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The 1st August industrial figure out, the NY manufacturing survey was about in line with expectations at 7.1 vs the consensus of 8.0 and is up from 5.1 in July but which was down sharply from the June level of 19.6. The components though were mixed as New Orders fell 13 pts to -2.7, the 1st negative figure since June ’09 and Shipments fell by 18 pts to -11.5, the weakest since March ’09. Backlogs rose 6 pts but still remain negative at -10. Employment rose 6 pts to 14.3, a 3 mo high. Inventories fell 3.5 pts but remained positive at 2.9. Prices Paid and Received fell to the lowest since Dec ’09. After falling sharply in July, the average workweek rose to +7.1 from -9.5. The overall outlook 6 months out did fall by almost 6 pts to 35.7, the lowest since July ’09. Net-net, after the FOMC fanned growth fears last week the market will take in line but we have many more Aug manufacturing surveys to see before drawing conclusions about this month.

According to the just reported June TIC data, China’s holdings of US Treasury securities fell by $24b after dropping $32.5b in May. This takes their total holdings to $843.7b, the lowest since June ’09 but still above Japan’s holdings of $803.6b. Up until June, the reduction in China’s holdings was more due to the maturation of short term US bills that were not fully reinvested back into Treasuries. June however saw the 1st net selling in longer term US Treasuries since April ’09. Japan’s holdings of US Treasuries are now at an all time record high after rising by $16.9b in June.

Here’s a stat that seems all but inevitable: China’s GDP has just passed that of Japan, to become the 2nd largest country’s economy in the world, after the US. (note these are nations, and not regions, like North America, Europe, Asia).

“China surpassed Japan as the world’s second-largest economy last quarter, capping the nation’s three- decade rise from Communist isolation to emerging superpower.

Japan’s nominal gross domestic product for the second quarter totaled $1.288 trillion, less than China’s $1.337 trillion, the Japanese Cabinet Office said today. Japan remained bigger in the first half of 2010, the government agency said.

China led the world out of last year’s global recession with an economy that’s more than 90-times bigger than when leader Deng Xiaoping ditched hard-line Communist policies in favor of free-market reforms in 1978.

China overtook the U.S. last year as the biggest automobile market and Germany as the largest exporter. The nation is the world’s No. 1 buyer of iron ore and copper and the second- biggest importer of crude oil, and has underpinned demand for exports by its Asian neighbors . . .

While China’s output was also larger in the fourth quarter of 2009, Japan’s GDP rebounded to exceed China’s in the first quarter, according to data compiled by Bloomberg News. According to IMF data using purchasing-power-parity calculations to adjust for exchange-rate differences, China overtook Japan in 2001.”

Goldman Sachs chief economist, Jim O’Neill, notes that the 1.3 billion people in China will overtake the U.S.’ $14 trillion economy by 2027.

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Source:
China GDP Surpasses Japan, Capping Three-Decade Rise
–Kevin Hamlin, Li Yanping. With assistance from Marco Babic and Sunil Jagtiani in Singapore, Russell Ward and Keiko Ujikane in Tokyo and Zhang Shidong in Shanghai
Bloomberg Aug. 16 2010
http://noir.bloomberg.com/apps/news?pid=20601087&sid=amT8rSlABQTM&

Our monetary policy soul mate (zero rates, QE) Japan, reported a much weaker than expected Q2 GDP gain of .4% annualized vs the consensus of 2.3%. The report is sending the Japanese 10 yr JGB yield to the lowest in 7 years. European bonds are rallying in response, sending the 10 yr German bund yield to a new record low. Also helping bunds is another selloff in Ireland bonds with the 10 yr spread between the two rising 10 bps to 303 bps, the highest since early May. US Treasuries are following with the 10 yr yield approaching the lowest since mid March ’09. Growth concerns also had the Chinese Yuan lower for a 5th day vs the US$ and the selloff has almost eliminated the entire post revaluation rally since late June. The Yuan weakness however did send the Shanghai index to a one week high. With the growth concerns fanned by the FOMC last week, we’ll see the 1st US Aug industrial #’s this week in the NY and Philly manufacturing surveys.

Peter Demirali
Managing Director and Portfolio Manager
BAB vs. JNJ
August 14, 2010

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The Build America Bond (BABs) program continues to garner increased interest on the part of institutional and international investors. Foreign investors are playing a larger role as buyers of this asset class. Some have estimated their participation at anywhere from 25-40% of an issue, especially for large, index-qualified debt. Given the problems and concerns of sovereign debt in places like Greece, Spain, and Portugal, it is not surprising to see international investors hedge their bets and diversify more than they might have previously. Additionally, spreads on similarly rated corporate debt are extremely narrow to Treasuries. In most instances, corporate bonds offer lower yields than Build America Bonds with the same or similar ratings.

Johnson & Johnson (J&J) came to market yesterday, issuing $1.1 billion of securities in ten and thirty years. The two tranches were equal in size and were priced at the tightest spreads relative to Treasuries witnessed in decades if not generations. J&J is one of the few remaining AAA-rated corporations and is considered one of the best-run and most profitable enterprises in the world. The ten-year bond was priced at a spread of 43 basis points over Treasuries and has a coupon of 2.95%. This company was able to borrow $550 million for thirty years at a spread of 68 basis points and pay interest of 4.50%.
The company clearly believes it can generate earnings that are higher than what it will cost them to borrow these funds.

Over the course of the last month or so, we have seen a number of AAA-rated municipal issuers come to market in the Build America Bond program. The University of Virginia (UVA) issued thirty-year bonds roughly three weeks ago at a spread of 95 basis points. Currently these bonds are trading five to ten basis points narrower in spread. Investors can sell their JNJ bonds and pick up over 20 basis points in yield by purchasing UVA bonds. As an aside, UVA was one of the first to issue Build America Bonds in early 2009. The spread at issuance was approximately 250 basis points over Treasuries, and approximately 150 basis points over JNJ thirty-year debt. Clearly, these bonds were a great buy at those spreads and still offer value today.

Other issuers with AAA ratings in the municipal area that have sold bonds recently are Texas Transportation Commission, Ohio Water Development Authority, Arlington (VA), and Columbus (OH). There has been no shortage of high-quality issuers coming to market and each deal was several times oversubscribed. To illustrate how attractive these bonds are when compared to JNJ debt, Texas Transportation bonds were issued at +115 to Treasuries, Ohio Water came +95, Arlington VA came at +120, and Columbus OH came at +150 over Treasuries.

Cumberland Advisors continues to favor this asset class over corporate bonds and mortgage backed securities. Build America Bonds comprise the majority of holdings in our total return taxable bond portfolios. It has provided our clients with significant outperformance relative to our benchmarks and greater diversification. The high relative yields also helped generate compelling returns in our Build America Bond Spread (duration-neutral) strategy. This strategy is an alternative to money market mutual funds and bank deposits that yield close to zero.

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Peter Demirali is a portfolio manager and heads Cumberland’s taxable fixed income area and is a long time veteran of taxable fixed income markets. He is a member of Cumberland Advisor’s Management Committee. His bio may be found at www.cumber.com.

Comments on this article may be directed to   peter.demirali -at- cumber -dot- com

In an interview with WSJ’s Kelly Evans, Gluskin Sheff’s Chief Economist David Rosenberg warned that the chances of a double-dip recession are greater than 50-50 and that the recession may not have ended last year at all. He also called for the cutting of corporate taxes to spur job growth.

8/13/2010 9:29:12 AM

The following comes to us via an appraiser who attended the Appraisal Institute’s 16th Annual Summer Conference:

The Appraisal Institute’s Southern California Chapter-the largest of its chapters in the country-hosted its 16th Annual Summer conference on Thursday, July 29, 2010. The chapter presented an excellent program of continuing education that was well attended by both residential and commercial appraisers.

Of particular interest to residential appraisers was a panel presentation- The Changing Role and Responsibilities of AMCs in the Current Marketplace. Panelists included Wes McDaniel, Corelogic; Jeff Dickstein, chief appraiser, Pro Teck Valuation Services; Gregg Whittlesey, SCCAI Government Relations; Bob Clark, director, California OREA; and FNC Chief Legal Officer Neil Olson.

The panelists discussed the new federal and state regulations directed at AMCs and various aspects of the relationship between appraisers and AMCs.

All the panelists agreed that the recent passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act has placed the legislative arena in the spotlight. California was one of the earliest states (the 6th) to pass an AMC regulation bill, so it is already in force and many appraisal management companies (AMCs) have already registered. Now the Dodd-Frank bill requires all states to pass AMC regulations, but they do have ample time to get it completed.

It was stated that the Home Valuation Code of Conduct (HVCC) and some of the AMC regulations were/are directed toward assuring that appraisers can exercise independent judgment in developing their appraisals. The Dodd-Frank bill “sunsets” the HVCC, but many of the HVCC policies have been adopted by the government-sponsored enterprises (GSEs) and will likely stay in place. As this process is sorted out over the next few months, or possibly years, the appraiser’s main obligation will be to focus on competence. All these regulations can’t change a slow market for appraisers, so it will be a challenge for many appraisers to remain geographically competent as they travel greater distances in search of work.

The panel presentation Alternatives to AMC’s was also of interest to residential appraisers. Panelists Bruce Norris, The Norris Group; Briar Scharfe, Skyline Financial Group; and Fred Kreger, American Family Funding, offered appraisers alternatives for finding sources of work other than the traditional lenders and AMCs. Norris, a real estate investor and hard-money lender, uses appraisers for many aspects of his business, including lending and home acquisition/selling.

Scharfe maintains a list of 43 approved appraisers covering four states. Her company’s business model awards the full appraisal fee to the appraiser and offers payment on a weekly schedule. Kreger discussed opportunities for appraisers who want to do work for small- and medium-size credit unions, which normally don’t have their own appraisal departments, or contract the work out to AMCs, and usually pay the appraiser the full fee.

During the session, Norris-who is considered to be a top authority on the Southern California real estate market-shared some intriguing insights. He believes the region is in an artificial market and is concerned about the shadow inventory that could flood the market, forcing prices even lower. However, this isn’t the shadow inventory of bank-owned homes you may have heard about; he refers to all the houses that may yet go into foreclosure. The problem will vary by region, but referring to Riverside County in Southern California, Norris presented some pretty alarming statistics:

• 23% of prime borrowers are not making payments
• 47% of non-prime borrowers are not making payments
• 90% of properties are upside down on value-to-loan (60% owe more than
150% of value)

Many borrowers haven’t made a payment in more than two years and have yet to receive a Notice of Default.

These numbers are frightening when considering the inventory that may come into the market in the next few years. Norris added that lenders and the federal government have slowed the foreclosure process to prevent a further deterioration of housing prices. But this artificial slowing of foreclosures belies the fact that there are still major waves of residential mortgage defaults on the horizon. It will be interesting to see if this policy plays out for the best or backfires and causes another flood of foreclosure properties into the market . . .

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Our reader, an active market participant who introduced TBP to the appraiser, adds the following:

Southern California: 23% of prime borrowers / 47% of non-prime borrowers not making mortgage payments is alarming…to me anyway.

I think that the banks are technically insolvent. If they did their accounting according to the rules, they would have to write down the value of non-performing loans. Given that this many loans are in the non-performing category, if the banks followed the rules, they would not have enough capital to remain in business and the FDIC would have to close them as they have closed 108 banks so far this year. The higher level problem is that the FDIC might have to close many / most banks, which would really upset the economy.

So, the banks are extending (Letting people stay in houses without making payments) and pretending (bending / breaking the accounting rules to hide the extent of their (and our) problems): Strategic Non-Foreclosure Becomes Official Policy.

Via the Chart Store, we learn it was a quiet weekend in terms of FDIC bank closings:

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Call it the revenge of Dick Grasso:

Since May 17, 1792, when the Buttonwood Agreement was signed by 24 stock brokers outside of 68 Wall Street (under a buttonwood tree), the NYSE has been a non-profit, run for the greater benefit of the public companies that trade there.

Following the brouhaha over NYSE Dick Grasso’s pay — New York State law at the time prohibited excess compensation for executives at non-profits — that changed. In 2006, the NYSE and ArcaEx merge, creating NYSE Arca — forming the publicly owned, for-profit NYSE Group. They later merge with Euronext.

Why is this significant?

As a for profit entity, the exchange is concerned with maximizing profitability. Hence, selling co-located servers for high frequency traders becomes a new revenue source. Allowing flash traders to see order flow of the public — also for a fee — is permitted, consequence be damned.

The SEC investigation of the so-called Flash Crash will be out next month, and these HFT are likely to be blamed, at least in part, for the disruptions.

Jim McTague in Barron’s reports:

“A final report on the Flash Crash by the staffs of the Securities and Exchange Commission and the Commodities Futures Trading Commission, due in September, will reveal that when the market went into an apparent death spiral around 2:30 p.m., virtually every professional trader immediately high-tailed it for the hills, an SEC staffer indicated in a public meeting last week. As a result, panicked retail investors were left on their own, struggling to liquidate their positions to save the profits they had amassed from the beginning of the year.

With the pros gone, so was liquidity—the ability to convert equity into cash. Bids on stocks that the pros—hedge funds, institutions, and high-frequency traders—had posted earlier disappeared with the big boys. The market suddenly had no depth. The dam had burst, and the reservoir was empty. All that was left, the SEC staffer suggested, were “stub quotes,” bid and ask prices ridiculously outside the usual trading range of a stock. The prices get posted to satisfy an essentially pointless regulation.”

Anyone care to hazard any guesses about the following?

• What was the cause of the crash?

• How much are the exchanges themselves to blame?

• What proposed solutions will the SEC suggest ? What might they insist upon?

• What will HFT look like in the future? Will it be modified slightly, dramatically curtailed, or banned outright?

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Source:
Dirty Rotten Scoundrels
Jim McTague
Barron’s August 14, 2010
http://online.barrons.com/article/SB50001424052970203880104575419671044248964.html

The Gulf Oil Spill Disaster
August 13, 2010
By John Mauldin

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The Gulf Oil Spill Disaster
From Unmitigated Disaster to Merely Disaster
The Corexit Decision
Some More Takeaways
Time to Lift the Moratorium
Getting the Balance Just Right
Omaha, Carbondale, and San Francisco

As I mentioned last Monday night in my Outside the Box, I did not make it to Turks and Caicos, but did end up in Baton Rouge for a special seminar on the Deepwater Horizon Gulf oil spill. I have both good news (or maybe more like less-bad news) and bad news. Today’s letter is a report on what I learned.

The conference was sponsored by the Global Interdependence Center (GIC – http://www.interdependence.org/). David Kotok of Cumberland Advisors organized the event with help from people from Louisiana State University. The quality of the speakers was outstanding. They were extremely knowledgeable and well-connected. The meeting was conducted under the Chatham House Rule, which means all the speakers spoke off the record, unless they indicated otherwise. This allows for a more frank discussion. So, much of what you will read from me is my impressions of what I heard, which I cannot attribute to specific speakers. Indeed, some would be at some occupational risk if I did so.

Some of what I write today will be controversial to some readers. That is a risk I will take, as the large majority will find this interesting, or at least I hope so.

From Unmitigated Disaster to Merely Disaster

First, let’s begin with the “good” news. The ecological destruction that was first feared is not going to be as bad as once thought, for a variety of reasons. It is not good, but it is not the unmitigated disaster it could have been.

Edward Overton, PhD, Professor Emeritus, Dept. of Environmental Sciences, LSU, is an expert on oil spills. He was at the Exxon Valdez. The Exxon Valdez (EV) was a big, black, thick tide of oil. The Deepwater Horizon is a much bigger spill: every ten days the amount of the EV spill spewed into the Gulf, from April 20 to July 15. Professor Overton spoke mostly for the record. He is very much a concerned environmentalist, and he is also a very serious scientist.

He reminded us that the Louisiana wetlands are a very important part of the ecological system of the Gulf of Mexico. Oversimplifying, they are the nutrient source for the small animal world which feeds the larger. Without the wetlands much of the Gulf ecosystem dies. If they were destroyed, they would not come back very easily, as without their very root system the land would erode away. Bluntly, oil kills wetlands if it gets into it.

There are only three ways to get rid of an oil spill. You can mechanically remove it, chemically remove it, or burn it. They used all three methods. But not fast enough. The Obama administration dithered while Rome burned. (This is not from Overton.)

As The Christian Science Monitor reported in “The Top Five Bottlenecks“:

“Three days after the accident, the Dutch government offered advanced skimming equipment capable of sucking up oiled water, separating out most of the oil, and returning the cleaner water to the Gulf. But citing discharge regulations that demand that 99.9985 percent of the returned water be oil-free, the EPA initially turned down the offer. A month into the crisis, the EPA backed off those regulations, and the Dutch equipment was airlifted to the Gulf.”

Really? For 0.0015 percent clean water from badly contaminated, toxic water? It takes a month to get that decision? I can guarantee you that there were people arguing for such a decision early on, and some rookie environmentalist at the EPA who never had responsibility in the real world made things a lot worse. Moving on:

“A giant Taiwanese oil skimming ship, The A Whale, is only now working on the spill. It can process 500,000 barrels of oily seawater per day, but it also needed the same waiver from the EPA which, expressed in another way, limits discharged water to trace amounts of less than 15 parts-per-million of oil residue. It also needed a waiver from the Jones Act, which prevents the use of specialized foreign ships from the North Sea oil fields because they use non-American crews. Previously, the skimmers had to return to port to offload almost pure seawater each time they filled up with water.” (http://reason.com/archives/2010/07/09/the-governments-catastrophic-r)

Ok, Let’s get this straight. The oil industry screwed up by not having enough disaster equipment and ships available. That’s bad beyond words. But for the government to compound that by not allowing needed ships to do the work, just because they did not have US union workers is just as bad. You expect better from government in a disaster, or we should.

(Overton said we never really did learn whether The A Whale would have been as useful as advertised, as it did not get into the Gulf soon enough.)

What should have been a no-brainer decision to use the Dutch ships was delayed for whatever reason. What should have been a no-brainer decision to waive the water purity rules was delayed beyond reason. My personal opinion. Whoever participated in that decision should be allowed to return to the private sector. They only made the problem of the spill worse. They should not be allowed near the decision-making process again.

Please note, this is no defense of British Petroleum. As noted below, they were extremely negligent, and deserve the costs and more. We just don’t need to compound stupid, incompetent, irresponsible (choose several more adjectives, some with color) corporate acts with dumb government ones.

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