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If you are a McCombs alumni in Houston, please consider coming to the alumni event on Thursday, February 18th. I’ll be speaking about the economy.
Now, on to a summary of what I read…
The Dow dropped 45 points on Friday, after being down as much as 160 points. The market received bad news about the European economy and also digested China’s increased reserve requirements.
The corporate bond market is getting weaker. Prices have had their biggest decline since the rally started last March. Credit default swaps have risen to their highest level in three months. In the past week, investors withdrew $984MM from high yield bond funds, the largest outflow since September 2005. New debt issuance has slowed: US investment grade and high yield debt new issuance totaled $5.1 billion this week, compared to $32 billion the prior week. Some offerings were pulled.
The dollar rally is at its highest level since May. There are 57,000 net short contracts by speculators against the euro. This is $9.9 billion of bets – which is large by historical measures, but small as a percentage of the market.
Lumber prices are up 32% this year. This is bad news for homebuilders. My recommendation to homebuilders…buy some houses out of foreclosure.
2. Economic News
Retail sales rose .5% in January (vs. December). Core retail sales (which exclude autos, gas and building materials) increased .8%. Interestingly, people are buying appliances and electronics.
Maybe this is part of the explanation for retail sales. Northeastern University’s Center for Labor Studies reports that unemployment for the top income decile (individuals earning > $150K) was 3% in Q4. That compares with 31% for the bottom decile and 9% for the middle decile.
Consumer sentiment fell. The University of Michigan / Reuters preliminary consumer-sentiment index fell in February to 73.7 (from 74.4). Future expectations dropped.
Two corporate studies (by John Burns Real Estate Consulting and S&P’s Financial Services) predict that more waves of foreclosures will maintain pressure on home prices for several years. They also said that modification efforts will result in delay of foreclosures, but will not avoid foreclosures. The firms also said that there is huge inventory that will need to be sold.
3. Municipality Issues
State problems flowing through to education. There are estimates that 25 – 30 states cut funding for K-12 education in fiscal 2010 and at least 15 expect to do the same in 2011. The result is that many classes are becoming larger. In California, approximately 75% of the state’s public elementary schools increased class sizes this year.
We are seeing similar cuts in police, fire and emergency medical services. In the past year, 14% of cities have cut public safety budgets. Public safety accounts for 22% of general municipal spending. (Education accounts for 27%.) You’re going to see fewer police departments respond to property crimes, more abandoned vehicles on the road (because the police won’t get involved) and fewer administrative officers. Some police departments aren’t even responding to assaults!
Municipalities are struggling with issues related to home-based businesses. Many unemployed people are starting businesses from their homes. That can result in customers coming to neighborhoods and creating traffic and noise. It seems like it’s one thing for a customer to come to your house for a haircut or to design a wedding dress. It’s another when you start to warehouse fish in your garage. (These were all stories from the article!)
4. International Economy
China raised the share of deposits banks must hold as reserves. Now, Chinese banks will have to hold 16.5% of deposits as reserves. This is the second increase of the year. China relies on reserve requirements while the US relies on interest rates. January loans totaled $203.6 billion, approximately 1/5 of their goal for the year! Property prices were up 9.5% in January (YOY). Consumer inflation was up 1.5% YOY (and this is a drop from December’s 1.9% YOY increase). Power demand rose 40% in January.
This creates fear that China’s slower demand will hurt the global recovery. In addition, there is further fear that the Chinese government will not get the tightening correct and China will slow too much.
The euro zone expanded .4% on an annualized basis in Q4. This is down from the 1.7% rate in Q3. This was bad news for the euro. It tells us that even with all of the government policies, the EU can hardly muster any growth. France’s 2.4% growth is what saves the EU numbers. Germany’s growth stagnated (after 3% growth in Q3). It’s hard to believe that this is the type of environment which will allow Greece to cut their deficit. (Greece is assuming 1.5% growth in 2011.)
Spain and Ireland have unemployment of 19.5% and 13.3%. Youth unemployment in those countries is 45% and 31%. Greece unemployment is 9.7%.
A little good news for Japan. Amid all of the Toyota problems and Japan Airlines bankruptcy, Japan’s GDP grew at a 4.6% annual rate. Japan’s exports to Asia increased 31/1% YOY in December. Unfortunately, prices show a 3% decline. For all of 2009, GDP is down 5%.
5. Sovereign Debt
On Monday, the finance ministers of the EU told Greece that they had to reduce their budget deficit by 4% of GDP within one month (by March 16). Otherwise, the EU will demand spending cuts and new taxes.
Bailing out Greece is necessary in order to protect European banks. In addition to bond holdings, there was fear of higher interest rates (which would increase the banks’ financing costs). Also, government tightening could lead everyone back into recession.
A NY Times article argues that the investment banks helped to hide the debt of Greece and other countries. I don’t know if that’s true or false, but the article certainly didn’t convince me of that. It sounds like Greece sold future rights to income (such as airport fees and lottery revenue). That tells me that Greece is in significant trouble and that they are even more likely to have a catastrophe in the long term, but it doesn’t bother me that this is an unrecorded loan. I could see it as simply a sale.
Investors are talking more about UK debt. The UK’s four major banks held $110 billion in UK government debt. If this debt is seen as risky, these banks may have to pay more to attract funding. In early September, it cost $57K (per year) to insure $10MM of UK debt. Now, the cost is $97K.
Dubai is back in the news. Dubai World may offer creditors just 60 cents on the dollar, paid back after seven years.
The cost of insuring Dubai’s debt increased $50K to $636K / year. Dubai is estimated to have $80B of debt and their property prices have plummeted.
6. Ideas About the Market
Interesting article about stock market indexes in the WSJ. As I often discuss in class, certain round numbers in the index (e.g., Dow 10,000) get a lot of attention, even though it makes no sense. Our brains tend to focus on particular triggers that seem to allow us to have order. Some studies show that trading is actually different when the indexes approach a round number. Stocks tend to exhibit “herding” – where they all move in a coordinated way (rather than based on the merits of the individual stocks). One researcher also found that stocks do better when they pass $5 or $10 increments. It’s possible that some investors will only buy stocks when they are above these levels.
Quadrophobia. There’s a ton of research that suggests managers try to meet earnings expectations. But some new research is getting press because of its approach. Researchers studied close to half a million earnings reports and found that when you look at EPS down to tenths of a cent (e.g., $.321 – in other words, 32.1 cents), you find that 4, 3 and 2 are underrepresented in the tenths column. The idea is that companies find ways to get to a higher level so that they can round up to the next cent.
Two thirds of institutional investors under-estimated how much turnover they had in their portfolio. On average, they under-estimated turnover by 26%. According to Morningstar, mutual funds with the highest turnover have underperformed those with the lowest trading by an annual average of 1.8%.
7. Olympic Thoughts
More evidence that skating isn’t a sport. Read the quote below:
“We don’t want to give him too heavy a workload. We treated him carefully, like a flower bouquet that should look fresh on the day of the competition. –Russia’s figure skating coach Alexei Mishin, on Evgeni Plushenko’s preparation following his European Championship victory.
If your “coach” compares you to a “flower bouquet”, what you do is not a sport.
People have no sense. The International Luge Federation said that there was no deficiency in the luge course in which a Georgian luger died. They basically blamed it on the athlete. Who would have ever thought that something bad could happen when these guys are going 90 MPH and there are exposed steel beams if you crash. It’s slightly difficult to believe that there was nothing wrong with the course after the Olympic Committee shortened it and covered the steel beams. If I were the Olympic Committee, I’d get my checkbook ready.
I don’t want to brag, but I watched figure skating last night. It might sound odd to you (after past posts) that I’m bragging about this. I can’t disclose details, but you can figure that I must have done something really bad to have to watch this crap. I’m not even sure what the hell I was watching. I think it was the men’s pairs or something like that.
Losing popularity. A recent WSJ / NBC News survey showed that 65% of voters believe that President Obama inherited the nation’s economic problems. (The other 35% were busy sniffing glue.) But, voters disapprove of Obama’s handling of the economy by a 49% to 43% vote.
Google “Karl Rabeder.” He is an Austrian millionaire who is giving away all of his wealth ($4.5MM). His goal is to have nothing left. He thinks that it is making him unhappy. Personally, I wouldn’t mind being a little less happy.
The FHLB of Seattle filed 11 lawsuits against investment banks, claiming that the FHLB was misled during the sale of mortgage backed securities. Apparently, it’s difficult for an institutional investor to recover in this type of suit. But, if there was ever a time that it could happen…this seems like the time. Some of these bonds have a 25% foreclosure rate (for the mortgages they hold)! My fear is that this will cut into bonuses. (That was a little Populist humor.)
Irony can be so ironic…Sunday was the Chinese New Year. It’s the year of the Tiger. I could be wrong, but I think the last few years on tour were the year of the Tiger. But, I certainly don’t think it’s this year.