Market Update – January 19, 2010

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Here’s what I read today…

1. The Economy

Stronger recovery. The IMF said that the global recovery is stronger than expected due to China, but there could be asset bubbles in emerging markets.




Tame inflation but you’re worse off. The consumer price index rose .1% in December.  The core CPI is up 1.8% for the year and the overall inflation rate was 2.7%.  At the same time, average weekly earnings dropped 1.6%.




Some risk in the future. Industrial capacity is dropping because new investment is not keeping pace with depreciation.  The yearly decline of 1% is the largest since this data has been collected (1967).  Reduced capacity means that there is more potential for inflation.  Oil and gas producers are operating at 97.4% of capacity, 5.3 percent above average.  Food prices rose at an annualized 1.2% rate for Q4.




Consumer sentiment stable. Sentiment in early January rose from 72.5 to 72.8 according to the Reuters / University of Michigan survey.  This is far below the long term trend.




Railroad warning signal! US railroads originated 237,000 carloads in the week ended January 9, down 12% from the same week a year ago and down 28% from 2008.  The recent high was 287,000 carloads, reached in November.  Railroads account for 40% of the freight hauled across country.




The big question. Our monetary base has expanded greatly.  But, banks have simply held excess reserves.  If they loaned this money out, there would be the potential for inflation.  M2 (currency + savings deposits + checking deposits) has only grown 6% / year.  Will the Fed be able to stop the monetary base from expanding the money supply?  The issue depends on whether the Fed can either sell their MBS and drain money out of the system or whether paying interest on reserves will stop the banks from lending the money out.




Big mistake coming up. The president of the Dallas Fed (Richard Fisher) said that it would lead “directly to economic ruin” if Congress interferes with the Fed’s independence.  Agreed.




California finds solution to all of its problems! California, Washington and Oregon all have proposals to legalize marijuana.  The idea is that this could create tax revenue.   Most importantly, this may help calm fears about the recession and increase sales of munchies.




2. Housing

The FHA disaster. The FHA doesn’t loan money.  Rather, the FHA insures lenders against default if a loan meets FHA criteria.  Many of the typical FHA borrowers used private subprime lenders earlier in the decade.  The FHA’s market share dropped to 2% in 2006.  Now, they are the only game in town.  In Q3 of 2009, they insured 25% of new mortgages!  Default rates of FHA loans are close to 24% (largely because of 2007 and 2008 loans).  A recent audit said that reserves exceed projected losses by just .5%.  This was 3% a year ago.  In 2008, your Congress temporarily raised the maximum FHA loan from $362,790 to $729,750 in some areas.




Foreclosure prevention plan. More than 900,000 borrowers have begun trial modifications under the Administration’s mortgage modification plan.  Only 7% (of these 900,000) have received permanent changes.  To receive a permanent modification, a borrower must make three trial payments, complete a hardship affidavit and complete other paperwork.  As of November, 13.15% of borrowers were delinquent or in foreclosure.




3. Market and Companies

Market dropped 100 points on Friday. This was the biggest drop in the new year.  The market had previously rallied 62% since March.  The market didn’t particularly care for Intel’s earnings or JP Morgan’s.  Intel had beaten expectations after Thursday’s close.




JPM disappoints. JPM earned $3.28 billion in Q4.  Revenue climbed 32%. Retail banking lost $400MM (after earning $624MM in Q4 of 2008).  The investment bank earned $1.9 billion (after losing $2.4 billion in Q4 2008).  Annual compensation reached $26.9 billion in 2009, up 19% from the prior two years.   Banking salaries increased 21%.




Overall, JPM’s investment banking unit looked good, but their retail banking and credit card businesses appeared weak.  JPM dropped 1.6%, but other banks dropped more.  JPM seemed hurt by the fact that more prime mortgages are defaulting and loans assumed with the Washington Mutual acquisition are also hurting. JPM has the largest market cap of all investment banks.




Financial intelligence is not our strong point. A nationwide survey showed that investors expect an average annual return of 13.7% over the next ten years.  If you ask people who study the subject what type of return you should expect after deducting for fees, inflation and taxes, the general range is 2.5 – 4%.




Tech IPOs. Tech IPOs peaked in 1999 (240) and averaged 38 / year from 2004 to 2007.  There were only three in 2008 and nine in 2009.




Oil dropped for the 5^th straight day. There is evidence that the US recovery is not that strong.  But, I think that the more important issue is that China is worried about inflation and is going to slow their growth rate.




Gimme some more junk. Last week, companies raised $11.7 billion in the high yield market – a one-week record.  Apparently, a lot of this debt is being used to pay off lower interest rate bank debt.  The companies are willing to pay higher interest rates in order to get rid of the loan covenants.  Some of the recent issues have been used to pay dividends to private equity owners.  In other words, we’re back to financial insanity.  The average gap between yields on junk bonds and Treasuries has dropped from 6.4% (at the start of the year) to 6%.  This was close to 22% at the peak of fear.




Florida freeze. Florida farmers are losing approximately 30% of their crop due to freezing temperatures.  Tomatoes will be hit the hardest.




A successful year for M&A? Acquirers outperformed the MSCI World Index by 3.2% in 2009 and 2.7% in 2008.  Cross-border deals underperformed the market by 5.2% (while domestic deals outperformed by 7%).  Kraft didn’t have time to read the study.  They were too busy raising their bid for Cadbury.




Greek tragedy. The new Greek government plans to cut their budget deficit from 13% of GDP to 3% in the next three years.  (That’s more of a Greek comedy.)  Greece’s public debt has increased from 113% of GDP to 120%.   Credit default swaps have increased to annual payments of $340K to insure $10MM of debt.




German bailout. Europe doesn’t want Greece to be their Lehman.  In other words, if Greece defaults, it will be difficult for Portugal and Spain to borrow money.  So that means that Germany may have to bail out Greece.




They suck worse than us! Some people think that Greece’s problems are helping the British pound.  The thought is that people are selling the euro and buying the pound for safety.  This reminds me of when Pamela Lee Anderson wanted a classier guy, so she dumped Tommy Lee for Kid Rock.




Accusations against JNJ. The government has accused JNJ of paying kickbacks worth tens of millions of dollars to Omnicare to buy JNJ medicines and recommend their use to nursing homes.  While this was going on, Omnicare’s purchases of JNJ drugs tripled to $280 million.




4. Financials

Bank closures. So far, three banks have been closed by regulators.  In 2009, 140 banks were shut down.




Not everyone lost money with Lehman. The lawyers, financial advisers and consultants that are working on Lehman’s bankruptcy charged $568.7 million in 2009.  Alvarez & Marsal has been paid $218.3 million since Lehman’s bankruptcy filing.  Weil Gotshal received $127.1 million.




Leveraged loan market picking up. More than $2.5 billion of loans are being prepared in early 2010 to help companies exit bankruptcy.  This amounts to approximately 42% of all leveraged loans. (There were 189 companies which defaulted on debt last year.) In 2009, there were only $1.5 billion of exit loans during the entire year.




Credit card charge-offs mixed, but delinquency rates slowed. Capital-One said charge-offs reached 10.1% (annual rate), up from 9.6% in November.  But, the number of 30-day delinquent loans dropped from 5.87% to 5.78%.  American Express said delinquencies dropped from 3.9% to 3.7%.    Charge offs dropped from 7.6% to 7.1%.    BAC’s charge-off rate increased from 13% to 13.5%.  JPM said charge-offs dropped from 8.8% to 7.1%.  Delinquency rates are a leading indicator of charge-offs – so this is a slightly positive sign.




AIG’s bonus woes. AIG is obligated to pay $195 million in retention bonuses in March.  The company has suggested paying it early if the employees will reduce it by 10% – 15%.  In the past, AIG promised to repay $45 million of March 2009 bonuses, but only $19 million has been collected.




Maybe some good news. There is an interesting article in today’s WSJ that argues that one (of the many) windfalls to banks that resulted from the huge Fed purchase of MBS came from the fact that the banks didn’t lower mortgage rates as much as normal.  In other words, the spread between Fannie / Freddie coupons and mortgage yields was higher than the historical average (98 basis points vs. 73 bps).  While this article focused on the subsidy that the banks were receiving, maybe we can interpret it in a better way.  Maybe this means that mortgage rates won’t increase as much when the Fed stops their massive purchases.  If Fannie / Freddie yields increase but the spreads return to normal, mortgage rates may not increase as much as we fear.  Of course, this is probably just wishful thinking.




5. Random

India accuses the Chinese. India’s National Security Adviser said that he suspects Chinese hackers of trying to access Indian government information.




Science and technology leader. The US accounted for nearly one-third of $1.1 trillion spent on R&D in 2007.  But while our ten-year annual increase in spending was 5 – 6%, China grew this spending at 20%.  Interestingly, China accounted for only 1% of US patents in 2008.  Of course, their competitive advantage is stealing patents, not creating them.




Maybe it’s just me? On Sunday night, the Golden Globe Awards ceremony took place.  I only know this because I saw it in the NY Times.  I don’t watch crap like this.  If you think I do, you really shouldn’t be reading this blog.   I’m guessing that they are doing some fund raising during the show.  But, the fact that they are giving out “awards” to crazy, overpaid actors and actresses who create very little social value other than supporting the tabloid and rehab industries, is absolutely absurd.  These people make speeches as if what they do has meaning.  You’ve got to be kidding me.  I wonder what the rest of the world thinks of us when we spend time worshipping these morons while the rest of the world worries about the people of Haiti.




Have you ever wondered? If you’ve ever wondered how much it costs to break a contract with a guy who’s not funny so he can be replaced with someone who also isn’t funny, now we know.  It’s $40 million.  Apparently, that’s how much NBC is paying Conan to get him to leave so they can put Jay Leno back in the best time slot.




How’s this for an efficient market? Shares of the old GM, now known as Motors Liquidation Company have increased from 47 cents at the start of the year to 77 cents today.  That means that it has a market cap of $500 million.  The restructured GM and the SEC both say that the shares will be worthless.

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