To close the day we present two different opinions, first one a relatively downbeat one by Goldman, and the second one modestly optimistic by Mike O'Rourke... note Mike's discussion on Buffett CDS - he brings up a very critical point that is true for all companies that have technicals preventing a true indication of risk either at the equity or debt levels.
Also, check this out: some pessimism porn from a high up Russian guy.
A technical rally sends US shares 2% into the green but leaves few feeling any better as we closed poorly and,fundamentally,the outlook is still grim. The news from the US today was mixed at best – with the Beige Book clear on the economy calling the outlook “poor.” Service ISM better than expected but worse than last month and still below 50. The Atlanta FED Lockhart comments are also a mixed message,warning of future hikes if growth returns – similar to the Obama budget promises of new taxes. And today’s ADP report reminded us how ugly Friday’s could be – many economists are calling for 700k job losses, with a few true pessimists looking for losses upward of 800k. The UK PM Brown address to Congress proved interesting as he extolled the Congress to see past protectionism and urged another round of global rate cuts – hard to do when you are already at zero. The larger push for Brown seems to be a quiet agenda on new regulation of the global financial sector – something that leaves many waiting for more information. Investors should be getting used to waiting by now though; clarity on bank stress tests, the ‘public-private’ partnership, and mark-to-market accounting rules are still forthcoming. On the MTM issue anyways, resolution could soon be on the way: House Financial Services subcommittee is expected to hold a hearing next week on mark-to-market accounting rules. The market wants the rules suspended but the risk is longer-term pain for a short-term gain. Suspension of MTM rules will only allow zombie banks to hobble along longer and further undermines confidence in the financial sector as a whole. But for today anyways, hope for a recovery holds – and it’s best reflected in the 7% rally in oil,which breaks $45 bbl and waits for confirmation of another China stimulus package. The commodity currencies have all benefited today – from NOK, AUD and CAD,not to mention a number of Emerging Markets, BRL in particular. Relative calm has also been good for the old relationships to risk – namely EUR/JPY breaking 125.50 and in EUR/CHF holding over 1.48. But few trust the tape or believe that this bounce today can rally beyond the 720-740 resistance in S&P500, especially after the technical rejection there. Many see today as a sickly cat,if not a dead one,with the fundamentals still begging for looser policy – global ZIRP? Much hope has been put on the FED TALF and on the push for a bigger bank fix like the private-public asset buying scheme. But hope isn’t sufficient to hold back the tide of gloom. ----- Goldman Sachs
Maybe we have come full circle and we are back to decoupling again. Of course, we are being facetious, but positive news out of China between expectations of increasing the stimulus and the 49 reading on China’s Manufacturing PMI indicated that there is improvement somewhere in the global economy. The Chinese economy should be able to endure this crisis in much better fashion than the rest of the world. Besides being a cash rich, creditor nation, growth economy, the top down political structure ensures that initiatives are instituted quickly. China does not suffer from ill-informed elected officials throwing terms like nationalization, etc. around. Although we would not trade the U.S. form of democracy for any other political system, it sure does make the healing process sloppy, and in some instances, more painful than necessary.
Chairman Bernanke deserves credit for standing up to the Senate Budget Committee with respect to AIG yesterday. Noting that he did not want to save AIG, but in order to protect the financial system, he had no choice, he then pushed these collective challenges back on the legislators: “I'd like to challenge the Congress to give us a framework, where we can resolve a multi-national complicated financial conglomerate like Citigroup, like AIG or others, if that became necessary.” That statement got them to back off. We all know that our politicians are not going to risk getting tied up in these messes. Bernanke should continue to take that stance going forward, and keep pushing back. In a small bit of irony, a bipartisan group of Congressman wrote a letter to Chairman Bernanke and Secretary Geithner claiming that the TALF may not be sufficient enough to help auto dealers.
On the housing front, First American CoreLogic published a report that 18% of mortgages in the U.S. have negative equity. What the headlines failed to mention was that 58% of the mortgages with negative equity were in 6 states and in the balance of the states, the average is 12%. First American notes that the 42 million mortgages in their survey represent 80% of all mortgages in the U.S. To put that in perspective, there are 75 million owner occupied housing units in the U.S.
To the market’s credit, Equities managed to post a good session despite further weakness in the Financials. The last few banks that were generally deemed “healthy” are now under siege. Since the government has failed to take a stand in favor of Regulatory Capital vs. TCE, the TARP funds have provided no help. At this point, whoever can return the funds should do so quickly. General Electric, which very well may be the last man standing in the shadow banking system, also finds itself under siege.
We are keeping an eye on a development we’re calling the “Berkshire Experiment.” Berkshire has become roundly loathed in the hedge fund community. Bloomberg reported today that Berkshire’s Credit Default Swaps have risen to record levels, implying “Junk Status.” Over the past year, throughout the financial sector, the market has witnessed a self-reinforcing process where the Credit Default Swaps of an institution would rise, prompting short sellers to pile in, and spooking long sellers as panic erupted in the common shares. Essentially, it is widely believed that the CDS market has been used to launch “Bear Raids” on common shares. We have argued the last leg down in the banks recently and that the nationalization talk was primarily a result of the downward move in the common shares. Here is why Berkshire is important. Berkshire has 650,000 A shares outstanding (with Buffett holding more than half) and 12.1 million B shares outstanding. The miniscule float makes shorting of the common stock nearly impossible, but you can buy as many Credit Default Swaps as you want. Buffett’s holders are among the most loyal, but Buffett has experienced a few setbacks just like everyone else. It is likely that only the CDS portion of this self-reinforcing two-step will be in play in Berkshire. Now, we will get to see in real time whether or not the CDS market has been creating panic in common shares or if it is simply legitimately pricing credit risk.
Mike O’Rourke, CMT
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