NEW HIGHLIGHTS
"The credit crisis has abated."
"The financial crisis is behind us."
Those statements were made by Warren Buffett, aka The Oracle of Omaha this week who went on to say that there was greater opportunity for investment inside the United States than outside it because the American economy is larger than all others.
Nearly concomitantly, President Obama addressed a crowd in Japan, telling it that Asian constituents should not count on the United States to be the standard-bearer for demand and growth going forward.
In an op-ed piece in The Washington Post, Jamie Dimon, Chair of JPMorgan Chase, wrote that there is nothing inherently bad about a bank being large, that limiting banks to a certain size is artificially limiting, but that banks should also then be allowed to fail. He went on to say that if a bank needed to fail, the government should then have the power to unwind it in an orderly fashion, taking control of management, liquidating assets, paying off senior secured creditors, and paying shareholders and unsecured creditors, as appropriate.
The Chair of Goldman Sachs, Lloyd Blankfein, told the press this week that he is just a banker "doing God's work." He went on:
We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It's a virtuous cycle.
Treasury Secretary Geithner, seeking to assuage investors in dollar-denominated assets, made statements affirming his commitment to a strong U.S. Dollar. At almost the same time, Robert Zoellick, President of the World Bank, said that the United States has limited ability to slow the Dollar's decline.
Australia took a stab this week at taming the problem of confidence in credit ratings agencies. The Australian Securities and Investment Commission will now require credit rating agencies to (1) obtain and maintain a financial services license issued by the government (2) file annual compliance reports and (3) distribute its methodology for ratings. Maintaining the license will require the agencies to manage conflicts of interest, show that they have adequate resources to match the size and complexity of their business, and demonstrate that they have adequate risk management systems.
Not that our opposition had anything to do with it, but this week, the International Monetary Fund, United States, Canada, European Central Bank, and Russia all voiced opposition to the financial transaction tax that Gordon Brown of Great Britain proposed last week.
With the government debt for European Union countries, in aggregate, expected to reach 79% of GDP in 2010 and 83% in 2011, some Finance Ministers of European Union countries began to talk about cutting budgets.
The issue of an unnaturally devalued Yuan was back in the news this week. Justin Yifu Lin, Chief Economist of the World Bank, speaking in an unofficial capacity, said that he doesn't think it's a good idea to allow the Chinese currency to appreciate, that it would derail the recovery, that it would make China's goods more expensive, but in the end would not substantially affect the balance of trade between China and the United States as the goods that the U.S. imports from China are, for the most part, not manufactured in the U.S.
Later in the week, the International Monetary Fund said that the Chinese currency was significantly undervalued. The Chinese responded that they would consider re-visiting the value of the Yuan based on capital flows and currency movements.
On a related note, Moody's Investor Service raised its outlook on both Mainland China and Hong Kong from stable to positive.
The FDIC shut three banks Friday night at a cost to the agency of $986BN: Pacific Coast National Bank (CA), Orion Bank (FL), and Century Bank (FL). One hundred and twenty three banks have failed this year.
ECONOMIC AND MARKET ANALYSIS
We're not sure who coined the phrase, "Manifest Destiny," but we think it's perfectly permissible to use it to characterize what investors seem to regard as their nature-given right to a higher stock market.
The Dow rose 2.5% this week, encouraged by...well, at this point, it seems that investors will use any excuse to pump more money into the market under the assumption that everyone else will do the same. Weak demand abroad? Well, you must invest in domestic companies or Treasuries. Strong demand abroad? The large multinationals stand to benefit from American goods being cheaper as the Dollar weakens relative to the currencies of those countries.
We're still waiting on Home Depot to report its most recent quarterly earnings, so a little more suspense is in the cards. But how about a sneak preview? Of 29 Dow components, looking at the most recent earnings quarter over the same period last year, 13 have reported higher net profit over last year. Doesn't sound too terrible? Consider that of that 13, only five did it on higher revenue, and of that five, only three are non-financial companies. But this is just a foretaste of the full analysis to come once Home Depot's numbers come in.
The U.S. Dollar closed down, on average 0.6%, with the Brazilian Real, unsurprisingly being the only major currency against which the Dollar advanced. We say it was an unsurprising development because the Brazilian government has increasingly taken steps to stem the flow of investment into that country, taking such steps as levying fees.
Despite the fact that most commodities finished up, with gold, corn, and natural gas being the biggest winners, on average, commodities were pulled down by crude oil, which weighs heavily as a factor in the index.
Given the still very low levels of inflation, both in consumer and producer prices, and given that investors are hardly in a panic over the possibility of financial pandemonium at this point, it is difficult to attribute gold's persistent rise the past six months to anything other than speculation. Speculation over what? This week, Vietnam lifted its ban on importing the metal. But, what of the past six months?
Let's not be naive: from May 1 through November 6, gold has risen 23.6%. We can attribute maybe half of that rise to the Dollar, which fell 10.4% over the same time period. [An aside: in fact, while we haven't performed the calculations, gold really rose more than 23.6% during that period. What do we mean? These contracts settle in U.S. Dollars. Assuming that some number of investors needed to convert foreign currency into Dollars to execute these transactions, that act would have put upward pressure on the Dollar, simultaneously working to make gold ever-so-slightly cheaper.]
So, where's all this demand for gold coming from?
- Fear of insolvency of the U.S. government and/or that the U.S. Dollar will lose value
- Expectations of higher industrial demand
- Expectations of higher inflation
Not to put too much stock into the words of Warren Buffett, but while our financial problems are far from behind us, it would be hyperbole to say that a financial panic is yet with us. Industrial demand? Maybe, but the jury is still out. We have had three consecutive months of increasing production, yet output levels are still lower than any time since February 2002, which leads to the next point.
While general business inventories have declined for 12 consecutive months, general business sales have risen for three months in a row. The Inventory/Sales ratio stands at 1.33. As we have discussed in previous issues, in "normal" times this figure would be seen as confirmation of a robust economy in which things are coming close to flying off the shelves. So, how do we get to this figure? Modestly rising sales and declining inventories. In other words, the same or greater number of dollars chasing fewer things? That's what inflation is all about, folks. The case against inflation? The continued contraction in bank lending and continued downward pressure on Employment and Personal Disposable Income.
In other words, higher inflation is hardly a foregone conclusion at this point. How much of gold's rise is attributable to investors simply betting that other investors are betting on higher gold? Your guess is as good as ours.
The week's economic data:
Trade Deficit - In September, the deficit grew 18.2% month-over-month, but is still down 39.4% year-over-year. Both exports and imports grew, but imports grew at a greater pace, helped by the fact that prices of things that Americans imported rose 0.7% and the price of things the U.S. exported fell 0.2%, due, mostly, to the falling Dollar.
Budget Deficit - The 12-month rolling deficit declined 3.8% month-over-month in October to October for a still-whopping $1,537BN. That figure is almost 3.5X the level a year ago.
Money Supply - As defined by M1, funds in transaction accounts, the nation's money supply grew 13.5% year-over-year in October. It sounds like a big jump, and it is, but in fact, the pace of growth in M1 has slowed considerably in recent months and rose just 0.8% in October over September.
Commercial Lending - The nation's domestically-chartered banks are continuing their terrified ways. The pace of growth in the money supply has slowed in October, but it did grow, while the magnitude of all lending by all domestically-chartered banks shrank 0.9%, and is down 6.3% year-over-year.
Some facts are difficult to hide from. The Federal Reserve is continuing to implement a policy of "loose" money that is unprecedented, and is, essentially, handing money over to the banks that it has raised through government borrowing. And that money, in turn, is--you guessed it--staying in the hands of the banks. Excess Reserves held by the nation's banks (this is the amount of reserves beyond what was required based on deposit accounts), grew a whopping 15.7% in October. That represents money that, in "normal" times would have made its way into the accounts of small businesses, large corporations, and consumers.
We have argued in recent issues that the nation's capacity for growth, based on debt levels, is very limited for the medium-term. And, with lending levels that are staying put or, even worse, decreasing, it's even harder to see where growth will come from.
Around the globe:
Consumer Prices - Prices in China fell 0.8% year-over-year, but that was a reflection of how low prices had fallen earlier in the year. Month-over-month in September, prices rose at a 4.9% annual rate, making the Chinese's statements that they are considering tightening the currency not only more credible, but possibly a necessity.
Producer Prices - Not a lot of interesting data here. Prices in the Euro Zone were down a marginal 0.3%.
Trade Balance -The most interesting story here was that Australia's surplus continued its decline, down 76.5% from August, leaving just a $800 million surplus. India's deficit shrank by 5.4% to -$78.1BN, and Indonesia's surplus fell 4.1% to $14.2BN.
Employment - Not a lot to report here. Japan's rate fell marginally to 5.3% frpom 5.5% and in the Euro Zone it rose to 9.7% from 9.6%.
Industrial Production - China saw a modest 1.4% boost in output, but the real story was in Russia, where there was a 3.7% increase in output.
ECONOMIC INDICATORS
- Trade Deficit - Rose 18.2% month-over-month in September as imports grew more than exports did, but is down 39.4% year-over-year.
- Budget Deficit - Twelve-month rolling deficit fell 3.8% in October to $1.5BN.
- Money Supply (M1) - Rose 0.8% in October, and is up 13.5% year-over-year.
- Commercial Lending - Fell 0.9% from September to October, and is down 6.3% year-over-year.
REQUIRED READING
On Mainland China, Exxon Mobil began operating a refinery in the Fujian Province. The company also opened its first gas station on the Mainland and plans to open 750 more. The Company is in the process of shutting down all of its company-owned gas stations in the United States. These steps are part of the company's strategy to adapt to what it believes is a slow decline of energy consumption in the West and greater consumption in the East, specifically China.
VITAL STATISTICS
| Market Close Nov 13 |
Market Close Nov 6 |
TPE Index* | ||
| Dow Jones Ind. |
10270.47 |
10023.42 |
89.33 | |
|
S & P 500 |
|
1093.48 |
1069.30 |
74.42 |
|
FTSE 100 |
|
5296.38 |
5142.72 |
76.42 |
|
Hang Seng Index |
|
22553.63 |
21829.72 |
132.96 |
|
US Dollar Index |
|
75.28 |
75.77 |
63.74 |
|
S&P GS Comm. Index |
|
479.60 |
481.55 |
-- |
|
Fed Funds |
|
0.12% - w/e 11/6 |
0.11% -w/e 10/30 |
2.26 |
|
3-Month LIBOR |
|
0.27% |
0.27% |
4.46 |
|
13-Week T-Bill |
|
0.06% |
0.06% |
1.20 |
|
Money Supply (M1)** |
|
1673.9 (Oct) |
1659.9 (Sep) |
149.20 |
|
Commercial Lending** |
|
6156.6 (Oct) |
6212.5 (Sep) |
195.74 |
|
Excess Bank Reserves** |
|
994.7 (Oct) |
860.1 (Sep) |
76872.57 |
|
Foreign Treas Purchases/Sales |
|
1.02 (Aug '09) |
1.03 (Aug '08) |
-- |
|
|
|
|
|
|
|
*TPE Index is a measure of the absolute closing value on a scale |
| |||
|
where 100 = opening on January 2, 2000. |
|
| ||
|
**Billions |
|
|
|
|
CORPORATE ANNOUNCEMENTS
- Barclay's PLC reported net profit of 1.1BN Euros, down from 2.3BN Euros last year, for the third quarter. The company cited a one-time gain last year and credit charges this year.
- Hewlett-Packard is buying Dow component, 3Com, for $2.7BN in cash.
- ING reported net profit of 499 million Euros compared with a net loss of 478 million Euros for the same time last year.
- Lloyds Banking said it will cut 5,000 jobs this year.
- Spring Nextel said it will cut up to 2,500 jobs (5% of the workforce) this year.
MORE NEWS YOU CAN USE
- Liechtenstein Washes Away the Gray: The Organisation for Economic Cooperation and Development has removed Liechtenstein from its "gray list" of tax havens after concluding mutual tax treaties with Belgium, France, Germany, The Netherlands, The United Kingdom, and the United States.
- Fed Prohibits Automatic Overdrafts: The Federal Reserve took the step of requiring banks to obtain the explicit approval of consumers before permitting overdrafts on accounts and charging overdraft fees.
- FDIC Approves Pre-Payment: The Board of the FDIC formally approved that members be required to pre-pay their insurance premiums to shore up the agency's reserves. The measure is expected to buttress the reserves by $45BN.
- FHA Reserves Running Low: As of September 30, the Federal Housing Administration's capital reserves were at $3.6BN, down 72% year-over-year, and are sufficient to cover just 0.53% of the roughly $685BN in loans insured by the agency.
- Nissan Goes Electric: Nissan unveiled its electric car, the Leaf.
COMMENTARY
An Unabashed, Self-Serving Advertisement
We're not shy about saying that this-or-that action or statement by a government official, bank executive, or global trade body is ludicrous.
And yet we do not traffic in drama. We don't report on the little dramas that comprise the preliminaries of deliberations, prognostications of the outcomes, or the back-stories related to the outcome.
Don't you get enough soap opera in your life already?
This week provided an excellent example of what we think sets us apart.
Bloomberg's website carried an item on Tuesday about HSBC's profitability in the third quarter. It was a fascinating piece of journalism...fascinating the way you have to stare at a car wreck.
The piece was composed of seven paragraphs. It said that the bank said that third-quarter profitability rose higher over last year. It discussed the impact of credit charges to the company and the development of the company's consumer finance arm. It tracked the company's stock price over the past week.
What did it not specifically mention? You guessed it: the quarter's net profit and revenue.
Maybe we pare things down a little too much for the taste of some who live and breathe what they think is Finance. We think a lot of it is really just a talk show.
You Just Can't Make This Stuff Up
The financial crisis is over?
The FDIC formally approved a measure to require member banks to pre-pay insurance premiums because it is running out of money. The Federal Housing Administration has enough in reserves to cover 0.53% of the loans it guarantees. And as a proof that the panic is over, banks contracted their lending in October by 0.9%.
And while Chairman Buffett was touting the exigencies, not to say, benefits, of investing in the good ol' U.S.A., halfway around the world, the President of the most powerful country on Earth was trying hard not to exactly warn Asia that it had better not expect the U.S. to lead the way forward with economic growth.
If you didn't know better, you'd swear this was some kind of television-made parody, no?
Let's talk about the truth:
- The credit crisis isn't what it was a year ago, but it is far from over--issues over confidence in credit ratings continue to rage, assets on banks' books continue to deteriorate, and it's almost more palatable, not to say easier, to borrow from your local Cosa Nostra representative than from a domestically-chartered bank.
- The United States economy is still, by far, the largest of any country. By far. If you're trying to reach a mass market, it's still all about reaching the American consumer. Without some kind of growth in the American market, there will be no worldwide recovery in the short-term.
- Having said the previous, it's extremely difficult to say where long-term growth on the American continent will come from. In terms of consumer consumption, debt levels, and marginal tax rates, we believe that a relatively high level of saturation has been reached.
There's a critical distinction between recovery and growth. We're terribly sanguine about the medium-term prospects for a recovery in the United States economy. But long-term growth? If there are readers who can tell us why, across the board, the American economy can be expected to experience significant long-term growth, we'd love to hear it.
Isn't this What Tibetan Monks Pray for?
God's work? We're not going to go on and on about Chairman Blankfein's inane statement that Goldman Sachs is doing God's work. We'll say this: it would behoove Blankfein to demonstrate some appreciation of the situation. Goldman is placing debt and advising and mergers and acquisitions right and left. And why? All because interest rate levels are so low that investor appetite for fixed income debt has risen appreciably and the financial crisis has created the need for companies to raise capital.
Financial crises--they're wonderful things. Chairman Blankfein may be holding the wrong end of a divine interest-rate swap, though.
Adding 2 + 2 and Getting 22
Here's a pop quiz: what's the difference between too big to fail and having the government intervene to manage its dismantling?
They sound elegantly opposite, don't they? But are they, really? Let's try one of Einstein's thought experiments. Let's pretend that the government permitted/forced Citigroup, at the height of its financial distress, to fail. What would have happened? Would the process of deleveraging the balance sheet, dismantling assets, and managing the company out of business take up fewer taxpayer resources than the alternate scenario would?
We don't think so. At least with the scenario that has the bank struggling to stay afloat, the company is actively working to generate profit and be as self-sustaining as possible and more importantly, creating a perception that it is doing so, thus inhibiting the likelihood of a "run," or panic, on the bank, surely a desperate situation in which the bank has deteriorating assets and apprehensive deposit holders.
How about you? How would you feel if you had $100 million on deposit with a bank that had assets that were deteriorating in value and whose assets' maturities poorly matched the liquidity needs of its depositors? Would you be more comfortable with the government managing the bank or the government supporting the bank's effort to be profitable?
Neither situation is very appealing, is it?
Chairman Dimon has it half right.
Here's what the Teacher's Edition says:
- Banks must be permitted to fail.
- Depositors and borrowers must have access to full disclosure about banks' financial condition, requiring a level of transparency that does not exist today.
- FDIC guarantees should be eliminated.
- Depositors should have a voice/vote in deciding how banks' assets are treated, for accounting purposes. (In other words, banks should not be able to use accounting rules that obscure the true value of assets.)
When depositors stand to lose their money, the market will aright itself very nicely.
YOU ASKED
Q: I find it curious that you haven't talked about the bill introduced by Senator Dodd to overhaul regulation of the nation's banks. Why not?
A: This is a great example of our editorial policy. We rarely like to dwell on items that have only the potential to become news. There are several versions of the bill Senator Dodd introduced, and we believe that the version that the Senator introduced has the least chance of passing. Why?
To present a perfectly cynical analysis, the ratio of current stakeholders in the regulatory infrastructure to the number of stakeholders that would exist after the bill woud be adopted is just too high.
To put it more crudely, too many people who have a lot of power now would be put out of work.
Someday we'll get tired of saying it, but, for now: Follow the Money.
