GM: The Ultimate Cyclical Stock?

Stock Price vs. GDP
Five Year Change in Stock Price (the rough length of a business cycle) vs. GDP.

Krugman's Stimulus Math: $600 Billion

Interesting post from Paul Krugman about how large an upcoming U.S. stimulus package should be. Lets see if I can't make his already easy to understand post even clearer for those that prefer a visual format:

First, Paul determines the likely employment gap (the difference between the natural rate of unemployment and the likely unemployment we will see when this cycle bottoms). Using 5% as the natural rate of unemployment and an 8.5% unemployment rate (a Goldman Sachs estimate... I personally think it will be higher), we get a 3.5% employment gap. According to Okun's Law:

For every 1% excess of the natural unemployment rate, a 2%reduction in GDP is predicted. The difference between actual and potential GDP is called the GDP (or output) gap.

So if we take 3.5% and multiply by 2, we come up with a 7% output gap in GDP. To close this gap, we need a stimulus package that adds this 7% back to the economy. Considering the poor result of the first stimulus package, Paul assigns a multiplier of 2 to any package (the stimulus isn't spent once, it is spent multiple times as it works its ways through our consumer economy). With this 2x multiplier, the stimulus package should be 7% / 2 = 3.5%, which he rounds up to 4% be on the safe side or ~$600 Billion.



How big could a package get? Looking at only two variables, unemployment and the multiplier, we can see how the size of a package moves in response to any change. Moving the unemployment out to 9.5% (massive, but not altogether impossible) and the multiplier down to 1 (if unemployment is 9.5%, will people really be spending their checks?), the "required" package more than doubles to $1.4 Trillion or about 10% of our GDP. Still significantly lower than China's (as a percent of GDP) which was almost 20% of their GDP.

Chinese Hard Landing

This explains China's massive stimulus package.

Sources: BBC, China Daily via Mish

GM = Small Cap Stock

GM closed at $2.92 a share, their lowest level in more than 60 years (December 2nd, 1946 to be exact). I can't even find the data going back that far, but this chart shows just how far things have come.

Amazingly, GM is now technically a small-cap stock according to the WSJ:

Since the company’s market capitalization has roughly fallen in half in a week, the once proud Dow component is now below the $2 billion threshold used by many Wall Street trading operations to denote the difference between a small cap and mid cap.

Data Source: Yahoo

The End of Wall Street / Investment Banking Bonus Matrix

Michael Lewis has a great article titled 'The End' in Portfolio which inspired the investment banking bonus matrix below. I wrote back in September about the Downfall of the Investment Banking Model and he goes 1000 steps further, with details that are only possible from starting out in Wall Street's epicenter in the early 1980's. While I highlight some sections of the article, I highly recommend you go and read the whole thing. He doesn't take long to dive in:

To this day, the willingness of a Wall Street investment bank to pay me hundreds of thousands of dollars to dispense investment advice to grownups remains a mystery to me. I was 24 years old, with no experience of, or particular interest in, guessing which stocks and bonds would rise and which would fall. The essential function of Wall Street is to allocate capital—to decide who should get it and who should not. Believe me when I tell you that I hadn’t the first clue.

The amazing part is that after a while, the pure and absolute ego that drives Wall Street makes those that stay feel like they deserve all this money. Even after ALL that has happened over the past year and a half, they can look you in the eye and honestly say they DESERVE another round of massive bonuses. Does the fact that they have accepted hundreds of billions of taxpayer money stop them? Of course not... every situation can be explained by the Investment Banking Bonus Matrix...

Enough of a rant... back to the article. As Lewis points out in a later passage regarding the supposed "changes" that were made on Wall Street in the 1990's:

The changes were camouflage. They helped distract outsiders from the truly profane event: the growing misalignment of interests between the people who trafficked in financial risk and the wider culture.

And he traces this misalignment all the way back to John Gutfreund, the former CEO of Salomon and antagonist of his great book Liar's Poker. John Gutfrend changed the social order of Wall Street by transforming Salomon Brothers from a private partnership into Wall Street's first publicly traded corporation. Why? By doing so:

they transferred the ultimate financial risk from themselves to their shareholders. It didn’t, in the end, make a great deal of sense for the shareholders. (A share of Salomon Brothers purchased when I arrived on the trading floor, in 1986, at a then market price of $42, would be worth 2.26 shares of Citigroup today—market value: $27.) But it made fantastic sense for the investment bankers.

And in a statement that seals my opinion on Gutfrend once and for all, he delivers this doozy:

“When things go wrong, it’s their problem,” he said—and obviously not theirs alone. When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government. “It’s laissez-faire until you get in deep shit,” he said, with a half chuckle.

You Call That a Knife? THIS is a Knife!

You call that market volatility? This is market volatility. Below is a chart for Double Inverse Real Estate (Symbol SRS), which is up another 10 points as of this post.

20 point daily swings have been commonplace and a 60 point move occurred just a few weeks back on October 28th. The following news explains it all in a nutshell (WSJ):

One of the nation's largest shopping mall owners, General Growth made the warning in a quarterly filing with the U.S. Securities and Exchange Commission. The company, based in Chicago, faces an additional $3.07 billion in debt coming due next year.

General Growth has struggled for the past year to refinance and pay down a $27 billion debt load, amassed in acquisition sprees in recent years. The company owns more than 200 U.S. malls, including flagships such as Honolulu's Ala Moana Center and Las Vegas's Fashion Show mall.

General Growth has $900 million in debt coming due Nov. 28 on two luxury malls on the Las Vegas strip. It has another $58 million in bonds due on Dec. 1. The company is attempting to meet those obligations by selling those two malls as well as another on the Las Vegas Strip. It also is negotiating with its lenders to gain an extension on its deadline to pay those debts.

Another victim of an era of easy money. Expect commercial real estate properties to be under immense pressure as they get hit from the bottom (vacancies due to unemployment) and the top (deleveraging).

In other words, expect this volatility to continue for a long time to come...

Are Convertible Bonds a "Screaming Buy"?

Investment grade corporate bonds have "outperformed" high yield bonds, which have "outperformed" convertible bonds, which have "outperformed" the S&P 500. Why the "quotes"? Because the best performing of the bunch is still down more than 10% YTD.

While it is hard to look at the above chart and not see at least some value, convertible bonds are what catches my eye as they have performed like equities, even though they are (per the WSJ):

part stocks, part bonds. They act like bonds and usually pay interest. But, as an added kicker, they give holders the right to convert the securities into stocks at a certain price. The market is normally less volatile than stocks, but the securities can have the same upside if a company rebounds.

The massive hedge fund unwind has sent convertible bonds reeling. Back to the WSJ:

Hedge funds, which at times owned as much as 70% of the outstanding convertible bonds, traditionally try to protect themselves by shorting, or borrowing and selling, shares of the same companies, profiting from the difference in the movement of the securities. But some funds did a poor job hedging themselves, or didn't do much hedging at all, figuring the market wouldn't tumble, traders say.
At the same time, some funds focused on convertibles borrowed as much as $5 for each $1 of equity in recent years, leverage that for some has turned small losses into huge ones. A 10% loss can become a 60% drop if a firm's borrowings amounted to five times its capital.

In other words, technical rather than fundamental factors are at play qualifying these for the latest installment of screaming buy. Does anyone know of a good convertible bond fund?

Source: Barclays

Fannie: Going Concern, but I am Getting Concerned

Fannie Mae lost a reported $29 Billion in Q3. Over the past 7 quarters, they have now lost ALL earnings associated with the housing boom.

But after the $100 Billion Treasury injection and a variety of new liquidity facilities, the future must look bright... right? Well, maybe once they get past problems associated with their soon to be negative net worth, lack of liquidity, and bad loans. Lets get some more details.

Net Worth:

Under the Regulatory Reform Act, the Federal Housing Finance Agency MUST place Fannie Mae into receivership if their assets are less than obligations for a period of 60 days (I'll believe that when I see it).

Net worth is down from $44.1 Billion as of December 2007, to a reported $9.4 Billion at the end of September 2008. Of that $9.4 Billion, almost half is deferred taxes (i.e. provides no benefit without futures earnings).

Liquidity:

This past September, the Treasury made available two additional sources of funding to Fannie Mae; the Treasury credit facility and the senior preferred stock purchase agreement (i.e. the $100 Billion). Unfortunately this hasn't helped much; according to Fannie Mae in their 10-Q:

We have experienced reduced demand for our debt obligations from some of our historical sources of that demand, particularly in international markets.

Well if you keep making the following statements, you won't need to search for a reason why:

The U.S. government does not guarantee, directly or indirectly, our securities or other obligations.

Hmm.... just a few weeks back Federal Housing Finance Agency James Lockhart declared:

A government takeover of the two companies gives the companies “access to credit from the U.S. Treasury (and) an explicit guarantee to existing and future debt holders of Fannie Mae and Freddie Mac”

What's important is that the market agrees with Mr. Lockhart, as Fannie MBS currently trades within 5 bps of Ginnie MBS, which is absolutely guaranteed by the U.S. Government. The problem is the lack of liquidity in credit markets for anything with longer dated maturites outside of Treasuries.

Managing Problem Mortgage Loans and Preventing Foreclosures:

Finally, lets review the quality of Fannie's mortgage pools. After all, we are told on Fannie's website that:

Fannie Mae first ensures that the loans it acquires generally meet its credit quality guidelines and then it securitizes the pool of mortgages.

Unfortunately, even high quality loans can become non-performing in this environment. Non-perfoming loans are almost twice the level seen just nine months ago.

Conclusion:

There is absolutely no way any Agency MBS will be allowed to fail as the outcome would be disastrous. At the same time, putting Fannie and Freddie on the Treasury Balance Sheet is not an option as there is incentive to keep up the appearance of Fannie as a "going concern" regardless of how much money they lose (this would require too much transparency). In other words, I expect the original $100 Billion to just be a drop in the bucket.

Credit Risk Analysis

Below are the historical yields of the following fixed income indices; Treasury, U.S. Investment Grade / High Yield, and Emerging Market.

Of note is the recent spike in the cost of borrowing for Emerging Market countries. Emerging Markets were supposed to provide the cushion to our global economy, but as the NY Times pointed out on October 7th:

Many of the world’s fastest-growing economies thought they had insulated themselves from problems in the developed world. But economists said that simultaneous turmoil in Europe and the United States was too much to bear. “The potential of a global recession is awakening emerging markets that they will be hit stronger than we thought before,” Alfredo Coutiño, a senior economist at Moody’s, the credit rating agency, told The Times.

Source: Barclays

How Much of the Bailout Money Will Make it into the System?

We've already detailed how Goldman is expected to pay bonuses in excess of the $10 billion equity injection provided by the Treasury. Now, according to Alternet, of the $125B paid to the largest 9 recipients of the bailout to date, only $17B is projected to remain at the institutions:

It turns out that the nine banks about to be getting a total equity capital injection of $125 billion, courtesy of Phase I of The Bailout Plan, had reserved $108 billion during the first nine months of 2008 in order to pay for compensation and bonuses.

Paying Wall Street bonuses was not supposed to be part of the plan. At least that's how Federal Reserve Chairman Ben Bernanke and Treasury Secretary Hank Paulson explained it to Congress and the American people.

China Gets on the Stimulus Train

China is implementing a stimulus package to the tune of $586 Billion, dwarfing the United States own ~$160 Billion package last spring. Per the WSJ:

Premier Wen Jiabao's cabinet set plans for 4 trillion yuan, or $586 billion, in spending and stimulus measures through the end of 2010 aimed specifically to target people's livelihood, the official Xinhua News Agency said Sunday night.

While the stimulus package is almost 4x larger in dollar terms, it is a whopping 15x larger as a percent of their economy.

Along with reasons associated with the global slowdown, according to Naked Capitalism the measure was enacted because:

the Chinese economy is likely decelerating faster than was commonly believed. It also means the Chinese officialdom is not at all willing to let growth slow far enough to risk social unrest. It will take some time to discern whether they succeed in the latter objective.

Expect additional packages in the U.S. in the coming months / years that brings the relative size of the United States stimulus packages more in line. As Paul Krugman outlines, Obama should be prepared to spend, spend, spend:

Implications for Obama: be inspired by FDR, but don’t imitate him slavishly. In particular, your economic policy should be bolder, not more cautious.

Other Sources: Wikipedia

EconomPics of the Week (11-7-08)

Economic Data
Additional Employment Analysis
Birth Death Model Overstates Employment... Again
Unemployment Analysis (October)
Same Store Sales (October)
Non-Manufacturing Index (October)
ISM Report: Manufacturing Contracted in October

Autos
Auto Sales: Month over Month Sales Shows a Different Story
U.S. Autos Bleeding Cash
Auto Sales Crash... Again

Federal Reserve
Federal Reserve Bank Credit Balance Sheet Over $2 Trillion
Bank of England Has Some Catching Up to Do

Equities / Fixed Income
Hedge Funds Performing "Relatively" Well
S&P 500 Down Another 5%
LIBOR Improves
Gross Notional CDS
S&P 500 and Treasury Rally in the Same Day? Finally
MBS Issuance

Politics
Voter Turnout: Diverse and Strong
Obama Poll Lead by State
I Proudly Present... Our Next President

Other
Tax Payer Fueled Bonus Binge

Additional Employment Analysis

Source: BLS

U.S. Autos Bleeding Cash

Source: Calculated Risk, WSJ

Federal Reserve Bank Credit Balance Sheet Over $2 Trillion

Source: Federal Reserve

Birth Death Model Overstates Employment... Again

The Birth Death Model once again overstates employment. In other words, things are a lot worse than the 6.5% rate presented to us. Per The Big Picture:

Since 2003, the B/D adjustment has been part and parcel to BLS' Current Employment Statistics (CES) program, the official measure of US employment. In brief, the Birth Death adjustment imagines (hypothesizes) how many jobs were created by companies too new and/or too small to participate or be found by CES. The model attempts to create what is perceived as a BLS error at the start of any recovery, when many new jobs are created but missed by BLS.

Does anyone think small businesses have really added 50,000 jobs to the financial sector over the past 12 months?

Source: BLS

Unemployment Analysis (October)

We also broke out a Broader Total Unemployed Rate, which includes unemployed, plus discouraged workers, those working part time who want a full time position, plus marginally attached workers. For more information on why, Barry has a great post over at The Big Picture.

S&P 500 Down Another 5%

Same Store Sales (October)

Per CNN:

U.S. retailers, already struggling with a protracted sales slump this year, suffered another disastrous sales month in October as Americans continue to shun unnecessary purchases in tough economic times.

The sales reported Thursday were the worst in at least eight years, since Thomson Reuters - which tracks monthly sales for 34 of the nation's largest retailers including Wal-Mart, Gap, Sears, and J.C. Penney - began tracking the results in 2000.

Voter Turnout: Diverse and Strong

Per the AP:

What's most interesting about early results is not just how many people voted but the shifting demographic of American voters, said Stephen Ansolabehere, a political science professor at Harvard and MIT.

Also interesting (to me at least) was the sheer quantity of voters that turned out.

Source: Infectious Greed

Bank of England Has Some Catching Up to Do

Per Bloomberg:

The Bank of England unexpectedly cut the benchmark interest rate by 1.5 percentage points to the lowest since 1955 as policy makers tried to limit damage caused by the worst banking crisis in almost a century.

The nine-member Monetary Policy Committee, led by Governor Mervyn King, reduced the bank rate to 3 percent, the biggest single step in more than a decade. The move was predicted by none of the 60 economists in a Bloomberg News survey.

LIBOR 11-6-08

Source: Across the Curve

Hedge Funds Performing "Relatively" Well

For all the problems hedge funds have faced, they have solidly outperformed equities during all of this market turmoil through October 31st.


Source: BarclayHedge

Non-Manufacturing Index (October)

Per Calculated Risk:

There were a couple of interesting comments on discretionary spending:

"Uncertainty is having the usual effect on business. Our response is traditional — stop all discretionary spending."

"Business down significantly! Discretionary spending disappearing."

This is exactly how businesses (and consumers) react to uncertainty - halt all discretionary spending. This is usually a temporary reaction until the business can adjust to changes in economic conditions.

Source: ISM

Gross Notional CDS

Source: DTCC

LIBOR Improves Again

Source: Across the Curve

Auto Sales: Month over Month Sales Shows a Different Story

We have already taken a look at the huge drop in year over year unit sales in autos, but month over month unit sales tell a different story. Saturn, GMC, Buick, Pontiac, Hummer, and Chevy round out the biggest drops. Why? A lack of financing. Per the Associated Press:

Neff said a key factor in the GM slump was that its finance arm, GMAC, majority owned by Cerberus (which owns Chrysler) "decreed it would only lend money to buyers with a credit score above 700, which effectively wiped out in-house financing for the majority of GM customers."

Source: Auto Blog

I Proudly Present... Our Next President

S&P 500 and Treasury Rally in the Same Day? Finally!

Both equities and 10 year Treasuries rallied today for the first time since October 23rd (as the WSJ tells us every time, when yield goes down, price goes up). Over the past few weeks, Treasuries have rallied as a result of a flight to quality, not exactly the best environment for equities.

Has fear finally subsided?

MBS Issuance

B&C Lending via Infectious Greed:

There was no issuance of subprime, Alt A or “other” non-prime mortgage backed securities in the third quarter of 2008, the first blank quarter since the creation of the non-prime MBS market, according to the Inside Mortgage Finance MBS Database.

It looks like issuance of Prime non-agency MBS dried up as well.

Source: SIFMA

LIBOR Down... Again

Some more good news on the LIBOR front:


Source: Across the Curve

Auto Sales Crash... Again

Auto sales were once again crushed in October.

On a good note (and ignored above as the brand was VERY new last year) was the Mini's 56%+ year over year growth to 5272 units. How fast was this growth? Well, lets compare it to Hummer.

Source: Auto Blog

ISM Report: Manufacturing Contracted in October

Per ISM:

Manufacturing contracted in October as the PMI registered 38.9 percent, 4.6 percentage points lower than the 43.5 percent reported in September. This is the lowest reading since September 1982 when the PMI registered 38.8 percent. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

LIBOR Down

Source: Across the Curve

Obama Poll Lead by State

WSJ:

The latest NBC/Wall Street Journal poll shows voters’ top concern in the coming election is the economy, and 49% of respondents said Sen. Barack Obama would do a better job fixing the economy, compared to 28% who said Sen. John McCain would do better.

Click below for gigantic chart.

Tax Payer Fueled Bonus Binge

After receiving $10 Billion from the Government "Investment Plan", Goldman will be doling out over $11 Billion in bonuses.

To date, the government has provided over $160 Billion to 35 firms.

Source: Naked Capitalism WSJ