April Month End

What a day for price influencing. Month end for the hedge funds, Fed Meeting and Oil inventories. Not sure what games are going to be played, but mkt action is sure to be interesting as the game of bluff continues.

Citibank raising more cash to rebuild the balance sheet. Short positions in US Financials continues to build. Bearish sentiment on Oil continues to build. Bullissh sentiment on the US equity mkt has rebounded to 'normal' levels.

CDN Tax day

April 30 is Tax Day in Canada, that means investors tend to sell their mutual funds or position to pay for any taxes owing. TSX got clocked for 200+ points yesterday as oil,gold and commodities got a pasting dur to the FED spin of the last 25 bps cut to 2%. What a joke-2% or 2.25% -does it make a difference when the shadow financial system is creating credit north of 10%. The Treasury for Toxic waste program allows the banks to hold onto their poor investments-just like Japan in the 1990s.

Cdn Feb. GDP dropped .2% in Feb.-worse than expected-likely to lead to another rate cut by the BoC late in q2 -probably 25 bps

Japan announced it was not biased to raising rates in the near term-despite inflation rising above 1%. They do not want to risk the same mistake they made in the mid 1990s-raising rates too early and snuffing out the recovery.

Brazils' recent oil find

Details are becoming available regarding the massive oil find off the coast of Brazil. Early talk of 30 bln barrels has been circulating but now the facts coming out that the oil is trapped-much like the Arctic natural gas. The oil is 30,000 feet below the waves and is in rock that is at 500 F. The cost to drill a single well is north of 100mm. This oil will come out if oil is at 125 and above for a sustained time. Looking at the oil strip curve shows that after 2012, the oil curve starts tomove back up. In particular the curve is as follows: Dec.2011-107.37, Dec 2012 107.30, Dec. 2013 107.50 , Dec. 2014 107.77, Dec. 2015 108.12, Dec. 2016 108.71.

Employment

Who has been the biggest employer over the las century. It is the government at all levels. That is going to be put to a test over the next few years-particularly at the state and local level. The latest Case-Shiller home price index shows a 12.7% decrease in home prices. As home prices decline and foreclosures go home, revenues to the state and local governments are going to decline. To date, governments are not laying people off, but with budget deficits starting to pile up-we know which way the trend is. The next surprise for the mkt is going to be job growth or more importantly lack of job growth. Longer term I am constructive on the US employment situation as the lower USD is going to bring some companies back to the US and also the lack of quality in certain Asian products is going to create a back lash. However, in the short term, government hiring is going to drop and that coupled with the financial and real estate layoffs is going to push the unemployment rate to 6% and above IMO.

As for the Fed-does it really matter anymore what their rate is. The Shadow Financial system circumvents the Fed anyhow and it will be years before the FED regains control. Over the last 3 weeks, 2 yr USTs have moved from 1.85 to 2.35 %. The mkt has alreaady priced in no more rate cuts. The Fed is going to play the probabilities game of seeing the US economy level off from the plunge and thus allow the FF rate to remain at 2%. (of course that is after tomorrows 25 bps cut). Real estate is still heading south as the oversupply of homes and lack of income from the bottom 75% of the population keeps the affordability index from reaching the proper levels.

What would you rather have?

What is the USD? It is a medium used for the exchange of goods. The car manufacturer sells their car to the salesman who got his money from the ABC widget company. Now that the US gov't has embarked on a USD devaluation program, foreign countries are waking up to the plundering of their resources by the US empire. Trade restrictions and nationalization of resources is happening across the developing world. They do not want a piece of paper with a dead president on it. They have seen the value of different currencies evaporate overnight as the color changes from blue to green. These people want tangible assets-whether it is corn, wheat, copper, gold, gasoline-but it is something that has barter power.
The Euro is no better as it looks like the Club Med economies are grinding to a halt-mainly due to real estate issues (Again). The pressure on the ECB to weaken the Euro will build. Right now the Germans have control of the ECB, but the French take over in 2009 and things ay become a little different. The Armstron cycle model predicts early 2009 as the equity mkt top and then a swoon through to 2011.

Silver

I prefer Silver over gold for 2 main reasons. Central gov'ts do not have a stockpile of silver to throw into the mkt. Silver usage is expanding-medical benefits and more importnatly now is that Mitsui has developed a silver based catalytic converter. The converter will be available in 2012 and will be applied to farm equipment and other lower horsepower diesel motors.

Credit Spreads

A quick look at the credit mkts from the St. Louis Fed page:

Feb. 1 /2008: Fed funds: 3.50 April 25 /2008: 2.25
2 yr Int. Rate Swap 2.88 3.08
Corp Aaa bonds 5.38 5.56
Corp Baa bonds 6.63 6.96
5 yr UST 2.84 2.96
10 yr UST 3.67 3.75

So despite a 125 BP decrease in Fed Funds, the credit mkts actually have higher yields. That is bad for borrowers and good for lenders. The steep yield curve and wider credit spreads will help the financials rebuild their balance sheets over time. But that only applies to new loans! Existing loans are an anchor to earnings as they get marked down to current market levels. When the writedowns end and the bank start lending again (or corps start borrowing), the financials will scream. Is the worst over for the financials? Not sure, but I expect one and maybe 2 more legs down as the expectations for an end to the real estate bubble bursting are quashed.

3 Trillion in MMKT funds

Plenty of talk of the amount of money in mmkt funds. The main issue is what about the amount of money owed on housing and credit cards and other auto loans. has this money been earmarked for debt repayment, or is this discretionary savings from the upper 25% that will rotate back into risky assets. Some is definitely going to equities as the real rates in short fixed income instruments are negative. The rally in fixed income due to the belief that the FED was going to cut rates to Japan like levels is over. The inflation bogeyman is starting to wake. Long term bonds have broken their uptrends. Rising rates are not going to help equity valuations. Portfolio mgrs still use the FED model of earnings yield vs the inverse of the 10 yr treasury yield. That is wrong IMO as the credit quality is mis matched. The 10 yr BBB yield index is more appropriate.

Monday Morning Playbook

Fed meeting on Tuesday and Wednesday will hold the focus early in the week. My expectations are for a 25 bps cut followed by text that states that they are going to take a pause and see how their actions over the past qtr transpire. There will likely be a split vote as some voters will cite the inflation issue. If the Fed does not cut, it will signal they are really worried about inflation. Economic data suggests the US economy is still slowing down, but interest rate cuts take 6-9 mths to show an effect. US stimulus checks are in the mail-let's see how many get used to buy TVs and how much pays down their debt.

Plenty of talk in the press regarding the bulging MMKTs accounts. That is dead money. Buyers of fixed income are not adding to their positions as the FED rate cutting program gets cut short. Few are talking of rate cuts to the 1% level now, but 3 weeks ago, the mkt was convinced deeper rate cuts are on the way. 2 yr UST are at 2.20% from 1.80% 2 weeks ago. Japan showed its fastest inflation rate in 10 yrs and the bond mkt sold off vilolently. Interest rates remain negative and investment pros are starting to shift out of FI and into equities. Risk is being forced back intothe portfolios just like 2002 and 2003.

China-Strengths and Weakness

What is China's greastest strength and weakness? Its vast population. Over the last 10 yrs, China has mobilised its citizens and migration from subsistence farming to urbanite continues to impress even the most hardened skeptic. However, as the mass of people move up the economic food chain, their demands increase-starting with food. Is it any surprise that the US has thus mandated bio fuel use to increase. Did they not know the damage the use of bio fuels would have on the developing and poor nations? Of course they did, but they need to slow the China economic miracle. Using food as a weapon is not new and it will continue. The developed nations spend the least amount as a percentage on their food bills. While the developing nations spend a much larger percentage on their food. An army marches on its stomach comes from the Napoleonic times and it still holds true. The US can not stop the Chinese and Indians from advancing their economies, but they can make life more miserable for their leaders as the cost of food skyrockets. Resource wars are starting to erupt. Why is the US stockpiling oil? Are they going to attack Iran? Maybe, but they know they are printing useless pieces of money and they are buying as many hard assets as possible. Why are futures contracts settling above cash prices? Because the buyers actually want the product and the paper shorts are unable to deliver. Most futures contracts get settled for cash, not actually delivery. However the system is breaking down as the physical buyers are starting to overwhelm the paper sellers. Gold is going to be last commodity to accelerate as the political significance of gold will be paramount with the PTB. Consummables are going to outperform-copper, zinc, oil, nat gas, corn etc.

As the 'all powerful' Fed meets this week, talk is that 25 bps will be cut to put the FF rate at 2%. The spin will be that the worst is over and the Fed is being prudent. Reality is that any more cuts will ignite a commodity rally. The nations of the world realize they have been duped over the last 10 yrs taking USD for their valuable resources-now they are nationalizing assets and kicking US firms out-witness Big Oil in Venezuela. More to come in other jurisdictions in other commodities-witness mining in Ecuador. The barter system could return as the USD reserve currency gets called into question. The power of the US military only keeps the power of the USD viable, but the lack of result in Iraq is depleting the USD power.

Subprime resets

The bulk of the sub prime resets should be attempted by the end of May. Judging by the early data, the resets are not going well as defaults are moving higher and deliquencies rise. That is only half the problem. The lenders are under the pressure of not receiving any income, yet still being required to pay their financing costs. This will have profit implications in q3 and q4. In addition, there is a time delay from when a home goes into foreclosure and when it is taken over by the financing unit. Hence, homeowners are stiffing the banks. Nice.
The subprime resets tail off in q3 and q4, BUT option ARMS and alt-A resets start to accelerate in q1 2009 and accelerate all through the yr. That coupled with a Democratic President and Congress and Senate could spell significant trouble for the US financial markets. The US Treasury mkt is one to watch. The bearish economic news ahas not resulted in a rally in the Treasury mkt-plenty of bubble callers in US interest rates. IF UST start to back up significantly, that could be trouble for the eequity mkt since so mauch talk of fair value rests on FED model, ie a 4% 10 yr yield implying a 25 X multiple. That is ridiculous. According to the latest St Louis Fed release, Corporate Baa bonds have moved from 6.63 on Feb.1 to 7.01 on April 17. Using the equivalent calculation results in an implied multiple of 14.3X-that is more realistic. Of course the Fed has cut rates by 125 bps since that time, but that has only helped banks and not consumers as the lower interest rates have not filtered through.

Prediction

With little economic data between now and month end, the mkt will focus on earnings and only earnings. The mkt is going up as the sellers have stayed too late at the party and the buyers are going to be joined by the short covering bid. Oil and Gold will trade weak until at least Tuesdayas the PTB makes its move. The SSEC (Shanghai) index continues to give backs its gains as the mkt prices more closely with its HK equivalents. As an example-Petro China has lost half its value (595 bln) as the arbitrage goes whittled down (As a refresher PTR was trading with a mkt cap north of 1 trillion in Shanghai, but only at less than half that value in the US).
The USD is due for a technical bounce, but that is it. Gold and Oil will suffer-probably testing 900 and 105 respectively. However, the mkt action on the equities will be interesting over the next 3 days. Watch for divergences

Canada is starting to catch the US cold. Housing sales dropped markedly in Feb. (partly due to the weather) and the LEI dropped .3. This is likely to play out in other countries as growth slows.

Here Comes the Spin

The plan is unfolding as the Master Planners are hard at work trying to spin the recent news on earnings. GOOG blew past earnings estimates, C posted terrible earnings (15 bln in writedowns), but the talk remains that the kitchen sink was thrown intothe numbers and the worst is over -for now. MER was the same situation y'day as the shorts did not get enough bad news to maintain positions. The mkt sentiment is too negative and a relief rally for the SP500 to 1400-1420 is likely.
Needless to say, the gold and oil mkts are being used as a source of funds by the hot money crowd. The talk is shifting to the FED being one and done (25 bps on April 30). Hence that is being perceived as positive by the USD bulls as the spin of the FED being concerned about inflation has the mkt looking to lock in recent profits.
CAT reported good earnings-mainly due to growth outside the US-a recurring theme. NOK reported poor earnings, partly due to the strong EURO. European politicians are all over the ECB to lower rates, but the ECB being controlled by the Germans is not budging-inflation still running ahead of the upper end of their band.
US Treasuries have been hammered this week as the mkt wakes up to the fact that the world is not going to end. The 2 yrs have moved from 1.60% to 2.20%. There is a pile of money on the sidelines (2-3 trillion) by some estimates and it will soon be forced into the mkt. What they buy is anybodies guess, but I suspect financials and tech.
As I write, gold is down 30$ to 912 and oil is down 2$ to 113. These are the weak $ tradesand they are being unwound as the chatter from the street regarding a vigilant FED and the crisis being over takes hold.

What Now?

Equity mkts took y'day on rumours of better earnings from certain companies and a relief rally that has the 'street' short. The mkts are right up against resistance levels. Can they break through? My guess is yes as the 2 yr treasuries are now above 2%-up from 1.6%. Mkt players are coming to the realization that the FED is not going to slash rates to 1% unless a major problem develops before the US election. 25 bps at the next meeting is the most likely outcome.
Stocks are diverging, financials are still for sale while real economy companies are delivering results ahead of consensus.
Commodity companies blasted off y'day lead by the agri companies. POT announced a 200% increase in potash prices. That is unbelievable. Arcelor Mittal announced a surcharge on US steel contracts. Oil trades above 115, and gold trades above 940. Copper testing 4$.
The mkt is starting to revalue some of these base commodity producers and discount the financials. Merrill announced a 2 bln $ loss as they marked down their positions. But once again, the balance sheet is so confusing to obfuscate the damaged positions. Until the B/S clears up, the bid for financials in general will be limited as there will be plenty of sellers on upticks. JPM-which avoided most of the subprime issue-is looking to raise 6 bln in prefferred shares-yielding 7.9%. US 10 yrs are yielding 3.70%. Generous to say the least.
Mkt action is to sell the rallies if as and when companies beat earning expectations. Intel beat yesterday and guided higher-opened higher and then sold off all day despite the Dow being up 250 pts and the NDX up close to 3%-No follow through. IBM beat expectations and price action today indicates a sell on news scenario. NOK missed and is getting hammered. Risk still resides on the downside

Oil service companies are taking off-especially the Cdn drillers-either some hedge funds got caught short or there is some big aggressive buyers pouring in. CET.un and PHX.un-2 directional drillers are up 40-50% in 3-4 weeks. Maybe the depressed drilling fleet in Western Canada is starting t be used. Plenty of promotion of the Bakken in Sask., Montney in NE BC and the gas shale in Quebec.

Gambling Trends

In the never ending quest to relate real life events with financial trends, news from MGM cutting 440 employees from MGM Grand due to a decline in gambling is in my mind clearly a sign that the wealth effect is in reverse. When people are flush, they are more apt to head to Vegas to try their luck-not anymore. What does this mean for the casino on Wall Street? Probably less volume, and in fact the volume figures have declined in last 3 weeks. Part of this is due to the de leveraging of the financial institutions. Hedge Funds are going the way of the Dodo bird, since they were not hedge funds at all, but rather overlevered pools of capital. Some will survive, but most will fail. Unless of course the FED bails them out. Another reason for interest rates to rise as the buyers (black box gurus running a failed model) retreat.

Interest Rates

As one looks around the investment universe, it is hard to believe where some products are trading. Dividend yields on some good quality stocks are at 2x the level of 2 yr treasuries. As this financial mess works its way through the python, these spreads are going to narrow. The easy trade right now is to be sitting in cash which implies 1yr or less paper-and given the issue of what is some of this paper, the less sophisticated are buying treasuries. Even some munis are suspect now that real estate prices have declined-(munis get their revs from property taxes).
Bonds are the next bubble to pop-once the flight to safety runs its course, investors are going to wake up and realize that interest rates are way too low.

More Financing details

Here are the details of the Wachovia financing
http://www.theaustralian.news.com.au/story/0,25197,23535528-643,00.html

More Financial Dilution

The capital raising from US financial institutions continues. Wachovia (WB) latest -raising 7 bln at a 15% discount. WM also raised some cash last week from the PE group-suspicions about the FED to JPM to PE firms to Financials entities circles are being mentioned. Merrill and Citi are expected to announce more major writedowns.
The financial tricks are running rampant-LEH repackaging LBO debt into a SIV to securitize and get rated AAA by SP and then sent to the FED for treasuries. Professor Bernanke is getting a portfolio full of toxic waste. How much abuse can the FED take before it realizes the sharks of Wall Cheat have once again taken full advantage of the system to remove money from the publics pocket?
Financials remain overlevered with more loan portfolios.

G7 let down

Stocks got pummeled on Friday due to the GE earnings miss and a lack of buying interest. The G7 meeting on Friday also had investors on the sidelines as the 'expect the unexpected' thinking reigned supreme. More importantly though was that The Masters was taking place and no doubt the big power brokers and fund mgrs were in Augusta being wined and dined by the Wall St crowd (Trevor Immelman won for the record).
The G7 meeting was a bust as they stated they were concerned about the pace of the USD fall, but not about the fall. They were watching mkt developments closely, but no policy initative was announced. Talk about a toothless tiger.
Oil and gold have become the anti $ trade.

Things 2 remember

Everytime the stock market drops, the cheerleaders state that you would miss out on the gains if you are not in the market. They are correct, but every law has a corollary. How much money would you lose if you were fully invested during the 5% biggest down days in the last 40 yrs. A couple of examples include the 1987 mkt meltdown-20% in 2 days. 1994, 1998, 2000-2002. U would be broke. The fact is that the biggest rallies occur during bear markets as the shorts get scared and bid up prices as profits try to get locked in. Hence in bull markets, the biggest drops occur for the same reason. In this environment-renting stocks-buying OS and selling OB is the strategy. Buy and Hold is not going to perform.

The solution nobody wants to talk about

Why is the US is a downward spiral-demographics, poor monetary policy, poor fiscal policy are contributors to the problem. However, the outsourcing of labor and the subsequent diminishing of the true middle class has resulted in the US having fewer consumers. SP500 chieftains took full advantage of the outsourcing option brought about by the instant communication via the internet. The World is Flat highlighted the benefits of the profit potential from moving high cost labor to low cost countries. As long as those countries were stable and friendly to Western policies, US corps were able to expand their bottom lines at the expense of the average US worker who was forced to take lower paying jobs. What the corporate chieftains failed to realize they were also taking away the buying power of their products. This did not happen overnight, but it was the product of a decade of outsourcing. So until the developing countries finally develop, the mkt for finished goods is going to be limitied. The developing countries like China, Russia and India are more centrally planned and therefore the main task is to build the infrastructure to make life more amenable for its inhabitants. That means less plasma TVs and more roads. The free trade argument has been abused by corp. executives and now has come back to bite them. From the Henry Ford/Walter Ruether conversation='that's great Henry,but who are you going to sell your cars to?' There has to be a balance between corp. bottom lines and workers making enough $ to support the economic landscape. I suspect the unions are going to gain power in the years ahead and if the Dems take Washington, Free trade is going to run into some roadblocks.

The Circle of Credit

Here we go again=JPM is going to loan Blackstone and Carlyle group 2bln. Where is JPM getting the money? More than likely from the FED Discount window. Where is the money going? Probably to buy some of the toxic garbage from C's balance sheet. Once again the FED is becoming the banker of last resort using JPM to skirt the law and implement its program. Blackstone, Apollo and TPG are in the process of buying some LBO loans from Citi-some are probably their own paper for 90 cents on the $, but backed buy a 20% indemnity from C. This is to sidestep the issue of marking the paper to true mkt and thus forcing the rest of the garbage portfolio to be marked accordingly. The deeper the problem, the elaborate the balance sheet manouevers.

Banks have the real mtg problem

All this talk in the press regarding the US homeowner as being in distress from the mortgage resets is not entirely true. Lets go through an example of the average person who bot a home in 2006 for 500k. They put down less than 5% (25K). Rolled their closing costs and taxes into the original mtg. Approx. 3K month is the mtg payment at 6% int. So after 2 yrs, the owner is in for roughly 100K. If the house is only worth 400k, the owner has broke even, but if the house is worth less, the bank is in trouble. Because this where the homeowner gains the upper hand over the bank. In the past, the banks assumed that real estate appreciated always and thus any foreclosures could be sold at a level above the remaining amount on the loan. Not so any more. In addition, given the problems with the paper regarding the mortgage (more than likely sold off to a third party and then sliced and diced into a securitized debt obligation), the current homeowner should stop paying their mortgage and wait for due process to take place. More then likely the current owner could live in the house for another 8-14 months rent free. Now who is in trouble. Even if the current homeowner could pay the mtg, why would they. They could simply refuse to pay and threaten to leave the property once their due process is complete. Foreclosures and the subsequent auctions are not what the banks want so the current homeoqner holds the upper hand. To date, few realize this fact, but given time they will figure it out and then the banks will be scrambling to negotiate loan terms.

Too many Bears

Here we are on April 10, 5 days before US Tax payday and the mkts are taking a pounding as GE's earnings have sapped any mkt momentum. The weak handed bulls are being forced out while the Mutual Fund crowd is no doubt receiving redemption notices form their unit holders as they raise capital to pay their taxes (or mtgs). This could be another test of the lows and it will be interesting to see if the lows hold. Not sure if the will-Timw will tell (twt)

Steer clear of Financials

Plenty of stories today, GE missing by a mile in its q1/08 earnings-mostly due to the financial side of the business. Jeff Immelts comments following the announcement summed up the battle in the mkts=financial side is depressed while the real economy outside of the US continues to expand. Other comments regarding US domestic consumption, in particular the housing sector continue to show weakness. Mkt impact was to start lowering the bar for all financials as q1 reporting season gets under way.
The Wall Street firms are once again trying to hide their terrible balance sheets by accounting gimmickery. GS and MS have already moved some of their assets into the Level 3 (L3) category as the recent letter regarding pricing of L3 assets suggests a more lenient interpretation. In addition, the WS dealers have been repackaging all sorts of financial garbage(CDOs, CMBS, LBOs,etc) and then lending them to the FED via the TLSF. On top of that, the FED has then re lent the re packaged garbage out. The balance sheets of the US Financials are not to be trusted and they are delaying the day of reckoning hoping to trick some investor to take some the garbage. Latest money supply stats show the banks are technically insolvent=http://www.federalreserve.gov/releases/h3/ . Non borrowed reserves at -98 bln while TAF at 100 bln. Next week should put them over the top.
G7 meeting this weekend might result in a plan being developed to lift the load from the Financials, but I suspect there is great disagreement between the US and European interests.

Commodity Fight

The commodity complex went on a tear yesterday as the US $ lost more ground. BoE droppeed rates 25 bps to 5%- 3% more to drop. ECB held fast at 4%. The debate on commodities continues-on one side the slowing Western economies and on the other side the raging Asian and SA economies. Demand remains firm-though not surging, but supply is stagnant. Problems with nationalization and costs to develop mines have inhibited mine development. Copper testing 4$/lb is a sign that Asia continues to move ahead. In addition, the Middle East is on a building boom-re investing all the petro dollars.
US is in recession-probably a long, extended one as the excess credit boom deflates.

Level 3 Assets

The Balance Sheets of the WS brokers are not getting any better. GS and MS both revealed substantial increases to their Level 3 assets (Assets that are illiquid and hence hard to value-best guess at what they are worth). Goldman's surged 39% to 96.4 bln, increase the value of level 3 assets to 8.1% of total assets. Of course the off balance sheet items are not available and only GOD knows what and where they are. MS level 3 assets increased 6.1 % to 78.2 bln or 7.2 % of total assets. LEH actually reduced its level 3 assets from 6.1% to 5.4 %. Maybe GS and MS are 'helping' out their WS brethren and buying what they perceive as value. Time will tell.

The Balance Sheet Shuffle

As always there is more to the story than the headline. It turns out the euphoria surrounding Citi (C) selling 12 bln in LBO loans to a group of hedge funds is nothing more than a balance sheet shuffle. What is really happening is that C is selling the loans at 90 cents on the dollar to TPG, APollo, and Blackstone and then financing the purchase of these loans. It will probably be revealed in time that the loans are actually TPG, Apollo, and Blackstone LBO loans so in essence the hedge funds are buying back their own paper. The PE entities do not have access to the discount window, but C does and therefore they can borrow as much as they like at the current 2.50% and move that through to the PEs. This is a balance sheet move as C is subject to regulatory filings, while the PEs are basically unregulated-plenty of tax haven and off shore entities tied to these entities
Once again, the opaqueness of Wall Street is evident-this action should give investors more concern about the balance sheets of the US financial firms.