Thursday, July 31, 2008

Rate Hikes / Cuts Haven't Impacted Inflation

Why Low Rates in the U.S. Haven't Impacted Inflation

Yves pointed out at Naked Capitalism:

Yes, negative real interest rates normally lead to speculative investment. But pray tell who is getting credit in the US now? Consumers most certainly aren't, businesses have it tough, the mortgage market depends on Federal guarantees, and by all accounts, the credit markets are having liquidity issues in many sectors. We saw a different version of this phenomenon in the S&L crisis: the prime rate wasn't all that bad, but it was irrelevant because just about no one could borrow in any meaningful size.
Why High Rates in Europe Haven't Impacted Inflation

Ambrose Evans-Pritchard points out:
For once I find myself in total agreement with France's Nicolas Sarkozy, who said the EBC rise was "at best pointless, at worst counter-productive." This is now plain to anybody who steps outside the Frankfurt Eurotower and takes the pulse of the -- collapsing -- credit and equity markets.

If the rate rise pushes the euro higher against the dollar, it will merely push oil higher as well -- since oil is trading as inverse dollar with seven times leverage. Eurozone inflation" -- that treacherous term -- will get worse. Brilliant.

As can be seen above, the difference between the Fed Funds rate and the European Central Bank's target rate generally predicted the future inflation variance between the U.S. and Europe (as defined by the difference between Consumer Prices in the U.S. and the Haromonized Index of Consumer Prices in Europe). From 1998 - early 2007 each Central Bank acted "ahead of the curve". The Fed took the lead either cutting or raising rates and the ECB followed.

Since mid-2007 the U.S. has cut the Fed Funds in dramatic fashion believing slow growth would inevitably deter inflation, while the ECB felt inflation could be stamped out with higher rates. Thus far, it looks like neither situation has worked out to eithers liking as the difference in inflation between the two areas has been negligible (the U.S. has seen inflation tick up 2.7% to 5.1%, while the Eurozone has seen inflation rise 2.3% to 4.1%).

Merrill: SHOW ME THE ($30B in New) MONEY!

I've detailed Merrill's write-downs previously, but now lets take a look at how much capital they have been able to raise to replenish these write-downs. Over the past 6-7 months Merrill has raised a whopping $30B.

Source: Bloomberg

Update: I proudly present (and this time I have WAY too much time on my hands).... MERRILL'S SPILLED MILK!

Q2 GDP / Revisions...

July 31 (Bloomberg): The economy grew at a 1.9 percent rate from April through June, less than forecast, after a 0.9 percent gain in the first quarter that was smaller than previously estimated, the Commerce Department said in Washington. The report also contained annual revisions that lowered the growth rate back to 2005 and showed the economy contracted in the last three months of 2007.

Check out the revisions in 'State and Local' Consumption, Expenditure, and Investment below. Further proof of the struggles States are facing in this economic environment.

Wednesday, July 30, 2008

World Wide Write-Downs

$474 million in write-downs to date and counting. This will be the last write-down related chart until we see another. In other words, stay tuned...

Source: Credit Writedowns

Loss of 6.7 Million StarBUCKS

WallStreet Fighter Reports:

For the first time since the company went public in 1992, Starbucks has announced a quarterly net loss.

Last year at this time, Starbucks announced a quarterly profit of $158.3 million, but now it's a $6.7 million quarterly loss. Oh how the mighty have fallen in these dark recession days.

Is there any non-essential luxury item consistently being purchased in this era? Now that porn is out, maybe cigarettes?

In spite of this news, Starbucks shares traded 5% hirer today because many investors are happy that many store locations are closing. Even their own investors think they have too many stores. So we're all in agreement now - that Starbucks across the street from another Starbucks plan was a bad idea, right?

Better get out and use that FAKE free drink coupon before anything worse happens to the coffee kings. That is, as long as your local 'Bucks is still alive and brewin'.

Wii Sales Rocket: Sign of the Times?

Are more people getting their entertainment fix at home in these hard times?

Looking at results of the user friendly Wii one may think so, as sales skyrocketed in the recent quarter from games catered to the non-traditional "gamer". Comparing Nintendo's stock performance since the Wii launch (late 2006) to Sony's (maker of the more traditional Playstation gaming consoles), one can see Wii is in a planet all their own...

TOKYO (AP) -- Nintendo Co.'s profit for the fiscal first quarter surged 34 percent as sales of its hit Wii console shot up, underlining the success of the video game unit in attracting novice players.

The Japanese manufacturer of Super Mario and Pokemon video games reported Wednesday a profit of 107.27 billion yen ($996 million) from April through June, up from 80.25 billion yen in the same period last year.

The big factor behind the stellar performance was the Wii and its game software, including the "Wii Fit," which has drawn the health-conscious to doing simple exercises like yoga and aerobics with a video game.

Tuesday, July 29, 2008

Round II: Citi Write Downs to Date

Yesterday, we took a look at where Merrill stood to date with write-downs, and with a recent forecast of another $8 Billion more to come from Citi, I thought it was only appropriate to look in their direction (for the record the huge interest in yesterday's entry makes the contrarian investor in me think I have to put some money to use on the long side...)

I again searched all over the web, but was unable to find a cumulative total of write-downs to date for Citi (except here as of 1/18/08, BUT the numbers are flat out wrong - Citi had already hit $28B at this point).

So... below is my attempt to piece together what I calculated at ~$54B (thanks for the tip Nicholas!) based upon statements directly from Citi (linked to below). Again, please let me know where I may have gone awry.
Click to see larger chart:

October 1st, 2007: $5.9B (Pre-release): "Our fixed income trading business has a long history of earnings power and success, as shown in this year's record first half results. In September, this business performed at more normalized levels and we see this quarter's overall poor trading performance as an aberration. While we cannot predict market conditions or other unforeseeable events that may affect our businesses, we expect to return to a normal earnings environment in the fourth quarter," said Prince.

October 15th, 2007 (Earnings date): "As we move into the fourth quarter, we are focusing closely on improving those areas where we performed below expectation, while at the same time continuing to execute on our strategic priorities," said Prince.

November 5th 2007: $8-11B (in chart as $9.5): Citigroup Inc. (NYSE: C) announced today significant declines since September 30, 2007 in the fair value of the approximately $55 billion in U.S. sub-prime related direct exposures in its Securities and Banking (S&B) business. Citi estimates that, at the present time, the reduction in revenues attributable to these declines ranges from approximately $8 billion to $11 billion

January 15th, 2008: $12.9B: "Citi's fourth-quarter results are unacceptable," said Vikram Pandit, recently named chief executive of the company, which is the largest U.S. bank by assets. "We need to do better, and we will do better," he said in a conference call with investors and analysts.

April 18th, 2008: $12.1B: The bank sees "strong momentum throughout the organization. To start with, we're not happy with our financial results this quarter, although they're not completely unexpected given the assets we hold," Pandit later said on the conference call.

July 18th: $7.2B: "We continue to demonstrate strength in our core franchise. We cut our second quarter losses in half compared to the first quarter. The cost of credit increased by 20% from the first quarter, but write-downs in our Securities and Banking business dropped by 42%. " said Vikram Pandit, Chief Executive Officer of Citi.

Case-Schiller - May

I previously detailed that CPI may overstate inflation for an individual who:

  • does not own a home
  • would like to own a home
  • will likely soon buy a home
as it does not include how "affordable" housing has become with the recent price collapse for non-homeowners (full details here).

As can be seen below, the Case-Shiller Price Index remained negative (year over year) as today's Case-Shiller release shows further deterioration, with the Composite 10 dropping over 16% year over year.

In looking at the Composite 10's five year returns (annualized), even after the huge downturn in prices, returns over the most recent five year period are still positive at ~4.5% / year and indicates there may still be room for further deterioration.

Consumer Confidence Analysis (July)

Up to 51.9 from 50.4 in June, but worse when compared from a Year over Year absolute basis (actually worse than at any time over the last 40 years by that measure).

Hey... it could be worse!

Merrill Number Crunching

$4.4B of the CDO write-down:

  • Super Senior CDO positions worth $30.6bn sold to Lone Star for $6.7bn
  • … 22 cents on the dollar
  • … a further $4.4bn writedown from the mark Merrill reported barely two weeks ago, when they were valued at $11.1bn, or 36 cents on the dollar
  • Loan Star purchasing the CDOs using a $5bn loan from Merrill

Monday, July 28, 2008

Merrill Write-Downs to Date...

I searched all over the web, but was unable to find a cumulative total of write-downs to date for Merrill Lynch. Below is my attempt to piece together what I calculated at ~$40B in write-downs to date. For comparison's sake, Merrill's equity market cap at today's close was ~$24B...

If someone finds / knows of different figures than those that I used, please send them along...

October 5th, 2007: $5B: Merrill Lynch's chairman and chief executive, Stan O'Neal, said market conditions have shown improvement recently and are returning to more normal levels.

October 24th, 2007: Revised to $7.9B: "In light of difficult credit markets and additional analysis by management during our quarter-end closing process, we re-examined our remaining CDO positions with more conservative assumptions," he said in a statement. "The result is a larger write-down of these assets than initially anticipated."

January 17th, 2008: Another $11.5B: Calling the results "clearly unacceptable," newly minted Chief Executive John Thain said he was nevertheless encouraged by the company's recent steps to strengthen its cash position. "Over the last few weeks we have substantially strengthened the firm's liquidity and balance sheet," Thain said

April 17th, 2008: Throw in $6.6B: "Despite this quarter's loss, Merrill Lynch's underlying businesses produced solid results in a difficult market environment," Chairman and CEO John Thain said in a company statement.

July 18th, 2008: What’s another $9.4B: "So the strength of the core franchise, very liquid and reducing risky assets, and shrinking our balance sheet. Next point I want to make is that in spite of this loss for the quarter we likely have in our last two quarters more then replaced the capital that we’ve lost. So at the end of the first quarter we replaced the capital that we lost, at the end of the year we more then replaced the capital that we lost", Chairman and CEO John Thain in Merrill Lynch's earnings call transcript.

July 28th, 2008: And another $5.7B: John A. Thain, who has struggled to turn Merrill around since becoming chief executive in December, said the sale of the worrisome investments, known as collateralized debt obligations, or C.D.O.’s, was “a significant milestone in our risk reduction efforts.”

Update (apparently I have too much time on my hands) I present... The TUMBLING BULL!

Budget Deficit

The Bush administration on Monday cut its budget deficit forecast for the current year but expanded it to a record $482 billion for 2009 as the weakening U.S. economy slows revenues and spending remains high.

The White House said the budget shortfall for fiscal 2008, which ends September 30, will likely come in at around $389 billion, below its $410 billion estimate released in February, because receipts were holding up better than expected.

Backtrack to 2003:

(AP) President Bush's goal of cutting in half a projected $500 billion federal deficit within five years is being dismissed as too timid by conservatives, unachievable by analysts and laughable by Democrats. Mr. Bush will include the objective in the $2.3 trillion budget for 2005 he sends Congress in February, nine months away from the presidential and congressional elections. The goal is backed by many Republicans, but conservatives want a bolder move against the record deficits and big spending increases the administration has run up...

Other Sources: Reuters, CBO

Where's the Equity Premium?

Single A Corporate Spread Curve

Now wider than at Bear Stearns bail out levels:

Sunday, July 27, 2008

Minimum Wage

Equally Weighted Leading Economic Indicators

The factor weights for the Conference Board’s Leading Economic Indicators

were revised effective on the release for April 2008, and all historical values for the three composite indexes were revised at this time to reflect the changes. (Under normal circumstances, updates to the leading, coincident, and lagging indexes only incorporate revisions to data over the past six months.) The factors for the leading index were calculated using 1984-2006 as the sample period for measuring volatility. A separate set of factors for the 1959-1983 period is available upon request.

Using these historical factors, the year over year LEI was a recession indicating –2.0%.

To create the EWLEI Index, I simply revised the weightings of each indicator to 10% of the total. The UGLY results are below.

Equal weighting shows a decline of 8.2% year over year and a negative index starting all the way back in 2006.

Saturday, July 26, 2008

Friday, July 25, 2008

S&P: Fannie Subordinated Debt Holders May be In Trouble

Per Dealbreaker:

Will the government's bailout of Fannie Mae and Freddie Mac wipe out holders of their preferred stock and subordinated debt? That's what S&P warned today with its statement that it was placing these instruments on a negative credit watch pending a review of the legislation on Capitol Hill.

"Although there is still ambiguity on the part of regulatory authority as it applies to how nonsenior creditors of Fannie Mae and Freddie Mac would be treated if the U.S. Treasury ever acted on its three-point liquidity plan, the language in HR 3221 increases the likelihood that subordinated debtholders and preferred stockholders would face greater subordination risk," S&P's analyst wrote.

Update: Yves over at Naked Capitalism points out the downgrade:

Validates some of the critics' worries about Fannie and Freddie but also signals the possibility that not only shareowners could be wiped out, but even preferred stockholders and sub debt owners are exposed even with the government rescue effort. Put more simply, this move the view that the firms are undercapitalized.

Aggregate Reserves of Depository Institution...

Does this show what I think it shows? YIKES!

A little further back.

Durable Goods: Shipping

Durable Goods: New Orders

Thursday, July 24, 2008

U.S. Airline Industry Analysis

Got a little carried away with all the data from the Bureau of Transportation Statistics.

Summary (with the additional info in the post below):

  • Fuel is hurting demand

  • Low cost providers are getting especially hit

  • Cost cutting = crap service

Fuel and Airlines: The Tail that Wags the Dog?

Between 2001-2005, airline fuel consumption led the price of fuel by around 3 months (see below) in a classic case of demand driving the price. Since mid-2005 this relationship has broken down and over the past six months or so the two have diverged with the cost of fuel rallying ~60% YoY.

I expect the relationship to re-emerge and I suspect it won't be due to an increase in consumption.
Source: BTS

12 Cents a Gallon?


Wednesday, July 23, 2008

Fannie MBS vs. Fed Funds

Fannie Mae Mortgage Backed Security Yield (Current Coupon TBA) vs. Fed Funds.

Psssstttt.... it's not working.

Salary by Degree

The Secret Sauce Revealed...

There was a guess that the 'Secret Sauce' was a Corporate Bond Index and one that the 'Secret Sauce' was instead a Treasury Index. As these (actually a combination of the two in the form of a Long Government / Credit Index) formed the 'Secret Sauce', I thought I'd take a look at how well these two security types have performed relative to one another...

The results actually surprised me. While there were somewhat large year to year variations, since 1973 the cumulative returns are remarkably close.

Historical International Investment Positions

Source: BEA

Tuesday, July 22, 2008

Leading Indicators (June)

The Fed is trying its best to bring our economy back as interest rate spread (10 Year less Fed Funds) and Money Supply have been consistent positive contributors. Everything else except vendor performance (companies receiving slower deliveries from suppliers - i.e. not necessarily a good sign), have been a drag.

Wachovia Non-Performing Assets

For additional data, go here

Monday, July 21, 2008

Are Fannie Mortgages Cheap or is its Debt Expensive?

The government is willing to backstop Fannie so Fannie can backstop their Mortgage Backed Securities "MBS" if needed to.

So why is the MBS trading ~100 bps cheap to their debt (OAS less CDS) after trading MORE EXPENSIVE JUST SIX MONTHS AGO? Interesting times...

World Equity Returns as of 7/18/08

Go to Investment Postcards for all the data...

Run on Banks --> Banks Run

Following rumours of a bank run, banks ran.

Last week the S&P Financials Index returned a whopping 11.4% (the 6th highest week since its inception back in Sept. 1989) AND this is only the second highest week of 2008 (it returned 11.9% the week of the Bear Stearns bail out)! So far this year, in 29 weeks time, we have seen 13 of the largest drops and 6 of the largest gains in the history of the index (as defined by bottom / top 100 weeks of the ~1000 week history).

So how have financials reacted after weeks similar to last's? On average, the S&P Financial Index maintained momentum returning 9% over the next 6 months and 11% over the next year and only one of those 8 other times (that we have data for) did it show a loss over those next 12 months.

While I am not convinced that I should dive in on the long side, I am ready to pounce if the government continues to squeeze those on the short side...

Sell in May, Don't Go Completely Away...

As the saying "Sell in May, Go Away" implies, the S&P 500 has historically performed dramatically better in the November-April time frame. EconomPicData noticed this trend has continued dramatically in 2008, but questions the desire for many to hold cash six months out of the year.

So, I decided to test out a few alternatives for the May-October period and one stood out from the rest since the benchmarks 1976 inception (not sure if that is or isn't a hint), now referred by my inner circle as the "Secret Sauce".

So, any guesses on what this "Secret Sauce" is?

UPDATE: so far I've gotten Emerging Market Equity, oil, and real estate among the various guesses. Lets take a look at a variety of them (the different starting points are due to index inception).

As can be seen, none have outperformed the S&P except oil (and that just barely). Maybe my "Secret Sauce" is better than I thought?


  • What does well when equities tank (i.e. becomes even more uncorrelated)?
  • Think long term (not just this business cycle)
  • If equities typically underperform in the May-October time frame, where would an investment manager likely put it?
UPDATE(2): Secret Sauce Revealed