Friday, January 30, 2009

EconomPics of the Week (Recession Special Edition)

BIG week of economic data. I will be traveling early next week, so you may see limited posts until Wednesday (tear).

Economic Data
GDP Price Index Turns Negative: Stimulus on the Ch...
Government Spending on the Move
GDP Down 3.8%... Beats Estimates
New Home Sales Drop to Lowest Ever Recorded
"Are We Going to War?" Durable Goods Edition
Cargo Plane Traffic... Crash
European Capacity Cliff Dive
Used Car Sales Suffering Too
Deflation: Front, Center, and Even Down Under
Consumer Confidence to New Historic Low
Case Shiller Price Index (CSCPI) - November
Another 74k Jobs Cut
Leading Economic Indicators: Green is Good (or at ...
California Unemployment Rockets to 9.3%

Shameful Bankers / Investment Banker Bonus Matrix

Earnings Roundup
GE Rated Aaa = Aaa Joke

Fixed Income
California Munis are "Whispering" Buy
Oxymoron of the Day: A Public, Private Equity Shop...
Long Bond Drops Most in 22 Years... A Trend or Volatility.

Stimulus Timeline

GDP Price Index Turns Negative: Stimulus on the Cheap?

For more details on the GDP Price Index (i.e. GDP Deflator), see GDP Deflator De-Mystified.

Bespoke details:

While the markets have been focused on the better than expected GDP report for the fourth quarter, the GDP price index was potentially even more notable. While economists were looking for a quarter/quarter annualized increase of 0.4%, the actual level was a decline of 0.1%. This negative print is only the seventh time since the end of WWII (and the first time since 1954) that prices decrease based on this measure. For now at least, the Fed's view that "inflation pressures will remain subdued in coming quarters" appears to be right on target.

The greatest impact on the GDP deflator (i.e. when negative it is the GDP inflator) were consumption prices (makes sense). What doesn't ring a bell is the decline in prices involved in government spending. Is it that this slowdown has made any stimulus plan more inexpensive to implement?

Source: BEA

Government Spending on the Move

Expect this figure to fly in coming quarters / years...

Source: BEA

GDP Down 3.8%... Beats Estimates

Marketwatch reports:

The U.S. economy contracted at a 3.8% seasonally adjusted annual rate in the fourth quarter, the Commerce Department estimated Friday. This is the largest contraction since the first quarter of 1982. Economists surveyed by MarketWatch were expecting a negative 5.5% growth rate in the fourth quarter.

The weakness in the fourth quarter was masked by a buildup in inventories, which adds to output even if they are unwanted. Real final sales for domestic product, which excludes inventories, decreased 5.1% in the fourth quarter. This is the biggest drop since 1980.

Breakout of the Components

Contribution of the Components

Nominal GDP Crushed (the problem here is debt is nominal)

Source: BEA

Shameful Bankers: Bonuses Down ALL THE WAY to a Level Not Seen Since.... 2004?

I was ready to rant, but I saw President Obama already took care of it on my behalf:

When I saw an article today indicating that Wall Street bankers had given themselves $20 billion worth of bonuses -- the same amount of bonuses as they gave themselves in 2004 -- at a time when most of these institutions were teetering on collapse and they are asking for taxpayers to help sustain them, and when taxpayers find themselves in the difficult position that, if they don't provide help, that the entire system could come down on top of our heads," the president said, "that is the height of irresponsibility. It is shameful.

To me this is more than shameful. I'd go with outright criminal to those determining and approving bonuses of this level, in this environment, and with taxpayer money. Lets hope (make that pray) that Christopher Dodd makes good on his promise:
"I’m going to be urging — in fact not urging, demanding — that the Treasury Department figures out some way to get the money back. This is unacceptable."
Because apparently, the Investment Banking Bonus Matrix we detailed back in November is all too accurate:


Thursday, January 29, 2009

Cargo Plane Traffic... Crash

IATA reports (hat tip Calculated Risk):

In the month of December global international cargo traffic plummeted by 22.6%compared to December 2007. The same comparison for international passenger traffic showed a 4.6% drop. The international load factor stood at 73.8%. For the full-year 2008, international cargo traffic was down 4.0%, passenger traffic showed a modest increase of 1.6%, and the international load factor stood at 75.9%.

“The 22.6% free fall in global cargo is unprecedented and shocking. There is no clearer description of the slowdown in world trade. Even in September 2001, when much of the global fleet was grounded, the decline was only 13.9%,” said Giovanni Bisignani, IATA’s Director General and CEO.” Air cargo carries 35% of the value of goods traded internationally.

I don't want to about global decoupling for at least 5 years...

Earnings Roundup

New Home Sales Drop to Lowest Ever Recorded

Bloomberg reports:

Sales of new homes in the U.S. fell in December to the lowest level on record, creating an unprecedented glut of unsold properties that casts doubt on any recovery in the industry this year.

Purchases dropped to an annual pace of 331,000, lower than all 70 forecasts in a Bloomberg News survey, Commerce Department figures showed in Washington. Other reports today said orders for durable goods slumped for a fifth month and a record number of Americans were collecting jobless benefits.

Yes, the lowest on record... all the way back to 1963.

"Are We Going to War?" Durable Goods Edition

The latest figures from the Census for Durable Goods show further deterioration and a huge spike in spending on Defense:

New orders for manufactured durable goods in December decreased $4.7 billion or 2.6 percent to $176.8 billion, the U.S. Census Bureau announced today. This was the fifth consecutive monthly decrease and followed a 3.7 percent November decrease. Excluding transportation, new orders decreased 3.6 percent. Excluding defense, new orders decreased 4.9 percent.
Month over Month (Seasonally Adjusted)

Year over Year (Full Year 2008 vs. 2007)

California Munis are "Whispering" Buy

Now for what seems like my weekly California update:

Housing continues to deteriorate (per Bloomberg):

California home prices plunged 42 percent in December from a year earlier as the U.S. housing slump deepened and foreclosures hit record levels.

The median price for a single-family home in the most populous U.S. state dropped to $281,100 from $480,820 a year earlier, the Los Angeles-based California Association of Realtors said today in a statement.
The price decline is in part due to foreclosures:
Foreclosed properties tend to sell at a discount of 25 percent or more, and California home sales rose 85 percent in response to last month's drop in prices, the Realtors association said.
Assuming every sale was a foreclosure (and sold at a 25% discount), this indicates the average non-foreclosed price was $374,800 or a 22% drop. Knowing that "only" ~50% of sales were foreclosures, that means most sales were at the "lower-end" of the price spectrum.

As the housing market goes, so goes California Munis:

Municipal General Obligation "GO" bonds (i.e. bonds backed by the taxing authority of states) have historical traded at yields less than Treasuries (due to the high-quality nature and tax benefits of Muni bonds). Rather than track California GO bonds to Treasuries, below is the ratio of California GO bonds to the Muni GO bond index.

This past week hasn't been kind. The ratio of California Muni bonds to those in the index is almost 1.4x (and this chart is for bonds with just five years to maturity). If / when state funding troubles are addressed with Federal money, I expect this ratio to come back down. For investors dieing to make a "whopping" non-taxable 2.9% return (hey... much better than Treasuries!), I'll call this a "whispering" rather than "screaming" buy.

Speaking of that 2.9%... for all the trouble California is facing, the financing cost for the state is still down a full percent since the turmoil began.

Wednesday, January 28, 2009

European Capacity Cliff Dive

We've discussed the issues facing Ireland and Spain in the past, and now we'll show that things aren't much better for Italy and France. FT Alphaville reports:

French and Italians quarterly production utilization figures are out and they're not pretty.
The chart below details the percent change we've seen in capacity on an annual basis (i.e. if it was 80% and is now 70%, the decline is 10%... not a percent of a percent).

Used Car Sales Suffering Too

I would have thought buyers would be "downsizing" to used cars with all the market turmoil. Apparently not, as Autonews reports:

Used-vehicle prices have fluctuated so much recently that dealers say they are having trouble choosing which used cars and trucks to buy and how to price them at retail.

The chief culprit, dealers say, is the price of gasoline, which has swung from about $3 a gallon a year ago to more than $4 last summer to less than $2. As gasoline prices drop, dealers say, used-vehicle customers are more interested in trucks and less drawn to fuel-efficient cars. When fuel prices spiked last year, they say, the preferences were reversed. Those changes affect used-vehicle sales and prices.

Compounding the problem, dealers add, are the decreased availability and higher cost of floorplan loans, which make decisions about used-vehicle inventory even more critical.

Fortunately, there may be some relief on the way for sellers:
Tom Webb, chief economist at Manheim, the nation's largest auto auction company, says relief is on the way. Gasoline prices are stabilizing and lenders are making more floorplan credit available to dealers, he says. Both factors should moderate swings in wholesale used-vehicle prices, he predicts. "January will be a pretty good month on the upside," Webb says. "A lot of volatility has passed."

Deflation: Front, Center, and Even Down Under

Across the Curve details some more deflationary news:

Australian consumer prices declined 0.3 percent in the most recent quarter after rising 1.2 percent in the previous quarter. It was the biggest drop in the index in 11 years. Leading Indicators in Australia fell 1.0 in November to 253.5. Toyota, Honda and Nissan slashed global production last month by 25 percent, 7.5 percent and 36 percent, respectively.

While longer term (i.e. at some point), I view the all the stimulus as inflationary, those trillions of dollars are no match for a global slowdown in the short-run.

Oxymoron of the Day: A Public, Private Equity Shop


A figure of speech that combines two usually contradictory terms in a compressed paradox.
When Fortress Investment Group became the first hedge-fund/private-equity group to list in the US back in February of 2007, it stormed out of the gate:
In the most widely anticipated public offering of the young year, Fortress Investment Group (FIG), the first U.S.-based hedge fund to go public, stormed the ramparts. The shares opened trading at $35. At that level the company had a market capitalization of more than $12 billion. A group of five company insiders hold more than three quarters of the company's shares.
In a recent article, the Wall Street Journal detailed just how much Fortress' five principals were able to extract from the firm prior to the IPO:
The firm's five principals -- led by founder Wesley Edens -- cashed out just prior to the IPO, selling 15% of the company to Nomura Securities for $888 million. On top of the Nomura proceeds, the principals received an additional $409.2 million in distributions from the company just before listing.
That adds up to almost $1.3 billion... and it was just in time. Less than two years later, the market valuation of Fortress has since crashed 95%.

That leaves the current valuation of the entire firm at about half of the $1.3 billion the principals were able monetize for a mere ~15% stake just two years ago. The performance (or lack there of) was not a complete surprise to those that thought strategically about what this all meant. Dealbook reported just prior to the IPO:
A hedge fund manager interviewed by The Los Angeles Times sounded even more skeptical about the Fortress offering before it began trading: “These are very smart guys,” he said. “If they’re selling, I probably don’t want to be buying.”

And a finance professor had this observation for MarketWatch’s David Weidner: “When the smart money is pulling out, it’s time to start selling to the dumb money.”
Maybe only in hindsight it was obvious, but why would anyone believe that a company (known for taking publicly traded companies private), was going public for the benefit of anyone except themselves?

Tuesday, January 27, 2009

Stimulus Timeline

CBO reports the time path of estimated outlays on government purchases under the proposed stimulus bill.

Assuming enactment in mid-February, CBO estimates that the bill would increase outlays by $93 billion during the remaining several months of fiscal year 2009, by $225 billion in fiscal year 2010 (which begins on October 1), by $159 billion in 2011, and by a total of $604 billion over the 2009-2019 period.

Is this too long a time frame to cause any benefit?

Yes, according to the tone of Greg Mankiw (maybe I'm reading too much into the "So"):
So only 8 percent of this spending occurs in budget year 2009, and only 41 percent occurs in first two years.
No, according to Paul Krugman:
By my count, 70 percent of the Division A stuff and 91 percent of the Division B spending comes within the fiscal 2009-2011 window. If you go up to the end of calendar 2011, we’re probably up to about 77 and 96 percent. That’s not at all bad.

Consumer Confidence to New Historic Low

The Conference Board details:

The Conference Board Consumer Confidence Index, which had decreased in ecember, inched lower in January and continues to be at a historic low. The Index now stands at 37.7 (1985=100), down from 38.6 in December. The Present Situation Index declined slightly to 29.9 from 30.2 last month. The Expectations Index decreased moderately to 43.0 from 44.2.

Case Shiller Price Index (CSCPI) - November

For more information on what the Case Shiller Price Index is and why it may be an important measure, check out this old post.

The Case-Shiller Price Index (an adjustment to CPI) turned severly negative year over year, down 4% from November 2007 as home prices, a global slowdown, and the reversal in energy prices severely impacted price levels.

Update (jvanginneken comments):

Jake, it's a very interesting graph, I think it would be interesting to also see a graph of the difference.
Here it is...

Source: BLS / S&P

GE Rated Aaa = Aaa Joke

In my post regarding the shift in the composition of the Barclays Capital Investment Grade Index, I was asked:

Any idea why most recent data points show Aaa at higher yields than Aa??
In fact, I do... the Aaa (FYI- Barclays Capital refers to this ratings 'tranche' as Aaa, not AAA) is made up predominantly by GE Capital (predominantly is an understatement).

And since mid-2007, spreads on GE Capital bonds have blown out, especially after the Lehman failure in mid-September 2008.

A 450+ bp spread for the CDS (as wide as 600 bp) on a Aaa rated security? As a refresher, an S&P triple A rating is saved for:
The best quality borrowers, reliable and stable (many of them governments)
So why are spreads so wide? According to Morgan Stanley (in reference to GE):
“Investors do not want to own a stock with dividend cut risk. Investors do not want to own a stock with rating agency risk. Investors do not want to own a stock where substantial earnings tailwinds come from past tax reversals. And lastly, investors do not want to own a stock with a financial sub, particularly one which is substantially under-reserved.”
This doesn't sound like a "best quality" "reliable" "stable" or "government-like" entity. Surely the ratings agencies must think differently. Lets get the opinion of S&P analyst Robert Schulz:
The quarterly results show that 2009 may be more difficult than expected for GE Capital. The financial arm makes loans for everything from consumer credit cards to big commercial energy projects.
How difficult? According to Schulz:
Credit losses are now expected to be $10 billion, $1 billion more than GE forecast in December. Losses in the company's real estate portfolio are also expected to reach $4 billion, compared with a $2 billion gain.
So, in the worst financial crisis since the Great Depression, S&P's own analyst declared that after GE needed a $139 billion in FDIC backed debt just two months ago, was put on negative outlook in December, and has its hands in everything from consumer credit cards to big commercial energy projects (again, in the worst financial crisis since the Great Depression) they still deserve a triple A rating.

And this is why the most recent data points show Aaa at higher yields than Aa.

Monday, January 26, 2009

Another 74k Jobs Cut

Chron reports another ugly day on the employment front:

Caterpillar Inc., Sprint Nextel Corp. and Home Depot Inc. led companies today announcing at least 73,900 job cuts as sales withered and construction slowed amid a global economic recession that may persist through 2009.

“Certainly since 2001, with the dot-com collapse, we haven’t seen these kinds of large cuts,” James Pedderson, a spokesman for Challenger Gray & Christmas Inc., a Chicago-based provider of executive-outplacement services, said in an interview. “In terms of the number of companies and the number of cuts, this morning is certainly unusual.”

Leading Economic Indicators: Green is Good (or at Least Positive)

Barry (i.e. The Big Picture) beat me to the punch:

The surge in real money supply growth added a full percentage point to the headline number. From September til today, this has added between 0.4ppts and 1.0ppts to each month’s gain. The artificial boost to the LEIs has not translated into increased lending from the banks.
Over the least year, the increase in money supply has been the only leading economic indicator with a significant positive contribution.

Source: Conference Board

Long Bond Drops Most in 22 Years... A Trend or Volatility?

According to Brad Setser (former staff economist at the Treasury and current fellow at the Council of Foreign Relations):

In 2007, my best estimate is that China accounted for $120.3b of the $247.2b increase in the outstanding stock of marketable Treasuries not held by the Fed. China absorbed 49% of the net increase.

In 2008, my best estimate is that China bought $374.6 billion of the $1684.8 billion increase in the outstanding stock of marketable Treasuries not held by the Fed. China absorbed 22.2% of net issuance.

Thus, while China is an extremely important player in the Treasury market, purchasing 3x more Treasuries in 2008 than in 2007, they became a smaller relative player as demand from non-Chinese sources grew astronomically. So while there has been a media frenzy over Treasury Secretary Geithner's comments regarding Chinese currency manipulation and how China might react, it may be the lesser concern (back to Brad):
Obviously, it would be a big deal if China stopped buying and started selling. But it would be much bigger deal if private investors lost their appetite for Treasuries.
This past week we saw a massive sell off of long-dated Treasuries, supposed proof that this appetite is waning relative to the expected supply. According to Bloomberg:
Treasuries fell, with 30-year bonds losing the most this week in 22 years, as the U.S. readied $78 billion in debt sales over the next five days to finance fiscal stimulus spending projected to swell the deficit to $1 trillion.
While it is important to take note of any movement not seen in 20+ years, one week does not make a trend. In looking at the chart below, which details the historical 'week over week' change in the yield of the thirty year bond (in relative terms as a 30 bp move is obviously more drastic when yields are 2.9% vs. 10.6%), we see just how large an outlier this past week's move was (hint- the top right dot).

However, this chart also details how volatile the long bond has been... far more volatile in 2008-09 than at any other point in recent history and in both directions. The only previous time since 1980 the yield jumped or dropped at a similar magnitude was the week following Black Monday, October 1987. But that 100 bp drop (from ~10.2% to ~9.1%) was in response to a massive liquidity injection by Alan Greenspan following the 22.6% drop in the Dow on that single day.

Thus, while it is important to keep an eye on the long bond to see if the recent sell off does become a trend, please don't declare victory on your long Treasury shorts yet. Just remember, the Fed has another "weapon" available... the outright purchasing of Treasuries which may be on the way...

California Unemployment Rockets to 9.3%

Businessweek reports:

The jobless rate announced Friday by the state Employment Development Department represents a jump from the 8.4 percent figure in November 2008.

Excluding farmworkers, California lost 78,200 jobs in December as employers sliced payrolls to deal with the slowing economy.

California's unemployment rate hasn't been at this level since January 1994, when the state was coming out of its recession in the early part of that decade, said Stephen Levy, senior economist for the Center for Continuing Study of the California Economy.

Source: BLS

Friday, January 23, 2009

EconomPics of the Week: Global Edition (1-23-09)

Global Economy Coming to Halt
Don't Mention Decoupling in Asia
Chinese Unemployment Projected at 30 Year High
Spain Downgraded... Ireland to Follow?
UK GDP Down at Lowest QoQ Level in 29 Years
Russian Reserves Sink
Global Banking Sector Struggles

Asset Classes
Is Oil Ready to Crash?
Real Yields Matter
California Freeze Up: Are Munis Still Safe?
Not All AA Bonds are the Same
Investment Grade Bonds: Attractively Priced, But With Reason
Spreads: Not Seen Since the Great Depression
From "Crowding Out", to "Running Away"

Beware the Media's “Obama Rally”
Out With the Outgoing Overly Optimistic View on the Economy

Greed / Newspapers / The Feel Bad Rainbow
"Pimp My Ride": Thain's $1.2 Million Office Remodel
Death of the Newspaper
A Feel Bad Rainbow: Job Cuts YTD

From "Crowding Out", to "Running Away"

While I don't agree with the entire piece, the following portion of Hoisington Investment Management Company's The Great Experiment caught my attention :

If there is a desire to increase government spending, the federal government must either increase taxes on the far larger private sector, an option that would presumably be precluded under the present circumstances, or borrow funds in the financial markets that would have gone to the private sector. At this point we have to ask which sector has the better track record of growing the economic pie—private or government expenditures? The private sector has demonstrated the greater flexibility and creativity to expand the economic pie, increasing productivity and thereby improving living standards for all. The risk is that increased federal borrowing will stunt the private sector's ability to grow.
In other words, the attractiveness of Treasuries has increased relative to U.S. equities and corporate debt. As of 2007 (the latest data available), Foreign investors owned $9.1 Trillion in Long Term (i.e. more than 1 year) U.S. Securities, split almost evenly between equities, private debt, and public (Treasury / Agency) debt. If the blue portion of the pie is growing, it is coming at the expense of the red, which explains part of the pressure on corporate spreads and equity prices.

But as Interest Rate Roundup details, there is no such thing as a "free lunch":
You can't simply bail out anyone and everyone, especially when you're a debtor nation, and expect your creditors to just grin and bear it forever.

Now investors seem to be waking up. Treasuries have been getting mauled this week, losing value every single trading day this week (Long bond futures are going for around 128 21/32 vs. 136 7/32 last Friday). Yields on 10-year Treasury Notes have shot up to 2.68% from their December 30 low of 2.06%.
The problem is that while investors are fleeing Treasuries, they aren't flying back to private securities, as both equities and corporate debt are down on the week. In other words, they may just be selling all of the above outright, but what are they buying? Mike Larson at Interest Rate Roundup seems to believe it is the old doomsday standby:
I have a thesis that might explain what's going on: Global investors are starting to sour on government debt all around the world. They can see that the cost of bailing out banks and economies here in the U.S., in Asia, and in Europe is spiraling out of control. They know that means governments are going to be issuing trillions of dollars in new debt, driving down the price of existing securities. Result: They’re flocking to alternative stores of value -- including silver and gold.
Source: InvestorsInsight

Oil Ready to Crash?

The following adds a little more color to last week's post Oil Tankers are a Banks Best Friend. For those that missed it, factors have appeared in the oil market that make it attractive for investors to buy oil in the spot market, store it, and sell through the (higher priced) oil futures market. Now that storage is reaching capacity, there is a significant possibility the spot price of crude will "tank" as a source of demand (storage) is no longer available. This is especially true for WTI crude, which is delivered in Cushing, OK and HAS reached its limits according to Marketwatch:

Inventory levels at Cushing, Okla. -- the delivery point for Nymex oil futures -- rose by 0.2 million barrels to a record 33.2 million barrels, the EIA reported. Platts estimates that maximum storage capacity at Cushing is about 42.4 million barrels, but only 80% of that is considered operable.
This suggests that maximum operating capacity is about 34 million barrels, meaning there is little room to add to storage tanks out in Cushing, according to Linda Rafield, senior oil analyst at Platts.

Assuming that 34 million barrels is an accurate level of the maximum capacity in Cushing (i.e. 98% of the capacity is filled) this explain why the price of WTI crude has fallen so much relative to Brent and makes the case for a potential crash in the WTI crude spot market.

Source: EIA

UK GDP Down at Lowest QoQ Level in 29 Years

FT Alphaville reports:

The UK's in recession and it's worse than we thought. The quarterly figure is the biggest (decline) since Q2 1980, while full-year GDP is the weakest since 1992. The standout disaster was manufacturing, down 4.6 percent on the quarter.

"Pimp My Ride": Thain's $1.2 Million Office Remodel

Naked Capitalism reports John Thain spent upwards of $1.2mm on an upgrade of his "suite" upon joining Merrill Lynch. After all, what's a million here and there when you're losing 10-50,000x that (yes... 50,000x that). Below is a breakout of ~$400k of that total (rumor has it the other $800k was to hire celeb designer Michael Smith).

But really... who doesn't need a $1400 parchment "waste can"? At least it's not a $1400 "garbage can", that would be insane.

Speaking of cans, I look forward to seeing the size of Thain's exit package for getting "canned".

I'll set the over / under at $30mm.

Thursday, January 22, 2009

Russian Reserves Sink

The AP reports:

Russia's Central Bank says it will widen the ruble's trading range to allow an effective 10 percent devaluation of the national currency. Analysts said the move would prompt an immediate drop in the currency's value. The bank said the limit of the band, measured against a two currency "basket" of dollars and euros, will be set at 41 rubles as of Friday.
Why? For one to be more competitive, but as important to protect their reserves. Bloomberg reports:
Russia’s international reserves tumbled $30.3 billion last week, the second-biggest drop on record, as the central bank accelerated the pace of the ruble’s devaluation and sold more foreign currency to manage the decline. The value of the stockpile, the world’s largest after China’s and Japan’s, fell to $396.2 billion, after dropping $11.7 billion between Dec. 26 and Jan. 9, when there were 2 1/2 official currency trading days.

“The central bank was intervening heavily on the market last week, selling foreign currency,” said Natalia Orlova, chief economist at Moscow’s Alfa Bank, the country’s largest privately owned lender. “They quickened the pace of the step-by-step ruble depreciation, so everyone rushed for foreign currency.”

Beware the Media's “Obama Rally”

The market is down. It must be Obama.

The market is up. It must be Obama.

Tuesday, after the market sold off more than 300 points the Kansas City Star reported:

The dawn of the Obama presidency could not shake the stock market from its dejection over the rapidly deteriorating state of the banking industry.

While the Wall Street Journal went the opposite direction:

Problems with overseas banks contributed to weakness in U.S. stocks, said Alan Valdes, a floor trader with Hilliard Lyons. "It's an aberration -- I think we're going to get an Obama honeymoon rally," he said.

And after yesterday's big rally, Bloomberg hinted the honeymoon has official begun:

U.S. stocks rebounded from a two- month low, led by the biggest gain in financial shares in a month, on speculation a plan from President Barack Obama will shore up banks.

Please take this all with a grain of salt. Why? Maybe an example is needed... This past Friday, the day after the remarkable / amazing landing of the US Airway plane into the Hudson River, the Wall Street Journal declared:

US Airways Group Inc. shares rose 13% to $8.53 Friday in New York Stock Exchange trading Friday, outpacing gains in other carriers' stocks.

Accidents with fatalities can dent airline's reputations in the short term. But an outcome like the one with Flight 1549, which is being praised as an example of superior airmanship and crew training, appears to have prompted a rally.

If that is what prompted the rally (it didn't), it was short-lived. Since that Friday level (which just allowed the stock to bounce back to a pre-crash price), US Airways Group stock is... down 12%.

So... in a nutshell. Take everything you hear from financial TV, or newspapers (or even this blog) with a grain of salt. In the end, take in all the relevant information (most isn't) and proceed cautiously...

Don't Mention Decoupling in Asia

FT's Alphaville details:

The bottom dropped out of Japan's export industry in December, with exports diving a record 35 percent year on year.
China's economy grew at the slowest pace in seven years as the global recession dragged down exports, increasing pressure for more government spending and lower interest rates. Chinese GDP grew 6.8 percent in the fourth quarter from a year earlier.

However, as Yves over at Naked Capitalism points out:
If you believe the China fourth quarter GDP release, I have a bridge I'd like to sell you.
The 6.8% figure just "happened" to match the median estimate of 12 economists surveyed by Bloomberg News. A look at Chinese exports (as measured in yuan) shows how far things have fallen.

Spain Downgraded... Ireland to Follow?

Last week I detailed the struggles Spain is working through, specifically a tumbling housing market and frozen credit markets. Throw in Spain's dependence on the ECB to enact policy across the Eurozone and no flexibility with their currency (i.e. the Euro) and it's not surprising they were under pressure. This ultimately led to S&P's placement of Spain on negative watch and days after my post, S&P downgraded Spain to AA+ from AAA (per the Irish Times):

The cut in Spain’s rating to AA+ from AAA, a level Spain had held since late 2004, sent the euro to a session low against the dollar as investors feared Portugal and Ireland would suffer the same fate after receiving SP warnings.
As detailed on Across the Curve, the debt of "have nots" in Europe (including Spain and Ireland) continue to sell off:
Yields on Italian Spanish and Greek bonds have widened by 7 basis points, 4 basis points, and 10 basis points respectively against Germany. Irish bonds have widened by 26 basis points versus Germany.
In looking at Ireland, we see a country that like Spain depended on the financial sector and an asset bubble to fuel growth. While the Irish economy boomed through mid-2007, the money supply grew even faster, at a rate of between 15-30% annually from 2004-2007. This added fuel to the fire and created an asset bubble of mammoth proportions. According to Professor Morgan Kelly (i.e. the Irish Dr. Doom, who like the Roubini is looking smarter EVERY day):
Back in 2000, lending to construction and real estate made up only 8 per cent of Irish bank lending, much like other European countries. Now it has risen to 28 per cent. By comparison, just before the Japanese bubble burst in late 1989, construction and property development had grown to a little over 25 per cent of bank lending.

Now, we see that process in reverse. When credit ran dry, the bubbles (both housing and economic) popped. The economy, in desperate need of liquidity to help slow the unwind, has seen its money supply (in terms of M3 which literally doubled from July 2004 - August 2007), decrease year over year at a rate of more than 10%. Back to the Irish Times:
Ireland's economy will contract faster than most EU economies this year and its budget deficit will be the highest in Europe in 2010, according to new forecasts published by the European Commission. Brussels predicts Irish economic output will fall 5 per cent in 2009, unemployment will rise to 9.7 per cent and the deficit will reach 13 per cent of gross domestic product (GDP) by 2010 in the face of the world’s worst recession since the second World War.
Just to see how different the situation can be with a country that has control of their money supply, below is a chart detailing that of the UK. While the UK had its own asset / credit bubble, they had a more controlled increase in money supply (a still too high for the time 10-15% vs. Ireland's 15-30%), but importantly they have been able to increase this level to almost 20% as the economy has become in desperate need of liquidity.

Source: CSO

Wednesday, January 21, 2009

Death of the Newspaper

Financial Times (hat tip Felix' Market Movers) reveals that News Corp may have been a bit too early with their acquisition of Dow Jones (i.e. the Wall Street Journal), though it is important to note that the value of News Corp stock (it was a stock acquisition) is down 2/3 since the 2007 acquisition:

The $5.6bn Rupert Murdoch’s News Corp paid in 2007 for Dow Jones, owner of the Wall Street Journal and several local papers, would now be sufficient to buy Gannett, the New York Times, McClatchy, Media General, Belo and Lee Enterprises, even at twice their current share prices.

Investment Grade Bonds: Attractively Priced, But With Reason

While the Barclays Capital Investment Grade Index has rallied significantly over the past few months (from slightly more than 9% to just over 7%), the yield is still significantly higher than it was pre-financial crisis, presenting what appears to be a great investment opportunity.

While a portion of this is due to the sell-off across investment grade corporate bonds, another explanation lies in the composition of the index. Since January 2007, the composition of the index has stayed relatively static with regards to holdings of Aaa and Baa rated securities. However, there has been a 7% shift by market value from Aa rated to A rated securities due to downgrades (in addition there have been downgrades from A to Baa, and Baa to high yield, which brings up survivorship bias, but that is another post altogether).

The relevance? Since early 2007, the yield of Aaa and Aa securities has stayed flat (though spreads to Treasuries have widened significantly). On the other hand, A and Baa Investment Grade corporates are 140 and 240 bps wider respectively in that period (note the crossing pattern of Baa and A yields in September / October and Aa and Aaa yields currently due to the market's disagreement with the agencies ratings, specifically financials).

In other words, a lot of the increase in 'absolute yield' levels of Investment Grade Corporate Bond indices are due to a worsening of credit, not necessarily pure market opportunity. While I personally find value at these levels, it is important to understand what risks you are taking as an investor.

Chinese Unemployment Projected at 30 Year High

Some more bad news ahead of tomorrow's Chinese GDP release. Bloomberg (hat tip Naked Capitalism) reports :

China’s official urban unemployment rate jumped for the first time since 2003 and may climb to an almost 30-year high as exports slump and a slowdown deepens in the world’s third-biggest economy.

A rate as high as the government’s 4.6 percent target for this year, which was announced by Yin today, would be the worst since 1980, official data show. Premier Wen Jiabao said yesterday that the government must do more to preserve social stability in the face of a “very grim” job outlook.

Tuesday, January 20, 2009

California Freeze Up: Are Munis Still Safe?

This is a recycling of a previous post, which again becomes relevant given the new issues facing California. CNN reports:

The check isn't in the mail, and it's not going to be for at least 30 days, California will start telling some of its creditors in February.

The state, facing a $42 billion deficit, will delay some crucial payments to stay liquid, state Controller John Chiang announced Friday.

Among those who will be left waiting for checks are thousands of businesses that provide services and products to the state; more than 1 million aged and disabled Californians who need to pay for rent, utilities or food; and individuals and businesses awaiting tax refunds to the tune of $1.91 billion.
While the state has too many issues to discuss in a single post, is California's debt still likely to be paid back? As seen below, the state's general obligation bonds have sold off significantly more than the index in recent months (peaking at the end of December).

Not to worry says Investor Nirav:
They asked the California state treasurer Bill Lockyer whether the California public debt was completely safe. “Absolutely, the only way we’re going to default is if there’s a thermonuclear war.”

So there’s no doubt that California will pay back the debt. In the worst case, the Federal Reserve would just bail the state out. If they’re willing to bail out car companies, I’m sure they’ll step in for California.
I agree... and I'll also agree with the article's obvious finishing comment.
But if there’s more bad news, the yields could go higher still, and the prices of the bonds could fall in value.
In other words, be prepared to face volatility / uncertainty in any investment in the current environment.

Not All AA Bonds are the Same

According to Moody's, Aa Bond:

Obligations rated Aa are judged to be of high quality and are subject to very low credit risk, but "their susceptibility to long-term risks appears somewhat greater".
In other words, while they are not bullet-proof like Aaa's, they should have a minor chance of default. Given the current market condition, it is not surprising that financial and insurance company bonds have sold off more than other AA corporates, but it is pretty wild by how much.

The reason? Ignoring the thought that financial bonds have a higher likelihood of default (I can see both sides of this... on their own yes they do, but government assistance will greatly help), it has become painfully clear that the recovery value of these financial bonds given default is slim (Lehman junior debt is trading at close to nil, while CDS on the senior debt paid out less than 10 cents to the dollar).

Out With the Outgoing Overly Optimistic View on the Economy

EconomPic Data reader Alan directed me to the NY Times 'Economix' post which details the recently released Economic Report of the President. This report is the outgoing administration's view / forecast for the economy. As the NY Times reports, the forecast is that things won't be pretty:

Net job losses in 2009 will be more than twice those in 2008. (Also note that these numbers are based on data collected as of Nov. 10, and do not reflect reports that have come out since then.)
While Alan "gasped" at the bottom chart detailing consumption vs. wealth, I am more taken aback by what I feel is an overly optimistic forecast within the Council of Economic Advisers report. Although some may give the outgoing administration the benefit of the doubt as a lot has happened since November 10th (the date in which the data for the report was finalized), these figures, while ugly, were extremely optimistic even at that date.

As can be seen below, projections are not only for a significantly improved economy by 2010, but an economy growing above levels we have seen over the ten years leading up to this crisis (i.e. when the term "Goldilocks" was running amok). This seems extremely hopeful given recent economic news releases and the uncertainty easily witnessed in the global economy.

projections are for positive growth in 2009 (highly unlikely) and a bounce back to 5% real growth in the next two years (vs. a 2.8% 10 year average)

projections are for a "Goldilocks" 1.5% - 2% CPI rate each year from 2010-2014. This versus a 10 year average of 2.5%. If / when we are able to move from the deflation threat, I don't see how inflation doesn't move well above these levels given the flooding of liquidity already witnessed and massive stimulus to come.

Unemployment Rate: projections are for a spike to 8% in 2009, but a retrace to the 10 year average (5%) by 2012. Most optimistic projections I've seen now call for a 9% peak, while 12% targets are now making the rounds. Either way, 5% by 2012 would be a dream come true.

Non-farm Payroll Growth: While the NY Times remarked that 2009 expectations are for net job losses twice that of 2008, these figures are WAY too low. In December alone, we saw the number of those employed down almost 1,000,000 IN ONE MONTH on a non-seasonal basis. Add the birth /death adjustment that may add ANOTHER million in coming months and their figures are a joke.

While optimists have their place in society (heck, I wish I was an optimist), they don't belong in policy making when the downside risks of getting this wrong are so large. I am hopeful that the new administration is as realistic and open as they have appeared to be leading up to tomorrow's historic inauguration.

Spreads: Not Seen Since the Great Depression

JG provided an interesting insight in the comments section of my "Real Yields Matter" post. Credit risk premium, as defined by the difference between the yield of the Moody's Baa and Aaa rated indices (more detail regarding Moody's here), recently moved above 3%. What is the significance?

As of Nov. ‘08, the Baa-Aaa risk premium moved above 3.0%, to 3.07%; in December, it was 3.38%.
When were the last times that the Baa-Aaa risk premium rose above 3.0%? August ‘31, October ‘32, October ‘33, and March ‘38, in the depths of the Lesser Depression (first two) and its protracted recovery (last two).

We are one year into The Greater Depression.

In plotting the data, JG is correct. Although we were awfully close in the early 1980's and 338 bps is a a lot smaller than the 560+ bps we saw in 1932, this does put the current crisis into the correct context.

Source: St. Louis Fed (BBB) / St. Louis Fed (AAA)

Monday, January 19, 2009

Real Yields Matter

Paul Krugman comments:

The really striking thing about corporate borrowing rates isn’t that they’re high by historical standards, although they are, but the fact that they’re high even though interest rates on government debt are very, very low. Below I show the spreads on AAA and Baa debt against 30-year Treasuries: they really have spiked.

Also bear in mind the decline in expected inflation: real corporate rates are very high.
That last sentence is key. Even though Treasury rates have rallied significantly in nominal terms over the past 1 1/2 years, they still yield more in real terms than when the financial crisis began. Corporates, as Paul points out, are the greater issue. Real yields on Investment Grade Corporate Bonds are now 2.5x higher than they were just six months ago.

Throw in a declining economy and the diminished end-user demand we are witnessing across industries, and it is very easy to see why corporations are having such a difficult time.