As the days of easy profits in one way markets comes to an end, fundamental analysis is once again in vogue among managers and analysts. All this is emphasized by a recent report at Bloomberg on how certain Japanese hedge funds were able to beat the horrendous markets of last year by doing away with technical analysis, and holding old fashioned meetings with company management. This is a trend that is going to intensify and strengthen with the passage of time, but technical analysis will maintain its popularity among traders as a predictive method, due to the large infrastructure that exists to support its use.

Technical analysis (and its more sophisticated cousin, quantitative analysis), both are predicated on the notion that markets discount all available information to market participants. Markets indeed discount most, if not all of the information available, but the problem arises out of the weightings attached to each piece of data can alter the outcome of these studies massively. The market discounts rumours, unrevised data, high and low frequency information with equal avidity, and weighs them depending on the mood and attitude of the day. Thus, the picture painted by the markets is similar to a cubist painting, rather than a clear descriptive one depicting the situation as it is. It is clear that the discounting mechanism of the markets is a deeply flawed one, but that dfoesn’t mean that there’s a better method, medium for pricing assets.

Technical analysis assumes that historical prices offer guidance on future price movements. Instead, most scientists believe that stock prices possess the Markov Property. In other words, all one needs to know to guess the future price is the price of today, with everything before that completely irrelevant to future price action. Indeed, experience tells us the same too: how many times has the trader seen breakouts occur without absolutely no hint on the previous price action?

Technical and quantitative analysis both discount fat tails of the probability distribution as improbable. On the other hand, experience clearly shows that spikes and collapses are the most common feature of the markets, with periods of calm being the exception. These periods usually emerge as a result of non-market influences,  such as government action, or central bank expansion of the money supply. 

The predictive power of technical analysis is as limited as that of astrology. It’s effectiveness is as limited as that of gambling strategies in the long term. Confidence and success are the greatest rewards of trading. But confidence and success are the enemies of technical analyst, since he believes that success and failure come in strings.


There appears to be a belief now that the dollar is going to collapse rather soon, driving the US Treasury bond interest rates to higher levels. There’s also a lot of speculation that there’s a bubble in Treasuries.


It’s true that there’s a bubble in Treasuries. Negative interest rates, or zero interest rates are simply too low to be justified by the fundamentals of the US economy, and it is true that the dollar must eventually lose much of its value in order to allow the US economy to find a balance.


On the other hand, bubbles can run for longer periods than people expect them to. Irrational valuations can deteriorate even further if the conditions that sustain the bubble persist.


In that sense, we must ask ourselves: What is there in the world, today, other than Treasuries that can suck out the uncommitted dollars in the system, and allow the global economy to breathe?  That the stock markets are incapable of doing so is obvious, as there’s too much uncertainty, at this stage, to allow this. Commodities are unlikely to appreciate much, unless emerging markets return to their growth path, but they can’t do so without US demand coming pack, which will not happen for many years. Gold is a speculative instrument tied to commodities, and it’s hard to hold it in very large quantities. The money flows that sustained its rise over the past few years, such as Asian exporter money, and Middle-Eastern, or Russian petrodollars, are blocked. The Euro cannot gain much value, because the ECB, despite its hawkishness, is likely to be forced to follow the rest of the world as financial conditions deteriorate: Eurozone banks are no less leveraged than their US counterparts.  


On the other hand, dollar demand is no less urgent than before. While libor values may have eased somewhat, the fundamental factors that force financial actors to hoard dollars are still powerful: Deleveraging is continuing in the West, Asian firms are facing bankruptcy, and many firms are facing great difficulty in the finding the dollars to meet their obligations. Of course, as we see at the moment, there’re periods of relaxation, but the underlying theme is as alive as ever, and it is premature, therefore, to speak of the demise of the dollar until the real impact of the global stimulus is seen. At the moment, it’s still unclear if it will be of much help, because of the global nature and scale of this crisis.

The rally in Treasuries that pushed yields on bills below zero percent this week is adding to concerns that the $5.3 trillion market for government debt is a bubble waiting to burst.

Investors seeking safety from losses in equity and credit markets charged the Treasury zero percent interest when the government sold $30 billion of four-week bills on Dec. 9, the same day three-month bill rates turned negative for the first time since the U.S. began selling the debt in 1929. Yields on two-, 10- and 30-year securities touched record lows this month.

“Treasuries have some bubble characteristics, certainly the Treasury bill does,” said Bill Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., which oversees the world’s largest bond fund. “A Treasury bill at zero percent is overvalued. Who could argue with that in terms of the return relative to the risk?” he said in a Bloomberg Television interview yesterday.

The 30-year bond returned 23.6 percent since September, including reinvested interest, more than it earned in any one year since gaining 34.1 percent in 1995, according to Merrill Lynch & Co. index data. Treasuries of all maturities gained an average of 11.9 percent this year, compared with a 41 percent drop in the Standard & Poor’s 500 Index and a loss of 15.3 percent in Merrill Lynch’s broadest corporate bond index.

Rising Supply

Rising supply of government debt to pay for the bailout of the economy and financial system has done little to damp demand. Treasury Assistant Secretary Karthik Ramanathan said in a speech yesterday in New York that the U.S. may introduce new financing methods to meet borrowing needs of $1.5 trillion to $2 trillion in the financial year that ends in September.

While supply has increased, rates on three-month bills fell 2.89 percentage points in the last year to 0.01 percent today, after trading as low as negative 0.05 percent on Dec. 9. The rate on four-week bills plummeted from a peak of 5.175 percent on Jan. 29, 2007. The three-month bill yield was unchanged today.

An investor who bought $1 million in three-month bills at the closing rate of negative 0.01 percent on Dec. 9 would realize a loss of $25.56 when the securities mature. Bills are sold at a discount and appreciate to par at maturity.

Even at the low yields, the government received bids for four times the amount of four-week bills it auctioned this week, according to the Treasury.

‘Insatiable Demand’

“There is basically insatiable demand for Treasury bills,” Ira Jersey, a New York-based interest-rate strategist at Credit Suisse Group AG, said in a Bloomberg Television interview. “There is a number of reasons for this, not only angst over deflation and what’s going on with risky assets, but there is also just a lot of cash that does not want to take any credit risk.”

Hunger for Treasuries increased as financial companies reported $984 billion of losses and writedowns related to the collapse of subprime mortgages since the start of 2007. The losses froze credit markets and helped send the U.S., Europe and Japan into the first simultaneous recessions since World War II.

Gross said he regrets not buying Treasuries in the past year. “If we went back 12 months and we had known then what we know now, it would have been all invested in Treasuries,” he said in the interview.

David Rosenberg, the chief North American economist at New York-based Merrill Lynch, said last week that demand for Treasuries had reached the “bubble” phase like in technology stocks in 2000 and real estate six years later.

Waive Fees

Record-low yields on government debt have led money-market funds to waive fees to keep returns positive. If the Federal Reserve cuts its 1 percent target rate for overnight loans between banks, as is expected next week by all but two of 56 economists surveyed by Bloomberg, some Treasury fund returns may turn negative, said Peter Crane, president of Crane Data LLC, a research firm in Westborough, Massachusetts.

Sentiment among investors in Treasuries turned negative for the first time in four months, according to a JPMorgan Securities Inc. survey of clients. The firm’s weekly index fell to minus 6 on Dec. 8, from this year’s high of 27 a month ago. The figure is the difference between the percentage of investors betting prices will rise and those expecting a decline.

Deflation Speculation

Speculation that the recession will result in deflation, or a prolonged slide in prices, is also driving demand for Treasuries. Consumer prices fell 1 percent in October, the most since records began in 1947, and may drop 1.2 percent in November, according to a Bloomberg survey of economists.

Deflation may worsen the economic downturn by making debts harder to pay and countering the impact of Fed rate cuts. Deflation also makes bonds more valuable, even with yields at record lows.

Treasuries may actually be “fairly valued,” Tony Crescenzi, chief bond strategist at Miller Tabak & Co. in New York, said in a report yesterday. Even so, yields will likely rise in mid-January as investors’ focus turns to prospects for an economic recovery, he wrote.

The U.S. pledged $8.5 trillion, more than half of the country’s gross domestic product, to spur lending and limit the damage of the recession.

Economists forecast higher bond yields as those efforts take effect over the next year. The yield on the 10-year note will rise to 3.66 percent by the end of 2009 from 2.67 percent today, according to 50 estimates in a Bloomberg survey. That would result in a loss of 3.88 percent as bond prices decline.

“At some point we are going to get some signal, some indication that this massive policy response is getting some traction,” said Mitchell Stapley, who oversees $22 billion as chief fixed-income officer for Grand Rapids, Michigan-based Fifth Third Asset Management. “The flight out of Treasuries is something that will be breathtaking.”






The median of Bloomberg’s analyst estimates is that US consumption will shrink by about 1 percent during 2009. To put this in context, this is the first time such a contraction is happening since Pearl Harbour. In other words, no one knows what kind of impact this will have on the global economy, let alone the domestic one.


By now it’s clear to most people that next year will be a nightmare for the US consumer. The Obama administration is planning total spending to the size of 3-4 billion over two years, but that amount is likely to be dwarfed by what the US economy will eventually need to stay afloat. And I doubt that the government will be willing or able to create anything else in this scale over the next few years.


The Federal government’s chosen path is indeed scary, but the danger that state governments and local authorities face is even greater. Unlike the Federal Government, which is still seen as a kind of safe heaven by fearful investors, the local governments are regarded as risky, unstable, partisan entities that can offer little guarantee for asset value during an economic crisis. They are unable to tap the international markets, and in most cases they will not be able to raise taxes to reorder the balance sheets. This will probably add anyother item to the list of federal government bailouts.


But the real danger is that the negative loop will be perpetuated by the continued deterioration of the Us economy. At this stage, all should be done to support the US consumer, but I’m afraid that the exponential deterioration in the status of the US consumer is only following a bubble, and it may therefore be irreversible in the medium term, and unstoppable.






The stock market is very optimistic that within about six months, we’ll be over with this crisis. The crisis may need go away at some stage later this year, but stagnation, and perhaps even contraction will remain with us for quite a longer while. I detailed the reasons for that in a previous post, but the belief that the government’s takeover of the US economy by becoming the main creditor of the US consumer and the corporate sector will resurrect a healthy economy is superstitious. If socialistic economies were that prosperous, the whole world would have gladly followed the USSR – into oblivion.

An argument Bloomberg makes today is that many companies hold so much cash or cash equivalents that buying stocks now allows a speculator free and immedite profit. Prudent invdividuals will not be overtaken by that suggestion by countering that there’s a reason for the existence of these firms’ cash hoards: they have no confidence in the future, they have no investment plans, and they are very worried about their own survivability. The fact is that this mentality can indeed create magnificent bargains under the right circumstances, but most of the time it will create large holes in the investors pockets.

What can be said with some confidence, in my opinion, is that we’re very far from being in a healthy investing environment. Valuations are suffering revisions quite often, and the life span of any firm is much shorter than it was only 13-15 months ago. It’s certain that the economy will suffer muchmwore before it will be able to grow again in  meaningful manner, and we also know that risks are still extremely high, with rewards only modest, when averaged for a portfolio. More importantly, there’s no need to hurry at the moment. Liquidity is gone for a very long time, and the market simply has no potential to create any bubbles.  Patient people will prosper.

Just to sober us all, here’s a report from Bloomberg today:

Most U.S. mortgages modified in a voluntary effort to keep struggling borrowers in their homes and stem foreclosures fell back into delinquency within six months, the chief regulator of national banks said.

Almost 53 percent of borrowers whose loans were modified in the first quarter were more than 30 days overdue by the third quarter, John Dugan, head of the Treasury Department’s Office of the Comptroller of the Currency, said today at a housing conference in Washington.

“The results, I confess, were somewhat surprising, and I say that not in a good way,” Dugan said, citing a third-quarter survey his agency plans to release next week.

Lenders and loan-servicing companies have been modifying mortgages by lowering interest rates or creating repayment plans through the voluntary Hope Now Alliance. The group, which includes Citigroup Inc., JPMorgan Chase & Co. and Bank of America Corp., said last month it helped 225,000 borrowers keep their homes in October.

Foreclosures rose to a record in the third quarter as one in 10 U.S. homeowners fell behind on payments or were in foreclosure, the Mortgage Bankers Association said last week.

“Our third-quarter report will show many of the same disturbing trends as other recent mortgage reports,” Dugan said. “Credit quality continued to decline across the board, with delinquencies increasing for subprime, Alt-A and prime mortgages.”

The OCC’s survey represents institutions that service more than 60 percent of all first mortgages, or 35 million loans worth $6 trillion, Dugan said.

‘More Questions’

The data “raises more questions than answers because it fails to define, in any meaningful way, the modifications that have re-defaulted,” Federal Deposit Insurance Corp. Chairman Sheila Bair said in a statement.

The lack of detail makes it tough to distinguish “re- default rates of sustainable modifications versus cosmetic modifications that by their nature are more likely to re- default,” said Bair, who has proposed using $24 billion from the U.S. Treasury’s $700 billion financial-rescue package to modify 1.5 million mortgages through the end of 2009.

Dugan’s figures reflect a failed focus on interest rates in loan modifications, House Financial Services Committee Chairman Barney Frank said today in a Bloomberg Television interview. If companies were to cut the amount owed on mortgages, borrowers would be less likely to default again, Frank said.

“The people who made the bad loans or bought the bad loans from others need to realize” that they would be better off with principal reductions than with foreclosure, the Massachusetts Democrat said.

Foreclosure ‘Timeout’

New Jersey Governor Jon Corzine, speaking at the conference earlier today, urged a three- to six-month “timeout” on foreclosures, saying keeping people in their homes is necessary to correct a “deeply troubled” market.

“Housing markets and mortgage-finance markets are the fuel for this problem,” said Corzine, a Democrat and former chairman of Goldman Sachs Group Inc. “We need a systematic protocol and process.”

John Reich, director of the Office of Thrift Supervision, questioned whether the federal government should be more involved in foreclosure prevention.

“I do have a concern of allocating government resources with such a high rate of re-default,” said Reich, whose agency sponsored today’s National Housing conference

BLS reported on Friday that 530000 jobs were lost in November. Here’s their report:


   Nonfarm payroll employment fell sharply (-533,000) in November, and
the unemployment rate rose from 6.5 to 6.7 percent, the Bureau of Labor
Statistics of the U.S. Department of Labor reported today.  November’s
drop in payroll employment followed declines of 403,000 in September and
320,000 in October, as revised.  Job losses were large and widespread
across the major industry sectors in November.

Unemployment (Household Survey Data)

   Both the number of unemployed persons (10.3 million) and the unemploy-
ment rate (6.7 percent) continued to increase in November.  Since the start
of the recession in December 2007, as recently announced by the National
Bureau of Economic Research, the number of unemployed persons increased by
2.7 million, and the unemployment rate rose by 1.7 percentage points.  
   The unemployment rates for adult men (6.5 percent) and adult women (5.5
percent) continued to trend up in November.  The unemployment rates for
teenagers (20.4 percent), whites (6.1 percent), blacks (11.2 percent), and
Hispanics (8.6 percent) showed little change over the month.  The jobless
rate for Asians was 4.8 percent in November, not seasonally adjusted. 
   Among the unemployed, the number of persons who lost their job and did not
expect to be recalled to work increased by 298,000 to 4.7 million in November. 
Over the past 12 months, the size of this group has increased by 2.0 million.  
   The number of long-term unemployed (those jobless for 27 weeks or more) was
little changed at 2.2 million in November, but was up by 822,000 over the past
12 months. 

Total Employment and the Labor Force (Household Survey Data)

   In November, the labor force participation rate declined by 0.3 percentage
point to 65.8 percent.  Total employment continued to decline, and the employ-
ment-population ratio fell to 61.4 percent.  

   Over the month, the number of persons who worked part time for economic
reasons (sometimes referred to as involuntary part-time workers) continued
to increase, reaching 7.3 million.  The number of such workers rose by 2.8
million over the past 12 months.  This category includes persons who would
like to work full time but were working part time because their hours had
been cut back or because they were unable to find full-time jobs. 

Persons Not in the Labor Force (Household Survey Data)

   About 1.9 million persons (not seasonally adjusted) were marginally
attached to the labor force in November, 584,000 more than 12 months
earlier.  These individuals wanted and were available for work and had
looked for a job sometime in the prior 12 months.  They were not counted
as unemployed because they had not searched for work in the 4 weeks pre-
ceding the survey.  Among the marginally attached, there were 608,000 dis-
couraged workers in November, up by 259,000 from a year earlier.  Discour-
aged workers are persons not currently looking for work specifically be-
cause they believe no jobs are available for them.  The other 1.3 million
persons marginally attached to the labor force in November had not searched
for work in the 4 weeks preceding the survey for reasons such as school
attendance or family responsibilities. 

Industry Payroll Employment (Establishment Survey Data)
   Total nonfarm payroll employment fell by 533,000 in November, bringing
losses to 1. 9 million since the start of the recession in December 2007.
Two-thirds of these losses occurred in the last 3 months.  In November,
employment declined in nearly all major industries, although health care
continued to add jobs. 

   In November, employment continued to decline in manufacturing (-85,000),
with widespread job losses occurring among the component industries.  Manufacturing employment has declined by 604,000 since December.  Within durable goods manufacturing, job losses occurred in November in fabricated
metal products (-15,000), machinery (-11,000), wood products (-9,000),
furniture and related products (-7,000), primary metals (-7,000), and com-
puter and electronic products (-7,000).  Employment in transportation
equipment edged up, as a return of 27,000 aerospace workers from strike
more than offset a job loss in motor vehicle and parts (-13,000).  In the
nondurable goods component, job losses occurred in plastics and rubber
products (-12,000), printing and related support activities (-5,000), and
textile mills (-5,000).
   Employment in construction fell by 82,000 in November, with losses oc-
curring throughout the industry.  Since peaking in September 2006, con-
struction employment has decreased by 780,000.  Specialty trade contrac-
tors lost 50,000 jobs in November, with both residential and nonresiden-
tial components contributing to the decline.
   Within professional and business services, the employment services
industry lost 101,000 jobs over the month, bringing total job losses
since December to 495,000.  In November, employment fell by 10,000 in
architectural and engineering services.
   Employment in retail trade fell by 91,000 in November.  Job losses
continued in automobile dealerships (-24,000).  Employment in the indus-
try has fallen by 115,000 since December, with much of the decrease oc-
curring over the last 2 months.  In several other retail industries, sea-
sonal hiring for the holidays fell short of normal in November.  After
seasonal adjustment, employment declined in clothing and accessories
stores (-18,000); sporting goods, hobby, book, and music stores (-11,000);
and furniture and home furnishing stores (-10,000).  Wholesale trade em-
ployment was down by 25,000 over the month, with most of the decrease
among durable goods wholesalers.
   Employment in leisure and hospitality declined by 76,000 in November,
with most of the decline occurring in accommodation and food services
(-54,000).  Since peaking in April 2008, accommodation and food services
has lost 150,000 jobs.

                                 – 4 –

   In November, employment in financial activities continued to decline
(-32,000).  Within the industry, job losses occurred in credit intermedi-
ation and related activities (-16,000) and in rental and leasing services
(-9,000).  Job losses in financial activities have accelerated over the
last 3 months, bringing the total decline since December to 142,000.
   Elsewhere in the service-providing sector, employment in transporta-
tion and warehousing declined by 32,000 in November, with most of the
losses in truck transportation (-12,000) and couriers and messengers
(-8,000).  The information industry lost 19,000 jobs over the month.
   Health care employment grew by 34,000 in November.  Over the past 12
months, health care has added 369,000 jobs.
   The change in total nonfarm employment for September was revised from
-284,000 to -403,000, and the change for October was revised from -240,000
to -320,000.  In both months, there were large revisions in most of the
major industry sectors.  These revisions resulted primarily because of the
normal monthly recalculation of seasonal factors rather than the incorpora-
tion of additional sample reports.
Weekly Hours (Establishment Survey Data)
   In November, the average workweek for production and nonsupervisory
workers on private nonfarm payrolls fell by 0.1 hour to 33.5 hours, sea-
sonally adjusted–the lowest in the history of the series, which began
in 1964.  Both the manufacturing workweek and factory overtime fell by
0.2 hour over the month, to 40.3 and 3.3 hours, respectively.  

   The index of aggregate weekly hours of production and nonsupervisory
workers on nonfarm payrolls fell by 0.9 percent in November.  The manu-
facturing index declined by 1.4 percent.
Hourly and Weekly Earnings (Establishment Survey Data)
   In November, average hourly earnings of production and nonsupervisory
workers on private nonfarm payrolls rose by 7 cents, or 0.4 percent.  This
followed gains of 6 cents in October and 3 cents in September.  Over the
past 12 months, average hourly earnings increased by 3.7 percent, and
average weekly earnings rose by 2.8 percent.

The CDS market’s size has halved from $64 trillion to $31 trillion in three months. But finally, we’re told, the much-needed central clearinghouse for this market is being built:

 New York approved Intercontinental Exchange Inc.’s application to form a state-regulated trust to guarantee trades in the $31 trillion credit-default swap market, boosting the company’s bid to beat rival CME Group Inc. in running a clearinghouse for the trades.

The state Banking Department approved the application after a meeting today, Chairman Richard Neiman said in a statement. The approval paves the way for Intercontinental, the second-largest U.S. futures exchange also known as ICE, to raise capital to fund the clearinghouse, according to the statement. ICE U.S. Trust LLC, as the subsidiary is known, still needs regulatory approval from the Federal Reserve.

“We have worked closely with our counterparts at the Federal Reserve Bank of New York in overseeing this industry initiative,” Neiman said in the statement. A clearinghouse for CDS contracts will “reduce systemic risk” within the banking industry, he said.

The Fed has been pushing for a clearinghouse after Lehman Brothers Inc., one of the largest dealers in the CDS market, went bankrupt in September, threatening the stability of its trading partners. A clearinghouse, capitalized by its members, all but eliminates counterparty default risk by becoming the buyer for every seller and the seller for every buyer.

CME Group

Chicago-based CME Group, the world’s largest futures market, is seeking to use its existing clearinghouse to back CDS trades. It still requires regulatory approval from the Commodity Futures Trading Commission, as well as license agreements from Markit Group Ltd., which owns the most used CDS indexes and pricing systems.

A clearinghouse owner could earn between $100 million and $400 million a year in revenue from clearing CDS trades, according to estimates by Wachovia Capital Markets and Keefe Bruyette & Woods Inc.

NYSE Euronext and Eurex AG are also seeking to clear CDS trades. ICE earlier this year said it will buy the Clearing Corp., the clearinghouse owned by banks including Goldman Sachs Group Inc. and JPMorgan Chase & Co., to secure commitments from nine dealers in the CDS market to participate in its plan.

Today the ECB has reduced its main refinancing rate (which is quivalent to the Fed funds rate)  by 75 percent points, the biggest amount in its short history. The Bank of England also cut its key rate by one percentage point to 2 percent and Sweden’s Riksbank lowered the same by the most since 1992. My attitude toward the ECB has been the same throughout this crisis. They’re more disciplined, because the financial state of the governments and citizens who they regulate is much better than that of their counterparts in the US. M. Trichet today showed some willingness to purchase some troubled paper directly, but whatever, and whenever this happens, its size and scope is likely to be far smaller than the Fed’s operations.

European Central Bank President Jean- Claude Trichet signaled he’s reluctant to cut interest rates so low that policy makers are “trapped” with few options to respond to a deepening recession.

“We have to beware of being trapped at nominal levels that would be much too low,” Trichet said at a press conference in Brussels today. The ECB earlier lowered its benchmark by three quarters of a percentage point to 2.5 percent, the biggest cut in its ten-year history.

Some of the ECB’s 21 policy makers have advocated a steady- hand approach to tackling the recession.

Council Split?

Luxembourg’s Yves Mersch told Luxembourg’s Tageblatt newspaper today that the bank is “entering calmer waters” with future rate changes more likely to be in the order of 25 basis points. Executive Board member Lorenzo Bini Smaghi said on Oct. 31 that “the present crisis is partially due to interest rates that remained at low levels for too long.”

“The council is split between those wanting to cut rates by only 50 basis points and those who wanted a more aggressive 100 basis-point cut,” said Juergen Michels, chief European economist at Citigroup Inc. in London. “So 75 basis points was a compromise and policy makers can keep their powder dry until February.”

Trichet said today’s decision was reached by “consensus,” and declined to divulge if there were calls for smaller or bigger cuts. ECB has reduced rates by 1.75 percentage points since October after the financial-market crisis intensified.

ECB forecasts published today show the euro-region economy will shrink about 0.5 percent next year, which would be its first full-year contraction since 1993. Inflation will average about 1.4 percent in 2009 and 1.8 percent in 2010, the new projections show, meeting the ECB’s price-stability goal of keeping the rate just below 2 percent.

“European policy makers, as we’ve seen in past global crises, continue to underestimate both the degree of the problem and their own part in its creation and solution,” Jim O’Neill, chief economist at Goldman Sachs Group Inc., said in a Bloomberg Television interview. “I prayed that the ECB would do 100. At least they didn’t do 50.”

Manufacturing and service industries contracted at the fastest pace on record in November and economic confidence plunged to a 15-year low. With oil prices collapsing, the inflation rate fell the most in almost 20 years last month, to 2.1 percent from 3.2 percent in October.


While “global and euro-area demand are likely to be dampened for a protracted period of time,” lower commodity prices may support a gradual recovery from the second half of next year, Trichet said.

As well as cutting rates, the bank has flooded money markets with cash and widened its collateral rules to unfreeze credit markets. Trichet said today it may be possible for the ECB to purchase assets and securities outright, while declining to say if it would.

With those who don’t receive unemployment payouts included, the total joblessnumber is close to 6 million now:

The number of people on unemployment benefit rolls rose to 4.09 million in the week ended Nov. 22, the most since December 1982. A separate report showed orders at U.S. factories tumbled in October by the most in eight years as demand collapsed at home and abroad.

AT&T Inc., DuPont Co. and Viacom Inc. today announced plans to eliminate more than 15,000 jobs as consumer spending falters and the recession deepens.

Figures from the Commerce Department showed factory orders dropped 5.1 percent, the biggest decline since July 2000. Excluding transportation gear, bookings decreased for a third consecutive month.

Fed Perspective

Dennis Lockhart, president of the Fed Bank of Atlanta, told a conference in New Orleans the economy was “in the midst of a long and very painful adjustment process.” Chicago Fed President Charles Evans, speaking in Dearborn, Michigan, said the U.S. faced a “very substantial downturn.”

Trending Up

The four-week moving average of initial claims, a less volatile measure, climbed to 524,500, the highest since 1982, from 518,250, today’s report showed.

The unemployment rate among people eligible for benefits, which tends to track the jobless rate, increased to 3.1 percent, the highest since 1992, from 3 percent. These data are reported with a one-week lag.

Forty-nine states and territories reported an increase in new claims, while 4 reported a decrease. The biggest increases were reported by California, Ohio and Michigan.

Longer Slump

What started as a housing slump has spread to manufacturing and services. The Institute for Supply Management’s factory index dropped last month to the lowest level since 1982, and its services gauge, which accounts for almost 90 percent of the economy, fell to the lowest level since records began in 1997.

Financial firms are among those making the biggest job cuts. JPMorgan Chase & Co., the largest U.S. bank by assets, said this week it will cut 9,200 jobs nationwide at Washington Mutual Inc. as it acquires the Seattle-based lender.

“We have seen a fairly significant dropoff in demand, starting in October,” Delta Airlines Inc. President Ed Bastian said on a Webcast of a Credit Suisse Group AG airline conference in New York this week. “The revenue environment is as cloudy as it’s ever been. We’ve never seen the level of demand destruction that some are forecasting for our business.”

Delta, the world’s largest carrier, said it will cut seating capacity by as much as 8 percent in 2009 and eliminate an unspecified number of jobs.

The SIV story is not entirely over yet, and Bloomberg today reports that the creditors of the failed SIV “Sigma” may not paid “in full or in part”. In other words, they may get zero cent(s) on the dollar…

Sigma, which held securities with a face value of $2 billion, according to Moody’s Investors Service, raised a total $306 million from a Dec. 2 auction as part of its liquidation, the SIV’s receivers Ernst & Young LLP said in a statement today. Sigma has $6.2 billion of secured debt outstanding, the receivers said.

“Short-term liabilities which fell due for payment after Oct. 23, 2008 will not be met either in full or in part out of these assets,” the statement said. The liquidation follows a judgment by the U.K. Court of Appeal and the receivers said their estimate may change should the case go before the House of Lords.

Sigma, created by London-based Gordian Knot Ltd., survived longer than other SIVs that defaulted after money markets shut down by borrowing from banks through collateralized loans known as repurchase agreements. Sigma stopped paying creditors at the end of September after failing margin calls, according to court documents.

Sigma pledged $25 billion of its assets to banks to cover $17.4 billion of borrowings, according to Moody’s, leaving just $2 billion of unencumbered assets to repay about $6 billion of outstanding bonds.

Senior creditors in Cheyne Finance Plc, the first SIV to collapse, recovered about 61 percent after the company was reorganized, according to an Aug. 12 statement.

Not only hedge funds suffer redemptios. Mutual funds are also facing something of a run by worried investors nowadays. One positive development is the return of investors to money market funds, which is for now preventing some investment grade companies from falling apart:

Investors fled from stock and bond mutual funds for the third straight month in November, removing $86.4 billion as signs of a worsening economy drove them out from all but the safest investments.

Shareholders removed $52 billion from stock funds and $34.4 billion from bond funds last month, said Conrad Gann, chief operating officer of TrimTabs Investment Research, citing preliminary data compiled by the Sausalito, California-based firm. While outflows were less than a record $111 billion in October, investors are still scared, he said.

“There’s still plenty of fear out there,” Gann said. “It’s more of a continuing drumbeat.”

Stock and bond mutual funds have lost $270 billion to investor withdrawals since September. Every bond-fund category has lost ground in 2008 except those that invest in U.S. Treasuries.

Cash has poured into money-market funds, considered the safest investments outside of bank deposits and government-backed bonds. Taxable money-market mutual fund assets surged to a record of $3.657 trillion in the week ended Dec. 2, according to IMoneyNet of Westborough, Massachusetts.

Drop Since May

Mutual funds had $9.6 trillion in assets as of Oct. 31, a 22 percent drop since May, according to data compiled by Washington, D.C.-based Investment Company Institute.

Merril Lynch says that oil may fall to $25 per barrel if China falls into a recession:

Crude oil fell below $44 a barrel to the lowest since January 2005 and gasoline dropped below $1 a gallon as the deepening recession in the U.S., Europe and Japan cuts fuel consumption.

Prices may dip below $25 a barrel next year if the recession spreads to China, Merrill Lynch & Co. said in a report today. “We’ve got the U.S, U.K., Europe and Japan all in recession for the first time since World War II, and the oil market is reacting,” said Chip Hodge, a managing director at MFC Global Investment Management in Boston, who oversees a $5 billion energy-company bond portfolio.

Oil prices have tumbled 70 percent since reaching a record $147.27 on July 11.

 “There is no sign where it will stop,” said Tom Bentz, senior energy analyst at BNP Paribas in New York. “We are now looking at $41.15, which was the pre-Gulf-War high and after that at the $40 and $37 level.”

Oil reached a then-record $41.15 in October 10, 1990, when Iraqi troops were occupying Kuwait. The milestone held until May 2004. Prices were last below $40 a barrel in July 2004.

“A temporary drop below $25 a barrel is possible if the global recession extends to China and significant non-OPEC cuts are required,” Merrill commodity strategist Francisco Blanch said in today’s report. “In the short run, global oil-demand growth will likely take a further beating as banks continue to cut credit to consumers and corporations.”

OPEC oil ministers agreed on Oct. 24 in Vienna that the 11 members with quotas would cut supply by 1.5 million barrels a day starting in November.

“Prices won’t rebound until either the financial crisis is fixed or oil-market fundamentals tighten,” said Michael Lynch, president of Strategic Energy & Economic Research, in Winchester, Massachusetts. “We will have to see substantial inventory reductions and OPEC cuts.”

Commercial mortgage delinquencies continued to rise in November, as would be expected. The highest-rated CMBS are right now paying about a massive 12 percentage points more than Treasuries, compared with with just 0.82 in January:

Commercial mortgage delinquencies rose in November and will climb as the economy slows and unemployment grows, according to Barclays Plc.

Payments more than 60 days late on commercial real estate loans that were bundled together and sold as bonds increased to 0.69 percent last month, compared with 0.57 percent in October and 0.51 percent in September, Barclays data show.

The “relative spike” in delinquent loans marks the “beginning of a sustained, upward trend,” Barclays analysts led by Aaron Bryson in New York said in a report yesterday. “We have repeatedly stressed that CMBS delinquencies are a lagging indicator of performance and tend to lag changes in employment by close to a year.”

Waning demand for the bonds, which are backed by pools of commercial mortgages, caused sales to slump to $12.2 billion this year, compared with a record $237 billion in 2007, according to JPMorgan Chase & Co. estimates.

Delinquent Retailers

Retailers are leading the rise in commercial mortgage delinquencies, according to Barclays. Late payments on retail space rose to 0.58 percent in November, compared with 0.43 percent in October, the data show.

 “The depth and length of this economic downturn looks to be materially worse than many investors initially expected and worse than that experienced during the last recession,” the analysts wrote in a Nov. 26 report.

Looser Underwriting

Underwriting standards on commercial real estate mortgages taken out between 2005 and 2007 were looser than those on loans in prior years, which will contribute to more delinquencies, the JPMorgan analysts said.

The impending default of two commercial mortgages sent spreads soaring to record highs last month. A $209 million loan to finance the Westin La Paloma Resort & Spa in Tucson, Arizona, and the Westin Hilton Head Island Resort & Spa in South Carolina, is near default after cancellations sapped revenue. In southern California, the owner of the Promenade Shops at Dos Lagos missed two payments on a $125 million loan.

The loans were among the largest in a $1.16 billion commercial mortgage debt offering sold by JPMorgan on April 30, Bloomberg data show.

Another hedge fund has frozen redemptions:

Fortress Investment Group LLC fell 25 percent to a record low after the private-equity and hedge-fund manager halted redemptions from its Drawbridge Global Macro fund, which had lost value this year.

Investors asked to withdraw $3.51 billion by year-end, including the $1.5 billion in redemption notices disclosed last month, the New York-based company said today in a filing with the U.S. Securities and Exchange Commission. Fortress spokeswoman Lilly Donohue declined to comment.

“The market essentially lost faith in Fortress as a franchise so that anything Fortress does is tainted by problems that it had in its private-equity portfolio,” said Jackson Turner, an analyst with Argus Research Co. in New York, who has a “sell” rating on the company.

More than 80 firms have liquidated funds, restricted redemptions or segregated assets following a stock-market decline and a credit freeze that started with a housing slump and rising defaults on U.S. subprime mortgages. Hedge funds have posted losses averaging 23 percent this year through Dec. 1, according to Chicago-based Hedge Fund Research Inc.’s HFRX Global Hedge Fund Index.

Fortress said in November its hedge-fund clients asked to pull more than $4.5 billion, or 25 percent of their money, as the company reported its first quarterly loss since going public. The Drawbridge fund had $8 billion as of Sept. 30, and the requested withdrawals amount to about 44 percent of the money pool, said Roger Smith, an analyst with Fox-Pitt Kelton Cochran Caronia Waller USA LLC in New York. Drawbridge lost 12 percent this year, he said.

The hedge-fund industry may shrink as much as 45 percent by the end of this month to $1.1 trillion from its peak of $1.9 trillion in June because of investor redemptions and market losses, Morgan Stanley analyst Huw van Steenis said in a Nov. 24 report.

Yields on speculative-grade bonds imply a default rate of 21 percent, which is higher than the record of the Great Depression. Moody’s forecasts the U.S. default rate to rise to 3.3 percent in October, to 4.9 percent in December 2008 and to 11.2 percent by November 2009. In other words, the US economy will face a period of consolidation and reorganisation, and the US economy of tomorrow will probably depend on exports and manufacturing to a far greater degree than the economy today does. In essence, we’re witnessing that much feared, and discussed, seldom understood unwinding of global imbalances: China is forced to shrink its export sector, as the US is forced to restrain its domestic spending habits. While in sum this is a healing process, the surgery is rather painful because the patient was a bit too late in seeking help for its illnesses:

The extra yield investors demand to own U.S. high-yield bonds was 19.19 percentage points on Dec. 1, according to Moody’s. Assuming a 20 percent recovery rate, the spread implies a default rate of 20.9 percent, John Lonski, chief economist at Moody’s Investors Service, said yesterday in a market commentary. That compares with a rate of 11 percent in January 2001, 12.1 percent in June 1991 and 15.4 percent in 1933.

Defaults and bankruptcies are accelerating as financing options for high-yield companies dwindle amid the longest U.S. economic recession in at least 26 years. The U.S. default rate rose to 3.3 percent in October, according to Moody’s, which forecasts the rate to increase to 4.9 percent in December and 11.2 percent by November 2009.

“The default rate is going to start rising quickly, soon enough it’s going to be breaking above 10 percent,” Lonski said in an interview. “Lack of access to financial capital is a very big problem for high-yield bonds.”

Hawaiian Telcom Communications Inc., a provider of local and long-distance telephone service, and Pilgrim’s Pride Corp., the largest U.S. chicken producer, sought bankruptcy protection on Dec. 1, as they struggled with too much debt taken on before the credit crisis.

Trump Entertainment

Trump Entertainment Resorts Inc., the casino company founded by Donald Trump, had its ratings cut by Moody’s on Dec. 1 after announcing last week it would forgo a $53 million interest payment to conserve cash. Moody’s lowered its probability of default rating to Ca from Caa2 and its rating on the company’s senior secured notes due 2015 to Ca from Caa2, with a negative outlook, suggesting the company is more likely to default.

Three companies have sold $2.7 billion of high-yield bonds this quarter, compared with $30 billion in the same period a year ago, according to data compiled by Bloomberg. Leveraged loans arranged this year total $301 billion, down more than a third from last year, Bloomberg data show.

“There’s a lot of forced selling of high-yield bonds by hedge funds owing to the need to de-lever as well as by mutual funds in response to redemptions,” Lonski said. “You’re looking at a market where the sellers well outnumber the buyers and the reluctance on the part of buyers makes sense if only because a bottom for economic activity is not yet in sight.”

High-yield, high-risk bonds are rated below Baa3 by Moody’s and BBB- by Standard & Poor’s.

U.S. stock swings will be more than triple the average for the next seven months, volatility futures are saying:.

May contracts on the Chicago Board Options Exchange Volatility Index, or VIX, closed yesterday at 43.80, while futures expiring before then trade at higher levels, showing investors expect the Standard & Poor’s 500 Index to rise or fall at least 2.8 percent a day through June 17, according to data compiled by Bloomberg. The last time the benchmark index for U.S. stocks moved that much during the same amount of time was 1932.

“It’s astonishing,” said Jeremy Wien, a volatility trader at Societe Generale SA in New York. “It’s beyond even what were considered worst-case scenarios just last year.”

The S&P 500 rose or fell 4 percent or more on 26 days since Sept. 15, as bank writedowns and losses from the U.S. mortgage market’s collapse approached $1 trillion worldwide. The last time the S&P 500 had as many 4 percent moves was 1933, when it happened 38 times, according to data compiled by Bloomberg. The index has increased or decreased 0.8 percent each day on average in its 80 years of history, Bloomberg data show.

Record High

The 18-year-old VIX, which never exceeded 50 before October, closed at a record 80.86 on Nov. 20 when the S&P 500 tumbled to the lowest level since 1997. The VIX fell four straight years through 2006 and slid to a 13-year low of 9.89 in January 2007, a month before surging a record 64 percent to 18.31 on Feb. 27, 2007, as U.S. equities suffered the worst rout in four years. It lost 8.1 percent to 62.98 today.

The VIX averaged 30.98 this year and 56.14 since Sept. 15, compared with 15.60 in 2003 through the jump in February 2007. January VIX futures closed at 56.24 yesterday, while March contracts were at 47.88.

GM wants 4 billion to survive this month:

GM won’t have enough money to finish this year, asked Congress for $4 billion immediately and access to $18 billion total as a worsening economy forces the automaker to use more cash.

GM is seeking $12 billion in loans and an additional credit line of $6 billion, as it tries to shrink U.S. employment by 34 percent, close plants and emphasize only four of eight current U.S. brands, according to a statement today on its Web site. The Detroit-based company also is seeking to cut debt in half and win new concessions from the United Auto Workers union.

Ford Motor Co. earlier today asked Congress for a credit line of as much as $9 billion, saying it expects to break even or be profitable before taxes in 2011.

The two companies’ requests exceed the $25 billion in aid lawmakers have been considering for all three U.S. automakers. Ford, GM and Chrysler LLC must convince a divided Congress their plans to shrink are severe enough to ensure repayment of the loans.

Are stocks really cheap?

December 2, 2008

Some people still seem to expect a gradual return to the golden days of this decade, but I believe they’re deeply mistaken. We’re going to go through a protacted bear market, or at least a highly volatile but eventually stagnant one for the next 3-5 years. Here are the reasons:


  1. Companies thrive in an environment of deregulation. Regulation is not only costly, but it also prevents “innovative” CFO’s from getting the best performance from extraordinary accounting methods. Regulation is best when it can prevent bubbles from forming, but where there’s no overconfidence, no euphoria, and no stupidity, people are less willing to take risks, and less risk means less growth, less profit and more volatility.
  2. A lot of people have been very badly burnt in the recent economic collapse. History shows that in the aftermath of an event as severe as this, people save more, spend less and take greater care of how they allocate their savings. All this results in less leverage, and consequently slower growth.
  3. Economical events of this scale are usually followed by periods of political instability, and international turmoil. Political instability is never a friend of the stock market.
  4. It’s highly likely that the severe damage that many economies suffer and will suffer from will result in increased protectionism in many countries. I already read reports of governments with high current account deficits encouraging citizens to use domestically produced goods. Protectionism is the bane of globalization, and it’s almost certainly bad for everyone. Trade has been a major stimulant of progress and growth throughout the ages. Yet after so much rampant internationalization, politicians are certain to be drawn to protectionist policies and nationalism to alleviate the people’s concerns and anger, which will lead to slower growth, and lesser profits.
  5. The banking system at the heart of the global economy, has almost been nationalized in many countries. The resurrection of the financial system will take a lot of time, and in the mean time, the lack of credit will cause stagnant stock prices, even in the best of circumstances.  
  6. Many nations have chosen to prolong the crisis by allowing bankrupt and unsustainable firms to continue their existence through government grants. This is obviously a mistake, and there’s a significant chance that these inefficient actors will reduce the global growth potential until they’re able to work through their accumulated losses which should take a long time.
  7. The bailouts across the globe will eventually have to be financed by the taxpayer. That means higher taxes, higher taxes means less consumption, and that means slower growth.