Saturday, February 28, 2009

Weekly review courtesy Payden & Rygel

There were few signs of light at the end of the tunnel in the dismal economic data released this week. more...

Treasury yields headed higher this week as investors placed more credence on supply and funding concerns than on poor economic data.more...

Large-Cap Equities
The stock market continued its decline for the year due to weak macroeconomic data and continued concerns in the financial sector. more...

Corporate Bonds
Investment grade primary activity continued to churn out several large deals in light of some disconcerting economic releases. more...

Mortgage-Backed Securities
The Federal Reserve's active support of the US mortgage market helped pass-throughs outperform Treasuries. more...

Municipal Bonds
The new issue market set a weak tone for the broader municipal bond market this week and yields moved higher. more...

The high yield market tone has been notably weaker over the last two weeks of February, as the tumult in the equity markets has worsened. more...

Western European Equities
Stocks in Western Europe lost ground over the past week. The stocks with the worst performance were autos and parts (-10.8%) and health care (-8.5%). more...

Eastern European Equities
The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and Poland) lost -0.6% this week, while the Russian stock index RTS went up by +5.3%. more...

Global Bonds and Currencies
Longer-dated Gilts and Bunds took their main lead from the US Treasury market again over the past week. more...

Emerging-Market Bonds
Emerging market dollar-pay debt spreads tightened this week. Although equity markets continued their recent weak trend, the relative stability in emerging markets and the back-up in US Treasury yields resulted in the tightening of spreads. more...

Next week, the steady drum beat of negative economic news will continue with new reports on the manufacturing and service sectors of the US economy from the Institute of Supply Management. more...

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Market Reflections 2/27/2009

A higher government stake in Citigroup, now up to 40 percent, has raised the risk that more trouble, not less trouble, lies ahead for the banking sector. Banking stocks plunged including a 39 percent loss for Citigroup to $1.50 per share and a 26 percent loss for Bank of America to $3.95 per share. Share prices keep shrinking. GM is at $2.25 per share, down 6 percent on the day. General Electric, once a great blue chip, is at $8.51, down 7 percent on the day. GE slashed its dividend late in the session.

And then there was the economic data. GDP was revised sharply lower to -6.2 percent in the fourth quarter. Many indications are pointing to an even greater rate of contraction in the first quarter. Consumer sentiment remains at rock bottom, and purchasers in the Chicago area say layoffs are getting even worse. The financial markets have discounted a lot and hopefully they've discounted what looks to be this recession's worst employment report yet, data to be released next Friday.

Stocks opened sharply lower, battled back, but ended near their lows, at 735.09 for the S&P 500, down 2.4 percent on the day and a new 12-year low. Money moved into the dollar which ended 1/2 cent higher against the euro to end at $1.2668. Treasuries were narrowly mixed with the 3-month rate at 0.25 percent, not nearly as tight as the worst of last year's panic and a reminder that financial markets are still stable. April WTI oil was little changed at $44.30 but did end the week solidly over $40 after Wednesday's EIA data showed rising demand for gasoline, which is another subtle plus for the outlook. Gold was little changed at $944.40.

Friday, February 27, 2009

Gobal Warming debunked by Japanese Scientists

Chalk one up for dissent. Japanese scientists were smart enough to find the fraud in the anthropogenic global warming hypothesis and then had the balls to publicly disagree with the UN's Intergovernmental Panel on Climate Change about it.

The Japan Society of Energy and Resources issued a report that says global warming is related to solar activity, and the rise in global temperatures was primarily a recovery from the so-called Little Ice Age, which lasted from 1400 to 1800. Kanya Kusano, program director for the Earth simulator at the Japan Agency for Marine-Earth Science & Technology, says computer climate modeling used to support the manmade global warming theory is like "ancient astrology."

If you think fraudulent climate science doesn't affect you financially, you may wish to know that, according to The Politico, there are now four climate change lobbyists for every member of Congress.

The Federal Deposit Insurance Corporation is running out of money.

That's why it's considering assessing a special fee on the banking industry in the second quarter of 2009. The fee would be around $0.15 per $100 of deposits, in addition to the regular fee, which is $0.12–$0.14 cents per $100 for most banks.

An American Banker article said today, "A diminished fund could undermine consumer confidence in deposit insurance. Such an outcome would be catastrophic for the banking industry if consumers began running on banks." If fractional reserve banks weren't inherently insolvent, you couldn't run them. If deposit insurance really worked, a bank run wouldn't be a catastrophe. Fractional reserve banking and deposit insurance are complementary frauds unraveling in tandem.

The FDIC's perennial inadequacy has two clear implications for investors: inflation and insolvency, the twin opportunity-creating dangers.

First, the FDIC's inherent insolvency provides another incentive to create money. Camden Fine of the Independent Community Bankers of America, realizing the new FDIC fee would punish small banks worse than large ones, says, "The FDIC should just cut out the middle man and go directly to the Treasury to recapitalize the [Depositors Insurance Fund] and not assess thousands of banks that had nothing to do with this mess." He's right. Inflation is the only way out.

The other implication of the FDIC running out of money is that our inherently insolvent fractional reserve banking system is in the painful, drawn-out process of being found out. FDR's New Deal is unwinding, decades after the crime was perpetrated, the same way communism fell apart, decades after it was erected.

Q4 GDP Revised Much Lower

I'm putting my money on worse than expected growth, and higher than anticipated deficits and unemployment for the next two years.

Some may call me a bear, but I prefer the word 'realist'"

So of course, the Obama budget projections of growth in the next few years are dead on arrival. Not realistic.

But then, when have budget projections ever been related even remotely to reality?
Just look back a few budgets and compare the projections of growth, or spending to what actually transpired a few years later.

Economic Briefing

Q4 GDP Revised Much Lower

Updated: 27-Feb-09 08:53 ET

To no one's surprise, Q4 GDP was revised down, although the revision was larger than expected. Specifically, Q4 real GDP decreased at an annual rate of 6.2% versus a previously estimated 3.8%.

Great Buying Opportunity in Stocks

This table shows you how stocks go through generational cycles, lasting roughly 17 years... One generation learns to love stocks. The next generation learns to be disgusted by them.


1914-1930 market UP 159% in 16 years
1930-1947 market DOWN -30% in 17mo
1947-1965 market UP 503% in 18mo
1965-1981 market UP 35% in 16years
1981-1999 market UP 1054% in 18years
1999-2016 market DOWN?-? in 17years

My grandparents lived through the Great Depression. The experience scarred them so dramatically, they never bought stocks, ever.

My parents' generation lived through the Great Stock Boom, spanning most of the 1980s and the 1990s. Ten years of negative returns haven't killed off their faith in stocks yet... It'll be tough to convince them they'll never make money in stocks. (Another five to seven years of terrible times like now... that should do it!)

Is today the stock market bottom? Has the fear reached its peak right this second? Or will the fear get worse, and will the stock market bottom five years from now?

Unfortunately, I don't have the answer to those questions. But we do know stocks will find a bottom. We are closer to a bottom than a top. And we are closer to a historic buying opportunity than a historic high.

I will be a buyer again when the uptrend returns. I define the return of the uptrend as when the S&P 500 closes a week above its 45-week moving average. (History shows this is an incredible indicator, good for double-digit annual gains in stocks.)

This could take five years, or it could happen tomorrow.

My generation may end up like my grandparents... swearing off stocks forever. But that will be the wrong way to go. Chances are excellent that my kids' generation will have the luxury of a seventeen-year bull market, an epic tailwind.

market – where you could buy and go to sleep and still make money – should begin sometime in the next five years.

In the best case, we're almost there already. I'm seeing more cheap and hated opportunities than I ever have in my career.

I'm just waiting on the uptrend.

Dow adjusted for inflation since 1925

For some long-term perspective:

The inflation-adjusted Dow has gained a mere 55% since its 1929 peak and gained only 10% since its 1966 peak – not that impressive considering it took many decades to achieve those gains.

It is also interesting to note that based on an inflation-adjusted Dow, the current bear market actually began in 1999 only to be interrupted briefly by a multi-trillion dollar credit bubble. That bubble has burst, of course, and the Dow now trades at a level not seen since 1995.

Market Reflections 2/26/2009

President Obama has proposed a $1.75 trillion budget deficit for fiscal 2009, a deficit that would represent 12 percent of GDP, the highest percentage since World War II. Among items, the budget calls for $750 billion in new support for the financial sector, news that lifted bank shares in the session. But the market as a whole failed to get a lift. Not helping were deep declines in durable goods orders and steep increases in jobless claim data, the latter pointing to the deepest declines yet for the monthly employment report, the next of which will be released a week from Friday.

It was another choppy session for stocks which opened higher despite the bad economic news only to fall back through the afternoon. Once again, very strong support was evident at the 752 level on the S&P 500, below which traders warn are heavy sell orders. The index closed right at that level, at 752.82 for a 1.6 percent decline on the day.

The dollar ended little changed at $1.2738 against the euro. Treasuries were a bit softer with the 10-year yield rising 5 basis points to 2.99 percent. The day's $22 billion auction of 7-year notes, the first 7-year auction in 16 years, drew only moderate demand in contrast to the run of auctions earlier in the week.

Oil rose more than $2 on the April WTI contract to end at $44.60. Traders attributed the rise to short covering in reaction to the morning gains in the stock market. Gold fell another $20 to $945.20, also in reaction to early gains in the stock market.

Thursday, February 26, 2009

GM says it "may" go bankrupt. Which means it "will"

Thursday, February 26, 2009

GM's auditors are pouring through its financial statements to determine if it can continue as a "going concern." GM lost $9.6 billion in the fourth-quarter, so you can't blame them for worrying about bankruptcy. The current quarter is going to be another bomb.

According to CFO Ray Young, GM needs more federal aid (just $30 billion) to stay afloat. Even so, it's expected that GM will get the "going concern" notice. Most companies that receive one go bankrupt.


Yes, as the article says, “That’s right. In the past ten years, for the largest 10 mutual funds, our society has spent $21 billion to watch stocks go up and down.”

These same mutual funds have also spent millions to lobby DC for years to keep alternative strategies such as trend following away from the average investor.

HANOVER, NH ( - The highest mutual fund advisory fee, of all time, was collected from the Fidelity Magellan Fund (Nasdaq: FMAGX - News). In 2001 it took in $792 million. Magellan has earned the top three, all-time records, grossing $1.8 billion between 2000 and 2002. Much of that is profit, from future retirees who don't read their statements. Most can't believe such large sums go directly into one manager's pocket. After all, if they did, wouldn't we read about it in the press? No. Mutual fund companies provide a steady stream of advertising dollars. It isn't a conspiracy. It's natural self-interest for all involved, from The New York Times to the Wall Street Journal.

Ironically, American mutual fund regulation is the finest in the world. I'm not joking. There's no secret to the numbers I'm pointing out. They're sent to every shareholder once a year. Sadly, few journalist read fund financial statements either. And any Fidelity shareholder who doesn't like the fees is free to leave.

Mutual funds are corporations run on the behalf of their shareholders, represented by a board of trustees. It's a legal structure that makes for some confusing language; for example, fund fees are often called expenses (which legally they are), rather than fees (which functionally, you pay). For example, Fidelity never charges you, the shareholder, directly. Rather, the fund trust pays a fee, from the fund's assets, to various Fidelity companies (which are separate from the fund corporation) for various services. Your board of trustees enters into contracts, on the shareholder's behalf, with the advisor (like Fidelity) and other service providers. Ironically, mutual funds were born during a 'socialistic' time in American history. Again, I kid you not. Should shareholders revolt, trustees can easily fire the portfolio management companies which serve the funds. Interestingly, that has seldom happened.

If you have any question about the profitability of the fund business, consider this. Last year, these five funds alone earned over $2 billion in advisory fees. Fidelity Contrafund: $522 Million (Nasdaq: FCNTX - News), PIMCO Total Return Fund: $506 Million (Nasdaq: PTTAX - News), Growth Fund Of America: $450 Million (Nasdaq: AGTHX - News), Europacific Growth Fund: $439 Million (Nasdaq: AEPGX - News), Fidelity Diversified International Fund: $374 Million (Nasdaq: FDIVX - News). Again, believe it or not, these are the fees the manager charges for a few people to pick stocks for the fund. The operational costs are separate.

Flying under the radar, because they don't offer shares directly to the public, the CREF Stock Account Fund paid $586 million in advisory and administrative fees, the largest amount of any fund in my database. TIAA-CREF says it's 'at cost'. We have to assume it's true, that the teachers did their own homework and thought for themselves.

Every shareholder should understand that all mutual funds have two basic costs. The first is the cost to manage the portfolio; that is, buy and sell stocks and bonds. A single person with a brokerage account can do this. In mutual funds, the fee for this 'portfolio management' work is called the advisory fee. The second basic cost is operational. This work is often done by hundreds of people: administrators, call center workers, accountants, IT professionals, custodians, printers and lawyers. The operational work is what shareholders 'see and touch' when they deal with their mutual fund. Shareholders seldom, if ever, have any contact with the portfolio manager (advisor).

In 2001 Fidelity charged shareholders $162 million for operational costs (on top of the $792 million). Fidelity probably makes some money on these costs too, since Fidelity subsidiaries handle shareholder servicing, administration and other 'touch' services. Yet most people don't believe me when I say most of the advisory fee is profit. They just can't believe it's legal for Fidelity to collect $792 million for a few people picking stocks (which they pay a handsome salary in the millions, but it's a fraction of what they charge). Here's a list of 58 Fund Managers Who Took in Over $100 Million in Advisory Fees Last Year.

Why is it so unbelievable? In the 1970s no one bought mutual funds. Everyone kept their money in banks and indirectly through pensions. Then all the money moved from bank accounts to mutual funds, to catch the technology revolution. Mutual funds were priced based on low-demand; that is, their margins were very high. As mutual funds grew they were sued to lower their costs (See the 'Gartenberg' case). But the effect was minimal.

We must keep advisory fees in perspective. According to Sports Illustrated, Tiger Woods will collect about $127 million in 2008. Alex Rodriguez is expected to earn half a billion during his career. And to be fair to Fidelity, unlike Tiger Woods, they must funnel money into marketing. Yet the bottom line remains, that some mutual funds are wildly profitable, beyond the imaginings of people who began in the industry decades ago.

Here is the top ten list since 1995. It's doubtful mutual funds will ever be so profitable again.

Top 10 Highest Advisory Fee Grossing Funds
Fund Year Advisory Fee

Fidelity Magellan Fund 2001 710
Fidelity Magellan Fund 2002 556
Fidelity Magellan Fund 2000 554
Fidelity Contrafund 2007 528
Fidelity Contrafund 2006 461
American Funds Growth Fund Of America 2007 455
American Century Ultra Fund 2000 418
Europacific Growth Fund 2007 387
Fidelity Diversified International Fund 2008 382
American Funds Growth Fund Of America 2006 370


An important issue, overlooked by the media, is that most people are no longer hoping for the growth promised them in the 1980s or 1990s. They're in funds like Magellan, saving for retirement. Their needs changed, but the fund fees didn't. Economically, it may not be good for society to pay high fees to chase growth for its retirement accounts. Because portfolio managers can't beat indexes on a large scale (it's numerically impossible) most of the fees collected end up as a wealth transfer between savers and portfolio managers. And don't misunderstand me. This isn't a diatribe against Fidelity. Fidelity has also created the lowest fee index mutual funds (the Spartan Funds). This is a public policy issue that only the government can solve.

But don't expect Obama to muddy the mutual fund waters anytime soon. He's already picked a politically savvy bureaucrat (read industry friendly executive) to run the SEC, even though it may not seem that way. Let me clarify. Despite being antiquated, our fund regulation is the best in the world. But that's due to the culture of the 1930s that took our financial market risks very seriously. Today's regulators, on the other hand, have long ago sold out to free-market malarkey. If we enter a real depression, it might change.

In the past 10 years stock funds have taken in $21.4 billion in stock picking (advisory) fees. Imagine reading that social security had squandered that amount playing the stock market with social security money? A couple of years ago Republicans tried to push through private savings plans to replace social security. Fortunately, the public seems to recognize its own laziness and poor understanding of investment fees.

The following is a list of the largest funds in 2003 and how much in advisory fees they collected in the most recent 10-year period. Keep in mind, these are just the fees for a few people to pick stocks. The money to do the shareholder work was part of additional fees.

Stock Funds With Largest Advisory Fees
Stock Picking Fees
10-Year Period $ Billions
Fidelity Magellan 1999-2008 $ 3.70
Fidelity Contrafund 1998-2007 $ 3.00
American Century Ultra 1999-2008 $ 2.30
PIMCO Total Return 1999-2008 $ 3.00
American Funds Inv Co Amer 1998-2007 $ 1.54
Fidelity Growth and Income 1999-2008 $ 1.56
American Funds Growth Fnd Amer 1999-2008 $ 2.10
Fidelity Low-Priced Stock Fund 1999-2008 $ 1.66
American Funds Europacific 1998-2007 $ 1.74
Fidelity Dividend Growth 1999-2008 $ 0.80

TOTAL: $ 21.40


That's right. In the past ten years, for the largest 10 funds, our society has spent $21 billion to watch stocks go up and down.

If you're not convinced that advisory fees are immensely profitable for large funds let's look at another fund similar in size to the Magellan Fund.

In 2001 the Magellan fund had $99 billion in assets. The Vanguard 500 Index Fund (Nasdaq: VFINX - News) had $89 billion. Because operational costs are generally a function of the number of shareholders, the Vanguard fund had similar operational expenses of $153 million (compared to Magellan's $162 million). The only difference is that the Vanguard fund didn't charge its shareholders to 'beat the market.' Therefore, the Vanguard advisory fee was only in the thousands, $181,000 (though administrative fees were $12 million). It only takes one person to buy and sell the stocks listed in the S&P 500 index, no matter how many shareholders are in the fund.

Vanguard could easily have told its shareholders that it would pick and choose from the S&P 500, with the idea of beating it, and charge an additional $780 million. The shareholders would never know if one person did the work, or one hundred. But Vanguard shareholders expected, over time, to save more than the Magellan shareholders because they were getting, essentially, a $780 million rebate every year, compared to the Magellan fund. History has proven their assumption correct.

A shareholder who had $10,000 in Magellan in 1995 would have watched it grow to $70,057. The Vanguard shareholder's account grew to $93, 597. This experience is not the same for all actively managed funds however. A few funds have collected large fees and beat the market.

Although the Fidelity Contrafund (Nasdaq: FCNTX - News) took in $3.3 billion, its shareholder have ended up with $56,592 and Vanguard's shareholders, $39,646.

But keep in mind, the asset-weighted, long-term average of all shareholders in actively managed fund do not beat low-cost funds. Over time Fidelity's Spartan funds will probably beat most of Fidelity's own actively managed funds. I am showing the Contrafund for the sake of fairness.

Again, everyone should be free to invest in smart people (at Fidelity for instance). But retirement is a numbers game and over the long-term a low-fee and diversified portfolio is the proven winner. The government isn't going to save you from yourself. Indeed, they can barely keep the fund industry off your social security assets. If you'd like to discover the fees of your fund you can check this Mutual Fund Costs Database.

Max Rottersman is a principal of Hanover Technology Group, LLC. His opinions don't necessarily represent the views of or Yahoo Finance.

Stock Market Update 2/26/09

16:25 ET Dow -80.05 at 7270.89, Nasdaq -16.40 at 1425.43, S&P -8.24 at 764.90 :
[BRIEFING.COM] A rally in financial stocks helped the broader market overcome a fit of early weakness, but the advance proved unsustainable as stocks finished the session more than 1% lower.

Stocks spent the majority of the session trading in the red as traders opted to take profits from Tuesday's 4% advance. The selling effort came amid a lack of positive headlines and continued uncertainty in the financial system, which failed to improve after President Obama gave his first speech before a joint meeting of Congress.

The need for additional capital amid such uncertainty led both Lincoln National (LNC 11.21, -1.83) and Allstate (ALL 17.57, -1.07) to cut their quarterly dividends. Meanwhile, an article in The Wall Street Journal seemed to suggest Wells Fargo (WFC 13.40, +0.35) should cut its dividend to help improve the bank's capital ratios.

The Fed and Treasury released key details of its bank stress-test plan. Officials will assess potential losses at banks and estimated resources to absorb those losses.

Capital provided under the plan will come in the form of preferred stock that is convertible into common equity at a 10% discount to the price prevailing prior to Feb. 9. Securities under the plan will carry a 9% dividend yield and will be convertible at the issuer's option.

The plan essentially backstops financial institutions, though the banks receiving capital will be required to submit monthly reports on their lending and will be subject to restrictions on paying quarterly common stock dividends, repurchasing shares, and pursuing cash acquisitions.

Financial stocks gave ground in the wake of the announcement, but eventually rallied to a 3.8% gain. Financials finished the session with a 0.5% loss as sellers pushed back, but that was still better than the 6.5% loss that financials traded with at their session lows.

Nine of the 10 sectors finished lower. Telecom (+1.0%) was the only sector in the S&P 500 to finish with a gain.

There was only a trickle of earnings announcements ahead of the opening bell, none of which received much attention from the broader market. Still, trading volume was above-average as nearly 1.8 billion shares traded hands on the NYSE.

The only item on the economic calendar was a bleak January existing homes sales report. Sales fell more than expected to their lowest level since 1997. Many of the sales were distressed, contributing to a near 15% year-over-year drop in the median home price. Inventory supply increased slightly to 9.6 months.

..Nasdaq 100 -0.9%. ..S&P Midcap 400 -1.4%. ..Russell 2000 -2.7%. ..NYSE Adv/Dec 1208/1878. ..NASDAQ Adv/Dec 799/1863.

Wednesday, February 25, 2009

Growing East/West Divide in the EU?

Greeting from RGE Monitor!

The Central and Eastern Europe (CEE) region is the sick man of emerging markets. While the global crisis means few, if any, bright spots worldwide, the situation in the CEE area is particularly bleak. After almost a decade of outpacing worldwide growth, the region looks set to contract in 2009, with almost every country either in or on the verge of recession. The once high-flying Baltics (Estonia, Latvia, Lithuania) look headed for double-digit contractions, while countries relatively less affected by the crisis (i.e. Czech Republic, Slovakia and Slovenia) will have a hard time posting even positive growth. Meanwhile, Hungary and Latvia’s economies already deteriorated to the point where IMF help was needed late last year.

The CEE’s ill health is primarily driven by two factors – collapsing exports and the drying-up of capital inflows. Exports were key to the region's economic success, accounting for a significant 80-90% of GDP in the Czech Republic, Hungary and Slovakia. By far the biggest market for CEE goods is the Eurozone, which is now in recession. Meanwhile, the global credit crunch has dried up capital inflows to the region. An easy flow of credit fueled Eastern Europe’s boom in recent years, but the good times are gone. According to the Institute of International Finance, net private capital flows to Emerging Europe are projected to fall from an estimated $254 billion in 2008 to $30 billion in 2009. Whether or not this is formally considered a ‘sudden stop’ of capital, it will necessitate a very painful adjustment process.

Classic Emerging Markets Crisis In The Works?

What is especially worrisome is that the days of easy credit flows were accompanied by rising external imbalances that rival or even exceed the build-up of imbalances in pre-crisis Asia – e.g. current account deficits in Southeast Asia from 1995-97 fell within the 3.0-8.5% of GDP range, while those in CEE were in the double-digits in Romania, Bulgaria and the Baltics in 2008. As examined in a recent RGE analysis piece, the vulnerabilities in many CEE countries – high foreign currency borrowing, hefty levels of external debt and massive current-account deficits – suggest the classic makings of a capital account crisis a la Asia in the late 1990s.

Spillover Effects To Rest Of World

Like the Asia crisis of 1997-98, a regional crisis in Eastern Europe would have far-reaching effects. As Harvard professor Kenneth Rogoff noted in a recent New York Times article: “There’s a domino effect. International credit markets are linked, and so a snowballing credit crisis in Eastern Europe and the Baltic countries could cause New York municipal bonds to fall.” Western Europe looks set to be particularly impacted via its strong trade and financial linkages. Of particular concern is the strong presence of Western European banks (via subsidiaries) in the CEE, where they hold 60-90% market share depending on the country, which paves the way for contagion.

So is this the making of a cross-border banking crisis? It could be. Given the sharp contraction in Eastern Europe’s economies, combined with high foreign currency-denominated lending (particularly in Croatia, Hungary and Romania), weakening currencies and heavy reliance on non-deposit external financing, Eastern Europe’s banks will likely see a large spike in non-performing loans. Banking systems in the region are likely only as strong as their weakest link – or in this case, weakest country. That’s because of the ‘common lender’ phenomenon. As many CEE countries share foreign parent bank(s) in common, this paves the way for problems in just one of these countries to have ripple effects into other CEE countries. So even a relatively healthy economy/banking system like the Czech Republic’s – with a reasonable loan-to-deposit ratio and scant fx-denominated lending to households – is still vulnerable.

Austria is far and away the Western European country most heavily exposed to the CEE region (via Austrian-based banks like Raiffeisen and Erste Bank). These banks’ collective exposure to the region amounts to over 70% of Austria’s GDP. Notably, however, other Western European countries’ total exposure is far less. Belgium and Sweden are the next in line after Austria; their lenders’ total exposure to the region amounts to a still significant 20-25% of GDP. Some fear that parent banks, if they get into trouble, could either fire-sell subsidiaries or simply walk away. Another concern is Europe’s fragmented regulatory system, which means that if a cross-border bank needs to be unwound, the process is likely to be extremely messy.

Policymakers In Virtual Straitjackets

CEE policymakers have fairly limited tools to cope with the crisis. Fiscal policy is constrained by the fact that belt-tightening is required to restore order to the balance of payments in some countries (i.e. Hungary, Romania, Ukraine, and the Baltics), while euro adoption ambitions limit the fiscal response in others (i.e. Poland). Meanwhile, monetary policy easing is constrained in countries with heavy foreign currency-denominated lending, like Hungary and Romania, where a weakening of the local currency could potentially trigger defaults, thereby impacting financial stability. In others (i.e. Bulgaria, Estonia, Latvia and Lithuania), monetary policy is not an available tool due to fixed exchange rates.

Due to limited fiscal and monetary policy options, other CEE countries might need to follow in the footsteps of Latvia and Hungary and call on IMF help. In a nod to the difficult situation of many CEE countries, EU leaders called last week for IMF resources to be doubled to $500 billion to help head off new problems in crisis-hit countries. It remains to be seen, however, whether IMF help will be enough to return financial stability to the region.

In a recent research report, economists from Danske Bank point to the increasing concern of spill-back from problems in Eastern Europe to the Eurozone. Polish authorities and commentators, such as Wolfgang Munchau, recently made the point that East European countries should be given a shortcut to join the euro and access to its safety and stability net. However, current problems faced by some EMU members show that EMU membership alone is no panacea. Moreover, previous experience shows that currency pegs can be double-edged swords that often end in capitulation. The current test case for the entire region is Latvia, whose currency peg looks increasingly fragile even after its IMF-led EUR 7.5 billion bailout package. Devaluation with its ripple effects through the region would be devastating for the mostly foreign-owned banks in the region.

Unlike EMU member countries, EU countries that have not yet adopted the euro have access to the 'medium-term financial assistance' facility worth EUR 25 billion, of which EUR 10 billion in loans have already been extended to Latvia and Hungary. Additional assistance to the region will have to come from a revamped IMF, as noted before and the EBRD is also providing funds to banks in the region. Despite a 20% funding boost, however, its resources are much smaller.

Spotlight On Ukraine

European banks are also exposed to vulnerable economies outside of the EU. Russia is the second largest borrower from EU banks and it has over $100 billion of debt that must be financed this year. However, it is the Ukraine that may pose the biggest contagion risk, particularly if the next tranche of IMF funding continues to be deferred. Austrian, French, Swedish, Italian and German banks have a collective exposure of around EUR 30 billion to the Ukraine. Ukraine has $46 billion in foreign debt obligations falling due in 2009 and the swift plunge of the Hyrvnia has boosted the cost of servicing these debts even as corporate debts are on the rise. Ukraine’s political divisions and economic contraction of at least 6% suggest further sovereign and corporate ratings downgrades are on the way. Ukraine may thus be forced to make the budget cuts required by the IMF, but it is also reaching out to the U.S., Russia, China, Japan and the EU for additional funds.

Government Collapse in Latvia: More Yet To Come?

The series of riots that erupted in Bulgaria, Lithuania and Latvia in January, followed by Latvia’s government collapse last week, raise concerns that Eastern European countries may experience a period of deep destabilization and social strife as the economic crisis deepens and unemployment rates soar. The recent wave of popular unrest was not isolated to Eastern Europe. Ireland, Iceland, France, the UK and Greece also experienced street protests, but many Eastern European governments seem more vulnerable as they have limited policy options to address the crisis and little or no room for fiscal stimulus due to budgetary or financing constrains. Deeply unpopular austerity measures including slashed public wages, tax hikes and curbs on social spending will keep fanning public discontent in the Baltic states, Hungary and Romania. Dissatisfaction linked to the economic woes will be amplified in the countries where governments have been weakened by high-profile corruption and fraud scandals (Latvia, Lithuania, Hungary, Romania and Bulgaria). The political forces most likely to benefit from public disaffection are those running on the populist platforms, which could disrupt efforts to battle the effects of the economic crisis. Latvia could be a case in point, as there are growing concerns that the coming election campaign might suspend the fiscal austerity measures required by the IMF bail-out package. Two other political hotspots that are at risk of early elections are Romania and Estonia, while Bulgarian national elections are due in mid-2009.

EU’s Free Market Rules Under Pressure: Eastern Disillusionment and Western Protectionism

Overall, a big rise in support for populist and radical parties in the region could put social, structural and environmental reforms on hold in the region and could even call into question the economic and political model Eastern European countries have followed since the 1990s. The eastern EU member states’ decisions to open their markets and move toward greater integration with the EU are now being second-guessed by some. Moreover, the protectionist measures implemented in some western EU states in support of their automotive and financial sectors are threatening the EU’s single market rules and could particularly hurt Eastern European economies. Meanwhile, a backlash over immigrant labor is likely. With the 2009 unemployment rate set to rise to 8.75% in the EU27, according to the European Commission, member states are tempted to interpret the laws in a way more favorable to their nationals. This suggests that migration trends will reverse and the eastward flow of remittances will dwindle. The return of Eastern European migrant workers, in turn, may add to social discontent in their countries of origin.

The financial crisis has exacerbated the East/West divide within the EU illustrated by the persistent bickering between the Czech Republic, the current holder of the EU presidency and France over trade and protectionist bail out packages that hurt automotive industries in Poland, Czech Republic, Slovakia and Hungary. So far, the EU has helped economically troubled Latvia, Poland and Hungary with swap lines and loans and called for the resources of the IMF to double in order to help the countries facing the crisis. Yet, there have been a growing number of calls for EU-led coordinated support to the Eastern European economies (recently echoed by the World Bank). If there is a perceived lack of help, the financial crisis could deepen the divide between so called “Old Europe” and “New Europe” and bring structural changes to the political landscape in Eastern Europe, such as strengthening the nationalist, euro-skeptic voices in Central Europe (Czech Republic, Poland) and the pro-Russian parties in the Baltic states.

Be a realist

We are in a bear market.. it might even be called a Depression

So far, the 2007-2009 bear market seems to be a dead ringer for the ’29-’32 decline.

The truth is hard to deny, and I’m not much good at sugarcoating things anyway. As Mississippi blues man R.L. Burnside once sang: “It’s bad, you know.”

No Need for a Window Ledge Just Yet

This is the reality we now face. No one knows how much longer the pain will last – or when a new bull market will finally kick in. The shiny happy stuff is wearing thin... I’m not telling you anything you don’t already know here.
But even then... even if our current woes wind up matching the ’29-’32 period blow for blow in terms of pure grizzly destructiveness... the news still isn’t all bad.
Stocks could be on a highway to hell and the following would still be true:

In the roaring grizzly of ’29-’32, it’s true that stocks declined a staggering 89% before hitting bottom. But even in that three-year period of epic decline, there were half a dozen tradable rallies of 20% or more.

Bloomberg columnist and money manager John Dorfman recently conducted an interesting study on “waterfall declines” – defined as “sudden drops of 20 percent or more in a few days or weeks.” Among other things, Dorfman concluded that, based on ten 20th-century instances of waterfall declines, positive post-decline returns averaged 24% in 12 months.

Not all businesses suffered in the great bear of ’29-’32. Some went right on making money for shareholders. Some actually saw their profits grow, not shrink. And not all stocks or industry groups went down either... some just kept going up. Homestake Mining, a gold mining stock, hit a new all-time high in 1932.

Gold miners did just fine in the depths of the Great Depression.
Nor were they the only bright spot.
  • According to The Wall Street Journal, the logging industry served up a cumulative 120.1% return between 1930 and 1933.
  • Miscellaneous manufacturing returned 74.2%.
  • Cigars and tobacco, 33.4%. In the depths of the Great Depression.

Catching my drift here?
Unless you’re scanning the sky for signs of the apocalypse, there’s no reason to think the world is going to end. Even in the worst bear market the modern world has ever known – the grinding days of the Great Depression – there were plenty of fat, juicy, tradable rallies to exploit... and plenty of investment opportunities in stocks that went up, not down, over the period.

Life Goes On

When people think about the “Great Depression” – or whisper about it in hushed tones – a lot of times they get caught up in the drama of the phrase.

The less you actually know about something, the more menacing it can sound – like the monsters in the closet (or under the bed) when you were a kid. Remember wondering what might be in that closet and not knowing, freaking out a little as your imagination ran wild? (I sure do.)

When it comes to hard times and apocalyptic economic scenarios, adults can be like kids in that regard. The imagination runs wild and it becomes natural to freak out a little.

But when amorphous anxiety is replaced with knowledge and insight, oftentimes the fear recedes.

The reality of the market, as far as recessions and even depressions go, is that life goes on. Profit goes on.
Opportunity still exists.

Neither Optimist nor Pessimist

When people ask me if I’m an optimist or a pessimist, I usually say “Neither... I’m a realist.” I reject the notion of being a “permanent” anything.

Flexibility is a virtue.

Right now it feels like there are two “permanent” camps out there in market commentary land: optimist and pessimist.

The optimist camp says, “Don’t worry, be happy... things will turn around soon... just hold on to your index funds and your ABC and your XYZ because things will be great again before you know it!”

Meanwhile the pessimist camp says, “Are you kidding? It’s all going to hell in a handbasket... the market is a fool’s dream... put your head between your legs and kiss your butt goodbye, because clipping coupons is about all anyone can do.”

I say, reject both those foolish schools. Neither is in touch with reality.

Market Reflections 2/24/2009

Reassuring comments from Federal Reserve Chairman Ben Bernanke triggered a big afternoon rally in banking shares and a big rally for the stock market. Bernanke downplayed the risk that banks will be nationalized anytime soon, stressing that their greatest value lies in their existing structure. Bank shares, the market's central area of weakness, jumped as much as 20 percent. The S&P 500 rose 4.0 percent to 773.14.

The rush back into risk hurt the dollar which fell more than 1 cent against the euro to end at $1.2850. Treasuries were little changed despite the movement into stocks. Demand was very strong for today's 4-week and especially 2-year auctions. Oil gained as stocks gained, up 3.9% for April WTI to $39.93. Gold fell back after failing to hold $1,000. February gold fell 2.5 percent to $970.50.

Tuesday, February 24, 2009



Ilike the 'fine for now' part of it. If we have not done the stress yet, how can the Obama administration keep telling us that large banks have adequate regulatory capital?? read my lips......

Market Reflections 2/23/2009

News that the government will raise its stake in Citigroup gave the bank's shares a big lift but failed to ease wider concern whether and when the banking sector will begin to recover. Driving the market to lows was a CNBC report late in the session that American International Group, the insurer that has already taken $150 billion in government funds, is asking for more money. CNBC said the insurer will post a $60 billion loss next week, a loss that will trip rating cuts and require it to raise cash.

Stocks fell very steeply with the S&P 500 down 3.5 percent to 743.33. Other markets were steady. The dollar ended at $1.2711 against the euro with the 10-year note little changed at 2.77 percent. Crude fell about 75 cents to end at $38.15. Momentum has come to a stop in the oil market though some are warning that falling demand will offset OPEC output cuts. Chinese trade data show a 10 percent year-on-year drop in oil imports during January. Gold held quietly under $1,000, ending at just over $996. There's talk that a move to the $1,005 level will trip a rush of buy stops that will quickly push it over the record $1,033.

Monday, February 23, 2009

The "stimulus" timed to next election campaign

It is interesting to note that the "stimulus" package of spending just passed has been touted by politicians from congress to the White House as the medicine the economy needs.

It is ironic that the vast bulk of spending dosn't come on stream this year 2009 or even next year 2010 but really hots up in 2011. Just in time for the next presidential election er re-election, campaign.

So those of you who think that politicians cared to read the details of this behemoth spending bill, let alone been given time to think through the unintended consequences of these expenditures must have been at the same party that Michael Phelps attended.

Between now and the start of the next election campaign, we are going to see ever more strained relations with our trading partners who are going to be strong armed into buying the trillion dollars of Treasury securities we must sell. They are ,of course, going to extract tribute by forcing us to pay ever higher interest rates.

That means that every other interest rate in this country that is keyed off treasuries must go up in tandem. Poof goes the real estate/mortgage rescue... So the banking system will paralyze..

And of course unemployment is going to hit 8% this year and 9% to who knows maybe even 10% next year. So tax revenues will drop... it does work that way ya know, no income so no tax liability...oh yes we do tax unemployment benefits..we dont?? just wait a while.

Then of course, that exquisitely timed political calculation kicks in. Spend untold billions of dollars into an economy with rising unemployment (nevermind that the banking system will be in a mess), and rising prices and dropping real estate values and rising bankruptcies, foreclosures and demands for costly social services.

But wait... the solution is obvious!! Raise tax rates on those who can afford to pay!!Easy peasy!!

About 5% ish of taxpayers by then will fall into that magic $250,000/yr rich category. Or is that $100,000 or $75,000 I forget. But then we can always go back and see where our esteemed Veep defined rich.

Oh yes... the most wonderful political fairy tale is that higher tax rates wont ever change the behaviour of those suffering the tax raise. Their behaviour dosn't no they meekly pay up. The DONT hire accountants to find any and all loopholes, or buy legal tax shelters, or switch their behaviour so that they avoid rising into the higher tax brackets. No No they dont do that despite 5000 years of economic history to the contrary with nary an exception (there are a few but weapons and death threats were involved--our legal system would never stand for that).

This time its different. Ask Nancy Pelosi. The arithmetic is too elegant to mess up with reality. Or Chuck Schumer who wants us to join him in his arrogant conviction that people "dont really care about a little pork". I believe Marie Antoinette referred to it as cake but she lost her head anyway. Watch out Chuck!!!

Prediction: the people WILL notice. Beware o politicians. You might have to get a real job where your pay actually does depend on your performance and making tthe correct choices. The greatest politician job security bill ever foisted on a weary and scared nation will come back to bite you.
Chuck..lowest ever approval ratings for Congress are that way for a reason. Remember it cost Marie Antoinette her head. Will this cost this nation its head? We are a few heartbeats away from finding out.

If you have any investments sell them now and sit on the cash.... I predict that very soon you will get VERY much bigger returns from US treasury debt than available now.