bizzXceleration: Performance, Value and Profit

The graphic is from a WW2 combat artist and was painted in the immediate, we mean immediate, aftermath of a major German shelling of the beachhead when the survivors crawled up out of their holes and were staring dazedly at the few scrawny trees that survived in the devastated landscape. You can't quite look into their eyes but for many people that's not necessary - they just need to look into the mirror. After a few e-mail and other exchanges my take would be that there are a lot of Market PTSD (that's post-traumatic stress disorder, shell-shock, battle-fatigue, etc.) sufferers out there who are still wondering what hit them. And where about to pull the plug on their 401Ks last Mon. when they got the biggest surge in DJ history....and almost panicked several times during the week. Yet for the week the markets had one of their best weeks ever. The question is, now what ?

Intermediate Market Appreciation

 Well take a look at the accompanying composite chart for an intermediate-term appreciation. Appreciation is a pun since we're using it in the military intelligence sense of assessment as well as the normal psychological one - in this case ironically. The top shows a 1YR daily and shows how a continued downtrend metastasized into a completely unexpected collapse. A collapse compressed into basically a week when what normally takes months and years happened in a few days. Anybody who's feeling a little PTSD'd comes by it fairly and honestly.

The second sub-chart looks at the last six months so you can see some more of the detail. First off notice how abrupt the collapse was. But not, and more importantly and hopefully, notice that it appears to be arrested. If the credit markets continue to unfreeze so that they begin operating normally then we're likely to get some sort of bear market rally here. Which'll pick up some momentum if the indices breaks back above the blue downtrend line. Whether that happens depends on no more black swans and the dawning grasp of the painful economic futures not overwhelming the "theoretical" under-valued present. Yeah, right !

Long-term Appreciation

If we get a rally it's strength and duration will be driven by fundamentals - that is what are the expectations for the worsening economic and earning situations and how well is that yet factored into the marekts ? We suspect that the grasp is enormously improved but still hasn't sunk in as yet. In fact for a downturn that's been clearly visible for months and has recently accelerated the deeply surprising, one might almost say appalling, thing is the apparant lack of grasp of most business managements about the situation. And as a result the surreal earnings outlooks we're still seeing. In this longer-term chart the SP500 is shown since 1980. The recent downturn has busted the long-term trend pretty badly (the diagonal blue line) so the question becomes where does it stop ? Well the horizontal blue lines show two areas of resistance - the '02 lows and the pre-'95 high before we got so much bubblicious over-optimism. It certainly wouldn't be surprising to retest those lows in the 800 region nor eve, given the likely severities of the economic downturn, those of the 500 region. Reinforcing that is the natural speed limits shown in the green (the Fibonacci limits). If we get a bear rally with some legs it might run thru the rest of the year but early in '09 the depth of the downturn will be clearer and then we should tip back over and more than likely at least head for the area of resistance around 650 +/- 50.

Depending on what you want to do in terms of risk acceptance and work you can play the rally up and down or look for re-positioning and re-structuring. If you're a long-term investor who doesn't want to spend several hours a week working on this - not necessarily a wise choice IOHO in a market described as all too likely to rip your face off - use the rally to head for cash, s.t. bond funds and dividend paying stocks, preferably preferred shares which have amazing yields right now.

But here's something to keep in mind - some of the best companies in the world are at multi-generational low prices. And if our prognostications are anywhere near accurate, are likely to go quite a bit lower. As Warren Buffett has pointed out you're not going to see bargains like these again in your lifetimes. Start preparing to take advantage. That and other very good advice is presented in the readings excerpts. We strongly recommend - if you have any interest whatsoever in your own retirement situation - clicking on thru and reading most of these excerpts in full. Especially Jim Jubak's ! 

Markets

Have we gone as low as we can go? A Chinese philosopher said, when it's obvious that goals cannot be reached, don't adjust the goals -- adjust the action steps. Global central banks have taken those lessons to heart. The construct of capitalism has changed forever, and investors are spinning from the volatility gripping financial markets. Moves of 20% in major market averages -- session over session -- are tough to stomach regardless of your directional bias.One year ago, when the writing was on the wall as the Dow Jones Industrial Average  probed all-time highs, pundits confidently proclaimed there was clear sailing ahead. Last week, as perception caught up with the daunting reality of debt and derivatives that we've warned of for years, depression was debated across mainstream America. You can't blame folks for being confused. We're past the point where bulls and bears profit or lose. We've entered a new world order, a scary stretch where politicians rewrite history on a daily basis in an attempt to escape the devil of deflation. Last week, when we offered a more constructive stance on a trading basis, the pushback was palpable. In fact, the variant views were consistent with feedback received after previous against-the-grain stances such as shorting crude in May and shifting to 100% cash at the beginning of summer. Nobody is smarter than the market and I've long ago learned that if you don't stay humble, the market will do it for you. What I'll say with confidence is that the tape tends to follow the path of maximum frustration and rarely rewards herds running aimlessly towards a cliff. McCain misstated Obama's position on health care when he claimed people like Wurzelbacher and small businesses would be fined under Obama's health care plan. That's not true. McCain also misstated how Obama's tax plan would affect small businesses. But Obama was wrong when he said all of McCain's television ads have been negative. That's not true. Obama also underplayed his connection to the community organizing group Acorn. Ultimately, McCain didn't do enough to stop people from voting for Obama. Over the course of three debate the Obama campaign met their goal of reassuring the American people that he's ready to serve as president. The only thing that McCain could have done tonight to change the tenor of this campaign was to get under Obama's skin or force him into making an error but that did not happen.

What investors should do now It's time to panic. Okay, now that we've got your attention, let's be clear: We're exaggerating - at least a little. We don't think the financial system is on the verge of collapse. But the complacency exhibited by many market pundits in the wake of the most wrenching episode in modern financial history is sufficiently shocking that it almost demands some scare-tactic response.By our count some 300 articles were published last month telling investors "don't panic" or "not to panic." Urging calm is one thing. But too much soothing talk implies that there are no lessons to be learned. What's the use of a vertigo-inducing bout of market turbulence if the only conclusion is "stay the course"? At the very least, it's a good reminder to take a hard look at your financial plans and to reevaluate how much market risk you can truly withstand in your portfolio. Because - don't panic! - this might not be completely over.Richard Bernstein, the chief investment strategist at Merrill Lynch, worries that investors still don't appreciate the scope of the credit crisis. "It's weird - the canary in the mineshaft has fallen over, and now everyone thinks there's a problem with canaries," says Bernstein, who, despite sounding the alarm about a global credit bubble as far back as 2006, could find himself out of a job after Merrill's forced sale to Bank of America. (Too bad Bernstein's Merrill bosses didn't heed his warnings.) In Bernstein's eyes, the canary is the U.S. mortgage market, but the silent killer of loose credit was an international epidemic. "I don't perceive that most investors fully appreciate either the depth of the credit bubble or how broad-reaching it was in terms of emerging markets and hedge funds and commodities and all these other inflated asset classes that were dependent on easy credit," he says. Here's another reason to be concerned: The professionals managing your money haven't gotten this market right. Consider that at the market low on Sept. 17, only five diversified U.S. equity mutual funds - out of a universe of 9,100 - had positive total returns for the year, according to Morningstar. FIVE! Even after the market rebounded, there were still only three funds with returns this year of 10% or better: Parnassus Small-Cap, Heartland Value Plus, and Forester Value. If you haven't heard of any of those funds, that's the point. The investing world's best and brightest appear to be just as confused as the rest of us. Like Bill Miller. His streak of beating the S&P 500 now a distant memory, the Legg Mason Value Trust manager is down 35% this year. CGM Focus's Ken Heebner, whom Fortune dubbed "America's hottest investor" in June, is down 16%, while FPA Capital's Bob Rodriguez ("the best fund manager of our time," according to our sister magazine Money) is down 3%. So how did the three 10%-plus returners beat the odds? One common thread is that they all stayed away from bank stocks. Beyond that, each went his own way.

Everything's changed now -- for the worse I was wrong. I no longer think we're facing a garden-variety recession. At a minimum, it will last longer than the two quarters I projected on Sept. 30. Economists are now talking about a recession that will last three, four or even five quarters. (Keep some perspective here, please. We're still not looking at anything like the Great Depression. In 1932, the economy contracted by 13% and unemployment hit 24%.) And I don't think we're looking at anything like the hoped-for V-shaped recovery, in which the economy zooms out of the bottom, showing growth of 5% or more. The economy, I believe, is going to crawl off the bottom with growth that's likely to linger at less than the 2.5% the Federal Reserve calls the U.S. economy's noninflationary speed limit.I no longer think this is the typical bear market, not even if your benchmark is the painful one of 1973-74 or the excruciating one of 2000-02. Stocks now face a triple-whammy. First, a slow-growing economy will keep earnings growth depressed from levels investors now regard as customary. That means price-to-earnings ratios will have to come down to something below the historical averages for stocks. Second, the higher interest rates will cut into earnings further as all companies have to pay more to raise capital and as some companies defer expanding production or developing new products completely. In industries where this deferral leads to supply lagging demand, it will also lead to higher inflation, which will push up interest rates. So how should you position a "rethinking everything" portfolio? Begin building the "rethinking everything" portfolio by dividing your stock market assets into four unequal parts.

• Barton Biggs Says U.S. Stock Markets Are `Uninvestable'

How to rescue your retirement  It's rough traveling out there, with the market's twists and turns surprising us daily. But this 5-part road map could lead you through the coming dips and curves. The landscape is changing so quickly that no map can pretend to offer more than momentary accuracy, but even the most rapidly outdated guide can tell us when we've missed a turn. It can separate the minor deviations where a bad or good choice doesn't make much difference from the truly decisive forks in the road. And it can give us a sense of when we have a chance to adjust our course and when we don't have any option but to ride out the route we're on. So where are we? Let me try to give you a financial road map. It breaks down into five stages. Stage 1: In the next month or so, a big rally, Stage 2: The rally fails in early 2009, Stage 3: By mid-2009, pessimism deepens. I know right now it feels like the stock market can't get worse and that investors can't feel more pessimistic. But it can, and they will. The mere fact that so many investors are anticipating a bear market rally announces to me that we haven't hit bottom yet. Investors haven't reached the stage called capitulation, which will finally put the bottom in this bear. Stage 4: In late 2009 and early 2010, the bottom  This time I don't think we'll get a rocket of a recovery off the bottom. The damage to the economy has been too deep. The destruction of trust in the financial markets is too profound. The deleveraging of balance sheets is too big a break on corporate earnings growth. Stage 5: Recovery after 2010. You know what this stage looks like: It's the economy and stock market of the 1990s before the dot-com boom turned into a bubble, or the economy and market before the housing boom turned into a global financial market bust.

Stocks are safe again -- for now Realizing that investors were properly scared out of their wits by the lack of cooperation among governments in an era of intense globalization, U.S. and British finance officials have abandoned half-baked plans to buy bad banks' lousy mortgages at a premium and instead are attacking the problem of solvency and confidence by directly injecting capital into good banks to immunize them against future potential losses and by proposing a blanket guarantee of all deposits, period. The Dow Jones Industrial Average ($INDU) soared more than 900 points Monday. Volume on the New York Stock Exchange tracked around 10-1 positive -- meaning more than 90% of trades were buying shares at a higher price -- as investors recognized this was a very important step forward. The session constituted the sort of "90% upside day" that I suggested in this July 24 column would signal at least an intermediate end to the 2008 slide. And signal that it's time to get back into the market, at least for a while. More on that in a moment. Yet once the market stages a classic retracement rally, we must recognize that still not all will be well in the world: So much personal wealth has been destroyed in recent months -- particularly among people who sold stocks and won't buy them back until they're much higher -- that consumer purchasing power is impaired. Analysts at institutional research firm ISI Group in New York had held out against making a recession call for most of the year but finally gave way a month ago. Now they've gone farther: On Friday, they cut their gross-domestic-product estimate for the fourth quarter to minus 4% for the fourth quarter of 2008 and minus 2% for the first quarter of next year, as they say their company surveys have weakened significantly as credit markets have remained frozen.

Stocks Meredith Whitney loves Meredith Whitney, the über-bearish bank-stock analyst at Oppenheimer & Co., continues to tell clients to steer clear of the financial sector. But Whitney makes one exception: She tells Fortune that she likes the preferred shares of the "strong" U.S. banks - JPMorgan Chase, Bank of America, and Wells Fargo. Whitney isn't the only market sage who prefers preferreds these days. Warren Buffett recently bought $3 billion in preferred stock from General Electric (GE, Fortune 500) and another $5 billion from Goldman Sachs (GS, Fortune 500). What's the attraction? Yield, in a word. Buffett's GE and Goldman shares carry a dividend yield of 10%. While you can't get the same deal he did, the yield on the leading preferred-stock exchange-traded index fund - iShares S&P U.S. Preferred Stock (PFF) - now stands at 11.5%. Best of all, those bond-like yields are not taxed as regular income but at the much lower dividend tax rate (usually either 5% or 15%, depending on your tax bracket). Preferred stock is safer than common shares, but still comes with plenty of risk. In the event of a bankruptcy, preferred shareholders have a higher claim on assets than common stockholders, although that might not be much help in the event of a complete meltdown. The preferred shareholders of Fannie Mae and Freddie Mac are expected to be nearly wiped out. That said, depending on your stomach for risk, this may be a buying opportunity in preferred stock. Sophisticated investors might take Whitney's suggestion and buy the preferred shares of JPMorgan (JPM, Fortune 500), Wells Fargo (WFC, Fortune 500), or Bank of America (BAC, Fortune 500), all three of which recently yielded between 8% and 9%. A more diversified approach would be to buy the iShares ETF, which has exposure to the three names Whitney likes as well as 60 others, including nonfinancials such as miner Freeport McMoRan Copper & Gold and less robust names like Ford.

Inside Details of Sequoia Capital’s Doomsday Meeting With its Companies For the fourth quarter, analysts say companies in the Standard & Poor's 500 Index will earn about $241 billion, the most ever.  ``It's absolutely ridiculous,'' said Nick Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati, which oversees $30 billion. ``Analysts are playing catch-up. It's crystal clear that you've got a weaker economy for several quarters. That's inescapable.''  Investors who are expecting a rebound after almost $7 trillion was erased from U.S. equity markets this year may be disappointed as earnings fail to match forecasts. S&P 500 companies that earned less than analysts estimated in the past year dropped 13 times more than the index's average decline, data compiled by Bespoke Investment Group LLC show. Another 56 S&P 500 companies report this week after the index fell 23 percent over eight straight days of declines. The benchmark gauge's 39 percent retreat in 2008 would be the worst since 1937 as banks' losses on mortgage-related investments ballooned to more than $600 billion worldwide. Operating profit at S&P 500 companies fell 7.5 percent last quarter and will jump 28 percent this quarter, led by banks and brokers, according to analysts' estimates compiled by Bloomberg. That would exceed the record $222 billion they earned in the April-June period last year. Six of 10 industries will report record profits or come within 5 percent of all-time highs, according to Wall Street projections, which are usually based on company outlooks. ``The consensus will have to go down significantly,'' said John Praveen, Newark, New Jersey-based chief investment strategist at Prudential International Investments Advisers LLC, a unit of Prudential Financial Inc., which oversees $638 billion. ``The numbers are way too high.''  Any rebound may hinge on whether companies can overcome higher borrowing costs and a slowing economy to meet analyst forecasts that earnings will increase in the fourth quarter for the first time since April to June of 2007.

Oil: Remember Iran? I went tactically long of equities at the end of last week, expecting a sharp bear rally, and Monday's one day move, particularly in Japan (up 14%) and the US (up 11%) was what I might have reasonably expected for this whole week, so I've booked some profits. We're in a period of what veteran investor Barton Biggs has termed 'condensed lunacy'. The speed and scale of moves across asset markets are stunning, and in stocks we have seen nothing like this volatility since the huge swings during the 1929-33 Great Crash. This hasn't been a 'buy and hold' market for a very long time, as evidenced by the appalling returns generated by mutual funds over the last decade. So stepping back from the gut wrenching volatility, what's the big picture? We're still in a huge bear cycle for US equities. I wrote on 24 July that 'we're now probably midway through a structural cycle that may last to 2015 or so. Another way of looking at it is that returns were 'front loaded' during the huge bull market from 1983 to 2000, making the entry point crucial for successful investing'. Indeed, I'd expect the 2002 lows to be tested in the next few months, although with the immediate threat of financial meltdown averted, this rally may get us into the New Year, albeit in choppy fashion. Last Friday looked like an important interim low, although it may be tested. Even in long term bear markets, big rallies lasting weeks and even months are common, and a wise investor will make the most of them and then cash out and sit on the sidelines. It's buy and fold, not buy and hold. Away from the banking mess, it is notable that big mining groups like Rio are now warning of a slowdown in Chinese demand; I warned as long ago as last Spring that China would stumble as their growth model was simply unsustainable. As US consumers retrench dramatically, we now need Chinese and other Asian consumers to take up some of the slack to sustain global growth. Alternatively, China needs to use its huge holdings of US Treasuries held at the Fed to help support the US economy eg by swapping them for MBS and other securities to inject liquidity into financial markets. Otherwise, China will become part of the problem, not the solution. Iran has also fallen off the market's radar screen; back in July, there was probably $25-30 of geopolitical risk premium in the oil price related to Iran/Nigeria, now there's zilch. I correctly identified the investment bubble in oil a few months back and was a seller against the overwhelmingly bullish consensus; now I'm going long crude call options.

Buy American. I Am. A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now. Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over. A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent.

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After arresting its' precipitous collapse on the backs of coordinated worldwide policy interventions

the markets gave up those gains and seems schizophrenic and paranoid. As it should be. Schizoid because it hasn't got a clear picture of where the economy is headed and paranoid because it suspects, correctly, that we're just seeing the start of the pain. What's stunningly surprising to us is how badly this economic pain, which has been clearly visible in the data and charts for a long-time, was anticipated. And how badly prepared almost everybody is. Including supposedly deeply informed observers, not just the usual talking heads. On the other hand there are some deeply informed observers who have been sounding the appropriate alarms for some time and who have, on balance, proven correct time and again. The accompanying Rose interviews are worth your time to put a lot of this in perspective. There are several questions that you, and most, should have in mind.

Policy, Economy, Markets, Outlook 

1. Intervention - will the coordinated interventions stop the collapse ? We'd almost say absolutely but nothing is guaranteed. That said this is a pretty complete toolkit, it's worked before and the level of international collaboration is unprecedented. All of this is stark contrast to the situation in the '30s where policy-makers did everything completely wrong.

2. Economy - which doesn't mean we aren't in for some protracted pain. This is likely to go on for two years and lead to a weak economy for a considerable time after that. It is likely to be as severe as the downturn in 1980 at least. Unemployment might rise to 8% or more...but then again back in the day that was an improvement.

3. Markets - still aren't adequately adjusted to reality but are getting there. We're likely to see a bear rally if the credit markets return to normal. There are certainly plenty of talking heads who are still too complacent. But then the pain, as the deeper economic realities sink into the headlines, are liable to lead to a market decline lasting thru '09 and into '10.

Take another look at the conceptual graphic of the Business Cycle - it's intended to help you frame the situation. This is like watching a giant wave build up offshore - the surprise is not that it turns into huge surf crashing on the beech. The surprise is the folks standing there watching it believing it won't happen. 

Alternatives and Liklihoods 

The world has changed in many ways and there are going to be new long-term structural shifts as consumers shift into saving more, financial industry de-leveraging continues to work out and companies adjust to this brave new world. Get over it. Or better put the sooner you get over it and re-orient yourself the better able you'll be to cope. But one way or another you will get over it. MUCH easier said than done I know full well. Hopefully by sorting the chaos, filtering and giving you some tools to help turn it into real information we'll all find some ground to stand on.

People can cope with emergencies and surprises, even the most drastic, when they have some clear understanding of what's going on. And some framework to make their decisions around. Right now many are still in shock and numb fugue as the result of the near-collapse of the markets. If we can get them stabilized then we will fight thru this.

The chart shows four alternative scenarios for GDP future growth paths. NONE of them is anywhere near as bad as the Great Depression, which would be completely off the chart. What the recent policy actions do is make it highly likely that the worst two won't come to pass. What we want is to get as close to the better two as possible. Which in turn is going to be dependent on government fiscal policy and continued support of the markets. The difference is going to lie between returning to the sustained malaise of the '70s or pulling ourselves up by our bootstraps ala the '80s - only this time with some good sense instead of voodoo economics and self-delusion.

Rescue Interventions

Federal bank buy-in no economic quick-fix With any luck, the government's quarter-trillion dollar cash infusion in banks will get them lending again, but the radical move won't quickly turn around the tottering economy. The pain will almost certainly drag on as vanishing jobs, shrinking paychecks and nest eggs, and slumping home values continue to force millions of Americans to pull back. Sales at the nation's retailers are expected to drop in September even as they get a break from record-high energy prices. Uncertainty about the economy -- and their own financial fortunes -- probably will force consumers and businesses alike to hunker down further, spelling more problems for the already troubled economy. Anxiety about the economy is the No. 1 concern of voters. With the presidential election just weeks away, Democrat Barack Obama and Republican rival John McCain are working furiously to convince people that each is the best choice to steer the economy through these perilous times. In addition to September retail sales numbers, other economic data out Wednesday is expected to show that even though the recent retreat in energy prices calmed inflation at the wholesale level bit, costs are still high and are squeezing businesses. Many economists believe the country is on the edge of -- or already in -- its first recession since 2001. If the government's new plan works -- it will merely cushion the blow. Democrats on Capitol Hill are pushing for another round of stimulus that could cost as much as $150 billion, an effort to provide additional relief and lift the country out of the doldrums.

Back From the Precipice So is it over? Have governments in the U.S. and Europe finally found the cure? Has recession been averted?No. We're still in for a rough recession, with U.S. unemployment, now at 6.1%, likely to rise above 8%, with all the misery that brings.But it could be worse. For a few scary moments last week, governments began to take action to protect their own countries that made other countries worse off. It looked like the world economy was lurching uncomfortably close to conditions that precipitated the Great Depression. The newfound trans-Atlantic unity -- particularly the move by the U.K., then the rest of Europe and now the U.S., to give the banking system a taxpayer-funded transfusion -- has significantly reduced the odds of a really bad outcome. That alone is reason to be less panicky today than many were this time last week. Last week it became clear to the remaining advocates that buying bad assets from banks, as the original plan outlined by Treasury Secretary Henry Paulson involved, wouldn't suffice. It might help eventually, but it would take too long and was too indirect -- hence the radical remedy of investing taxpayer money directly into those banks that have a reasonable chance of survival. (Officials know, but haven't advertised, the corollary: Regulators must quickly close banks so weak that their only plausible strategy is to gamble for resurrection or use taxpayer money to take foolishly risky bets.) The latest steps reduce the risk of the worst-case scenario and may mark a turning point in the 14-month-old crisis, though it's too soon to know. But they don't reverse the forces that were crushing the economy before Lehman Brothers Holdings Inc. went under on Sept. 14. Stock prices are well below Oct. 1 levels, so investors are poorer. House prices are still falling. Consumers, companies and bankers still have good reason to be extremely cautious, and they will be. The global economy is far from healthy. It almost surely will get worse before it gets better. The U.S. economy's legendary resilience will be tested. The market will have some bad days. But for the first time in weeks, governments -- with the grudging acquiescence of big banks -- are moving in ways that bolster, rather than undermine, confidence, and that's a very welcome development.

Governments have at last thrown the world a lifeline In the last week the world has seen the UK’s “good Gordon” in action. Confronted by the implosion of the country’s financial system, Gordon Brown, the British prime minister, acted. The plan his government came up with is comprehensive and bold. It will also be expensive. But the cost will be much less than the alternative – a depression – would have been. More important, others now agree. The meetings of financial policymakers in Washington over the weekend bore fruit, first in a general communiqué and then in detailed programmes of action. The European agreement is particularly impressive. Mr Brown can rightly claim to have been the leader. The world has, as a result, stepped away from an abyss, though the road ahead remains strewn with obstacles. Policymakers finally realised that a plan for dealing with such a severe financial crisis must contain those elements that are individually necessary and collectively sufficient. Two elements are necessary: massive provision of liquidity and recapitalisation of financially weak institutions. Two other elements will help, dependent on the circumstances: guarantees to lenders and purchases of defective assets. The US, with its complex financial system and bad mortgage assets, will find blanket guarantees hard to manage but may benefit from purchases. Europeans seem to be in the opposite situation. The announced programmes are, in scale and construction, what is needed. Difficulties will arise in containing the distorting effects of the guarantees and arranging an exit from a partially nationalised system into one better regulated than before. But the announcements made this week, not least in the US, epicentre of the storm, should abate the panic.*  The US Treasury’s programme is, at last, suitably comprehensive. The European announcements, with promises to spend more than €1,873bn ($2,544bn, £1,479bn) are also impressive. Meanwhile, the UK has already invested £37bn in three of the country’s biggest banks. These are extraordinary actions for extraordinary times. But will they work? Two risks remain: first, worry may shift from the creditworthiness of banks to that of governments; second, economies may weaken far more profoundly than policymakers believe. These risks are real, but containable.

• Rescue models compared Interactive graphic: Compare past bail-out structures with the current UK and US Treasury plans using this handy tool.

• America was right to look and learn Mr Bush and Mr Paulson were forced to accept that they were either with European governments or the markets would be against them

Macroeconomic Outlook

Economists Expect U.S. Crisis to Deepen The U.S. economy has sunk into a recession and government action is critical to stem the damage, according to economists in the latest Wall Street Journal forecasting survey. "We're in the middle of a very dark tunnel," said Brian Fabbri of BNP Paribas, referring to the worsening credit crunch. "Each day we see another crack in the system." Those cracks are quickly adding up. On average, the 52 economists surveyed now expect gross domestic product to contract in the third and fourth quarters of this year, as well as the first quarter of 2009. This is the first time that survey forecasts for those periods have turned negative. If those predictions bear out, it would mark the first time U.S. GDP—the total value of goods and services produced—has contracted for three consecutive quarters in more than a half century. Economists put the odds of recession in the next 12 months at 89%, up from 60% in last month's survey. See and download forecasts

IMF: World economy to slow sharply, led by US The International Monetary Fund, in a World Economic Outlook released Wednesday, slashed growth projections for the global economy and predicted the United States -- the epicenter of the financial meltdown -- will continue to lose traction. "The world economy is now entering a major downturn in the face of the most dangerous shock in mature financial markets since the 1930s," the IMF said in its report. The IMF now projects that the global economy, which grew by a hardy 5 percent last year, will lose considerable speed, slowing to 3.9 percent this year. It is forecast to weaken even more -- to just 3 percent -- next year, marking the worst showing since 2002. In the past, the IMF has called global growth of 3 percent or less the equivalent to a global recession. The IMF's projection was made before the Federal Reserve and other major central banks from around the world slashed interest rates Wednesday in an attempt to prevent a financial crisis from becoming a global economic meltdown. The Fed reduced its key rate from 2 percent to 1.5 percent. In Europe, which also has been hard hit by the financial crisis, the Bank of England cut its rate by half a point to 4.5 percent, while the European Central Bank sliced its rate to 3.75 percent. Also cutting rates: The central banks of China, Canada, Sweden, and Switzerland. The Bank of Japan said it strongly supported the actions.

Key Economic Indicators 

Retail Sales in U.S. Fall Most in Three Years on Job Losses, Housing Woes Sales at U.S. retailers dropped in September by the most in three years as mounting job losses, plunging home prices and the deepening credit crisis rattled consumers. Purchases fell 1.2 percent, more than forecast, following a 0.4 percent decline the prior month, the Commerce Department said today in Washington. Excluding autos, sales fell 0.6 percent, also more than anticipated. The biggest decline in stock prices in at least seven decades last week may further undermine confidence, prompting consumers to cut back on non-essentials like new cars and vacations that will deepen the economic slump. Stock-index futures retreated. ``Consumers are hunkering down,'' said Brian Bethune, chief financial economist at Global Insight Inc. in Lexington, Massachusetts. ``The fourth quarter is guaranteed to be terrible.'' September's drop, the largest since August 2005, extended declines in retail sales to three consecutive months, the first time that's happened since comparable records began in 1992. Sales are slowing just as merchants prepare for the holiday selling season, which may account for as much as 35 percent of a retailer's revenue. The median forecast of 75 economists surveyed projected purchases would drop 0.7 percent following a previously reported 0.3 percent decline the prior month. Estimates ranged from a fall of 1.5 percent to a 0.1 percent gain.

Beige Book Suggests Broad Weakness  As problems in global financial markets intensified last month, economic activity weakened across all 12 Federal Reserve districts. The gloomy report, prepared ahead of the Fed's October policy-setting meeting and known as the "beige book," shows that regions across the U.S. have taken on a more pessimistic view about the economic outlook. Most of the Fed's 12 regional banks reported that manufacturing has slowed and consumer spending has decreased. "Credit conditions were characterized as being tight across the 12 districts, with several reporting reduced credit availability for both financial and nonfinancial institutions," the beige book said. The report is based on information collected during "Black September," when the economy buckled dramatically after the collapse of the 158-year-old investment firm Lehman Brothers. Agricultural, mining and energy-related businesses stood out as the unique bright spots in the generally bleak report. Exports continued to boost agricultural demand although adverse weather associated with Hurricanes Ike and Gustav hurt the South and Midwest, the report said. Meanwhile, the beige book described the energy and mining sectors as "positive," except for temporary problems caused by the hurricanes. Natural gas drilling jumped significantly, coal prices were stable, and oil and natural gas prices declined, the report said.

The Impact of Less Equity Withdrawal on Consumption Earlier today I posted the Q2 2008 home equity extraction data provided by the Fed's Dr. James Kennedy. This shows that equity withdrawal has fallen almost to zero as of Q2. Equity extraction was close to $700 billion per year in 2004, 2005 and 2006, before declining to $471 billion last year and will probably be less than $100 billion in 2008.The questions are: how much will this impact consumption? And over what period? Unfortunately there is no clear answer. Fed Chairman Bernanke has argued that falling house prices, not equity extraction, impacts consumption (from the WSJ in 2007):  My guess is that the MEW effect lasts over several quarters (only a guess). Greenspan estimated that approximately 50% of MEW is consumed, and in interviews he suggested it is probably consumed over several quarters. Since MEW was $471 billion in 2007, and will probably be under $100 billion in 2008, we can estimate that half of the $400 billion or so decline in MEW (or $200 billion) is the drag on PCE in 2008 from less MEW. That is a big number, but to put that in perspective, PCE increased over $500 billion from 2007 to 2008. So nominal PCE will increase in 2008, although consumption will probably slow sharply. PCE will also be impacted by lost jobs and changes in consumer psychology (all the scary news will probably lead to less consumer spending). So once again it will be difficult to separate out the various factors impacting consumption. This will probably be an area of significant econometric research over the next few years. It does appear that real personal consumption expenditures declined in Q3 2008 for the first time since 1991. And some of that decline is probably related to the decline in MEW.

California May Point Way for U.S. Here's the latest trend that started in California and is spreading to the rest of the country: recession.It's all but certain the U.S. economy is in a recession, as falling home prices and Wall Street turmoil have put the brakes on consumer spending and stoked unemployment. But California got there first. Now, the state provides a template of how a broad U.S. downturn could look. With its export businesses, manufacturing sector, professional services and big retail employers, California looks like many other U.S. states, only more so. California's $1.8 trillion economy -- twice the size of India's and accounting for about 15% of the U.S. gross domestic product -- is powerful enough to have ripple effects nationally. It is home to Hollywood, five of 30 Major League Baseball franchises and the largest farming sector in the nation. California was also at the leading edge of the nation's recent housing bubble, which is where its current problems started. Home prices in California rose higher and faster than in most of the U.S., and started weakening earlier, in 2005. Some mortgage-holders defaulted. Others struggle along under a mountain of debt. The problems spread to the state's financial sector, which was heavily exposed to local real estate. As Californians cut their spending, job losses spread from the housing sector to retail stores and auto dealers. Now the state's unemployment rate is 7.7%, among the highest in the nation.Along with Sunbelt states such as Florida and Nevada, California is a big source of the shocks now working through the world's banks, corporations and stock markets. The financial crisis has frozen credit markets, cutting into companies' ability to engage in even the day-to-day borrowing they need to run their businesses. But even before the most recent blows to the national economy, Californians were feeling the downward drag of a consumer-led recession -- in which shrinking home values caused people to rein in their spending, fueling unemployment and, in turn, sparking further spending cuts and joblessness. A similar dynamic is playing out nationally. Retail sales recently started declining, after peaking in June. Rising job losses appear likely to cut into future sales. In September, the U.S. economy shed 159,000 workers from its payrolls. The unemployment rate was 6.1%, compared with 4.7% a year earlier.

The Adjustment Process When I started this blog (Jan 2005), I was concerned about excessive speculation in housing and extremely loose lending practices. It appeared that housing starts and new home sales would fall significantly. I forecast record foreclosures and significant declines in home prices. Many of us wondered who the eventual bagholders would be for all the bad loans. I was also concerned about the extent of equity extraction from homes (the home ATM), and I believed that the coming housing bust would lead the economy into a recession. This blog was a daily dose of doom and gloom! I'm frequently asked if I'm more concerned today than I was in 2005. There are reasons for concern: the credit markets have seized up, many financial institutions are insolvent, consumer spending and investment in commercial real estate is starting to decline, export growth appears to be slowing, the unemployment rate is rising ... and the economy is clearly in a recession. There are huge and scary downside risks today, but I'm actually more sanguine now than I was in 2005. If you think back to 2005, we were standing at the precipice, and there was no where to go but over the cliff.

Posted by dblwyo at 09:26 AM | Permalink | Comments (0)

I haven't drawn attention to the fact that we run two blogs - this one business and economics and another on public affairs. Now that we're in a position where it's difficult, to say the least to seperate the two and we're headed into tonight's last debate let me point you at the following excerpt (if you follow the URL pointer you can see the entire thing along with the accompanying readings that compare and contrast the two candidates approachs and economic teams).

This builds on the short paragraph in our last post here by sketching in some detail what we think a total, integrated and comprehensive economic strategy should be.

Populist Panderings, the Candidates and Real Solutions

Comprehensive & Strategic Economic Program

Given all that what should we be doing - and therefore what should be looking for in tonight's debate. Well two things. One as close to this outline as possible and two minimal populist pandering, bearing in mind "nobody can handle the truth". That said in both his acceptance speech and the last debate Barry basically walked right down our reccy's while Johnboy appears to be improvising as he goes and throwing out one offs - not an integrated program. You might/ought/should invest the time to listen to this interview very carefully - from the guy who's called it for three years now !

Nouriel Roubini, New York University, Economics Professor Nouriel Roubini, an economist who predicted the depth and magnitude of the current financial situation before the decline of Bear Sterns, discusses the indicators he saw and his recommendations for stemming the financial downturn.

Step 1: Get Credit Flowing Again - we've been discussing this almost exclusively for the last several posts. While it's still very early days yet we think that the basic elements are in place and being acted on as rapidly as possible.

Step 2: "FIX" Housing - we're not going to get the economy back on it's feet while Housing continues to drag so much. At the same time too many people bought too many houses for unsupportable prices with funny money. Until prices come down significantly MORE it won't start self-correcting. In other words we need for the homeowners and the lenders to take another 15% haircut, write it off and re-negotiate the loans to something more sensible. And it'll need a serious institutional framework.

Step 3: Major Fiscal Stimulus - the last so-called recovery was put together on the Housing ATM and was pumping $500-700B/year into the economy at least. The economy will fall into a major serious recession unless we stimulate it and that stimulus needs to be of the same order of magnitude. This also needs to be quick, targeted and temporary - not another political boondoggle (fat chance I know but....). Tax cuts won't do it. On the other hand the impact on the deficit is irrelevant for a lot of reasons (still be low as a % of GDP, worse w/o stimulus). Things like extended unemployment benefits, more rebates, and direct spending programs fit the bill. Lots of very...y good economists like Larry Summers have tabled excellent proposals (btw - Barry's econ team is non-pareil and Larry's on it. See below). 

Step 4: Infrastructure Investment -the US has let it's electrical, waterway and transportation infrastructures deteriorate to the point of...well never mind. A massive decade long infrastructure rebuilding project would see us get new electrical grids, new highways and transportation systems and possibly new power plants and alternative energy supplies. This would have the benefit of providing enormous fiscal stimulus, i.e. creating jobs and making a major long-term investment for things we know how to do. BtW - major sidebar. The long boom of the '80s and '90s was primarily built around two things. Supply side is utter nonsense. Reagan got it going the old-fashioned way with deficit spending and Clinton got lucky and also cut the defense budget. Bingo, that's it.

Step 5: Strategic Investment (Energy, Biosystems, Materials) - we need new industries and we need to get off of our oil dependencies. There's things we can do in each and both. For example by increasing conservation as well as mandating enormously higher mileage thru better materials and engineering we could get a huge jump for the next ten years. Then we need to build new power plants, particularly nuclear, we need to open up our own offshore deepwater to oil exploration and we need more refineries. That all togeter takes us into the next decade. Beyond that we need some major alternatives - and don't believe 'em. We don't have the knowledge or technology do magic yet. For example we should really be heavily emphasizing coal but need major new technology not the Rube Goldberg fixes running around. So a concerted national effort (does the word Manhattan Project ring any bells) to create major new energy sources and technologies would stimulate the economy, create new industries and provide us several paths to the future.

Combine that we major parallel investments in new life sciences and materials, both because they offer the best hopes for the Next Big Things and because they are synergistic with energy investments. For example if we pie-in-the-sky about Fusion we need the new materials for the reactor vessels. Or new lightweight composites for high-temperature turbines. Similarly new bio-sciences offer up their own benefits not least of which is designed alternative energy crops as well as way to control and manage environmental problems. The real beauty of this is that it doesn't take a lot now because it's all at early stages.

Step 6 - Education Investment: the decline in average income is due more to natural evolutionary shifts in the kinds of labor demanded by an increasingly technical economy. When the US Economy really started on its' accelerated path after the turn of the 19thC few know that a key ingredient was the widespread development of high-schools and the resultant upgrading of the skills and knowledge of the population. Education is the co-dependent imperative along with creating new industries IMHO. (Readings(Education): the Single Most Important Domestic Policy Issue) 

 So there you have it in a nutshell :) A complete now to futures strategic economic policy recommendation. Believe it or not it's at least a decent strawman based on reality, the ways things actually work instead of fantasies and offers some real benefits. Test it against the candidates if you like. The results might be interesting ! The guy you want to vote for is the one that comes closet to ticking off this strategic agenda, doesn't offer up utter unsinn (German for nonsense and Supply Side III more than qualifies), has the best team and sounds like he's got a better grasp. We highly recommend you at least skim the readings to get a feel for how they stack up therein. And also to help you decide on where you think economic policy lies on the importance spectrum. We happen to think it is the sine qua non and will dominate the next Presidential term and outweigh almost any other issue short of a major shooting war.

Posted by dblwyo at 07:12 PM | Permalink | Comments (0)

Whew - 10% + bounce in the SP500 ! I'll take it - the best thing on offer and it began on Friday. But what just happened ? At least three things, which lead to some key questions about what's next. But let's start with what just happened. As you can see from the chart not only did the markets self-arrest but we got a major bounce (the largest since the GD ?) in the equity markets.

1) Coordinated Global Intervention: After the feckless recklessness and ignorant ideology of the US House of Representatives triggered a loss of confidence and a genuine market crash on a worldwide basis coordinated worldwide intervention by all the major developed countries has restored some confidence.

2) Action Under Pressure: That intervention is not some dry academic affair, obviously. It was the actions under enormous pressures by key groups of leaders. Somewhere in Churchill's writings are his biographical sketches of Sir John Jellicoe, Grand Admiral of the British Fleet in WW1. Jellicoe was widely criticized after Jutland for not winning a decisive victory which misses a key point. As Winston pointed out he was the only man on either side who could have lost the war in an afternoon, literally. And he lived under that incredible pressure of having to be prepared to act decisively and correctly for years until he managed to win a strategic victory by not losing. Adm. James Stockdale in his book, "Reflections of a Philosophical Fighter Pilot" talks about his experiences of seven years in a prison camp in solitary confinement, torture and horrible conditions as a laboratory of human performance. Several of his writings focus on the ability of key players, e.g. the American commanders at Midway, to have functioned well and at the top of their game in the afternoon that really mattered. We've just seen, and will hopefully continue to see, that kind of improvisation in crisis when no clear answers are provided yet decisive action is required. The ability to function under that kind of remorseless pressure is the product of years of preparation and be very glad the people in the hot seats were prepared. The consequences bear thinking about.

3) Wheels on the Wagon: as part of that intervention, and thru the leadership of the Prime Minister of Great Britain, the Rescue Package has morphed from using the acquisition of bad assets to get the credit markets unfrozen to direct re-capitalization of the banks, the guarantee of accounts and direct lending. While these actions are well within the authorities of the Bill they represent fundamental changes in emphasis. All the pretty packaging wrapped around the Bill to get it past the idiots and self-servers didn't affect the core content as much as the last few days. The vidclip will take you to the CSpan video of Kashkari's discussion and outlook.

4) Next Steps: the key test will be whether or not the banks start lending to one other again and thereby free up the credit markets from their lockdown. One wants to carefully monitor the LIBOR and TED spreads. But it looks like it's going to work.

• We're likely to get a serious bounce which may even turn into a bear rally. But it will be a bear rally since the fundamental weaknesses of the economy are still waiting to greet us. If you look back to the last recession the hunt for the bottom was a process that went on for almost three years with rallies interspersed thruout.
• You very much need to consider how to best re-structure your portfolio - which the readings in the last post started to lay out btw. (Whistling Past the Graveyard: Market Assessment and Outlook)
  

 Strategic Outlook

On a strategic policy level we're still faced with a more severe economic downturn than anything we've seen since the '80s or the mid-'70s. The accompanying chart lays out some alternative scenarios which we'll discuss more fully in a follow-up post. Two major economic policy initiatives are required at minimum.

1. Fiscal Stimulus - to mitigate the unavoidable downturn serious stimulus is required. During this last "recovery" consumption was sustained largely thru borrowing against home equity - the Housing ATM - and it was pumping $700-800B/year into the economy at the peak. The stimulus needs to be of that order of magnitude.

2. Housing - the biggest drag on the beginnings of a recovery is still. What we need is for all the bad mortgages to be re-structured. Which means that both banks and homeowners need to take some serious haircuts, write it down and move on. Fortunately that seems to be more widely recognized.

We are and will get thru this not an economic collapse has been averted but we want to minimize the damage as much as possible. Interestingly this means that political considerations are now major economic and investment considerations. For the foreseeable future we're going to continue to be in an event-driven, macro environment. At the same time micro-performance on the individual firm level will have a level of criticality we haven't seen in decades. In addition to the rest of the readings which'll read you into the sequence of things as we've summarized it pay really close attention to Nouriel Roubini's outlook: Our Choice: Recession or Depression !!!

We truly are finding out who's been swimming naked. And we're going to find out who the good leaders are. Your lesson here is that not paying attention to the economy and the markets is truly dangerous.

 

 

 

Policy and Outlook.

When fortune frowned AFTER the stockmarket crash of October 1929 it took over three years for America’s government to launch a series of dramatic efforts to end the Depression, starting with Roosevelt’s declaration of a four-day bank holiday in March 1933. In-between, America saw the worst economic collapse in its history. Thousands of banks failed, a devastating deflation set in, output plunged by a third and unemployment rose to 25%. The Depression wreaked enormous damage across the globe, but most of all on America’s economic psyche. In its aftermath the boundaries between government and markets were redrawn. During the past month, little more than a year after the financial storm first struck in August 2007, America’s government made its most dramatic interventions in financial markets since the 1930s. At the time it was not even certain that the economy was in recession and unemployment stood at 6.1%. But history teaches an important lesson: that big banking crises are ultimately solved by throwing in large dollops of public money, and that early and decisive government action, whether to recapitalise banks or take on troubled debts, can minimise the cost to the taxpayer and the damage to the economy. For example, Sweden quickly took over its failed banks after a property bust in the early 1990s and recovered relatively fast. By contrast, Japan took a decade to recover from a financial bust that ultimately cost its taxpayers a sum equivalent to 24% of GDP. All in all, America’s government has put some 7% of GDP on the line, a vast amount of money but well below the 16% of GDP that the average systemic banking crisis (if there is such a thing) ultimately costs the public purse. For the time being, that offers a reason for optimism. So, too, does the relative strength of the biggest emerging markets, particularly China. These economies are not as “decoupled” from the rich world’s travails as they once seemed. Their stockmarkets have plunged and many currencies have fallen sharply. Domestic demand in much of the emerging world is slowing but not collapsing. The IMF expects emerging economies, led by China, to grow by 6.9% in 2008 and 6.1% in 2009. That will cushion the world economy but may not save it from recession.

What Will Break the Worldwide Panic Reaction?  Call it capitulation: around the world, traders spooked by no end of bad news are dumping shares wholesale. That process continued on Friday as indexes in Asia and Europe opened trading with breathtaking falls of up to 10%. Though most markets partially rallied to limit losses to single digits, it represented only the most recent in a series of bearish days that threaten to transform a global credit crisis into a global economic crash. Does this make sense? "The markets have gone completely crazy and are reacting in fear to a bad situation in a way guaranteed to make it far worse," says Marc Touati, deputy executive manager of the French economic- and finance-research group Global Equities. "We once had 'irrational exuberance' pushing markets ever higher; now we have irrational pessimism running them into the ground. People have to calm down, or we're in for big trouble."

All that money you've lost — where did it go? Trillions in stock market value — gone. Trillions in retirement savings — gone. A huge chunk of the money you paid for your house, the money you're saving for college, the money your boss needs to make payroll — gone, gone, gone. Whether you're a stock broker or Joe Six-pack, if you have a 401(k), a mutual fund or a college savings plan, tumbling stock markets and sagging home prices mean you've lost a whole lot of the money that was right there on your account statements just a few months ago. But if you no longer have that money, who does? The fat cats on Wall Street? Some oil baron in Saudi Arabia? The government of China? Or is it just — gone? If you're looking to track down your missing money — figure out who has it now, maybe ask to have it back — you might be disappointed to learn that is was never really money in the first place. Robert Shiller, an economist at Yale, puts it bluntly: The notion that you lose a pile of money whenever the stock market tanks is a "fallacy." He says the price of a stock has never been the same thing as money — it's simply the "best guess" of what the stock is worth.

The International Currency Crisis Europe does therefore not need any bail-out plan, but a plan that specifically addresses the capitalisation problem. Concretely, three things are needed: the first and most important is money. A sum of €300bn will not cover the EU in a worst-case scenario, but it is a sensible number to start with; secondly, you need a semi-permanent crisis committee empowered to take decisions; and finally you need a strategy to apply symmetrically and based on clear rules about when to recapitalise, and when not. If you pursue a strategy of taking purely national decisions, you run the risk that at least one government will hit its own financial ceiling before this crisis is over, or that decisions have negative spillovers on the banking systems of other countries. Moreover, you end up with a beggar-thy-neighbour regulatory race, as we saw last week when Ireland and Greece unilaterally issued blanket guarantees for large parts of their banking sector. Last night, Germany was preparing a full deposit guarantee for its own banking system. Last but not least is the risk of violent political setback against a process that lacks transparency.
For Europe, this is more than just a banking crisis. Unlike in the US, it could develop into a monetary regime crisis. A systemic banking crisis is one of those few conceivable shocks with the potential to destroy Europe's monetary union. The enthusiasm for creating a single currency was unfortunately never matched by an equal enthusiasm to provide the correspondingly effective institutions to handle financial crises. Most of the time, it does not matter. But it matters now. For that reason alone, the case for a European rescue plan is overwhelming.

Can't We All Just Get Along on Economy? The global economy is a ship quickly taking on water, but not all its crew members are bailing with equal fervor. Finance ministers and central bankers from the Group of Seven leading nations will meet in Washington, D.C., this weekend to discuss the global financial crisis. So will the Group of 20, which includes developing nations such as China and Russia. It isn't a bad time for a get-together. One might wonder why they haven't been thick as thieves for months now, as a crisis that started in the U.S. has steadily squeezed the world's financial system. Instead, a coordinated response has been lacking, at least until this week's unprecedented global interest-rate cut. More such "Kumbaya" moments might be rare. There has been almost as much sniping among nations as unity, and some still seem to consider the crisis mostly a U.S. or European problem. By now, it should be clear that all are in this together, as exemplified by Iceland. Its woes are sending shudders around the world. If corrective measures are taken in some nations and not others, those other nations will suffer and the overall problem will worsen. "Policies at least have to be consistent, and there needs to be more consultation," said Global Insight chief economist Brian Bethune. "The absence of that has really been limiting the effectiveness in dealing with contagion." A detailed global response won't come quickly. But a group of economists associated with London's Centre for Economic Policy Research this week urged the G-7 to at least agree to recapitalize the global banking system and raise the guarantee on global bank deposits. That seems manageable, and will have to be done eventually. Better to do it right away, and hand-in-hand, than in piecemeal fashion stretched out over weeks or months.

History Isn't About to Repeat Itself The year, of course, was 1929, though it sounds just enough like today to make us wonder if we should stock up the pantry, take the cash out of the bank and hunker down for a 21st-century Great Depression. No doubt, the parallels are stark and frightening. But the differences between now and then are even greater. Let's start with lending. In the late 1920s, as the stock market took off, banks expanded their loans for those most unpredictable of assets: stocks. Investors could easily borrow up to 75% of the value of a stock purchase. By 1929, almost $4 of every $10 in bank loans went to buy shares. In addition, Chrysler, General Motors and Standard Oil of New Jersey all made tens of millions of dollars available for stock loans. In one of the most egregious examples, an energy company called Cities Service sold stock and then used the cash to make loans for people to buy more shares. When the market started to fall, however, brokers had to call clients for more cash to secure their loans -- a so-called margin call. Because they had seen short downturns before, customers weren't eager to bail out. Initially, the Federal Reserve did nothing. To try to keep speculative borrowing on stocks from continuing, it declined to reduce interest rates, choking off credit. Unemployment climbed toward 25% at a time when there was no unemployment compensation. In the Prohibition era, those without jobs couldn't even legally drown their sorrows in beer. Most striking was the long reluctance to acknowledge a serious problem. During the crash, President Herbert Hoover insisted that "the fundamental business of the country ... is on a sound and prosperous basis."

• We’re Not Headed For A Depression, Becker: We’re Not Headed For A Depression, Good Policies Can Save the Economy

Progress Amid the Ruins It may not look like it amid the wild markets, but the world's political leaders are making progress against the global financial panic. The biggest problem continues to be that no one in authority seems able to explain what is happening and why, so all of this feverish government action is scaring everyone to death. The world is nonetheless making intellectual strides, not least in London with yesterday's announcement that the British government will inject up to £50 billion into eight major banks and others that may qualify. France also said it will set up a legal body so the state can intervene swiftly to take stakes in banks that run into trouble. And late Tuesday, the Spanish government said it will set aside a €30 billion fund, which may increase to €50 billion, to buy illiquid but healthy assets. The London move goes to the heart of the problem, which is the capital hole in the financial system that is fueling the global panic. Private capital won't fill that hole with fear so rampant, so some public capital is going to have to serve as a temporary life preserver -- in the U.S. and Europe. The U.K. government plans to inject up to £50 billion in return for preferred shares -- giving taxpayers some upside once the panic passes. London will further guarantee £250 billion in new debt issuance for those banks that participate in the recapitalization plan in order to secure their short- and medium-term funding. Britain has thus helped to shore up its own banks, moving beyond the ad hoc crisis management after individual bank failures. Meanwhile, in the U.S., Treasury Secretary Hank Paulson signaled that his new rescue power includes the ability to do something similar. "It is the policy of the federal government to use all resources at its disposal to make our financial system stronger," Mr. Paulson said, "including strengthening the capitalization of financial institutions of every size." We take -- and hope -- that this means Mr. Paulson is willing to use some of his new $700 billion Troubled Asset Relief Program (Tarp) to inject capital into individual banks if needed to prevent failures. Treasury would still move ahead with its auctions to purchase toxic bank securities, but amid a panic more urgent action may be necessary. Mr. Paulson is right to interpret his mandate broadly, and to show that he is willing to use it. In essence, he is saying the Tarp could be used as a larger, better capitalized version of the Federal Deposit Insurance Corp., injecting capital into banks in return for preferred stock to protect the taxpayer. This is a policy breakthrough.

• How to Recapitalize the Financial System, White House considers ownership stakes in banks, Time to Call Out the Big Guns

Money-Market Rates Decline After European Governments Step Up Bank Rescues Money-market rates in Europe fell after policy makers offered banks unlimited dollar funding and European governments pledged to take ``all necessary steps'' to shore up confidence among lenders. The euro interbank offered rate, or Euribor, for one-week loans dropped 26 basis points to 4.37 percent today, the biggest decline this year, according to the European Banking Federation. The London interbank offered rate, or Libor, for three-month dollar loans dropped 7 basis points to 4.75 percent, the largest drop since Dec. 28, the British Bankers' Association said. The Federal Reserve said today central banks around the world will offer banks as much dollar funding as required. Leaders of the 15 nations using the common currency agreed yesterday to guarantee new bank debt and use taxpayers' money to keep lenders afloat. The three-month rate banks charge for euro loans dropped by the most since Jan. 22. ``Taken together, the latest moves increase the chances that we will begin to see some relaxation of the intense funding stresses that have prevailed in commercial paper and inter-bank markets,'' a team including Dominic Wilson, senior global economist at Goldman Sachs Group Inc. in New York, wrote in an investor report today. ``This is because bank solvency risk should decline as the government offers protection.''

Rescue Plan Comes Around to Views of the Academics The government's plan to buy equity in financial institutions, announced Friday by Treasury Secretary Henry Paulson, is an idea that many academic economists have championed from the start of the crisis. Many economists believed that the heart of the government's initial plan to pay $700 billion for toxic assets was aimed at the wrong target. Purchasing mortgage securities from banks wouldn't do anything to kick-start lending and get credit flowing again, they said. Rather, banks would use the proceeds they got from the Treasury to pay off debtors, and those debtors would use the proceeds to buy safe assets. They said a wiser course -- the one the Treasury now seems to have come around to -- was for government to rebuild the badly depleted cash levels on bank balance sheets. That would cushion institutions against future losses, giving them the wherewithal to lend again. Other hitches in the original plan include coming up with a price for mortgage securities that is above the "fire sale" level they would draw on the open market, but not so high that taxpayers end up getting taken for a ride. The Treasury move is a sign of how, as international efforts to contain the crisis continue this weekend at meetings of the International Monetary Fund and World Bank, economists' ideas for solutions are influencing policy and entering the public discourse. Wednesday morning, Barry Eichengreen, an economic historian at the University of California, Berkeley, sent an email to VoxEU.org, the Internet portal of the Centre for Economic Policy Research, a European economic-research network, asking economists to submit brief essays on ways government leaders could tackle the financial crisis. By the next day, VoxEu had produced a booklet of 14 essays by 18 economists. As of Friday, when the Group of Seven finance ministers and central bankers met in Washington, the booklet had been downloaded more than 10,000 times. The economists came from different schools of thought and varying political stripes but all agreed that recapitalizing banks was a key initiative. A final step toward stabilizing the economy would be a large economic stimulus plan, said Berkeley economist Brad DeLong. He suggests that in the U.S. this could be two-tiered, with half the stimulus going toward a tax rebate and the other half dedicated to infrastructure spending. Mr. DeLong said he is encouraged by how quickly economists' thoughts on the crisis have made it into the public sphere. "Everything seems good in terms of people understanding the seriousness of the problem," he said. "I'm actually remarkably optimistic."

• Paulson Says Treasury to Buy Equity in Financial Firms `As Soon as We Can',

G-7 Pledges to Take `All Necessary Steps' to Stem Global Financial Crisis Group of Seven finance chiefs, meeting after stocks plunged and as a global recession looms, vowed to prevent the failure of vital banks while failing to unveil new initiatives for thawing credit markets. ``The current situation calls for urgent and exceptional action,'' the finance ministers and central bankers said in a statement after talks in Washington yesterday. They pledged to ``take all necessary steps to unfreeze credit and money markets'' without detailing how that would be accomplished. Signaling they would intervene to avoid a repeat of last month's collapse of Lehman Brothers Holdings Inc., the officials promised to ensure major banks have access to cash and are able to tap public funds for capital. By refraining from specific fresh measures such as embracing a U.K. plan to guarantee loans between banks, they still run a risk of disappointing investors. ``They've seen what Lehman did and the repercussions,'' said Jeff Pantages, chief investment officer at Alaska Permanent Capital Management in Anchorage, which oversees $2 billion. ``If you're a bondholder, you've got to feel better. If you're a shareholder, you're not so sure.'' A sign of the strains: The G-7 ministers today met with President George W. Bush, an echo of former President Bill Clinton's visit with the group in 1998 amid the Russian debt default and collapse of hedge fund Long Term Capital. ``This is a serious global crisis and therefore requires a serious global response,'' Bush said at the White House. The Group of 20, which includes emerging markets such as Russia and China, convenes later.

• Bush Says a `Serious Global Response' Needed to Confront Economic Crisis, Trichet, ECB Officials Say Liquidity Steps Will Take Time to Calm Markets
• German Bailout Likely to Be Over $400 Billion, U.K. Banks to Announce Bailout Details, Treasury Official: Equity Purchase Plan to be Announced Within Days  

EU Writes Menu of Options The euro zone's biggest economies prepared to unveil plans to spend tens of billions of euros in state funds to prop up their banking systems. The leaders of the 15 countries that use the euro said choices on the menu, to be implemented as governments see fit, included partial nationalization of banks and provision of state-guaranteed loans. The euro-zone leaders also agreed to loosen mark-to-market rules -- which force banks to book their assets at the price they would get if they sold them now."Under the current exceptional circumstances, financial and non-financial institutions should be allowed as necessary to value their assets consistently with risk of default assumptions rather than immediate market value which, in illiquid markets may no longer be appropriate," the leaders said in a statement. A decision on how to implement this might be made as early as this week. French President Nicolas Sarkozy, hosting a conference in Paris, said Germany, France and Italy would detail their national plans at about the same time on Monday. On Monday, the French government will indicate the amount of bank loans it is willing to guarantee. Mr. Sarkozy said France will also pass a bill in the coming days creating a special-purpose state vehicle that will raise enough money to nationalize any distressed bank. Germany's plan, according to people familiar with it, could include massive government guarantees for banks' debts and capital injections for some banks. Sunday's accord was an attempt to overcome the EU's recent disarray, as diverging national attempts to prevent banks from collapsing have failed to reassure financial markets. As the credit crunch spilled over into bourses, the pan-European Dow Jones Stoxx 600 index lost more than a fifth of its value last week. Suggestions by France and the Netherlands for a pan-European fund to rescue banks have been vetoed by Germany, which fears its taxpayers would have to pay for costly bailout schemes in other countries. The U.K., which doesn't use the euro but is a member of the 27-nation European Union, is also opposed. Participants in Sunday's summit tried to draw up a common European strategy by allowing each country to pick and choose which parts to implement -- without forcing neighbors to pay for others' choices. While there will be no common European bailout fund, governments have said they will rescue their own banks when needed. The "common basket of instruments," as German Chancellor Angela Merkel dubbed them, is roughly based on a plan the U.K. announced last week to stabilize its financial system.

Our Choice: Recession or Depression  Last week, I suggested the need for a coordinated monetary policy rate cut. That cut arrived yesterday, with the Fed, the European Central Bank and other central banks cutting their policy rates by 50 basis points (bps). This action is necessary, but only cosmetic, and it is too little too late. Policy rate cuts will have a limited effect as they don’t resolve the fundamental problem in markets--massive counter-party risk--that is keeping money-market spreads relative to safe rates so high. Yesterday’s plan to support the commercial paper market is a step in the right direction, but other, more radical policy actions are also needed now. Here are four suggestions for such additional policy action. --To reduce the counter-party risk in the money markets, a triage between insolvent banks that need to be shut down and a recapitalization of solvent banks is necessary, together with massive injections of liquidity in non-banks and the corporate sector. The flawed $700 billion Troubled Asset Relief Program (TARP) legislation will have to be modified in three ways to: a) allow for direct government injection of public capital in banks in the form of preferred shares, matched by private capital contributions by current shareholders (via suspension of all dividend payments and matching Tier 1 capital provided by private shareholders); b) implement a clear plan to reduce the face value of mortgages for distressed homeowners and avoid a tsunami of foreclosures; c) do a rapid and radical triage between solvent banks and insolvent banks that need to be rapidly closed. Since the private sector is not spending, and since the first fiscal stimulus plan (tax rebates for households and tax incentives to firms) failed miserably as households and firms are saving rather than spending and investing, it is necessary now to boost public consumption of goods and services via a massive spending program (a $300 billion fiscal stimulus). The federal government should have a plan to immediately spend on infrastructure and new green technologies; also unemployment benefits should be sharply increased, together with targeted tax rebates only for lower income households at risk; and federal block grants should be given to state and local government to boost their infrastructure spending (roads, sewer systems, etc.). If the private sector does not spend and/or cannot spend, old-fashioned traditional Keynesian spending by the government is necessary. It is true that we already have large and growing budget deficits; but $300 billion of public works is more effective and productive than spending $700 billion to buy toxic assets.

Posted by dblwyo at 05:26 AM | Permalink | Comments (0)

Well what an astonishing and astounding week - the single worst one, as a whole, we've had in post-war America and it seems since the Great Depression. Now when we use the words contagion and metastasis perhaps we'll all have a reference point, and hopefully not too many more. To be honest seeing a decade's worth of market change compressed into 5-10 days exceeded any of our prognostications. Even though we've been using the words for months, if not years, seeing and experiencing it in action is a lot different than just intellectualizing about systemic risk and market collapse. Our shock, awe and puzzlement is rather widely shared - which is scary and comforting. Comforting in that it's company, scary in that we'd like somebody to know what's going on.

And we see some glimmers of that beginning to emerge - that the light is not just another freight train with the throttle rammed wide open. Which must sound more than a little odd given our normal "bearish" stance and outlook. Let me explain. And discount all you like - part of our outlook is more than likely built on straw-grasping but we hope more is built on solider grounds.

Market Perspectives

Let's start with a longer term market perspective and reach back to 1994, which given the depth of the collapse we need to do. Rather like a climber sliding down an icy ravine who needs to self-arrest before slipping over the edge of the cliff onto the rockfield below the markets needed to halt their freefall. That's very much not an invented metaphor btw - been there, did that, here to tell it. As you can see looking at the charts the level of drop has taken us back to the nadir of '02, or just about. And the VIX index, which measures volatility = fear, uncertainty, doubt and panic, reached un-precedented levels. HOWEVER, if you go back to '04 when we began all this and apply some natural speed limits, or recurring patterns (technically called Fibonacci limits) we arrested just short of the cliff edge. Whew. Which is not to say that there's more possibly in store, just that we're not going to go sailing off the edge to our (figurative) deaths but have an opportunity to pick our way to the bottom carefully !

Market Details

 Let's tunnel down a bit and de-construct the recent market behavior to see what we can see. The accompanying chart shows the SP500 for three time periods:2002-08, three months and the last five days with each more detailed chart a blowup of the higher-level one. Again the market crash was unprecedented and destroyed almost all the last six years of "progress." Quotes because it was ill-grounded as we're learning. Breaking it down the ~20% drop this month was actually concentrated in the last few days. In fact looking at the three month chart you can see where those of us anticipating a bounce had some grounds. On the five day chart the fractalism continues with the bulk of the crash happening just this week. For those of you withe the courage of our "convictions" who were short/inverted this was a great week. For those of us in cash - o.k., not bad. For those of you who were blindly following standard practices we're sorry to see that. Here's the ray of hope in the carnage. Late Friday afternoon which started by looking like another slide toward the cliff the markets self-arrested and almost broke even before last minute, and sensibly risk-averse profit-taking. The keys to whether or not that turns into a bear market bounce lie in the credit markets. And if we get such a bounce make sure you re-construct your portfolios, please ! There's still a lot more Main St. downturn to go once we get the crisis on Wall St. contained. Which means btw that this weekend's G-7 meetings are the keys to all our collective futures.

Credit Crisis

It's always easier to follow and understand the equity markets but the heart of this crisis is in the credit markets, which froze, locked up and spread to the equity markets. This chart looks at 3Mo Treasuries for four years and YtD (divide by 10 to get interest rates). Normally this is a stable market that follows along with the Fed rates. But you can see the BSC disruption in March and the huge flight to safety in the last few weeks as investors rushed out of all other investments and into the safest things they knew. And in the process almost drove interest rates to 0% ! The YtD chart shows that these markets are still severely discombobulated but nowhere near where they were when Sec. Paulson hit the panic button. But it ain't over 'til it's over - that is until these markets return to something resembling normalcy. Which they haven't.

Credit Discombobulation

Which you can see in this next chart which shows the TED spread, or difference between 3Mo rates and the LIBOR - the rates fixed in London for banks to lend to each other. Normally that spread is as near zero as possible but once the crisis started last summer it began widening rapidly. Yet the piecemeal approach being followed to address the crisis was actually working. While the spread was still swinging wildly it the general trend was downward. Until suddenly it wasn't ! In fact it literally metastasized nearly instantaneously. If Paulson hadn't spoken up about a rescue package this would be much..much worse. Be glad our understandings of markets and policies is vastly improved over the wrong-headed policies that brought us the Great Depression. Now you're going to hear all the same people who were whining about the moral hazard problem now complaining that the proximate trigger was allowing LEH to collapse. What we think happened is that when the House Rips put ideology and partisan advantage over the good of the country that the markets suddenly realize the fragility of the ecology and the depths of the problem. Perhaps a necessary wakeup call but surely there were and are better ways to more gradually bleed off the poisons than sudden amputation.

Again, we repeat, developing a coordinated set of policies will dictate where we go from here. This weekend could be one of the most important in your life.

After the break you'll find our usual collection of readings that back all this up but please read Jim Jubak's column on re-structuring your portfolio:  Everything's changed now -- for the worse.

Market Perspectives 

Wild Day Caps Worst Week Ever for Stocks The Dow Jones Industrial Average capped the worst week in its 112-year history with its most volatile day ever, as hopes for a major international bank-rescue plan were overwhelmed at day's end by another wave of selling. Some investors who normally would be jumping to buy beaten-down stocks after a 22% drop over eight trading days said the relentless declines have left them shell-shocked and unwilling to take new risks. Some spent the day trying to protect themselves from further declines. The Dow fell 697 points shortly after the opening bell, and remained down most of the day. It surged to a 322-point advance less than half an hour before the close. Investors stampeded into bank stocks as reports circulated that the Group of Seven leading industrial countries was going to agree on a plan to rescue major banks, and that Morgan Stanley had been assured that it would receive funding from a Japanese bank. Hopes briefly blossomed that the worst might finally be over.

• Irrational Market As market turmoil defies conventional wisdom, WSJ's Andy Jordan profiles a behavioral economist's take: vengeance, and opportunity.
• Stocks Slave to Credit The biggest thing the stock market needs is some thawing in the frozen credit market, according to S&P's Alec Young, and may have another 15% to 20% to drop. Stacey Delo reports.

Five Days, 1900 Points, and No Solution A programmer for the trading desk at an electronic foreign-exchange and equity network was smoking outside a financial office in Jersey City, N.J., around 6 p.m. Thursday. The man was red in the face and glassy-eyed from exhaustion. “Look at me,” he said. “It’s a flush. It’s a panic.” He said one client, a hedge fund, lost $30 million on Thursday alone. The relentless selling throughout the week leaves many an investor much less wealthy and sporting a thousand-yard stare that would rival a deer wandering out onto the Adirondack Northway to find themselves facing an oncoming tractor-trailer. “I’m a certified financial planner and I’ve been doing this for 20 years, and I’ve never seen volatility that could even come remotely close to this,” says Ken Roberts, principal at Harbors Lights Financial Group in Manasquan, N.J. Casual suggestions to close the market for a day, an erratic thought a few weeks ago, seem like a rational course of action while authorities attempt to save the global banking system, which has self-immolated on the back of debt obligations upon debt obligations, and insurance contracts on top of those debts. Without a sense of understanding that an injection of liquidity into the banking system would jump-start a machine that has ground itself into the mud, the investment community remains frozen, able to sustain a rally so long as nobody notices it exists — such as the sharp turn late on Friday that took the Dow up nearly 300 points, one that disappeared inside of 15 minutes. Some may take comfort in the fact that the major averages pulled out something other than a rout, but this is folly in a week when the Standard & Poor’s 500-stock index lost 15% of its value. It’s akin to an all-night celebration by Miami Dolphins fans after the gridiron squad finally gutted out one win amid 15 losses in the 2007 season. The rapidity of the decline overwhelmed many savvy investors. The Dow’s 1,000-point swing Friday represented the widest one-day trading range for the 30-stock average in his history. Its decline of 18.2% is the worst for a week in its history; the 1874-point drop also marks a one-week record for the average. “It’s feeling like this is bottomless,” Mr. Roberts says. “Obviously, we know it’s not bottomless.” Such a happening knows few post-World War II peers: the week of the 1987 crash was the ninth-worst week, attributable to one day. The week of Sept. 11, 2001 is fifth-worst, and was a psychological reaction to external events. Unlike that week, the market owns this slump.

• Stewards of Capital Gather at NYSE. What Happens Next? Who Knows?

Market Outlook and Strategies 

Where Do We Go From Here? These are extraordinary times. I know there will be those who believe the markets should be allowed to work or simply want those who created the crisis to pay. I do understand the anger. I too am angry, and have been for a long time. Those of us who saw this crisis coming are frustrated that no one bothered to pay attention. But now that we are in it the midst of the crisis, there is no going back. We must look forward and do what we can to avoid an even worse crisis and potential depression. I believe we can do so if governments act promptly. We are already in what will prove to be one of the longer recessions on record. If we look at the Leading Economic Indicators, which have about a 9-month forward-looking view, it will be late next year before we start to grow once again. Given that everything peaked last October through January (sales, employment, etc.), it is likely that the recession will be dated from the beginning of this year. I have been fielding calls all week asking me if I think we are close to a bottom in the stock market. And my answer is, we are close to a short-term bottom, but I think we will trade lower over time due to what I think are going to be poor earnings for the next few quarters. If you are a trader (and that means you have been doing it for some time - not the time to get on the job training!), then maybe you can catch a rebound, which is overdue. But (and here is the big caveat) if there is no global coordination on some or all of the recommendations I made above, this is not going to be pretty. It will end in tears. Let's hope the authorities can get their collective act together.

Everything's changed now -- for the worse I was wrong. I no longer think we're facing a garden-variety recession. At a minimum, it will last longer than the two quarters I projected on Sept. 30. Economists are now talking about a recession that will last three, four or even five quarters. (Keep some perspective here, please. We're still not looking at anything like the Great Depression. In 1932, the economy contracted by 13% and unemployment hit 24%.) And I don't think we're looking at anything like the hoped-for V-shaped recovery, in which the economy zooms out of the bottom, showing growth of 5% or more. The economy, I believe, is going to crawl off the bottom with growth that's likely to linger at less than the 2.5% the Federal Reserve calls the U.S. economy's noninflationary speed limit.I no longer think this is the typical bear market, not even if your benchmark is the painful one of 1973-74 or the excruciating one of 2000-02. Stocks now face a triple-whammy. First, a slow-growing economy will keep earnings growth depressed from levels investors now regard as customary. That means price-to-earnings ratios will have to come down to something below the historical averages for stocks. Second, the higher interest rates will cut into earnings further as all companies have to pay more to raise capital and as some companies defer expanding production or developing new products completely. In industries where this deferral leads to supply lagging demand, it will also lead to higher inflation, which will push up interest rates. And third, the deleveraging of bank and industrial balance sheets that will occur as a result of this crisis means companies will be less profitable in the years after the crisis than they were when cheap money enabled them to bump up reported growth. The news of the past week supports the shift in my view toward a recession that will last longer than previously expected and a recovery that will be slower than previously expected. So how should you position a "rethinking everything" portfolio? Begin building the "rethinking everything" portfolio by dividing your stock market assets into four unequal parts. Part 1, the largest part, is cash. I'm going to raise my cash position in the portfolio to 40% from the current 30%. Part 2, 20% of the portfolio, will remain in natural-resources stocks. Part 3, another 20% of the portfolio, will go into high-dividend stocks in sectors with good growth prospects beginning in the second half of 2009.  Part 4, the last 20% of the portfolio, will go into growth at a very reasonable price -- PE ratios of 25 or less to reduce risk in a sell-off, and price-to-earnings growth (PEG) ratios of 0.75 or lower.

The bottom is still to come, says one market timing indicator In today's column, I want to focus on a related way of assessing whether a major bear market is nearing its final low: A gauge I first introduced more than 15 years ago that I call the "Market Timing Popularity Indicator." This indicator measures where the average adviser lies between the extremes of buy-and-hold and market timing. Historically, buy-and-hold tends to reach its peak of popularity at market tops, just as market timing becomes most out of favor. The inverse tends to be the case at market bottoms. For example, that means that, as a bear market approaches its final low, at least a few die-hard believers in long-term buy-and-hold throw in the towel and become latter-day converts to market timing. That has yet to happen, however, at least as judged by my reading of the 200 newsletters monitored by the Hulbert Financial Digest.

10 Bullish Charts, Signals, Indicators Earlier this week, we discussed several anecdotal pieces of evidence that suggested we were closer to the bottom then the top. Today, we look at specific data and charts that can provide some insight as to how extreme these present levels are. These suggest to us that we are increasingly close to a bottom that can be purchased for an upside trade of 20-30% from these levels. NOTE:  We scale in over time, in 10% increments, and recognize that the bottoming process can take several months to several quarters to complete. Hence, slowly buying in is the key.

Posted by dblwyo at 12:37 PM | Permalink | Comments (0)

In case you haven't noticed the markets are giving new meaning to the word volatile - as in wild, wacky and woolly indeed. We haven't posted on the markets though because our analysis in several prior posts has held up reasonably well; and truth be told because we've been too distracted. (Managing the Lizard Brain: Beyond Crisis and Kabukit to Realities,The People's Choices: Rescue vs Revenge)In fact as a not-so-small confession, the last several days down moves compress several months into a few days and were weigh/way beyond our expectations. As a result of which while we were looking for a short-term bounce the markets were in the process of grasping the same economic and fundamental realities and taking them to heart we've been nattering on about for months. The long- and short of it is, literally, we were in cash when we should have been riding the crash down.

After the break you'll find two sets of readings. One on the market per se and the other on the extraordinary measures being taken by the Fed and the world's central banks to re-liquefy the credit markets and get the wheels turning. In the long-run we still stand by our overall analysis. In the short-run, despite the amazing downdrafts of the last three days, we're still looking for a bounce. Which however long it might be we still view as an opportunity to beat on the downside or get out of any positions you've still got. And please note - the important thing here is the credit markets which are still deep in the doodoo indeed. But since everybody looks at and can follow the markets that's where we'll concentrate.

Equity Markets Breakdowns

 Let's start with three complementary views of the same stock chart so we can get an idea of just how bad it got and what the implications might be. The first sub-chart shows downtrend lines drawn to filter the excesses of some of the wild swings out. The second shows what happens when they're included. In the latter case the markets were like a high-power engine so over-revved it was shaking itself to pieces. Fortunately various policy actions managed to reduce the fuel flow enough to keep that from happening. Which leads to the third sub-chart with some filtering but showing the bottom resistance still being almost broached last week (these charts are all thru  Oct 3rd  btw). The question then becomes where do we go from here ? Which dynamic is in control ? That question got answered this week and, unlike all the prior bear rallies we railed against, the economic realities combined with the credit implosion seem to have completely changed market sentiment. Now everybody's running in fear. As they should be - this'll get worse long before it gets better.

Market Outlook

To try and answer those questions we take a look at a 1 year and 10 year chart combination. In the first chart which looks at the SP500 since Oct07 you can see the downtrend metastasizing into a crash. Which if we'd posted this as intended on Sa. would have made us look very prescient on Mo/Tu and today so far. Do good (bad) intentions count ? To some extent perhaps because the long-turn trends downward are more than intact. What we'd hope for is less panic, a more orderly process and not having six months of change compressed into three days. Then on the other hand we've just seen a decade's worth of Financial Industry re-structuring compressed into three weeks so why not ? The bottom 10Yr chart puts this in some perspective. Looking back to 1998 we set up something called Fibonacci lines which show the natural, internal limits that markets tend to follow. The line around 1055 should have been major resistance but was blown right thru. The next stop down would be to give up the last five years and retreat to around 850. But there is an area of resistance in the 950-1000 region. Which in fact seems to be holding, however weakly. If we get a rally off this - yeah, right ! - it'll likely be weak, short and deceptive. It will be however your last clear alternative for cleaning up your investments and re-positioning yourself prior to the return of the Housing and Business Cycle problems. It's also possible that we'll blow on thru it and then we'll be having a different discussion indeed. One where then we'd be back to trimming off the excesses left over from the late '90s. Which, note for the record and from much earlier posts, we never did do. The rally in '03 bottomed before we drained those poisons off; and as we now know there were a lot of poisons indeed that needed draining. Which we're now being forced to deal with willy-nilly, like it or not !

UPDATE: Very interesting BNN interview that's a welcome dosage of reality, calmness and informed assessment vs. the typical CNBC yadda yadda. Recommended - 5 min !

Market Morning : October 8, 2008 : Market Lookahead [10-08-08 9:15 AM] BNN sets you up for your trading day with Chyanne Fickes, VP investments, Stone Funds.

Market Delusions Continued 

SP500 Damage Done on Monthly Chart Today’s equity decline undersay has stunning ramifications for the larger time-frame structure of the S&P 500 and other US Equity Indexes - we’re now at levels not seen since 2003.  Let’s take a quick look at this structure to see where this takes us. First, let me state that we’ve now officially ‘blown through’ the long-term (large scale) Fibonacci retracements from the 2002 lows to the 2007 highs.  The sellers took out the 61.8% Fibonacci retracement at roughly 1,080 this morning. Price is undeniably in a monthly downtrend, though the 20 and 50 month EMAs have yet to cross (the 10 and 30 month EMAs have done so - a popular combination used on longer time frame charts). Where’s the next level of possible support?  I suggest it’s potentially the rising 200 month SMA just under 1,000.  We may get a bounce off current levels, but should price test the longer SMA, a bounce would be in order. Ultimately, I find it highly conceivable that we retest the 750 - 800 area which  marked the early 2000’s bear market low - it looks clearer than ever now that we’re headed there at some point - but not before a few more counter-trend rallies occur. This is not an environment for aggression on either side (long or short).  Though it may not seem so, bear markets are much more difficult to trade than bull markets.  Case in point, it took only one year to totally destroy the equity gains that were achieved in five years - let that sink in.

Capitulation watch continues in vain It certainly felt like capitulation on Monday, after the Dow Jones Industrial Average plunged more than 800 points intra-day before recovering to end the day down "just" 370 points. But, then again, it has felt like capitulation on a lot of other days in recent weeks too. And yet, as we know all too well now, those earlier days of apparent capitulation turned out to be nothing more than false alarms. So the fact that Monday felt like capitulation tells us little about whether it indeed will mark the final low of the bear market. To determine whether it will, therefore, we have to go beyond our subjective feelings and focus instead on the hard data: Did sentiment really and truly drop far enough on Monday to constitute genuine capitulation? From where I sit as monitor of several hundred newsletters, I'm afraid my answer is "no." Believe it or not, the editor of the average short-term market-timing newsletter actually reduced his bearishness Monday. Consider the Hulbert Stock Newsletter Sentiment Index (HSNSI), which reflects the average recommended stock market exposure among a subset of short-term stock market-timing newsletters tracked by the Hulbert Financial Digest. As of Monday evening, the HSNSI stood at minus 33.5%. As of last Friday's close, in contrast, the HSNSI stood at minus 36.1%. Believe it or not, in other words, the HSNSI actually rose slightly on the day -- by 2.6 percentage points -- despite Monday's market tumult. That's telling enough. But, as I have mentioned on several occasions in recent days, that's not the only source of contrarian concern about the HSNSI. Even at Friday's minus 36.1%, this sentiment index was still markedly higher than where it stood in early July. And though the market wasn't in great shape then, from the perspective of the markets today it looks awfully attractive. Why should there be less fear among the market-timing newsletters today than then? Why should sentiment actually have increased on a day like Monday? In large part, I'm convinced, it's because newsletter editors are so eager to declare that a bottom has been formed. Every time we have a big down day like we had on Monday, some of the short-term market-timing newsletter editors conclude that capitulation has taken place -- and hence decide to become more bullish. This process keeps the HSNSI from dropping as far as it otherwise would, and prevents genuine capitulation from occurring. It's worth remembering a truism about market psychology that has been too often overlooked in recent weeks: When genuine capitulation finally takes place, few will recognize it as such at the time. In contrast, an eagerness to declare that capitulation has occurred probably means that it hasn't.

S&P 500's Drop Points to Potential `Significant Rally': Chart of the Day U.S. stocks may be destined for a rebound because so many shares in the Standard & Poor's 500 Index have fallen to relatively low prices, according to Bespoke Investment Group LLC. ``We believe a significant rally is set to take place,'' Bespoke's analysts wrote in a report today. Only 28 companies in the S&P 500 closed yesterday above their average price in the last 50 trading days, a signal that shares were ``oversold,'' the note said. The CHART OF THE DAY shows the S&P 500 and its 50-day moving average this year. Yesterday's close was 14.7 percent lower than the average, the biggest discount of the year. Four of the index's 10 main industry groups -- energy, industrials, materials and telecommunications -- didn't have a single stock close above its 50-day average yesterday, Bespoke's data show. Chart of the Day

Citigroup's Levkovich Goes From Most Bullish to Most Bearish Stock Analyst Citigroup Inc.'s Tobias Levkovich cut his Standard & Poor's 500 Index forecast by 19 percent to 1,200, turning him from the most bullish U.S. equity strategist tracked by Bloomberg to the most bearish. The new projection represents a 20 percent gain from today's close of 996.23 through the end of the year. Levkovich, 47, said the credit crisis and a slowing global economy made his previous forecast of 1,475 unreachable. The S&P 500 has plunged 36 percent since its October 2007 record under the weight of almost $600 billion in subprime-related losses at banks and an increase in borrowing costs. Levkovich is the third of nine strategists to cut estimates since Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, according to data compiled by Bloomberg. On average, the analysts project the S&P 500 will end the year at 1,344. That would require a fourth-quarter advance of 15 percent, the steepest quarterly gain since the final three months of 1998. ``The anxiety generated by collapsing international stock markets, weaker economies around the world and the failure of a number of leading financial institutions made our previous year- end S&P 500 forecast both stale and improbable,'' New York-based Levkovich wrote today in a note titled ``Eating Humble Pie.'' Levkovich said a month ago that he was sticking with his year-end estimate even though he was getting ``enormous pushback'' from clients. He said he was eating more doughnuts to cope with the pressure.

Coping with the Credit Crisis

Business loan bailout The Federal Reserve announced a new program to help the battered market for short-term business loans - taking its closest step yet to lending directly to businesses. The program addresses commercial paper, a form of short-term funding that is crucial to many businesses operations. In the past month, the amount of money outstanding in commercial paper loans has fallen 11% to $1.6 trillion on Oct. 1 from $1.82 trillion on Sept. 10. Since much of the paper that was outstanding at the start of the credit crisis is now coming up for renewal, there were fears that it could drop even more sharply in the weeks to come without some drastic improvement in the market. Under the program announced Tuesday morning, the Fed will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The program is slated to expire in April 2009 and will have financial support from taxpayers.

Tuesday’s Trading George Says: Has anyone ever had a business and had to meet a payroll? I have. My brother and I ran an electronics business both retail and commercial. We would get loans for big projects to buy equipment and pay employees until such time we got paid for the job from the customer. During seasonal activity, such as Christmas holidays, we would get loans to stock up on those items and in general increase all of the inventory. At the end of the season, if everything went well, we would pay the loans back within weeks or a couple of months. We would have sales to reduce inventory and get prepared for the next season. There were rough economic times when we could not get adequate loans to meet project and seasonal requirements. Then there were times when the loans we got had high interest rates. These were usually short-lived, but these conditions reduced our profits considerably. Imagine not being able to get adequate loans to run a business for years. It doesn’t work. You go out of business.  This is similar to not getting a paycheck. And the reason I believe something needs to be done to provide financial institutions capital to keep business running. Each of us is biased about the bail-out due to our environmental conditions, past experience, current financial situation, etc. Sure, some businesses are not run properly. There are greedy cheaters and gouging. Piecemeal, that doesn’t hurt the overall economy. But the bottom line is, if farmers, businesses, cities, states, individuals, and all other sectors of society can’t get the funds needed to survive AT THE SAME TIME, we face a calamity beyond our wildest dreams.

Fed, ECB, BOE Cut Rates in Unprecedented Response to Combat Credit Freeze The Federal Reserve, European Central Bank and four other central banks lowered interest rates in an unprecedented coordinated effort to ease the economic effects of the worst financial crisis since the Great Depression. The Fed, ECB, Bank of England, Bank of Canada and Sweden's Riksbank each cut their benchmark rates by half a percentage point. The Bank of Japan, which didn't participate in the move, said it supported the action. Switzerland also took part. Separately, China's central bank lowered its key one-year lending rate by 0.27 percentage point. Today's decision follows a global meltdown that sent U.S. stock indexes heading for their biggest annual decline since 1937; Japan's benchmark today had the worst drop in two decades. Policy makers are also aiming to unfreeze credit markets after the premium on the three-month London interbank offered rate over the Fed's main rate doubled in two weeks to a record. The Fed reduced its benchmark rate to 1.5 percent. The ECB's main rate is now 3.75 percent; Canada's fell to 2.5 percent; the U.K.'s rate dropped to 4.5 percent; and Sweden's rate declined to 4.25 percent. China cut interest rates for the second time in three weeks, reducing the main rate to 6.93 percent. ``The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability,'' according to a joint statement by the central banks. ``Some easing of global monetary conditions is therefore warranted.''

Understanding the Significance of Mark-to-Market Accounting Recent actions of corporate titans in the financial sector are essentially an admission that their business model was deeply flawed. No one would invest any capital for a ROI of 50 bps per year. They of course knew this -- so they leveraged up that 50 bps 35X or so, creating the false appearance of more attractive returns. This higher risk, potentially higher return paper was part of that misleading process. Suspending FASB 157 amounts to little more than an attempt to hide this broken business model from investors, regulators and the public. Its not just getting through the next few quarters that matters; Rather, its allowing the market place to appropriately reallocate this capital to where it will serve its investors best. If FASB 157 is suspended, I would advise our clients and the investing public that owning any financials that failed to disclose their holdings accurately were no longer investments -- they were pure speculations, with more in common to spinning a roulette wheel than owning Berkshire Hathaway (BRK) or Apple (AAPL) or Google (GOOG). Indeed, I know of no faster way to end up on the DO NOT OWN list than to hide from your shareholders what is on your books. If investors cannot trust the valuations of what is on a firms books, they simply cannot invest in these firms PERIOD. There are other alternatives for the institutions that now must deal with this discounted, thinly traded hard to value junk paper. They can sell it for whatever price a the market will bear, they can spin it off into a separate holding company, they can write it down to zero and reap the rewards of mark ups in future quarters. But suspending the proper accounting of this paper is the refuge of cowards. It reflects a refusal to admit the original error, it hides the mistake, and it misleads shareholders. I find it to be totally unacceptable solution to the current crisis. As Japan learned, not taking the write downs only delays the day of reckoning. They propped up insolvent banks, and suffered a decade long recession for it. That way disaster lay . . .

Quote of the Day: Aggressive lending to 1st-time buyers Its important to understand how this situation occurred in the first place, if we want to be able to fix it. Blaming the CRA and Fannie/Freddie is a total misunderstanding of how the problem occurred, and what we need to do to fix it now, and avoid doing it again in the future. To repeat my prior arguments, the proximate cause of the Housing crisis were 1) Ultra-low rates; and 2) Abdication of traditional lending standards, thanks to 3) originators ability to resell mortgages for securitization purposes, and hence, 4) not have to worry about loan defaults. The credit crisis was caused by 1) the above securitized mortgage paper, that was 2) rated triple AAA by Moody's and Standard & Poors, which then 3) Which was then "insured" by credit default swaps (CDS) -- the unreserved for, shadow insurance products 4) whose exemption was made possible by the Commodities Futures Modernization Act. That legislation exempted these derivatives from any supervision or regulation. The lack of reserve requirements is why there is now $62 trillion in CDS, many of which will never pay their counter parties the promised insurance. If you are going to blame Fannie/Freddie/CRA, or George Bush or Barney Frank, you are missing the big picture.

Posted by dblwyo at 12:08 PM | Permalink | Comments (0)

Back in the day the winter after first getting my driver's license my mom was over-joyed to let me drive myself and little brother to our ski lessons, which were 90min away up a rather steep, single-lane (albeit interstate quality) road. Though officially only having a few months my summer jobs had been on a golf course where I'd been driving for over a year so technically my skills were pretty decent. Coming back home on the steepest and iciest corner my teenaged lack of judgment led to a spinout with the rear wheel hanging over the edge of a 3,000' droppoff and no guard rails. The rescue package should put the wheels back on our kiddy wagons but we still have some steep and icy curves with scary dropoffs to negotiate. After we manage that feat of legerdemain the road is still headed down. It would appear that after almost a year of denial of those facts the realities are fast sinking in, in the markets (both credit and equity), policy makers and politicians and the consumer.How else does one read the final passage and the subsequent market drop ? BtW - on Mon. when the bill failed the markets tanked at the exact moment and on Fri. when the bill passed they reversed again and re-tanked. Welcome to the jungle. Let's talk about mapping, navigating and surviving the trip.

Economic Situation and Outlook

The economic news has been un-relievedly bad with  a major downward revision in GDP,  surprisingly bad  employment numbers, scary revisions to durable goods orders and so forth. Worse the consumer is really beginning to pull in their horns, as we've long expected. We won't review all the data in detail but a quik skim of the Economic Data archive might be worth your time, just to look at the headlines and charts if nothing else. As you can see from the accompanying chart Real Retail Sales is negative and has been for some time, having cross that tipping point earlier this year. Both it and Real Consumption are in fact already worse than '01 in YoY terms and would appear to be headed lower than in either '80 or '75. That tells us this is likely to be a more severe and longer-lasting recession than any we've seen in over 25+ years. Sorry for the bad news but if you've been in denial all this time we think it better to look at the unvarnished truth and try to move on to acceptance.

As for Employment and GDP, both of which are lower frequency numbers and lagging ones as well they too will be navigating those steep and icy roads. Just to reinforce out argument we're bypassing the monthly, s.t. data and show the YoY quarterly changes back to 1980 where you can see Employment turning more sharply down in the top sub-chart. In the middle we compare Employment, Hours Worked and Unemployment. The latter is showing a particular sharp and steep rise, increasing almost 30% YoY. No wonder the markets are tanking - they should be. It's now commonly recognized that this has been the weakest "recovery" in a very long time. That's because after the implosion of the Tech Boom we never got back to self-sustaining organic growth. In fact in the last sub-chart you can see that net of the 450K jobs/quarter needed to breakeven, we're actually "in the hole" on net new job creation almost 5 million jobs. A weak recovery indeed. Which means there's no pent up consumer demand waiting in the wings since it was held up by the Housing ATM and MEW above where it should have fallen. This will make the downturn worse before we start re-building toward a recovery.

Politics and Politicians

More than anything this last three weeks are a pragmatic lesson in how the sausage-making factory works. The answer is not very well at all when a Rep. dominated House put the entire economy at risk for self-serving purposes. Make no mistake about this - key public servants like Bernanke and  Paulson more than did their duty, the Senate did o.k., the two Presidential candidates demonstrated a caution that is NOT true leadership but the House conservatives were, in the services of their ideological shibboleths, the proximate trigger of this last week's implosions. And they in turn were driven by the sheeple. Who were, in turn, driven by a perfectly natural spirit of revenge. We like to think of this as the peasants in pursuit of the monster burning down the village instead. Now we need to put out that conflagration before it destroys the whole forest. We covered some of this ground in the prior post (The People's Choices: Rescue vs Revenge) but if you want to understand the social biology of peasants the key article to read is this one:Animal Instincts: Main Street Seeks Revenge on Wall Street.

After the break you'll find a lot more on the economic data and outlook, the rescue package and the continuing crisis in the credit markets - which is not repairing itself so far and is instead continuing to be a major drag, and on the politics of pandering. The consequences, we have to say, are now obvious. 

Economic Outlook 

Recession now certain Even before the latest squeeze in the credit markets, the U.S. economy had slipped into what could be a relatively lengthy recession, economists say. The latest data, covering activity in August and September, make it all but certain that the academic economists will eventually declare that the economy is in a recession.  The big economic forecasting firms are in the process of updating their forecasts following the release of key data on consumer spending. While the final numbers aren't available yet, forecasters say it doesn't look good.  The economy seems to be on the "edge of the abyss," said Joel Prakken, chairman of Macroeconomic Advisers, which will update its forecast on Friday. "Anyone who's wondering if there's a recession should stop wondering," said Nigel Gault, U.S. economist for Global Insight, which will release its updated forecast on Monday. "The recent data were deteriorating sharply" even before factoring in the latest impact of the credit squeeze. Global Insight doesn't think the recovery will be quick or powerful. The economy will likely contract for three quarters and then show weak growth in the second quarter next year.If the recession lasts from December 2007 until April 2009, as Gault suspects it will, it would be the longest since the Great Depression. And the recovery, when it comes, won't feel anything like a boom. Goldman Sachs Forecasts "Deeper" Recession  

• Estimating PCE Growth for Q3 2008  But in general, the two month estimate is pretty accurate. Maybe September was exceptionally strong (very unlikely from anecdotal evidence), or maybe July and August will be revised upwards, but the two month estimate suggests real PCE will decline in Q3 by about 2.4% (annual rate). Since PCE accounts for about 71% of GDP, this also suggests the change in real GDP in Q3 might be negative. This depends on exports and changes in inventories (investment will be weak).If accurate, this will be the first decline in PCE since Q4 1991. This is strong evidence that the indefatigable U.S. consumer is finally throwing in the towel.
• Be Afraid, Very Afraid: Five Things to Know About the Economy

Payrolls in U.S. Fell 159,000 in September, Biggest Decline in Five Years The U.S. lost the most jobs in five years in September and earnings rose less than forecast as the credit crisis deepened the economic slowdown. Payrolls fell by 159,000, more than anticipated, after a 73,000 decline in August, the Labor Department said today in Washington. The jobless rate, the last one reported before the presidential election, remained at 6.1 percent. Hours worked reached the lowest level since records began in 1964. The world's largest economy may be headed for bigger job losses as the worst financial meltdown since the Great Depression causes consumers and companies to retrench. A sinking labor market and rising borrowing costs raise the odds Federal Reserve policy makers will cut interest rates by their Oct. 29 meeting. ``The financial panic is a body blow to business confidence, and companies are now battening down the hatches,'' Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pennsylvania, said before the report. ``We're in store for very sizable job losses across many industries. A rate cut by the Fed could come before the next meeting.'' U.S. Payrolls Plunge in Sign Economy May Enter Worst Recession in 25 Years

Managing the Lizard Brain: Beyond Crisis and Kabukit to Realities Not sure about you but re-fighting Stalingrad and watching the Kabuki dancing of the political poseurs is wearing on my nerves. Call it the triumph of the lizard-brained. That's not a pejorative btw but a technically accurate description of how our brains are wired. Instead we'd like to remind you that beyond today's credit crisis du jour are a host of real economic problems, including a Housing market that has at least two years before recovery from excess and mounting inventories. And a real economy that we warned sometime back was in an accelerating downturn and was now crossing the tipping point all on it's own. (Be Afraid, Very Afraid: Five Things to Know About the Economy) Summarized in the accompanying table which dates from around Feb (we think). (Filtering the Non-Linearities: Sorting the Risk Factors) Take a minute and read it because you'll notice that there's a lot still qued up to be worked thru. A lot indeed. The point here is not to celebrate my own prescience but to highlight the fact that that the machinery available here allows one to be prescient within divine gifts of insight. So instead we're going to focus on recent economics news, which you'll find summarized and excerpted after the break.

Gross domestic income and recessions Measures of employment growth and the unemployment rate seem to be signaling pretty strongly that the U.S. is already in a recession, whereas the GDP numbers do not. Which should we believe? Given that one can reconcile the employment and GDP inferences entirely on the basis of the known numerical value for the statistical discrepancy in the GDP numbers, it seems like a pretty clear call to me-- the U.S. economy is currently in a recession which likely began in the fourth quarter of last year. There's an important implication of this for the ongoing discussion of the current financial turmoil. The U.S. is currently in a recession, and events of the last two weeks are sure to make things worse for the next few months, even if we had some policy to bring immediate stability to financial markets. That is water under the bridge at this point. The purpose of the Paulson-Dodd proposals is thus not to prevent the economy from going into recession. The purpose is to prevent the recession from turning into a severe contraction. Last Quarter's Fundamentals..., Gross domestic income and recessions, Real GDP likely fell in Q3

Wheels  ON: Post  Rescue  Challenges

The Bailout: What It Means for You The $700 billion rescue bill that Congress finally passed will limit panic in the markets, since it gives the government vast new authority to take over sclerotic securities that have clogged the credit system and already brought down some of America's biggest companies. With the feds stepping into the bloodbath, the hemorrhaging should stop. But the economy is still in precarious shape, and unrealistic expectations about the bailout could end up disappointing consumers hoping for some kind of immediate relief. What You Need to Know About the Financial-Rescue Plan Bush Signed Into Law

• Political Kabuki: It's NOT a Bailout, It's Your Life !
• Kabuki Wheels Fall Off Wagon: Time to Quite Fing Around
• The People's Choices: Rescue vs Revenge

Libor Mystifies, Frightens Americans as a Michigan Mayor Reads `Doomsday' Americans are getting a crash course as a once obscure acronym weighs on the economy. In interviews across the country, oil workers, ministers, bank managers and politicians said they were baffled by the London interbank offered rate or fearful of its surge this week. They agreed Libor was important, even if they couldn't put their finger on why. Libor, set every morning in London, is what banks pay to borrow money from each other. That in turn determines prices for financial contracts valued at $393 trillion as of Dec. 31, 2007, or $60,000 for every person in the world, and helps set consumer interest rates on everything from home loans to credit cards. In the past week, as governments in Europe rescued five banks and the U.S. debated a bailout, the cost of one-month bank loans in euros and overnight dollar loans soared to records. In practice, that means banks are hoarding cash, raising borrowing costs and slowing economies worldwide. Today's three-month Libor for loans in dollars jumped to 4.33 percent. Still, explaining Libor can be a challenge. Explaining the LIBOR

• Understanding the TED spread

Credit Crisis, Companies, and the Economic Outlook New Greenwich Associates survey out on how credit market problems are hitting companies of all sizes, both in terms of their ability to get capital and in their economic outlook: Forty-five percent of large U.S. companies say their access to commercial paper markets has decreased as a result of the current market turmoil. More than 70% of companies say pricing on commercial paper programs has increased, including 22% that report their pricing has increased “significantly.” Forty-three percent of companies with more than $5 billion in annual sales say their access to commercial paper has been reduced, and among companies with annual sales of $500-$999 million, that share jumps to approximately two thirds. Almost a quarter of U.S. companies say these historic shifts in credit conditions have increased their needs for credit to fund ongoing operations. Smaller companies are feeling the pinch the most. One third of companies with annual sales of $500-$999 million say market turbulence has increased their need for operational funding. Among the industries with the highest proportion of companies saying they’ve experienced an increased need for operational funding are consumer goods (36%), industrial/transportation (28%) and financial institutions (26%). And then on the economic outlook: Only 4% of companies think the economy will turn positive in the next six months; 47% expect the slowdown to last for 18 months or longer. Not a single company with annual sales of less than $1 billion thinks there’s any possibility of an economic rebound in the next six months. Mid-sized companies are especially gloomy in their outlook. Among companies with annual sales of $1-$5 billion, nearly 50% say the economy will not begin to recover for at least the next 18 months. Demand for the funding of capital expenditures is slowing. Sixteen percent of U.S. companies — including a quarter of consumer products companies and almost 25% of natural resource companies — say current market conditions have led to a decrease in their need for cap-ex financing.

• Credit Default Swaps Reflect Fear, Not Reality, Industry Executives Say

Blockages in the money markets  ANY good tradesman will tell you the importance of the bits of a house that you cannot see. Never mind the new kitchen: what about the rafters, the wiring and the pipes? So it is with financial markets. The stockmarkets are the most visible: as they soar or swoon, the headline-writers get to work. The money markets, however, are the plumbing of the system. Normally, they function efficiently and unseen, allowing investment institutions, companies and banks to lend and borrow trillions of dollars for up to a year at a time. They are only noticed when they go wrong. And, like plumbing, when they do get blocked, they make an almighty stink. At the moment, these markets are well and truly bunged up. In the words of Michael Hartnett, a strategist at Merrill Lynch, “the global interbank market is effectively closed.” The equivalent of a run on banks has been taking place, without the queues of depositors seen outside Northern Rock, a British mortgage bank, last year. This stealthy run has been led by institutional investors and by banks themselves. Many banks have had to be rescued by rivals or the state. This week the Irish government felt compelled to guarantee the deposits and some other liabilities of the country’s six largest banks.

Treasurers Struggle to Keep Credit Lines as Banks Play `Hardball' on Loans Almost 100 U.S. corporate treasurers gathered for an emergency conference call yesterday to warn each other that banks are using any excuse to charge more to renew lines of credit. ``Capital is fleeing to safety,'' said Edward E. Liebert, treasurer of Rohm & Haas Co., who took part in the 90-minute call organized by the National Association of Corporate Treasurers. ``Interbank lending is not free-flowing any more,'' said Liebert, 56, chairman of the Reston, Virginia-based trade group. One bank charged a participant in the call 80 basis points to renew a routine $25 million credit line, according to Liebert, who wouldn't identify the speaker or the company. Rohm & Haas, based in Philadelphia and rated BBB by Standard & Poor's, is paying 8 basis points for a $750 million revolving line of credit provided by 13 banks, the treasurer said. A basis point is 0.01 percentage point. As the U.S. House of Representatives prepares to vote on a $700 billion bailout bill passed by the Senate, global credit markets are being squeezed by banks afraid to lend to each other and to even some investment-grade corporate clients. Treasurers are struggling to keep credit lines open so they can pay employees, fund pension benefits and purchase raw materials. ``The banks are really starting to play hardball,'' said Jeff Wallace, managing partner at Greenwich Treasury Advisors, a financial consultant in Boulder, Colorado. ``They don't want to give out any more money to people because they don't have enough capital.''

Bad credit-card debt could be next shot to rip through economy Credit-card debt is on the brink of imploding and will be the next storm to hit the fragile finance industry, an investment research firm predicted this week. According to Innovest StrategicValue Advisors, banks will charge off $18.6 billion in delinquent credit-card accounts in the first quarter of 2009 and $96 billion in all of 2009, more than double the research firm's forecast for all of this year.  Innovest projects that amount would be high enough to damage some of the biggest card issuers. Credit-card charge-offs are "defying gravity" when compared with the problems in the mortgage market, according to Gregory Larkin, senior banking analyst for Innovest. But that will change as they catch up with mortgage charge-offs, which have spiked eightfold since the third quarter of 2007. "If history is any indicator, there should be an equivalent surge of credit-card charge-offs very soon," he said, though he concedes that an eightfold increase would be very aggressive. Comparatively, charge-offs reached $4.2 billion in the first quarter of this year and $3.2 billion in the same period a year before, according to the Federal Reserve, which only reports non-securitized debt. Innovest's projections include all credit-card debt, which the firm believes is double what the Federal Reserve reports. For all of 2007, charge-offs tallied $26.6 billion, according to Innovest's calculations, and the firm estimates they will reach $41.5 billion at the end of this year. The jump in credit-card charge-offs is linked in part to the credit crisis now in play. As banks have tightened lending standards, they have mostly done away with the once-popular roll-over options -- usually at 0% introductory rates -- that allowed borrowers with delinquent accounts to get new cards elsewhere. Larkin believes all that bad credit is going to surface quickly and could have a similar impact as the mortgage crisis has had on banking.

Politics, Choices and Consequences 

Animal Instincts: Main Street Seeks Revenge on Wall Street The outrage expressed by many so-called Main Street folks over the proposed Wall Street bailout is based on more than a sense of injustice. It's about revenge, a basic animal instinct shared by humans, chimpanzees and even blue-footed boobies. And Washington politicians would be wise to listen up and stick some get-back-at-'em clauses into the bailout bill if they hope to get the support of the average American, says one behavioral economist who studies these things. In phone calls made by constituents to politicians, as well as e-mails to news organizations and other media, the public has expressed a preference for a package that helps consumers and homeowners without assisting fat cats on Wall Street. In fact, a Pew Research Center survey conducted Sept. 27 through Sept. 29 found that nearly 70 percent of Americans say they feel angry about the government's plan, and half admit they are scared. President Bush and other leaders who support the bailout warn, however, that if financial institutions are not propped up quickly and significantly with public money, the average American will pay the price. Bring it on, many people seem to be saying. Dan Ariely would agree. "People are willing to lose money to get those people [on Wall Street] to suffer" because the corporate financial leaders have violated a social contract, says Ariely, a behavioral economist at Duke University. "We need to include revenge in the bill." The bill should also include a code of punishment for exacting revenge for future financial misdeeds, Ariely said last night on "Marketplace," a radio program produced and distributed by American Public Media. However, psychologist David Schroeder of the University of Arkansas, Fayetteville, doesn't think revenge is technically the right word for what the public seeks, because it implies an urge to make others suffer at whatever cost. The public wants retribution, he says, for what is seen as a violation of the rules of the game, one they put their trust in. "Retribution involves a punitive component," Schroeder said, "and we're hoping that's going to deter these people from doing it again and we'll get them to abide by the rules in the future."

House opposition wilts  As the final high stakes vote on the bailout bill approaches Friday, Cummings is not alone among lawmakers who have found solid reasons to reconsider their vote. Whether it's the "Obama factor," or the fact that billions in new tax incentives have been added to the bailout bill, it's becoming clear that opposition is wilting to the $700 billion financial rescue plan just in time for a second House vote on Friday. After a blitz of last-minute lobbying, Republicans and the Bush administration are hoping to get in the neighborhood of 80 to 85 GOP votes on the bailout bill after garnering only 65 on Monday. And Democrats are hoping to build slightly on the 140 lawmakers who supported the bill earlier this week. The outcome still hangs on the prerogatives of a dozen or so wavering lawmakers in both parties, but congressional leaders are “cautiously optimistic” about the outcome Friday even after watching their rank and file sink the initial bill on Monday in a public revolt that shook financial markets around the world. Thursday brought another round of public – and private – reversals, with Georgia Rep. John Lewis, a prominent member of the Congressional Black Caucus, telling colleagues at a closed-door meeting that he would support the bailout plan, according to people present – Lewis wouldn’t confirm as he left the meeting, but said, “Just watch the board.” Republicans, from retiring Minnesota Rep. Jim Ramstad to Tennessee Rep. Zach Wamp, and Democrats, from Nevada Rep. Shelley Berkley to Missouri Rep. Emanuel Cleaver, all declared on Thursday they would support the current bill, according to various news sources. It's important to note that nothing is certain until the gavel falls Friday, so none of these public or private declaration means a thing until that point.

Buffett: My fix for the economy Warren Buffett suggested Thursday that the U.S. Treasury team with private investors to buy the distressed mortgage assets at the center of the controversial $700 billion Wall Street bailout, and said the price tag of the rescue plan may have to rise. Buffett, the chairman and CEO of Berkshire Hathaway (BRK.A), called the problems facing world markets "unprecedented" and warned of a "disaster" if Congress does not move faster to shore up the economy. "We had an economic Pearl Harbor hit," he said during an appearance at FORTUNE's Most Powerful Women Summit in Carlsbad, Calif. "For a couple of weeks we've been arguing about who's at fault [and] fooling around while things have gotten a lot worse." Buffett said the bill isn't perfect, but it's a crucial step in the right direction. He then warned it will take a while to work and that the economy is going to struggle even with its passage. Buffett didn't estimate how much more money would be needed to buy enough toxic mortgage investments in order to create a more stable market and get credit flowing again. But he described a plan he thought of Thursday morning on the way to the Summit that would allow Treasury and private investors to buy assets together. He said his proposal would kickstart demand for mortgage-backed securities, help find a market price for these troubled assets and make it more likely that taxpayers would be made whole or even come out ahead in the bailout. Under Buffett's plan, Treasury would lend hedge funds, Wall Street firms or any other investors 80% of the price for distressed assets. Investors would benefit from borrowing at lower rates available to the Treasury. But the government would get first claim on the sale of those assets, which means it would get its loan back plus interest and possibly turn a profit. Only then would investors see a penny. "Now you have someone with 20% skin in the game," explained Buffett. "Believe me, I won't be overpaying if I'm buying with that kind of leverage. And you have someone [the investors] to manage the assets to the extent they need to be managed." Buffett also noted that the presence of the government in the transactions would raise the price of assets above the absolute firesale levels for which they could now be sold. That would benefit the banks trying to unload them.Bailout: Will it work?
Senate Rescue Plan Vote [10-02-08 10:10 AM] Professor Jeffrey Frankel, Kennedy school of government, Harvard University, talks to BNN about the U.S. government bailout.

Posted by dblwyo at 09:17 AM | Permalink | Comments (0)

Well the news has just been swirling of late but the reason, aside from that, that we've postponed another post is that most of it's been political, rather than economic or business or markets. Yet that political news has dominated the other three categories. We'd be a little surprised if by this time you don't know that the Rescue Package didn't pass the House, that it largely didn't pass thru the failure of the House Republicans to get enough votes, and that they failed to accomplish that - beyond ideological principles - because the overwhelming major of the electorate doesn't support this. Houston we have a problem. Now there's a wide variety of good news, other than the amusement factor, in all this. First, and perhaps most importantly, the equity markets seem to believe something will get done though the credit markets are still in deep trouble. Second, oddly enough, today's economics news was pretty bad. IN particular the drop in auto sales was spectacular and that was mostly due to consumer confidence and credit conditions. Third, the biggest problem is that people don't believe this administration, that this is a problem or that it affects them. Which means that between the market almost crashing and today's sales figures a little more light might be dawning. At the end of the day we get to learn yet another lesson in strategic business planning that we've talked about before. The socio-political context really matters, it defines your ecology, you can't control it but you can deal with it. (Strategy, Context and Awareness: Sub-prime Lessons,WRFest 23FEb08(Business Strategy): What the Future May Hold ?) In fact so many major companies were convinced the package would pass they neglected to speak up not wanting to get tarred and feathered - hopefully we'll be able to chalk this up to painful lessons rather than bitter mistakes. Given our focus we won't go into the details of the political Kabuki nor the popular reactions but to our point, you might benefit from consulting these other posts (Calm Down: the Fat Lady Ain't Sung, Yet., Marketing Elephant Pills: Struggling to Explain the Rescue).

After the break you'll find our usual survey of selected relevent news with a caveat - this is all from today. We won't put up more econ charts to bring home our major arguments about the economic situation having just reviewed it in a prior post (Managing the Lizard Brain: Beyond Crisis and Kabukit to Realities). And we've also previously put up the discussion and chart characterizing the implosion in the credit markets by looking at the huge drop in the 3Mo Treasuries. If you'd like to scare yourself again here's the chart. But we would like to look at the market chart for the last three months. Monday certainly stands out (our only regret personally is that we'd bailed out of down-leveraged positions a week earlier in anticipation of the package passing. BtW - don't presume it goes this time either !!).

The thing we'd really like to draw your attention to is the expanding funnel of doom - when a system starts getting bad behavior amplified by external forces (technically a positive feedback loop otherwise a vicious cycle with a bad end) it shakes itself to collapse. Whether it's a turbine with a broken governor or the Classical Maya civilization pushing it's look. Go visit the natives of Easter Island if you want some firsthand stories. Notice that the swings were getting wilder and wilder but driving harder on the downside. So how would you interpret that ? And oh yeah, be sure you check out the 3Mo Treasury chart. 

Right now the markets have calmed down but if Hank Paulson had headed out to get drunk like any normal person Monday night instead of not only heading back to the office but immediately marshaling the troops that'd been all she wrote. It might be time for you to write and express your views to your elected representative. Even if you're investing in inverse funds you still have to have markets to play in after all :) ! 

Why Corporate Layoffs Loom "It's all RIFs. A lot of RIFs." That's reduction-in-force. Business-speak for layoff. And in the words of one top corporate handler last week, the cuts are being prepared across the economy, just days before the presidential election. Impending cuts would follow in part from the past 12 months of economic woe. But a more acute link to layoffs has emerged in the past 12 days, a period when the credit markets have squeezed shut. Many seem to view these changes as arcane Wall Street machinations. If only. The credit connection is clear in a look at General Electric, a company at the top of the corporate pecking order. GE is regarded as such a stable, reliable company, that it also runs a bank. That stability helps it borrow at a very low cost, which it can then use to lend to others at a higher rate. One such type of borrowing is called commercial paper -- short-term, low-cost loans often made for just a month. Commercial paper is like the WD-40 of corporate finance, lubricating the joints of the financial system, helping sellers bridge costs between the time they deliver a product and when they get paid, for instance. Without commercial paper, the economy rusts over. Unless a sharp uptick in confidence sweeps through the markets, higher rates will cascade across less-solid companies, if they can get hold of cash at all. The scary part is that few companies have the same financial cushion as GE. And as their borrowing costs increase, they will have to scramble to cut their fixed costs. And what is the No.1 cost of business? People. Right now the unemployment rate is at about 6.1%, up substantially since the beginning of the year, but still well below the highs of the early 1980s. It was, in fact, late 1982 when unemployment reached its modern peak. Nearly 11 out of every 100 working-age Americans was without a job. Nearly 11 out of every 100 working-age Americans who wanted a job didn't have one. If these sorts of numbers still seem arcane, just wait. The RIFs will soon make them all too real.

Shipments tumble 52% A key index tracking commodities shipments has fallen 52% since the start of the month, a steep decline that suggests manufacturing activity will recede as the world economy slows further. The drop in the Baltic Dry Index underlines the extent of the U.S. financial crisis' impact on growth in emerging markets and puts into doubt the ability of these economies to expand with North American and European financial markets mired in uncertainty. A drop in the index creates a domino effect across commodity types, so prices are likely to fall further. Global markets are in turmoil as banks collapse and governments either take direct control or promise to bail out lenders. The BDI is a daily index of the 22 main dry-bulk routes shipping raw materials such as those needed in the production of steel, coal and grains. It is a predictor of global growth by showing demand for the raw materials required for manufacturing and construction. "The index is a good global growth proxy," said Michael Lewis, global head of commodities research at Deutsche Bank. Currently the market consensus is that global growth will be 3.5% this year, but the index is indicating growth will be closer to 2.5%, Mr. Lewis said. Iron-ore prices have declined in the past month by 25% between India and China and 24% between Brazil and China. Base metals are also down. Copper traded on the London Metal Exchange has fallen 31% since its July record high of $8,940 a ton and global steel prices in September were down 9.8% on the month. Chicago Board of Trade nearby wheat futures prices have fallen by roughly 16% since the end of August. Energy prices are expected to be the next commodity to post sharp declines, Mr. Lewis said. Deutsche Bank forecasts oil to fall toward $85 a barrel before the end of 2008.

Ford Motor's, Honda's September U.S. Auto Sales Tumble as Credit Tightens Ford Motor Co. and Honda Motor Co.'s U.S. sales of cars and trucks tumbled in September as tighter credit scared off consumers. Sales at Ford, the second-largest U.S. automaker, fell 35 percent from a year earlier, the Dearborn, Michigan-based company said in a statement today. Honda reported a 24 percent drop. Industrywide sales probably will fall for the 11th month in a row, the longest slide in 17 years, as the financial crisis caused lenders to toughen loan standards and consumers curbed spending. Sales already had dropped 11 percent through August, in part because of high gasoline prices. Ford's decline ``is an indicator of the state of the industry, with the credit problem hitting all segments, all types of vehicles,'' said Dennis Virag, president of Automotive Consulting Group in Ann Arbor, Michigan. ``People of all economic backgrounds are going to be impacted.'' The annual sales rate for September may drop to 13 million cars and light trucks, the average estimate in a Bloomberg survey of 36 analysts and economists. The rate was 16.2 million in September 2007, according to data compiled by Bloomberg. U.S. yearly sales reached a record 17.4 million in 2000 and averaged 16.8 million this decade.

Honda, Nissan Join U.S. Auto Sales Slump; Toyota Declines Most Since 1980s Honda Motor Co. and Nissan Motor Co., the only big automakers still adding U.S. sales through 2008's first eight months, couldn't escape an industrywide plunge in September as the credit crisis kept buyers away from showrooms. Sales for Asia-based brands fell 30 percent, led by Toyota Motor Corp.'s 32 percent tumble, Honda's 24 percent drop and a 37 percent decrease for Nissan. Toyota and Honda haven't posted declines that large since the 1980s.The results dragged U.S. market share for Japanese and South Korean automakers to the lowest since April 2007 after lenders tightened standards and bank failures chilled demand. Last month's total was 39.9 percent, down from 42.1 percent a year earlier, according to industry-research firm Autodata Corp. Even companies with compelling new products aren't finding buyers, said Jesse Toprak, director of industry analysis for automotive research firm Edmunds.com in Santa Monica, California. ``The main reason for the decline is the lack of consumer confidence,'' Toprak said in an interview. ``A lot of consumers have the ability and desire to make a purchase, but are going to wait and see how things turn out.''

Manufacturing in U.S. Contracts at Faster Pace Than Economists Estimated Manufacturing in the U.S. contracted in September at the fastest pace since the last recession as the credit crisis spread beyond Wall Street. The Institute for Supply Management's factory index dropped to 43.5, the lowest level since October 2001 and below economists' forecasts, the Tempe, Arizona-based group reported today. A reading of 50 is the dividing line between expansion and contraction. Today's figures show that manufacturing, which had weathered a domestic slowdown because of record exports, is now starting to buckle as expansions from Japan to Germany falter with the global financial crisis. The housing slump has already spread to autos, and other industries may follow as mounting foreclosures, tougher lending rules and rising unemployment choke off spending. ``Manufacturing could be on the brink of a collapse,'' said Lindsey Piegza, a market analyst at FTN Financial in New York. ``There are no orders, no jobs and there is really no incentive for businesses to invest. The credit crisis is compounding the problem.''

 Banking crash hits Europe as ECB loses traction The Dutch-Belgian bank Fortis, Britain's Bradford and Bingley, and Iceland's Glitnir, were all partially or fully nationalized after failing to roll-over debts in the short-term money markets, while the French state pledged support for the Franco-Belgian lender Dexia after the share price collapsed on reports of a capital shortage. Germany's Hypo Real Estate, a commercial property lender, was rescued with a €35bn lifeline from a consortium of local banks. The lender has $560bn in liabilities, almost as much as Lehman Brothers. Europe's credit markets have come close to seizing up as three-month Euribor jumped to a record 5.22pc and OIS spreads rocketed to 113 basis points. "The interbank market has collapsed," said Hans Redeker, currency chief at BNP Paribas. "We're now seeing a domino effect as the credit multiplier goes into reverse and forces banks to cut back lending to clients," he said. Mr Redeker said the latest alarming twist is a move by banks to deposit €28bn in funds at the European Central Bank in a panic flight to safety. This has jammed the mechanism used by the authorities to shore up the financial system in a crisis. "The ECB is no longer able to inject liquidity because the money is just coming back to them again. This is extremely serious. If monetary policy is no longer working, there is a risk that the whole system will blow up in days," he said. The euro plunged on Monday as the wave of bank failures hit the newswires, dropping 2pc to $1.43 against the dollar. It recovered slightly as the US Federal Reserve flooded the markets with $630bn of dollar funding with fellow central banks in the biggest liquidity blitz in history. Analysts say German finance minister Peer Steinbrueck may have spoken too soon when he crowed last week that the US would lose its status as a superpower as a result of this crisis. He told Der Spiegel yesterday that we are "all staring into the abyss". Germany - over-leveraged to Asian demand for machine tools, and Mid-East and Russian demand for luxury cars - is perhaps in equally deep trouble, though of a different kind. Carsten Brzenski, chief economist at ING in Brussels, said the global crisis was now engulfing Europe with devastating speed. "We are at imminent risk of a credit crunch. Key markets are not functioning properly. The Europeans thought the sub-prime crisis was just American rubbish that the US should clean up itself, but now they are finding out that it is their rubbish too," he said. Data from the IMF shows that European banks hold 75pc as much exposure to toxic US housing debt as US banks themselves. Moreover they have mounting bad debts from the British, Spanish, French, Dutch, Scandinavian, and East European housing markets, where property bubbles reached even more extreme levels that in the US. The interest spread between Italian 10-year bonds and German Bunds have ballooned to 92 basis points, the highest since the launch of the euro. Bond traders warn that the spreads are starting to reflect a serious risk of EMU break-up and could spiral out of control in a self-feeding effect.
Freeze in lending extends to fourth quarter

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