Just returned to the blog

Market is a mess.  Deflation scare coming.  More pain before the Central Banks turn on the money spigot.  Will it be enough?  Time will tell

David Walker

David Walker is on CNBC today and he is telling it like it is-the government is broken. Financial commitments are big and getting bigger. In fact, the commitments are massive-unfunded liabilities are 50 trillion at the low side of estimates and growing

More bottom callers

Bill Miller of Legg Mason fame is calling the bottom is in. This is the same fund manager who owns a whack of financials. Probably bot more in the last few days. On the other side-Dupont comes out today and says the economy stinks and will remain that way well into 2009. Dupont is in autos, construction and manufacturing . Freeport McMoran said the same thing yesterday. I knowinvestors have to look across the valley, unfortunately that valley is wide
The bottom will be in when Bill Miller and the rest of the long funds either lose their jobs, or they go bearish on the mkt. On top of that-Bill Miller suggests the US Federal Government should buy stocks to help the US consumer-or help out Wall Street and the Den of Thieves. Having the US Gov't (or PPT) buy equities is a plan fraught with disaster-but they are already doing it under the table. Bill Miller and his frat pack are so disconnected from Main Street that it is laughable.

As a prediction for tomorrows employment report-expectations are for 350-400k-I suspect the report will show that, BUT there will be a revision in January to a much larger job loss. The central planners are out in full force.

Debt Markets remain the key

The debt market remains the key to the markets. The spreads between mortgages, corps, junk and municipals to Treasuries are at extreme wides. RISK is a four letter word. With hedge funds seeing massive redemption requests and mutual funds seeing sales requests, selling pressure remains intense. What do hedge funds own-spread product. The carry trade overheated and is still unwinding. This is the Tech Wreck 2000 Redux. No traditional asset manager wants this rocket science product. They are protecting their job, their assets, and their scarce capital. The unwind will take months if not years.
Banks are not lending as their balance sheets are a disaster. Who knows what they own off balance sheet. There will be short covering rallies as the calendar moves through year end, but the business model for the financials needs to be revised. Gone are the days of the wealthy and not so wealthy paying up for a piece of the action. Slow growth is the norm.

The list of Problems Grows

Where to start. Since my last post, the global economy has tanked. No bounce-straight down. Announced job cuts are growing day by day. Today we have AT&T 12k, Dupont 2.5 K, plus several other smaller ones. It is getting nasty.
Today, the big 3 go back to congress with tin cup in hand. The US gov't is becoming the owner of more companies-can you spell socialism. This is getting ridiculous. The financial sector is getting massive amounts of capital to stay alive. The big 3 are next. Soon the airlines and homebuilders will be lining up for gov't money. The only problem I can see is where is all this money going to come from. I am not even including the unfunded liabilities regarding social security and medicare. The states are now following-California is struggling with a 10+ billion deficit. Of course the typical response from the political circles is borrow more money, and kick the can down the road. How many times do we have to do that to realize the next generation is not going to enjoy the current standard of living. Planet ME and I want it now generation is driving the economy over the cliff.
Financial Reckoning Day is rapidly approaching.
Despite this, US Treasuries are yielding absurd levels on the pretense of the gov't buying FNM and FRE bonds, plus US Treasuries. This known as monetizing the debt. This could turn out like Iceland-the bonds stay the same price, but the currency becomes virtually worthless. In fact all fiat currencies are in a sad state of affairs.

Solving the US crisis

In the immortal words of Walter Ruether-'That's great Henry (Ford), now who are you going to sell your cars to'

Executives better realign their moral compasses and realize that shipping jobs off shore to low wage countries is killing their consumer base. Low wage countries buy basic necessities, not luxury items. In addition, CEO compensation of 500X the average employee pay is ridiculous, as it was at 300X and 400X. Maybe the top brass should take a pay cut and come down from their exalted ivory tower.

Going forward, I suspect the democrats to implement policies that are going to be hard on the wealthy. Whether or not some 'income redistribution' takes place via gov't actions remains to be seen. But given the fat cat pay packages on Wall Street being slashed, expect to see all sorts of layoffs in the staf of these people. No more trickle down economics.

Hedge Fund Implosion

Hedge funds remain in liquidation mode: Important dates going forward

Nov. 15: Last day to announce the intention to redeem for Nov. 30.

Nov. 30: Yr end for Goldman and Morgan Stanley, plus hedge fund liquidation

Dec. 31: YR end-tax loss selling, capital gain crystalization.

US Unemployment

In true US Gov't fashion, the employment report shows a drop of 240K for October. But more important, a massive downward revision to August and Septemeber. Gee, was there an election this yr-u betcha. Workforce increased 800k, and of the 800k-600k were unemployed. Finally the US is getting back to reality. Expect large revisions to q3 GDP and for the recession to be dated for early 2008. Once again the rear view mirror is crystal clear with the gov't.

Going forward-expect to see an unwind of all the Republican efforts to make the economy better than what it was before the election. That ploy failed miserably-maybe the gov't will learn that doctoring/shading numbers is a failed strategy and will only affect short term decisions. Unemployment rate up to 6.5%-proabably on its way to 8-8.5%. One bright spot-avg hourly earnings up slightly.

FACT: The largest economy is in a tailspin. NOW that the truth is out and the disease has been identified, maybe the proper treatment can be administered.

As an aside-part of the large revisions is due to reduced government employment. Deficits do matter Mr. Cheney.

GE and Buy Backs

Last week GE released an earnings update-they would miss the ANALYSTS expectations. They maintained their dividend, but they cut their share buyback program. How much have they bought back over the last 5 yrs and what was the average price. According to their annual report, GE purchased 13.9 bln of stock (357mm shares=avg. cost of 38.9) in 2007. In 2006, GE purchased $7.8 bln of stock (229 mm shares=avg. cost of 34.06). Today they issue 12 bln of common stock at $22.50. WHAT is WRONG with this picture. Very simply management is inept-buying high and selling low. Instead of paying down debt and giving shareholders a bigger dividend, GE wasted its capital buying back shares that were issued under employee/executive pay programs. The more complicated the books, the more likely their is some dirty laundry in the mix. On top of that, Warren Buffett continues to build his cash spinning empire by buying a special class of preferred shares (10% dividend yield) plus warrants thrown into buy the common shares. Sounds to me like another round of expensive financing ala Goldman Sachs.
On a positive note, LIBOR dropped to 4% today from 6%, so all those short term LIBOR based loans are a little less expensive today. Let's see how long this lasts.

Solving the problem

Either the world deflates as in 1929, or the world infltes like 1923 Germany. I suspect 1923 will be the choice .

The Day After

Mkts cratered yesterday as the spineless and undercapitalized/over leveraged mkt participants were all leaning on the bailout going through. Call it a rescue package or whatever, but it does not help the average US citizen. In fact, the homeowner up to his eyeballs in debt is in the drivers seat. They can just stop paying their mortgage and and then wait for the bank to try and foreclose-good luck as the bank probably has no paperwork regarding the titile to the property. The mortgage has been packaged and re packaged and probably repackaged again. It will take months if not years to put all the pieces back together. Wait unitl the majority of subprime borrowers and then Alt-A borrowers and then credit card borrowers and then Auto borrowers go through the same process and then realize that if they stop paying, the banks/financial institutions have recourse only to the pledged asset. Given that the pledged asset is upside down, highly unlikely the banks are in a rush to take the asset back.

Fireworks

Listening to the Financial News on the MSM, one would think the world is coming to an end. Maybe the financial world, but not the real world. In a capitalist society, bankruptcy is necessary to reign in excessive risks. Thw wise and strong will survive, while the ignorant and weak wither. For the last 8 yrs, risk control has taken a back seat to greed. Now the opposite is happening as risk control has shifted to the other side and fear reigns supreme. How long this lasts is anybody's guess. The 'Free' Market will sort it out eventually, but the markets have been anyhting but free in the last 12 months. Heavy PPT intervention, followed by excessive rule changing has completely screwed the system up. Let the Mkts work-set the interest rate, provide liquidity and then help the players build a solid base to continue business. The fact is that when the retail investor has been duped into buying stocks that are supported by a 25-1 leverage ratio-bad things happen. There are some great investments out their right now, but with capital short and tied up in illiquid and junky assets, it can not migrate to the better investments. The Paulsen plan would help free up some of that capital, but it is being bogged down in Congress as the cost of the plan is being difficult to sell. The US gov't has abandoned the middle class in the last 8 yrs while pandering to the rich. The gall to ask for taxpayer funds to support the Fat Cats is ridiculous. Let the mkt work it out-sure there will be bankruptcies, but that is life. The sun will rise in the East and Set in the West-life will go on, but it will not be as nice as it was when money and credit were cheap and esy to get.

Fed Losing Influence

One thing to note that is being downplayed by the MSM is that the Treasury had to go to the market for more money to initiate some of its programs. The US FED is raising NEW MONEY to pay for these bailouts. In the past the FED was able to use its existing balance sheet to bailout financial institutions or influence the mkts. More fund raising required.

An early morning Saturday note is the Pres. Bush has just requested Congress to raise the National Debt limit to 11.3 trillion from 10.6 trillion. This is after Paulsen and Bernanke had the debt limit raised form 9.8 trillion to 10.6 trillion for their rescue plan for Frediie and Fannie (also AIG). The ink is not even dry on the proposals and the price tag is rising (just like oilsands projects). In the last 2 months, the National debt limit has been raised from 9.8 T to 11.3 T or 15% (1.5 T total). If it was not so sad, it would be funny. To put it into context, each and every US citizen has just gone $5,000 deeper into debt.

Saturday Notes

Capital markets rally huge on Friday as the World Gov'ts intervene in the mkts. Banning short selling in the finacials resulted in a massive short squeeze. Other events-guaranteeing MMKT funds, creating a RTC and/or RFC type gov't agency to take the bad debts off the banks balance sheet. What has become clear in the last month is that US Financial Institutions are a protected species. They are also an endangered species are on the protected list-NO HUNTING US BANKS.

Interesting timeline. IN 2004 the SEC granted 5 US Broker Dealers with the ability to leverage themselves up from 10-12X to 30-40 X. Who were they-Bear Stearns, Lehman, Merrill Lynch, Morgan Stanley, and Goldman.
3 of the 5 have blown up or been married off. If that was not bad enough, the top talent from these firms went off to set up hedge funds which in turn were levered 20 to 40X. So the capital pyramind not only get bigger, but it almost got more unstable. NOTICE the SEC created this mess and the greed on Wall Street amplified the mess. Was this a plan by the NEOCONS to finance the US economy. This entire leveraging experience is going to unwind. The process is 1/3 to 1/2 way through.

The FEDS are taking the inflation way out. Instead of letting asset prices fall to a clearing level-DEFLATION, they are going to maintain asset prices by deflating the value of the USD. All of these plans by the government are going to require new debt to be issued and new money to be created to pay for this. The US TAXPAYER is going to get creamed in the next decade. The US is going to muddle along for years as the excesses are unwound. The fraud is coming out and it is just like ENRON and Worldcom-only larger. Interest rates are going a lot higher as they full faith of the US GOV'T has been compromised. Foreign investors are skeptical of the US Gov't actions. The theory it will never happen due to mutual economic destruction (similiar to the Nuclear arms race) is now toast. The Chinese, Middle East, and Europeans are going to build their domestic economies up and stop relying on the US for there products. The Chinese have 1.2 Trillion of reserves and part of that is going to be used to maintain a positive domestic economy.

Hang on-my fearless forecast: Interest rates, Precious Metals up, oil prices flat at 80-120, copper up (due to the electrification of global economies), base metals down to flat, food crops up as the third world wants to eat, stocks down as the higher interest rates will decrease the multiple investors are willing to pay. In addition as the demographics swing to a retiring population, the asset mix is going to favor fixed income/dividend products. Corporate bonds are trading at wide spreads as default rates rise. If 5 yr corporate bonds are yield 6%+, why buy equities?

Is anything safe?

The US government is confiscating companies left and right. What is next after Fannie and Freddie go down. AIG is bailed out, Lehman obliterated, and Merrill forced to marry Bank of America. When the smoke clears in a year or two, the strong will be stronger and the weak will be dead.

GOLD vs OIL

Here is the quandry, which asset goes up the most in a reflationary cycle. I thought it would be oil, but have been switching back to gold as oil is more economically sensitive. Storing gold is infinitely cheaper than storing oil.

The ratio has been swinging in gold's favor the last week so it bears watching.

THE United Socialist States of America

The US Government is out of control. Banning Short Sales of 799 Financials for 10 days (over qtr end funny enough) is another act of desparation. The unwinding of trillions of OTC CDS contracts is causing massive balance sheet distortions. Insurance companies thought they had is not necessarily there-hence forcing asset right downs. What a CON JOB.

The reflation trade is taking place. Printing money to buy garbage assets-bailing out banks and bank execs. With no shorting of financials, it gives the remaining executives a chance to unload their shares before they get the Bear Stearns and Lehman treatment. Gold is going to soar after the Exchange Stabilization Fund has shot its last bullet.

The US Government finally acknowledged the existance of the ESF as it will lend 50 bln to insure money market funds. The LIBOR rate has yet to drop below 3%. That is key as it should trade 20-30 bps over funds. It has been trading around 2.80 over the last 2 weeks, so things are still uncertain in financial circles.

China cuts rates

In what maybe the start of looser financing in the overheated kingdom, the BOC dropped interest rate 27 bps last night to 7.20%. Also they lowered the reserve requirements by 1% for the smaller banks-larger banks get no break.
Fed meeting tomorrow-rumors of a 25-50 bp rate cut-I think unlikely, but I suspect DOVISH talk and another liquidity injection.

Is there enough blood yet?

The bankruptcy of Lehman, followed by Merrill being acquired by Bank of America, and AIG desparately seeking capital. All equities are for sale as the realization that they actually do go to zero is resulting in a repricing of risk. Good, BAd and purely awful stocks are for sale-no buyers of substance. Expect more selling tomorrow as the mutual fund redemptions get exercised.
Some of the losses are truly amazing as the lack of capital across the spectrum is hampering any buying. The Hedge Funds-especially the undercapitalized ones are getting squeezed.

SEC is making comments about short selling -tightening the standards for short selling-trying to curb the abuse. Nothing like trying to influence the markets after the cow has left the barn. Unless there are serious consequences for 'illegal' shorts, they will continue.

Gold up, but not by much-only 2%. Oil crushed as the reality of a prolonged economic slump takes hold. Waiting for a supply response to the demand drop. Already hearing chatter about some oil sand projects being shelved. Treasury bonds are getting bid to the moon as the flight to safety continues. USDX is up as the USD benefits from the return of capital to the US-all the emerging mkts are under pressure as deleveraging continues. Not sure about property rights in emerging markets.

Stay tuned, the beginning of the end is near as the panic level is rising. Maintain capital.

Killing the Golden Goose

In what amounts to a huge amount of irony, the hedge fund mavericks have killed their golden goose. By attacking the Wall Street IB and the weaker financial institutions (small regional banks), they have effectively shut off the flow of blood to their brains-ie cheap financing. These funds have put short term gains ahead of long term plans. Now they are being forced to reduce their positions, take losses and hence be below the high water mark and hence no bonus payments. What a bunch of 2 qtr mgrs. The hedge fund community has cut off their noses to spite their face. Good bye multi million $ penthouses, hello to 2 bedroom apartments in Brooklyn. Wall Street is going to feel the pain for yrs to come.