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

Treasury Secretary Tim Geithner released his desperately awaited banking-system fix last week…and the market immediately dropped several hundred points.

Why? Because the plan lacked what the market needs most right now: clarity. And, says our guest Chris Whalen of Institutional Risk Analytics, because it is just another half-measure that will attempt to prop up zombie banks and preserve the status quo.

Even as Geithner puts the finishing touches on his new hybrid public-private rescue, Whalen thinks the idea is doomed. But, he says, Geithner needs to do something, soon, or the stock market will continue to collapse.

Yahoo Tech Ticker, Feb 17, 2009

Dan Greenhaus is at the Equity Strategy Group at Miller Tabak + Co. where he covers markets and portfolio theory. He has contributed several chapters to Investing From the Top Down: A Macro Approach to Capital Markets (by Anthony Crescenzi).

This is his most recent commentary:

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I don’t have much to add this morning but I will say that the thesis concerning equity fragility as February progresses is coming to pass. I hate to sound like a broken record but it’s clear that equities simply are not pricing in the type of economic contraction that is increasing in probability with each passing day. Doubt lingers regarding the stimulus plan and how it is implemented is going to be crucial to whether the government can play a role in jumpstarting aggregate demand.

Some would say that simply isn’t the case (economic theory which I wont get into) and others simply say there is no evidence for a Keynesian based stimulus plan having worked. That may be the case but we’re going to find out. The stimulus bill is going to be a drag on longer term growth thanks to, among other things, higher interest rates from the high debt levels that is the new reality but of course the hope is that in the short term, we can arrest the economic decline that seems to be gaining strength rather than abating.

With all that said, let’s get to equities. $65 earnings, which I have maintained since October, no longer seems likely and while I don’t have a firm grasp on what that number should be (who does?) we can do some basic math to see where we’re at. To repeat, historically equities have found a bottom anywhere from 11x-13x earnings. I have used 12x earnings in the past for my price targets but seeing as how this recession and contraction is longer and more violent than normal, let’s take it down a step and slap an 11x multiple on various price targets. Below is a quick little chart on where the S&P should trade based on an 11x multiple of earnings at various points. Following the price target is the percentage the S&P would need to fall from last night’s closing level of 778.94 in order to get to “Fair Value” assuming the multiple and price target hold.

$60 x 11x = 660 15.27%

$55 x 11x = 605 22.33%

$50 x 11x = 550 29.39%

$45 x 11x = 495 36.45%

$40 x 11x = 440 43.51%

I am in no way endorsing any of those price targets at this time but again, its clear that $65 isn’t going to happen. I continue to believe that buying certain stocks at their current levels and the S&P as a whole in the 700 range remains attractive but one must be ready to bear further losses in the short term as we ride out the equity decline.

Protective puts and covered calls continue to reward investors and I beg anyone who is *not* using these options to run their P&L WITH the options. The difference is going to be striking.

Simon Constable of Dow Jones Newswires asks radio show host John Batchelor what it will mean for the banks if they are nationalized and finds out about a new idea: pre-privatization. (Feb. 19)

Marketwatch 2/19/2009

The Short and Simple Story of the Credit Crisis, via Crisisofcredit.com:

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The Crisis of Credit Visualized from Jonathan Jarvis.

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From the author:

The goal of giving form to a complex situation like the credit crisis is to quickly supply the essence of the situation to those unfamiliar and uninitiated. This project was completed as part of my thesis work in the Media Design Program, a graduate studio at the Art Center College of Design in Pasadena, California. For more on my broader thesis work exploring the use of new media to make sense of a increasingly complex world, visit jdjarvis.com.

Its not perfect, but its well done . . .

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This morning, I will be chit chatting from 7:10 am to 8:00 am on the Bloomberg radio program “Bloomberg Surveillance,” with hosts Tom Keene and Ken Prewitt.

Also on the show is Vincent Reinhart, Resident scholar at American Enterprise Institute, and  Robert Hormats, Vice chairman at Goldman Sachs.

You can catch it live, or via podcast at either Bloomberg or at iTunes.

Good Evening: Many investors had their eyes trained on the Dow Jones Industrial average today. This venerable index has been in retreat for most of 2009 and market participants openly wondered whether it could hold the closing low it set back during the dark days of November. Dow 7500 saw none of the white-knuckle angst that was so apparent on November 20; the VIX, for example, actually declined today. But instead of putting up a fight, Charles Dow’s creation simply surrendered and set a new closing low for this bear market. In so doing, both the industrials and transports have now flashed a renewed “Dow Theory” sell signal by setting new cycle lows at the same time. Whether the S&P 500, NASDAQ, and Russell 2000 follow suit cannot be known in advance, but investors should be alert to the very real possibility that the 2007-2009 bear stock market may be entering the despair/capitulation phase.

Heading into today’s session, U.S. stock index futures were indicating a mildly positive bounce at the opening bell. Few clues could be found in the economic data, which were a mixed bag. On the negative side, jobless claims remained mired above the troublesome 600K mark, while the Philly Fed survey virtually collapsed (see below). PPI and leading indicators both surprised to the upside, however, though it must be said that most analysts viewed both of these results with skepticism. Even with a 14% rise in crude oil today (due to a surprisingly low inventory figure), it’s hard to make the case that either inflation or economic growth will be blasting off any time soon. Aside from some earnings results (WFMI, CVS, and S reported upside surprises, while HPQ disappointed), the only other corporate news of note came in the form of a ratings downgrade for Prudential Financial that resulted in PRU’s dismissal from the Fed’s commercial paper program (see below). The insurers were all weak in response, causing more than one pundit to wonder how soon the insurance industry will head to Washington in search of a spot in the bread line known as TARP. The warm feeling for equities at today’s open proved to be short-lived. After jumping 1% or more within the first 15 minutes of trading, the major averages put in their highs and then spent the rest of the session easing lower. Yesterday’s lows were tested by lunchtime, and when they held, a brief rally ensued. This pop could only regain the unchanged mark, and the indexes then slid to new lows at the closing bell. There was little discussion about the hard-to-see “silver lining” for housing spied by BAC/MER’s David Rosenberg (see below). An original housing bear, Mr. Rosenberg is happy to finally see the homebuilding industry “get it” by cutting back on new home construction. Before you get the sense that Mr. Rosenberg may be crawling out of hibernation, a thorough read of his piece reveals that working down the inventories in housing will take not weeks but months (and perhaps years). The final damage for equities ranged from the S&P 500′s 1.2% decline to the Dow Transport’s 2% loss, and the Dow Industrials set a six year low in the process.

Surprisingly, the fixed income markets couldn’t rally on the weak showing by equities. Almost every sector, from Treasurys to High Yield, retreated today. Treasurys face a large amount of supply in the weeks ahead, and yields rose between 3 bps and 12 bps as the yield curve steepened. The dollar was also weak, dropping against all but the yen. The attached piece from Societe General makes a pretty solid case for further yen weakness, too. Analyst Albert Edwards points out that almost no country has been hit harder by the drop off in global economic activity than Japan. Furthermore, he thinks the yen’s strength until earlier this month has been the result of global risk aversion causing many to unwind the “yen carry trade”. Since Japan’s economy is very sensitive to currency movements, and since it’s far easier for a government to trash its own currency than to support it, I agree with Mr. Edwards that the yen could head a lot lower. Whether China then feels compelled to devalue in response is a harder call, but gold and maybe even the U.S. dollar should benefit in the interim. Of course, in the long run the dollar and all fiat currencies will be reduced to confetti. And speaking of gold, the yellow metal headed lower today as the worries continue over its recent rise. Despite the drop in precious metals, the CRB was pulled higher by firmer crude prices and the index finished with a gain of 2.2%.

Like grief, bear markets are famous for a progression through various stages before a peaceful acceptance finally sets it. I’ve seen definitions of these stages run from as few as two to as many as five. The most common number of stages for bear stock markets is three: 1) denial, 2) concern & fear, and 3) despair & capitulation. From the time two Bear Stearns hedge funds blew up in mid 2007 until the time Bear Stearns itself was subsumed in March of 2008, I think the evidence points to our markets being in phase one — denial. Heck, the Dow even managed to set a new all time high in between those two dates, and the crisis known then as “subprime” was already in full view. After a spring rally last year, the second phase hit during the summer when Fannie and Freddie were hastily ushered into the Treasury Department’s version of the Federal Witness Protection program. The concern on display even into September of last year became abject fear when Lehman Brothers went the way of the Woolly mammoth. This phase of concern and fear peaked on November 20 and 21, coinciding with the lows in the Dow and Dow Transports that, until today, marked the bottom.

After what turned out to be a small (20%) and short (6 weeks) rally into early January, today’s new lows for the Dow Industrials and Transports, in addition to flashing a classic “Dow Theory” sell signal, may mean we are entering the final stage of the bear market — capitulation. I say this not as a prediction but to provide food for thought for serious investors to consider. This hypothesis could prove null and void if a rally of substance soon takes hold, or if the decline under way accelerates (i.e. a resumption of the concern/fear stage). And even if we are in the final and capitulatory phase of the great bear market of 2007 – 2009, there are no hard and fast rules for how low prices can go or how long the decline can last. For visual evidence of just how grizzly can a bear market become, please click on the link below that will take you to a chart of the Dow Industrials from 1920 to 1940. You won’t be able to help yourself; your eyes will be drawn to the massive drop from 1929 to 1932. Although I don’t expect a replay of this horror show (both the amount of financial leverage and governmental policy responses have been larger this time around, enough so to cloud even the best crystal ball), I do think Mr. Market will suffer another beating by the time the capitulatory phase of this bear market plays out. To repeat: I’m not sure the stock market is entering the capitulation phase. I am sure, however, that some day our grandchildren will be almost as frightened by the 2007 – 2009 chart as the grandchildren of the Great Depression are today when they gaze upon the one from 1929 – 1932.

– Jack McHugh

U.S. Stocks Decline, Dow Industrials Close at Six-Year Low

U.S. Economy: Producer Prices Rise, Jobless Rolls Set a Record

Prudential Parent Disqualified From Commercial Paper

Dow Jones Industrial Average (1920 – 1940 Daily

Housing In search of a silver .pdf

soc-gen-global-strategy-weekly

Mark Zandi, Nina Easton, Nouriel Roubini and Fred Mishkin

Wednesday, February 18, 2009

Hey kids, its time for a Thursday nite open thread.

Anything goes, no subject off limits — the only requirements being that comments are intelligent or informative or amusing.

What say ye?

The following is via economist Warren Mosler of Illinois Income Investors Offshore Advisors.

Mosler is a a believer in MOSLER’S LAW, which states: There is no financial crisis so deep that a sufficiently large increase in public spending cannot deal with it.

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The media is screaming that deficit spending simply takes money from borrowers and gives it to someone else, so it doesn’t work.

This is NOT the case. In fact, deficit spending ADDS to our total savings of financial assets.

Operationally, this is how $100 billion of deficit spending ‘works’ to ADD to nominal savings of financial assets:

1. The Treasury sells $100 billion of treasury securities.
2. Paying for the new securities reduces member bank balances held at the Fed by $100 billion.
3. And our holdings of treasury securities increase by $100 billion.

Quick recap-

We buy treasury securities from the government which means we have $100 billion more treasury securities.

We pay for them which means we have $100 billion less in our bank accounts.

So far all we have done is exchange bank balances at the Fed for treasury securities, which also held at the Fed.

So far nothing of economic consequence has changed, apart from now we could be earning more interest on our treasury securities than we had been earning on our Fed balances.

4. The Treasury spends the $100 billion it got from selling us the $100 billion of new treasury securities.
5. This increases member bank balances at the Fed by $100 billion.

Final recap:

• Bank balances are back where they started from.
• Our holdings of treasury securities, which are financial assets and saving, have increased by $100 billion.

Conclusion and proof:

Government deficit spending of $100 billion necessarily increases savings of financial assets by $100 billion.

Its not just the Federal Reserve that has seen its balance sheet skyrocket — the European Central Bank and the Bank of England have also ramped up the assets they hold significant in their attempt to unfreeze the credit markets:

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Bank of England

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European Central Bank

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All charts via David Kotok, Cumberland Advisors

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Previously:
Reserves and Off Balance Sheet Securities Lending (June 27th, 2008)

http://www.ritholtz.com/blog/2008/06/reserves-and-off-balance-sheet-securities-lending/