Stock Volatility Continues

Yesterday was another day where investors were bullish and today's futures point to another higher opening. The consumer confidence number has brought some new life into the market. Rising rates, higher commodity prices, and elevated gold prices doesn't seem to bother stock buyers.



We are pleased to see stocks go higher even though we remain very cautious. The bulls say rates are rising because the economy is getting stronger and higher commodity prices are a result of expected improving industrial activity.



We believe that interest rates are up because the government needs to raise trillions of dollars in the treasury market to fund the stimulus plan and all the programs implemented to avert a financial crisis. The Fed is printing money, the monetary base is growing, and the fear of inflation has been driving gold prices higher.



We like commodities for two reasons. Precious metals are appealing if one believes inflation is around the corner and some commodities like silver also would benefit with an improved economy. Farming related commodities could rise as farmers struggle to get enough bank credit to plant their crops. A lack of loans to the farming industry is likely to restrict crop production and thus cause prices to rise as the supply demand imbalance ensues.



As treasury prices decline, concern could grow with the U.S. dollar. A weak dollar is likely to push oil prices higher while also driving gold up. Rising energy prices could choke off the mild economic improvement we are seeing and then stock prices will reverse direction, quickly. A declining stock market is also likely to reverse consumer confidence.



We believe there was a chain reaction that has added to the bullish sentiment in the markets. Stocks took a dive through the beginning of March. The oversold condition led to a huge rally. Higher stock prices resulted in higher consumer confidence and higher consumer confidence led to even higher stock prices.



We are not convinced that this chain event will continue. Rising unemployment, weak corporate earnings, lower housing prices, and higher gas prices could lead to lower consumer confidence. Lower consumer confidence leads to reduced spending, minimal inventory replacement, declining corporate profits, and lower stock prices. If we add higher interest rates to the mix, misery will be ubiquitous and holding cash and gold will be the best investment strategy.

Should The Government Bailout The Auto Companies II?

On November 6, 2008 we wrote how the government should not give the auto companies a loan until they forced them into a prepackaged bankruptcy. It took over six months and some wasted taxpayer money but the government finally got it. The auto industry is about to be deleveraged and the legacy operational cost structures and benefit plans improved to give the United States car companies a fighting chance to compete.

We applaud the GM process as being fairer to creditors than the Chrysler case. Perhaps the government realized that strong arming creditors isn't the best way to approach debt investors as they did with Chrysler. We are not opining on whether everybody got their fair share in the proposed new GM but at least it is not totally unjust. The completion of the bankruptcy process for GM will take at least 2 to 3 months but hopefully when the company is restructured, it won't need anymore government financial assistance.

Nothing Like a Little Confidence

Consumer Confidence soared and so did the markets. Investors have been hoping for a turn in the economy and the glee from consumers is one data point moving in that direction. There are trillions of dollars waiting on the sidelines and whenever good news is announced hoards of cash seem to move into stocks. All markets were up more than 2.6% and everybody cheered for a day.

The global economy is still struggling and the financial industry is still fragile but we all hope the worst is behind us. Many problems are still ahead and the debt burden of the U.S. government will tax consumers for generations in the future. We still maintain caution as we ride the current wave.

How Will May End?

We continue to be worried about a big pull back in the markets. The rally has been pushed higher as the cash on the sidelines gets antsy and feels compelled to participate in the rising stock market. For every positive tea leaf, we still see negative news.

This weekend North Korea stirred the pot with the launch of a nuclear missile test. OPEC ministers are gathering to determine the fate of oil supplies this week. Finally, GM is likely to file for bankruptcy. None of these events will ease investor concerns. Furthermore, we remain concerned with the weak consumer and the pending collapse of commercial real estate. Stocks fell off a cliff in the beginning of March but now they have risen too far, too fast. If the upcoming economic news turns slightly negative, investors are likely to become scared and begin to sell stocks again. If a black swan in the form of political uncertainty in Venezuela, Russia, or North Korea arises, look out.

We are still in fragile times. The financial industry is desperately trying to heal itself by equitizing their balance sheets but the toxic assets still exist. Citigroup is not out of the woods and BankAmerica is not minting money. The global financial industry will take years to undue the sins of the past and many surprises will pop up. We believe it will be years until the world is normal again and until that light at the end of the tunnel shines, investing will remain difficult. It is easy to become bullish as stocks gallop higher but we believe economic times will remain difficult and corporate growth stagnant. Stocks discount future earningsbut the short term earnings boost is due to aggressive management cost cutting. Long term earnings growth depends upon the growth in sales. Unless the Asian export machine picks up and corporate lending is reinvigorated, we don't expect corporations to resume their growth.

We continue to raise cash and buy S&P puts but until enough tea leaves convince us that the economic turn is here to stay, we will be cautious investors in this volatile and risky environment.

What Are We Missing?

For the last few weeks we have been wondering why the market keeps rising in the face of a weakening economy. Investors have been assuming the economy is going to turn around in the second half of 2009 or at least by the beginning of 2010. We have our doubts.

Home Depot and Hewlett Packard don't see any improvement in the business environment. Our trading partners' economies are falling off a cliff. Mexico's GDP was down 21.5%, Germany's was down 14.4%, and Japan's dropped 15.2%. It will be hard to grow exports when the buyers of our goods are in dire economic shape.

Today the Fed released its April minutes and they expect a steeper recession and a slower recovery than their previous pronostications. With all this good news, what are we missing? The stock market has sucked in some of the cash burning a hole in investor's pockets. The short covering rally got us going and the mad dash to not miss the rally by investors with a plethora of cash kept it going. The rising market brought us rosy colored glasses about the economic prospects and stocks moved higher. When the disappointing news about the economy continues to flow in for the next few months stocks could retest the old lows. Buyer beware.

"Obama's Auto Plan Is Capitalism At Work" or Not

The WSJ.com has an article written by Scott Sperling titled "Obama's Auto Plan Is Capitalism at Work". We have been saying since November 6, 2008 that the government needs to force a prepackaged bankruptcy at the auto companies to improve the cost structures and to reduce the leverage before tossing away precious taxpayer money. The Obama administration did just that as Mr. Sperling articulated. We agree with most of his article except for how the banks were treated in the Chrysler situation. The strong arming of banks, especially those with TARP money, and the public lambasting of the money managers who were trying to get their fair share was not capitalism as we know it. Nobody would benefit in liquidation. Perhaps the banks would have received less than 29 cents on the dollar but the unions and their pension plan and health plans would have wound up with nothing. The government was right to force a restructuring where everyone took some pain but the unions who had subordinated claims to the banks didn't deserve a bigger piece of the pie than the banks. The conclusion can only mean Socialism defeated Capitalism.

Lowe's Drives the Markets Higher

Lowe's, the home improvement retail chain posted better than expected earnings. Although the numbers were still considerably lower than last year, the company's outlook was a little rosier than last quarter. We also got an uptick in the housing index which spurred investors to buy stocks. If the housing market is bottoming, the bull market must be on its way. We hope this is true and we hope our recent thoughts about the impending troubles ahead are wrong. This uncertainty keeps us still long some stocks but a little bounce in the economic data and corporate earnings which are declining less than previous quarters is nothing to get too excited about. Time will prove us right or wrong but we will continue to raise cash as the markets fly higher.

A New Week of Uncertainty

Last week the market dropped as earnings season is coming to an end and the financial institutions have begun to recapitalize their balance sheets. Markets soared from the March 9 lows as tidbits of positive economic news fueled investor sentiment. The world began to enjoy economic news that wasn't as bad as much as it had been recently. Sounds great. Business continues to be weak, unemployment is rising, but production picked up a little and the retailers saw some light. Consumer sentiment ticked up, smiles came across peoples' faces as spring began, and the stock market began to fixate itself on the impending recovery. We don't believe everything is quite so cheery.

Gas prices are on the rise which won't make consumers happy. Most businesses whether large or small tell us they are not very optimistic about the near future. Of course, most companies have seen a slight improvement in sales but how much is related to an inventory build. Business shut down in the fourth quarter of 2008 so any positive news in the first quarter was welcome. Does that mean stocks are off to the races and everything is fine? Clearly not as toxic assets remain on the books of financial institutions, commercial real estate is heading for trouble, corporate bankruptcies are rising, and consumer defaults will multiply.

Nobody, including us, wants to miss the next bull market but we think a true economic expansion is a long way off. The government is providing stimulus and the Fed has grown the monetary base but consumers are in saving mode, businesses are cutting costs not investing, and financial institutions are garnering huge capital markets fees but not driving business growth through the lending machine.

Stocks discount the future but sometimes they overshoot on the downside and sometimes they overshoot on the upside. March was a point in time where fear was high and nobody wanted to lose more money in stocks as the economy cratered. Stocks are much higher today and nobody wants to be in cash as stock prices move up. As it becomes apparent that economic activity will slow again, stocks could continue the downward trend. We remain cautious and hedged.

Socialism Keeps Popping Up

Are we citizens of the United States? Capitalism is driven by a strong entrepreneurial spirit and those who take risk improve their chances of earning large financial rewards. The banking and investment banking industries create the greatest opportunities for highly intelligent risk takers to generate outsize profits. Such gains usually result in the growth of one's personal net worth. It all falls under the concept of risk/reward. So how can the Obama administration try to punish success and the entrepreneurial spirit? The President wants to control the pay of individuals in the financial industry regardless of whether the institution received TARP funds. If we allow this to happen, what else will we let the Government control?

Most Americans love their freedom and the freedom to "earn" a very large income should not be limited by government. This is not a Socialistic society and we should not allow the government to move us in that direction. This country has enough problems to deal with from Social Security to Health Care to the stability of the financial system so we must let the free enterprise system keep capitalism alive.

The Markets Swoon

Stocks are certainly drifting lower lately. The stress test results have lead to many public stock offerings by financial institutions with more on the way. The market has been able to absorb this new supply of equity so Ford and MGM are following right behind with large stock sales. This onslaught of new equity is good for the stability of our nation and our financial system. However, it may not be good for stock prices.

New massive dilution should limit the upside of stocks in the short term but lower leverage could be good for the future. We have been concerned with the weakening economy and its effect on stocks. Investors have become more bullish with each positive tea leaf as stocks soared since March 9th. Will they become more concerned as the economic data doesn't improve as expected? Retail sales were weaker than expected as reported this morning and the S&P is off 1.85%. If the employment picture continues to look bleak, the commercial real estate market begins to really crack, and credit card defaults soar, where will stocks be?

The Obama administration is attempting to tackle many problems but the government debt continues to grow. If the rumors of a downgrade to the U.S. Government credit ratings becomes a reality, the cost of funding such debt will increase and the value of the dollar could decline. Such a result will not be good for stocks or the financial industry.

The Bulls Have Been Winning

The markets certainly roared last week. The stress tests resulted in a few new large stocks deals for the big banks and a few more on the way. That should add to the stability of the financial system but it won't get rid of the bad loans on the books. However, investors seem happy and have driven stocks up quickly in the face of rising unemployment and a weakening economy. Stocks always go up before the economy turns but is it too far too fast?

The Chrysler bankruptcy should move along swiftly as the government successfully strong armed creditors. This event may effect the credit markets and the bankruptcy process in the future as big brother becomes a new risk a prudent investor must account for when deciding on whether to lend a company money. If contractual rights can be easily broken and moral suasion rues the day, capitalism may go by the wayside.

Many investors missed the big rally and don't want to miss the next move up. Plenty of cash is sitting on the sidelines and nobody wants to be left behind. Short covering drove stocks higher and as prices moved up long investors began to participate. Now we are at a point where most investors are unsure if we ran too far too fast. Bull markets climb the Wall of Worry but the economy seems to still have many risks as uttered by John Chambers at Cisco. Perhaps businesses are seeing a slight improvement but much of that is due to a reversal of the inventory correction. Consumer confidence has been moving up but are higher stock prices driving that optimism?

In a few months we will be able to look back and see if investor zeal has pushed stocks up too quickly or not. We will continue to be cautious and read the economic tea leaves as they appear.

Banks Stocks Applaud The Stress Test

The bad news is out and bank stocks rallied. Bank of America needs to increase its equity by $34B and its stock is up $2 to increase its market cap by $12.8 billion. Perhaps the markets need more bad news like this. Obviously the government leak regarding the stress test results set up investor expectations such that a relief rally for financial institutions ensued after the actual results were released.

We must remember that these stress tests assume unemployment tops out at 10.3%. That is a very big assumption. By the time we get to that point, the banks are likely going to position their balance sheets to allow for additional capital raises, if their smart. Also, the Federal Reserve is assuming maximum bank losses for the 19 banks will top out at $600 billion whereas other forecasts have overall banks losses as high as $3 trillion. Of course those numbers aggregate all banks but the largest banks will likely encompass the bulk of the damage.

Today we will get the April jobs report. Most investors are hoping for an improvement similar to the ADP report. If more jobs were lost than anticipated, the market could reverse quickly and move lower. Futures are higher this morning which reverses the downdraft of yesterday but the employment report could change that quickly.

The Stress Test Brings Stress to Investors

D-Day is today as we wait for the results of the bank stress tests. There have been a number of leaks about the results but nobody knows for sure how much money needs to be raised by some of the weaker banks in the group of nineteen. It appears that between six and nine banks will need to raise additional common equity or convert an equivalent amount of preferred into common or execute asset sales to deleverage. We will know all the facts soon but this is clearly the first step towards forcing the financial industry to delever.

The markets have been grasping onto all the rumors and leaks as stocks continue to rise. We foresee many more issues ahead for the banks but perhaps investors view these problems to be fully discounted. Only time will tell but the toxic assets are still toxic, the commercial real estate loans are still heading for default, the consumer loans are not being paid back, and the housing crisis is not over.

The ADP employment number brought a pleasant surprise to stocks yesterday but will tomorrow's actual employment numbers match those results? If not, stocks could sell off aggressively. Cisco reported its results last night and although their customers are seeing some stabilization, growth is not expected for the next two quarters. Visibility is still limited and the end of the recession is not in sight. Perhaps rising oil prices is a better gage of impending economic activity. Clearly, many of the cyclical stocks continue to rise. The overall market is a compilation of many individual companies and the discounting of all the economic tea leaves. It seems hard to believe that this rally is a true discounting of all this information but it more likely appears to be driven by short covering and the concern by money managers, with lots of cash, missing the next bull run. We like to see rising stocks but we continue to raise cash and put on hedges to protect the downside. If bull markets climb on walls of worry, perhaps it is a bull market but we will remain on the cautious side.

The S&P Turns Positive

Investors continue to shrug off the many risks to the economy and corporate earnings as the S&P rose 3.4% yesterday and moved into positive territory for the year. We are still not convinced that good times are ahead as many risks still abound. Only 3 industry groups in the S&P Index are actually up this year but the excessive rise in technology, basic materials, and consumer discretionary goods carried the whole index higher. This narrow breath with small overall volume leaves us concerned about this rally in the bear market.

Yesterday some new economic tea leaves brought smiles to stock investors. Pending home sales rose both month to month and year over year. It doesn't seem like such a big stretch to think sales would improve from February to March as home buyers typically go shopping as spring approaches. It is good to see that 2009 is better than 2008 and perhaps housing has bottomed but we need many good months to clear out the inventory. China's manufacturing sector also showed an uptick which added another catalyst to the economic recovery. All these signs are good but may be countered by the many risks still facing this country.

Tomorrow we will hear about the results of the bank stress test. If the Wall Street Journal is right and 10 of the 19 banks will need to raise capital, there will be hundreds more who will also have to deleverage their balance sheets once the Federal Reserve examines their books. It will also likely result in many of them merging or taken over by the government. The stress tests also assume the unemployment rate tops out at 10.3% in 2010. That is a big assumption and we believe that the risk of the job picture being worse is high enough to be concerned.

We hope the markets have discounted the many future risks facing the global economy but hope is no way to invest. Corporate earnings will remain choppy and the banking industry and real estate markets will continue to have problems so we remain cautious as the bull charges ahead.

Socialism or Capitalism

The core of American business has been driven through a capitalistic society. Entrepreneurs raise money privately to create new companies. As these entities grow, the capital markets allow these businesses to raise additional funds from banks, the bond market, and the stock market. As companies prosper, so do the creditors and investors. When businesses falter, the creditors have protections written in the form of covenants on their debt and the priority given to them through security or other subordination language. This process has worked well for many years as small companies have grown into large global enterprises and poorly managed and over leveraged companies sometimes get reorganized through the bankruptcy process. Of course, these are the extremes but the United States is the leader of capitalism because this process is fair and not corrupted by government.

The world's financial system is in unprecedented times. Banks and other financial institutions have been weakened globally and their zeal to lend has been dramatically curtailed. The capital markets, although improving, is still not accommodating to many of the companies that easily accessed capital in the past few years. Unfortunately, many of these companies have increased their leverage during the peak years and are suffering during these weak economic times. We expect the bankruptcy rates to skyrocket this year and next and the reorganization of these entities will move the ownership from shareholders to creditors.

This brings us to the auto industry. We have been arguing for a restructuring of GM and Chrysler though prepackaged bankruptcies since November. These over bloated and over leveraged entities have needed to reorganize their cost structure and capitalization for a long time. Unfortunately, management was never willing to make hard decisions in euphoric economic times and are now being forced to right their ships during the worst economic time since the Great Depression. Banks and the capital markets did not provide new capital to GM and Chrysler so the government became the lender of last resort.

It is never a good idea to meld government finances with private enterprise. Just ask companies in Russia and Venezuela. Many banks took TARP money from the government to shore up their liquidity and it certainly seems like a curse as the Obama Administration lays out compensation conditions for employees of these companies. We can only anticipate what other requirements might be put forth to constrain corporate managers from running their businesses for the benefit of the shareholders. Many of these TARP banks are creditors of GM and Chrysler. Is the government pushing these financial institutions to make decisions in the restructuring process that is counter to the rights they process as secured lenders? It certainly appears that way when it comes to Chrysler.

The Obama administration is clearly orchestrating Chrysler's bankruptcy and has set the terms for a GM restructuring. Non TARP creditors in Chrysler are fighting back. They have a secured loan and expect to get better terms than unsecured lenders. The UAW and their health and pension plans are not secured. The rules of bankruptcy have not changed and the Obama government can not unilaterally change them. It certainly feels like a new Socialist Government is trying to abrogate the contractual rights of the lenders. If these methods of coercion persist, Capitalism in the United States could be harmed forever.

We warned that the government should have only made a loan to the auto companies in bankruptcy. They chose to do it their way and will likely lose some of the taxpayer money because they didn't do their homework. These restructurings are very complex and the creditors have rights. Just because Mr. Obama favors unions doesn't mean he can give them greater ownership of these companies than they deserve in bankruptcy. Furthermore, as long as the government loans to GM aren't breached, the Administration cannot unilaterally cram down the creditors.

Many of these actions are disconcerting. Investors have complicated analysis to make as shareholders or creditors. Thankfully, in the U.S. we don't have political risk to worry about. Or do we? The Obama Administration is clearly adding more risk to investing as its Socialistic principles are impeding our Capitalistic Society.

April Was A Winner but May Is Here

If you owned stocks in April, you are wealthier today as the S&P was up 9.4% and the DOW up 7.4% for the month. The economic news wasn't great but earnings season has produced better than expected results for 70% of the companies who have reported. Investors have climbed aboard the stock train as they don't want to miss the road to a stronger economy. We still do not believe the economy will get better until sometime in 2010 as the gloabal financial crisis has a long way to go before the deleveraging process is complete.

The good news is that the Government and the Federal Reserve continue to try and address the big problems. By summer time the auto industry may be streamlined and set on its way to recovery. There may be some pain and fighting to get there but a financial and operational restructuring is definitely needed to allow U.S. auto companies to compete with powerful foreign car companies.

Today is D-Day to find out the details of the Government's stress test for banks. It sounds like there is a bunch of bickering going on about the results and we will have to wait till next week to find out how much capital needs to be raised by some of the banks being scrutinized.

We have been concerned about rising defaults in various consumer loans and the financing of their asset backed deals. The same can be true for the commercial real estate markets. It looks like the Fed is trying to address those issues as it may set up TALF lending facilities for both these markets. The Federal Reserve traditionally only made short term loans but is now considering a program with maturities of three to five years. A successful launch of such a program could be very positive for the economy and the markets. Perhaps investors have seen these tea leaves coming and discounted the results in stock prices.