- Warnings from a man who knows… Paul Volcker on the current crisis
- Amoss and Denning on the end of the financial rally… and what sector will suffer next
- Chris Mayer on Cuba… investments worth considering should the embargo end
- Washington’s backdoor nationalization… the latest TARP scheme from Capitol Hill
- The theme that will “dominate the consumer sector”… and change the way you invest
“For better or worse,” said the octogenarian Paul Volcker yesterday, “we are at a point where the Federal Reserve Act is going to be reviewed."
"None of us has seen a decline in economic activity at the rate of speed seen late last year," he stated the former Fed chair in a speech at Vanderbilt University — a noteworthy observation from the guy who was credited with slaying the rampant inflation of the late ’70s.
One of the data points that has Volcker spooked? The corporate earnings disaster currently under way:
For a closer look, click here.
We’ve never seen a “balance sheet” recession as severe as the one we’re going through right now.
A side note on Volcker: He’s a bit cranky, but he knows his stuff. When we met Volcker in his office overlooking the skating rink at Rockefeller Center (for I.O.U.S.A. ), we described our project to him.
“We’re trying to help ‘ordinary’ people understand the economic and financial crisis we expect will beset the country,” we said.
“Why?” he replied under his breath, “You ought to leave economics to me.”
Volcker was one of the few members of the Nixon administration who argued that dismantling the Bretton Woods exchange rate system in 1971 — effectively removing gold as the guarantor of the dollar’s value and replacing it with “the full faith and credit” of the U.S. government — was a bad idea. (Arthur Laffer was another. Both discussed that fateful day in their interviews for the film, the complete transcripts for which we’ve published here.)
Now, it looks like the powers that be are openly discussing not just the dollar’s role as reserve currency of the world, but the role of the Fed as set forth by the Federal Reserve Act of 1913 itself.
Our late friend Dr. Richebacher was an outspoken critic of the Federal Reserve throughout his 40-year career as a credit and currency analyst. “Sometimes I think it’s the role of the chairman of the Federal Reserve to prove Kurt Richebacher wrong,” Paul Volcker once said.
Kurt was hot on Corporate America’s lack of attention to their own balance sheets, too. They’d become a “cult of shareholder value” he decried. Many of Kurt’s own critics, including Volcker, cautiously dismissed Kurt’s work as gloom and doom… and yet he was right on so many levels.
We only wish Kurt were here to participate in the cleanup.
In meantime, as we’re sure you’re now aware, we aim to honor the man by doing our best to uphold the high level of critique he labored over. Please join us. But quickly… our open invitation to join the new Richebacher Society ends in about 24 hours. Please read the following.
In spite of the end of the world as we know it, consumer sentiment is improving.
The Reuters/University of Michigan measure of consumer feelings registered a preliminary score of 61.9 for April. That’s a notable bump from 57.3 in March and far better than the 57.5 score the Street expected.
If you’re curious why, look no further than the sucker’s rally on the NYSE.
But a strong word of caution from Rob Parenteau, now dean of The Richebacher Letter:
“To be sure,” Mr. Parenteau writes, “the larger theme we believe will dominate consumer attitude is the need to reduce leverage, which will require a higher savings rate than households previously achieved.
“We recently made the case that $1.2 trillion of household debt would need to be paid down over the next three years to return the household debt-to-income ratio to pre-housing bubble levels. French banking group Societe Generale, however, estimated that a return to the trend of the past five decades would require nearly twice that much… over $2 trillion.
“The key point: The American consumer’s contribution to any future recovery is likely to be muted, regardless of the fiscal and monetary stimulus coming from Washington. Stock investors using the regular playbook and running into companies that rely on consumer spending should make sure their long-run earnings expectations reflect this new trend.”
Indeed, the sucker’s rally appears to be getting stale. But really… what should we have expected from a rally fueled by fictitious banking profits?
“In most sectors of the stock market,” our short side sleuth Dan Amoss writes this morning, “I see signs that buyers lack conviction. Volume is weak in most rallies, and heavily shorted stocks are going up the most. Who in their right mind owns Citigroup as an investment at $4 (other than short sellers covering)? Especially considering the low odds that Citi stock will survive 2009 without going to zero in a restructuring or getting diluted by billions more common shares.
“Even the CEO of NYSE Euronext, Duncan Niederauer, was quoted in the Financial Times opining that this rally ‘was driven by short-term traders trying to take advantage of high volatility, and not by large institutional or other long-term investors.’ You’d think the NYSE would be biased to be bullish, so this says a lot about the sustainability of this rally.
“From my perspective, the greatest complacency appears to be developing in the commercial real estate investment trusts (REITs). There is widespread hope that the TALF program will bail out the industry from the tsunami of debt maturities coming due over the next three years. The weakest, most heavily shorted REITs have rallied the hardest in recent weeks, setting up a nice entry point for us to short those at risk of tripping their debt covenants. Stay tuned for more detail in the next issue of Strategic Short Report, which should be online by the end of next week.”
Not a subscriber? Fix that, here.
Bank of America could be the best example of Dan’s thesis today. America’s most prevalent bank reported earnings this morning, and, like seemingly every financial over the last two weeks, beat Wall Street estimates. Just one quarter after losing nearly $2 billion, BoA said they profited $4.2 billion last quarter — nearly seven times greater than expected.
But shares of BOA opened down 10% this morning.
Why? Because Bank of America has rallied high enough already, and Wall Street is starting to see the forest for the trees. Even the most cursory look at BoA’s earnings reveals a rotted vine… over $4 billion in profits came from selling a huge stake in China Construction Bank and “debt adjustments” on Merrill Lynch’s balance sheet. That ain’t growth, or even stability… it’s just moving money around.
“Citigroup reported $4.69 billion in fixed income trading last quarter,” reports Dan Denning, “which allowed them to eke out a $1.6 billion profit. In fact, all of Citigroup’s other major operating segments reported declining revenues for the quarter. Its global credit card revenues fell by 10%. Consumer banking revenues were down 18%. And Citi’s Global Wealth Management revenues were down 20%.
“But something magic happened in the fixed income trading group for Citi. Fixed income trading revenues were boosted by a "net $2.5 billion positive CVA on derivative positions, excluding monoclines, mainly due to the widening of Citi’s CDS spread.”
“A CVA is a ‘credit value adjustment.’ As you can learn here, it’s the credit risk premium of a derivative contract. Once you sort it out, you learn that Citi ‘made’ $2.5 billion on a derivatives position designed to profit when the company’s own credit default swaps spreads widen.
“Or, in plain English, Citi profited because it made a bet that the cost of insuring itself against a default would go up. As far as we can tell, if you use this kind of perverted logic, the closer Citi gets to bankruptcy, the more money it will ‘make’ on its derivatives.”
To make matters worse, the White House and Treasury leaked today that they are considering converting financial bailout loans to common stock. The government claims it would be a way to stretch the TARP to its limit — the move would give financials more available capital without having to bother with that whole “congressional approval” nonsense.
And of course — conveniently — converting those loans to common shares would make Uncle Sam a major, in some cases the biggest, shareholder in 19 of the nation’s biggest banks. And instead of having these banks simply owe us money, the American taxpayer would be locked in a long-term investment in the world’s most hated companies during the twilight of their existence.
The Dow opened down 1.5% this fine Monday morning.
Another sign this rally has run its course — Oracle announced today it will buy Sun Micro for $7.4 billion. That kind of deal would have ignited an additional rally two weeks ago. This morning, no one cares… the Nasdaq opened down almost 2%.
Stocks were barely able to extend their six-week winning streak last week, the best since the 1930s. Despite market-beating earnings from Citi and GE, the Dow inched up only 0.1%. For the whole week, it managed a 0.6% gain. Hey, its up 24% from its low last month… what more could you want?
Two more quick nuggets from our friends in the banking sector today:
Despite all the hemming and hawing at congressional hearings, banks loans from the top 21 TARP recipients fell 4.7% in February. According to a Wall Street Journal study, new loan origination from mega banks has steadily declined since the credit crisis began in October — from $226 billion then to $174 billion in February.
Granted, with the jobs as grim as they are, fewer people and business qualify for loans. Still…
Four U.S. banks, including Goldman Sachs and Citi, have filed the papers needed to open branches in Iran.
Iran… the new financial frontier? Heh, or maybe just the only place in the world that hasn’t been burned by Wall Street logic yet.
“The U.S. is lifting certain sanctions against Cuba,” notes Chris Mayer, recounting one of the big stories from last week — a new frontier of its own. “This is like the gingham dog extending a paw to the calico cat. Investors quickly set off in search of ‘Cuba plays.’ They did not hesitate punching the ‘buy’ button.
“The Herzfeld Caribbean Basin Fund, for instance, spiked 41% on Monday. Thomas Herzfeld, who runs the fund, suddenly became a hot number. His portfolio is full of ideas that would benefit from a lifting of the embargo of Cuba.
“There are some interesting ‘Cuba plays,’ as it turns out — ideas that would benefit from more trade between Cuba and the U.S. Herzfeld points out that half of the sales of cruise line operators Royal and Carnival come from the Caribbean. ‘We believe the opening of Cuba could actually double their business in the Caribbean,’ Herzfeld said. Double!
“Of course, all those visitors are going to need hotel rooms. Hotels rooms are going to be a definite problem. Most hotels are nearly full already. The city of Miami alone has about as many rooms as all of Cuba.
“Then there is the telecom angle — cell phones, Internet connections, satellite televisions and radio. Right now, Cuba has the lowest rate of cell phone usage in Latin America. There is lots of potential in these areas.
“It will be interesting to see how Cuba develops. There could be some good opportunities for travel — and investing — in Cuba soon.”
In the finer details of the market, most of the trends forming late last week are ramping up today. The dollar index is up from 85 Thursday to 86.5 as we write, with a half a point rise this morning alone. Looks like we’re back to the old playbook: Sell stocks, rush to the dollar.
Oil’s taking a page from early 2009 too… as stocks go, so too does the black goo. The light sweet variety is down over $4 today, to $46 a barrel.
And last gold. It too is playing a traditional role today. This new round of skepticism and uncertainly has given the metal a boost. The spot price is up $15 as we write, to just below $885.
The famous Fortune 500 list suffered a notable shuffling in 2008, the publisher reported today. Exxon Mobil battled back to the top of the list, beating Wal-Mart for the spot, with $442 billion in revenue during 2008.
But here’s the spot that got our attention: Overall earnings for the 500 biggest companies crashed 85% last year, to a mere $99 billion — the biggest drop in the 55-year history of the list.
Happy Monday from Baltimore, where it promises to rain all day.
The 5 Min. Forecast
P.S. If you’re planning to join us as a member of the new Richebacher Society, please remember the open invitation we’ve issued ends tonight at midnight. From there, we’ll reassess and let you know how enrollment has shaped up. But one thing is for sure: History suggests that you’ll never get as good a deal on our enrollment as when we kick it off for the first time. For example, as you’ll see, if you reply by 5 p.m. tomorrow, you’ll get $9,554 worth of member benefits, free for the first year of enrollment.