Friday, October 31, 2008

GDP Beats Forecast - Stocks Rise; Oil Falls 2% on GDP Report

Wall Street was feeling more upbeat Thursday after a government report showed the economy contracted in the third quarter by less than expected and after the Federal Reserve's second interest rate cut in a month. The major stock indexes up more than 2.1%, including the Dow Jones, which rose 190 points.

The Commerce Department reported that the nation's economic output was the weakest since the third quarter of 2001, but it wasn't as bad a showing as Wall Street had feared. The department said the gross domestic product (GDP), the measure of all goods and services produced within the U.S., fell at a 0.3% annual rate in the July-September quarter, rather than 0.5% as expected.

Wall Street had a mixed finish Wednesday after the Fed's decision to lower its fed funds rate by a half-point to 1%. Many investors had hoped the market would build on an 889-point surge in the Dow Jones industrial average on Tuesday. But the buying momentum seemed to reappear Thursday after the GDP report and the Fed's second interest rate cut since Oct. 8.

Michael Strauss, chief economist at Commonfund, said Wall Street was relieved that the GDP figures weren't worse and that, more broadly, investors are drawing some confidence from the government's array of efforts to revive the credit markets as boding well for a weak economy.

"I think it's sort of 'What do you have to do to get someone back from cardiac arrest?' You have to shock them pretty hard and sometimes you have to shock them a couple of times. I think that's what going on here," he said, referring to steps like the Fed's rate cuts and government cash injections in banks, which began this week.

Strauss contends the programs, most of which have yet to take effect, are creating some appetite for snapping up stocks that have been pounded down this month.

Oil Falls on GDP Report

Oil fell more than 2% on Thursday as weak U.S. economic data stirred concerns demand could fall further.

"The GDP numbers made traders rethink whether the economy was going to be strong enough to support oil demand," said Phil Flynn, analyst at Alaron Trading.

U.S. crude settled down $1.54 at $65.96 a barrel, after trading up to $70.60 earlier. London Brent crude settled $1.76 lower at $63.71.

Oil has more than halved its record high of $147.27 from July and is down 30% in October alone, on track for its biggest-ever monthly drop.

U.S. oil demand in August was revised down by 4.8% from the EIA's early estimate of 20.242 million bpd to the agency's final demand number of 19.267 million bpd, and was 8.4% less than demand of 21.035 million bpd a year earlier.

U.S. stocks gained on Thursday, buoyed by hopes that interest rate cuts by global central banks, including the Federal Reserve, will help. The Federal Reserve cut interest rates by half a percentage point on Wednesday, taking its target for overnight bank lending to 1% to help the economy.

China also cut interest rates on Wednesday, kicking off what is expected to be a global round of rate cuts. Norway, Taiwan and Hong Kong have also cut rates.

The Fed cut pushed the dollar lower on Wednesday, making dollar-priced commodities like oil cheaper and more attractive for holders of other currencies. But the dollar rose on Thursday amid month-end book squaring by investors.

Oil drew some support from OPEC's decision last week to cut output by 1.5 million barrels per day, or about 5%, to prop up prices and hints that it might further reduce supply.

Nigeria's state oil company said in a statement it would reduce crude oil export volumes by 5% in November and December because of the OPEC cutback.

Members of the cartel have said they could cut output again to support prices.

Venezuelan Oil Minister Rafael Ramirez said on Thursday OPEC should cut oil output by 1 million barrels per day -- possibly before its next scheduled meeting in December -- and should set a minimum price target of $70 or $80 a barrel.

Venezuela's socialist President Hugo Chavez has used high oil prices to finance lavish social spending. Chavez hawkishly backs output cuts to support oil but says analysts and opponents are wrong to assert that at current price levels he will have to cut social projects.

Sources: Yahoo, Reuters

Thursday, October 30, 2008

Fed Cuts Rates with Global Easing Expected

The United States and China kicked off what is likely to be a global round of emergency interest rate cuts aimed at mitigating an economic downturn.

Norway also cut interest rates on Wednesday and Britain indicated it may lift self-imposed limits on government borrowing to counter a recession that stems from the financial crisis triggered by the collapsed U.S. housing bubble. Japan may cut rates on Friday and the European Central Bank (ECB) and Britain are expected to add to the monetary easing next week.

U.S. regulators are putting the final touches on a new federal program that could provide up to $600 billion in government guarantees of home mortgages to help prevent foreclosures, a source familiar with the talks said. The government hopes to announce the program as soon as Thursday, the source said.

The Federal Reserve cut rates by 1/2 a percentage point, in line with most analysts' forecasts. The Fed, in a statement after a policy-setting meeting, said the pace of U.S. economic activity appeared to have slowed markedly and it expected inflation to moderate as a result of lower energy and commodities prices.

China, increasingly appearing to be the world's last engine of economic growth, has said it would not fall victim to the crisis that has ravaged the world's financial markets in the past year. China cut its interest rate to 6.66% from 6.93%.

Norway's central bank cut rates by half a percentage point to 4.75%, ending more than three years of monetary tightening, while signaling more moderate cuts ahead to help shield the oil-fueled economy from the crisis.

The interest rate cuts, and expectations of action in the U.S., lifted world stock markets for much of the day and sent the U.S. dollar plunging, sparking a 9.0% surge in oil to just under $68 a barrel. Japan's Nikkei index ended up 7.7% and European shares climbed 7.5%.

Wall Street followed Tuesday's 10% rally, its second-biggest rise ever, with more modest gains. After rising moderately before the Fed move, the Dow and the S&P 500 dipped right after the cut before rising more than 2% by late afternoon.

The unanimous decision by the central bank's Federal Open Market Committee takes its target for overnight bank lending to 1%, the lowest since June 2004.

The Fed has cut benchmark overnight rates from 5.25% in nine steps over the past 13 months to counter a financial storm that started with the collapse of the U.S. mortgage market and spread around the world.

British finance minister Alistair Darling said Britain is moving into recession and the government will need to spend more and forget about its self-imposed limits on borrowing for the time being. Darling said he would set out in his forthcoming pre-budget report how the government would keep fiscal policy sustainable over the medium-term but said "to apply the fiscal rules in a rigid manner today would be perverse".

The Bank of Japan will consider cutting rates on Friday but will watch market conditions before deciding, a source with knowledge of the matter told Reuters.

Bets on a quarter-point cut to 0.25% reversed a recent surge in the yen, sparking the dollar's biggest one-day gain versus the yen on Tuesday since 1974. The yen regained a small portion of those losses on Wednesday.

The ECB and the Bank of England are expected to ease policy at their regular meetings next week. The ECB is expected to cut a half point off rates to 3.25%, according to a Reuters poll.

While that would bring the ECB's benchmark rate to its lowest in two years, policy-makers have the scope to deal with a worsening economy that should stabilize by late next year, ECB Governing Council member George Provopoulos was quoted on Wednesday as saying. "I don't think that the ECB has exhausted its ammunition," he said in an interview with Dow Jones newswire.

Governments have pledged about $4 trillion to support banks and restart money markets to try to stem the crisis set off by the bursting of a bubble in the U.S. housing market.

There were more signs that the acute financing difficulties were easing. The closely watched rates that banks charge each other to borrow dollars fell again as central banks continued to inject extra liquidity into the system.

As credit lines have dried up, a growing number of governments have had to look for help from global lenders.

The IMF, European Union and World Bank agreed to a $25.1 billion economic rescue package for Hungary.

Ukraine, Belarus, Pakistan and Iceland are also among the countries in various stages of seeking, securing or considering IMF help.

South Korea denied speculation it was seeking IMF support but said it would ease won liquidity requirements on banks to help bring down their funding costs.

IMF officials have said the fund may need additional resources in a prolonged crisis and European Commission President Jose Manuel Barroso said on Wednesday China and the Gulf countries could do more to help the IMF support countries hit by the financial crisis.

Source: Reuters

Wednesday, October 29, 2008

Wall Street Rally - Fed in Focus; The New Most Valuable Company in the World - For Now...

U.S. stocks rose more than 10% on Tuesday, the second-biggest point gain ever for the Dow and S&P, after investors scooped up beaten-down shares on optimism that the Federal Reserve and other central banks will cut interest rates further.

Hopes for a rate cut grew at midday after a newspaper reported the Bank of Japan is considering lowering rates, further fueling hopes for a Fed cut after its latest policy meeting on Wednesday. Lower borrowing costs could help bolster corporate profits.

Japan's Nikkei newspaper report pulled the yen down more than 5% against the dollar, easing worries after a recent sharp rally in the Japanese currency that had slammed global markets.

Shares of capital-intensive companies such as telecoms posted the day's sharpest gains, including Verizon Communications - 14% and AT&T - 13%.

Big oil companies gave the Dow its biggest boost after BP reported a record quarterly profit beating expectations. Exxon Mobil and Chevron both rose more than 13%.

Shares of Boeing jumped more than 15% to $48.91 after the aircraft manufacturer came to a tentative agreement with its largest union to end a strike and stop revenue losses estimated at $100 million a day.

The Dow Jones jumped 889.35 points (10.88%). The S&P 500 surged 91.59 points (10.79%). The Nasdaq ran up 143.57 points (9.53%). It was the second-biggest point gain ever for the Dow and the S&P.

The yen's rally has forced an unwinding of the so-called "carry trade" -- a phenomenon of Japan's low interest rates, in which investors borrowed yen to finance investments in higher-yielding assets, such as U.S. stocks.

Wal-Mart's stock rose after the world's largest retailer stuck to its 2009 sales growth forecast, saying it will weather the economic turmoil now and could come out even stronger than its rivals when the economy rebounds. Wal-Mart shot up 11.1% to $55.17 on the NYSE.

The rally came despite a gloomy U.S. consumer confidence report that tumbled to a record low in October. Interestingly, in the report, the interest in buying a home went up about 0.5%.

Verizon ended at $31.65, up 14.6 percent, and AT&T finished at $27.61, up 13.2 percent, in NYSE trading.

In the oil sector, Exxon climbed 13.3 percent to $74.86, while Chevron soared 13.5 percent to $70.02. The big energy producers' shares gained even as U.S. oil futures slipped 49 cents to settle at $62.73 a barrel.

Whirlpool Corp tumbled 8.3% to $45.87 after the world's biggest appliance maker said it would cut 7% of its workforce and slashed its 2008 earnings outlook amid weakening demand.

Trading was moderate on the NYSE, with about 1.73 billion shares changing hands, below last year's estimated daily average of roughly 1.90 billion. Most of the volume came in the last hour of trading.

On Nasdaq, about 2.77 billion shares traded, above last year's daily average of 2.17 billion.

The New Most Valuable Company in the World - For Now...

LONDON -- Short sellers of Volkswagen scrambled for the exits on Tuesday, briefly making the European auto maker the world's largest company by market capitalization and raising worries about the banks that sold Porsche Automobil Holding the options to build its stake in the Beetle maker.

The short squeeze sent Volkswagen shares up as much as 93% on Tuesday, extending Monday's massive rally that sent VW's common shares up 250%. Volkswagen shares have been volatile over the past two months, leading to speculation that short sellers were desperate to cover positions. But covering activity took on renewed speed after Porsche announced over the weekend that it increased its equity stake in VW to 42.6% from about 35%, and more crucially, that it had options to buy another 31.5% of VW.

Porsche hasn't disclosed the strike price of the options but said that it will lock in gains between whatever the market price of VW when it exercises the option and the strike price. Porsche said over the weekend that it was acting, in part, because it was "clear that there are by far more short positions in the market than expected."

Porsche was able to build up its options position without detection because of relatively lax German disclosure rules that are due to be tightened next year.
The scramble for Volkswagen shares is particularly acute because its free float is estimated to be just over 5%, since Porsche holds VW shares either directly or indirectly that amount to 74% -- and the Lower State of Saxony, which is fighting both Porsche and the European Union to keep blocking control over VW, holds another 20%.

The massive gains for Volkswagen are raising worries whether funds which shorted the common stock will be able to survive -- and in turn about the banks that brokered the options and short sales transactions. Banks ranging from Goldman Sachs to Commerzbank came under pressure on Tuesday.

At its high on Tuesday, VW was worth 295 billion euros, or $367 billion, making it more valuable than Toyota Motor, Honda Motor, Nissan Motors, Daimler, Renault, Peugeot, General Motors and Ford Motor Co. combined -- not to mention the paltry 4.8 billion euro market cap of Porsche.

Exxon Mobil closed Monday with a market capitalization of $343 billion. Exxon shares have dropped about 30% this year as oil prices have plunged to the low $60-a-barrel level from $147.

The gains for VW come during a period of turmoil for Volkswagen. Volkswagen last week said nine-month deliveries edged up 3.9% to 4.8 million vehicles, picking up market share vs. rivals, but said it was concerned about the "marked deterioration in the situation for our industry throughout the world."

Sources: Reuters, Marketwatch

Tuesday, October 28, 2008

The TARP Funding to Banks; Fed Takes on LIBOR Rate

In the office, we have been discussing the U.S. Treasury's "TARP", and we found it interesting that with all of the comments and questions floating around that the Treasury has still not actually funded the banks. On Monday morning though, Reuters reported the following:

The U.S. Treasury will begin sending $125 billion to the first nine banks to sign up for its capital program early this week, and is willing to listen to other industries seeking government assistance, a senior Treasury official said.

David Nason, the U.S. Treasury's Assistant Secretary for Financial Institutions, told CNBC television that the Treasury executed final investment agreements with the nine banks on Sunday.

He declined to rule out capital injections for insurers and other companies but said there were significant questions about how such investments would work and whether they were needed for financial stability.

"We started with the banks because that's targeted to providing credit to the economy, but there are a lot of industries coming in saying they need federal assistance, so we're willing to listen to their asks," Nason said.

Nason said the Treasury was working quickly on plans for reverse auctions to buy distressed assets from banks, but said the initial auctions were still weeks away.

The Fed Takes on LIBOR Rate with Commercial Paper Program

The much-awaited commercial paper backstop program set up by the U.S. government to support the $1.45 trillion market launched Monday, with the Federal Reserve of New York publishing rates companies would pay to tap the facility.

It will take a few days before the impact of the program is felt and to know if the program is improving conditions by getting issuers and investors directly trading with each other.

The Fed has said "several dozen" companies have signed up for the program, called the Commercial Paper Funding Facility, designed to boost this market that companies access for short-term funds.

For three-month debt, the Fed will offer high grade commercial paper issuers 1.88%. For asset-backed commercial paper, the rate was set at 3.88%.

These rates will serve as a benchmark for the market. If the rates offered by the Fed are higher than what issuers offer investors, it should spur investors to lend to them. If the rates are lower, companies may still tap the Fed, even though they have to pay a fee to utilize the program.

Companies registering for the program have to pay an upfront fee of 10 basis points. For unsecured debt, companies also have to pay 100 basis points over the overnight index swap rate on the day of the purchase and a 100 basis points surcharge per year on each trade execution date. For asset-backed paper, issuers have to pay 300 basis points per year.

The Fed has said the higher-than-market rates on asset-backed paper are designed to keep investors and issuers trading with each other.

While the Fed's rates are considered high by market participants, these rates are lower than a key interbank lending rate, the London InterBank Offered Rate (LIBOR), which generally serves as a benchmark for commercial paper.

Bill Gross, chief investment officer at Pacific Investment Management Co. (Pimco), told CNBC on Monday the LIBOR should fall as the Fed sets its average commercial paper purchase rates below it.

According to data from the British Bankers' Association, three-month U.S. dollar Libor edged lower to 3.5075% from Friday's fixing of 3.51625%. The rate peaked at 4.81875% on Oct. 10.

Libor "can't stand at this level," Gross said on CNBC.

Short-term dollar lending rates also could decline this week on an expected interest rate cut by Fed policy-makers at the end of a two-day meeting on Wednesday.

On Monday, traders have fully priced in the chance the Fed will lower the target rate on federal funds, the overnight cost banks charge each other to borrow surplus reserves, to 1.00% from the current 1.50%, according to interest rate futures.

There is a two-day lag between registering for the Fed's backstop program and using it. The Fed will not announce the names of the companies signing up for the program. On Thursday each week, however, the Fed will announce how much issuers accessed through this program.

General Electric and American Express Co. are registered for the program. The companies did not immediately respond to calls about whether they will access funds through the program.

Sources: Reuters, The Wall Street Journal, CNBC

Monday, October 27, 2008

Fed Expected to Cut Rates; IMF to Give Ukraine Loan With Conditions

The U.S. Federal Reserve is expected to cut lending rates at a two-day policy meeting this week in response to unprecedented turmoil in financial markets.

The consensus among Fed watchers is for a half-point cut in overnight rates to 1%, which would be the lowest level since June 2004. The central bank is also expected to signal a willingness to lower borrowing costs again if needed -- especially with inflation pressures fading fast.

"The economic and financial stability backdrop could not be more challenging," said Robert DiClemente, chief U.S. economist at Citigroup. "The deteriorating economic outlook suggests still greater scope for action."

Fed Chairman Ben Bernanke and his colleagues, who gather on Tuesday and Wednesday, have already cut the benchmark federal funds rate to 1.5% from 5.25% over the past 13 months. They will announce their latest decision around 2:15 p.m. EDT on Wednesday.

The Fed held rates steady at its last policy meeting on September 16, but cut rates by a half-point on October 8 in an emergency move coordinated with other major central banks. The sharp rate cut was complemented by other recent steps to create new funding facilities or expand existing ones to try to ease strains in credit markets that had become increasingly paralyzed by risk aversion, especially after investment bank Lehman Brothers failed in September.

The coordinated efforts have helped ease the global credit crunch, but baby steps on short-term money markets have been overwhelmed by bigger problems for the overall economy.

"The stabilization of the financial system, though an essential first step, will not quickly eliminate the challenges still faced by the broader economy," Bernanke acknowledged in congressional testimony last Monday.

A Reuters poll on October 16 showed economists predicting the U.S. economy would contract for three straight quarters, beginning with the third quarter that ended last month. Such a streak of declining gross domestic product would be the longest since 1974-75.

The U.S. Commerce Department will release its first snapshot of third-quarter GDP on Thursday, the day after the Fed announces its decision.

The U.S. labor market has shed jobs for nine consecutive months, while industrial output slowed in September and consumer confidence has faltered, taking retail demand down.

The Institute for Supply Management's (ISM) index of factory activity fell in September to 43.5, into territory associated with recession, and regional indexes have suggested manufacturing activity has fallen further this month.

While retail sales dropped by 1.2% in September, a dramatic plunge in gasoline prices might salvage consumer spending in the final weeks of 2008 -- which would offer a bright spot for the economy.

Gas prices have already been tracking the sharp drop in the price of crude oil, which has fallen by more than half since a record peak at $147 in July. "If gasoline prices continue to move lower, they will start to act like an economic tail wind, which is clearly a positive development," said economists at Deutsche Bank.

San Francisco Federal Reserve Bank President Janet Yellen said on October 14 that the nation "appears to be in recession," while Chicago Fed President Charles Evans three days later said that the spike in the jobless rate to 6.1 percent from a low of 4.4 percent in March 2007 basically makes recession inevitable.

With the Fed's interest-rate ammunition already running low, Bernanke went before Congress last week and endorsed the idea of a second fiscal stimulus plan to complement the central bank's efforts to rescue the economy.

"With the economy likely to be weak for several quarters, and with the risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate," Bernanke said.

The Fed had astounded some analysts in September by expressing equal worries about growth and inflation, even though energy and other commodities prices were already two months off their peaks and falling rapidly.

Since then the pendulum has swung further toward deflation, so September's assessment that "downside risks to growth and the upside risks to inflation are both of significant concern" will certainly be reworked.

Ten-year inflation expectations reflected in securities prices are now below 1 percent, or under the low end of a range that many policy-makers see as "price stability."

IMF to Give Ukraine $16.5 Billion Loan With Conditions

The International Monetary Fund (IMF) and Ukraine said on Sunday they had reached an agreement in principle for a $16.5 billion loan package to ease the effects of the global financial crisis.

But analysts said politicians would have to set aside differences to adopt a set of financial measures needed to clinch the deal and secure the loan. The former Soviet republic is in the throes of the latest bout of political turmoil that has gripped it since the 2004 "Orange Revolution."

With Ukraine facing its third parliamentary election in as many years, the hryvnia currency has slumped to a record low. Analysts are concerned over the ability of the government, firms and banks to refinance with global lending at a standstill.

The economy is expected to slow dramatically as prices fall for steel, Ukraine's major export, and energy costs climb. Foreign investment is also expected to drop, compounding the pressure on the currency by a current account gap.

"The IMF is moving expeditiously to help Ukraine, and this programme is focused on the essential upfront measures needed to maintain confidence and economic and financial stability," IMF chief Dominique Strauss-Kahn said in a statement.

Analysts welcomed the deal and said the $16.5 billion to be made available over two years was adequate for now.

"In terms of the figure, it's on the higher side of what was mentioned by key politicians in Ukraine. However, this is not such a big fund that it will solve all the problems in one swoop," said Martin Blum, head of EEMEA Economics and Strategy at UniCredit bank.

Ukraine can use the funds to bolster the central bank's reserves -- which it is now spending to stop the currency from sliding further -- and to prop up the banking sector.

Analysts said they did not expect news of the IMF loan to help Ukraine's fledgling stock market which has fallen 60% since the start of September when investors rushed from emerging markets. Bonds may do better though, they said.

The IMF statement said nothing about the conditions it sought from Ukraine. But a joint central bank and finance ministry statement said the government would have to draw up a balanced budget and introduce measures to support banks. "These include legislative changes which must be adopted very soon by Ukraine's parliament," the statement said. Parliament, which has a long history of fractious behavior, has been in disarray for the past week.

President Viktor Yushchenko dissolved the chamber this month after the collapse of a coalition of groups led by him and his estranged ally and now rival, Prime Minister Yulia Tymoshenko. The premier opposes the election.

The president called a December election, but suspended his decree last week to enable parliament to sit and approve financial legislation that include the IMF's demands.

But the prime minister's supporters blocked proceedings to prevent passage of any measures to finance the December poll. It is not certain now when it will take place. Parliament is next due to meet on Tuesday.

Competing packages of financial measures have been drawn up and it is not clear if either of them meet the IMF's conditions.

One package submitted to parliament failed to balance this year's budget. It extended sovereign guarantees to companies borrowing abroad, set out plans for government's own borrowing and barred troubled banks to pay out dividends.

"Judging by the (loan) figure, this is definitely something that allows the recapitalization of the banking system," said Katya Malofeeva, chief economist at Renaissance Capital. "This requires quite a bit of preparatory work and the bills submitted last week definitely didn't include that much detail."

She said two to three weeks would probably be required to approve the measures and passage was made more complicated by the unpredictable behavior of Ukrainian politicians. - Sounds quite a bit like our Congress.

Sources: Reuters, Yahoo

Sunday, October 26, 2008

Asia, Europe Leaders Urge More Finance Rules Before Bush Summit

French President Nicolas Sarkozy has started to try to put pressure on the U.S. in an effort to spur on the U.S. to embraces more regulatory supervision of the global financial markets. Asian and European leaders have agreed with Sarkozy and called for an overhaul of World War II-era banking rules.

The leaders "pledged to undertake effective and comprehensive reform of the international monetary and financial systems, according to a statement in Beijing on Friday. Chinese Premier Wen Jiabao told reporters after the gathering of more than 40 heads of state and government that "we need even more financial regulation to ensure financial safety."

U.S. and European leaders have sparred over the causes of the credit crunch and how to cure it. Sarkozy has called for stricter government oversight of banks and hedge funds. President George W. Bush, who will host the Group of 20 (G20) industrialized and developing nations on Nov. 15, emphasized the role of free markets in a speech yesterday.

"It is foolish to think that within a few weeks Europe and the U.S. are going to be able to overhaul international financial regulation," said Allan Meltzer, a professor at Carnegie Mellon University in Pittsburgh. "It will be extremely hard to come up with a consensus. I doubt the Europeans will even be able to agree among themselves." (Meltzer chaired a U.S. congressional commission that studied the international financial system in 2000 after the Asian financial crisis.)

The EU has floated the ideas of including more bank supervision, stricter regulation of hedge funds, new rules for credit-rating companies and changes at the International Monetary Fund (IMF). The French president has compared the effort to the 1944 Bretton Woods conference in New Hampshire that fixed exchange rates, hitched the world to the gold standard and created the IMF and World Bank.

"While the specific solutions pursued by every country may not be the same, agreeing on a common set of principles will be an essential step towards preventing similar crises in the future," Bush said Saturday in his weekly radio address. Nations must focus on "the fundamentals of long-term economic growth: free markets, free enterprise and free trade," Bush said.

The two-day summit in Beijing was the first meeting of Asian and EU chiefs since calls for coordinated action mounted along with bank failures and plunging stock prices that began last month.

"The IMF, World Bank and other agencies are falling behind the times," said Jeon Hyochan, a researcher at Samsung Economic Research Institute in Seoul. "The agencies need to strengthen their ability to take pre-emptive measures."

The Washington-based IMF is considering an emergency program to prevent a collapse of emerging markets by almost doubling borrowing limits for members and waiving its standard demands for economic austerity measures. The agency agreed on Friday to lend Iceland $2.1 billion in accordance with existing rules after the island nation's banking system collapsed, threatening a prolonged economic contraction.

"There is a unanimous consensus to push forward reform," said Kazuo Kodama, a spokesman at Japan's Ministry of Foreign Affairs. No agreement has been reached on the details of that reform, he said.

Japan wants the IMF to be able to act in a "nimble, speedy, timely manner" and "without excessively stringent conditions" when helping poorer nations, said Osamu Sakashita, a spokesman for Prime Minister Taro Aso.

The EU and Asian leaders were less specific in their statement, which says the "IMF should play a critical role in assisting countries seriously affected by the crisis."

Sarkozy's campaign for an overhaul threatens to expose differences with the U.S. over global financial governance. That may provoke tensions and bog down talks while individual countries continue to act on their own to limit the fallout.

Sarkozy said the mid-November meeting in Washington will involve regulatory decisions because EU and Asian leaders agree that action is needed.

"We have all understood it would not be possible to simply meet and have a conversation," Sarkozy said. "We needed to turn it into a decision-making forum."

The gathering to be hosted by Bush, who leaves office in January, will be the first of a series of financial summits that will also address foreign-exchange rates, according to Sarkozy, who said talks about currencies may be put off until after Nov. 15. "It is simply impossible to talk about the financial crisis without discussing currencies and the way in which they interact."

The pound and the euro have both lost more than 20% against the dollar in the past three months, and more than 30% against the yen. Aso said derivatives products that "flow around the world" should also feature on the agenda.

South Korea stressed the importance of trans-Atlantic unity in taking any actions. "If Europe and the U.S. become united, it would enhance whatever countermeasures are taken," South Korean President Lee Myung Bak said, according to his spokesman, Lee Dong Kwan.

The credit crisis is choking off funds to companies and people, undermining business and consumer sentiment. Stock markets and commodities have tumbled along with currencies this year.

Source: Bloomberg

Saturday, October 25, 2008

OPEC Cuts Output - Oil Still Drops; Existing Home Sales Rise Unexpectedly; Traders Relieved

At an emergency OPEC meeting on Friday, the organization quickly reached an agreement to cut production by 1.5 million barrels per day (bpd) in an effort to halt a deep oil price slide.

International benchmark U.S. crude has slumped by close to 60% from a record high of $147.27 hit in July. On Friday, it fell again to below $63 a barrel before recovering slightly.

"The decision was straightforward," Saudi Oil Minister Ali al-Naimi said after the meeting. "OPEC will do whatever is necessary to balance oil markets."

In the world's biggest energy consumer the United States, oil prices and economic weakness have been major factors in the run-up to the November presidential election. Washington was quick to criticize OPEC's decision.

"It has always been our view that the value of commodities, including oil, should be determined in open, competitive markets and not by these kinds of anti-market production decisions," White House spokesman Tony Fratto said.

For OPEC, the speed of the oil market's collapse after a record rally has stirred memories of the Asian financial crisis in the late 1990s. OPEC's sluggish response then as demand disappeared and oil stocks mounted up helped to push oil to less than $10 in 1998.

"OPEC is showing it is not going to make that mistake again," said David Kirsch, a manager at Washington-based PFC Energy.

Before the roughly two hours of talks, ministers had agreed about the need to reduce production, but differed over the extent of a cut.

Saudi Arabia and other core Gulf producers have relatively low price requirements and are nervous about further destruction of demand in consumer countries as the world economy slows. They had favored a relatively modest reduction of around a million bpd, delegates said.

Iran and others are more dependent on higher oil revenues and was among those who had pushed for a deeper cut of around 2 million bpd. The extent of the market's collapse focused minds and the two sides soon met in the middle.

"The message to the market is, first, of the strength and unity of OPEC in terms of its decisions. There was no dispute or fight, here we were all in agreement," said Venezuela's Energy and Petroleum Minister Rafael Ramirez in an interview with Venezuelan state television.

OPEC's President Chakib Khelil of Algeria said the only option for member countries was to respect the new agreement. "They don't have a choice. What choice do they have? See the oil price go down to lower levels? They'll make the cuts," he said. He also said OPEC would take further action if necessary before the next scheduled meeting in December in Oran, Algeria.

Under Friday's agreement, the 1.5 million bpd being removed from the September production ceiling of 28.8 million bpd includes 466,000 bpd less from top exporter Saudi Arabia and 199,000 bpd from Iran, the second biggest exporter, OPEC said in a communique.

Although the group said at its September meeting it would strictly adhere to targets, it is still pumping above its collective ceiling.

Khelil said the total removed from the market by the end of the year would be closer to 1.8 million bpd as overproduction was eliminated.

Saudi Arabia, the only OPEC member to be pumping significantly above target, has already reduced supplies slightly. It unilaterally increased its production when prices were racing to their July record.

Existing Homes Sales Rise

Sales of existing homes rose by the largest amount in more than five years in September. But analysts cautioned against reading too much into the gain, noting that it reflected conditions before the latest upheaval in financial markets increased the likelihood of a recession in the overall economy.

The National Association of Realtors reported that sales of existing homes rose by 5.5% from August to September to a seasonally adjusted annual rate of 5.18 million units -- far better than the flat results analysts had expected. On an unadjusted basis, sales were up 7.8% from September last year.

But even with the gain in sales, prices kept falling. The median sales price has dropped to $191,600, down by 9% from a year ago.

The National Association of Realtors estimated that 35-40% of sales currently are distressed sales -- either foreclosed homes or short sales in which the owner is selling the house for less than the value of the mortgage.

Distressed sales are having a big impact in lowering prices in some formerly red-hot sales markets in such regions as the West, where sales prices fell in September by 18.5% from a year ago.

Lawrence Yun, chief economist for the Realtors, said there were some glimmers of hope that the bottom of the housing slump may be near. He said that a sales turnaround first seen in California was beginning to broaden to other regions of the country including Colorado, Kansas, Minnesota, Missouri and Rhode Island.

And the number of unsold existing homes on the market dropped by 1.6% in September to 4.27 million units. That marked the second month in a row inventories have dipped, but the level still represented a 9.9-month supply -- about double what's normal.

Other economists, including former Federal Reserve Chairman Alan Greenspan, are expressing concerns that the financial market turmoil will further weaken housing activity and prolong the current slump.

Greenspan told Congress on Thursday that the country had been hit by a "once-in-a-century credit tsunami." He said he did not expect the overall economy to make a sustained rebound until housing, where the economic troubles began, stabilized. He said that was still many months away.

Congress on Oct. 3 passed a $700 billion rescue package for the financial system. Shelia Bair, the head of the Federal Deposit Insurance Corp., is pushing Treasury to include in that package a new program to prevent more mortgage foreclosures as a way to provide further support for housing.

Under Bair's proposal, the government would provide guarantees for mortgages that have been reworked by banks to lower the payment schedules to more affordable levels.

By region of the country, sales in the West soared by 43%, on an unadjusted basis, from September last year, and rose a more moderate 5% in the Midwest. In the South, sales dipped 1.2% and in the Northeast they slipped 1.4%.

Traders Relieved

If ever a 300-point loss on Wall Street could be a good thing, it was Friday. Wall Street started the day with a nervous eye on how far stocks would have to fall before triggering emergency trading halts. They ended the session relieved, even though the Dow Jones industrial average closed down 312, or 3.6%, its lowest finish since the financial crisis began six weeks ago.

The morning started with Dow futures -- a bet, before trading opens, on where stocks would go -- had plunged 550 points Friday morning, triggering a temporary trading halt. This left the traders with many questions and no answers.

As the market opened extraordinarily orderly, the market dropped 503 points before moving higher throughout the day. In the last hour of trading, the Dow got within about 100 points of being positive, but the market slid south. In the last six weeks, the Dow has experienced triple-digit moves in 27 of 30 trading sessions.

The Federal Reserve Open Market Committee, which sets the Fed's target short-term interest rates, meets Tuesday and Wednesday. Most investors are expecting further rate cuts beyond the current 1.5%, which is already near historic lows.

Sources: Reuters, Yahoo

Friday, October 24, 2008

Microsoft Beats the Street; Greenspan "shocked" at Credit System Breakdown; Dow and S&P 500 Finish Higher

Microsoft (MSFT) reported a 2% rise in quarterly profit, driven by sales of new computer server software, and lowered its full-year earnings forecasts to account for a toughening economy.

Shares of Microsoft rose 5% in after-hours trade after the announcement. Microsoft posted a net profit of $4.37 billion, or 48 cents per diluted share, in its fiscal first quarter ended September 30 versus a profit of $4.29 billion, or 45 cents per diluted share, in the year-ago period. Revenue rose 9% to $15.06 billion.

Analysts, on average, were forecasting Microsoft to earn 47 cents per share on revenue of $14.8 billion, according to Reuters Estimates.

Microsoft, the world's largest software maker, cashed in on new releases of computer server software such as Windows Server 2008 operating system and database software SQL Server 2008.

Shares of Microsoft have fallen 19 percent since it last reported earnings on July 17. Microsoft stock closed at $22.32, up 3.67%, on the Nasdaq before rising to $23.35 in extended trade.

Greenspan "Shocked"

Former Federal Reserve Chairman Alan Greenspan told Congress on Thursday he is "shocked" at the breakdown in U.S. credit markets and said he was "partially" wrong to resist regulation of some securities.

Despite concerns he had in 2005 that risks were being underestimated by investors, "this crisis, however, has turned out to be much broader than anything I could have imagined," Greenspan said in remarks prepared for delivery to the House of Representatives Committee on Oversight and Government Reform.

"Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity -- myself especially -- are in a state of shocked disbelief," said Greenspan, who stepped down from the Fed in 2006.

With a general election looming November 4, U.S. lawmakers were sharply divided along political lines in either blaming regulators or bickering for failure to prevent the crisis that has gripped financial markets around the world.

Democrats blamed the departments of the SEC (Chairman Cox was in attendance) and U.S. Treasury (former Secretary Snow also attended) for not having more regulation to guard against these problems.

Republicans, for their part, singled out government sponsored mortgage finance agencies Fannie Mae and Freddie Mac for their role in unsettling financial markets and faulted Congress, which has been led by the Democrats since 2006, for failing to pass measures to rein them in sooner. Republicans have angrily protested a decision by Democrats to not hold a hearing on the mortgage finance firms, which the government took over in September to restore financial health, until two weeks after the election.

Greenspan softened his longstanding opposition to many forms of financial market regulation, acknowledging in an exchange with Representative Waxman that he was "partially" wrong in his belief that some trading instruments, specifically credit default swaps, did not need oversight.

Waxman cited a series of public statements by Greenspan saying the market could handle regulation of derivatives without government intervention.

"My question is simple: Were you wrong?" Waxman asked.

Greenspan said he was "partially" wrong in the case of credit default swaps, complex trading instruments meant to act as insurance against default for bond buyers.

While Greenspan was once hailed as one of the most accomplished central bankers in U.S. history, the low interest rates during his final years at the Fed have been blamed for fueling the housing bubble and eventual crash that touched off the current financial crisis. His strong advocacy for limited regulation of financial markets has also been called into question as a result of the crisis.

The former Fed chair said that a securitization system that stimulated appetite for loans made to borrowers with spotty credit histories, was at the heart of the breakdown of credit markets.

"Without the excess demand from securitizers, subprime mortgage originations -- undeniably the original source of crisis -- would have been far smaller and defaults, accordingly, far fewer," he said.

A surge in demand for U.S. subprime securities, supported by unrealistically positive ratings by credit agencies, was the core of the problem, he added.

Greenspan proposed that that securitizers be required to retain "a meaningful part" of securities they issued. He said that regulatory reform will be necessary in the areas of fraud, settlement, and securitization to re-establish financial stability.

He backed the recently approved $700 billion bailout package, saying that without it, banks and other financial institutions would likely face a serious reduction in credit.

Greenspan also told lawmakers that regulators could not predict the future or make perfect decisions. "It's a very difficult problem with respect to supervision and regulation. We cannot expect perfection in any area where forecasting is required. We have to do our best but cannot expect infallibility or omniscience," he added.

Dow and S&P 500 Finish Higher

Stocks clawed back from five-year lows on Thursday, led by a bounce in energy and health-care stocks after oil recovered from a 16-month trough and top pharmaceutical companies posted reassuring earnings.

The Dow rose 172.04 points, or 2.02%, to end at 8,691.25. The S&P 500 Index gained 11.33 points, or 1.26%, to finish at 908.11. The Nasdaq was down 11.84 points, or 0.73%, to close at 1,603.91.

Sources: Reuters

Thursday, October 23, 2008

'Have to Admit It's Getting Better'; Oil Drops Below $67

There have been numerous articles written about the issues with the credit markets recently. Most point to the fact that until the credit markets start to move forward, the global economy and equity markets will be strained. Even though the first checks from the U.S. Treasury to the banks have not been sent, there has been some movement in the last few days on credit. This is the first of many moves that will help the economy and equity markets start to gain traction. Thus, on Wednesday morning, Barron's had a good article written by Randall Forsyth regarding the credit markets and how they have been reacting over the last few days.

Have to Admit It's Getting Better

The Beatles might have been singing about today's money market. What's the next line?

WHEN LIBOR IS THE LEAD STORY in The New York Times and drive-time all-news radio, it's a pretty sure bet that the worst of the short-term credit crunch has passed.

Tuesday, the Times led its page one with news of Monday's dip in the key money-market benchmark rate. Meanwhile, the radio business report was devoted to the further decline in Libor that morning.

Of course, all this was anticipated by readers of Barron's. It reported last weekend a strong rally in futures contracts tied to Libor Friday, which portended the sharp declines in the key rate Monday and Tuesday ("A Thaw in the Freeze," Oct. 20.)

The three-month London interbank offered rate fell to 3.83375% Tuesday, nearly 100 basis points (one percentage point) below its peak only a few days ago. But Libor still is 100 basis points higher than where it stood in September before the current crisis erupted with full force.

That's of more than academic interest to the companies with the billions of business loans tied to Libor or American homeowners whose adjustable-rate mortgages' interest rates are dependent on an interest rate set across the Atlantic.

More than the absolute drop in Libor, the key rate also fell relative to other benchmarks, such as Treasury bills and the Federal Reserve's overnight federal-funds rate target. That indicates an easing of fears in the money markets, analogous to a fall in the VIX for the stock market.

According to Morgan Stanley money-market maven George Goncalves, the TED spread -- the difference between Libor and T-bills -- by Tuesday had shrunk by 89 basis points, to 275 basis points, since Friday.

Compared to the overnight interbank swap rate -- which measures where the market expects the moving target for fed funds to be in the months immediately ahead -- the Libor-OIS spread has contracted 53 basis points, to 277 basis points, since Friday.

Despite these marked contractions, the TED and OIS-Libor spreads still are extremely wide relative to their historic norms. Which means that the crisis isn't over by any means.

By the time you read this, banks in London will have fixed Libor for Wednesday, no doubt sharply lower again.

And, according to the futures market's reckoning, Libor should average 2.60% in November, which would still be a relatively wide spread from OIS. By early 2009, three-month Libor should bottom around 2.15%, while the fed-funds rate should trough between 1% and 1.25%, according to the futures market, leaving a spread of more than 100 basis points.

Helping to relieve pressures on the money market further was the announcement of the MMIFF, the Money Market Investor Funding Facility. That's the latest in the alphabet soup of Fed programs, this time to provide up to $540 billion to provide liquidity to money-market mutual funds. Money funds can sell instruments such as commercial paper they can't unload on the market to a special purpose vehicle financed by commercial paper funded by the Fed. Got that?

Elsewhere, yesterday's TAF auction was undersubscribed. Translation: banks didn't bid for all the Term Auction Facility money the Fed offered, and paid only 1.11% for what they did borrow. That means they weren't strapped for dough. And that's a good thing.

(At this point, Fed financing facilities could make a category on Jeopardy: "Alex, what is PDCF?")

Elsewhere on the credit beat, another disaster didn't happen in the settlement of Lehman Brothers' CDS. That stands for credit default swaps, insurance policies against the bankrupt investment bank going bust. Which, of course, did happen. Tuesday was the final day to settle up the claims, which conjured fears of somebody having bet wrong not being able to pay up.

It went off without a hitch, as it turns out. Perhaps $6 billion of cash changed hands on $400 billion worth of Lehman CDS outstanding. How's that possible? Say a big investment bank might have sold $11 billion of Lehman CDS but also bought $10 billion. There was $21 billion of Lehman CDS outstanding, but the firm had only a net $1 billion of exposure.

This was like a property-casualty insurer having written homeowner policies with a hurricane approaching. Most of the exposure was reinsured. And for the rest, the insurer had to post more collateral as the barometer dropped. That's how the CDS market works.

As a result, the Lehman CDS settlement was a non-event. But, if ever there was a time that no news is good news, this is it. The mysterious nature of credit default swaps raised the specter that insurers that had written policies could default, leaving billions of unpaid claims. That didn't happen, and the market's worst fears weren't realized.

Back in 1967, the Beatles sang on Sgt. Pepper's Lonely Hearts Club Band, "I have to admit it's getting better…" "Can't get no worse," was the lyrical response.

Not much has changed in four-plus decades.

Oil Drops Below $67

Oil prices tumbled below $67 a barrel to 16-month lows Wednesday after the government reported big increases in U.S. fuel supplies -- more evidence that the economic downturn is drying up energy demand.

The Energy Information Administration (EIA) said crude inventories jumped by 3.2 million barrels last week, above the 2.9 million barrel increase expected by analysts surveyed by energy research firm Platts. Gasoline inventories rose by 2.7 million barrels last week, and inventories of distillates, which include heating oil and diesel, rose by 2.2 million barrels.

Over the last four weeks, the EIA said, motor gasoline demand was down 4.3% from the same period last year. Distillate fuel demand was down 5.8%, and jet fuel demand was down 9.2%.

"The main theme here that's driving this market into new low ground is demand deterioration," said Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates. "As we begin to see evidence that demand is leveling -- it doesn't have to increase, just level -- then we can start discussing a possible price bottom. But it appears premature at this point."

Light, sweet crude for December delivery fell $5.43 to settle at $66.75 on the New York Mercantile Exchange, after falling as low as $66.20. It was the lowest close for a front-month contract since June 13, 2007, when crude settled at $66.26.

The dollar's strength this week relative to other currencies has contributed to oil's decline. Investors often buy commodities like crude oil to hedge against a weakening dollar, and sell those investments when the dollar rebounds.

The euro fell below $1.28 for the first time in nearly two years Wednesday. The 15-nation euro dipped as low as $1.2736 in morning trading before recovering to $1.29, still down from $1.3003 late Tuesday in New York.

Meanwhile, the Organization of Petroleum Exporting Countries (OPEC), which accounts for about 40% of global oil supply, signaled that the group plans to announce an output quota reduction at an emergency meeting Friday in Vienna.

Russia's top energy official said Wednesday that Russia, the largest oil producer outside of OPEC, may set aside an oil reserve to influence global prices -- but won't cut output, according to news reports. Deputy Prime Minister Igor Sechin said the government was considering creating an oil production reserve "which would allow it to work more efficiently with prices on the market."

Barron's, Reuters, Marketwatch

Wednesday, October 22, 2008

Paulson Sees Banking Consolidation; Oil Drops to $70 a Barrel; iPhone Delivers for Apple

Treasury Secretary Henry Paulson said on Tuesday that he expects to see consolidation within the stressed U.S. banking industry and indicated he sees that as positive, according to Bloomberg.

"There will be some situations where it's best for the economy and for the banking system for there to be a consolidation," Paulson was quoted saying by Bloomberg.

Oil Falls to $70 a Barrel

Oil prices slumped back below $71 a barrel Tuesday as a stronger dollar overshadowed expectations of a sizable OPEC output cut and led investors to shed commodities bought as an inflation hedge (investors often buy commodities like crude oil as an inflation hedge when the dollar weakens and sell those investments when the greenback rises).

At the pump, consumers got another price cut as a gallon of regular gasoline lost 3.4 cents overnight to a new national average of $2.89, according to auto club AAA, the Oil Price Information Service and Wright Express. Prices have fallen 30% from their July 11 peak of $4.11 a gallon and are quickly closing in on year-ago levels.

The dollar muscled higher against rival currencies as credit market conditions eased some and on speculation that the U.S. government might roll out another stimulus package in an effort to jump start the economy.

Light, sweet crude for November delivery fell $3.36 to settle at $70.89 on the NYMex. On Monday, the contract rose $2.40 to settle at $74.25 a barrel. Crude oil is down 52% from its all-time peak of $147.27 reached July 11.

Alarmed by the rapid slide, the Organization of the Petroleum Exporting Countries (OPEC), which controls 40% of the world's oil supply, is holding an extraordinary meeting Friday in Vienna. OPEC's president, Chakib Khelil, said Sunday the group is planning to announce an output reduction that analysts believe could total at least 1 million barrels a day.

But experts are divided over how much impact on OPEC cut will have on prices. Some believe waning global demand for energy will push prices as low as $50 a barrel, while others say a significant supply reduction could halt the downward the momentum.

"If OPEC does cut production, prices could return to the upside over the next three to six months," said Costanza Jacazio, an oil analyst with Barclays Capital in New York. She said tighter global supplies could eventually push prices back toward the $90 range, a level believed to be favored by several OPEC members including Iran and Venezuela.

Oil-producing countries are facing steep serious budget shortfalls as oil prices come down from record levels. Khelil has said OPEC may cut output again at a meeting in December, and that the group considers the oil market oversupplied by about 2 million barrels a day.

Investors are also keeping a close eye on whether non-OPEC producers, such as Russia, will reduce supply as analysts lower price expectations for next year. Deutsche Bank on Monday cut its 2009 oil price forecast to $60 a barrel from $92 and predicted $57.50 for 2010.

Oil market traders are also closely watching economic conditions in the U.S.

Federal Reserve Chairman Ben Bernanke told the House Budget Committee on Monday that a fresh round of government measures might help ease the country's downturn. There were also signs Tuesday of a reviving credit market as bank-to-bank lending rates eased further.

In other NYMex trading, heating oil futures fell 3.24 cents to settle at $2.1975 a gallon, while gasoline prices lost 2.82 cents to settle at $1.6919 a gallon. Natural Gas for December delivery rose 10.1 cents to settle at $7.312 per 1,000 cubic feet.

iPhone Delivers for Apple

Apple (AAPL) said its profit jumped 26% in its fiscal fourth quarter as the newest iPhone 3G outsold the market-leading BlackBerry from Research in Motion (RIMM).

For the three months ended Sept. 27, Apple's profit climbed to $1.14 billion, or $1.26 per share, from $904 million, or $1.01 per share in the same period last year. Sales jumped 27% to $7.9 billion from $6.22 billion in the year-ago quarter.

Cupertino, Calif.-based Apple's profit topped Wall Street's expectations, but the sales revenue missed slightly. Analysts had expected the company to sell $8 billion worth of Macintosh computers, iPods, iPhones and other gadgets, for a profit of $1.11 per share, according to a Thomson Reuters poll.

Peter Oppenheimer, Apple's chief financial officer, said in an interview Tuesday that Apple set records for Macintosh sales and for iPod sales in a non-holiday quarter, but that iPhone results marked the brightest spot. The company sold 6.9 million of its next-generation iPhone 3G in the quarter -- more than the 6.1 million total first-generation iPhones sold.

Research in Motion reported it sold 6.1 million BlackBerry smart phones in the quarter that ended Aug. 30.

"We blew it out on the iPhone," Oppenheimer said. Apple said it sold 2.6 million Macs and 11.1 million iPods in the quarter, allaying fears that the sluggish economy would weigh on Apple's back-to-school sales.

Sources: Reuters, Bloomberg, AP, Yahoo

Tuesday, October 21, 2008

Sorry, Chicken Little

Over the weekend, the Barron's cover story, "Sorry, Chicken Little" by Gene Epstein, discussed some of the same items that Joe Rollins wrote about in his last post, Let's Talk Turkey. We have all heard the dire predictions from some economists, and the article below gives a bit of a different take.

Sorry, Chicken Little
By Gene Epstein

It may feel as if the sky is falling, but things aren't as bad as they seem. Our saviors: cheap oil, strong exports and inventory rebuilding.

THESE ARE HARDLY THE BEST OF TIMES FOR THE U.S. ECONOMY. But they may not be as bad as you think. The credit crisis, stock-market crash and fall in home prices have raised legitimate fears of a nasty and protracted recession. Yet the economy has often proved more resilient than is commonly thought -- and constructive factors that have gotten scant attention should help the U.S. skirt a deep recession. In fact, it's possible that the downturn could prove to be one of the briefest and mildest on record.

The main positive is the huge boost to consumer spending that will come from the decline in energy costs. Although the run-up in oil, which punished consumers in the spring and summer, made front-page news, far less attention has been paid to the benefits of petroleum's recent slide.

The wide swing in both the percentage and sheer dollar magnitude of prices has been unprecedented. Over the past 14 months, the bellwether price of crude oil has made a stunning round trip, rising from around $70 a barrel in mid-August 2007 to $147 by mid-July, and falling below $70 Thursday. Natural gas has also slid about 50% from its early-July peak. If oil's price averages around $80, consumers will get a big dose of relief. Soaring energy costs had body-slammed them in July, August and September. Hence the dismal performance of retail sales over that stretch. But beginning with the current month, the energy payback will be enormous. This economic shock absorber should help offset the cruel blows of the credit crunch and declining wealth from equities and homes.

The cavalry hasn't exactly swept in to rescue the economy. But the energy benefit could keep a significant recession at bay until reinforcements -- particularly inventory rebuilding -- arrive early next year, and as credit starts to flow more freely.

What's the most likely scenario? We're now in the roughest patch. Real -- that is, inflation-adjusted -- gross domestic product probably grew at an annual rate of 0% to 1% in the three months ended Sept. 30 and will do no better in the current quarter. Growth should then accelerate, to an annualized pace exceeding 1% by 2009's first quarter and 2% by the second. By the third and fourth quarters, something resembling a recovery will have begun, with annual GDP growth topping 3%. However, the unemployment rate will continue to rise through mid-2009. This reflects the reality that, since mid-2007, real GDP hasn't risen fast enough to prevent joblessness from climbing and won't until the end of 2009.

Such forecasts may sound surprisingly upbeat, given all the scare headlines. But they're roughly in line with the consensus of the 10 most optimistic forecasts in the latest survey published by Kansas City-based Blue Chip Economic Indicators. This organization, which surveys 50 forecasts each month, reported in its Oct. 10 release that the overall consensus now believes a recession began in this year's third quarter and will persist through 2009's first three months. However, the average of the 10 most optimistic predictions put economic expansion at an annual rate of 0.6% in both 2008's third and fourth quarters.

In a story last month ("And Now Some Good News -- Courtesy of Oil," Sept. 22), I noted that a bellwether crude price of $90 would produce an estimated overall energy savings of $150 billion over about six months. If the price holds at $80, the energy dividend could be closer to $170 billion. Assume that $75 billion of that is spent in the fourth quarter and another $75 billion is spent in 2009's first quarter, and the boost to real consumer spending from the energy dividend alone would run at an annual rate of 3.5% in each period.

Unfortunately, declining credit and decreased wealth in homes and stocks will drain away most of the gains from energy in both quarters. In fact, the net contribution from energy will be quite small when the full debit from credit-and-wealth woes is applied.

What, then, will help boost real consumer spending? For one thing, labor income should rise. The projected jobless rate of 6.2% is still fairly low by historical standards, and should be enough to lift wages and salaries. With energy prices falling and food tabs moderating, the headline consumer price index may even go negative for a few months. It should certainly be low enough to permit an increase in real wages and salaries.

What this comes down to, after due allowance for credit-and-wealth shocks, is projected growth in real consumer spending of only 0.9% in the fourth quarter and 1.5% in the first. Since consumer spending accounts for 70% of gross domestic product, this should push GDP into plus territory.

And by next year, in addition to the freer flow of credit, other reinforcements should begin to arrive. The expansion phase of this business cycle produced relatively modest increases in capital investment. Thus, there's no capital overhang to work off. Manufacturing capacity, in high-tech and other industries, grew at a subdued rate. Sometime in 2009, then, capital investment could start contributing to growth.

EARLY IN 2009, inventory rebuilding could resume, to remedy the inventory liquidation that started late last year and that has pushed inventory-to-sales ratios unusually low. The only inventory overhang currently is in vehicles, and is partly attributable to a scarcity of auto loans. But as the credit crunch eases, auto sales probably will pick up. If gasoline prices don't rise, consumers may be more willing to buy the now-unwanted cars that are less than fuel-efficient. In any case, the stage could be set for inventory rebuilding of all other manufactured goods.

In addition, exports, which boost GDP growth, are rising faster than imports, which reduce it. The slowdown in the growth of foreign markets will trim export gains, as will the appreciation of the trade-weighted dollar. But net exports should keep boosting gross domestic product growth through 2009, although at a diminished rate.

A comparison with the economic landscape after 9/11 is constructive. Reflecting the general pessimism at the time, one Wall Street economist observed on Oct. 22, 2001, that with "layoffs mounting, debt burdens elevated, saving rates low, wealth effects tapped out and year-end bonuses likely to be very disappointing, I find it hard to envision a prompt rebound in consumer demand over the next couple of months." Yet, the rebound in demand was not only prompt, it was virtually off the charts. After rising at an annualized 1.8% in 2001's third quarter, real consumer spending soared at a 7% clip in the fourth. By 2002's first quarter, consumption was up by 1.4%; by the second, 2.4%.

True, as scary a month as October 2001 was for the U.S. economy, October 2008 seems far worse. For one thing, while the decline in wealth was quite large seven years ago, it was far smaller than it is now. But, remember, I'm not looking for anything like a 7% jump in consumer spending coming on top of a previous 1.8% gain. As mentioned, the projected increase in this year's fourth quarter is a mere 0.9%, against a probable 1% decline in the previous quarter. (Third-quarter estimates won't arrive until Oct. 30.)

MORE TO THE POINT, why didn't consumers fiercely tighten their belts after 9/11? A March 2005 staff report from the New York Federal Reserve seems to have the answer: "While consumption responds to permanent changes in wealth in the expected manner, most changes in wealth are transitory with no effect on consumption."

In October 2001, then, consumers must have viewed the change in their wealth as transitory, rather than permanent. How do they view the current decline? No one knows yet. I assume that there will be a substantial blow to consumption. But I don't assume that it will be nearly as great as do those who believe that all large drops in wealth, however temporary, hurt consumption.

If I'm right, then, the only quarter of contraction this time around (barring revisions) will have been 2007's fourth, in which GDP fell at an annualized 0.2%. The economy won't be great through the end of 2009, but it should do far better than the gloom-mongers expect.

Source: Barron's

Monday, October 20, 2008

Report Says Medicaid Spending "Unsustainable"

Spending on the Medicaid health program for the poor is on a path to grow at a much higher rate than the overall U.S. economy in the next 10 years, officials said on Friday.

Spending on Medicaid benefits will increase 7.3% from 2007 to 2008, reaching $339 billion, and will expand at an annual average of 7.9% over the next decade, hitting $674 billion by 2017, the U.S. Department of Health and Human Services said in a report.

Over that same time span, the projected rate of growth for the overall economy is 4.8%, the report stated.

The report's release comes at a time of growing worry over the fact that health spending has become an increasing burden on individual Americans, businesses and governments.

Medicaid is the joint state-federal health insurance program for low-income people.

Medicaid spending is projected to grow at a higher rate than spending on the Medicare federal health insurance program for the elderly and disabled, according to the report.

Spending on Medicaid over the next decade is forecast to amount to $4.9 trillion, the report said. Average Medicaid enrollment is seen increasing 1.8% to 50 million people in 2008, and is projected to hit 55.1 million by 2017.

Medicaid is forecast to increase as a share of the federal budget from 7% in 2007 to 8.4% by 2013, according to the report.

"This report should serve as an urgent reminder that the current path of Medicaid spending is unsustainable for both federal and state governments," Health and Human Services Secretary Mike Leavitt said in a statement. "If nothing is done to rein in these costs, access to health care for the nation's most vulnerable citizens could be threatened."

In 1970, the report said, combined federal and state expenditures for Medicaid represented 0.4 percent of the economy, but this percentage grew to 0.9% in 1980, 1.2% in 1990, 2.0% in 2000 and 2.3% in 2007.

Source: Reuters

Sunday, October 19, 2008

Cox Asks Congress for Legislation on Credit Default Swaps

SEC Chairman Christopher Cox has called on Congress to pass legislation that would make so-called credit default swaps more transparent, including requiring that dealers in over-the-counter swaps publicly report their trades and the trades' value.

Writing in Sunday's New York Times, Cox noted that the $55 trillion credit defaults market is more than the GNP of all the world's nations combined, and that credit default swaps "play an important role in the smooth functioning of capital markets." But, he said, "our markets function best when they are highly transparent," while credit default swaps have "operated in the shadows," with "no public discourse nor any legal requirement for these contracts to be reported to the Securities and Exchange Commission or any other agency."

"Having been bought and sold widely and in many cases anonymously," trapping large financial institutions "in a web of transactions," the swaps market has left government regulators with "no way to assess how much risk is in the system."

"All investors ... are paying a price today for the lack of oversight" of credit default swaps, which Cox describes as being "like insurance contracts on bonds and any other assets that are meant to pay off if those assets default," he stated.

Noting the market for credit default swaps has doubled in just the past two years alone and that "private counterparty discipline has proven inadequate," Cox proffers several suggestions:

Congress should pass legislation to increase the swaps' transparency and give regulators "the power to rein in fraudulent or manipulative trading practices and help everyone better assess the risks involved."

It should also require dealers to report over-the-counter swaps and their value publicly, he wrote, while the SEC "should be given explicit authority to issue rules against fraudulent, deceptive or manipulative acts and practices in credit default swaps."

Lastly, he posits that Congress could provide support for federal regulators "to mandate the use of one or more central counterparties -- financially stable clearance and settlement organizations -- and exchange-like trading platforms for the credit-default swaps market."

The SEC, he said, is "working with the Federal Reserve, the Commodities Futures Trading Commission and industry participants to accomplish these goals on a voluntary basis, using the authority we already have." But "we will need to work closely with governments in other major markets," Cox warns.

He concluded that giving regulators authority "to bring the credit derivatives market into the sunshine" would constitute a "giant step forwarding in protecting our financial system and the well-being of every American."

Sources: Reuters, New York Times

Saturday, October 18, 2008

Let’s Talk Turkey

From the Desk of Joe Rollins

I have never before seen U.S. stocks as cheap as they are today. This may be the greatest buying opportunity in our lifetime! I marvel at how far U.S. stocks have fallen, and now is the time for us to take advantage of these low prices.

I have never seen opportunities to purchase stocks so inexpensively with such incredibly high amounts of cash sitting on the sidelines. Interest rates on money market accounts are now paying somewhere in the 2% range, but you can buy the stocks of some of the titans of American industry with yields that are two to three times the amount that you would earn on cash. Furthermore, these dividend yields come with a favorable tax rate that is one-third that of the income tax on cash.

I feel like the proverbial fox in the henhouse when reviewing these stock buying opportunities. Just look at the following list of stocks that could be purchased on Friday morning and their dividends yields:

General Electric Company6.4%9.8
Merck & Company, Inc.5.7%12.4
Altria (Phlip Morris USA)7.1%4.9
Chevron Corporation4.3%6.7
United States Steel Corporation3.1%4.0
Exxon Mobil Corporation2.6%8.6
Johnson & Johnson3.0%14.0
AT&T, Inc.6.5%11.9

When you invest in cash, you will earn the stated rate of return. However, I think it’s almost a given that the interest rate earned on money market accounts is falling and will soon be in the 1% range. On the other hand, if you invest in the companies above, you not only get paid a significantly higher rate of return, you also receive the potential for the companies to appreciate through the years. In other words, you would be buying stocks of some of the greatest U.S. companies at bargain basement prices and with a dividend yield far in excess of anything you could earn on cash.

Do you know who else thinks that right now is a great opportunity for buying equities? Warren Buffett, who wrote a convincing Op-Ed in Friday’s edition of The New York Times. Click here to read Buffett’s "Buy American. I am." editorial column.

Warren Buffett is probably the most legendary investor of our lifetime, and he is actively buying American stocks in his personal account today. Buffett explains his thought process on why he’s so keen on United States equities right now: “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.” No other explanation is needed. With the extraordinary volatility in investing today, no one could argue that fear is quite widespread. Now is the time to buy!

Buffett also explains that, “Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.” You don’t need a higher endorsement to purchase stocks than one from the greatest investor in our lifetime.

I continue to be somewhat confused as exactly why there is such a high fear level surrounding the financial world today. Stocks prices have fallen dramatically, but that is part of investing – stocks go up and stocks go down, but over time it is proven that stocks are the best investment vehicle.

One potential fear was completely resolved on Thursday; the most recent inflation reading indicates that there is no inflation. A clear example of that is the dramatic fall-off in the price of energy. In addition to oil, nearly all commodities have realized 50% to 70% declines in value over the last six months. It is estimated that every penny that the price of gas goes down represents over $10 billion in reduced costs to Americans. While everyone sees the savings at the pump, most people don’t recognize how representative this is of savings across the board. For instance, transportation of food and other commodities are dramatically reduced when the price of oil decreases. Accordingly, the fear of inflation is not an impending issue right now.

Moreover, I see no reason for investors to be fearful of the banking industry anymore. The extraordinary actions of our Federal Reserve have resolved those issues. The Department of Treasury is scheduled to inject $125 billion in cash into our major banks; their futures are now secure. Additionally, the Treasury will soon deploy the remainder of the almost one-half of a trillion dollars to stabilize banking in America.

If you were concerned about your checking account, you should set your mind at ease. The FDIC has increased the insured account amount to $250,000, and there is currently a government guarantee on all non-interest bearing checking in the United States. Therefore, any checking account in any Federally-insured bank is absolutely secure. Other governments around the world have made similar banking guarantees.

The U.S. Treasury is creating a market in loaning to banks. They have guaranteed inter-bank loans effective this past week, and they are now providing direct financing to corporations in the commercial paper market. In fact, the Federal government appears to be guaranteeing anything that resembles cash. Frankly, I believe that they probably have an indirect guarantee on your Sears & Roebuck credit card…

If you are an avid reader of my posts, you know that I’m an ardent supporter of capitalism. In spite of my strong beliefs, the government’s intervention in the banking system was mandatory this time. As I listened to Congress debate regarding the bill to save the banks, I was stunned at the complete ineptitude of our elected officials. Those members of Congress who believe it would’ve been okay for banks and companies to fail just don’t get it! There’s nothing wrong with our government assisting businesses through a rough patch. While nationalization is never pretty, the human suffering and the damage to our economy due to massive unemployment would be a lot less attractive. I think we will see that the money used in this transaction will be quickly repaid and the government will no longer have an ownership interest in our businesses. In this particular case, it was a win-win for all parties.

When listening to the news this morning, I heard several analysts comment that the economy had yet to start recovering. Considering that not one single check was been written by the government yet, these comments were bewildering. It would be astonishing if things started getting better before the money supply was actually funded. However, next week – once this money starts flowing through the system – you will see immediate and significant improvements in liquidity, creditworthiness and, eventually, the economy.

Perhaps you’re assuming from the foregoing that I’m oblivious to the elephant in the room – the upcoming recession. Almost assuredly, there will be some sort of economic slowdown soon. We may already be in a mild recession, but if not, it’s certainly a possibility to happen sometime during this quarter. However, any discussion that it will be a devastating and prolonged recession is just not supported by the facts.

The U.S. Treasury is currently pushing close to $1 trillion through the American banking system. Milton Friedman, the American Nobel Laureate economist, made it very clear: If you want to avoid recessions, you must liquefy America by flooding the cash accounts. Never in the history of American finance has there been such a rush to put liquidity into the system.

Moreover, there is an absolutely unprecedented worldwide coordination going on with the major banks in Asia, Europe, the Americas and others, including interbank guarantees and checking account guarantees. There have been coordinated interest rate cuts around the world, and this enormous and swift international cooperation in resolving a potential economic disaster will prove to be effective.

The only way to assume that the potential recession will be devastating is to first assume that the most basic economic principals no longer work. I am not one who believes that the end of the world is near – the fundamental economic theories of monetary policy are well-proven, and the fact that we have never seen such a coordinated global effort to create positive monetary flow further supports my position.

According to the principal well-respected economists, any forthcoming recession should be short and swift. In fact, most economists are saying that we will only have three negative quarters. The third and fourth quarters of 2008 and the first quarter of 2009 could potentially be negative, but the general consensus among these economists is that the second quarter of 2009 will start to provide a positive economic upturn. If I’m not mistaken, that’s only five months away. I continue to wonder why fear is gripping investors when we are only a short period of time away from potential recovery.

So that you don’t start to think that my ramblings are strictly hyperbole, the following are some supporting facts:

I have previously written on the Federal Reserve’s IBES valuation model. This model was introduced to Congress by former Federal Reserve Chairman Alan Greenspan on July 22, 1997. Essentially, it defined the interaction of common stock equities and risk-free Treasury bonds. Its formula is the current estimate for the 12-month future earnings for the S&P 500 divided by the yield on the 10-year Treasury bond at any one point in time.

Assuming that economic fundamentals are currently working, this formula should give us some direction as to the fair value of stocks. According to the Standard & Poor’s projection of operating earnings from the issue I received on October 14, 2008, operating earnings for the S&P 500 for 2008 are at $76.73. For 2007, the confirmed numbers were at $82.54. In 2008, the banks and financial institutions – which are a large part of the S&P 500 composite – provided a significant draw-down in earnings. Without the banks, operating earnings would be significantly higher.

Today, the 10-year Treasury bond has an approximate interest rate of 4% (it’s actually slightly lower, but for illustration purposes I am using an approximated percentage). If you divide the current estimated earnings for 2008 of $76.73 by .04, the result is a fair value of the S&P at 1,919. The S&P today is at 946, so a move to this level would be over a 100% increase. While this is certainly desirable, it’s probably not realistic.

Cynics argue that earnings will be dramatically reduced by the upcoming recession, but frankly, I do not agree with that assessment. I do, however, understand their concerns, and while it’s perfectly possible that earnings will be reduced in 2009 for some industries in the United States, banks and financial institutions will still be dramatically higher. The corresponding net effect will likely change very little.

In order to satisfy the cynics, I will reduce corporate earnings in my example above by a full 30%. At this level, estimated corporate earnings would be $53.71, which would yield a fair market value of the S&P at 1,343, or a 42% increase from the current level.

As I’ve often said, no one can adequately time the market. In fact, the market may go even lower from where it is right now. Whether the trend is up or down, you can expect extraordinary volatility that will delight you some days and frustrate you others. Don’t misunderstand what I’m saying to mean that we’ve reached the bottom of the market; I’m simply saying that stocks by any measure are extraordinarily cheap – perhaps even legendarily cheap – from an investment standpoint.

It’s time for Americans to step up and support the U.S. financial system. Stocks are cheap and there is a significant investment opportunity available to us all. I can’t predict when stocks will go up, but I am certain that they most assuredly will. Many years from now, we will reflect on these days and realize that it was the greatest stock buying opportunity of our lifetime.

When one of the greatest investors of all time says stocks are looking cheap, it’s time to really reassess the market. Buffett isn’t calling a “bottom,” but he is looking forward one, three, five and 10 years out. If he is investing with his personal money, then shouldn’t we start looking for investments, too?

Friday, October 17, 2008

Opposing Uptick Rule Is Truly Short-Sighted

In Thursday's print edition of the Investor's Business Daily, there was an editorial that discusses the SEC's lack of forethought into the issues involving the removal of the "uptick rule" for shorting stocks. Since we have discussed it frequently in our blog, we thought it would be good to have a different voice discuss the issue.

Opposing Uptick Rule Is Truly Short-Sighted

Investing: On July 6, 2007, the Securities and Exchange Commission voted to repeal the uptick rule for short sales. The Dow industrials then stood at 13,611, just three months away from an all-time high of 14,198. The SEC's timing couldn't have been worse.

About the same time, the subprime mortgage mess was surfacing and would soon escort the market on a volatile, 12-month, 40%-plus decline. Investors worldwide have suffered. Worse yet, some of our largest and (we thought) safest financial institutions have gone bankrupt.

Culprits in this yearlong financial train wreck are many. The extremes of leverage and risk taken were unthinkable. But make no mistake: Unbridled short selling also played a role.

The SEC's fateful decision to repeal the rule has exposed us to the very same "bear raids" and "runs on the banks" that prompted the rule's original enactment in 1934. Prudent lessons learned from the crash of 1929 and the ensuing Depression have been unlearned and, in the process, left us unprotected from predatory trading abuses and financial terrorism.

Reasons given for the repeal show a regrettably shallow understanding of the issues. Fact is, politicians have been pressured for years by influential, deep-pocketed hedge funds and financial institutions that wanted faster, cheaper trading venues and looser rules.

The SEC studied the effects of repeal by conducting its pilot program on 1,000 stocks for 12 months from May 2005 to April 2006. Unfortunately, this was a period of low volatility that saw the Dow advance from 10,404 to 11,366 in an orderly fashion. The uptick rule was not enacted for such periods of tranquility. It was enacted as a lifeboat for severe financial upheavals such as those in 1929-1933.

Another excuse for repeal was that, in the era of decimal trading, the rule is impotent. But this is not about the increments of the uptick itself; it is about the negative obligation (in specialist speak) of not being able to short a security repeatedly lower and pound it into the dirt.

Besides, the rule does not have to apply to an uptick of a few cents. It can just as easily require, say, a 10-cent uptick for stocks priced below $20, and 25 cents on those above.

The evidence that volatility has increased after the rule change is powerful. A study by Birinyi Associates in April 2008 shows that after the rule change the VIX (Volatility Index) increased immediately from 13.25 to 23.55. In addition Birinyi showed that during the same period, the absolute dollar value of the daily change in each stock in the S&P 500 increased to $1.77 from $1.02.

Even more compelling is a chart showing the volume of stocks purchased on plus ticks (higher prices than prior sale) and those purchased on minus ticks (lower prices).

The real date -- July 6, 2007 -- shows an immediate and dramatic shift in volume from plus ticks to minus ticks, suggesting unbridled shorting pushing prices lower. Proponents of the repeal say these data are just coincidence. We think not.

Finally, much has been written and reported about the role of predatory shorting in the demise of Bear Stearns and Lehman Bros. Clearly, both of these venerable investment bankers were in serious trouble. Yet, if one carefully analyzes the price and volume action in the final five days of their dramatic declines (when most of the damage was done), the evidence is compelling.

Bear, with a float of 159,098,000 shares, traded down from $61.58 to $2.84 in just five trading days (March 14 to March 20) on stunning volume of 669,737,000 shares, or 4.2 times its total float.

Lehman had similar footprints, diving from $16.20 to 15 cents in five days on almost three times its floating supply. In the process of these startling declines, these firms' ability to fund their businesses disappeared, and both failed.

All this, according to many crusty old traders, smells like a replay of the 1929-33 bear raids that the uptick rule was designed to prevent from ever happening again. Proponents of repeal think not. The difference is that the traders can shake their heads and move on to the next trade.

Those who stand by the repeal must bear the burden of knowing that their poorly researched decision and reluctance to admit their mistake has put our very nation, our markets, our economy, and indeed our national security at risk. The uptick rule needs to be reinstated now.

Source: Investor's Business Daily