Financial Review

Laissez les Bons Temps Rouler

Sinclair Noe — January 26, 2016

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DOW + 282 = 16,167
SPX + 26 = 1903
NAS + 49 = 4567
10 Y – .03 = 1.99%
OIL + .11 = 30.45
GOLD + 11.80 = 1120.70

The Federal Reserve had always planned to pause after raising interest rates in December, but the question now is how long that break will last. Initial expectations were that the FOMC would raise rates again this March, but a downturn in the equity markets, a stronger dollar and weak inflation have led some to predict that another move may be months away. Investors may get some more insight as Fed officials gather today for a two-day session, their first policy-making meeting of 2016.

For now, the Fed can simply say that they are data dependent and the 25 basis point increase in December has not had an effect on the economy. They might say that everything is basically good in the economy and the markets, if they get any mention at all, are just not looking at the right data.

In a recent speech, Federal Reserve Bank of New York President William Dudley summed up the situation:
“In terms of the economic outlook, the situation does not appear to have changed much since the last [Federal Open Market Committee] meeting. Some recent activity indicators have been on the softer side, pointing to a relatively weak fourth quarter for real GDP growth. But this needs to be weighed against the strength evident in the U.S. labor market.

I continue to expect that the economy will expand at a pace slightly above its long-term trend in 2016. In other words, I anticipate sufficient economic strength to push the unemployment rate down a bit further and to more fully utilize the nation’s labor resources.”

But the Fed is not unanimous in its confidence. St. Louis Fed President James Bullard, a noted hawk of late, was more cautious given five-year forward-inflation expectations. Bullard told reporters after his speech that strong U.S. employment would argue that the FOMC’S median projection of rate increases totaling 1 percentage point this year is “about right,” while inflation and price expectations concerns “would tend to push off rate increases.” Bullard said he would put more weight on expectations if they continue to decline.

The bottom line is that the Fed does not know if the economy will slip into recession, or if the economy will stabilize and the markets continue to act crazy, or if both the markets and the economy stabilize. And so tomorrow the Fed will try to act like things are basically on track and their eyes are wide open.

Once again oil prices were leading equity markets on news that Kuwait and Saudi Arabia want to stabilize oil prices, which means they want to cut production; more specifically they want non-OPEC producers to cut output, which probably won’t happen. Anyway, that’s today’s justification for a more than 6% jump in oil intraday, which follows yesterday’s 7% decline, which follows last week’s three-day 21% rally in oil.

And some people think there is no money to be made in $30 oil. Wrong. No money for the producers working in the field, but for the speculators, “laissez les bons temps rouler”, let the good times roll. Is there any reason behind these wild swings? Did the rules of supply and demand expire? Have the fundamentals changed from last Tuesday to today? Nope.

So, this raises the question of whether low oil prices can push the economy into recession. Well, there is no history of that. A drop in oil prices means less money in the hands of oil producers but more money in the hands of oil consumers. Currently the U.S. is importing about 5.1 million barrels a day more than we’re exporting of crude oil and petroleum products. At $100 a barrel, that had been a net drain on the U.S. economy of $190 billion each year. That drain that will now be cut by more than half by falling oil prices.

We usually see consumers spend their extra income right away, whereas it takes more time for producers to alter their spending plans. As a result, even if the U.S. was not a net importer of oil, we might still expect to see a short-run positive stimulus from dropping oil prices. The actual change in overall consumption spending in response to the oil price decline through March of last year was about 0.4% smaller than would have been predicted on the basis of the historical correlations. But we see something different when we look at the behavior of individual consumers.

A study by the JP Morgan Chase Institute compared the response to lower gasoline prices of people who had previously been buying a lot of gasoline with the responses of people who had been buying relatively little. They found that the first group increased spending relative to the second, with the magnitude of the difference in spending between the two groups consistent with the claim that consumers spent almost all of their windfall.

In any case, we’ve now had plenty of time for cuts in spending by U.S. oil producers to start to have an economic effect of their own. If there’s an increase in spending by consumers of $1 and a decrease in spending by producers of $1, it’s really a net wash for the economy, just spread out in different places.

The S&P/Case-Shiller 20-City Composite Index rose 0.1% in the three months ending in November, for a 5.8% yearly increase. That was up from a 5.5% yearly gain in the period ending in October, and marked the strongest reading since July 2014.

Phoenix home prices were up 0.3% for November, and up 5.9% for the 12 months ending in November. At the peak, prices in Phoenix were 127% above the January 2000 level. Then prices in Phoenix fell slightly below the January 2000 level, and are now up 55% above January 2000 (55% nominal gain in almost 16 years).

The Conference Board reported that consumer confidence rose to 98.1 in January from a reading of 96.3 in December, and the best reading since October.

China’s stock market crashed to a 13-month low. China’s Shanghai Composite plunged 6.4% to its lowest level since December 2014. The telecom and IT sectors were hit the hardest during Wednesday’s rout, tumbling 9.6% and 8.7%, respectively.

The big news in earnings came after the closing bell; Apple posted $18.4 billion in net income on sales of $75.9 billion in the December quarter. Earnings per share were $3.28, or 5-cents better than estimates. Holiday sales of iPhones rose to 74.8 million, which was below estimates, and the best guess is that everyone who wants an iPhone has one. Revenue in the first three months of the year will be $50 billion to $53 billion, the first quarterly drop since 2003 and below estimates.

Apple said the strength of the U.S. dollar against foreign currencies is trimming revenue. What would have been $100 in sales in the fourth quarter of 2014 is today worth only $85 because of the shift in currency-exchange rates. The smartphone industry is transforming. The entire planet is becoming connected one sensor at a time. So, it is less important how many individual products Apple sold, and more important to understand how they are or are not transitioning. Apple up slightly in after hours.

Freeport-McMoRan posted a loss of $4.1 billion, or $3.47 a share, in the quarter, after a loss of $12.2 billion, or $11.31 a share, in the year-earlier period. On an adjusted basis, results topped estimates.  Revenue fell to $3.8 billion from $5.2 billion, matching estimates.

Lockheed Martin will separate its government information technology business and combine it with national security firm Leidos Holdings in a $5 billion transaction, a move to shift the contractor’s focus to its core aerospace and defense units. The news came as the company lifted its sales guidance for the year after easily topping fourth-quarter expectations, thanks in part to a recent acquisition and F-35 jet fighter production contracts.

In other earnings news:  D.R. Horton dropped after reporting slowing price gains. Halliburton was down following a big drop in Q4 revenues. Kimberly-Clark lost more than 3% after guidance fell short. 3M, Johnson & Johnson, and Procter and Gamble all reported better than expected profits. Coach reported its first increase in sales in 10 quarters.

American International Group, AIG, said it would spin off its mortgage insurance unit, cut jobs and sell its broker-dealer network as part of an overhaul promised to shareholders to fend off activist investor Carl Icahn. The insurer said in a statement that it plans to cut $1.6 billion of costs and return at least $25 billion to shareholders over the next two years. In a separate filing, AIG said it had frozen its pension plan and let about 300 of its “top 1,400 employees” leave. Further job cuts are planned this year.

JPMorgan has agreed to pay the remnants of Lehman Brothers $1.42 billion in cash to settle most of the failed investment bank’s $8.6 billion lawsuit over claims that it illegally siphoned billions of dollars from Lehman before its collapse. The payment doesn’t settle every claim, but resolves the bulk of the suit, and allows post-bankruptcy Lehman to make another $1.5 billion distribution to its creditors. The settlement is not expected to have a material impact on JPMorgan’s upcoming results.

Huntington Bancshares has agreed to acquire smaller rival FirstMerit for $3.4 billion in a tie-up of two Ohio-based lenders. Regional banks have seen a steady consolidation since the global financial crisis.

Tax inversions are still on the loose. Johnson Controls is set to become the latest American company to move abroad in search of savings upon merging with Tyco and taking on its Irish tax address. The deal is at least the 12th inversion since the U.S. Department of the Treasury moved to curb the tax-reducing deals in September 2014 – roughly the same number in the 16 months before the legislation.

Wednesday, April 30, 2014 - Record Highs in First Gear

Financial Review with Sinclair Noe

DOW + 45 = 16580.84 (record close)
SPX + 5 = 1883
NAS + 11 = 4114
10 YR YLD - .04 = 2.65%
OIL – 1.59 = 99.69
GOLD – 4.60 = 1292.30
SILV - .29 = 19.25

Back on December 31^st, we finished the old year with a record high close on the Dow Industrial Average at 16,576; since then the index has bobbed up  and down, briefly hitting an intraday high of  16,631 on April 4^th, but on that day we finished in negative territory. Today, a record high close. The S&P 500 is closing in on the record high close of 1890, but not today.

Now, when you hear the Dow is breaking records, you might think the economy is roaring, cruising along the highway in fifth gear. You would be wrong; the economy is stuck in first gear and the clutch is slipping. The Commerce Department reports the economy expanded at a mere 0.1% annual pace in the first three months of the year, one of the weakest rates of growth in the nearly 5-year-old recovery.

A slowdown had been expected due to the harsh winter weather that froze business activity across a large swath of the country, but this report was worse than expected. The gross domestic product had been expanding at a 3.4% pace in the second half of last year. No worries, the weather has warmed and everything is returning to normal. Yeah, not exactly.

There has been a rebound in the monthly data for March but there have been some disappointments as well. On the positive side, households have pared down some of their debt, credit is a little more available, and consumer spending should bounce back. Even the 2% growth in consumption spending is not all that encouraging; 1.1% of that consumption growth, more than half, was attributed to higher household expenditures on health care.

Home construction is likely to pick up speed as the weather improves, but the housing market seems to be slowing down, with reports this week on new home sales turning soft and existing home sales turning negative in many areas. Residential investment has been negative for 2 quarters. The housing market probably won’t deliver much horsepower as the engine of economic growth but it should be a little better than the winter months, when many parts of the nation were frozen.

An area of concern is business investment, as company spending on equipment fell in the first quarter, and the 3 quarter average is barely positive. The change in inventories subtracted 0.57 percentage points from growth in Q1, exports subtracted 0.83 percentage points. The outlook for trade is soft; the US is not immune to weakness overseas; China’s economy has slowed; there are problems in the Eurozone; and emerging markets are still struggling. Meanwhile, incomes have flat lined and unemployment remains unpleasantly high.

On Friday we’ll get the monthly jobs report. Today, we got a preview from ADP, the human resources firm, and their data shows the economy added 210,000 jobs in April. The ADP report showed hiring picking up in nearly all industries and company sizes; it just isn’t picking up at a real fast pace.

The Federal Reserve FOMC wrapping up their policy meeting and they issued a statement that they will keep policy on the same track; interest rate targets are unchanged and the taper continues with another $10 billion in large scale asset purchases cut this month, to a mere $45 billion a month. The central bankers said that economic activity “slowed sharply” earlier in the year but noted it has “picked up recently.” And “The committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.”

The disappointing reading on economic growth earlier in the day underscored how bumpy the road back to normal can be. The FOMC statement repeated language from its last meeting in March stating that it will consider the country’s realized and expected progress toward full employment and 2% inflation in determining when to increase rates. The Fed also reiterated that it will take into account “a wide range of information,” including the health of the labor market, inflation pressures and financial developments. In some ways, you could look at the continuation of the taper as a vote of confidence from the Fed. Fed policymakers have said that the phaseout of bond purchases is not on autopilot; the Fed can speed it up or slow it down, depending on how the economy progresses, but apparently the weak GDP number today was not convincing enough to alter expectations; or maybe GDP falls outside the Fed mandate of price stability and maximum employment, and maybe it isn’t something they should specifically pinpoint. Of course, if the economy turns south, they will have to deal with it.

Many Americans are still wondering when the recovery is going to start, but by economic measures, the economy stopped shrinking and started growing in June 2009, the official start of the recovery. That was 58 months ago. Since 1945, the average length of a business-cycle expansion has been 58 months. So if the current recovery continues, it will end up being longer than average, not to mention much weaker. And today’s GDP number was right on the edge of recessionary. The cold weather excuse only goes so far. Already in the second quarter we’ve had deadly and damaging tornadoes, and as the weather continues to warm, we’ll deal with the effects of drought. You have to wonder if the economy was plagued by more than just weather last quarter.

That doesn’t mean we are now entering a recession; we may be close but we aren’t there yet, and we may still rebound, but this affords a good opportunity to think about how you might handle the next downturn in the business cycle. The stock market was up today, and in light of the GDP report, you have to wonder about stock valuations; the earnings reports haven’t afforded much to cheer. Are you still buying or are you looking to sell into strength.

Since Q4 2011, the average peak-to-trough pull-back on the Dow has been roughly -6%, with no correction exceeding -10%. One may ascertain that a "buy-on-the-dip" mentality remains pervasive among equity investors. So why not add to long, risk-on positions once again? Could this pull-back be different? Aren't stocks "the only game in town" with the excessively accommodative Fed monetary policy?

And while you consider market risk, don’t forget the old idea of the best and worst six months in the stock market; we’re entering the worst six months by the way. The old adage "Sell in May and Go Away", warning investors of a seasonal decline in equities, is often attributed to summer vacations and decreased investment flows relative to winter months. According to the Stock Trader's Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period. 

When we look at the 13 cases since 2001, the strategy of selling out just before May would have given rise to successful trades in 9 cases, or about 70 % of the time. Moreover, we observe that the "Sell in May" strategy has not failed in two consecutive years since 1992-1993. Given that "Sell in May" failed in 2013, we estimate the odds for a seasonal decline are even higher for 2014. This is not a perfect indicator, but there are not perfect indicators. You have to think that anybody who doesn’t recognize the odds is just trying to sell you something.

And on the question of valuations, at 18 times forward earnings for the S&P 500 and 36 times forward earnings for the Nasdaq, US stocks are generally closer to the high end of their range; that seems a bit pricey compared to emerging markets with 12 times forward earnings. Still, somebody was buying today, at least enough to push the Dow to a record high close. Investor optimism for US stocks has been trending up since the end of 2011, reaching an extreme level in January. Of course that would be a contrary indicator. There are plenty of voices telling you to stay the course, or even buy, and then buy some more. I’m just saying it is important to consider the possibility of selling into strength.

Investing through the summer fog of 2012

The economy continued to throw off mixed signals for the month of July, whipsawing traders and making investors even more squeamish and paranoid about where to tuck their wealth.

Added to this seesaw of economic data from everything from July's consumer confidence of 65.9, up from a revised 62.7; the July Chicago PMI of 53.7 up from 52.9.

The May S&P Case-Shiller HPI 20-city M/M rose 0.9%, however, the Yr/Yr fell 0.7%. The June New Home Sales figure fell to 350k from a revised up 382,000. The M/M Pending Home Sales Index for June dropped -1.4% from a revised downward 5.4% increase.

The Richmond Fed Manufacturing Index for July fell from -3 to -17. Conversely, the Empire State Manufacturing Survey, Kansas City Fed Manufacturing Index, Philadelphia Fed Survey all improved from the previous month.

The Dallas Fed Manufacturing Survey, consisting of a Business Activity Index and Production Index, found both indexes falling.

The knowledge that short-term markets are driven first by news headlines and central bank policies rather than primarily macro and macroeconomic data forces a perverse reaction onto the market in this unfamiliar climate we find our capital in.

Deteriorating economic statistics brings hope, by some, of additional stimulus measures from the Feds. Today, August 1, the Feds may shed some light onto their contingency plans, if there are any plans, for supporting a decaying economy between now and the November elections.

If Quantitative Easing III (QE III) or some variation of yield repression doesn't materialize from the Feds, markets will have an excuse to move lower, decaying as well.

Secondly, European Central Bank President, Mario Draghi, kicked off last Thursday's stock market rally by stating that he will do whatever it takes to save the Euro. A quick recap; in theory, generally, saving the Euro and the EU requires capping rising Spanish and Italian debt yields by the ECB agreeing to purchase their sovereign debt.

Because of inflationary fears, many German politicians, including Chancellor Angela Merkel's coalition government, vigorously oppose this action and similar bailout schemes. Two days ago, Monday, Treasury Secretary Timothy Geithner met with German Finance Minister Wolfgang Schaeuble and Mario Draghi, reaffirming their commitment in solving this crisis.

On Thursday, the European Central Bank will hold another policy meeting to find common ground. If the meeting fails to produce the proper response in the eyes of the market, this too will reverse last week's rally and send the market lower.

A third item that will send stocks lower in August, extending the S&P 500 incarceration in the current trading range between 1,099 and 1,419, if the realization sinks in of the draconian effects of federal budget automatic sequestration.

When austerity begins appearing in budgeting decisions in government, and workers begin preparing for possible layoffs and downsizing by reducing personal spending, and when businesses relying on government contracts to purchase their goods and services recalculate their cash flow and revenue, GDP will decline.

The May 2012, G.19 Federal Reserve Statistical Release, dated July 9th, shows "consumer credit increased at an annual rate of 8 percent in May. Revolving credit increased at an annual rate of 11-1/4 percent, while non-revolving credit increased at an annual rate of 6-1/2 percent." It's hard to imagine this type of credit activity continuing in the third and fourth quarters of 2012.

Our anemic economy grew 1.5% in the second quarter, down from 2.0% in the first quarter, with major help from consumer credit. Subtracting significant credit in the third and fourth quarters will exacerbate any weakness.

Individual savings rates were reported up 4.3%, annualized, in the first three months of this year, starving an already malnourished economy of vital disposable income. The minuscule interest currently being paid on savings is also problematic for an economy in need of greater money supply velocity.

An economically weakened Europe and a weakening China will inadvertently push the US economy over the edge unless smaller emerging markets can somehow re-accelerate the global economy while avoiding the developed nations' debt contagion.

The final culprit with the motive and opportunity to assassinate the economy is stagflation. As 2012 futures' prices on corn, oats, soy beans, and wheat reached multiyear highs, 1,300 counties spread over 29 Midwest states have been declared natural disaster areas by the USDA.

In the 1970's, President Richard M. Nixon imposed wage and price controls in an attempt to snuff out stagflation and inflation. President Gerald Ford attempted to talk down inflation with a Whip Inflation Now (WIN) campaign, complete with WIN buttons. Inflation ran rampant throughout the 1970's until a new Sheriff rode into town in 1979.

The newly appointed Federal Reserve Board Chairman, "Tall" Paul Volcker, ended inflation by jacking up short-term interest rates to 22%. Although, lifting interest rates to nosebleed levels induced at the time the deepest recession since the Great Depression, inflation did not return.

Another smart decision made by the government at the time was issuing callable long-dated treasury bonds and zero coupon bonds to minimize interest expense. This morning, Treasury announced it is investigating issuing floating rate notes; while interest rates are lower than they have been in the past 100 years. I'm puzzled by such a decision.

This earnings' season, restaurants such as McDonalds (MCD), Chipotle (CMG), Buffalo Wild Wings (BWLD), have admitted to struggles with cost inputs, missing earnings estimates, and are now lowering guidance for upcoming quarters. Food suppliers like Hormel Foods Corporation (HRL), Tyson Foods, Inc. (TSN), and Smithfield Foods, Inc. (SFD) are experiencing these headwinds, as well.

Brent Crude oil is priced north of $100 dollars a barrel. Members of OPEC require the price of oil to stay north on $80 dollars a barrel to maintain political stability at home. That price level is in conflict with jump-starting the global economy that is continuing to deleverage from the previous decade.

Regardless, if the price of oil should rise or fall short-term, the global economy will be petroleum-based for decades to come. Therefore, an essential building block for any inflation defensive portfolio requires an integrated oil company such as Exxon Mobile (XOM) or Chevron (CVX).

One final thought; although, we have experienced deflation in many things since 2008, technology, of course, real estate and virtually any asset requiring financing, and the cost of capital itself, this economic period will end, too. And once more, we will again face and fight inflation.

Unappreciated is the two-stage intermediate step between deflation and inflation – stagflation. Ben Bernanke has spent years and trillions of dollars attempting to re-inflate asset prices. One day he will succeed. At that point, Stage One, the rising cost of living, or cost-push inflation kicks in, whereby, too few dollars are available for rising prices.

Stage two of the stagflation equation is flat wages and personal income. Whether one draws a paycheck from a job or clip coupons from investments, purchasing power begins contracting, not growing.

This reality of less disposable income relative to prices, combined with an aging population and extended life expectancy is a recipe for structural economic arrested development until we surrender to full-blown inflation in future years.

Politicians will feel obligated to rectify the former condition and then, the more radical and dangerous phase of inflation occurs, demand-pull, leading to too many cheapened dollars chasing too few goods.

Confidence or the lack thereof, in a nation's currency, is the thin line straddling inflation and hyperinflation.

And, it is here, that your portfolio of hard assets such as gold and silver, agricultural commodities providing food security, natural resources such as land, timber, water, energy, selective adjustable rate debt, and very selective stocks, will pay off for the patient, long-term, investor during inflationary times.

The Second Quarter T.K.O.

Friday morning the big number, the BLS Employment Situation, landed with a thud. The unemployment rate drifted down to 9.5%, private sector jobs increased by 83,000, the non-farm payroll employment loss was 125,000 and the birth/death rate adjustment figure was 144,000. Government jobs shed 90,000 and 652,000 job seekers left the market. Two-hundred twenty-five thousand temporary census workers were let go. The average workweek fell 0.1% to 34.1 hours and the average earnings also fell 0.1%.

Before we pick up our swords and shields in the third quarter to do battle for gains and profits with a rising Euro, a weakening dollar, massive state and local spending cuts, possibly minimum wage wages for California state employees, a chronically ill housing market, fugitive employment and falling consumer confidence, let’s review the barrel we found ourselves spinning in throughout the second quarter.

The second quarter was one of the most brutal trading quarters I have seen in 27 years, in investing. Here are a few second quarter headline stats from the WSJ MarketBeat Blog: for the DJIA - down 1082.61 points, or 9.97% to 9774.02, the worst quarterly performance since 1st Quarter 2009; S&P 500 Index - down 138.72 points, or 11.86% to 1030.71, the worst quarterly performance since 4th Quarter 2008; and NASDAQ - down 288.72 points, or 12.04% to 2109.24, the worst quarterly performance since 4th Quarter 2008.

These loses are comparable to those we experienced when we were in the thick of the meltdown. Unlike the express elevator to hell we were trapped in the last half of 2008 and the first quarter of 2009, this was a Six Flags rollercoaster ride that took our cash, our lunch, and our sanity. Investors should not hold their heads down in shame. Professionals did not trade this quarter well either. If this quarter had been a boxing match they would have stopped it. This was not an investors’ market and the last week in the quarter told the story.

Referees stop fights when fighters can no longer protect themselves in the ring. Boxers cannot block punches, jab, counterpunch, move on their feet, or throw a combination. Their eyes have a glassy stare. They are unaware of their circumstance.

The last week of the month and quarter is for profit taking and window dressing. Markets are purposely traded. This market, this week, responded not at all based on its whereabouts. Compare the first quarter to the second quarter.

In the first quarter, the market rallied from the start of the year until January 19th. It sold off until the first week in February. Then, it counterpunched and fought it way back to new yearly highs to end the quarter. The beginning of April saw the same fight in the market. A rotation in sectors kept the market moving forward. Traditional punches landed but did little damage to the rally.

Before the second quarter bell ranged, on March 29th, the 7-year Greek auction bombed. On April 19th, the yield spread between Greek and German bonds hit 469 basis points. Then, on April 20th, the BP oil spill occurred. These events rocked the market. On May 6th, the flash crash occurred and markets never really recovered. The market staggered for the rest of May. Investors should have exited the market here. Money managers were tightly clenched throughout June by FinReg negotiations in Washington. Markets and investors set themselves up to win the second quarter on points with improving economic data being released this week. The improvement in the economy did not materialize.

A market hurt and running out of gas whose only hope of surviving was avoiding any more blows and to catch a break. Luck turned out not to be a lady, but rather, a loud, nasty, violent drunk. The oil spill worsened with failed attempts to cap the well, accompanied by pictures of gulf coast estuaries being damaged, innocent wildlife being murdered, and the first hurricane to enter the Gulf of Mexico in June in 15 years. Also, actions of austerity around the world by governments – our allies - were counterproductive to the US economy recovery narrative. The Euro’s fall reversed. The unemployment picture did not improve.

The rally from the spring of 2009 was predicated on the assumption that economic recovery would support higher valuations. Without significant improvement going forward, the markets were overvalued. The only market that withstood the shots of international governmental policies, macroeconomic trends, and supply/demand curves was the mellow yellow – Gold. Au – 196.9665, which refused to be knocked out.

One of the most stunning championship fights in history was the 1965 rematch between, then, current Heavyweight Champion Mohammed Ali and former Heavyweight Champion Sonny Liston. For years, boxing fans argued about the “phantom punch” which knocked out Liston in the first round. Today, we’re still debating what caused the May 6th flash crash. The bottom line is that the explanation or truth for either event is moot; history has recorded Sonny Liston’s loss in a small auditorium in Lewiston, Maine and the 1,000 point drop within minutes did grave technical and psychological damage to the markets.

This third quarter market is no longer the same cyclical bull rally that began in the spring of 2009. The bell has rung, the secular bear is advancing across the ring and he is fighting mad.

Macro Economic Trend Outlook: January 2009

Happy New Year, everyone!  This is my first letter in several weeks.  Because the economic data reported in December was just plain awful, I decided to stop delivering the drip, drip, drip, of negative news and allow everyone to enjoy the holidays.

Now, that we are in 2009, I feel comfortable in resuming the transmission of data to describe the current state of affairs.  In a word – ugly – will be the operative word for 2009.  As you know, 2008 was the most brutal year, for virtually all assets classes, except for treasury and municipal debt.  Holding these specific assets, while our financial, banking, and credit systems imploded, not only protected your principal, they increased your account value.  Individual stock portfolios, mutual funds, ETFs, and so forth, meanwhile, experienced declines of 20, 30, 40 percent or more.

Last year’s margin call on global assets played havoc on the global financial structure to the point of its near collapse.  The forecasts and predictions for 2009 are grossly overly optimistic.  Analysts and money managers behave as if 2008 was a routine year.  Nothing could be further from the truth.  This year, the pain will appear from the beneficiary of ongoing de-leveraging; negative GDP growth and rising unemployment.  

Slipping Into Darkness

From October 29, 2008

The Federal Reserve Board today, at 2:15 pm, announced their obligatory 50 basis point cut of the Federal Funds Rate, from 1.5 per cent to 1 per cent. This is the latest action taken to assuage investors’ fears about the hydra-bear market that has engulfed all capitalism. A triple digit rally was quickly vaporized with an erroneous General Electric rumor concerning the company’s 2009 earnings.

What are not mistaken rumors are the disastrous economic data that continues to flow. On Tuesday came the U.S. consumer confidence index, by the Conference Board, reporting an all time low of 38, down from 68 the previous month. That same day, the S&P Case-Shiller home price index fell 1 per cent, in August from July, and 16.6 per cent, from the previous year. The Census Bureau estimates for the 3rd quarter of 2008, of some 130 million housing units, nationwide, 18.6 million stand empty; 13.8 million year-round, 4 million for rent, and 2.2 million for sale.

On Wednesday, Durable Goods Orders were reported a curved up .8 per cent versus an expected decline of 1.8 per cent. For Thursday, the October 25th week Initial Jobless Claims are announced. Expect a drop of 3,000. Why, I’m not sure.

A General Motors -Chrysler shotgun merger is one step closer to happening, according to reports. If completed, it may add an additional 25,000 auto blue and white collar auto workers to the unemployment line of fixed income investment bankers recently cashiered.

Employment is rising, however, in villages and hamlets across the land as Investment Advisors and Money Managers are deploying their minions to hotel banquet rooms and restaurant’s private cubby holes, armed with clever four-color handouts, PowerPoint Presentations, and empty explanations, as to why their propriety indicators and models could not see the greatest bear market since the Great Depression, sneak up behind them.

I have a feeling that the traditional holiday feathered vertebra – turkey; will not be served this Thanksgiving. Instead, investors will be dining, if they can still afford a meal, on black swan; only recently very, very popular fowl of spenders of others-peoples-money. Of course, it’s too late to sale stocks with portfolios down 30 to over 50 per cent. But, if these Money managers are wrong again, keep some Gray Goose handy.

Macro Trends Spell Doom for Banks and Their Profits

The rise and fall of debt is continuing without abatement. In the U.K., bankers refuse to write new mortgages. U.S. consumers are tapped out. Businesses are finding their cost of borrowing prohibitively expensive to continue certain lines of business, i.e. consumer auto leasing at Chrysler Financial, all the while asset-backed portfolio valuation is tenuous and overvalued, at best.

After 30 years, two generations of consumers and businesses relying on hyper-credit to generate an enviable lifestyle for the middle and working class, trumpeting painless capitalism – all winners, no losers, and endless increasing corporate profits, that bubble has burst.

This perspective should be viewed from two positions, first, historical and secondly, relative to global living standards. The U.S. is the largest economic engine in the world. Household debt has tripled in the last 25 years.

In 2008, the inability to service debt is akin to the credit depression of the 1830's. Europe in the 1820's became mesmerized with transcontinental travel by train and flooded America with credit. The term transcontinental attracted money then the way dot.com attracted funds in the 1990's. A land rush, sponsored by the government, coincided with this period. Between servicing the railroad bonds debt and the leveraged real estate debt, remaining disposable income left little domestic spending for growth. Expansion became contraction. The great depression of the 1930's was more a function of technological advances increasing output, relative to consumption, thereby collapsing demand.

Our savings rate is the lowest in the developed world. It has dropped below 1 percent. Yet, we also buy more things than anyone else using maximum credit. Credit cards, home equity loans, secured and unsecured personal loans, loans against retirement accounts; any loan that continues the buy now, pay later, merry-go-round, until recently, without question and interruption, was marketed and consumed. Ironically, brokerage firms' margin accounts, the villain of the stock market crash of 1929, is our most conservative usage of debt, today.

Currently, home equity, which rose on cheap capital and hid stagnate wages this decade, has reversed while its cost has risen. Homes that were once ATM machines only three years ago are being repossessed in the tens of thousands each month by banks. Equity in an individual's home once was his or her greatest investment. Servicing debt on growing negative equity is becoming harder to do, both financially and philosophically, for underwater consumers. Prosperity from the mirage of supply-side economics has vanished for the masses.

Looking back, in the 1980's, deregulation through supply-side economics redefined risk and value. In the 1990's, heretofore, imprudent levels of credit, a peace dividend from the end of the cold war in the 1990's, and the integration of cheap global labor, provided the west a temporary and significant head start re-imagining comfort and convenience for the working and middle class.

Looking forward, new banking regulations, regardless of the outcome of the November elections, will restrict the future of credit and leverage for commercial and investment banks. The defense industry peace dividend was consumed years ago by the endless war on terror. Wages in developing countries are rising, and so is the cost of limited natural resources. And, the true bill on previous runaway debt created and consumed in a lax atmosphere is past due.

We are heading into a global recession. The IMF projects at least $1 trillion in total write downs. Total U.S. residential single family home real estate value is expected to fall another 5 per cent to 20 per cent; easily another $1 trillion in value. Bankers are considering reducing outstanding credit lines in the next two years by at least $2 trillion dollars.

Yes, banks and their profits are in dire straits.

Weekly Review and Outlook: Deleveraging's Not Just for I-Banks

Like a wild jungle creature forced into a confrontation, but unsuccessful, this past week's stock market limped into the weekend, stunned, pensive, and little changed with Dow Jones Industrial Average [DJIA] closing at 11370.69, the Standard & Poor's 500 ending at 1256.76, and NASDAQ finishing its week at 2310.53. The Dow lost 125.88 for the week. Likewise, the S&P 500 dropped 2.92 and NASDAQ subtracted 27.75, respectively.

The CNBC midday rowdies strained themselves lifting a Hubble sized telescope looking for positive data points in the housing numbers. Existing home sales came out Thursday; they were down 2.4 percent in June, at a seasonally adjusted annual rate of 4.86 million units. New home sales for June, appearing Friday, was lower by .06 percent, on a seasonally adjusted annual rate of 530,000, from a revised upward May figure of 533,000.

I can imagine the rowdies on an express elevator to hell remarking that our destination has dry heat, that it's a gated community, and that it's a Christian neighborhood with few trespassers.

In the second quarter, 739,714 foreclosure filings were recorded. Also, 220,000 homes were lost to bank repossession, according to RealtyTrac. That is up 14 percent from the first quarter and up 121 percent from the same quarter in 2007.

A report published on Friday, by an International Monetary Fund economist, concluded U.S. housing prices were still overvalued, in the first quarter this year, perhaps, 14 percent, within a range of 8 percent to 20 percent. According to Reuters, IMF economist Vladimir Klyuev's report "What goes up must come down? House price dynamics in the United States", examined the inventory-to-sales ratio, foreclosure rates, market inertia, and other data points, formulating this opinion. That would mean at least an additional $1 trillion in lost asset value. The government debt market is still comatose.

The 2 year and 10 year US Treasury Notes, as well as the 30 year US Treasury Bond ended the week with higher yields, paying 2.71%, 4.10%, and 4.68%, versus 2.64%, 4.85%, and 4.65, respectively. August is a major refunding month with auctions scheduled for the Two, Five, Ten, and Thirty Year Treasury obligations, in addition to the weekly T-Bill The brightest spot in the market was the Nymex Light Sweet Crude Oil September contract; it closed Friday at $123.26 per barrel, extending its reprieve to cash strapped motorists from its recent high of $147.20.

Online retail analysts are reporting double digit growth in sales among several retailers because of consumers passively boycotting higher gasoline prices. Who would have thought that one day we would be happy seeing oil prices heading towards $100 a barrel?

Late Friday afternoon, the Office of the Comptroller of the Currency closed First National Bank and the FDIC was named receiver of another two banks, one California-based and the other Nevada based, First National Bank of Nevada with $3.4 billion in assets, and First Heritage with $254 million in assets. Both were owned by undercapitalized First National Bank Holding Co., of Scottsdale, Arizona. First National lost $140 million in the first quarter. They reported $4.6 billion in assets and $4.3 billion in liabilities. Nine point four percent of it $3.7 billion in loans were non-current, ending March 31. Mutual of Omaha Bank acquired the deposits of the two banks from the FDIC for a 4.41 percent premium. The new Mutual of Omaha Bank branches will open Monday morning.

There are currently 8,494 institutions holding $13.4 trillion assets insured by the FDIC. The FDIC said the failures would cost its deposit insurance fund roughly $862 million. This brings the total number of bank failures in 2008 to seven. You can learn more about the status of a particular bank here

Game Changer : The really, really, big news this week came from Chrysler LLC. It announced Friday afternoon that its financing arm would discontinue offering leasing deals to its U.S. customers beginning August 1; the same date when their $30 billion credit facility is up for renewal. The rising cost of capital is making leasing terms less attractive to consumers. This is another aftershock resulting from stifling energy prices and an economy that's deleveraging.

Declining SUV and lease values forced Ford to take a $2.1 billion charge at its finance division last week. Although, third party banks and credit unions will step in to fill the void, expect some slippage in the approval rates for leasing transactions. The same market pressures compelling Ford (F) to exit this market will certainly continue to present as a business factor for any entity looking to make a profit leasing vehicles. The cost of capital is important, however, the residual value of the underlying asset is monumental. The percentage of Chrysler sales attributed to leasing is greater than 20 percent.

It will be very interesting to see if this extemporaneous admission becomes evolutionary inside America's automobile industry. Americans divine right to drive automobiles has been an unconditional assumption since the end of WWII. In 2008, it's a fair question to ask given this extraordinary economic environment of failing banks, growing home foreclosures, stagnant incomes, evaporating jobs, personal and business credit contraction, a runaway federal budget, an aging infrastructure, an expensive endless foreign war, a fractured financial system, rising worldwide demand for limited resources, and a demonstrable shifting of global wealth. Plus, the third generation of Americans, exposed growing up around an enlightenment concerning the ecology and global environmental issues, is being handed the task of running our economy. They will shape and modify our society's habits in the future.

The U.S. Senate actually gaveled a rare Saturday session passing landmark legislation to triage a metastasizing bankrupted residential real estate market. Highlights of the bill include; a new regulator for Fannie Mae (FNM) and Freddie Mac (FRE) and up to $300 billion to insure refinanced mortgages for the next 18 months; $4 billion to states to buy and rehabilitate foreclosed properties, a 10 percent tax credit up to $7,500 dollars for first time home buyers purchasing a home between April of this year and June of next year; increase the federal debt limit to $10.6 trillion, and more.

We now have a de facto nationalized residential real estate market. The reversal by the White House to withdraw a veto threat and sign a passed bill into law would create tears of joy on the face of Scottish economist John Law and Louis the XIV of France. Welcome to the new depression. France has succumbed to capitalism. In between fist bumping with the Democratic presumptive nominee Barack Obama and checking out his Italian-born former model turned pop star wife's, Carla Bruni-Sarkozy's new music album, "Comme si de rien n'etait"(As if nothing had happened), President Nicolas Sarkozy of France bullied his National Assembly into radically reforming their 1958 Constitution. Passage of the reform package includes limiting Presidential terms, strengthening the power of the legislature, weakening the position of Prime Minister, and repealing the 35 hour per week cap for workers.

It is an indication that the global downturn will affect everyone. The French are now more aware than ever of prioritizing work and leisure to enhance income and productivity. Calling national strikes on idealistic principles was an industrial age luxury. Cash flow is paramount in the beginning of the 21st century. Welcome to the club.

The year 2008 will record the resignation of Fidel Castro of Cuba, as its President, and the abandonment of immense leisure time by the average French worker; two aging symbols of 20th Century socialism. I wonder if Hank Paulson and Ben Bernanke are erecting the first 21st century's symbol of socialism. Tonight, I shall pour a very, very, nice XO Cognac and contemplate the upcoming Consumer Confidence figure on the 29th; the Employment and Crude Inventories figures on the 30th; the GDP-Advanced, Initial Claims, and Chicago PMI, on the 31st; and August 1st, Auto and Truck Sales, Average Workweek, Hourly Earnings, Nonfarm Payrolls, Unemployment Rate, Construction Spending, and the ISM Index. Maybe two drinks, au revoir!

AmEx Misses: The Bear Trap Thickens

Monday evening American Express (AXP) reported a 37% drop in profits for the second quarter, the third consecutive quarter in which profits fell for the supreme credit card issuer. The second course at this summer’s secular bear market feast is now served. Enjoy.

The consensus of $.86 a share was missed – by a lot. The actual number was $.58 a share, a stunning $385 million dollars off, or $.28 cents a share. Furthermore, Bloomberg reported, Kenneth Chenault, Chief Executive Office said on yesterday’s conference call, American Express is “no longer tracking” a prior forecast of 4% and until the U.S. economy improves, the company will not meet longer term targets.

I believe this is significant because American Express exemplifies the best-of-breed of American credit card issuers. If defaults are rising in this luxurious consumer area, then any remaining doubters or non-believers of this crisis' intensity should perform a financial autopsy on one of America’s signature haute cove for the affluent for confirmation.

This secular bear market is moving slowly across the land, destroying all in its path. The insidious part about this grizzly is that it’s part of an even larger menace. We’re now in the throes of a global downturn of unknown dimensions and ramifications. As the federal government rashly insures $5 trillion dollars of mortgages and refusing to raise interest rates, hoping to achieve a soft landing, the rest of the world is hiking short–term rates, while in a knife fight with inflation, hoping to avoid economic ruin.

Our decision to focus on recession, which is a natural part of the business cycle, versus inflation, a more discretionary and destructive economic occurrence, is a less valuable target to annihilate. Fighting recession will make inflation worse. Will we have the strength, wherewithal, and resolve, in 2009 and 2010, to seriously fight hat-size inflation of 7% or 8%?

Fed Chairman Ben Bernanke testified before congress last Tuesday. In his opening remarks, the following passage is most salient and succinct:

“Moreover, the currently high level of inflation, if sustained, might lead the public to revise up its expectations for longer-term inflation. If that were to occur, and those revised expectations were to become embedded in the domestic wage- and price-setting process, we could see an unwelcome rise in actual inflation over the longer term. A critical responsibility of monetary policy makers is to prevent that process from taking hold.”

Bloomberg reported that a private survey conducted by the National Association of Business Economics found that more companies will increase prices and limit hiring because of surging raw material costs are reducing profits. Seventy-one percent of the companies responding stated last quarter their costs rose. That was up from 65% of companies reporting experiencing higher costs the previous three months.

Also, the Labor Department last week reported that wages, adjusted for inflation, were down 2.4 percent for the past 12 months ending in June. Wage inflation is the final crucial element missing from current economic data that guarantees full blown inflation. The total number of new jobs created year-to-date in this economy is a negative 600,000 plus, and rising.

The rationale behind the $1.2 trillion in tax cuts, approved by Congress in 2001 for the wealthy, was that they could invest those dollars wisely and create jobs for the economy. Now would be an excellent moment for the upper crust of society to wave their magic wand and produce 200,000 jobs each month.

Our anemic domestic growth rate of 0.6% in the 4th quarter 2007 and 1.0% in the 1st quarter of 2008 faces formidable challenges in the 3rd and 4th quarters of 2008. Economies in Europe, Asia, and Latin America are in the process of reexamining both their monetary and fiscal policies. Going forward, if they are successful in lowering their respective growth rates will exacerbate our weakening economic condition. Likewise, if trade subsides between partners, some of the inflation embedded in the costs of raw materials that’s exported in finished products, before it evaporates in due course, will remain here long enough adding to our higher inflation figures.The bears can’t wait until the third course is served. Bon appetite!