January 11, 2010 – Jobs Still Weak; No Luck Getting Rid of California

We’ve had some technology problems this morning — we couldn’t get the system to send out the email. This problem is caused by spammers who put their crap into blogs like this. I guess this truly is revenge of the nerds.

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Now, on to what I read today…




1. Economy

We’re still losing jobs. There were 85,000 jobs lost in December, meaning that 7.2 million jobs have been lost since December 2007.  The unemployment rate is still at 10% because people who quit looking are not counted as unemployed.  In December, the work force declined by 661,000.  The broader measure of unemployment (which includes people who have quit looking even though they want to work and people who have accepted part-time work even though they want full-time work) is 17.3%.  This is a disappointing report, particularly as some economists think that GDP grew at a 5%+ rate in Q4.  The best part of the report was that there were 46,500 temporary-help jobs created.  This is often a precursor to hiring.

Revisions did reveal that 4,000 jobs were created in November (rather than the originally reported 11,000 jobs lost).  The average duration of unemployment is 29 weeks, the longest since this has been tracked (since 1948).




The short end of the yield curve moved down. The two-year treasury yield move below 1% (to .968%) as a result of the jobs report.  In other words, the report showed weakness in the economy which could lead to rates staying lower for a longer period of time.




Hourly average wages aren’t keeping up. Average hourly earnings for private sector production and nonsupervisory workers have increased 2.2% during the past year, while CPI has increased 2.3%.  This group includes 80% of non-farm workers.




The census solution. The government will hire approximately 1.2 million temporary workers during the first half of 2010 for the census count.  (The most will be hired in May.)  The stimulus bill provided money to hire a total of 1.4 million census counters (some have already been hired).  This is almost three times as many as were hired in 2000.




Credit continues to decline. Consumer credit (consumer loans except real estate) dropped at an 8.5% annualized rate in November.  Revolving credit (credit cards) declined at an 18.5% rate while non-revolving credit (e.g., vehicle and education loans) fell at a 2.9% annual rate.




But credit to hedge funds increases. Banks are increasing their lending to hedge funds and private equity funds.  Citi, BAC, JPM and MS are all offering more loans to these entities than they have in two years.  Citi’s lending to funds has increased 10% in the past few months.  This increased leverage allows for bigger bets.  To some extent, these loans are not particularly risky because the collateral (stocks and bonds) is liquid and can usually be sold quickly.  In addition, these loans can lead to trading revenue.  But, it’s not going to play well when bailed out banks are loaning less to consumers and more to hedge funds.




California beggin’. Governor Schwarzenegger asked the federal government for $6.9 billion.  He is also trying to cut $8.5 billion from the state budget and come up with $4.5 billion in alternative funding.  California’s $82.9 billion general-fund budget has a $19.9 billion gap.  Maybe it’s just me, but this seems like the perfect time to sell California to a sovereign wealth fund.




China is back! Chinese exports increased 18% in December (YOY) after 13 months of decline.  Imports grew 56%!!! reflecting raw material purchases (funded by their stimulus plan).  For the entire year, exports fell 16% (to $1.2 trillion) and imports fell 11.2% (to $1.01 trillion).  This was China’s first annual decline in exports since 1983.  There will be continued pressure on China to let their currency appreciate.




China is scared of a real estate bubble. The Chinese government said that it will monitor capital flows to “stop speculative flows from jeopardizing China’s property market.”  They will also require a 40% downpayment from anyone buying a second home.  Lending has risen at a 30% rate in 2009, with fear that standards have come down.  There is plenty of anecdotal evidence of speculation, as people believe that prices must rise.  There are factors which differentiate China’s problem from what happened in the US – banks have a smaller amount of exposure to the industry, total real estate credit is 40% of GDP (compared to 80% in the US during 2007) and homeowners carry less debt.




Commodity prices continue to rise. The price of a bushel of corn has risen 24% since September 1.  (With that said, the index is 21% lower than the June 2008 high.)  An index of global food prices increased 6.9% in November alone!  Some of the factors driving these prices include:

1. greater demand in developing countries
2. hope of stronger demand in the developed nations
3. lower interest rates which are leading to speculation in commodities

It’s possible that low interest rates are leading to speculation in these commodities.  This means that there’s a possibility that our Fed policy is really hurting some developing countries.




UPS raised projections. UPS increased its Q4 projections by 15%.  They are the world’s largest package handler, so they have some insight.  Their packages represent approximately 6% of GDP (or so they claim).  (Fed Ex had recently said that the economy had reached a turning point.)  At the same time, UPS said that they are laying off 1,800 employees.




2. Markets, Rates and Returns

Earnings recovery. S&P 500 Q4 operating earnings are expected to be higher (YOY) for the first time since 2007 Q2.  This has been the longest stretch of declines in operating earnings since these numbers have been tracked (1991).  Operating earnings are predicted to hit $15.80 for Q4 (compared to $5.62 for 2008 Q4).  This would bring the full year to $59.87, still lower than 2008 ($65.47) and well below the peak earnings of $85.12 (2006).  In Q3, 80% of companies beat expectations.




Dividends vs repurchases. Dividends are down approximately 20% from 2007.  But, share buybacks are down approximately 80%.  Firms don’t want to cut dividends, but they have less cash flow.  As a result, the flex point is the repurchase program.  In other words, companies didn’t buy back stock when it was cheap – only when it was expensive.  Someone needs a bonus for this…




Junk bonds continue rally. There was $2.37 billion of issuance in the first week – the busiest start to the year since 2005.  This issuance occurred even in the face of four defaults.  Spreads (above UST) on CCC rated debt fell to 9.17%.  Back on December 15, 2008, this was 44.29%!  Retail inflows to high yield funds and ETFs was positive for the 20^th consecutive week ($5.85 billion has poured in over this period).




Default expectations vary. Default expectations (for 2010) are somewhere around 7% of issues according to S&P and Fitch.  Moody’s expects only a 4.3% default rate.  In 2009, the default rate was ~10.9%.  This was 265 companies – the highest total since S&P has been tracking the number (since 1981).  The previous high was 229 (in 2001).




TIPS. The government is selling $10 billion of 10 year TIPS (Treasury Inflation Protected Securities) this week.  TIPS will exceed $600 billion (slightly less than 10% of the $7 trillion Treasury market).  There is high demand for TIPS as investors fear inflation.  China and Japan (our two largest investors) are demanding TIPS.  The Treasury is expected to issue approximately $80 billion of TIPS this year (compared to $58 billion in 2009).




Banks are on notice! Six regulators jointly issued a warning to banks to be prepared for higher interest rates.  GS calculated a 20% increase in securities owned by 24 large banks.  These securities could lose value if rates increase.




Regulators getting involved in employment decisions. The FT says that the FDIC and the Fed are asking more questions about potential bank appointees.  They are also describing the type of experience that they are looking for and pressuring companies to improve their boards.




Valuations change. In 2000, four of the five banks with the highest price-to-book ratio were US banks.  Today, five of the top six are Chinese banks.




Portugal is warned. Moody’s warned Portugal that they need to put together a plan to reduce their deficit (currently 8% of GDP) to avoid a downgrade.  Portugal’s debt is only 77% of GDP, much less than Greece’s 113%.




Individual investors doing okay. A survey by the Investment Company Institute (the mutual fund industry trade group) said that 73% of those surveyed said that they are confident that their 401(k) will help them to reach their retirement goals and 90% said that they have a favorable view of these plans.  They also said that 95% kept making contributions during the first three quarters of 2009 and only 10% changed their asset allocation.  Vanguard says that their studies show similar results.




3. Ethics / Opinions

Is defaulting morally wrong? There was a very interesting article in the NYT by one of my favorite business writers (Roger Lowenstein).  Ultimately, he asked whether you are immoral in walking away from your home when you are under water.  The arguments for honoring your debt include: (1) to not debase your character; and (2) you are hurting your neighbors.  The responses to these arguments are (1) enduring relationships are no longer valued as evidenced by the fact that the bank sells your mortgage; and (2) all of our transactions have economic impacts and we can’t just have positive economic signals (e.g., when you buy a credit default swap, you’re hurting the underlying company by sending negative information).   I’m not sure that I think that these are legitimate responses – the first response sounds much more like a justification to me.

He made several other interesting arguments:

1. private equity firms make these decisions all the time – closing parts of businesses that are effectively underwater
2. hedge funds with losses close the fund and start a new one so that they can compensate themselves with the 20% carry
3. mortgages explain the consequences of nonpayment – making this a viable option

Some argue that if we didn’t have this moral constraint whereby people fear being a bad person, they would be more willing to default.  If they were more willing to default, lenders would be more willing to renegotiate loan terms and this crisis could be done sooner.




Get ready for bonus season. GS is expected to pay its employees an average of $595K bonus per person and JPM investment bankers are expected to receive $463K / person.  They deserve this money.  They’re smarter than all of us.  Personally, I never could have figured out how to bring down the country’s financial system and they did it in very short order.

You have to ask yourself why bankers make so much money.  The banks are incredibly profitable.  The investment banking businesses are middle-men.  In effect, the amount charged for transactions can be extremely high.  One could argue that you’re paying for expertise.  Maybe so, but it makes me wonder why the lawyers receive so much less.  In addition, these banks derive significant profits from trading and this can be quantified.  Of course trading has become even more profitable since the Fed signaled what they would be buying for a year.  In effect, the Federal government has subsidized these bonuses.

Banks are going to argue that they are using a smaller percentage of revenue for bonuses than they have in past years.  That should be as successful as the time that Jenny caught me with a pocket-full of singles and I responded, “aren’t you proud of me honey…I saved them for you.”




Boo hoo hoo. The WSJ reports that many bank employees are very unhappy that a large component of their compensation will be stock (that they will likely have to hold for three years).  Some claim to have liquidity issues.  I’ll be interested to see how this plays out.  I think that they should fill some basketball arenas with people who don’t have jobs, have quit looking or have accepted part-time employment rather than full-time employment.  It shouldn’t be difficult to find people to sit in the arena, since one in six Americans fall into one of these categories.  Then, the bankers should be allowed to tell the audience their woes.  Lets hear all about their liquidity issues and how they had nothing to do with our economic problems and how their bank was not rescued by the bailout.




We all want to be bankers! A new survey by the Conference Board found that only 45% of people with jobs are satisfied.  This survey started in 1987 and at that time, 61% reported being satisfied.  People may feel less satisfied currently because they don’t have options (they can’t leave), but the trend of dissatisfaction has been consistent over the years.  In my opinion, there’s no way to disconnect from work any more.  Email is a terrible thing.




4. Random

The world is a sick place – the story of Prince OJ. One of the 19 sons of the United Arab Emirate’s founding father was acquitted in a trial over the beating and sexual assault of an Afghan trader.  This was all on videotape.  You can read the horrific details for yourself.  The defense lawyer said that the court believed that the Sheikh was drugged before the attack took place.  If you’re doing business with these animals, you’re on notice that this is how their judicial system works.   (While you could correctly argue that our judicial system has problems, it’s not controlled by a ruling family.)




Part-time students, listen up! A Maryland nurse won a case in Tax Court that allowed her to deduct the cost of her MBA.  Apparently, the decision lays out what needs to be done in order to prevail on this issue.  It sounds like your chances of success (with this deduction) are best if you are trying to improve your skills while staying within your same industry, but that it will be more difficult to obtain this deduction if you are transitioning into a different type of job.  I recommend you look into this.

A WSJ article discussed the infrequency with which individuals prevail in Tax Court.  As an example, they mentioned a lawyer who tried to deduct over $100,000 in medical deductions for his visits to prostitutes.  It strikes me as outrageous that they ruled against this attorney.  It’s like saying that an accountant can’t deduct the cost of an accountant or a doctor can’t deduct money he pays to another doctor.




I knew there was something different about my spaghettios. Many food makers are reducing the salt in our food.  Interestingly, they are not advertising it because consumers will assume that the product tastes bad.  Instead, they are reducing the salt gradually.  As an example, Chef Boyardee canned pasta has reduced the sodium by 35% over five years.




Nice try. An earthquake rocked California this weekend.  Unfortunately, California stayed attached to the country.  Call me a conspiracy theorist, but isn’t it interesting that this earthquake happened after California asked the federal government for money.

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