The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Bloomberg’s Chart of the Day:

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Source:
Worst Dow Drop Since Election Meant Rally in ’33
Jeff Kearns
Bloomberg, Jan. 20 2009

http://www.bloomberg.com/apps/news?pid=20601109&sid=aTv4IsA.Y7t8&

This morning, David Leonhardt asks:

Is the economy only a little worse than it was in the last couple recessions, as some have said, and still a long way from the dark days of 1982? Or are we instead on our way toward something that may even approach the severity of the Great Depression? Without more specifics, it is hard to judge the staggering stimulus numbers being thrown around Washington. It is hard to know how tough a task the Obama administration is facing — and whether it’s running the risk of being too timid or too aggressive.

I thought it would make sense to get some clearer historical perspective, and the economists at the Bureau of Labor Statistics were nice enough to help me do so. In the last week, they helped me put together a broad measure of the job market — one including both official unemployment and more subtle kinds — stretching back to 1970. Since the job market covers the entire economy and affects families in tangible ways, it seems to be the single best yardstick.

And it shows, for starters, that the economy is not yet as bad as it was in the early 1980s. It’s not even that close to being as bad. The ranks of unemployed and underemployed, controlling for the size of the population, were much larger in 1982 than today.

Many people would disagree with the statement that 1982 was worse than 2008-09 is. But I think David is onto something when he notes:

First, the economic expansion that just ended wasn’t as good as the 1970s expansions. The ’70s get a bad rap, and deservedly so in many ways. But median family income still rose 2 percent during the decade, after adjusting for inflation. Over the past decade, it has fallen.

Second, people seem to understand that the worst is yet to come — that the economy has not yet worked off its excesses.

Nice chart, too

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via NYT

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Source:
The Economy Is Bad, but 1982 Was Worse
DAVID LEONHARDT
NYT, January 20, 2009 http://www.nytimes.com/2009/01/21/business/economy/21leonhardt.html

Analysis and Discussion with Ben Phillips of Casey Quirk & Associates

The KBW Bank Index, via Chart of the Day:

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For some perspective into the all-important banking sector, today’s chart presents the current trend of the KBW Bank Index. As today’s chart illustrates, banking stocks were trading within the confines of an upward sloping trend channel from mid-2005 into early 2007. Then the impact of an already weakening real estate market began to take its toll and ultimately led to the current financial crisis. It is worth noting that the price of banking stocks have been decreasing and continue to decrease at an ever-increasing rate and today made new bear market lows.

It is 8:30am, and I am sitting in the Business Class section of a 7:30 am American Airlines flight to Miami. I was delighted to learn there is onboard wifi/internet. It will a race to see if this iBook G4 battery dies before the “all electronic device must be stowed” announcement is made.

A few years ago, my firm required lots of travel, and so I flied Jet Blue as much as possible. New planes, good crews, timely service and reasonable fares were only part of the appeal. To an easily bored and restless person (like me) the kicker was the onboard entertainment — 50 channels of TV plus 4 movies to choose from. It made the chore of traveling much more tolerable.

Then something funny happened: We were combining a business trip to California (Santa Rosa, North of San Francisco) with a pleasure trip thru the vineyards of Sonoma and Napa. The onboard movie was Sideways –perfect for our jaunt thru wine country. We hadn’t seen it yet, saw the great reviews, and were looking forward to it.

Then came the line — F%&king Merlot! — that sent Merlot sales down by 40% for the next few years.

Only that wasn’t the line we heard on Jet Blue: Instead, it was “Friggin Merlot.”

I was aghast — it ruined the film. You are left wondering what else was cut out, how much you missed. As soon as we landed, I fired up Amazon, and ordered a 9″ Panasonic portable DVD player.

I still don’t understand the editing of the movie, nor have I ever heard a good explanation why this is done: Its an R-Rated film, that only adults can order with their credit cards. Its on a seatback, its heard thru headphones, why mess up the seminal line of the film? What was the point of this artistic blasphemy?

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But here’s the interesting corporate aspect: I still fly a lot — but not nearly as much as I used to with Jet Blue.

I have both the laptop and the DVD player. I brought a few movies, the first season of Entourage, and the Best of Larry Sanders.

Its weird, but with that inexplicable film edit, Jet Blue lost their competitive advantage as a carrier for me

I wonder: What other bonehead corporate moves have cost firms revenue and sales by alienating their key customers? Are they explainable, defendable, even rational?

Accrued Interest is a buy-side bond trader for a registered RIA with $1 billion under management.

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Time for Tips
Deflation is the new buzzword, especially now that the Consumer Price Index has declined or remained flat four months in a row. But that being said, its time to consider intermediate and long-term Treasury Inflation Protected Securities, or TIPS. Its one thing to price in deflation in the near term, but these bonds have priced in zero inflation for the long-term. But given the various stimulus plans currently in place and/or about to be enacted, long-term inflation remains inevitable.

First, take a look at the TIPS “Breakeven” curve. This is simply the nominal yield on a TIPS minus the yield on a traditional Treasury bond with approximately the same maturity. One can infer that this is the “priced in” inflation rate over a given period. All are quoted as of January 9.

5-years: -0.40%
10-years: 0.55%
20-years: 0.103%
30-years: 1.23%

Roughly speaking, if actual CPI comes in higher than those breakeven numbers, the TIPS will outperform the Treasury. If CPI is lower, then the Treasury outperforms.

Might the CPI decline by 0.40% per year for the next 5 years? Or rise by a meager 0.55% for the next 10? Consider the Fed’s current tactics.

• • Cut the Fed Funds target to basically zero
• • Agreed to buy $500 billion in agency MBS
• • Agreed to buy $100 billion in GSE debt
• • Have or will extend funding to asset-backed securities, commercial paper, among other securities
• • Promised to “employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.”

All these things are funded by creating bank reserves. Or as Fed Chairman Bernanke said in 2002, “But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” That electronic equivalent is the creation of bank reserves. The Fed is printing money.

In a deflationary environment, printing money is the right policy. Had Japan followed a similar path, their generation-long malaise may have been shorter and less severe. But regardless of whether its the right policy, printing money is a highly inexact tool. The Fed will undoubtedly err on the side of creating too much money, as deflation is a much bigger threat. But given this, it is extremely likely that the Fed will wind up creating too much money, and thus create price inflation. To suggest that over a 10-year period, inflation will average zero is to suggest that the Fed will create just enough money to offset the private sector slowdown. That is giving the Fed way too much credit.

The best play here is in longer TIPS, at least 10-years. Short-term, CPI might print very low indeed, which results in a lower realized coupon for the investor. But over the course of the next 3-6 months, the market will start to realize that deflation is going to be a 1 or 2 year phenomenon, followed by a period of elevated inflation. So there is a chance that over 5-years, inflation is (on average) pretty low, but over longer periods, inflation protection will garner a premium.

Long time readers will remember that I’ve panned TIPS in the past as a quasi-commodity play. I haven’t changed that opinion generally, but now I think its clear that both commodities and core inflation should be rising rapidly from here, at least to where final CPI is in the 3′s and probably the 4′s, with upside much higher.

There are several TIPS funds, including iShares Barclays TIPS Bond (ticker is TIP) and the Western Asset Inflation Management Fund (IMF).

One warning is to beware of the correlation between TIPS and other bets you might have. I mentioned commodities already, but currency plays too might be highly correlated with a TIPS trade.

Disclosure: Long TIPS directly, do not own any TIPS funds.

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I am off to the (hopefully) sunny isle of Grand Cayman, to give a presentation on the subject “Global Crisis: From Disaster to Painful Recovery.”

Also presenting will be Todd Buchholz, former director of economic policy at the White House, Charles W. Calomiris, Columbia University Graduate School of Business; and noted congressional scholar Thomas Mann, Senior Fellow, Governance Studies, The W. Averell Harriman Chair.

Good Evening: As 2009 dawned, most investors held out the hope that our capital markets could hold together or even rally into today’s inauguration of President Obama. Conventional wisdom being what it is (i.e. too conventional), it should come as no huge surprise that, a mere three weeks into the new year, the S&P 500 now sports a double digit loss in 2009. The culprits (the banks) remain the same ones as in 2008, highlighting the need for not only change but also for creative solutions to our escalating financial problems. I humbly suggest a matching gift program is one such possible solution.

While U.S. markets were closed yesterday in observance of Martin Luther King Day, markets in Europe were hit when continued woes at RBS and other U.K. banks moved that nation ever closer to a full nationalization of its banking system (see below). The heightened scrutiny of U.K. financial institutions moved across the pond this morning when State Street dropped a bombshell on its stockholders (see below). STT previously held itself out as a different kind of bank, one involved mostly in money management and thus immune to most credit issues. The truth caught up with this Boston-based behemoth in the form of 59% hit to its stock price today, and the drop put pressure on its peers. Citi, Wells Fargo, and Bank of America were all hit for 20% or more, and the KBW Bank index dropped to levels not seen since the last great banking crack up in the early ’90′s.

Unfortunately, the undertow in the banking sector more than offset any wave of good will generated by Mr. Obama’s inauguration speech. Down 2% to 3% at the open, the major averages went sideways until most of the festivities in Washington were over. Once Mr. Obama signed off, the averages went into a slow and persistent tailspin that didn’t stop until the bell rang. The Dow (-4%) suffered least, while the Russell 2000 (-7%) was thumped the most. Oddly enough, Treasurys displayed little of the flight to quality that has consistently lifted them since mid 2007. Yields on the short end of the curve retreated a bit, but the long end saw yields rise as much as 10 bps. 2′s to 30′s steepened 12 bps, perhaps in anticipation of having to stomach all the spending being eyed in Washington. The only truly patriotic reaction to Mr. Obama’s swearing-in could be seen in the currency markets, where the U.S. dollar rose against all but the Japanese yen. The euro, for example, was tagged for a 3% loss, while the British Sterling took a 5.6% pounding. Commodities as an asset class were not spared the lash, though it should be noted that both crude oil and gold managed decent advances. The CRB index fell 2.4%.

Warren Buffett has probably offered more opinions and given more market advice to the public during the past 18 months than he had during the previous 18 years. His latest view is that the U.S. is in the midst of an “Economic Pearl Harbor”. Ever the optimist, Mr. Buffett sees our country eventually coming out of this crisis, saying, “it’s never paid to bet against America” (source: Bloomberg article below). Merrill Lynch, however, thinks this process will take years and that even Mr. Obama’s massive stimulus package will “do little more than provide a cushion to the blow the financial crisis is dealing the U.S. economy” (source: Merrill piece below). Other than offering that any healing will take time, neither of these viewpoints offers up much in the way of solutions for our financial ailments.

I would like to propose at least a partial solution, one that brings together the next round of TARP funding with an idea first proposed by Credit Suisse back in December and endorsed by this author at that time. To use a phrase that might appeal to the incoming administration, let’s create a hybrid of the CS idea and turn the TARP into a “matching gift program”. In its original form, the TARP was conceived to buy troubled assets from financial institutions, and I propose that at least some of the next $350 billion be spent in this manner. Rather than haggle over what prices should be paid for what financial instruments (which, as Hank Paulson discovered in October, is fraught with hazards and doomed the first $350 billion to be little more than a huge collection of bank C.D.s paying 5% to 8%), I believe we can let the prices be initially be determined by the banks themselves. Mr. Market will decide thereafter.

Before anyone hits the reply key with an angry riposte, let me say that the key lies in the Credit Suisse bonus pool plan I described back on December 23 (see: http://www.ritholtz.com/blog/2008/12/creating-mini-tarp-bonus-pools-would-help/). Recall, please, that C.S. proposed to set aside a large portion of its employee bonus pool as a fund to buy toxic assets from the bank. By itself, it is an elegant, though only partial, solution to moving bad assets off of bank balance sheets. But what if we broaden this concept by requiring any bank that has received TARP funding to set up a similar employee bonus pool? We could then turbo-charge the process by offering matching funds from the TARP to pay the same price for the bad assets that the employee bonus pool pays. TARP could match such funds on either a one to one, or even a two to one basis to provide true buying power in removing problem loans and goofy structures off bank balance sheets. If you think these bonus pools are small potatoes, think again; they represent the lion’s share of employee compensation at these firms and usually are the largest expense in the income statement. It is widely accepted that matching gift programs tend to engender more generosity, so let’s harness this force for the high purpose of rescuing our financial system from itself.

What makes this plan work better than the original TARP plan is that the banks will have self interest in choosing a proper price for the assets purchased by their bonus pools and their TARP partners (i.e. us). If the banks try to low-ball the price of assets destined for their bonus pools, then taxpayers will also benefit from the cheap prices and high future returns generated by these assets. If the banks pick too high a price and try to stick it to the taxpayers, then they are also sticking it to themselves by having their bonus pool pay the same high price. Though somnambulant in previous years, perhaps some of the independent directors on each firm’s board could oversee the process of determining a range of possible prices for each pool of tendered assets.

In addition, I would hope than any attempt to “claw back” previous bonus money from bank executives be sent to this same bonus pool cum TARP program. Instead of sponsoring legally dubious witch hunts, our regulators should ask that previous bonus payments made to top executives be used to buy up the troubled assets generated on their watch. Such a provision is not “fair”, but neither is it fair that these characters endangered our financial system and made tens of millions while doing so. Chipping in, say, 50% of their 2006 & 2007 bonuses is the best way to make the senior executives who should have known better pay up for their poor judgment. Besides, they’ll make it all back if the assets are as good as previously advertised to clients and shareholders. And please don’t tell me that each bank’s employees will bolt upon being required to join this scheme. Given the choice, and given short vesting periods, employees would much prefer a stake in these assets to the current cram-down equity programs already set aside for huge portions of their bonuses. They’ll welcome the diversification — just ask any LEH or BSC alumni. It’s over-regulation and/or the dilution created by the TARP thus far that are the real enemies of employee shareholders. Absent a plan like this one, more of both are most certainly on the way.

Yes, this idea can work. Employees, shareholders, and taxpayers will all shoulder similar burdens and should all receive similar outcomes. At once employing the carrot (no further dilution) and the stick (either a lot more regulation, no more TARP funding, or both), my plan is a marriage of Adam Smith’s invisible hand and the visible fist of government. Main Street will love this program, too, since taxpayers want to see Wall Street finally be forced to eat what they ill-advisedly cooked up. Taxpayers might even feel like “insiders” instead of feeling like the open-walleted chumps they’ve been until now. The average person will therefore understand this plan and will likely give it a chance to work under a new president. Heck, if the “TARP matching gift program” works, we can later dump the whole thing, gains and all, into Social Security.

– Jack McHugh

U.S. Stocks Slide in Dow Average’s Worst Inauguration Day Drop

RBS Plummets Amid Concern Bank May Be Nationalized

U.S. Banking Stocks Tumble as Citigroup Slumps to 17-Year Low

Buffett Says the U.S. Is in Midst of an ‘Economic Pearl Harbor’
Fiscal stimulus life jacket or.pdf

Whats going on in the vast trading nation out there?

Are we getting close to a buy? A short? Utter disgust?

Its an open thread!

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What say ye?

U.S. Stock Index Futures Fall – Live! From NYSE Trading Floor: Interview with Bespoke Investment Co-Founder Paul Hickey

Bloomberg, January 20, 2009