Andrew Busch

Over the weekend, the bad news has returned with the volume turned up to a Spin Tap level of 11. This has shaken the equity markets hard. This is what I was concerned about last week and why I thought we’d trade ranges. To recap, my call was: “We’re going to need to spend time bouncing around in ranges from the S&P 500 (780-840) to the 10 year note (2.5% to 2.9%) to the US dollar (82-87) before we can gain certainty that the worst is over and that our past isn’t going to catch up to us.” Well, the past was closer than I realized as the big stories out today are the big stories for the end of 2008: autos and banks.

The Obama administration has forced out the CEO of GM by threatening to withhold additional support. Also, the Obama Autos task force rejected the turnaround plans of General Motors Corp and Chrysler LLC and warned both could be put through bankruptcy to slash debts according to Reuters. “The announcement by the White House autos panel headed by former investment banker Steve Rattner marked a stunning reversal for management at both automakers and for GM investors and creditors who had bet on a softer line. “We have unfortunately concluded that neither plan submitted by either company represents viability and therefore does not warrant the substantial additional investments that they requested,” said a senior administration official, who asked not to be named.”

Next up, US Treasury Secretary Geithner dropped this bomb on the markets from his appearance on NBC’s Meet the Press: “Some banks are going to need some large amounts of assistance.” He said this to explain why the PPIP was needed and why investors in the program should not be taxed. He added that otherwise they’ll lose confidence in the plan. During his circuit of the Sunday morning talk shows, he also mentioned that the US Treasury has only $135 billion left of the $700 billion TARP money which further underscores the need for the public-private program to aid banks. Remember, Congress last week in the budget talks made it clear they are not willing to allocate additional money for the banks that the Obama administration requested.

Unfortunately, all of these comments put the bulls-eye back on the financial sector.

Banks had a bad end to the week after being summoned to talk to President Obama. He beat them up on executive pay and warned them not to return TARP money. Today, the big banks are under pressure with JPMorgan and Bank of America Corp. dropping. The big news from Friday was that JPMorgan had a “tougher” month in March and Bank of America’s trading book “was not as good” as in the first two months of the year, chief executive officers Jamie Dimon and Kenneth Lewis told CNBC.

Again, it was HSBC and Citigroup that started the rally in equities two weeks ago when they said that they were having great quarters. Now, this is in question for the entire industry and earnings will be crucial over the next 3 weeks. The news out overnight on UBS, on a Spanish bank bailout, on a failed Scottish property lender have shown that the bank problems remain global. The G20 will not solve these issues, but the US at least has a plan to deal with the toxic assets.

The questions the world will ask the US are twofold: will the cure work and will the cure be worse than the disease?

With huge equity rallies from the lows across Japan, US, and China, markets are trying to decide if this is anticipation of growth or if it’s the euphoria from surviving a near economic-death experience. Unfortunately with retail sales and industrial production collapsing around the globe, it should come as no surprise that earnings for companies worldwide are a disaster.

The canaries in the global trade mine are China and Japan. Chinese growth is expected to slip to 6% this quarter as the global economy has seen a massive drop in demand for their exports. Japan is experiencing a similar situation. There are questions being raised over the Chinese stimulus package’s ability to generate economic growth to stimulate earnings growth. For the first time on record (since Feb 2007), Chinese industrial companies profits dropped for January and February. Net income cratered 37.3% from a year earlier to 219.1 billion yuan ($32 billion) according to the Chinese statistics bureau.

On Thursday, the Commerce Department released updated US GDP figures and earnings for US companies. In the final months of the year, US corporations earnings contracted by 16.5% and saw $250 billion disappear. The financial sector remains the poster child for the global economic collapse and it’s profits fell $178 billion. This the steepest drop in 55 years and Q/Q was down more than 20% according to the WSJ.

The big question remains: do we ignore what is happening currently and focus on the potential first shoots of growth this spring? Or do we shift from a focus of survival/solvency to returns? As I posited this week, we have clearly found a bottom for equities and need to find earnings to support an additional rally. Best Buy was a good first step. 16 more companies are set to report and may give us some insight into the future. KB Homes said that it’s fiscal first-quarter loss narrowed sharply amidst fewer write-downs.

As far what the near-term the future, BMO Capital’s Mark Steele writes, “Though many groups are still near their lows, the rates of decline of some cyclical groups have turned the corner and have first-stage outperformance trends: Steel, Home Builders, Construction Materials, Fertilizers & Ag Chemicals. Also, the “hiding grounds”, or consistent outperformers: Biotech, Pharmaceuticals and Utilities are breaking their outperformance trends.”

Without question, the market is looking forward and this is reflected in the big rallies from the lows. However, we’ve run a long way on a series of positive data/information that has come out over the last two weeks. We’re going to need to spend time bouncing around in ranges from the S&P 500 (780-840) to the 10 year note (2.5% to 2.9%) to the US dollar (82-87) before we can gain certainty that the worst is over and that our past isn’t going to catch up to us.

Yesterday, we had some questionable reporting on US Treasury Secretary Geithner’s comments on the US dollar. Geithner was commenting on a Chinese proposal to develop a new world reserve currency. Appearing in Congress on Tuesday, Geithner said he didn’t think it was a good idea to replace the US dollar as a reserve currency. Both Ben Bernanke and Barack Obama said the same thing. Yesterday, Geithner said he was quite open to China’s suggestion of moving toward a SDR-linked currency system. He added that the dollar’s role in global financial system depends on establishing sustainable fiscal position.

The US dollar immediately lost 2% of its value against most major currencies. Then Geithner back-tracked and said he that the US dollar would remain the world’s reserve currency and that a strong dollar was in the US’s interest. The US dollar quickly recouped most of its losses.

Unfortunately, this reflects a lack of dexterity when it comes to providing information to the markets. This occurred on February 9th when Obama/Geithner announced their bank rescue plan. Had they said, “We are working on a plan and today we’ll give just an overview of what we are doing”, then the markets would likely have not aggressive sold financial stocks due to the lack of details. Instead, Obama told the world in his first primetime press conference that Geithner would release a detailed plan and the rest was history.

Imagine what would’ve happened yesterday if Geithner had said, “We have no change in our US dollar policy and we believe the US dollar will remain the world’s reserve currency. Now, the Chinese plan is interesting, but we’ll have to study it.” Nothing, nothing would’ve happened. Now, we have tremendous uncertainty created yet again by the US Treasury and this will make foreign investors nervous.

For an administration that has an extremely effective mainstream media campaign on the budget and the need to fix the economy, it’s perplexing that they do such a poor messaging job on critical financial market issues.

Apparently the WSJ agrees. In their Op-Ed entitled, “China and the Dollar”, they make the point that the markets don’t like Treasury talking down the dollar’s status. “Hu Xiaolian, a vice governor of the (Chinese central) bank, said Monday that “investing in U.S. Treasury bonds is an important component of China’s foreign currency reserve investments.” She added: “We are naturally relatively concerned with the safety and profitability of U.S. government bonds.”

“Ms. Hu isn’t alone, and we only wish the Treasury, the White House and the Fed were equally as concerned. The dollar’s status as a reserve currency gives the U.S. enormous advantages, and it should be protected ferociously by our public officials. It means we don’t have to repay our debts in foreign currency and that our borrowing costs are cheaper. To the extent that the rest of the world follows a dollar standard, it also gives us far greater global sway.”

“….And it means that when the U.S. falls for the temptation to debase its currency, it sends shocks through the entire global trading system. The dollar’s sharp but needless gyrations during this decade are in our view one of the major causes of the housing and commodity asset bubbles that led to the financial panic and global recession.”

As the new guys in DC get settled and get more of their staff confirmed, I expect this volatility of commentary to be reduced. In the meantime, US Treasury Secretary Geithner speaks at US House of Representatives at 10 AM ET……

Quiz Time!

Which of the following has helped make stock prices go up over the last two weeks?

1. Positive economic data
2. Positive bank earnings comments
3. Ben Bernanke: no failure of major bank
4. Fed QE program
5. Tsy Toxic asset plan details
6. Positive housing sales and prices
7. ? on suspending MtM and reinstalling uptick rule.
8. Bonus claw back bill stalling.
9. Soaring mortgage applications
10. Stalling of Obama budget
11. All of the above

Answer below….

With better than expected US mortgage applications, US durable goods, and an ECB member saying they can cut rates further, the greenback is stronger against most major currencies. The US dollar index is up .19 points at 84.05. Overnight Libor rates are mixed with spreads wide showing problems with credit: US is at .2875% v .226%, EU is at .87625% v .8675%, UK .60125% v .62%. The 3mth Libor to 3mth OIS spreads or LOIS are lower: US is at 98 v 100, EU is at 85 v 85, UK is 127 v 130. The 1yr OIS are US at .381% v .364%, EU .83% v .831%, and UK at .57%v .572%.

Global equity markets are mixed with the S&P 500 up 4 pts. With the Fed beginning to buy US Treasury securities, Tsy yields are higher with the US 10 yr note yield at 2.72% with the 2yr note at .89% with the spread at 183. The TED spread is at 103 and the VIX at 42.93. Commodity markets are softer with crude leading the way at $52.72, nat. gas is at $4.26, and home heating oil is at $1.47. Gold is at $925 and silver is at $13.23. Wheat is at 5.31 and corn is at 3.90.

Obama Media Fatigue?: Last night, US President Barack Obama gave another prime time press conference. He mainly focused on the economy and the budget, but got his growth numbers in the out years wrong. I think this has been an interesting media campaign to push his budget polices forward. Using main stream outlets like ESPN, Jay Leno, 60 Minutes, the Obama media team has attempted to reach it’s middle class target audience and get them to push their representatives in Congress. So far, it hasn’t hurt him in the polls, but Congress is growing restive over the massive spending his budget entails.

I think the President risks media overexposure. Already, this was showing up last night as the reporters were increasing aggressive follow-up questions to him. They especially questioned his logic on massive increases in spending and therefore debt and how that would be pushed down to the nations children to pay. Keep an eye on this going forward as Obama’s approval ratings inevitably drop…..

US Economic Data: Our Jennifer Lee writes, “U.S. durable goods orders unexpectedly rose in February. That’s right folks, they rose! The headline 3.4% increase brought to an abrupt halt six consecutive monthly declines. Yes, January’s 4.5% drop was revised down sharply (to -7.3%) so the February advance didn’t erase the start of the year dive, but this is a step in the right direction. Even excluding transportation, durable orders were higher (+3.9%) for the first time since last July. Glancing at the table below, it looks like the weak spots were in communications, nondefense aircraft/parts (Boeing), and primary metals….The Bottom Line: First we saw a number of positive developments coming from the housing sector over the past week. We’ve also seen more positive developments from the consumer side, with real spending higher. Add this to the list. Let’s hope that we will see growth before the end of this year.”

My Spin: Coupled with Japan announcing a trade surplus for the first time in four months is providing some positive data that economies are coming back from the depths. Don’t get crazy, but we needed to show some signs of life!

The Answer to today’s quiz is 11: Over the last 2 weeks, could we have gotten a better string of “good news” for economy and equities? Granted, the AIG situation was a side story to these 10 good things that have been happening. I would offer this as well: the financial system will not fail. This is the lesson from the turbulence and uncertainty from the fall. Industry leaders, regulators, Fed, and Treasury all pulled together and pulled us back from the abyss. From here, it’s a question of how much time will it take to recover. We know the process for banks to write-down/sell assets, raise capital, and shrink balance sheets will take longer than expected. We know the process for the housing market to stop building, work down inventories, and see prices stabilize will take longer than expected. We know that the process for the economy to recover will take longer than expected. We don’t know when all of these will occur, but it’s been a great two weeks.

Going forward to extend this rally, we’ll need to see the massive amount of cash that’s been on the sidelines come back into the market. In other words, we’re trying to decide if the veil of uncertainty has been lifted and confidence returned. I believe for the next quarter, this have been achieved. The earnings numbers for Q1 and the guidance companies give will be critical for extending the equity rally into Q2. We’ve already had the explosive rally in equities and the sell off in the buck. From here, it’ll range and grind more on this trend.

In an essay released Monday in Beijing, Chinese central bank governor Zhou Xiaochuan called for a creation of a new currency to eventually replace the US dollar as the main global reserve currency. This joins Russia in making a call to shift the global economic fulcrum away from the policies of the United States and wealthy nations. The currency impact was immediate as the Chinese Yuan dramatically strengthened in off-shore (NDF) trading.

As the world’s largest holder of US dollars as a reserve currency and US Treasury securities, China appears to be growing more and more assertive over it’s rights. They also gave notice that US Treasury, GSE, and corporate debt is not the only paper they will buy with their US dollars. At a press briefing prior to President Hu Jintao’s attendance at the April G20 meetings in the UK, the Chinese central banks vice governor, Hu Xiaolian, said that they would consider buying bonds issued by the IMF. Remember, Russia recommended that the IMF issue a new reserve currency to update the “obsolescent world economic order.”

This discussion began after Chinese Premier Wen Jiabao commented that he was concerned over the direction of US policy and had “worries” over China’s significant holdings of US government bonds. Given the “Zepplinizing” of US Treasury debt supply this coming year, the Chinese have every right to be concerned. The quantitative easing announcement last week by the Federal Reserve could also be driving the Chinese concern over the US dollar outlook.

All of this occurring at this time is not surprising. The G20 meeting in London is happening on April 2nd and the US releases its currency manipulators report on April 15th.

Yesterday, the US Treasury announced their nominee for Undersecretary for International Affairs who is responsible for US dollar policy. The nominee, Lael Brainard, comes from Brookings where she was the vice president and director of Global Economy and Development. She was the former White House Deputy National Economic Adviser and Associate Professor at MIT. Brainard has focused on competitiveness, trade, international economics, U.S. foreign assistance and global poverty.

During the campaign last year, she was considered to be a potential US Trade Representative for Obama. In this vein, she said that the US needs to have a material shift in resources within in the USTR toward more trade enforcement. More importantly at that time, she criticized the Bush administration for repeatedly failing to label China as a currency manipulator.

“We can’t keep giving China a free pass on maintaining an undervalued currency. We did that for about seven years,” Brainard said. Obama would use “existing authorities and all diplomatic means at his disposal” to pressure China and supports legislation to give the White House more tools, she said.

However in her latest article, she discusses emerging economies and how America’s traditional place as the world’s economic leader, which grew out of Bretton Woods, is being challenged by emerging countries of China, India, Brazil, and Russia. “This dispersion of economic power means that nations that once watched from the sidelines are now production and distribution hubs, service centers and financial headquarters.”

Unlike the heated campaign rhetoric, this should mean that Ms. Brainard will bring a cautious and balanced approach to working with the Chinese. This would be welcome news to the global markets and the global economy. The last thing the world needs now is a verbal trade&investment war between the US and China.

I’ll be appearing on CNBC’s Kudlow Report discussing the details of the US Treasury’s bank rescue plan.

US Treasury Secretary Tim Geithner leaked out the details of his bank recovery program over the weekend and had a early morning press conference to discuss the details of the plan. It’s complicated, it has a lot of moving parts, it attempts to involve the private sector, and no one is sure whether banks will sell these assets to create the program. Other than that, the markets are loving it early.

From the US Treasury Department, the details are as follows:

Three Basic Principles: Using $75 to $100 billion in TARP capital and capital from private investors, the Public-Private Investment Program will generate $500 billion in purchasing power to buy legacy assets – with the potential to expand to $1 trillion over time. The Public-Private Investment Program will be designed around three basic principles:

1. Maximizing the Impact of Each Taxpayer Dollar: First, by using government financing in partnership with the FDIC and Federal Reserve and co-investment with private sector investors, substantial purchasing power will be created, making the most of taxpayer resources.

2. Shared Risk and Profits With Private Sector Participants: Second, the Public-Private Investment Program ensures that private sector participants invest alongside the taxpayer, with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns.

3. Private Sector Price Discovery: Third, to reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program.

The devil’s in the details on this and there are questions already over the willingness of the private sector to work with the government due to credibility issues over retroactive taxes claw backs on executive pay. Here’s another question, why would banks part with these assets now?

To start the process, banks are going to determine which assets they wish to sell and then inform the FDIC. If a bank has written down the value of the “toxic” or legacy asset to a reasonable value (using mark-to-market), then the bank has already taken the loss on the asset. The potential return for that asset is what will drive the bank’s decision as to whether they want to sell it now or hold on to it. If it’s already written down to 30 cents on the dollar, the recovery rate or the potential return for that asset could be very high. Therefore, the willingness to sell these loans would be low. Remember, a written down loan or asset requires less capital and therefore a higher potential return.

If the bank has not written it down far enough to reflect the loans mark-to-market value or “true” value, then the bank would have an incentive to sell it. Then the question becomes, why would a private investor buy it? The private investor might be willing to absorb another 10-15% loss if the potential recovery rate is two or three times that rate. But wouldn’t the banks know this potential better than private investors? It’s a question of the recovery model for loans at this stage and whether banks are already seeing the rate improve to a point where they don’t want to part with the loans.

The financing aspect of the Geithner/Obama plan may be favorable enough to have private investors overpay for the assets. If the bank accepts the purchase price, the buyer would receive financing by issuing debt guaranteed by the FDIC. The FDIC-guaranteed debt would be collateralized by the purchased assets and the FDIC would receive a fee in return for its guarantee. Of an asset value of 84c on the dollar, the FDIC would provide financing of 72c and the Treasury would provide 6c of equity. This would leave only 6c of equity for the private investor to fund. This seems like an amazing financing structure for the private investor and may actually raise the ire of Congress.

The applications to be part of the program are due by May. This would mean at least four to six weeks of vetting. And then starting the program by September….If, if, if the banks are willing to part with the legacy loans and securities. By then, the recovery models may be projecting even higher at that point and lessen banks interest in the program.

Overall, time is going to continue to be the most important component for improving the balance sheets of banks.

Ray,

I think the Chinese are just concerned over the size of the spending and what it’ll do to US Treasury bonds.   They could also be concerned about the potential negative implications for the US dollar as well.  With the Federal Reserve printing money at an unbelievable clip, investors in US dollars may begin to get very nervous.

The question you may also be hinting at is this:  will the Chinese exert influence over foreign policy as well as domestic policy due to their holdings of US debt……I hope not or we’re all in trouble.

The NYT carries a story the populists are going to love:  AIG is paying out big bonuses to retain workers and there’s nothing the government can do to stop them.  It’s all legal and all required.  The US Treasury is hoping that by paying the money to keep employees at AIG, the government can get some of this money back via AIG returning to profitability.  Good luck as AIG still have a chunk of CDS and until that is lifted out of the company they will continue to experience difficulties.

Next up, the WSJ reports how the Obama administration is doing it’s best to answer criticism from its biggest debt holder, China.  On Friday, Chinese Premier Wen Jibao said, “We have lent a huge amount of money to the U.S., so of course we are concerned about the safety of our assets.  Frankly speakin, I do have some worries.”  These worries stem from the massive amount of debt that the US government will issue fto pay for the stimulus plan,  the 2nd round of TARP, the $410 spending bill, and the new budget.  With a deficit projected to rise above $1.75 trillion, I think the Chinese have every right to be concerned over their US debt portfolio.

Lastly, the G20 finmins were meeting this weekend to try to come to some agreement over the way forward for the global recession and credit crisis.  Unfortunately, there isn’t agreement on what to do first:  stimuluate or regulate.  Bloomberg says they have pledged to restore growth and tackle toxic asset.  “Our key priority now is to address the value of assets held on banks’ balance sheets, which are constraining banks’ lending,” they said in their statement.  Ahem, US were still waiting your plan…..

I wrote this week that the psychological bottom had been made as things couldn’t have gotten much lower on the doom and gloom scale.  With the Dow up 9%, the S&P up 10.7%, and the NASDAQ up 10.6%, everyone had a big “WHEW!” feeling.  However, no one should think we are out of the woods just yet as housing and toxic assets are not close to being resolved.  As we await Ben Bernanke’s 60 Minutes interview, let’s hope he gives us time frames for when the FDIC will finish stress testing, when Tim Geithner will have  a toxic asset plan, and when he thinks we’ll be out of this mess.