in all three guises ... but we can be sure it will come.

One more crystal ball thought: We are getting much, much closer to the bottom in housing prices. Local banks in my area are now offering 30-year mortgages at 4.875%. That's down from 6.25% a year ago. That will chop about 15% off a homeowner's monthly payment. I'm guessing that, coupled with falling values over the last few years, that will be enough to put in a bottom for prices in most locations.

Now to turn back to something I actually know something about...

As I reported this morning on Twitter (follow me as ETF_Twitter), I've been looking recently at one exchange-traded product in particular: the ELEMENTS S&P Commodity Trends Indicator ETN (NYSEArca: LSC). This has to be the most underreported ETP story of the past year.

LSC is a commodity futures index fund, similar in some ways to funds like the PowerShares DB Commodity Index Fund (NYSEArca: DBC). Except unlike DBC, which is down 35.93% over the past three months, LSC is up 23.78%.

That would make sense if LSC were an inverse fund, but it's not. Instead, LSC follows a long/short strategy based on momentum trends in the commodity markets. Recently, it's been short, which has paid off handsomely. What's nice is that, unlike an inverse fund, should the market reverse course, LSC should eventually abandon its shorts and adopt a long policy.

I'm generally not a fan of gimmicky ETFs and ETPs, but the commodities market is not like the equity or bonds markets, and this is a situation where a long/short strategy might make sense.

Fed Brings Rates Down to Near Zero

Contrarian Profits — Wed, 17 Dec 2008 16:08:15 +0000

pThe Fed fires its last bullet#8230; Euro breaks back above $1.40#8230; AUD and NZD rally#8230; And Now#8230; Today#8217;s Pfennig!Good day#8230; The #8216;noise#8217; from the street which I wrote about yesterday turned out to be correct, as the FOMC cut 75 basis points to put the Fed Funds target at .25%. The US now has the lowest interest rates in the industrialized world, even below those in Japan. The dollar lost ground quickly after the announcement and continued to fall overnight to a 13 year low vs the yen and the weakest vs. the Euro in 4 months./p pWith both Chuck and Frank out of the office, I fielded the calls from reporters after the FOMC cut, and the most popular question#8230;/p

Fed Slashes Interest Rates, but Now What?

Contrarian Profits — Wed, 17 Dec 2008 13:40:00 +0000

pAs expected, U.S. Federal Reserve policymakers slashed a benchmark interest rate yesterday (Tuesday). But they cut it by a bigger-than-expected amount, and did so in an unconventional manner./p pInstead of establishing a new, specific primary interest rate, the central bank’s Federal Open Market Committee (FOMC) voted for a target range – 0.0% to 0.25% – a record low. Before yesterday’s cut, the Federal Funds target rate stood at 1.0%./p pInstead of addressing the reason for its peculiar target range, the Federal Reserve opted for canned doomsday language that could have appeared verbatim in any of its previous rate cut announcements: It hasn’t been good. It doesn’t look good. And we’re trying to fix it./p pMost cryptically, the FOMC said it “will employ all#8230;/p

Santa Rally for the Currencies

Contrarian Profits — Tue, 16 Dec 2008 15:57:09 +0000

pA Santa Rally for the currencies?#8230; Waiting for the FOMC#8230; AUD and NZD rally#8230; China to try and keep growth above 8%#8230; And Now#8230; Today#8217;s Pfennig!/p pGood day#8230;It was actually a Great day for the currencies yesterday as the dollar index dropped another full point. The Euro moved past $1.35 and then blew through $1.36 to end the day over $1.37. And the Euro wasn#8217;t even the best performer, as the New Zealand dollar rallied over 2.1% vs. the US$ to take the title of best performing currency against the greenback. The South African rand was the only currency turning in a negative performance yesterday with the other commodity driven currencies of Norway and Brazil just barely holding their ground vs.#8230;/p

FOMC Statement Highlights The Week … Will The Fed Be Left With One Bullet?

Christian Hill — Mon, 15 Dec 2008 16:14:16 +0000

pWell we have made it to the end of another year, and this one has been quite a ride. This is the last full trading week of the year, so barring a huge rally, the Dow, NASDAQ, and S#38;P will all end the year with losses north of 30 percent./p pWith that being said, the calendar this week is full of some important reports that could set the tone for the early part of next year./p pOn Tuesday, the Building Permits report for November is released, and is anticipated to show only a slight decline of around 8k units. I am not sure if this is simply due to the seasonal slowdown of building in northern climates, or if perhaps builders have#8230;/p

Fed May Cut Rates Again as Policymakers Meet

Contrarian Profits — Mon, 15 Dec 2008 12:31:38 +0000

pAfter U.S. Federal Reserve policymakers meet today (Monday) and tomorrow (Tuesday), most experts expect a half a percentage point cut in the benchmark Federal Funds Rate – which is already 1.0%./p pThat doesn’t leave members of the central bank’s policymaking Federal Open Market Committee (FOMC) a href="http://www.moneymorning.com/2008/12/08/fed-rate-cut-2/" target="_blank"much room to maneuver/a. Still, the policymakers may have more ammunition in their arsenal and the statement that accompanies the rate decision at the end of the two-day session could shed some insight on the “creative” actions the Fed could consider in addition to rate cuts (For instance, the central bank could extend the new investment firm discount window, offer additional loan guarantees, or utilize any number of other tools)./p pAnd the Fed may well have to#8230;/p

Fed May Cut Rates Again as Policymakers Meet

William Patalon lll — Mon, 15 Dec 2008 10:30:34 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report After U.S. Federal Reserve policymakers meet today (Monday) and tomorrow (Tuesday), most experts expect a half a... Money Morning is here to help investors profit han...

Spending More Money

Contrarian Profits — Tue, 09 Dec 2008 20:19:34 +0000

pTurn back the clocks to 1950#8230; Currencies rally on the day#8230; Bank of Canada to cut rates today#8230;br / Fed Funds to zero? And Now#8230; Today#8217;s Pfennig!br / Well#8230; It looks like the new president wants to spend more money#8230; Yes, President-elect Obama, presented his economic plan yesterday, and before doing so, issued a warning that the economy is going to get a lot worse before it gets better. His plan calls for a pledge to spend the most on infrastructure since the 1950#8217;s#8230; Now, let me say this#8230; The Big Boss, Frank Trotter, and I talk about this all the time#8230; To spend money on Financial Institutions and things that don#8217;t get used more than once like bullets and bombs, isn#8217;t our #8220;fave#8221;#8230;/p

Fed Looking at Another Rate Cut, While Treasury Has New Plan for Housing

Contrarian Profits — Mon, 08 Dec 2008 13:01:56 +0000

pWith the benchmark Federal Funds rate already down to 1.0%, U.S. Federal Reserve Chairman Ben. S. Bernanke has only so much room for another cut (although many economists are predicting an additional half-percentage-point cut at the Dec.15-16 meeting)./p pThe Fed extended the lives of recently initiated programs (lending facilities for investment firms, for instance) and is exploring additional moves (like Treasury purchases) aimed at reviving the credit markets. Bernanke believes more needs to be done to slow the pace of foreclosures, especially since they jumped another 10% in September./p pMeanwhile, the U.S. Treasury Department is working on a plan to rejuvenate the housing market by slashing mortgage rates to 4.5% on new purchases. Experts say that at some point these stimuli must#8230;/p

U.S. Economic Outlook for 2009

Shah Gilani — Mon, 24 Nov 2008 12:51:04 +0000

pIf there’s a proverb that captures the outlook for the U.S. economy in the New Year, it’s the one that says: #8220;It’s always darkest before the dawn.#8221;/p pRegardless of any formal announcement of whether or not the United States drops into an actual recession, the ongoing credit crisis guarantees a contraction of the American economy by virtually every measure we know. That period of darkness will be marked by a dramatic slowdown in economic activity, as well as by rising unemployment, additional declines in U.S. stock prices, and constant volatility. a href="http://www.oxfonline.com/MMR/MMR0708deck.html?pub=MMR#38;code=WMMRJB05"And it could last as long as 12-18 months./a/p pBut when the dawn does come, it will be one to remember. If U.S. President-elect Barack Obama gets it right - and I#8230;/p

A Greater Depression?

Contrarian Profits — Mon, 17 Nov 2008 14:11:33 +0000

The record drop in consumer spending in October is clear evidence of a profound weakening of the US economy. Even President Bush think thinks the situation is bad. At the G20 summit over the weekend, he said it was conceivable that the US “could go into a depression greater than the Great Depression“.

- Of course a depression is what they used to call a recession. Then came the Great Depression. After that, economists and politicians stopped using the word for fear of jinxing the economy. Now, a depression means a severe and protracted recession.

- Bush may be right about the chances of the US slumping into a depression. Part of the problem is that it’s not only the US that’s…

U.S. Automakers, Freddie Mac (FRE) and Foreign Exporters Next in Line for Bailout Handouts

Contrarian Profits — Mon, 17 Nov 2008 13:02:19 +0000

This week is shaping up to be another active one on the bailout-and-financing front. First and foremost, Congress returns to work this week to consider a once-unthinkable proposal: Put up billions in taxpayer-backed loans so that Detroit’s “Big Three” can be saved. Expect a fight, however, as the bailout debate finally moves past banks to focus on General Motors Corp. (GM), Ford Motor Co. (F), and Chrysler Corp.

The situation is dire. GM is burning through cash at a pace that could mean bankruptcy, and all three players are struggling with high costs, weak vehicle sales, frozen credit lines and dwindling cash reserves calling into question whether they can survive much longer without government help. The answer, of course, is that…

The Consumption Path under Certain Assumptions: Back of the Envelope Calculations

Menzie Chinn — Thu, 13 Nov 2008 18:03:20 +0000

Suppose by 2009Q4, GDP is 0.13% below 2008Q3 levels, real equity wealth is 35.2% below end-June levels, and real nonequity wealth is 6% below end-June levels. Further assume that the real Fed Funds rate remains at 2008Q3 levels (-2.45%). Then, the conditional estimate of 2009Q4 consumption will be 2.16% below 2008Q3 levels. This implies a 3% y/y decline in consumption by 09Q3; the only comparable instance of such a decline is 1951Q3, when consumption declined y/y by 2.3% (all percent calculations in log terms).

Figure 1 depicts the path of consumption under these assumptions, and using error correction models for durables and nondurables consumption, and a VAR in first differences for services consumption.

Figure 1: Log real total consumption (blue) and log sum of forecasted consumption components (red), in Ch.2000$, SAAR. NBER defined recession dates shaded gray. Dashed line indicates beginning of forecast period. Source: BEA, NIPA release of 30 October, NBER, and author's calculations.

Note that I have taken the expedient of adding together the chained spending series (in Chained 2000$) even though chained series do not obey additivity constraints (see [1]). This shortcut does not appear to do too much violence to the data, as illustrated by the small gap between the blue and red lines.

Here are the disaggregated real consumption levels, in Ch.2000$.

Figure 2: Real durables consumption (dark blue) nondurables consumption (pink) and services consumption (dark green), in Ch.2000$, SAAR. NBER defined recession dates shaded gray. Dashed line indicates beginning of forecast period. Source: BEA, NIPA release of 30 October, NBER, and author's calculations.

The assumptions I've made for the explanatory variables are shown below.

Figure 3: Log real GDP (dark blue), log real non-equity wealth (pink), and log real equity wealth (black), and alternate log real equity wealth (teal), in Ch.2000$, SAAR. NBER defined recession dates shaded gray. Dashed line indicates beginning of forecast period. Wealth variables deflated by consumption expenditure deflator. Non-equity wealth and equity wealth calculated using flow of funds data as in Carroll, Otsuka, Slacalek (2006). Source: BEA, NIPA release of 30 October, Federal Reserve Board Flow of Funds, NBER, and author's calculations.

The trajectories displayed above assume: (i) equity wealth move with S&P500, and hold constant at Nov. 11 levels in real terms from 2008Q3 onward; (ii) real nonequity wealth declines at 1% per quarter (in log terms) from 2008Q2 onward. This compares with a 2.3% per annum decline for the two years following the 1990-91 recession. The GDP forecast is from the October 17, 2008 Deutsche Bank forecast (shown here).

The equations used are estimated over the 1969Q1-08Q3 period. They are:

Durables

Δc_dur_t = -1.49 - 0.18 (c_dur_t-1) + 0.14 (y_t-1) - 0.33 r _t-1 + 0.04 we _t-1 + 0.10 wn _t-1 + three lags of first differences + u _t

Adj.R² = 0.25, N=159, SER = 0.027, DW = 2.05; bold face denotes significant at 10% msl. we is equity wealth, wn is non-equity wealth.

Long run income elasticity: 0.78.
Long run interest semi-elasticity: -1.81.
Long run equity wealth elasticity: 0.23.

Nondurables

Δc_ndur _t = 0.006 - 0.07 (c_ndur _t-1) + 0.03 (y _t-1) - 0.05 r _t-1 + 0.006 we _t-1 + 0.10 wn _t-1 + three lags of first differences + u _t

Adj.R² = 0.20, N=159, SER = 0.006, DW = 1.86

Long run income elasticity: 0.43 (significant at 20% levels).
Long run interest semi-elasticity: -0.81.
Long run equity wealth elasticity: 0.09 (significant at 20% levels).
Long run nonequity wealth elasticity: 0.28 (significant at 20% levels).

Services

Δc_svcs _t = 0.028 - 0.003 (c_svcs _t-1) + 0.20 ( Δ c_svcs _t-1) + 0.07 Δ(y _t-1) - 0.14 ( Δ r _t-1) - 0.09 ( Δ r _t-3) + 0.036 ( Δ networth _t-1) + 0.030 ( Δ networth _t-3) + other nonsignificant lags of first differences + u _t

Adj.R² = 0.28, N=159, SER = 0.0036, DW = 2.06

Short run income elasticity: 0.35.
Short run interest semi-elasticity: 1.18.
Short run net worth elasticity: 0.44.

This projection would place the log ratio of consumption to GDP in 2009Q4 at the same levels that it was in 2000.

Time for (lots of) caveats:

The estimated coefficients are sensitive to the selection of specifications. I have searched for error correction model (ECM) specifications with 3 lags of first differences and a common set of determinants (income, household equity and household non-equity wealth, real interest rate). Three lags of first differences are consistent with 4 lags of the VAR representation of the VECM. I checked to see if the residuals then exhibited serial correlation. (Note Carroll et al. (2001) argues that the ECM approach is not appropriate.).
I did not adopt a formal general-to-specific modeling methodology. Variables with non-significant coefficients were retained. Additional searching would surely lead to other plausible specifications.
The coefficient estimates are sensitive to specification. However, I think the long run elasticities reported above are not implausible (although I am willing to be corrected). For instance, Alexander and Slok (2001) report for total consumption a long run equity wealth elasticity of 0.08, and 0.04 for housing wealth. While the corresponding long run elasticities are higher in the above specifications, it's important to recall that in particular durables is a small share of consumption total (10%), while nondurables is about 30%. Services, with no estimated long elasticity, constitutes the remaining 60% of consumption.
I could not obtain an ECM specification for services consumption that incorporates long run effects income, net worth, and real interest rates.
I did not include the relative price of durables in the durables consumption equation. This is true even though the variable shows up as significant, and exhibits a definite trend ([1]), because incorporating it into the projection would require taking a stand on the future trajectory of yet another variable.
The projection are sensitive to the assumptions regarding the path of the exogenous (for purposes of the simulation) variables.

Returning to this last point, consider what happens if I assume the household equity wealth returns to 2008Q1 levels (as shown in the teal line in Figure 3).

Figure 4: Log real total consumption (blue), log sum of forecasted consumption components under baseline (red), and log sum of forecasted consumption components when real household equity wealth rebounds to 2008Q1 levels (green), in Ch.2000$, SAAR. NBER defined recession dates shaded gray. Dashed line indicates beginning of forecast period. Source: BEA, NIPA release of 30 October, NBER, and author's calculations.

The consumption decline (as shown in the green line) is much less marked.

This leads me to my key take-away. Don't think of the above as so much a forecast as a projection conditional upon a number of assumptions, where I'm sure some readers will take them as either too optimistic or too pessimistice. From my perspective, the main point is one's projection of consumption's path will depend in large part on the path for equity (and non-equity) household wealth.

How This Crisis Could Make You A Fortune

Shah Gilani — Mon, 10 Nov 2008 15:19:21 +0000

By all reasonable measures, we are already in a recession, says Shah Gilani. Deflation has become today’s number one threat. But massive government rescues mean another bout of inflation looms on the horizon. Shah says investors should look to short vulnerable stocks in 2009. But in 12-18 months, they should be prepared for a “generational opportunity” to make a fortune.

This from Money Morning:

If there’s a proverb that captures the outlook for the U.S. economy in the New Year, it’s the one that says: “It’s always darkest before the dawn.”

Regardless of any formal announcement of whether or not the United States drops into an actual recession, the ongoing credit crisis guarantees a contraction of the American economy by virtually every measure…

China Stimulus, Troublesome Retail Earnings, Global Economic Woes

Contrarian Profits — Mon, 10 Nov 2008 12:23:58 +0000

China unveiled yesterday (Sunday) what it described as a “massive” economic stimulus package – a planned capital infusion of $586 billion that it plans to use to reverse its slowing growth, to loosen credit and to offset slowing global growth by stoking domestic demand.

Xinhua, China’s state-run news agency, said yesterday that the stimulus package represents “a shift long advocated by analysts of the Chinese economy and by some within the government. It comes amid indications that economic growth, exports and various industries are slowing.”

The decision was announced yesterday by the State Council after Premier Wen Jiabao presided over an executive meeting Wednesday. China reported in late October that its economy grew at a less-than-expected rate of 9% in the third…

China Stimulus, Troublesome Retail Earnings Point to Escalating Global Economic Woes

William Patalon lll — Mon, 10 Nov 2008 08:00:37 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report China unveiled yesterday (Sunday) what it described as a “massive” economic stimulus package – a... Money Morning is here to help investors profit ha...

For the U.S. Economy in the New Year, the Pain Will Precede the Promise

Shah Gilani — Mon, 10 Nov 2008 06:00:06 +0000

[Editor’s Note: This is the second installment of a new series that looks at the global investing outlook for 2009.] By Shah Gilani Contributing Editor Money Morning/The Money Map... Money Morning is here to help investors profit handso...

Uncertainty Escalates as Tomorrow’s Presidential Election Looms

Contrarian Profits — Mon, 03 Nov 2008 18:45:56 +0000

Come Wednesday morning – after the presidential election tomorrow (Tuesday) – the United States will have a new commander-in-chief. The president-elect will face some significant challenges: A weak economy (okay, a recession, given last week’s gross domestic product (GDP) report, which confirmed just how dire the country’s economic situation had become).

While this week’s data from the manufacturing and housing sectors will be eagerly anticipated, nothing compares to Friday’s reports on unemployment and the picture of the ailing labor market. After nine consecutive months of job contraction, few analysts hold out much hope for optimism. In fact, some believe the jobless rate will climb to 7.5% during 2009.

Clearly the new president will have some major problems to solve, perhaps the biggest…

Fed Cut Funds Rate to 1%

Contrarian Profits — Thu, 30 Oct 2008 13:44:31 +0000

Fed cuts rates 50 BPS!… Currencies rally Big!… 3rd QTR GDP to go negative?… I.O.U.S.A. … And Now… Today’s Pfennig!

Good day… And a Tub Thumpin’ Thursday to you! It certainly was a Tub Thumpin’ Wednesday for the currencies, foreign stocks, commodities, and the Philadelphia Phillies! This by no means that the deep dense fog that has hung over the markets for 3 months has lifted for good… It did, however, lift for one day, and what a day it was!

Oh, and the Fed did indeedly do cut their Fed Funds rate to 1%, which works out great since Fed Funds had been trading at 1% anyway! I had a reported from Dow Jones call me a few minutes after the…

Feds Cut Interest Rates By One Half Percent

Daniel Shepard — Wed, 29 Oct 2008 18:34:52 +0000

Wednesday October 29, 2008 Navivest The Federal Open Market Committee of the Federal Reserve, decided today to cut its target for the federal funds rate 50 basis points to 1 percent. The federal funds rate is the key bench mark interest rate in the U.S. and is also the interest rate that banks charge each other on overnight [...]

Links and More for Wednesday

Sean Brodrick — Wed, 29 Oct 2008 16:27:21 +0000

Our remaining short positions got cleaned out yesterday and this morning (ouch!) and now the market is waiting with bated breath to see if the Federal Reserve cuts the Fed Funds rate by 50 basis points (expected) or more or less (really not expected).

There are several technical — and temporary — reasons the major indices rallied hard yesterday. Traders seemed to anticipate a large cut to the Fed Funds rate today. The market was technically oversold. Governments everywhere are riding to the rescue on a flood of liquidity. And the yen carry trade (when traders borrow in low-interest yen to buy speculative assets) had been unwinding in a hurry, but that seems to have temporarily reversed, thanks to Japanese government intervention.

We could see more of a rally in the short-term, but fundamentals need to change to get the groundwork for a real, lasting rally. And that hasn’t happened yet.

The US economy is still tumbling into the worst recession in three decades, with no light at the end of the tunnel yet. Corporate financing is still incredibly tight. Earnings estimates are way too high, and will probably be hacked lower. Oil demand is lower, and lower prices haven’t helped, not yet anyway. The reason oil prices are rallying is because stock prices are going up … not exactly the basis for a sustainable rally.

One factor that could go either way: The notification date to withdraw from many hedge "fund of funds" is Nov. 15. According to an article by Real Money contributor Vince Farrell, because of the strength of the government bond market and the weakness of the stock market, pension fund asset allocations are out of whack and need rebalancing. Many funds are apparently overweight the bond market by 4% and underweight equities by about the same.

Farrell thinks this could lead to continued stock buying leading up to November 15. On the other hand, it could also lead to more and deeper selling of stocks if investors decide to cash out of those “funds of funds.”

It's all interesting. Here's what I'm watching ...

Gold Gains for Second Day in London as Global Equities Rally, Dollar Drops Gold rose for a second day in London as the dollar fell against the euro, buoying demand for the metal as an alternative to the U.S. currency. Silver gained.

Sean's note -- all eyes are on gold, but take a look at silver ...
Also ...

Second Planet Needed to Meet Natural-Resources Demand

That's what humans will need by the mid-2030s to keep up with our demand for metals, fossil fuels, timber and waste disposal, the environmental group WWF said in a global survey that found the United Arab Emirates to be the most wasteful country.

The temples of doom

"We think we are different," says Jared Diamond, the American evolutionary biologist. "In fact...all of those powerful societies of the past thought that they too were unique, right up to the moment of their collapse." The Maya, like us, were at the apex of their power when things began to unravel, he says. As stock markets zigzag into uncharted territory and ice caps continue to melt, it is a view increasingly echoed by scholars and commentators.

What, then, is the story of the Maya? And what lessons does it hold for us?

According to Diamond's thesis, this: the ancients built a very clever and advanced society but were undone by their own success. Populations grew and stretched natural resources to breaking point. Political elites failed to resolve the escalating economic problems and the system collapsed. There was no need for an external cataclysm or a plague. What did for the Maya was a slow-boiling environmental-driven crisis that its leaders failed to recognise and resolve until too late.

Investment key to meeting oil demand

The IEA believes oil companies and oil-producing countries will need to invest a total of about $360bn a year until 2030 to replace falling oil production and increase supply by enough to satisfy the demands of emerging countries such as China.
Investment decisions by Opec will be critical, the study argues, adding that the share of world oil production from members of the cartel, particularly in the Middle East, will grow significantly, from 44 per cent in 2007 to 51 per cent in 2030.

A Currency Bounce

Contrarian Profits — Wed, 29 Oct 2008 15:38:11 +0000

U.S. stocks soar! Currencies rally! Consumer Confidence at an all-time low! Getting off the bench! And Now… Today’s Pfennig!

Well… The trading theme remained in place yesterday, but this time it was reversed. For those of you new to class, or any of you who have been playing horse hooky, the trading theme that has gripped the markets since August is: The deeper, darker, and more dangerous the U.S. economy and financial meltdown, including the credit market’s locked status, the dollar gets bought… If there is any sign of light to all this mess, the dollar gets sold, for whenever the markets get their minds off the mess, they are reminded of awful fundamentals for the dollar.

So… Yesterday, the stock jockeys…

Correction upon us? AUD-JPY Bounce is due!

Jack Crooks — Wed, 29 Oct 2008 13:13:26 +0000

Key News
• China cut interest rates for the third time in two months to stimulate growth as the global financial crisis undermines the world's fourth-largest economy. (Bloomberg)
• The International Monetary Fund, the European Union and World Bank on Tuesday agreed to a $25.1bn economic rescue package for Hungary to bolster confidence in its economy hit by the global financial crisis. (FT)
• Key Reports Due (WSJ):
8:30a.m. Sep Durable Goods Orders: Expected: -1.8%. Previous: -4.5%.
2:15p.m. FOMC interest-rate annoucement: Previous: 1.5%.

Quotable
"All speculative bubbles have a kernel of truth behind them to justify their existence. This time around it was China and India. These emerging Asian giants were gobbling up all the commodities the world could produce to fuel their rapid industrialization.

“It wasn't that the story was untrue; it was old. Growing global demand probably was the reason for the gradual rise in oil prices from $20 a barrel to $40 earlier in the decade, and even to $60 by mid-2005.

“It was the moon shot to $147 that took on a life, and a litany, of its own. Emerging nations didn't start gobbling up crude, coal and copper all of a sudden in the middle of 2007.

Diversification Justification

“Yet analysts on TV and in print told us with a straight face that the doubling in oil prices from July 2007 to July 2008 was a result of fundamental demand, not speculative buying or investors, including pension funds, `diversifying' into `alternative investments' in search of `uncorrelated returns.' (It sounds a lot better than admitting you got suckered into buying what was going up and are now stuck with a pile of stuff that no one wants.)”

Caroline Baum

FX Trading – Correction upon us? AUD-JPY Bounce is due!
Buy the rumor of a 1% Fed Funds and sell the news? Hmmm….Maybe today’s better than expected US durable goods orders will neutralize that in here.
The key question: How long will this “correction” last? Will the one-day correction make it to two? Going back to June 1, 2008, the longest string of daily wins in the S&P 500 has been three; and it’s happened only five times since then. And the moves haven’t been much, as you can see in the chart of the S&P 500 below identified by the green dots. You can also see the huge rally bar yesterday. And taken from the intermediate-term high in September (where some decent consolidation appeared), the first Fib level (38.2%) carries the S&P to 1002.02 or 6.54%:

In short, the stock market, the global risk asset, is extremely oversold on many standard measures. And we can say ditto for the commodities side of the fence. It has been an almost straight-line risk aversion fear trade. It’s been a huge driver for dollar and yen and bad for just about anything else out there. But risk appetite is back on the table.

The key risk currency pair Aussie – Japanese yen; this cross has been decimated. So, if we are betting on some type of multi-week or more confidence flow in stocks, maybe it makes sense to be long the AUD/JPY pair in some form or another.

AUD/JPY Weekly: That is what we would call parabolic down. The breath-taking fall in this pair ERASED SEVEN YEARS OF GAINS IN LESS THAN FOUR MONTHS! It was a complete retracement.

To suggest a bounce is due is quite and understatement.

Regards,
Jack&JR

LIBOR Drops But Short-Term Credit Markets Remain Tight

Money Morning — Fri, 17 Oct 2008 19:09:45 +0000

By Jennifer Yousfi Managing Editor Money Morning Short-term lending rates fell after a week of unprecedented government intervention in the global financial markets helped to encourage ... Money Morning is here to help investors profit handso...

Credit-Crisis Update: An Inside Look at the Commercial Paper Debacle

Money Morning — Thu, 09 Oct 2008 10:34:27 +0000

By Shah Gilani Contributing Editor Money Morning The commercial paper market is the thoroughfare where Wall Street merges into Main Street. Corporations, finance companies and banks rely on... Money Morning is here to help investors profit h...

Ignore the Economic Reports, Even if You Can’t Ignore the Pain

William Patalon lll — Sun, 05 Oct 2008 22:53:21 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report The economic releases now (and for the immediate future) will be weak – that’s a given. Therefore,... Money Morning is here to help investors profit handsome...

Here’s How to End the Credit Crisis at No Cost to Taxpayers

Shah Gilani — Thu, 25 Sep 2008 16:39:47 +0000

While it’s clear from the current credit crisis that our financial system is at a critical juncture, it’s just as clear that there’s no agreement over how we should fix the problems we face. The reality is that neither the plan put forth by U.S. Treasury Secretary Henry M. "Hank" Paulson Jr. - nor any of the addendums offered up by Congress or the lobbyists - will resolve this crisis.

The key culprits are the structured financial products that reside on the balance sheets of banks, dead investment banks, insurance companies, hedge funds and all manner of other duped and unsuspecting investor entities worldwide, as well as the proliferation of the unregulated $62 trillion credit default swaps (CDS) market.

Because all these securities, and in the case of credit default swaps, bilateral contracts, are impossible to value and impossible to guarantee, no one trusts them. As a result, everyone is afraid of these securities and contracts.

Banks are currently not lending to one another because they are afraid that the next round of write-downs and losses may imperil some of their trading partner banks to which they formerly lent billions and billions of dollars to every night. If the answer were really as simple as adding liquidity, the Federal Reserve would have lowered the Fed Funds target. But that won’t work. It’s a vicious cycle that’s eroding banks’ faith in one another, and worse, our faith in our banks.

Unfortunately, I don’t see the Treasury Department’s much-needed rescue plan being effective without actually addressing the pricing of - indeed, the very existence of - credit default swaps and collateralized debt obligations. As well intentioned as it is, the Treasury plan will create more problems than it solves and will eventually saddle taxpayers with so much debt that it will tank the dollar. It could even put the U.S. government’s AAA investment rating at risk. That would be calamitous.

I have a modest proposal that I’m calling the Money Morning Plan, because it potentially heralds a new dawn in the credit crisis, addressing the problems from the bottom up, and not from the top down. The bottom line is that my plan will end the credit crisis quickly with potentially little or no cost to taxpayers. And those are the two most important benefits of all. I present my plan as an open letter for public debate.

The Money Morning Plan

Establish an empowered, not overpowering, regulatory apparatus to rein-in structured products and establish protocols for the creation and tradability of financial products based on real-world economics and hedging considerations. Products must be transparent, easily valued and rated on a universal ratings model.

Establish regulated standards to support the universal ratings model and allow free-market competition for providing rating services based on a "pooled-income revenue model," whereby all issuers that either want to be rated, or that are required to be rated, pool funds on a per-volume, pro-rata basis and ratings providers are paid blindly for rating services.

Immediately stop the issuance of credit default swaps without mandatory reserve requirements and safeguards typical of what insurance regulations already require of legitimate insurers. Net out all existing credit default swaps to tighten counterparty risk and unwind positions that cannot be secured by issuers meeting adequate reserve requirements. Eliminate virtual insurers.

Only allow issuance of credit default swaps up to the actual outstanding dollar value of corporate debts and loans outstanding. This will ensure legitimate hedging and eliminate undue pressure on outstanding debt issuers.

Create a class of "eligible (mortgage-related only) securities" that constitutes problem securities. Leave all eligible securities on the books of existing holders.

Have eligible security holders identify to the U.S. Federal Reserve every eligible security by CUSIP and face amount. Only the Fed will have knowledge of institutional and investor positions. This will allow the Fed to correctly assess the risks at hedge funds and others with "significant operations" without exposing their positions to competitors.

Create a new accounting domain in-between "held-to-maturity" and "available-to-trade" where only eligible securities, as of a predetermined valuation date, can be accounted for at their value on the predetermined valuation date and not further subject to fair-value (marked-to-market) accounting, while held.

Mandate all holders of eligible securities mark-to-market inventories on a predetermined valuation date, preferably as soon as the Fed expects all eligible securities to be registered with it. Those who have recently marked their securities have already taken their write-downs; those who haven’t will have to. If the totality of the resolution represents a bona-fide solution, investors and speculators will bid up eligible securities to own them before the predetermined valuation date, because of newly ascribed accounting advantages of holding eligible securities.

Reduce the haircut on the reserve requirements for all eligible securities covered by this plan. Since valuations have already fallen precipitously, reducing reserve requirements on eligible securities would additionally enhance their value as balance-sheet assets with upside potential.

Have both the Fed and Treasury determine a liquidation or receivership outcome for holders suffering from insolvency as a result of accurately marking-to-market their holdings on the predetermined valuation date in the event bankruptcy would result in further systemic problems. This scenario would be cheaper and quicker to manage than what’s in store for us under the present Treasury draft, and it allows the two to assess the potential fallout of insolvent entities prior to their exposing the financial system to resulting disruptions. Hedge funds would not be saved.

The Fed must establish and manage a conservative, transparent pricing model for eligible securities based on actual underlying cash-flow measures, projections and model specific criteria. Absolutely no trading would be allowed over-the-counter or otherwise on any of the eligible-securities specific pricing models or indexes.

The Fed, with a firm handle on all eligible securities and a transparent-pricing methodology, would have to take in any and all eligible securities as collateral against Fed borrowings from the discount window or through its dealer facility.

"Servicers" managing underlying mortgages on behalf of trust entities, under which securitized pools are created, must be empowered to alter and modify terms and conditions of underlying mortgages in conjunction with originating banks or lending institutions.

To incentivize banks and lending institutions to modify existing mortgages and to incentivize homeowners to stay in homes with upside-down mortgage-to-appraised values, eliminate all capital gains on appreciation of newly appraised homes when they are sold by either homeowners, banks or lending institutions.

Create tax-advantaged scenarios for banks and homeowners partnering in the reduction of delinquent obligations whenever loans can be brought to a performing status.

Source: Dear Hank: Here’s How to End the Credit Crisis at No Cost to Taxpayers

Dear Hank: Here’s How to End the Credit Crisis at No Cost to Taxpayers

Money Morning — Thu, 25 Sep 2008 09:45:04 +0000

By Shah Gilani Contributing Editor While it’s clear from the current credit crisis that our financial system is at a critical juncture, it’s just as clear that there’s no... Money Morning is here to help investors profit han...

Wracked by Problems, the U.S. Economy Keeps Digging Its Way Out

William Patalon lll — Mon, 22 Sep 2008 05:30:11 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report Where to start? Market volatility is sure to continue for the indefinite future as investors, economists,... Money Morning is here to help investors profit han...

The Fed Makes the Right Call – Analyst Blog

Zacks Market Commentaries — Tue, 16 Sep 2008 16:07:48 +0000

The Fed voted to leave interest rates unchanged. The decision was unanimous.

Given that the Federal Open Market Committee backed away from its hawkish stance on inflation, the statement will be viewed by some as befuddling. However, it is questionable how much lowering interest rates further will help right now.

Hubris and outright delusion by some CEOs over the health of their companies is what got us into the current situation. The positive impact of lower rates beyond improved investors psyche is limited. After all, the credit crunch is being fueled by a lack of trust of borrowers by lenders, not a high Fed Funds rate.

The immediate reaction by traders was a tantrum. Stocks recovered from the initial knee-jerk reaction, however, and closed with a gain.

Part of the reason for the late afternoon rebound was the realization that the Fed left the door wide open for future interest rates. Specifically, the committee stopped saying that "some indicators of inflation expectations have been elevated." Even the inflation hawks are admitting that the commodity bubble is deflating and that the real risk is the weakening world economy.

Nonetheless, todays decision was a non-event for financial firms such as Comerica (CMA), National City (NCC) and Washington Mutual (WM). Lower interest rates are not going to solve their problems with bad debt, nor reverse the fact that they originated mortgages that should have never been made.

Investors should keep in mind that the Fed has other options besides interest rates adjustments to help the economy. For example, the Fed actively brokered the Lehman (LEH) negotiations over the weekend. It has also injected liquidity and changed collateral requirements.

Most importantly, todays decision allows to the Fed to announce a surprise rate cut between now and the late October meeting, should such a move be warranted.

Read the full analyst report on CMA

Read the full analyst report on NCC

Read the full analyst report on WM

"NCC" Free Stock Analysis: Buy? Sell? Hold?
"WM" Free Stock Analysis: Buy? Sell? Hold?
"LEH" Free Stock Analysis: Buy? Sell? Hold?
"CMA" Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

No Fed Funds Rate Cut After All – Analyst Blog

Dirk Van Dijk — Tue, 16 Sep 2008 14:28:27 +0000

The Fed decided to keep the Fed Funds rate at 2.0%, disappointing many who were hoping for an ease in response to the current market turmoil. The statement they put out is substantially more dovish than they had been, leaving the door open to a cut in the near future.

The market did not originally take the news kindly, but the market is now up. The statement says:

"The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

"Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

"Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

"Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; "The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Ms. Cumming voted as the alternate for Timothy F. Geithner."

Zacks Investment Research

Expect a Rate Cut Today – Analyst Blog

Dirk Van Dijk — Tue, 16 Sep 2008 11:57:40 +0000

First and foremost, remember that the U.S. economy is like a battleship -- it is very large and very resilient. It has the capability of absorbing many blows and still remain afloat.

There is still a chance that we come out of this mess relatively unscathed. What do I mean by relatively unscathed? I mean an economy and financial system that is still recognizable to most Americans. It seems clear that we are headed into (or more likely are already in) a pretty deep recession, but another depression is not a foregone conclusion.

Much will depend on the skill of the policy makers over the next few months. We are extremely fortunate to have one of the worlds foremost experts on the causes of the Great Depression, Ben Bernanke, as the chairman of the Federal Reserve. So far he has shown incredible flexibility and responsiveness to this crisis.

While I had been expecting him to hold rates steady through the end of the year and then possibly increase them early next year, that is no longer the case. I expect that we will have a cut this afternoon, perhaps even a 50 bp cut. The Fed has to intentionally take what are normally highly inflationary steps to offset a massive deflation that is taking place due to massive deleveraging. However, the Fed does not have that much ammo left, the Fed Funds rate is already down at an extremely low 2.0%.

The crisis is not over, not by a long shot. This will particularly be true if American International Group (AIG) goes under today or tomorrow. As of last week, analysts were looking for a year-over-year decline in total net income of 49.8% for the Financial sector. Those estimates are no longer operative, and I seriously doubt we will have much of a recovery in the fourth quarter.

For starters, it may be a very different sector than a year ago. Several of the most important firms a year ago may not even be in the index by the time third quarter earnings are reported. These obviously include Lehman Brothers (LEH), Fannie Mae (FNM) and Freddie Mac (FRE). Merrill Lynch (MER) will most likely still be trading in time for third quarter earnings, but will most likely be subsumed by Bank of America (BAC) by the time the fourth quarter rolls around. AIG is a real question mark, as is Washington Mutual (WM). The federal takeover of the GSEs will require a big round of write-offs in many corners of the banking system, as will the counter party exposures to LEH.

The S&P 500 as a whole was expected to show just a 3.0% decline in year-over-year net income for the quarter. In large part due to the financials, that is no longer operative. The reality will most likely be closer to the 21% decline we experienced in the second quarter. The big driver on the positive side for earnings was expected to be the Energy sector, up 49.5%. As the world sinks in to a deep recession, oil prices are plunging. Profits will still be up for the sector, but it is unlikely that they will be up that much, and the plus 30.5% expected growth in the fourth quarter is looking increasingly unrealistic.

It is time to hunker down a bit and worry more about the return OF your capital rather than the return ON your capital. There will be great chances to buy good firms at great prices in the future, but now is not the time. For the time being, look to companies that have very strong balance sheets and which have products and services that demand holds up for in good times and bad. Consumer Staples and Health Care top that list. Electric Utilities may be worth considering.

I still think that as the world comes out of this downturn, you will want to be in Energy and Materials stocks. However, both the supply and demand curves for oil are highly inelastic, and this downturn is destroying lots of demand, hence prices are plunging.

I would continue to stay far, far away from the Financial sector and the Consumer Discretionary sector. Employment is going to continue to fall and wage growth is very weak. Consumer credit will become very difficult to obtain. Thus, spending on big ticket discretionary items is likely to be very constrained going forward.

Good policy moves will be essential to ward off the multiple blows the economy is on the receiving end of. Just because we are a battleship does not mean we are invulnerable. After all, eventually even the Bismarck sunk. Still in a big storm, I would rather be on a battleship than a small boat.

Read the full analyst report on AIG.

Read the full analyst report on LEH.

Read the full analyst report on FNM.

Read the full analyst report on FRE.

Read the full analyst report on MER.

Read the full analyst report on BAC.

Read the full analyst report on WM.

"FRE" Free Stock Analysis: Buy? Sell? Hold?
"FNM" Free Stock Analysis: Buy? Sell? Hold?
"MER" Free Stock Analysis: Buy? Sell? Hold?
"LEH" Free Stock Analysis: Buy? Sell? Hold?
"AIG" Free Stock Analysis: Buy? Sell? Hold?
"BAC" Free Stock Analysis: Buy? Sell? Hold?
"WM" Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

Buyout of Merrill and Bankruptcy of Lehman Heightens Worry of U.S. Credit Crisis Pain Still to Come

William Patalon lll — Tue, 16 Sep 2008 11:03:46 +0000

By William Patalon III And Jennifer Yousfi Money Morning Editors After a weekend in which the deepening U.S credit crisis sent one top investment bank to bankruptcy court and a second into... Money Morning is here to help investors profit han...

Hurricane Ike is the Latest Wild Card in the “Guess the Gasoline Price Game”

William Patalon lll — Mon, 15 Sep 2008 00:50:20 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report Last week’s crude and gasoline inventories dropped more than expected as the effects of Hurricane Gustav... Money Morning is here to help investors profit han...

With OPEC Meeting Looming, and Emerging Markets Growing, Oil Prices May Only be Temporary

William Patalon lll — Mon, 08 Sep 2008 10:48:43 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report Analysts are trumpeting the recent drop in oil prices as a step toward normalcy. But is this celebration... Money Morning is here to help investors profit handsomely ...

Contradictory Economic Reports Whipsaw Investor Expectations

William Patalon lll — Mon, 01 Sep 2008 22:01:46 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report No wonder this economy is so hard to figure out: The economic reports are as volatile as the economy... Money Morning is here to help investors profit handsomely...

Worrisome Stagflation Becomes More Real All the Time

William Patalon lll — Sun, 24 Aug 2008 23:22:47 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report U.S. Federal Reserve Chairman Ben S. Bernanke didn’t use the "S" word - stagflation - but he might as well... Money Morning is here to help investors profit hand...

Although Oil Prices Have Declined, the Energy Sector Remains a Global Investing Wild Card

William Patalon lll — Sun, 17 Aug 2008 22:02:48 +0000

By William Patalon III Executive Editor Money Morning/The Money Map Report Although consumers and businesses have gotten a bit of a reprieve at the gas pump as of late, the escalation in oil... Money Morning is here to help investors profit hands...

MARKET COMMENT

David Fry — Thu, 01 May 2008 01:04:11 +0000

The only surprise today was bulls couldn’t pump an end-of-month window dressing rally. The Fed gave investors what was expected coupled with a mixed message of guidance. To believe the Fed is now in inflation fighting mode with Fed Funds at 2% is comical. Barry Ritholtz probably outlined this comedy best [...]

Deceiving Rally Led by Large-Caps

Trader Mark — Thu, 13 Sep 2007 16:33:12 +0000

Dow is up 1% but 2 of its components are ripping today… MCD and GM both up 6-7%. (dividend increase on the former, UAW concessions on the latter) Breadth is actually still a bit troubling: 3 to 2 advance decline on NYSE, and 1:1 on the best performing exchange of late: NASDAQ. However, both the SP500 and [...]

Fed Fund Futures Setting Market Up for a Sell-Off?

Chad Brand — Fri, 07 Sep 2007 16:29:25 +0000

You would think that with everything Fed Chairman Ben Bernanke has said publicly thus far regarding the current turmoil in the mortgage and credit markets, the market might be at least somewhat doubting that a Fed Funds rate cut is coming later this month at the next FOMC meeting. After all, Bernanke came out and [...]

Growing Odds of a Recession

Jim Kingsland — Thu, 30 Aug 2007 19:29:23 +0000

Accurately predicting a recession is about as easy as pinpointing the landfall of a hurricane several days out. That’s still not stopping CEOs, government leaders and economists on both sides of the fence from weighing in on the matter with increasing frequency. The U.S. economy with a $13-trillion output of goods and services, as guaged by [...]

Reflection on the Week That Was (8/18 to 8/24, 2007)

Prieur du Plessis — Sun, 26 Aug 2007 18:43:24 +0000

I spend a very large amount of time reading investment-related material. In order to share some of the more interesting snippets with readers, I have decided to add a new section to the blog – Words from the Wise – where I will regularly publish a number of quotations from market commentators. The content will [...]

Which Banking Problem to Fix?

Richard Shaw — Thu, 23 Aug 2007 16:42:06 +0000

Central bankers seem bipolar these days as they to try to solve two structural problems with apparently mutually exclusive solutions — rising inflationary pressures and falling asset prices. China just raised its interest rates again in the face of inflation reaching a 10-year high. China’s inflation will inevitably be exported to the countries that consume their [...]

How to Watch The Bond Market

Roger Nusbaum — Tue, 21 Aug 2007 18:03:58 +0000

A reader left a quote from Forbes about important it is to watch the bond market for early signs of trouble for stocks. The reader then goes on to ask how one watches the bond market. I don’t think the answer to this question can be simple. The first point to make is that the bond [...]

Dow Up 233 on Fed Rate News

Jim Kingsland — Sun, 19 Aug 2007 22:19:40 +0000

Last Sunday this blog broached the possibility of some sort of intra-meeting move by the Fed. And then on Monday, Paul Kasriel at Northern Trust told me a cut in the discount rate would make life easier for the Fed as opposed to pumping the system via daily injections. Well, the discount cut happened, as [...]

A Great Move by Bernanke

Todd Sullivan — Sat, 18 Aug 2007 05:13:40 +0000

Bernanke moved today and unlike the chorus of calls for a Fed Funds Rate cut we have heard, he moved both to calm markets and keep rates steady. Saying, “Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data [...]

Subprime Jumps The Fire Line

Jim Kingsland — Sun, 22 Jul 2007 02:37:34 +0000

The stock market paid some attention to negative events on Friday. All of the major stock groups in the S&P were down with Capital Goods, Conglomerates and Financials leading the way lower as subprime worries and a few bad earnings reports from Cat and Google got under the skin of investors. Amazingly, an earnings miss the [...]