U.S. Automakers in Perspective - GM, Ford, Chrysler, Toyota

On Wednesday, General Motors Corp. (GM) announced plans to cut 15 percent of its U.S. and Canadian salaried work force (5,100 jobs) as part of a plan to slash billions of dollars in costs and help the automaker deal with falling sales. This follows last week's news by Ford (F) and Chrysler to cut their salaried workforce.

Foreign car companies have been having issues too. Nissan North America Inc. also offered buyouts to around 6,000 salaried and hourly employees at its two Tennessee plants Wednesday. Toyota is keeping nearly 5,000 workers on the job despite U.S. plant shutdowns but has laid off only 700 temporary workers in recent months.

GM's cuts are part of a multiyear downsizing as the company struggles to adjust to its shrinking U.S. market share. GM had 44,000 U.S. salaried workers in 2000; that had dropped to 32,000 by the end of last year. The company's U.S. hourly work force dropped by more than half to 57,000 last year, and an additional 19,000 hourly workers took buyouts this month.  When will the cuts be enough?

The entire U.S. auto industry though is not being completely beaten up. Earlier this month, Toyota Motor (TM) announced plans to start building the Toyota Prius in a new plant in Mississippi in 2010. The Prius will join the Toyota Camry Hybrid (built in Kentucky) as the automaker's hybrid fleet built in the U.S. Toyota is not immune to the pressures of the declining U.S. car sales, but it has had a better solution over the past few years allowing them to take share away.

While the big three (GM, Ford, Chrysler) have been closing plants, Toyota has continued to expand its North American workforce and facilities. Toyota now has over 43,000 employees in 13 manufacturing plants in North America. Will Toyota continue its run? Time will tell.

One final thought is, when will Toyota be considered a U.S. or at least a North American automaker? While they obviously are based overseas, it is quickly becoming one of the best and most streamlined companies in any industry. The Big Three lost their competitive edge, and they fell behind years ago.

Toyota does not have the labor issues or "legacy costs" of any of the Big Three. The legacy costs of the Big Three include healthcare for retirees and pension costs, and at one point, every car GM made had legacy costs of close to $2,500. Toyota meanwhile has costs of healthcare and matching 401(k)s that amounts to about $300 per car. Big difference! GM has essentially a mini Social Security system issue with 2 current employees working to supply 5 retirees with benefits. Some of these items are and have been reworked, but it will continue to be an issue.

So while the Big Three continue to layoff workers, cut costs, and rework labor contracts (effecting morale), Toyota just keeps building a better quality, more fuel efficient, great looking product. Can the Big Three turn it around?

Source: Yahoo, Washington Post

Markets Rise on Private Sector Employment Data, Oil Gains on Supply Data

On Wednesday, the major indices extended their gains from Tuesday on private sector jobs data from ADP and energy stocks buoyed by supply data.

Economists had been predicting a loss in jobs in the sector, but to everyone's surprise, the number was a gain of 9,000 jobs. This sent the futures up, and it set the tone for the day. Friday's payroll report is now the main focus, and if it is positive, the market could continue to see upward movement.

The price of oil rose nearly 4% after weekly inventory data showed a decline in gasoline stockpiles, sparking supply concerns. This moved ExxonMobil (XOM) and Chevron (CVX) higher, and it helped propel the Dow (both are Dow components).

The Dow and S&P were further helped by continued gains in financials. Bank of America (BAC) jumped 4.3% and Citigroup (C) climbed 2%. Merrill Lynch (MER) rose 2.5%.  Financials were primarily driven by statements from The Fed and other central banks. They said they would continue to increase liquidity to stabilize financial companies struggling with credit losses.

At day's end, the Dow Jones industrial average (INDU) had moved up 186.13 points or 1.63%. The S&P 500 Index (SPX) climbed 21.06 points or 1.67%. The NASDAQ (COMP) gained 10.10 points or 0.44%.

Source: Thomson Reuters, AP

The Market Roars Again - Strong Financials, Oil Falling, and a Consumer Confidence Surprise

All three market indices moved higher on Tuesday based on strong financial reports, oil falling to a three month low, and a consumer confidence surprise.

The Dow Jones Industrial Average (INDU) rose 2.4% Tuesday erasing the losses from Monday. The S&P 500 index (SPX) jumped 2.3%, and the NASDAQ (COMP) climbed 2.5% on the earnings report by drug maker Amgen (AMGN). Both the Dow and S&P 500 were helped immensely by the financials.

News of Merrill Lynch (MER) raising capital and selling some of it mortgage securities gave hope that the rest of the financial sector is starting to clean house and reposition itself. Shares of Merrill finished the day up 8%. Luckily, other names in the financial sector did as well or better than Merrill. Wachovia (WB) jumped 15.2%. Bank of America (BAC) finished up 14.8%, Washington Mutual (WM) gained 12.4%, Wells Fargo (WFC) moved up 9.1% and JP Morgan Chase (JPM) rose 8.2%. Bank of America and JP Morgan Chase are Dow components.

Crude oil prices finished down more than $2.50 on Tuesday to close at  just over $122 per barrel. Oil plummeted after OPEC President Chakib Khelil said oil was overpriced and could sink to $78 a barrel. Oil has fallen about $25 since setting a record high of $147.27 on July 11.

The Consumer Confidence Report displayed a small improvement over June according to the report by the Conference Board. The Consumer Confidence Index rose to 51.9, up from a revised 51 in June. Economists had expected the index to decline to 50. The end result though is a consumer that is still considered cautiously pessimistic. In July 2007, the report had a figure of 111.9.

Finally, May home prices dropped a record 15.8% from a year ago, according to the S&P/Case-Shiller Home Price Index of 20 cities. It was the 22nd consecutive month of decline recorded by the index. The good news here was that some analysts are saying the decline is slowing, and that a bottom could be reached soon.

The good news is that Asian markets have followed the U.S. lead, and they have moved higher in Wednesday trading.

Source - CNNMoney

Gasoline Consumption & Miles Driven Drops

For the seventh straight month in a row, motorists have driven less. This marks the first annual drop in driving since 1980. The trigger could have been the $4 a gallon gas we have been paying, and if people start to change their habits, it could snowball and add to the fewer miles driven statistic as people alter their lifestyles.

Americans drove 9.6 billion fewer miles in May 2008 than in May 2007, the third largest monthly drop in the 66 years the data has been collected, the Federal Highway Administration said in Sunday's report. The decline amounted to 3.7 percent from May last year.

Interestingly enough, May's drop comes during a month that traffic usually rises because of the Memorial Day holiday and the start of the summer-vacation season.

What else can be effecting the gas consumption? Motorists increasingly are using fuel-efficient vehicles, carpooling, and taking mass transportation.

This all means the federal highway trust fund - which relies on per-gallon taxes that do not rise with price - faces a multibillion-dollar shortfall next year, down from a surplus of more than $10 billion just three years ago.

Transportation Secretary Mary E. Peters said in a statement on Sunday that the drop in driving miles demonstrated that the federal gasoline tax no longer was sufficient to finance the nation's transportation infrastructure.

The highway trust fund gets 18.4 cents per gallon from gasoline sales and 24.4 cents per gallon for diesel sales. Driving fewer miles and using more fuel-efficient vehicles means less gasoline consumption - and less funding for the trust fund.

If gas prices continue to fall, will you start driving more again?

Source: Inquirer Wire Services

Bush to Sign Landmark Housing Bill

In a rare Saturday session, the U.S. Senate with bipartisan support passed a landmark housing bill that will offer up to $300 billion in loans for troubled homeowners and establish a government rescue plan for mortgage finance giants Fannie Mae and Freddie Mac. The U.S. House of Representatives had passed the bill on Wednesday not long after President Bush changed his mind and decided not to veto the bill if it came to his desk.

The two main objectives of the bill were to offer affordable government guaranteed mortgages to homeowners that were at risk for foreclosure and to help Fannie Mae (FNM) and Freedie Mac (FRE) with a rescue plan if needed and a better regulator of the two companies.

The specifics of the bill were:

• Alter the FHA Role - allow the FHA to over the new $300 billion in mortgages to those that need them if necessary. The estimate is that no more than $75 billion is really needed to help approximately 325,000 homeowners
• Establish a stronger regulator for Fannie Mae and Freddie Mac - keep the two companies in check
• Increase the limits on conforming loans - permanently increase the limits from $417,000 to $625,500
• Home-Buyer Credit/Loan - a weird one here with a first time home-buyer receiving a credit for 10% of the purchase price, but no more than $7,500. What makes it weird is it must be paid back over 15 years in installments. It ends up being a no-interest loan basically.
• Remove Down Payment Assistance for FHA loans/raise percentage - sellers had been able to help with the down payment on FHA loans by increasing the price to cover the down payment. This will no longer be allowed. Also, the old standard of 3% down payments on FHA loans will be increased to 3.5%.
• Affordable Housing Trust Fund - A fund to promote affordable housing created by contributions from Fannie Mae and Freddie Mac.
• Give grants to states to buy foreclosed properties - grant $4 billion to states to buy up and rehabilitate foreclosed properties. The funding had been opposed by most republicans and the White House which had said it would benefit lenders and not homeowners. This one provision almost held up the entire bill.

Most people credit Treasury Secretary Henry Paulson for getting the bill through Congress and The White House. It was Paulson that went to Congress asking for a "blank check" for the Treasury to come to the aid Fannie Mae and Freddie Mac if needed. The bill now includes provisions that let Treasury over the next 18 months offer Fannie Mae and Freddie Mac an unlimited line of credit and the authority to buy stock in the companies.

The Congressional Budget Office (CBO) estimated that there is less than a 50% chance that the Treasury Department would need to come to the aid of either company.

Source - CNNMoney.com

IRS Audit - Stimulus Payments

Today we are going to have a little fun at the expense of the IRS. They can usually be pretty tough on us, and it is thankfully now their turn to be in the spotlight...

Obviously, everyone is bit afraid of receiving an IRS audit notice, but did you know the IRS is also "audited"? Yes, the Treasury Inspector General for Tax Administration (TIGTA) checks the IRS to make sure it is doing its job correctly.

This year with the stimulus payments, the IRS was correct 99.6% of the time, but that 0.4% was equivalent to 385,000 payments.

When calculating some stimulus payments, the computers had a programming glitch that allowed 25,000 to miss out on $16.5 million in payments. The people most notably affected were clergy and other individuals not subject to self-employment income.  Never smart to short change the clergy.

The most glaring mistake though was that 350,000+ people missed out on the child portion of the stimulus payment because they simply did not check the Child Tax Credit qualifying box on their return. When the TIGTA first approached the IRS regarding this mistake, they said they could not tell if the taxpayer was eligible thus no payment.

Subsequently, the IRS has come back and said they would pay the 350,000+ households that did qualify for the payment.

Nothing quite like someone trying to keep you in line when it comes to tax payments.

Follow Up - Bank of America and Countrywide

On Thursday evening I finally sat down to read my latest copy of Condé Nast Portfolio (August 2008).  In it was a great article by Daniel Golden called "Angelo's Many 'Friends'" on Countrywide Financial and the "Friends of Angelo" (F.A.O.).  It named names and described how and how much the powerful benefited from their positions.  From political powerhouses to corporate partners, being a F.A.O. had its benefits.

What brings this particular magazine to today's blog though was the article within the article by Anthony Bianco called "What was Ken Lewis Thinking?"  For those not familiar with the name, Ken Lewis is the CEO of Bank of America (BAC).

This article gave some background on Lewis, and how Wall Street had been wrongly against him after his deals to acquire FleetBoston Financial in 2003 and credit-card specialist MBNA in 2004.  The article was bound together by saying Lewis's job was on the line, but if you review the success he has had, and the fact that no matter how things looked in the beginning with his deals (he also engineered the NationsBank and Bank of America merger in 1998), it has not been a good idea to bet against him.

Lewis has run a conservative ship that looks to grow the customer base of BAC while being able to generate savings and higher profit margins by placing BAC's $530 billion loan portfolio in the hands of the Countrywide servicing unit.  This could spell earnings in the coming years for the shareholders of BAC.

There could obviously be trouble on the horizon with the various lawsuits filed against Countrywide that are ultimately the responsibility of BAC, but if the past history of Lewis means anything, the lawsuits will be mere bumps in the road while BAC reaps the rewards of this merger for years to come.

As Lewis said on a conference call with Deutsche Bank, "All I can say is nothing has happened that is out of the boundaries of what we contemplated when we did the deal."  When asked on the conference call what would happen if housing prices declined in excess of the consensus forecast of 25%, Lewis replied, "If that's the case, we'll be worried about Countrywide, but we'll be worried about a lot of other things too - and not just at Bank of America."

Both articles are definitely worth a read.

Sources - Condé Nast Portfolio

Durable Goods Orders Up More Than Expected, Congress Chops Up the Commodities Speculation Bill

This morning a report was released that showed the durable goods orders to factories for big-ticket manufactured goods such as cars, appliances and machinery rose at the fastest pace in four months in June, a much stronger showing than had been expected. Economists had been predicting a 0.4% decline, but the number came in as an increase of 0.8% last month. This was the best showing since a 1.1% rise in February and reflected strength in demand for heavy machinery, primary metals such as steel and even a slight rebound in the beleaguered auto industry. New orders for motor vehicles and parts rose by 1.8%, the best showing in 11 months.

All three major market indices were poised for a positive open on the news.

Source: AP
------------
On Thursday, the House Agricultural Committee was looking through a bill that would control some of the speculation that has taken place in the agricultural and energy commodities markets.  Rather than trying to make sure the bill was tough, the committee chose to remove provisions that would have barred pensions funds from investing the agricultural and energy markets.

It seems the lobbyists for the pensions funds worked to stop the bill, sponsored by Congressman Collin Peterson (D-MN), in its previous form from leaving the committee.

After the revisions were made, the pension lobbyists and industry representatives were breathing a sigh of relief.  The pension industry believes they need access to the market for diversification reasons, and Congress believes they have helped to fuel speculation.

To give you some facts on the issue:

• Congress cites the growth of index-related commodity investments by major funds to $260 billion compared with just $13 billion five years ago.  The amount of assets now involved must have generated speculation according to Congress.
  
 
• Analysts say most institutional investors devote only 3 to 5 percent of their portfolio to commodities and alternative assets such as real estate, compared with the 40 to 50 percent typically allocated to equities and the balance to bonds.
 
• This means a pension fund with $500 million in assets will usually have up to $25 million in commodities, although the California Public Employees Retirement System, with $245 billion in assets, has $1.1 billion in the asset class.
 
• The strategy is intended to minimize losses from stocks as commodities move to their own fundamentals and have historically rallied during bear markets in equities.

Ultimately, if Congress disallows pension funds from investing in U.S. commodity markets, it could drive them to look for diversification opportunities outside the country.

"I'm Mad as Hell, and I'm Not Going to Take This Anymore!"

From the Desk of Joe Rollins

I had a Howard Beale moment this morning while watching the financial news. Growing more and more frustrated with the news, I found myself standing up in the middle of my living room at 5:30 a.m., yelling at the TV set like Beale’s character in the legendary movie, Network. My dogs, Shaft and Daisy, didn’t even notice my outburst, while Sam, my cat, glanced at me and decided it was time to stretch and then go back to sleep. Maybe they’re just used to it by now.

There are so many 24-hour news channels these days that the market is now completely saturated. I watch the international business news from 4:00 a.m. to 6:00 a.m., and it always seems to be one financial analyst after another giving an increasingly glum outlook on the financial world. According to these so-called experts, humankind is entering an economic depression unlike any seen since 1932.

These are the same “experts” that advised investors to not purchase financial stocks for the last six months, but have now turned 180 degrees and are bullish on the sector. If you read my “Think, Don’t Trade” blog on July 10th, you likely recall how ridiculously undervalued these stocks were at that time. Now, many are up 25% to 40% from their lows. This makes me wonder how these analysts even get on national TV. Is it because the more outrageous their comments, the more likely they are to get face time on a financial news program? Regardless, and as I’ll illustrate below, the wealth of misinformation they are circulating has gone too far!

A financial news report being broadcast out of London this morning featured a stately British financial author expressing his outrage concerning the world’s financial situation. As he explained the evils of the world in his incredibly monotone voice, I found myself dozing off from boredom. Of course, like most experts in the media who tend to just criticize, this fellow didn’t offer solutions or anything useful to investors. However, one of his statements did catch my attention, and that’s what made me stand up and scream, “I’m mad as hell, and I’m not going to take this anymore!”

The British commentator was criticizing the U.S. economy and the American banking institutions. Along with trashing nearly everything American, he stated, “The U.S. is now paying the ultimate financial sacrifice for over 30 years of complete and total mismanagement of the economy in the U.S.”

Admittedly, we do have financial strains in the U.S., but it’s a gross overstatement to say that we’re suffering from 30 years of economic mismanagement. It was even more irritating that the interviewer never bothered questioning how the British financial guru arrived at that opinion and simply seemed to accept it as fact. So, I think it’s time for me to get out my bullhorn and tell the world how ridiculous these commentaries have become.

It didn’t take much research to disprove the British financial author’s statement, since it was readily available on the U.S. Department of Commerce’s website. During the first quarter of 1978, the U.S. GDP was $2.15 trillion. Thirty years later, and for the first quarter of 2008, the U.S. GDP was $14.201 trillion. Recognizing that no other economy in the world has a GDP that exceeds $5 trillion (Japan is second with $4.5 trillion), I would have to say that the U.S. economy has done pretty well over the last 30 years. In fact, the U.S.’s GDP has compounded at an annual rate of 6.495% over the last 30 years.

With those facts, how dare the British author make such an inaccurate statement? It is even more offensive that he made that remark when he lives in a country with an economy that has gone from being the strongest in the world to a lower-tier economy over the same timeframe.

Virtually all of Europe’s socialist governments would love to have an economy growing at a 6% annualized rate for a single year. To believe their economies could grow at the same growth as the U.S. over 30 years borders on the absurd. I want to re-emphasize that the British financial author described the U.S. economy as “grossly mismanaged” over the last 30 years. Clearly, the facts do not support his misstatement.

There is absolutely no question that the U.S. economy is stressed right now. There is also absolutely no question that it’s improving. When I hear the daily exclamations in the media of the ongoing recession (and in some cases, a depression), I scratch my head since I know that neither is true. Next week the GDP report on the second quarter of 2008 will be released, and it’s more likely to reflect 2% GDP growth than 1%. But in either case, neither of those anticipated numbers is negative contrary to what many commentators would like for you to believe.

Let’s get real about the problems in the financial sector, people! There’s no question that the financial sector is tense at the moment. However, as second quarter earnings from these banks are reported, realization is setting in that things are not nearly as bad as the media would like for you to believe. Yes, banks are taking write-downs of assets, but never forget that these are write-downs not write-offs. It will be some time before the realization of these assets is accurately written down during this quarter. If these reserves are way too high, as I suspect, when they are reversed in future quarters then these banks will have phantom income to the likes never seen before in this country.

Many media members are now placing the blame on former Federal Reserve Chairman Dr. Alan Greenspan. Their opinion is that Dr. Greenspan, in his attempt to build-up the economy prior to his retirement in 2006 kept interest rates too low for too long. These commentators are Johnny-come-latelies as far as I’m concerned.

Those who know me likely remember my harsh criticisms of Dr. Greenspan in many of the years of his 17-year term. While Bob Woodruff was describing Dr. Greenspan as a “maestro,” and he was being knighted by the Queen of England, I was openly criticizing his economic gibberish and irrational moves in interest rates.

I had another one of those Howard Beale moments when reading a recent article in the New York Times, which placed the blame on our current financial woes at the feet of the financial institutions. The article stated that, “the lucrative lending practices of banks and other financial institutions [helped] create the current financial crisis of millions of borrowers and the financial system in general.” A more inaccurate statement regarding the bank’s responsibility for our financial situation has never been more clearly written.

The U.S. has become a country where no one seems to take responsibility for their own actions. While there are probably some borrowers who were misled, the vast majority of those facing foreclosure were responsible for their present situations.

Former Texas Senator, Dr. Phil Gramm recently exclaimed that the U.S. isn’t in a recession and that we had become a country of whiners where too many Americans are blaming their problems on someone else. After his statement, he was ridiculed by the press and resigned as the financial advisor to Senator John McCain. The fact of the matter is that he was absolutely correct and McCain made a critical mistake by not supporting his comments.

The source of the downturn in banking and sub-prime lending can clearly be laid at the feet of Congress itself. In the Community Reinvestment Act (or CRA) of 1977, Congress required banks to extend home mortgages to underserved populations and commercial loans to small businesses. In fact, Congress mandated that in order for banks to maintain their federal guarantees on deposits in changes to the CRA made in 2005, they would be required to make loans to low and moderate-income borrowers and to certain neighborhoods that they wouldn’t normally approve before that time.

In the late 1970’s, there was great outrage regarding bank “redlining” practices, where certain banks were accused of targeting only wealthier neighborhoods for their lending services. In fact, the Washington Post explained that minority applicants were approved for mortgages only 72% of the time while whites were approved 89%, and therefore, there was overwhelming evidence of discrimination in the lending industry (according to the Washington Post). The press didn’t focus on the quality of credit maintained by the potential borrowers who were being turned down or their ability to repay mortgage loans. But in any event, Congress dictated that income, credit history and net worth would basically be ignored, and subsequently, loans were made to credit unworthy borrowers who had no ability to repay the loans. Even worse, they required by law that Freddie  Mac (FRE) and Fannie Mae (FNM) fund these loans. Sound familiar?

I have known a lot of bankers during my professional life, and I can assure you that banks are in the business of loaning money. They really don’t care who they loan it to; they only care that it is repaid. I recognize that this is totally counter to politicians who couldn’t care less whether or not banks make money; they’re just out to get votes. If they can use their political clout to force banks to make loans that they shouldn’t, then it certainly gains votes for them.

I find it incredibly frustrating to hear how this matter is being reported in the news. Now that we have come full circle and many of these loans that the banks were required to make by government intervention have blown up, it is Congress saying that there now needs to be more governmental intervention in banking. I guess since they didn’t mess it up badly enough the first time, now they want to get involved and make it better….

Truly, banks would function much more efficiently without governmental intervention. “Governmental assistance” is an oxymoron; to suggest that our government can rectify this problem is incredibly naïve. Yes, the banks made enormous mistakes by lending to people they shouldn’t have extended loans to. But, it could hardly be legitimately argued that these lending tactics were the bank’s fault.

While there will certainly be foreclosures and a period of unrest in the real estate markets, the best solution to this problem would be to let the lenders and the banks work it out without governmental intervention. In a few years, we’ll look back at this time as being one of the great real estate buying opportunities of our lifetimes.

Dolly Moves Towards Land, Oil Drops, Interest Rates Creep Up, The Market Looks to Extend Gains

As Hurricane Dolly moves towards the Texas-Mexican border and away from the oil drilling platforms in the Gulf of Mexico, the oil market has decided thus far to take a breather once again. This morning oil is down on the Dolly news. This past week's earnings reports seem to be alluding to the fact that the financial stocks may be better than previously thought, thus the dollar has rallied on rising interest rates. We have already discussed in previous posts how a strong dollar will ultimately help drive oil prices lower.

There have been quite a few Fed presidents talking up the possibility of raising interest rates sooner rather than later to combat inflation. This would of course move only the short term rates, but the long term rates have moved higher on the inflation worries. When the long term rates creep up, mortgage rates go with them. There is some debate over whether this will cause potential buyers to get in now and lock in rates or stop them from buying altogether. History suggests that waiting around could be the wrong move to make. This could help jumpstart home sales from what the experts are saying.

The market has been performing well over the past week in almost all sectors but energy (due to the drop in energy prices) has lagged or fallen. Financials have jumped dramatically, and since the Dow and S&P are heavily weighted with financials, they have jumped accordingly. Remember our previous post - Where Do We Go From Here - 2nd Half 2008 - where we discussed the the financials and how we believed they would lead the rallies? Well, this has been exactly what has happened.

We will continue to watch the market for follow through with this rally and see what trends start to change or develop. It has been a very busy earnings season thus far, and most of the big financials have reported. We will see what starts to drive the market now.

Looking at Bank of America and Countrywide

On Monday, Bank of America (BAC) announced net income of $3.41 billion, or 72 cents per share, on $20.32 billion in revenue, for the 2nd quarter. That compared with net income of $5.76 billion, or $1.28 per share, on $19.63 billion in revenue a year earlier. Analysts expected a profit of 53 cents per share on $18.37 billion in revenue. Obviously, these were good numbers to beat analysts expectations by so much.

On July 1, after the end of the 2nd quarter, BAC completed its acquisition of Countrywide Financial Corporation. During the 2nd quarter, BAC says it spent $212 million in merger and acquisition costs. Since Countrywide was not part of BAC during the 2nd quarter, Countrywide announced its own earnings of a net loss of $2.33 billion including $4 billion in credit related losses.

BAC, in its statement, said that the Countrywide purchase will generate profits by the end of the year. Some of those profits will come from purchase accounting, which requires that the assets and liabilities of an acquired company, including estimates of future credit losses, be marked at fair value at the time of the deal (mark to market). Before including Countrywide in its results in the third quarter, BAC wrote down the value of the lender's assets by $12 billion to $13 billion. That means future credit losses, as long as they don't exceed $13 billion, won't flow through BAC's income statement in the future, according to BAC on Monday.

BAC expects $900 million of cost savings by 2011 from integrating Countrywide, up from an estimated $670 million at the time the acquisition was announced. BAC has already announced plans to cut about 7,500 jobs as Countrywide is incorporated into its own operations. The cuts amount to about 12.5 percent of the combined companies' mortgage, home equity and insurance businesses.

What does all of this mean? Well, BAC had reached a cap in terms of the percentage of assets that they could hold in the United States. Essentially, they had reached a limit and could not grow, save some non-core business acquisition. Enter Countrywide.

Countrywide originated purchases, securitized, and serviced mortgages. In 2006 Countrywide financed 20% of all mortgages in the United States, at a value of about 3.5% of United States GDP, a proportion greater than any other single mortgage lender.

One of the most lucrative arms of Countrywide is the servicing side. Loan servicing collects payments from the borrower, handles escrow accounts, tax and/or insurance payments, then remits "advances" to the investor's trustee as specified in the Pooling and Servicing Agreement (PSA). Loan Servicing typically retains a fraction of the payment made (typically 25 - 45 basis points of the unpaid principal balance) as a "servicing fee". Loan Servicing also generates income in the form of interest on monies received and held prior to paying scheduled advances to the trustee, fees charged for late payments, force-placed insurance, document requests, legal fees, payoff statements, etc. They do not hold the note, they only collect the money.

All of this may sound somewhat trivial, but when Countrywide services in excess of 8.3 million loans totaling over $1.3 trillion, it becomes more than trivial.

BAC has tapped into a company with an extreme reach that puts it upfront with 8.3 million customers. Banking, credit cards, auto loans, student loans, etc. are all within easy reach for whatever part of these customers are new. Toss in BAC's current loan portfolio (which will continue to be conservative), and you have a leader in loans and loan servicing.

In the end, it looks as though the giant company is gobbling up the smaller company after a "fire" sale, and the future looks positive. The continuing credit issues will force alterations somewhat, but as they subside, BAC will be more and more powerful with an even broader range of services to offer its residential and corporate clients.

Sources - AP, CBS Marketwatch

Who Is To Blame for Gas Prices?

With gas prices at the pump hitting $4 a gallon, and crude oil prices hitting $130+ (down from $145), where does your $4 per gallon go?

The quick response would be the big oil companies of course. That is the favorite target of everyone, but are they really reaping the rewards? No. According to an April 2008 study from the U.S. Energy Information Administration, the overwhelming cost of each gallon of gas you buy comes from crude oil.
The chart above illustrates exactly what the study reported. The lion's share of the costs are from crude oil with taxes, refining costs, and distribution and marketing making up the balance. Let's breakdown each individual piece.

Crude oil is just that. This is the oil straight from the ground. This is what those OPEC meetings and oil drillers are talking about. The largest oil companies (ExxonMobil, Chevron, etc.) have large oil exploration branches of their companies, and this is where the current profits are being produced.

Taxes account for around 11% (federal and state average) of every dollar you spend at the pump. California's 63.9 cents of tax is the nation's highest, Alaska's 26.4 cents the lowest. The way each state uses the money varies, but the federal government's portion is used to build and maintain highways and bridges.

Refining takes oil from its most basic form and alters it to produce everything from gasoline and diesel to heating oil. The actual dollar cost of that refining per gallon changes little based on what the price of oil is. The percentage will change based on the price per gallon, but the actual costs is relatively constant. The profit margins here are thin based on the study. FYI - it costs $0.05 less this year to refine that one gallon of gas than it did in 2004.

Distribution and marketing - Distribution costs cover the pipelines and trucks that do the actual transporting, while marketing is for the pretty little commercials all those oil companies have to tell you how great the product or company is.

What about your local gas station? Well, they have about 20 cents gross margin after paying all of the above, but that is gross. Take out credit card fees (every swipe gets a percentage), labor costs, and rent, and they will probably just break even. So where do they make money? Repair shops, mini-marts (beer, soda, chips), lottery (5-7% commission in Georgia), etc. They have a better chance of making money there versus anything with gasoline.

In the end, it is the countries and companies that are taking the oil from the ground with the profits. The other parts of the system are just cogs in the machine.

Senators Look to Control Loans & Debit Cards on Your 401(k)

Senators Herbert Kohl, D-WI, and Charles Schumer, D-NY, on Wednesday announced legislation setting limits on the number of loans that can be taken on your 401(k) and to prohibit 401(k) debit cards.

Currently, the law states that you can borrow up to 50% of your current balance or $50,000 whichever is less. The interest rate that is charged varies by plan, but usually 10% is used. The repayment period for the loan cannot be greater than 5 years from the date of the loan. Of course, this is the law, but your 401(k) may not allow loans or have more stringent rules.

According to a report by The Center for American Progress Action Fund, in 1989, there was a total of $6 billion in 401(k) loans. In 2004 that number had ballooned to an inflation adjusted $31 billion. This is obviously a big change.

The biggest issue is that loans from 401(k)'s do not generate returns, and usually, the employee stops contributing to the plan to payoff the loan. Thus, the employee is hit with zero contributions and no returns. Not a good long term strategy.

Additionally, 401(k)'s were established to fund retirements after the demise of defined benefit plans (pensions). By lessening any amount you have for your future retirement, you are actually putting in jeopardy that long term plan.

While the legislation seems to be aimed more at receiving some press considering the law already on the books for borrowing from your 401(k), prohibiting the 401(k) debit cards that have started to appear is a great idea. Those cards should not be in place at any time. If there is a need, there are ways to get access to the money beyond swiping a 401(k) debit card. Your retirement is too important to make accessing it so casual.

The Week In Review - Market Up, Commodities Down

The week finished with a mixed bag on Friday with gains by the Dow (+0.44%) and S&P 500 (+0.03%), but a loss by the NASDAQ (-1.28%) on earnings reports by Google (GOOG), Microsoft (MSFT), and AMD (AMD).

For the week, the market was impressive with all three indices moving higher after earnings reports from Wells Fargo (WFC), JP Morgan Chase (JPM), and Citigroup (C) beat expectations - Merrill Lynch (MER) missed. The Dow led the charge with a gain of 3.57% for the week, the NASDAQ with 1.95%, and the S&P 500 with 1.71%. The financial heavy Dow and S&P 500 needed the boost after a lackluster first two weeks of the quarter. Thankfully, oil dropped $16 over the last three days, and that helped to feed the market rally.

You cannot forget about the testimony of Bernanke, Paulson, and Cox on Capitol Hill this week as well. They helped to to calm some nerves, and it definitely appears that they are ready to step in at a moment's notice to help boost the economy, save the mortgage industry - Fannie Mae (FNM) and Freddie Mac (FRE), and overall just do whatever is necessary.

On deck for earnings early next week -

• Monday - Apple (AAPL), Bank of America (BAC), American Express (AXP), Merck (MRK), Schering-Plough (SGP), Texas Instruments (TXN)
• Tuesday - Caterpillar (CAT), Dupont (DD), Haliburton (HAL), SunTrust (STI), Wachovia Bank (WB), Yahoo (YHOO)

Continue to watch as earnings season stays in full swing.

Nice Follow Through - Still Watch Earnings

Financials continued to fuel the market today as all three indices moved higher again Thursday in heavy trading.

JP Morgan Chase (JPM) started the day off with better than expected earnings, then the drop in oil and natural gas helped to continue to fuel yesterday's rally. The Dow finished 207 points higher, the NASDAQ closed 27 points higher, and the S&P 500 had another good day at 15 points higher.

IBM (IBM) announced great earnings after the bell, and they raised their profit outlook for the year to $8.75. It was not all great news though as Microsoft (MSFT), Google (GOOG), and Merrill Lynch (MER) all missed their earnings when they reported after hours.

This morning Citigroup (C) announced their earnings before the bell. The company beat expectations by 12 cents (-54 cents vs. -66 cents). While they wrote down additional assets, these write downs were less than expected by Wall Street. The stock seemed to buoy the market against Thursday's earnings report by Merrill Lynch (MER). Citigroup shares were trading up in pre-market activity by about 8%.

Looking ahead, on Monday, Bank of America (BAC) will report its earnings for the 2nd Quarter.

Wells Fargo, Fannie Mae, Freddie Mac Help Power the Market

Well, the financials finally decided they had enough and came back strong today. The Financial Sector "Spider" (XLF) finished the day with its largest gain ever of 13.10% or $2.25. The Dow finished up 277 points (2.52%), the NASDAQ was up 69 points (3.12%), and the S&P 500 finished up 30 points (2.51%).

Wells Fargo (WFC) started the day with its second-quarter earnings that fell 22 percent as more customers at the nation's fifth-largest bank failed to repay loans. The news though was that the company's results beat Wall Street expectations, and Wells Fargo also decided to to raise its quarterly dividend to 34 cents from 31 cents. Wells Fargo finished the day higher by 32.8 percent to $27.23.

Both Fannie Mae (FNM) and Freddie Mac (FRE) also closed up more than 30% on continued comments by Fed Chairman Bernanke on Capitol Hill. Bernanke stated that the companies were both adequately capitalized and in no danger of failing. The main issue hurting the stocks and the companies was a "crisis of confidence". Additional comments by Fannie Mae's CEO says that their business is fine, and they do not need a bailout.

Is this the beginning of the financial rally we discussed in previous blog entries? Well, time will tell, but it is a good start.

Thursday will be a big day as several large companies from the Dow and S&P 500 report their earnings including large financial and tech firms. The highlights from Thursday's earnings reports will be from: Google (GOOG), IBM (IBM), JP Morgan Chase (JPM), Microsoft (MSFT), Coca-Cola (KO), Coca-Cola Enterprises (CCE), Merrill Lynch (MER), Nokia (NOK), and United Technologies (UTX).

Working Together - Bush Administration, The Fed, The SEC, and Congress

Can anyone remember a day where the President, Secretary of Treasury, Chairman of The Fed, and SEC Chairman all were busy outlining the ideas and policies of the financial markets?

The President dealt with trying to persuade Congress to change legislation allowing offshore drilling... a move he believes will start to help oil prices drop. Essentially, he reiterated his speech from Monday in The Rose Garden.

Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson and U.S. Securities and Exchange Commission Chairman Christopher Cox discussed their recent actions to shore up support for Fannie Mae (FNM) and Freddie Mac (FRE) and all other economic topics before the Senate Banking Committee on Tuesday.

• Paulson went after being given a "blank check" to deal with the current credit crisis. The feeling was that if Congress said a certain limit (a water gun), then the market would look to hit that limit. If you are given unlimited funds (a bazooka), then you might not need any of the funds. He also said the Fannie Mae and Freddie Mac plans are there if needed, but are not a foregone conclusion.

• Bernanke stated that The Fed was "particularly alert" to any sign that inflation was getting out of control. With that said, Bernanke also acknowledged that the economy was currently growing very slowly and that several risks could dampen that growth. These comments essentially put an end to any thought that The Fed would raise rates at its next meeting. The market also started to back off rates being raised at the September meeting.
  

• Cox said the Securities and Exchange Commission will try to limit so-called "naked" short selling of shares in Fannie Mae, Freddie Mac and big brokerage firms. Cox stated that the SEC will issue an emergency order stating that all short sales of shares in these companies will be subject to a "pre-borrow" requirement that will last for 30 days. The SEC is also planning more rule-making focused on short selling in the broader market.

These four men along with Congress are definitely looking for ways to boost the economy and market. We will definitely watch as they collectively and independently make changes that alter the financial landscape.

iPhone Mania!

Apple (AAPL) announced on Monday that it has already sold 1 million of the 3G iPhones which went on sale Friday. Compare these sales figures with the fact that it took Apple 74 days to sell 1 million of the original, also highly anticipated, version of the iPhone.

Now there have been system problems associated with the stampede of folks trying to activate their new phones, but it still is a great accomplishment for the company. Considering the high price of gasoline, issues with the banking industry and general economic dissatisfaction, it would appear that Apple’s customers represent some underlying strength in the U.S. and world economy.

No bread lines just incredibly long lines to buy the magical iPhone.

Working Weekend - Fannie & Freddie, InBev, Short Sellers Beware

Whoa... What a Sunday!!??!!

First, Fannie Mae (FNM) and Freddie Mac (FRE) are going to get aid from the U.S. Government in a big way. The Bush administration is going to ask for Congressional authorization to buy stock in the two mortgage industry giants and increase the government's credit line. This will strengthen the companies and stabilize the stock price. Then, the Fed is allowing both companies to access the discount window. Finally, Secretary of the Treasury Paulson is going to ask that Congress allow the Fed to essentially be a consultant in matters of "capital standards" of the two companies.

Second, American giant Anheuser-Busch (AB) has agreed to be purchased by InBev (a Belgium-Brazilian Company) for $49.91 billion to create the world's largest brewer. The $70 per share stock price was greeted much more eagerly than the previous $65 per share price. InBev has promised to make St. Louis its basis of North American operations, and InBev would keep many of the current icons and brands. In fact, Budweiser will become its flagship global brand.

Finally, a brief release from the SEC - The U.S. Securities and Exchange Commission said Sunday that it and other regulators are starting to look into new examinations to prevent stock-price manipulation by short sellers and others. The agencies' goal is the "prevention of the intentional spread of false information intended to manipulate securities prices."

So much for a slow weekend...

Sound Off to The Fed About Credit Cards

If you ever wanted to let someone really know how you feel about your credit card interest rate being changed, the late fees, and the bait and switch of low balance transfers, then now is your chance.

The Federal Reserve (The Fed) is asking for comments on credit card reform rules that were proposed in May. The deadline to "sound off" is August 4.

The Fed is really looking to try and help consumers with the new rules, and most advocacy groups are very pleased with the proposal. The two-cycle billing, payments being credited toward low interest rate items first, and not being able to change the rate on debt you have already accumulated.

The credit card companies disagree with the proposals of course. They say if they cannot make changes, then everyone will pay higher rates to start (even good credit holders). They make the claim that there will be less credit available, less competition, etc., etc.

Congress is also trying to weigh in. They want to change the time period they must mail the bill, allow payments with a post date of the due date to be considered on time, and limit marketing to those under age 21. The big issue of fees though is one they are really looking to tackle.

To make a comment to The Fed on the proposed rules, go to www.federalreserve.gov click on "Consumer Information" at the top of the page, click on "Proposed Rules for Credit Cards and Overdraft Services," scroll to the bottom of the page, and under "Regulation AA," click on "Submit Comment."

Remember, the comments are public.

Freddie and Fannie - Helping Them Out

The market headed lower Friday on concerns that U.S. government chartered companies Freddie Mac and Fannie Mae may need to shore up their financials. Together the pair hold or guarantee more than $5 trillion worth of mortgages. That's roughly half of the $9.5 trillion debt of the United States.

There were reports that said The Fed would allow either or both companies access to The Fed's discount window. This immediately gave the entire market a boost into positive territory before falling back into negative territory, but still far from the largest losses of the day.

The Dow was briefly under 11,000 for the first time in two years, but the market finished at 11,100.

According to reports from the AP, Senate Banking Committee chairman Christopher Dodd of Connecticut raised the prospect that the companies could be given access to emergency Federal Reserve lending.

Dodd, who spoke Friday to Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson, said the two are "looking at various options" for propping up the firms if they ultimately need help. Those include giving them access to the Fed's emergency lending "discount window," Dodd said.

The Fed, Congress, and Bush administration all look to be making sure that both of these firms and the mortgage industry are given help as needed.

Congressional Disapproval

From the Desk of Joe Rollins

On Tuesday, the electronic publishing firm, Rasmussen Reports, released the results of a recent public opinion poll indicating that only 9% of voters give Congress good or excellent ratings. This is one of the worst Congressional approval ratings ever recorded.

The 9% approval rating is comprised of the 2% who rated Congress’s performance as excellent plus the 7% who gave it a good rating. To be fair, 36% of those polled said Congress is doing a fair job, a percentage that was excluded from the total approval rating. But, a whopping 52% of voters polled said that Congress is doing a poor job, which I can’t say totally surprises me. I am surprised, however, by the 2% excellent approval rating. Which rock do these people live under?

Congress seems unable to accomplish anything these days. For example, they’ve been completely unable to approve a single bill that would improve the U.S.’s current energy situation. This isn’t because there was a proposed bill on the table that was shot down – they just haven’t even gotten around to it yet. In fact, this Congress cannot even seem to bring any type of bill up for a vote, much less get it approved or disapproved.

There is no doubt that the high price of gasoline in the U.S. will put a dent in oil demand. Americans are already using less gasoline causing a decline in U.S. oil consumption. The Middle East will soon realize that the demand decline in the U.S. will have long-term negative implications for their own economies. At that point, supply and demand will definitely dictate lower prices.

However, Congress’s argument that new exploration and drilling wouldn’t lead to an immediate price reduction is absolutely incomprehensible. If it were announced tomorrow that Congress had approved off-shore oil exploration in Florida and California and opened up Alaska for exploration, the Middle East would immediately get the point. If the U.S. launched an aggressive exploration campaign, it would be clear to the rest of the world that we intend to solve the issue.

Yesterday, the Speaker of the House recommended to President Bush that he release oil from the strategic oil reserves to solve the short-term high gasoline price issues. That recommendation only illustrates Congress’s shallow mindset: while releasing oil from the reserves might help the price over the next 90 days, exploration would help for years into the future. With oil being one of the most important economic problems the U.S. is facing today, it’s baffling that our Congress can’t get a single bill about it (or any issue) on the floor for a vote.

The problem with our Congress doesn’t stop there. I read yesterday that Federal judge nominations have been delayed by 18 months. That’s not to say that any hearings have actually been held concerning particular judges; they simply haven’t even gotten to the hearing stage. It would be hard to complain if they actually voted for or against a particular person, but the fact that they cannot even bring a nominee to a hearing is sad.

Rasmussen also reported that 72% of voters believe that most Congress members are more interested in furthering their own political careers and only 14% believe they are genuinely interested in helping the public. Duh! Some people have a firm grasp on the obvious.

I’ve often said that we’d be much better off if Congress went on a summer vacation and never came back. In a few weeks, Congress will be off for the entire month of August to take a much needed vacation from their lack of effort. With the ineptitude of this particular Congress, it seems that I have finally gotten my wish.

Think, Don't Trade!

From the Desk of Joe Rollins

It seems like the financial stocks have taken a beating every trading day so far during 2008. Even though most of these stocks are currently selling at much less than the banks’ book values, they continue to be violently traded down by the markets on a daily basis. One expert after another on the morning financial news programs seems to say that no one should be in the financial sector right now, and they suggest that if you are, then it’s time to cut your losses and get out.

I often find myself wondering if these financial “experts” have actually given any serious thought to their recommendations. I understand trading on momentum, and that “the trend is your friend,” as the saying goes. But at some point, common sense and economic reality must have some input on trading decisions.

For the last three weeks, the financial press has been pounding investors with talk regarding the bear market, and all of the major market indices now seem to be trading down 20% from their highs in October of 2007. I often find myself telling clients that investing in a bear market is really not that different than coming face-to-face with a bear in the wild. If you’re ever in that frightening predicament, it’s not wise to make any sudden moves. Rather, it’s best to lay low, move smoothly and think before reacting. Investors should take those same steps during a bear market.

Understanding how banks make their money is fundamental to investors investing money in financials. The central component of a bank’s earning stream is its ability to borrow at low interest rates and lend high. Banks make money on the spread of interest rates between what they can borrow from the public and how much they make by loaning money to the public.

 
Please review the chart I have provided titled, “U.S. Government Bonds – Yield Curve.” The top line represents bank interest rates from exactly one year ago today, while the bottom line represents bank interest rates today, based on U.S. Treasury bond rates. Any financial analyst who asserts that banks are in a worse financial position today than they were one year ago clearly does not have a handle on the income potential of banks and financial institutions.

In 2007, banks were borrowing and lending money essentially at 5%. Please note that virtually every focal point on the chart for 2007 is at or near the 5% level. It was impossible at that time for banks to make any serious money without taking inordinate risks since they were borrowing at exactly the same rate they were able extend loans. As evidenced by 2008’s results in the chart, all of that has now changed.

To put the bank interest rate spread into simpler terms, if you have money at your local bank in a money market account, you are likely receiving the three-month Treasury bond rate or lower. Basically, the bank borrows money from you, paying you money market interest rates, which are currently significantly below 2%.

With the money the bank borrows from you, they extend mortgages and other long-term loans to the general public. As you can see by the chart, the 30-year Treasury rate is now approaching 5% on the Treasury bond rate. Today, 30-year mortgages are at 6.25% to 6.5%.

If banks borrow money from its customers at less than 2% and subsequently loan that same money to the public at 6.5%, then the spread between the spread between the two is a staggering 4.5%. Believe me; rarely in the history of banking has there been this big of a spread on their borrowed capital.

The recent increase in interest rates by the European banks was also confusing. They increased interest rates by a quarter of a point under the assumption that it would help slow down inflation (inflation is basically the only mandate Europe has to work with within its economy). The Europeans have little or no control over energy, and therefore, their increasing of interest rates will have very little effect, if any at all, on the cost of energy.

Presumably, the Europeans intended to slow down their economy by increasing interest rates while their economy is basically already at break-even. I’m having a hard time understanding why any government would intentionally throw its economy into recession in an effort to slow the rise of a commodity for which they have no control. Am I alone is seeing the absurdity of this interest rate increase?

The “experts” also talk incessantly about the rising commodity prices and the potential fear of future inflation. Please review the chart titled, “Commodity Prices – 1 Year Percent Change,” representing the four basic commodities: oil, corn, wheat and rice. As you can see, wheat, which is the poorest performing of these commodities, is up approximately 50% over the last 12 months. One might assume that these out-of-control increases in these commodities must be leading to skyrocketing inflation. Each of these commodity’s prices will most likely work its way through the economy, as the supply of each commodity must increase to make up for the increase in price.

The rate of inflation is now approaching 4% annualized, and it is assumed it is only going higher due to these escalating commodity prices. However, please note on the chart concerning bond yields that the 30-year Treasury bond is currently yielding only 4.5%. Investors obviously have no long-term fear of inflation or they wouldn’t be willing to tie-up their money for 30 years only to receive a rate almost exactly equal to the rate of inflation. It is absolutely clear that the most sophisticated investors do not believe inflation is a long-term risk to the economy or they would demand a higher rate of interest.

As I watch the financials being traded down to almost ridiculous levels on the New York Stock Exchange, I think of the inconsistencies of the positions outlined above. A lot of investors are apparently trading before they’re thinking. If an investor properly evaluates the facts, it should be obvious that banks and financial institutions are currently in a position to make substantial sums of profits over the coming year.

There are two ways for the Federal government to bail out a financial institution: by “bailing out” the financial institution (similar to what happened with Bear Stearns), or; without government intervention, which is much more effective, by allowing the financial institution to make more profits.

By reducing the short-term interest rates, the Federal Reserve has made the yield curve very steep. The precipitous nature of this yield curve allows the banks to borrow from individuals at nearly zero interest rates, and then loan out the same money to the public with an almost 5 point interest rate spread. This spread on interest rates almost guarantees higher bank profits in the coming years. For the foregoing reasons, the next 30 days may be the best buying opportunity we will see in our lifetimes to purchase the stocks of the great U.S. banking institutions.

News - July 2008

Unlike the fictional Jed Clampett who discovered oil on his property in the classic television series, “The Beverly Hillbillies,” many speculators and some investors are being handsomely rewarded by betting on oil and energy. Corporations that have made investments in commodity and energy production continue to strike it rich as well.

While there is certainly a valid fundamental case that can be made to support the current high price of oil, it does seem as though additional demand was predictable during the past several years. A reasonable person could assume that there is some amount of speculative froth in oil prices that have advanced nearly 50% in 2008 and more than doubled over the past 12 months. Who didn’t understand a year ago that growing Chinese and Indian economies wouldn’t require additional energy consumption in concert with that economic development?

The advocates of the temporary bubble scenario like to compare current oil prices to past bubbles as the charts and investor sentiment mirror many past manias. Any asset that appreciates as rapidly as oil, and some of the other commodities, is very prone to corrections based on the shear magnitude of the price changes over the past few years. If the price of oil were to decline 50% over the next few months, it would still have gained 500% over the past ten years.

The flip side of the argument are those who argue that the high prices are completely justified and are likely to go higher in the future as demand continues to increase. They argue that the markets are working and slowing demand via higher prices as supply fails to keep pace with rising demand.

Oil supply and demand are currently drawing closer to parity at about 87 million barrels a day. There is some concern as to whether the current suppliers of oil can increase output and to what level. Some have opined that Middle Eastern suppliers have excess capacity, while others are not optimistic that the Saudis and others can boost their output. A component of the variance of opinions is the relative lack of specific information regarding the reserves and output capability by the OPEC nations.

It has been well documented that the new demand is coming from emerging economies, not from the already developed nations of Western Europe, Japan and the United States. Chinese citizens use about one-tenth of the amount of oil that the average American citizen uses on a daily basis, while an Indian citizen consumes less than 5% of the oil that the American citizen consumes on a daily basis. These two booming economies have the potential to surpass the U.S. demand for oil as their large populations acquire wealth and their lifestyles increasingly require energy consuming modern conveniences.

While political solutions to the rising costs of energy and other commodities abound, we are quite certain that the marketplace will adapt to these higher prices. High prices will encourage more development of current energy sources and inspire new technologies and efficiencies using alternatives and substitutes. Unfortunately, no solutions are immediate and consumers in the short run are sure to use a larger percentage of their incomes buying food and energy or adjusting their habits.

Over the past month, the markets have retested the general low levels reached by the stock market in January and March. While the Dow Industrial Average has eclipsed its lows reached earlier in the year, the S&P 500 and other broader measures of the equity market have not achieved a significantly lower low during 2008 as of June 30th. While it is not our position that these technical measures (such as eclipsing certain numerical milestones) are particularly meaningful, the fact remains that they do have some importance to many investors and traders who use these statistics to shape their investment philosophies.

June was a difficult month for most investors. The Dow Jones Industrial Average, one of the worst performing measures, plunged 10% for the month of June to bring the year-to-date totals for the highly followed average down 13.4% for the year. The S&P 500 was down 8.4% for the month and 11.9% for the year; the NASDAQ was down 9.1% for the month and 13.2% for the year, and; the Russell 2000 (small stocks) was down 7.8% for the month and down 9.4% for the year.

The broad international markets as measured by various ETF’s also performed poorly in June. The developed international markets lost 8.8% during the month and have lost 10.9% for the year. The emerging markets were off by 9.3% for the month of June and have lost 8.7% for the year. India’s and China’s stocks have been very poor, each posting negative returns in excess of 20% for 2008 through June 30th. Latin American and Canadian stocks have balanced out the falling Asian markets, gaining 11.6% and 3.6% for the year through June 30th. Many of the best performing international markets this year, such as Brazil and Canada, are benefiting from appreciating commodity prices.

Financials maintain their position as the poorest performers, falling a nearly inconceivable 30% for the year and an equally astounding 18.4% during the month of June alone. Some of the major brokerage firms reversed their predictions that the financials were on their way to recovery and instead downgraded the financials amid further concerns regarding the credit crunch and slumping housing market. The banks are raising huge sums of capital to meet requirements and to provide much needed liquidity, which is good for business, but these actions will dilute the earnings for equity investors as the earnings recover.

The remaining two areas of the market that remain positive for the year are commodities and materials stocks. Oil ran up about 10% during the month of June along with the broader measure of commodity prices that produced a positive return for the month of 9.2%. Oil, as we previously mentioned, is up roughly 50% during 2008, while a broader blend of commodities have returned 27% from January 1st 2008 through June 30th 2008. The materials stocks have posted a slight gain for the year at positive 0.8%, but fell 5.9% for the month of June.

Many of our portfolios have outperformed the broader indices, benefiting from greater exposure to commodities, energy and materials stocks during 2008. Several mutual funds we own for our clients have large positions in these outperforming sectors. It is nearly impossible to predict with absolute certainty which sectors of the market are going to do best, to what degree, and for how long.

We do make an effort to responsibly allocate our portfolios in a way that takes advantage of those areas of the market that are the likeliest to benefit from the current economic environment. A popular mantra is: “There is always a bull market somewhere,” however, that is only a small piece of the equation for investors as no bull markets last forever. We do believe that stocks will rise over long time horizons, although there will be pitfalls of various durations along the way.

Extreme bull markets such as the commodity run often end violently, which is why we would never suggest owning only such a narrow segment of the market. Portfolio diversity is essential in order to reduce portfolio risk and avoid catastrophic events that can derail your plan for financial security. As investment advisors, we take our responsibility of balancing potential rewards and the risks in the markets very seriously. This professional approach to investing is precisely why we feel our services are valuable to investors during difficult periods.

Parents Should Focus on Retirement First

A recent study by Putnam Investments found that most parents are finding it harder and harder to save for retirement while saving for their children's education.

The two biggest factors are the move away from defined benefit plans and that women are having children later in life. The move from defined benefit plans (pensions) to 401(k) plans is a glaring obstacle since workers now need to make the decisions on the amount to contribute and what investment decisions to make.

Couples having children later in life gives them less working years to save for educational needs. The birth rate for mothers 30-34 has risen 83% since 1975.

Additionally, the credit market tightening (fewer student loans) and home value decline (equity decreased) has also been an issue in saving for college.

Over the past 30 years, college costs have risen much faster than income (844% to 304%).

In the end, the main issue will be what options will be available for college students, and the need for parents to gauge the risks and rewards of saving for retirement versus education.

We feel that retirement should trump educational needs since a student can receive scholarships, grants, loans, etc. for college, but for retirement, you are usually on your own. Just remember to get in the financial aid forms early!

The New Generation of Funds

Investors are starting to understand and be comfortable with alternative investment funds, and a new type is called "130/30". The 130/30 funds are essentially, where the fund is invested 30% in short positions (sold a stock that is not owned), and the original fund's cash plus cash proceeds from the short sells are then used to buy 130% in long positions. This can be extremely effective if a fund manager believes that one asset class is falling (goes short) while others are climbing (goes long).

The benefit of this type of fund is that the fund holds both types of positions, so even if a bad day on the market occurs, if the short asset class went down, the fund's overall losses are lessened. There are several variations of the funds that different fund managers and fund families use, and not all of them are the same or even invest in the same asset classes.

While these are not a "magic fund" that always has the best returns, they are a good alternative investment to add to the portfolio. We have frequently used many of these types of funds, and we continue to analyze and use the best funds available.

Rush Cashes In

The conservative talk show host Rush Limbaugh is said to have reached a deal with Premiere Radio Network (owned by Clear Channel) through 2016 and reportedly $400 million. The numbers are staggering, but what makes the entire deal interesting is the struggling advertising market as a whole.

The advertising market on radio has been tough as well, and Clear Channel is looking to lock up one of the most successful and profitable names in radio. With an estimated 20 million listeners, Rush's show will continue to be a big draw for anyone looking to market their products.

Between now and 2016, anything can happen (think Howard Stern and his $500 million contract with Sirius that keeps looking smaller and smaller), but Rush has a 20 year history that has survived Bush, Clinton, and Bush. Whether McCain or Obama, Rush is going to have plenty to say.

Look for some more conservative dialogue coming out of the $400 million man for years to come...

Oil Falls $1 on Light Trading

The oil market was open Friday even though it was the July 4th holiday for the rest of the U.S. market. In trading, thanks to tensions easing around Iran's nuclear program and the dollar strengthening against the euro, crude oil fell $1.

Iran seems to be testing the waters on backing off on its nuclear program, if they receive economic benefits in exchange. Recently, the 2nd largest oil producer in OPEC had been threatened by either U.S. or Israeli military attacks unless it halted it nuclear program.

The dollar strengthened on Thursday after some comments from the European Central Bank (ECB) seemed to suggest that their would not be any further interest rate hikes coming thus the dollar did not seem to be in jeopardy.

Additionally, Saudi Arabia has made comments suggesting that it is trying to skate the fine line between supply and demand. They can raise production at anytime, but they believe there is no need currently.

As it has been recently, the news can change quickly, but maybe the rise in prices is starting to halt... maybe even retreat.

Attention Deficit Investing

From the Desk of Joe Rollins

It occurred to me recently that the market’s volatility over the last year is partially due to investors being negatively influenced by certain financial television programs. I sometimes watch the CNBC show “Fast Money,” which seems to be focused on telling investors how to quickly get in and out of trades. The definition of long-term investing to the producers of this show appears to be a mere 48 hours.

After “Fast Money” airs, Jim Cramer’s show, “Mad Money,” begins with lots of hollering and “Booyahs!” Cramer was a very successful hedge fund manager, but I’m not so sure that he does the investing public much good. In a recent broadcast, Cramer launched into an exuberant dissertation on the poor state of the stock market and how uncomfortable the investment environment was at the current time.

After Cramer’s diatribe, he began the popular “Lightning Round” segment of his show. In contradiction to Cramer’s earlier apprehensiveness of the current investing arena, he gave nearly every stock discussed a “buy” rating. The inconsistency of his two positions could only lead an investor to utter confusion.

When I first started investing in the stock market in the 1970’s, my research was provided solely by the Wall Street Journal. I looked forward to receiving that paper – via snail mail a full two days after the original publishing date – even though the articles were often old news.

Thirty years later, I still receive the Wall Street Journal, but it is now delivered to my house the very day it is published. By the time the paper hits my front porch, however, I have typically already read all of the important articles and subsequent updates online. Isn’t it funny how quickly information more than 15-minutes old nowadays becomes outdated?!?!

The endless marketplace opining seems to have manifested and caused the investing public to be in a phase of speculating instead of investing. Stocks are selling at historic lows, and hedge funds are moving billions of dollars at the stroke of a pen. This is undoubtedly due to speculation and not investing.

The trade du jour is to go long on oil and short the financials. This has made oil trade at 25% above where it should be based on demand, while banks are selling at the ridiculously low level of 50% of book value. Neither of these positions can be supported by quantitative evaluation of either sector.

When an investor’s goal is to make money over the long-term, it is important to invest and not speculate. It’s not wise to trade day-in and day-out based on the infinite whims of the market, and folks who trade in such a manner will unquestionably lose money.

Some of my clients have asked why I don’t agree with selling to a cash position. While I agree that cash is a viable short-term investment, anything left in cash for longer than 30 days only guarantees a loss. Current cash balances are generating returns of roughly 2% while the inflation rate is now at 4%. While it’s always possible to lose money in stocks, that’s not guaranteed to happen. In fact, most stock market investors typically make a lot of money over time. Conversely, if you sit in cash in today’s market for longer than the very short-term, you’re guaranteed to lose money based upon the increase in inflation alone.

I know that investors aren’t comforted by the current state of the stock market, but I truly believe that if people stopped trading speculatively on a daily basis and instead invested for the long-term, everyone would make more money. “Fast Money” and “Mad Money” may be entertaining and even informative sometimes, but they are probably not the prescription for long-term financial security.

Where Do We Go From Here - 2nd Half 2008

In the office, we have been talking at length about the direction of the market for the 2nd half of 2008 and into 2009 for the past few days. The Dow and S&P 500 are loaded with financials. As the year continues to progress and earnings and any other issues are finally put to bed, the financials should start to recover.

There are definitely some rallies out there to build on, and we believe the financials are going to be a big part of them. Deutsche Bank (DB) has already said it will be profitable in the 2nd quarter and it will have no more write downs. This goes in the face of what the market had believed would happen as it was forecast to lose and add additional write downs. Most of the banks should start to do the same. Bank of America has completed the deal for Countrywide because they want to service the loans. The interesting issue here will be that this will probably help if only to get beyond the doubt of the completion of the deal.

Also, there have been several news articles lately that have said the write downs have been exaggerated due to the "rules of accounting". Essentially, the rules state that the banks evaluate the investment at the "market rate" (mark to market), but when the investment has no current market value, the investment is marked to zero. This does not mean the investment has no value, but its value is masked in the vacuum of no market. There is a very good article from the NY Times - click here to read it. It should definitely shed some light on markdowns and what they actually mean in both accounting and realistic terms.

We do know that we continually analyze the market, and we definitely make adjustments to our clients' investment portfolios on an as needed basis. For the 2nd quarter, we outperformed all three of the major indices with our results being +0.99%. The Dow (-6.9%), the S&P 500 (-2.7%), and the NASDAQ (+0.8%) were clobbered with a horrible June.

The market ahead will be bumpy for the short term, but the long term outlook is positive as financials (a conservative bellwether) gets its feet back under it. The Dow and S&P are financially heavy that as this sector starts to improve the indexes will jump.