Banks keep firing analysts, analysts keep predicting rallies

November 10, 2008

This website declared a few days ago the Fed offers unlimited funding to institutions which it knows are bankrupt, but demands punitive interest in return, which it probably knows cannot be repaid.” Here are the latest developments on this matter:

American International Group Inc. got a $150 billion government rescue package, almost doubling the initial bailout of less than two months ago as the insurer burns through cash at a record rate. The Fed will reduce the $85 billion loan to $60 billion, buy $40 billion of preferred shares, and purchase $52.5 billion of mortgage securities owned or backed by the company. The interest rate on the $60 billion credit line will be reduced to the three-month London interbank offered rate plus 3 percentage points, from a previous spread of 8.5 percentage points in the original rescue plan.  The original $85 billion loan was disclosed on Sept. 16, a day after the collapse of  Lehman Brothers. AIG later received an additional $37.8 billion credit line on Oct. 8 to shore up its securities-lending program and then another $20.9 billion on Oct. 30 under the Fed commercial paper program designed to unlock short-term debt markets. AIG has about $5.6 billion left unused in the CPFF. The company renewed doubt about its prospects today by saying in a federal filing that it might not survive.

AIG has posted a $24.5 billion third- quarter loss today. The insurer has posted about $43 billion in quarterly losses tied to home mortgages. Edward Liddy’s plan to repay the original $85 billion loan by selling units stalled as plunging financial markets cut into their value and hobbled potential buyers.

“It was obvious to me from Day One that the terms of that arrangement were really quite punitive in terms of the interest rate and the commitment fee and the shortness of it,” Liddy said today in a Bloomberg Television interview. “I started really about a week after I got here trying to renegotiate.”.

AIG’s third-quarter loss equaled $9.05 a share and compared with profit of $3.09 billion, or $1.19, a year earlier, AIG said in a statement. Losses in the past year erased profit from 14 previous quarters dating back to 2004.

The revised rescue may fix two AIG operations that are draining cash because of the collapse of subprime mortgage markets. In the first, the U.S. will provide as much as $30 billion to help buy the underlying assets of credit-default swaps that AIG sold to investors, including banks. AIG will contribute $5 billion and bear the risk of the first $5 billion in losses, the Fed said.

Credit-Default Swaps

The insurer guaranteed about $372 billion of fixed-income investments in CDS as of Sept. 30, compared with $441 billion three months earlier. AIG booked more than $7 billion in writedowns during the quarter on the value of the swaps.

The New York Fed also will lend as much as $22.5 billion to a new limited-liability company to fund the purchase of residential mortgage-backed securities from AIG’s U.S. securities-lending collateral portfolio. AIG will make a $1 billion subordinated loan to the new entity and bear the risk for the first $1 billion of any losses, the Fed said. The securities lending operation and the previous $37.8 billion credit line from the Fed will be shut down, AIG said.

Securities lending accounted for $11.7 billion, or about two-thirds, of the $18.3 billion in impaired investments in the third quarter, AIG said.

The biggest insurers in North America posted more than $120 billion in writedowns and unrealized losses linked to the collapse of the mortgage market from the start of 2007, with AIG representing about half that total. The company has units that insure, originate and invest in home loans.

What’s the new one-year price target for GM? It’s zero, according to Deutsche Bank. GM is one of the best suited companies in the US for bankruptcy, as it hasn’t posted an annual profit since 2004 and its sales in the U.S. have declined every year since 1999. On what kind of capitalistic basis can the US government justify the saving of such a company? If it offers any great danger to the system, than it should be dismantled gradually. But to save it, and to allow it to exist as a living corpse is entirely against all the principles of a free market economy.

General Motors Corp. plummeted as much as 31 percent and moved toward its lowest level in 62 years after a Deutsche Bank AG analyst downgraded the shares, saying they may be worthless in a year.

“Even if GM succeeds in averting a bankruptcy, we believe that the company’s future path is likely to be bankruptcy-like,” Deutsche Bank’s Rod Lache wrote today in a note which recommended selling the shares and cut his 12-month price target to zero. He previously advised holding the stock.

Barclays Capital and Buckingham Research Group cut their price targets for GM to $1.

Government Support

This weekend, U.S. House Speaker Nancy Pelosi of California and Senate Majority Leader Harry Reid of Nevada wrote to Treasury Secretary Henry Paulson in order to urge that bank-bailout funds be opened up for loans to automakers. As Rahm Emanuel, chief of staff to President-elect Barack Obama, said the U.S. auto industry is “essential” to the economy, the White House signaled its opposition, saying aid to the industry wasn’t discussed during the debate on the banking bailout. Congress may take up automaker assistance when it returns next week.

GM, in a regulatory filing today said “Based on our estimated cash requirements through December 31, 2009, we do not expect our operations to generate sufficient cash flow to fund our obligations as they come due, and we do not currently have other traditional sources of liquidity available to fund these obligation.”

Implied volatility for GM options exceeded 300, a level Lehman Brothers Holdings Inc. topped before its bankruptcy filing and American International Group Inc. reached prior to the U.S. government’s bailout.

The particular case of GLG is related to Lehman, and thus its troubles are not that unexpected. However, we keep getting reports of more hedge funds freezing client withdrawals, as their debt-financed business model appears to have lost its credibility in the eyes of many investors:

GLG Partners Inc. limited client withdrawals from the $2.9 billion GLG European Long-Short Fund so it isn’t forced to sell selected investments that have tumbled in price, people familiar with the matter said. The fund, the London-based firm’s largest, segregated the securities in an account called a side-pocket, where it plans to hold them until values recover. Investors’ redemption requests will be reduced because the fund has fewer assets available for sale to raise cash.

GLG, which oversees $17 billion, took a similar step last month with its Emerging Markets Fund. GLG said last week it suspended redemptions from its Market Neutral Fund and GLG Credit Fund, also to prevent forced sales of investments.

“Hedge funds have seen and will likely see continued outflows given the market conditions,” Noam Gottesman, GLG’s chairman and co-chief executive officer, said in a call with analysts and investors today.

GLG, founded as a unit of Lehman Brothers Holdings Inc., said today that third-quarter profit excluding acquisition costs fell 25 percent to $21.8 million. Assets dropped 27 percent to $17.3 billion at the end of September from $23.7 billion on June 30.

Pre-IPO Securities

The European Long-Short fund saw the percentage of assets invested in companies preparing an IPO rise as the value of its publicly traded shares dropped. Those securities couldn’t be sold at the prices the fund paid for them.

Lagrange’s fund fell 14.6 percent this year through Sept. 30, according to data compiled by Bloomberg. That compares with the average 23 percent loss by long-short funds, according to data compiled by Hedge Fund Research Inc. in Chicago.

Meanwhile despite fears of waning demand, Treasuries gained after the government’s first sale of three-year notes in 18 months attracted stronger-than-forecast demand today. So far there is no evidence of any inflation panic among investors, and the continued massive borrowings of the government may hinder some inflation being realized, as the liquidity sucked out of the markets through government auctions is lost in the clogged channels of the US banking system, where the government throws it. But it’s especially important that, from Bloomberg “indirect bidders, a class of investors that includes foreign central banks, bought 36.1 percent of the notes sold today, the most since May 2005, when they purchased 40.3 percent. Investors bid for 3.07 times the amount offered, the most since May 1998.” This data in itself is enough to ensure continued strengthening of the dollar. Indeed, that is what I expect to occur throughout next year, and possibly beyong, based on the assumption that the economic slump will be long-lasting.

Yields on two-year notes fell to an almost eight-month low. The $25 billion auction drew a yield of 1.8 percent. Today’s sale was the first of three this week totaling $55 billion, the biggest quarterly refunding in more than four years.

“It was pretty obviously a very strong auction,” said, an interest-rate strategist in New York at Barclays Capital Inc., one of the 17 primary government securities dealers required to bid at Treasury sales. “It indicates that strong demand remains for short-end Treasuries and the Treasury’s not yet being penalized for increasing supply significantly.

Yields on the benchmark 10-year note fell 4 basis points to 3.75 percent, below their 200-day moving average of 3.79 percent.

AIG Rescue

The U.S. revived the three-year note to help pay for the Treasury’s $700 billion bank-rescue plan and fund a budget deficit projected to widen from last fiscal year’s $455 billion as the economy shrinks and tax receipts slow. The Federal Reserve and the Treasury today enhanced a rescue package for American International Group Inc., almost doubling to $150 billion an initial bailout in September, as the insurer burns through cash.

The government plans to sell $20 billion in 10-year notes Nov. 12 and $10 billion in 30-year bonds Nov. 13 as part of its quarterly refunding, the biggest since February 2004. The Securities Industry and Financial Markets Association recommended trading close at 2 p.m. in New York and stay shut worldwide tomorrow for the U.S. Veterans Day holiday.

`Find a Home’

“The fear was that this particular auction was going to fare poorly because the three-year was on a short day, the holiday was coming and we have more supply coming” this week, said Tom di Galoma, head of U.S. Treasury trading at Jefferies & Co., a brokerage for institutional investors in New York. “Money has got to find a home somewhere, and there are a lot of products that don’t exist anymore or institutions that just won’t buy those products anymore.”

Goldman Sachs Group Inc. forecast the deepest recession since 1982, with the economy contracting 3.5 percent in the fourth quarter and 2 percent in the first three months of 2009.

18-Month Turnaround

It will take at least 18 months to turn around the U.S., even if President-elect Barack Obama “does everything perfectly,” Columbia University Professor Joseph Stiglitz, a Nobel Prize-winning economist, wrote in the Washington Post yesterday.

The difference between two- and 10-year yields increased to 2.50 percentage points as the shorter-maturity notes outperformed. That’s the highest since October 2003, based on closing prices.

The yield gap reached a record of 2.74 percentage points in August 2003 after the Fed finished a series of 13 rate reductions. Typically, the spread is steepest as the central bank stops lowering borrowing costs and investors anticipate an economic recovery, according to Tony Crescenzi, chief bond strategist at Miller Tabak & Co. LLC in New York.

`Remain Depressed’

“I think yields will remain depressed and continue to decline here, particularly on the front end” of the Treasury market, said Martin Mitchell, head government bond trader at the Baltimore unit of Stifel Nicolaus & Co. “The Treasury needs to fund all these bailout programs they are announcing, and that could keep pressure on the curve and keep it relatively steep, and that could present a struggle for the long end.”

The Treasury today also auctioned $27 billion in three- month bills at a rate of 0.355 percent and $27 billion of six- month bills at a rate of 0.99 percent.

After Australia, China, Japan, India, the U.S., the euro region and the U.K. all reducing interest rates within the past three weeks, there’s some improvement in the unsecured lending market. However, with the Libor-OIS spread still at an enormous 170 points, compared with a normal of just  11 basis points in the five years before the crisis started, we’re very far from a recovery in lending, and we’ll probably see even worse numbers in the coming weeks.

The London interbank offered rate, or Libor, that banks say they charge each other for such loans declined 5 basis points to 2.24 percent today, the lowest level since November 2004, the British Bankers’ Association said. The overnight rate rose 2 basis points to 0.35 percent, still 65 basis points below the Federal Reserve’s target rate. The Libor-OIS spread, a measure of banks’ willingness to lend, narrowed.

In a sign that central bank attempts to loosen credit are starting to work, interest rates on U.S. commercial paper, or CP, fell to the lowest in at least 12 years today. Rates on the highest-ranked 30-year CP dropped 16 basis points to 0.88 percent, or 12 basis points less than the Fed’s target’s rate. Average rates soared to a record 278 basis points more than the target rate on Oct. 9, according to yields offered by companies and compiled by Bloomberg since January 1996.

On the other hand, financial institutions lodged 225.5 billion euros ($288 billion) in the European Central Bank’s overnight deposit facility Nov. 7, down from 297.4 billion euros the previous day, the ECB said, indicating many banks are still reluctant to lend to each other. The daily average in the first eight months of the year was 427 million euros.

In Asia, three-month Hibor, the benchmark for Hong Kong interbank loans, dropped 10 basis points to 2.14 percent as the city’s monetary authority added funds to the system. Australian banks lowered the rate they charge each other for three-month loans by 3.7 basis points to 4.95 percent as the Reserve Bank of Australia signaled more rate cuts. A basis point is 0.01 percentage point.


There’s now speculation of widespread devaluations in emerging market currencies, and I believe that defaults in the emerging market sphere will be inevitable during the next two years. Bloomberg is reporting on Russia, but I’m much more concerned about Turkey, with its very large and worrying external deficit position, and its seemingly complacent economic leadership.  


Goldman is added to list of those who are dissatisfied with their analysts:

Goldman Sachs Group Inc., the Wall Street bank that cut 3,200 jobs, about 10 percent of its work force, last week, identified six equity analysts who were fired by the firm, including William Tanona, who covered companies such as JPMorgan Chase & Co., and Deane Dray, who followed General Electric Co.

“Goldman has always been the best, and when the best of the breed starts to weaken, it’s not a good sign for any of them,” said Joseph Saluzzi, the co-head of equity trading at Themis Trading LLC in Chatham, New Jersey. “Research was kind of a loss leader. If you’re not making money on the trading side, you can’t support the research.”

Bank and brokerages worldwide have eliminated about 150,000 jobs since the subprime mortgage market collapsed last year.

But the analysts themselves keep fluttering in Cloudcuckooland: (kudos to Aristophanes for this term)

Even after cutting estimates at the fastest rate ever, Wall Street strategists still need the biggest year-end rally in the Standard & Poor’s 500 Index for their forecasts to come true.

David Kostin of Goldman Sachs Group Inc. predicts an advance because U.S. companies are cheap relative to earnings. Strategas Research Partners’ Jason Trennert is counting on a resumption in bank lending to lift equities. Thomas Lee at JPMorgan Chase & Co. says stocks are swinging so much that a 25 percent jump by Dec. 31 isn’t out of the question. Kostin, Trennert and Lee are among the most pessimistic of Wall Street strategists with year-end estimates tracked by Bloomberg.  The average Wall Street forecast calls for the S&P 500 to break out of a bear market and surge 20 percent to 1,118 by Dec. 31 — more than twice as much as the biggest-ever advance to close out a year. Strategists were even more bullish at the beginning of the year, predicting that the S&P 500 would end 2008 at a record 1,632.

Strategists were also calling for a record gain at this time last year, after the first quarterly decline in corporate profits dragged the S&P 500 down from its high of 1,565.15 on Oct. 9. It never materialized and stocks have dropped 41 percent since.

The S&P 500 is poised for its worst year since the 1930s after almost $700 billion in bank losses froze credit markets and spurred concern the economy will shrink. U.S. equities posted the steepest monthly loss in 21 years in October and $6 trillion was erased from U.S. markets in 2008.

The strategist who cut his projection the most since September was Deutsche Bank AG’s Binky Chadha. Chadha abandoned his year-end call for the S&P 500 to reach 1,350, decreasing it on Nov. 7 to as low as 800 and becoming the first strategist to acknowledge the possibility that stocks may fall for the rest of the year. Chadha, previously one of Wall Street’s biggest bulls, declined to comment through spokeswoman Renee Calabro.

Fair Value                                          

Merrill Lynch & Co.’s Richard Bernstein also reduced his forecast last week. “Severe overvaluation at the end of August is correcting,” wrote Bernstein, who doesn’t provide a year-end estimate, on Nov. 4. “Our models are still working their way back to fair value.”

The rate at which strategists are reducing their estimates is a sign equities are close to a nadir, some investors say.

“The U.S. is going to be the first market out of the bottom,” Barton Biggs, a former Morgan Stanley strategist who now runs Traxis Partners LLC, a New York-based hedge fund, said on Bloomberg Television. “We’re at a major buying opportunity.”

And this is also where my 500 target for the S&P 500 in 2009 comes from: The S&P 500 trades at 10.39 times next year’s estimated earnings from continuing operations, compared with the weekly average of 21.1 times historical operating profit over the past decade, says Bloomberg. The key phrase here, is, of course, “estimated”. With the “analysts” performing with the accuracy of a coin toss, or a dice roll, it’s only a matter of time before the estimates are reduced to much lower levels, and that is when even todays P/E ratios will appear expensive. There’s some time for all this, but at least I’m quite confident in what I expect from next year.

And finally:

The state agency that runs New York City’s buses and subways may raise fares next year by more than the 8 percent it had previously proposed and implement deeper service cuts amid a swelling deficit.

The Metropolitan Transportation Authority needs to find ways to fill a budget gap that may widen by a third from a July projection to as much as $1.2 billion in 2009. The agency is facing lower projected tax revenue, higher debt costs and less money from fares as ridership is forecast to drop because of the climbing unemployment rate in the New York metropolitan area.

All news clips are from Bloomberg.


One Response to “Banks keep firing analysts, analysts keep predicting rallies”

  1. Jason said

    The AIG bailout is small change and means nothing to the Fed. The Fed is transparent in that it is subject to the oversight of Congress. Is twice a year not fast enough? The intent of Congress in shaping the Federal Reserve Act was to keep politics out of monetary policy. Legislation requires that the Federal Reserve reports annually on its activities to the Speaker of the House of Representatives.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: