Market Update – March 4, 2010; Bill Gross’ Letter

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Now, on to what I read…




1. Markets

The Dow dropped 9.22 points.  It had been up 60 as a result of a decent jobs report from ADP.  The beige book had some mixed news.  Later in the day, some healthcare stocks reported bad news (lack of effectiveness of drugs) and the President said he was going to continue to push the healthcare debate.




The euro rallied against the dollar.  The weakness in the dollar helped commodity prices.  Looking at the euro, the question is whether Greece will live up to their promises and whether there will be problems with other countries.




Oil settled at $80.87. While inventories were larger than expected, the stronger economic news carried the day.




The ten-year treasury yield increased slightly (to 3.623%) based on economic strength.




The VIX (volatility index) has dropped 15 of the past 16 days.  This is somewhat strange given all of the unknowns out there.




In British pound terms, the FTSE world index is at all time highs. That’s because the pound has lost value.  In dollar terms, investors are down 25% from the all-time high.




2. The Economy

The ADP jobs report showed a loss of 20K jobs in February, fewer than expected.




The Fed’s Beige Book (a summary of economic evidence from each district) said that nine out of 12 districts showed improved economic activity.  But there was weakness in loan demand and the commercial real estate market.




The service sector (ISM nonmanufacturing purchase managers’ index) expanded faster than expected.  The index rose from 50.5 to 53.




3. Car News

Could Toyota’s problems get worse? There have been 10 complaints of sudden acceleration of Toyotas that had previously been fixed.  If these reports turn out to be true, this could really be devastating for Toyota.




Nissan has always wanted to be Toyota. As a result, Nissan is recalling ~540K trucks, SUVs and minivans because of problems with brake-pedal pins and fuel gauges.




The Toyota problem has turned out to be a great thing for consumer safety.  Car companies are now afraid to sit on information and fight recalls.




4. Greece

Greece announced their plan to cut their deficit by $6.5 billion. Some of the cuts include a 2% increase in the VAT, a one year freeze on public employee pension and a 30% reduction in public employee bonuses.  Everyone is watching to see how much of a premium investors will require when Greece sells ten-year bonds in the next week.




Investors seemed happy about Greece’s cuts, but now people are wondering what will happen to their economy.  If the cuts push the economy further into recession, Greece’s problems will not be solved.  The bottom line is that once you get into debt, there’s no easy way out.




The Greek Prime Minister said that Greece would turn to the IMF for an emergency loan if the EU does not provide support.




5. Politics

Charles Rangel stepped down temporarily as Chairman of the House Ways and Means Committee.  He was replaced by Pete Stark from California, but there will be a vote among Democrats to determine who will be the chairman in the future.




The Volker rule was sent to Congress on Wednesday.  The proposal is intended to limit banks from speculative trading (since they have access to low cost deposits).




President Obama has three openings for Fed governors in which he needs to fill.




6. Bill Gross’ Letter

I’ve had several people forward Bill Gross’ most recent letter to me.  That makes sense…it was really good.  Here’s a summary of his thoughts:

1. Workers in developed countries saw their real income hurt because of globalization.
2. Governments promoted asset price appreciation and leverage so that economic demand would not suffer.
3. When people became overleveraged and asset bubbles burst, we started to lose our belief in lower taxes, deregulation and leverage.
4. The bond market and banks started to limit credit.
5. This led to recession and deleveraging (people reducing their debt level).
6. This also led to the belief in more regulation and “de-globalization.”
7. Government stepped in (on the monetary policy side) with lower interest rates and purchasing of securities (to lower interest rates).
8. Government fiscal policy turned to heavier spending at the same time that tax revenues declined.  This led to deficits that were very large as a percentage of GDP.
9. It seemed like the government did its job – replacing the private sector.  Stock multiples returned to normal ranges as did credit spreads.  GDP growth resumed.

10. Everyone could believe in capitalism again.  Asset prices would bail us out.

11. Dubai, Iceland, Ireland and Greece reminded us that the model was flawed – governments can’t just keep leveraging themselves.

12. Maybe government debt will lead to sovereign defaults.  But even if there are no defaults, all of this government debt will be a drag on GDP.

13. Maybe we can’t get out of a debt crisis by having the government issue more debt.




Gross then effectively argued that in the short term, there was an “arbitrage opportunity” (my words for his description).  We could replace private debt with public debt and this lowered the cost.  The government seems like it is lower risk.

But, after a while we start to see credit deterioration.  Investors require higher rates from sovereign debt.  We see the premiums on credit default swaps increase (on sovereign debt).  We also see the risk of inflation result in higher rates.

So now the question is whether government bonds are really just as risky as the debt that they guarantee?  Sovereign debt yields should look more like the highest rated risky bonds.

In sum, it’s difficult to solve a debt crisis by issuing debt.  But, it’s particularly difficult if:

1. you already have a lot of debt
2. you have unfunded liabilities
3. you will experience higher interest rates (which will cost the government dearly)

7. Random




The biggest banks in the US and Europe paid 10% more for compensation than they did in 2008.




Lots of cash on hand…time to spend it. The 382 nonfinancial firms in the S&P 500 have $932 billion in cash and short-term investments.  That is 8% higher than Q3 and 31% higher YOY.  With the market 29% below its peak, companies are using cash for acquisitions.  Nearly 50% of deals this year have been all cash (double the 24% rate in 2008).  There were also 62 share buybacks announced in February, the most since September 2008.  Buybacks were up 37% in Q4 versus Q3.  In addition, in Q4 there were 79 dividends increased and only two reduced compared with 58 increases and 41 reductions in Q4 of 2008.
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