Friday, May 29, 2009

Shawdow Banks

Til Schuermann on the real size of the Non-Bank Sector

Til Schuermann a member of the Federal Reserve Bank of New York testified before congress and he made some scary remarks. It's a highly recommended reading

"When one adds credit provision though corporate bonds and commercial paper, one realizes that commercial banks have provided only about 20% of total U.S. lending, since the early 90s. The four decades prior had banks’ share closer to 40%. The rise of market-based instead of bank-based credit provision in the last twenty years has been substantial and important."

Bernanke was using misleading numbers about a 50% share a few months ago, I assumed his figure was correct. I first saw the 20% in the Economist a few weeks back, the FRBNY now is backing this. With the shadow banking system now in its grave(the commercial banks still zombified) plus market lending still weak(although enjoy a nice temporary rebound) this spells big trouble for future credit growth and US potential GDP. The stock market is almost surely being delusional if they expect the type of corporate profit margins the US had in 2007 to return, if anything they will continue to shrink. 2010 GDP which is forecast to be around 2-3% is also almost surely too optimistic with the current levels of credit growth and household stress

Monday, May 25, 2009


Green Shoot Smokers Running Out of Breath

Time to lay off the bong fellas

Friday, May 22, 2009

US Consumer

Retail Sales, PCE to surprise in the downside?

"Recession Turns Malls Into Ghost Towns" - WSJ

Gap Profit Falls as Consumers Trim Clothing Purchases

This week ICSC-Goldman Store Sales posted a 1.2% decline W-W
Redbook reported -0.2% in store sales from Apr to May

Wednesday, May 20, 2009

Japan GDP

Japan Posts its Worst GDP Number Ever

What are the odds that the worst GDP report ever is followed by a V type recovery as it seems to be currently embedded in Japanese equity values?(Or at least expectations that another L wont occur)
Here's some analyst comments from the worst report ever
We’ve turned the corner. The economy is no longer in free fall"
“The worst is over,” said Hiromichi Shirakawa, chief economist at Credit Suisse Group AG in Tokyo. “We’re going to see positive growth -- not significant growth, but growth --from the second quarter onward.”

They usually justify the optimism by hand picking data that is bouncing around
It just seems that the odds that people are engaging in wishful thinking is much greater than the odds of a actual V recovery after collapses of this magnitude(specially when needed reforms are still lacking), maybe wishful thinking is as much as 8-1 favorite to be taking place than the theory that an actual V type recovery is happening

I've been hearing a lot of 'inventory' recovery in the 2nd half following inventory drawdowns in the US and countries. That is totally wrong, inventories are down but SALES are down even more

As sales reset to a new level so does inventories, who is going to rebuild invetories when you can't sell anything?

Monday, May 18, 2009

Hussman Watch

John Hussman Watch

Hussman lastest article looks mostly correct with the exception of when he addresses the idea of pundits referring to consumers increasing their savings as being bad to the economy

He says
"At present, it is not valid to say that the economy is weak because people are saving too much, because if gross savings were up, gross investment would also be up."

Well the problem is that when pundits say 'people' are saving too much they refer to US consumers and to some extend to the corporate sector not to "gross domestic savings"(that is, total saving including consumer, corporate and government entities) that Hussman is addressing, in fact one of the arguments of the pro-stimulus people is that since consumers are saving more its up to the government to borrow and spend so to keep gross domestic saving from collapsing national income(Like in the example he outlined)

So yes he is right that gross domestic savings is not rising(Mainly due the government deficit) but its not rising because left to its own devices it would have risen and the government decided to try to cushion its impact by increasing government investment(thus lowering government saving) by running deficits and through the stimulus plan, so the pundits are wrong from a nit picky English perspective but their main point still stands, a rise in consumer saving in a macro level while desirable in the long-run is not its good for the economy at all when it happens in a major way very quickly, if uncontrolled it would lead the US into a deep depression,
yes savings equals investment but only because 'investment' includes inventories, so if everybody stopped buying from wall-mart tomorrow the rise in WMT inventories would show up as 'investment' even though WMT had no intention on increasing investment, in fact its just the opposite they will cut jobs, stop expanding till they see a pickup in sales(Hussman acknowledges this by saying "Output that is not consumed represents 'investment' even if it is unintentional 'inventory investment.' ")

This article from Wikipedia nails it
Savings Identity
"Note that this is an "identity", meaning it is true by definition. This identity only holds true because investment here is defined as including inventories. Thus, should consumers decide to save more, and spend less, the fall in demand would lead to an increase in business inventories. The change in inventories brings savings and investment into balance without any intention by business to increase investment.[2]

Note, that as such, this does not imply that an increase in savings must lead directly to an increase in investment. Indeed, business may respond to increased inventories by decreasing both output and intended investment. Likewise, this reduction in output by business will reduce incomes, forcing an unintended reduction in savings. Even if the end result of this process is ultimately a lower level of investment, it will nonetheless remain true at any given point in time that the S=I identity holds"

Therefore Hussman setup a bit of a straw man and is nit picking pundits and analysts because when they say a 'this rise in savings is hurting the economy' they do not mean 'gross domestic saving'(Which is affected by government deficits and investment) but they refer to consumer and business saving(that is gross domestic private saving), which a major quick rise in a macro level would result in a economy much weaker than otherwise(The so called Paradox of Thrift)

Friday, May 15, 2009

More DA

More Devil's Advocate

Credit Markets are healing and opening up for business. Credit Research indices of credit spreads are improving across the board

CDR counterparty risk spreads
US High Yield
US Investment Grade - CDR Liquid 50 NAIG Index
CDR Liquid 50 Asia IndexCDR Liquid 50 EU-IG Index
CDR government risk spreads
Bond issuance of IG and HY is also going strong. Libor is down a lot.
Could the market be engaging in wishful thinking and be ready for another blow out of spreads?Sure but this healing creates a self-fufilling propechy(What George Soros calls 'reflexivity'), the improvement in risk taking increases the amount of credit avaliable to economic agents which raises the chances they will make it without going through bankruptcy, it also lowers their cost of credit increasing their profitability which also raises their odds of survival. As Bill Ackman put it if everybody was a pessimist like Roubini the economy would die of a horrible death. If instead everyone just turned into a Pollyana the economy would perform much better than otherwise, thats why badly designed stimulus packages are not such a bad idea, quasi placebos can be a powerful thing

Thursday, May 14, 2009

Devils Advocate

Devil's Advocate

Since my current macro thesis calls for lower equity prices(particularly in financials, reits and other leveraged garbage companies) I thought about making some counter arguments against a bearish view in stocks and the US economy

1 - The Yield Curve is suggesting recovery. People who ignore the Yield Curve are usually wrong

2- Housing Affordability is reaching generational levels

Some housing experts believe that a particular level of home prices is not what drives demand but actually housing cost against income, with mortgage rates so low AND prices dropping affordability is rising. Perhaps Case Shiller will surprise everyone by bottoming earlier

3 - IMF Research on Financial Crisis suggest financial crisis recessions last 5.5 quarters on average and syncronized recessions last 4.5 quarters on average. So far this US recession has lasted a little more than 5 quarters so a bottom could be around the corner

4- Private Banks might not be lending a lot but the US government is taking over the role of a lender(The so called Minsky Solution). TALF, fed facilities(like the Commercial Paper facility) are substituting the private sector and helping support credit. Those programs can surprise on the upside by getting more traction, in fact TALF for CMBS could start a big bailout of REITs and prevent GGP type failures

5 - US stocks already went down by 60% or so from peak to through its silly to keep pounding on the same bearish thesis as the risk reward is getting terrible and risk premiums and projected returns are rising. Experienced short sellers such as Jim Chanos follow this disciplined approach, he is out of short selling financials and beaten down sectors due a 'asymetrical risk reward relationship' he says he will let 'others pick up the last $10 a share'. There is a lot of wisdom behind this theory, in fact its pounding on the same thesis what destroyed Citigroup, Bear Sterns, Boone Pickens, Dwight Anderson, Tech Stock investors, others. In fact when you have markets going one way or the other in a straight line at turning points a lot of people will go broke because its natural to look at the 'fundamentals' in a very biased way when you have huge profits. People will make up excuses to stay in the trade

Tuesday, May 12, 2009

Greenshooters Sheet

Breakdown of The Green Shooters Macro Outlook

The Stress Test seems to be using a slighly worse forecast than 'the blue chip' consensus. A few points

-If the Blue Chips forecast for 91-day T-Bill rates plays out, that implies a federal funds rate at 2.5-3% by 2011, this would hurt bank margins and earnings. It's very likely this fact wasn't factored in the stress test as the Treasury seems to think all banks problems will be magically over by december 2010

-Its May and the unemployment rate already matched the blue chip forecast for the entire 2009

-They all expect 10 Year US Treasuries to be around 5% from 2013 to 2019, this seems like a joke, its very likely its going to be one extreme or the other, either the US becames japan and the ten year trades around 2% for a long time or it gets out of this problem with inflation and fiscal issues(including the severe entitlement problem) and rates soar

The stock market own forecast is probably a mix of those above, it clearly doesn't expect the stress test 'more adverse' scenario to occur otherwise banks would have no earnings(They would post a more than $200b net loss) and the XLF would nosedive. Consensus is usually too bullish, especially when massive bubbles burst, when the market realizes that the more adverse scenario is actually the baseline things will get ugly

Friday, May 8, 2009

Bernanke The Bank Analyst

Federal Reserve: Virtually All Banks Will Lose Money Over The Next 2 Years

The stress test result is out showing that is expected that banks will lose $600b against $362.9b in pre-tax pre-provision income(What the feds call pre-provision net revenue, PPNR), this is a $237.1B in net losses for the US 19 largest banks
Of all the banks tests only three show they will have a net gain over the next two years, Goldman with a whopping $0.7B gain($17.8B losses against $18.5B in PPNR), Bank of New York Mellon with a gain of $1.3B, Amex with a gain of $0.7B

Now keep in mind that the PPNR uses the management estimates of what they will likely earn, this is almost certainly too optimistic as anything that depends on a CEO judgement usually is. It also uses the Treasury economic forecast that will likely prove too optimistic as well(Unemployment is likely to top at 11%). But even then, forget Meredith Whitney, the fed just launched their own earnings forecast for Bank Stocks
over the next 2 years, virtually all of them will show a netloss, some of them will need additional capital and dillute shareholders as their rosy scenarios dont playout. If you look at anlysts earnings estimates they painting a much more optimistic forecast and the stock market is putting something like a 10 multiple on those rosy forecasts, what happens when the market realizes the economy wont grow at 2% rate in 2010 and there will be no earnings and more dillution coming?
What we are seeing in banks stocks is one of the biggest suckers rally ever

Wednesday, May 6, 2009

Bernanke Not Smoking Yet

Bernanke Still Not Hooked in the XLF Green Shoot Bong

"We continue to expect economic activity to bottom out, then to turn up later this year....An important caveat is that our forecast assumes continuing gradual repair of the financial system; a relapse in financial conditions would be a significant drag on economic activity and could cause the incipient recovery to stall"

"Investors seemed to adopt a more positive outlook on the condition of financial institutions after several large banks reported profits in the first quarter, but readings from the credit default swap market and other indicators show that substantial concerns about the banking industry remain."

Bernanke's concern arises from his own research published in a paper and his book about the great depression. He found significant statistical correlation between banking panics in the 1930's and collapses in industrial production and economic activity

Most of the Q1 earnings were either one-time items(like mortgage refis or capital gains from holding GSE debt), volatile hedge fund type profits('trading' revenues), gains from declines in the bank own debt or write-ups from bad assets using rosy assumptions. It doesnt take a genius to realize that a quarter where GDP went down 6% and unemployment jumped shouldn't bring out profits to businesses that are simply levered bets in the US economy

With home prices still in decline and unemployment headed higher its very likely bank earnings will dissapoint the now optimistic forecasts, beating Q2 estimates will be much more difficult because everyone is now passing the green shoot bong and optimistic expectations are setting their own downfall

Looks like BAC needs $30b+ in capital, C $10b and 8 other banks also need money. Keep in mind that this is using the government rosy assumptions about unemployment and accepting bank management rosy assumptions about pre-tax pre-provision earnings, plug-in more realistic numbers and the capital needs would certaintly soar. This suggests Bernanke's fears might became reality as the market will grow its concerns about bank capital and earnings in the coming months. The XLF has lead this market all the way down, unless housing and the labor market turns around its quite likely this will happen again

Monday, May 4, 2009

Buffett The Zombie King

Warren Buffett The US Zombie Bank General

Apparently Buffett believes in Madoff banking, he wants the government allowing banks to 'earn' their way out of the problem even if they are insolvent. He said sometime ago he feared the 'government forcing banks to issue stock at very low prices, they can earn their way out of this mess', he is the US zombie banking commander in-chief. For him its not a big deal for the banks to be be critically undercapitalized in a tangible common equity basis(like Wells Fargo) as a long bankers get a chance of to hit again after one of the biggest strike threes in the century. Although its an extreme comparison it resembles the idea of allowing Madoff to keep his company as a going concern and hand him taxpayer subsidies so he can try to 'earn his way' out his hole playing futures

Whats the problem with this approach? Banks wont lend, the latest Fed report on banking lending shows that net credit is down again, the truth is that banks need to be massively overcapitalized(preferably through preferred stock/unsecured debt to equity swaps while respecting property rights)right now so they can feel safe lending again and they can stop using the FDIC deposit and bond guarantees for funding. Banks uncertain about capital will fear their regulators and hurt the lending markets

Buffett claims WFC is a fabulous bank and he would put his entire net worth there I disagree the plain fact is that lots of wells advantages comes from federal subsidies. First the bank is too big to fail, most of the banks with more than $10b in assets pay less in interest for their deposits even though their banking portfolios are worse than smaller banks(Source: FDIC quarterly banking profile). This is the US depositor betting the bigger banks will be saved. Secondly the federal funds rate is at 0% while lending rates are high, this federal subsidy is not sustainable it will reverse eventually, the 'margins' that buffett mentions as one of the great banking assets will decrease at some point. This is a transfer of wealth from savers to banking shareholders, when the economy recovers and banks puts their balance sheet issues behind them they will face as earning issues as the fed raises the rate and banks face massive regulations(along with lower lending rates). Plus there are the FDIC guarantee programs that almost certainly charge a price that misprices its risks(given that they need a bailout themselves), so its a subsidy

Thidly, Obama needled Buffett when the oracle suggested banks shouldn't be forced to issue stock to raise capital 'at very low prices', he said something like 'Buffett is a large player in the financial markets, he is a big shareholder of wells' suggesting he will do the right thing and make banks issue stock and de-zombify them
And finally, there is very little hope banking stocks are something to get excited for the next 10 years

Greater regulation, higher capital ratios(Alan Greenspan is suggesting 15% capital) and a less levered weak growth economy will almost surely hit US banks ROE and therefore stock returns going forward. So perhaps Wells will beat its bank index benchmarks because its a bank that seems to exploit the tendency to get subsidies from the government better than its competition but that doesn’t mean its something to get excited about, it certainly means you wont put a significant part of your networth there due uncertainties, specially with nationalization risk on the table(Maybe Wells Fargo, the company, survives but its possible WFC, the stock, gets destroyed in the process) this is a particulay worry in a undercapitalized bank like wells facing the fat tail risk of 12-14% unemployment

Of course Buffett would object to this saying you cant predict macro/regulatory/economic events, nonsense. Its amazing how someone who makes fun of the efficient market hypothesis turns into a EMH himself when confronted with examples of people predicting macro events for a long time

Friday, May 1, 2009

Hoarding Homes

US Real Estate Market Now Has A Ceilling

Banks are believed to be holding 600K of REO in their books. This is probably a combination of needed repairs in some homes(Since vandalism against foreclosured properties seem to be running high), and efforts to try to stablelize the market and prevent collapses

This should work an effective ceilling on US Real Estate as banks will use upticks and increases in activity(What delusional sellers refer as 'waiting for better market conditions') to dump their properties thefore keeping home prices and markets depressed

This also makes the 'months of supply' data less relevant since it doesnt count shadow inventory