Yesterday was a big day for history books. President Obama signed the most elaborate set of financial regulations since the Great Depression into power. Yesterday was also Ben Bernanke’s semi-annual Humphrey Hawkins Testimony. Both came at a time when the markets, investors, and the American public are looking for direction. Recovery strength is uncertain, markets remain hesitant, and elections loom around the corner. Some believe Bernanke stuck to the script by not lending a direction. Some believe he should have given more of a glimpse into the Fed’s actual plan, if there is one. There are those too who believe the Fed is more confused than they let on. In spite of this, my general sentiment about the economy is that we are in a good place-the middle. Strength of growth has waned but likelihood of a double-dip in our economy has also diminished. Economic data do not continue to meet expectations, yet they still reflect strength of the system. The markets have slowed their delusional press upward yet hold solidly the growth reflected in consumers and investors.

Listening to Bernanke’s testimony yesterday illustrates three major issues which largely overlap. The first is, should we fear deflation or inflation? The second is, should the Fed use additional stimulus or is it hindering growth by doing so? The third is, will the increased regulation hinder business or simply add to the deficit and negatively affect long-term fiscal sustainability?

I have long claimed that market confidence is the core of all change, actual or false. Talk of a double dip began when the markets and data began to show signs of pull-back or slowing. We feared losing the momentum gained in the first half of the year as a result of stimulus. But, on the contrary, we should fear rapid growth. Severe upswings are as dangerous, if not more, than severe down-turns. Just as we like when the economy begins to slow and rates are high, the Fed has room to move, we should like the idea that there is potential for growth, rather than imminent inflation due to the economy heating up too fast. In my opinion, the Fed has done a good job here of inflicting the perfect attitude onto the markets. We are still growing, just not so fast. I like this article: Guest Contribution: Double Dip? Seven Reasons Why Not* http://blogs.wsj.com/economics/2010/07/19/guest-contribution-double-dip-seven-reasons-why-not/

Now, I can hear you saying, “But what about unemployment?” As Bernanke stated today, we are seeing a “gradual decline” in unemployment. As the economy grows at a moderate pace the unemployment rate will equally abate. It would take an inflationary scenario to stimulate so much growth as too immediately reduce the American jobless rate. If the GDP data show 2.6%, as estimated, at the end of the month, that will put this year’s growth at the fastest recovery rate in thirty years. The risks of inflationary or deflationary outcomes seem to be contradictory. There is the element of cheap money causing hesitation in banks to lend which makes the Fed an agent of deflation. However, we can all agree, a deflation situation such as Japans is highly unlikely given the unconventional tools the Fed has used and has left to use if the situation warrants. The weaker economic data that came out over the past month prompted speculation of increased monetary stimulus. To this Bernanke answered, “We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed to foster a return to full utilization of our nation’s productive potential in a context of price stability.” He also said, however, that the Fed remains prepared to eventually raise interest rates and shrink their record balance sheet. By doing so the Fed has projected into the markets the confidence that it still has the ability to act. Confidence is all it takes.

 The Dodd-Frank Bill, named after two Democrats, Senator Chris Dodd of Connecticut and Representative Barney Frank of Massachusetts, has three main facets. First, it gives the government new authority to unwind failing financial firms that may threaten the entire system. Secondly, it imposes new rules on derivatives markets. Lastly, it creates a consumer-protection agency at the Federal Reserve to monitor everything from home loans to credit cards. The argument has been whether the bill will hinder or protect and promote long-term economic growth. Only time will tell the answer to that as multiple newly formed federal agencies must now begin writing the regulations that will give the framework for enforcing the law.

Bernanke used the words “unusual uncertainty” to describe the state of the markets and the economy yesterday but also said the Dodd-Frank Bill made “significant progress” toward reducing the likelihood of a crisis such as the one have just lived through. What I’ve come away with after watching the Humphrey Hawkins Testimony and the passage of FinReg is that we are right where we are supposed to be. We don’t need to be racing upward in order to prevent falling back.

Interest rate futures markets are increasingly baking in higher rates. A guru pointed out on Tuesday that Eurodollar contracts four years out have 3M Libor back around 4.75%. Then we have our classic 2/10yr yield curve at unprecedented record highs, today around 275, with the 10 yr adding 11 basis points since this morning’s jobless claims. As Bernanke said in his Testimony before the House Budget Committee yesterday, the rise in yields partly reflects deficit concerns, i.e. inflation, as well as signs that the pace of economic contraction may be slowing. There are also less obvious reasons, as in China dumping the dollar as its main reserve and treasury selling to hedge mortgage buying as the housing market show signs of bottoming. Is the rapid rise in yields premature or is it a hint that we are in for a ride?

The argument for rate action being premature is the point that foreign selling of longer dated maturity treasuries and mortgage-related selling are temporary phenomena and the market will digest these and stabilize. This may be, but just as some wanted to dismiss the inversion of our yield curve 2 years or so ago as “different this time” and not a signal of recession, I think it would be just as unreasonable to dismiss the steepening.

The other side of the coin has inflation being the cause of the recent spike in yields. There is the question if officials have gone too far to curb threats to financial instability. We heard the Kansas City Fed President Hoenig say the rapid rise in yields signals early market concern over inflation and the Fed must be alert to the market’s message. Although I lean more to this side, I don’t feel the need to adopt an extreme view. The expectation that the Fed will someday have to release all these treasuries on the balance sheet into the market may fuel the yield rise in part but it’s a little ignorant of anyone to think that this could happen in one fell swoop. Just as the buying is a measure of quantitative easing to help drive down mortgage and traditional lending rates it can be used as fire for quantitative hiking.

As Bernanke put it yesterday, “even after recovery gets under way, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further.” That’s not to say that Bernanke himself is not worried about imminent inflation but does address the uncertainty with which policy will be applied going forward to maintain fiscal stability.

On a shorter-term note, we have May jobs data tomorrow. The majority seems to see it falling around -500K, but more significantly, the unemployment rate around 9.2%. If this is the case, it will be an employment scenario not seen since 1983. Bernanke warned in yesterday’s testimony that we can expect to see higher unemployment in the coming months. If these number s are better than expected, expect those in the camp that believe our steepening yield curve to be a sign of certain economic recovery to be saying “I told you so.” If not, use it as a chance to get in on the flight.

The media just likes saying the word “pirate,” but I suppose that’s exactly what they are. The name for these marine criminals makes me think of Gooneys or some other fantasy movie that I pretended to be a character of as a child. All kidding aside, not that I wish any harm on crew trying to do their job, it’s refreshing to hear about something other than the global economy, politics, or the great scammers of our time. Now that everyone’s safe, the pirates are dead, and Thai protesters appear to be settling down, we have no choice but to get back to the aforementioned topics.

This may not be the first time we are here but right now the markets are sensitive. There’s less of a resolve in either direction to be confirmed by data or headlines.  Although we are already in the process of laying the groundwork for a foundation, the upcoming earnings reports and data points will be key in establishing either a footing or a bit of disappointment that the market has gotten ahead of itself. This week’s Goldman tomorrow, JP Morgan Thursday, and Citi Friday are especially pertinent. I’d like to insert that the market’s recent overzealousness is what has set it up for possible disappointment. Alan Abelson puts it perfectly, “…the exchange struck us as symptomatic of the insatiable yearning of Wall Street, in general, and sell-side analysts, in particular, to uncover some sliver of bullishness beneath the dismal surface of the unvarnished truth.” (See Barron’s: Barrons Online - More Meltdown) But I do think hangovers are part of this rebuilding process.

I’ve heard talk that lots of factors could make this week bond positive. The first is earnings, second is Fed buying, and third is data, and fourth is that technically speaking, it’s time for a pull-back in stocks, which normally fuels treasury buying. The only solid factor here is that the Fed is committed to keeping borrowing rates low so buying is definite. The other factors have as much potential to be bond negative as positive and it will be interesting to see how the markets digest each. If we have another stock positive week it will only force the hand of the Fed to lay out more cash and so fight the inverse between stocks and treasuries. Today being Easter Monday, action is not at all indicative of what the rest of the week will bring but we are seeing stocks make a comeback on the day on optimism about bank earnings. To be continued.

In a 60 Minutes interview back in March when Bernanke was asked what he thought would be the first signs of recovery he said this: (BERNANKE)”one sign would be that a large bank is successful in raising private equity. Right now, all the private money is sitting on the sidelines saying, ‘We don’t know what these banks are worth. We don’t know that they’re stable.’ And they’re not willing to put their money into the banks.” Goldman was just able to raise $5.5B in private equity dedicated to buying private equity investments on the secondary market as part of a plan to pay back $10 Billion in government funds. Since they have already been able to raise $6B, I don’t think this should be taken lightly.

So, this week here in the U.S. we have a big data week. We have PPI, Retail Sales, and Business Inventories on Tuesday, CPI, Empire Manufacturing, and Industrial Production on Wednesday, and Housing Starts and Philly Fed on Thursday. The numbers could be totally benign or, in search of treasure, the market could take anything better than expected and run, further setting itself up for disappointment as the foundation is laid. I’m still not ready to be bullish equities and I’m still not ready to be bearish treasuries. This should be a fun week for traders though.

The theme with markets and traders this week is a focus on whether or not the market has a clue. I’ve seen several interesting articles on the topic this morning already, including one cleverly titled in Barron’s: (Barrons Online - Promises, Not Problems, Occupy Markets). The stock market’s disregard for a devastatingly weak jobs report deserves some speculation, as does the fervor with which it has recently rallied. Being from the fixed income side, I hesitate to think the stock market may actually know something the rest of us don’t. Still, it would be nice if it did.

As pointed out this morning in the Journal, (WSJ.com - It's Starting To Look a Lot Like November) the hallmarks of a bear market rally are still evident. Although we have stronger drivers than what spurred the bear rally in November, we have reached a similar turning point. This will be a tell-tale week as first quarter earnings releases begin.

On the bright side, if this is just another happy bear, there is mounting evidence that the market has begun forming a solid foundation. It’s one thing to rally with no redeeming data to inspire it and another to rally briefly with some sturdy support. The week before last we got signs of improvement from home sales, Richmond Fed, durable goods orders, and University of Michigan consumer sentiment. Last week we saw improvement in auto sales, pending home sales, and manufacturing.

This week we have our eyes on market reaction to Treasury issuance (just announced: $35B in 3 yrs and $18B in reopened 10 yrs Wednesday, after $6B TIPS auction tomorrow), Fed buying ($2.35B in 10-17yrs today), and earnings releases. For data, we have consumer credit tomorrow, wholesale inventories on Wednesday, new and continued jobless claims on Thursday, and the budget deficit on Friday.

My forecast is for some more bottom-forming/foundation building in equities. And that could mean we bottom again. I’m not ready to be bearish fixed income on the same token, in spite of more issuance. The Fed is determined to ease credit and the foundation building process should fuel a flight to safety. However, the historical inverse relationship as we know it is slightly off kilter (I love talking about the tug-of-war between equities and treasuries, especially when it’s thrown off). Today is a perfect example. Treasuries are selling off with equities. Also, why did treasuries sell off across the curve after such a dismal jobs report? Because job losses are a lagging indicator? It being baked in or worry about inflation caused by quantitative easing is kind of stale. Although I don’t think the market is done, I do think it’s possible that market psychology is beginning to change. We already know ‘not bad’ news is enough. For all rights and purposes the inverse relationship is still there because equities are not going to be allowed out of the cage until rate market intervention is not absolutelynecessary to facilitate market functioning. Intervention alone should be considered ‘bad news.’ You know, Fed buying (etc.) supports fixed income, which holds rates down, which encourages borrowing, which scoots confidence in equity markets. At least, that’s what they hope is the consequence.

I think the fact that the equity market can rally with a partial inspiration from easing mortgage rates is a red herring. While rates are eased synthetically there is still the air that markets cannot function on their own. Whether they ever will again is another story but I don’t long for the days where I have to search for something to write about.

In spite of the disappointment after today’s Fed buying that took bids out of the bond market, stocks don’t get positive flow because of auto industry concerns. Last week’s treasury buying by the Fed in effort to lower consumer borrowing rates surprised to the upside at around $7.5B in shorter dated maturities so this week only buying $2.5B was deflating for prices. Coincidentally, as a good mood in stocks tends to take yields higher, this week’s dismal mood in the equity market kind of reassures yields will be held down so not as much buying is necessary. We keep in mind that month end/quarter end has accounts taking profits on the recent rally but although the Fed has a planned amount of buying in the works, it appears the quantitative easing through treasury buying can be circumstantial. 

Theory in point is that this implementation is going to allow some ultimate official control and it’s a good thing. The normal push-pull will be shaken up and so asset flow won’t be so indicative of ‘safety.’ Issuance drags on price but bad news flight to quality supports it. There’s enough bad news buying of treasuries going on with auto makers in the spotlight and jobs numbers expectations this Friday that the Fed doesn’t need to buy as much to hold yields down. Inversely, an equity sell-off like the one we’re seeing today would normally cause the bond market to go bid. Although this is supportive, the bond market has its own news, i.e. the disappointment after less Fed buying than expected, so less of a swing.  I’m sure I’m not the first to realize that or point it out but I’m stating it because I think it shows commitment to reduced volatility on the part of the government which could pull the plug on option premiums in rate space and maybe even pull some liquidity back into the market in outright futures.

So, Wagoner. Now, I know everyone has been saying for a while that the government should not bailout the auto industry because it’s too socialist of a solution and then what other industries could go knocking on the government’s door? And officials listened. There is less of an attack about giving them money because allowing them to go bankrupt is an option on the table.  Again, as with the case of AIG, the government is now a business partner because they chose to step in. It just seems so much simpler of a situation in this case though because of bankruptcy restructuring. Frankly, I don’t see why the market is so concerned about it. The reason it’s easier for the government to let them go bankrupt rather than just throw money at it is because its failure will be easier to absorb.

Fed speak tomorrow could be of more interest than usual with Philly Fed Prez, Plosser, likely to talk about inflation concerns resulting from highly stimulating monetary policy actions. It’s a worrisome topic that’s easy to ignore in the do or die times we’ve been seeing so his speech could have some impact on rate markets (at least here). The ECB rate announcement is Thursday so rate market action over there will have that as a driver.

This bottoming process/foundation building phase we are apparently in with equities is going to be sensitive to data now as well as headlines. There’s been enough stabilization that positive (or not so negative) data can be taken seriously and I like the macro situation returning as a force. For a while, the market just expected bad data and when it was worse than expectations there wasn’t really much of a reaction. It was also numb to better than expected data as it was easily dismissed in the face of headlines.  U.S. employment figures Friday could mean the difference between another bottom and support if the housing market price data, confidence and PMI show signs of possible bottoming tomorrow. Look forward to hearing thoughts about GM.

http://thehill.com/leading-the-news/senator-no-consultation-on-asking-wagoner-to-leave-2009-03-30.html

Historically the bottoming process can have some wild swings while the market builds itself a new foundation. Although stock indexes are 22% off their lows it’s still contrarian to think this is more than a bear market rally. However, it does appear to be part of the bottoming process, which is almost as comforting.

Yesterday’s existing home sales number showed a surprising spike to the positive, up 5.1% while consumers are taking advantage of the deep discounts resulting from foreclosures. The median home price is down 15.5% from last year. Although the latter isn’t a happy fact, it’s what needs to happen for buyers to sniff around.

The stock market likes the details of the PPIF but a pull-back today doesn’t surprise me. Although it will take a while to demonstrate whether or not it will work it is the first time a direct attack on toxic assets has been implemented. All other attempts have been pulled back before they had a chance. The same risks are still there in valuing toxic (aka legacy) assets on banks’ balance sheets because only the owners actually know what they’re worth. Not only can they decrease in value because their elements default but they can increase when recovery comes or an actual market is created and then by banks selling they expose themselves to opportunity risk. Another detail that may make people weary is that PPIF encourages using leverage. A private investor can split the cost in half with the government and then finance it to purchase up to six times more. The tax payer then makes half of whatever the private investor gains. The plan will work if investors find a reason to buy and if banks find a reason to sell.

Strategic planning on the part of officials sent yields to the floor last week when the Fed announced its plan to purchase treasuries. Prices need to be supported, not only to keep yields low in effort to lower borrowing rates but because treasury issuance is funding the bailout. When the stock market has a good day (or days) treasuries tend to suffer as a result of asset flow. The details of Geithner’s plan released yesterday made the market optimistic that our government has the ability to fix our problem.  Normally when stocks rally like that we see a spike in yields but that didn’t happen.

So now the next few days will tell the truth about equities and the next few weeks about our recession timeline. This afternoon’s 2 yr auction will be closely watched because it’s the first since details of the Fed treasury buy-back and PPIF (or P, whatever). You’ll notice treasury price charts look like they have just readjusted into a higher range, but are still sloping downwards. Questions, comments please.

http://online.barrons.com/article/SB123777960194411389-email.html

I might get some hate mail for this but any idiot knows you can’t retain talent without paying for it. Here’s where I insult government employees. Now that AIG has been given upwards of $160 the tax payer’s stake is 80%. AIG employees are in essence government employees. Would talented individuals choose to work there without the prospect of compensation that rewards their talent? 

On Squawk Box yesterday Jack Welch discussed the need for leaders of the new partner in these giant ailing firms, the government, to act like business people. The following excerpt comes from The Welch Way (http://www.welchway.com/)
 and sums up his comments on CNBC:

There is a lot of heat over the AIG bonuses. Without commenting on specific bonuses, I want to comment on the process... People have to understand that the government is now the majority owner of AIG. They have paid 165 billion dollars and now own 80% of the company.  They are, in effect, responsible for the governance of the institution. The CEO and government representatives (like a corporate board and the CEO) have to work together on issues like investment strategy and compensation matters. They can't be public critics (second guessers) of their (and our) company. Tearing the institution apart with carping will not improve our chances of getting our money back.
-Jack Welch, March 17, 2009

Now apparently AIG was contractually bound to pay these bonuses, some of which for employees who no longer work for the company. The money was supposedly left out of the agreement between AIG and the government.  That’s something I would throw stones at.  Also, I need to mention that the bonuses amounted to much less than 1% of the money received from the government.
If we are worried about percentages of bailout money, I suppose it’s time to ask why there is any current focus on initiatives that are unrelated (in any way) to the economic crisis at hand, initiatives that also cost tax payer dollars.

If you know me at all you know I idolize Larry Kudlow. As interesting and provocative his opinion may be, it’s one that no one has yet pointed out. He says the investor is partly responsible for his or her losses because he or she is responsible for due diligence. I mention that because I believe a more outrageous issue to be the suggestion that the government should aid in recouping losses realized by Madoff investors.

Politics are making a mountain out of this mole hill. I agree with Welch that the accusatory approach is counter-productive and this isn’t the only issue that’s creating division among constituents. It is exacerbated by the administration’s America-splitting pronouncement that spreading wealth is a great idea, and is confirmed by the attention showered upon energy, healthcare, etc. initiatives in a time of economic crisis.

In spite of the public’s outrage the market still managed another positive day. Consensus is that we are in a bear market rally that could last a few more days just to add to the disappointment when it’s over. Just thought I would vent a little. Thanks for listening.

 

Either the market is utterly confused because Obama said that now is a good time for long term investors to buy stocks or there’s little downside risk left in the stock market. I don’t disagree with the President but the latter explanation is quite unlikely.

Under normal circumstances if the market doesn’t fall a good clip on jobs data as dismal as what we got Friday on top of sizeable downward revisions to the two months prior I might read into it that the market is done falling. That’s easy to doubt lately though. Like everyone else, I’m thinking there has to be a different explanation. Many reasoned that since the number was roughly in line with expectations the damage was already factored in so short covering took the market back into positive territory, which is quite logical. However, knowing what we know about seasonal adjustments and unfavorable revisions during a recession, I want to doubt that one too.

Alan Abelson talked in his piece this week about how bottom callers have thinned out. Obviously they’re sick of being wrong. After all, three out of four industries are shedding jobs, with total job losses over the past four months reaching 2.6 million and 4.4 million since the recession began. It seems that market players, officials, and investors alike have finally come to terms with how dire our situation is and how little there is to be hopeful about. You get that feeling when you watch the news, read the paper, or simply talk to the person next to you. On Sunday the World Bank predicted that the global economy would shrink for the first time since WWII as well as that global trade would decline for the first time since 1982 at a rate not seen since the 30’s. It’s also no secret that it’s our (the U.S. that is) fault.

The market will spend the week first digesting jobs data and then debt supply, both corporate and government. The market is going to have a hard time getting any traction while there’s no clarity on plans to remove toxic assets from banks balance sheets and so far today has chopped around in anticipation. I know a lot of people who feel better about the market having no direction than the one it has had for the past few months.

Since I am not afraid to say I am afraid to be wrong, I’m not going to call a bottom here. But I will say this, usually when everyone gets on the same page the page turns.

About Obama making market calls:

http://www.foxnews.com/politics/first100days/2009/03/03/obama-good-time-buy-stocks/

About the World Bank’s predictions:

http://www.iht.com/articles/2009/03/08/business/econ.php

 

Oddly enough, I came across an article with the same I title as I gave my piece last week. It’s called Commonwealth and is from the February 6th issue of NY Magazine. This article had a similar connotation to mine except with a much more specific and controversial thread. Now, I’m not saying I agree or disagree, but I like that someone took the time to point out the other side of the coin. Its subtitle reads, “Sure, we want to see Wall Street humbled. But beggaring these guys is bad for New York.” I’m hoping, and not alone on this, that we see another book out of Michael Lewis about the demise of some gluttonous financial operations. Liar’s Poker is the first book I read when I decided to enter this realm. This writer, though you can tell he doesn’t have the depth of knowledge on the subject that those in our little financial world do, believes, “Wall Street has a warped incentive ecosystem, but it’s evolved that way because, over the years, it’s worked.” And he thinks Michael Lewis is wrong about the industry being doomed. I will confess I also disagree with Lewis. Please read this. It’s short.

http://nymag.com/news/intelligencer/54080/

Although a staggeringly unfathomable number, we have selectively disregarded the budget deficit this week. After all, it’s last week’s news. This week the AIG bailout restructuring holds the candle. The first attempt was hastily put together back when bailing out was barely considered as an option. Now that officials have more of a handle on a strategy it’s only right that they should use the same one on AIG. The Treasury is exchanging $40B of the preferred shares they currently hold for preferred shares with terms that more closely resemble common equity as well as another $30B line of credit. The Treasury will now have a 77.9% interest in the company. (See front page of today’s WSJ)

Equity markets are choking the AIG plan down being reminded of how hopeless the financial world seems but the treasury market is actually able to take a safety bid from equity’s slide while it has a break from issuance this week. Next week we get 3’s, 10’s, and 30’s. The curve has recently been pushed to the steepest levels since Nov and now we call the 2-10-yr yield spread flat when it runs under 200. Next week’s issuance is likely to push it even wider.

The question is no longer whether or not the government will spend the money it’s what they will spend it on. The Financial Stability Plan will be in textbooks from here on with the same regard as the New Deal. There are just as many, if not more, acronyms invented in its progress. The most prominent at the moment are TALF and PPIF. The decision of the government to buy toxic assets off the sheets of financial institutions is the solution that would stem the need for nationalization. The risk is in how truthfully they can be valued. As soon as details about the PPIF are released, I’ll be sure and post them. I don’t mean to be such a Debbie Downer but every time we wait for THE answer, we are disappointed. Just a heads-up.

I'd like to find out your opinions on nationalization and, more specefically, this stress test idea. It sounds to me like another creative way of stalling the public from demanding answers. But will there be any?