Gene Inger's Daily Briefing. . . . for Friday, November 2, 2007:
Good evening,
Stock market rebound bubbles . . evaporated in multiple 'lightning rounds' of selling very much inline with our admonition on Wednesday to focus not on the Fed rate cut noise (which is just 'pushing on a string' for the vast majority of considerations now; albeit not down-the-line later next year, as we have outlined)… and to focus on what was going on 'beneath the advertised stimulus'… by looking at the 'Achilles Heel' for this market, which had and has by no means run its course (we agree unfortunately).
A few gunslingers went for the bait of the Fed cut, and did precisely what we warned not to do: chase already expensive big-cap or even technology stocks, after their run. Some thought it time to focus on the message of the market and not fundamentals. I concur. But the message of the market, by virtue of stocks being taken out and shot, for the past two weeks beneath the cover of a firmer DJIA and fluctuating S&P, was run for the hills, not chase sheep up a sheer cliff.
Daily action . . . remarks by us have focused on the efforts by the Fed to provide just a bit of cushion to the banking system essentially so they could shore up capital; not provide a rescue of homeowners with extended leveraged loans living by the shore. It was also a belief that 'pushing on a string' would not help (other than nominally) quite literally any of the home industry, since only a long-term (not short-end) borrower will care about mortgage rates coming down. It has nothing to with refinancing loans that are upside-down, and hardly anything to do with mortgage resets, which are looming large, as we've forewarned for months (more than ample time to prepare).
Tonight's remarks are going to be brief, because the market broke in the wake of the (nothing more than) end-of-fiscal yearend romp by the mutual funds late Wednesday; which had hardly anything to do with the Fed's further nominal rate cut (if anything it's notable that the Fed intelligently phrased their remarks to suggests open options that relate to their next move, if any, which might well not be until next year). Nothing that the Fed is doing will prevent the tsunami of foreclosures still looming ahead, and will not prevent the other scenarios, such as pension funds and insurers managing large pools of money for which (in many cases) they are not allowed to have less than fully investment grade securities therein. Many of the CMO or CDO holdings don't qualify, so that is one of the great little discussed fundamental issues worthy of analyzing.
As Merrill Lynch ran into (little publicized) difficulties in that regard in Florida overnight (as was reported locally but not Nationally..yet), we'll see if that refreshes memories a bit in this regard. Further, the Chinese Government today 'ordered' banks or brokers, in a vaguely worded directive, to cool speculation by reducing market exposure. As in the past we've mentioned there is very little history of regulatory oversight methods in 'commie' capitalist China, and thus we don't know what kind of systems are in place if any for that matter.. to address this 'command'. Keep in mind that there are more ties between the Communist Party and the banks (and 'pools' of money) there than here; a challenge to decipher. They probably don't know what Beijing means by this 'order'.
In New York, if you miss-manage risk, you get fired and receive a 160 million bonus; unless of course you’re an underling, and they bleed you for your last nickel. But now in China, where there's no history, it will be interesting to see if they actually bleed all money managers who lose money or fail to comply. Maybe instead of a severance or similar deal, they take the poor guy out; yank his teeth (ying & yang) or then sell his organs for 'the good of common man'. Am I teething (I mean teasing); no, of course I simply make the point tha we have no idea what it means when a nation like that has so much money, much of our production, with fewer modern society capital controls.
Beneath the 'advertised' stimulus . . . intended to absorb or at least cushion risk as a result of CMO, CDO, LBO and other difficult (that's being kind) debt accumulated in the wake of the housing crisis, which we contended is only a microcosm of the 'credit crunch'; we also reiterate last night's remarks where we focused on Arthur Levitt and the generally non-published Greenspan China warning; which followed our prior day discussion of 'a bull in a China shop' risk assessment comments.
The New York Times expressed journalistic candor on this (unlike financial media that omitted comments from Former Chairman Greenspan, stated to Bloomberg in which he forecast a bursting bubble in China). NYR noted the Arthur Levitt comment (among other accomplishments a longest-running SEC chief in our history) as follows in remarks to pension officials from New York as well as to several other states: Mr. Levitt said their world is fraught with problems, including conflicts of interest, opaque accounting and a tendency among elected officials to promise valuable benefits, then fail to set aside enough money to pay for them.
Mr. Levitt says New York’s pension woes are just the latest in a series of scandals at public funds all over the country, including those in the cities of Chicago, San Diego and Philadelphia and the states of Illinois, Ohio and California. Levitt says much of the trouble is rooted in pension accounting rules that 'fail to reflect accurately' costs of benefits public workers have earned or the value of assets set aside to pay benefits.
Mr. Levitt questioned the way governmental accounting rule-makers are chosen. He believes trustees of boards should be named by the S.E.C. Constituency groups do recommend trustees currently. Even if pension accounting rules are beefed up, it will make little difference unless oversight boards of funds were also improved. Currently, less than half of public pension funds have 'trustee' formal education requirements.
Current practices also allow pension officials to give priority to political concerns, he said, like calling for divestment of pension money from “rogue states”. He expressed concern over practices of some pension officials of soliciting campaign contributions from Wall Street firms. “We've created a situation where workers’ retirement savings are being used for private gain,” he said. While at the S.E.C. Levitt said he directed staff members to investigate these practices. They even drafted a rule barring money managers from working for public pension funds if money managers recently made political contributions to any fund official. The rule conceived in 1999 when the S.E.C. was fighting to curb conflicts of interest in the auditing profession, never made it past drafting stages. Eight years later, Levitt says he the problems were worse than ever.
I'm noting this tonight because of our emphasis (excessive conservative or not) that a lot of what we're hearing is what we're meant to hear from Government, as they more or less circle the wagons to defend against further revelations of what's really 'at risk'. As ingerletter.com members know, we've mentioned 'pension funds', insurance pools and other entities, as holding enormous amounts of debt that cannot be easily priced.
That was last night's comment; rather than dwelling on the minor shuffle of Fed cuts. And we focused on the idea of a 'break' occurring in the wake of that climactic blowoff for all the reasons we've thoroughly reviewed here at ingerletter.com and via audio.
A developing Florida pension fund (cities) situation is symptomatic of related issues.
The Fed and Treasury are doing their utmost to mask true transparency of the extent of the issues; and they may succeed (not being permabears, we actually wish them a modicum of success, but not at the expense of further debasement of our currency or delusional continuity of impossible debt growth). However, the inflationary risks grow, and the societal disparity is amplified. This portion is somehow taken as a partisan or political issue, which it should not be. As a matter of fact it must not be, or the bosses (the people) will make more changes than are broadly expected by those who are the complicit partners in further eroding our financial sovereignty and masking the reality.
Serendipity . . . is less conceivable, as the Feds already print money fast, concealed risk with a vengeance as intended to make off-balance-sheet activities almost kosher, and drop interest rates to give the illusion (pushing on a string) of helping home loans overall, whereas the reality is it only helps a little, because it does nothing with regard to 'resetting' mortgages that hit the Index wall, which peaks in February-March of '08.
It is idiocy to say if that's so the market is a buy here and should discount that, as the guys saying that are either naïve about how long ripple effects permeate the system, or are still trying to get folks to underpin related selling, so they can offload risk more. Of course the market is a discounting mechanism; but that's for later on; not as yet. If the peak of pain is late winter/spring of '08; then it will months later to work it all out. If we see opportunity for an earlier low, we'll be pleased to share such views, of course.
Meanwhile, prudent Americans have been dealt a stacked deck by virtue of debasing of their currency concurrently with erosion of their home-equity values, irrespective of whether they were responsible enough to avoid any sort of dubious loan involvement.
Oversight by regulatory agencies and lending institutions was shameful as we know; but at the same time the problem may be so huge that Government is cooperating to a large extent with the perpetrators of the (inconceivably investment-grade rated by major rating agencies) 'junk debt' paper, so as to at least mitigate National impacts. There's little more to say about this; because the alternative is economic risk. And the GDP reported is artificial, because it reflected the weaker Dollar; similarly to how data is massaged to give inaccurate employment levels, omitting whether a worker lowers his or her quality of work, or of course easily shuffles folks out of work-force tracking. If they viewed compensation/skill levels, you'd see the numbers closer to 8%, and/or as high as 11% if you included those that are no longer counted in the work force. In that regard, if you get a 'better' jobs number in the morning; view that as a 'hook'.
Of course we're not trying to scare anyone, or talk about solvency excessively; but it is what it is, and ain't what it isn't. A lot of liquidity is trying to answer the problem; as few know whether there's sufficient time to avoid collision with that iceberg out there. Again, just because you see it coming, and try to steer asunder, doesn't assure you'll be successful in avoiding a scrape, or something more traumatic, for stock markets. And, with respect to 'rate cuts', none of that impacts 'easy lending', or return to crazy deal-making, which isn't going to be returning for some time. Therefore for now cuts in rates helping the banking system, they do nothing to strengthen the economy, yet.
As to everyone saying Citigroup money is 'good'; how simplistic. They were number 2 or so on our (sorry; not available to share anew) capital reserves problem list posted here months ago (a risk profile which was subjective, not verifiable, but worrisome, as we noted). It meant that lots of the big houses had lots of CMO and/or CDO holdings. As of now nobody really knows how much of that has been offloaded or what is really proper pricing, since the market is still hobbled for such 'junk debt' or similar paper. In our opinion, it's above our pay grade to assess this further, but we do believe there is a modicum of the 'too big to fail' mantra associated in everything transpiring from the 'back-channel' aspects of markets which generally are not broached by talking heads.
Some of the modern contemporaries of mine get a word of sanity in here and there of course; but not often enough, and not in the depth I would allow in the old days. That is too bad, because I always felt that there is a time (before a market transition but as things are stewing) to assess thoroughly (not sound bytes) what's afoot; not reduce it to headline grabbing stuff, or shut-up an analyst or economist who actually has views that go against the grain of the 'establishment'. Otherwise all you have is another day of financial broadcasting with too many 'links' to those who might actually be behind a campaign to mask from society what are the real issues to contend with. That's been a problem for years with headline-format-top-40 (if it bleeds it leads) news scenarios. So my argument in past few months has been to air-out the real challenges and risks to our society, that the aggregators of 'junk debt' or 'extreme globalism' constitute.
Stop looking at stocks based on current multiples; even if they were cheap which isn't the case, that is not what the current market challenge is about (but would magnify it) primarily. It's about greed, unsavory management(s), tout promotion after rallies, and a horrendous debt and credit situation, domestically and internationally, which is not at this point remotely adequately addressed as far as workable solutions in the future.
Finally, remember plastic: markets celebrate more debt, and the MasterCard gains. Harrumph. That, in our thinking, is ultimate low level debt. This says, it is that people are trickling into increasing cash withdrawals to survive from credit cards (something we argue for years was not advisable as credit cards are ridiculous to use other than convenience tools, given their high interest rates and risk of piling small charges into essentially big debt) .. again this sounds old-fashioned, but it's sound. Big purchases should always be on zero-interest rate deferred deals (that's different if handled right by average folks), and large purchases by established families needing use of credit have almost always been via 'credit lines', by which interest typically was deductible, or even under prime. Lately I hear American Express has increasing delinquencies (they too are in 'credit card', rather than convenience card, business for affinity cards of course), so this is symptomatic of the continuing increase in the risk of lowly plastic debt. This market rallied such stocks, instead of selling them off based on rising risks.
Bottom line: the cascading impact of mortgage resets lies ahead; that stampede of foreclosure risks has virtually everyone in finance trying to skirt a train wreck; but that doesn't ensure they'll be successful. Some think we have a year or more to go before risk returns; we thought on Wednesday it was more in terms of days or hours (if even and obviously was just minutes); and that focus will switch to stronger Greenback (at least a stabilizing one); no further near-term rate cuts likely; and higher retail gasoline prices right at the start of seasonal shopping as deterrents to chase stock markets.
We suggested the stampede might be to protect assets not under duress; that comes just in-front of a series of 'capital gains' distributions which follow ending of the fiscal yearends at the funds, which is now accomplished on a fairly solid note, which was I thought the characteristic of Wednesday's rally; not anything related to the Fed action really. I thought a stampede would be out of the 'money corral', as there was risk. For sure, rebounds not withstanding we do not believe the market's near any low point(s).
We don't mean to scare anyone; nor paint an overly negative picture. We do mean to be realistic. I don't believe that consumers can deal with what's developing constantly with periods of hope that do not come to real fruition of a resolution. I believe that our warnings (which on real estate go back two years or so) rather for the most part have been helpful, and gave a modicum of sufficient time to take action if one was inclined (we don't give advice on anything; just our perspective). Those thrilled that they offer comfort and encourage folks never to 'panic' or exit, might be right; or they (so far it's generally the case) actually gave folks reason to commit portions of reserve capital at the wrong time, or worse (if the family unit is pressed by all that is happening), they're providing comfort in doing nothing but just crossing fingers. If this all really unravels…
Bottom line: signs as we interpret them, included the (slightly updated only) following bullet points:
· China 'ordered' cooling of speculation within the next few weeks; whatever that may portend;
· Citigroup downgrade and limited response, suggest challenge may be larger, not smaller;
· Is it coincidental that lots of analysts this week suggested 'C' as a 'bargain stock' to buy?;
· Is Merrill Lynch situation in Florida (pensions) similar to what Arthur Levitt warned about;
· Mr. Levitt's comments to the NYT emulate our overall concern about pensions and insurers;
· Fed cut precisely as desired (25 bp/funds & discount rate); and may be done pending trend;
· Dollar dangerously down; likely bottoming very soon (or starting); at least temporarily;
· Foreign monies via sovereign funds will question coming into U.S. markets at high levels;
· China ordered increased bank reserves; still not generally reported; market(s) flings risky;
· Greenspan warning about China a "bubble to burst" amplified our recently stated concerns;
· Asian markets in-general extended; and cash flow to here limited based on protectionist fear;
· Net capital inflows likely continue constricted; may worsen if U.S. cuts interest rates too much;
· Turkey / Iraq crisis has indeed flared-up, along with the price of Oil, as outlined preceding it;
· 'Crack Spread' issues mean rising U.S. gasoline would press consumers anew (ongoing);
· (Ditto) likely behind the wide expectation that a couple major oil companies miss forecasts;
· Russia / Iran alliance back-burnered by Israel cluing them; Moscow rumored to correct policy;
· Suspect U.S. offered to not proceed with European missiles, if Russia backs-off Iran plans;
· However, Putin likely is doing all of this to keep Oil prices up, which enriches Russia overall;
· Moral hazard of SIV fund situation smacks of Enron; must be monitored (not working well yet);
· Debt issues are not resolved; massaging of every aspect being attempted as 'they' best can;
· Sec'y. Paulson finally stopped saying everything's fine; remains candid (as they fight hard);
· Merrill Lynch and now Bank of America are enlightening many ordinary folks as to goings-on;
· Moody's issued late warning on CDO's; this downgrade might retard further stabilization now;
· The rumors about AIG at least contribute to transparency about possible other debt holdings;
· Transparency sobering market's further break ebbs next week; as reality is again confronted;
· Subprime bubble forecast to burse was a microcosm of bigger issues clearly not resolved;
· Institutional debt issue; housing; commercial property bubble bursting; are all 'acts in motion';
· Collapse of consumer addiction cycle debated; we suspect ending like all excessive habits;
· The question is not whether we have 'recession' (likely underway); but something worse;
· Foregoing would explain why Gov'ment is pulling out the stops to intervene (free markets?);
· Basically they probably feel they may as well, as the alternative is too heavy to contend with;
· Earnings reports remain expectedly mixed; view good news selling as signs of next faltering;
· Market coming-off repeated bearish reversals; even forecast 'hail Mary' rally likely temporary;
· Murky financial structures have less liquidity than 'advertised'; there is only limited cushion;
· Many major banks have far larger and riskier derivative holdings than generally realized;
· Fed action or actions stop systemic freezing; but won't instantly solve overall credit crunch;
· Economic data affirms virtually everything we've addressed; few want to admit it however;
· Oh yes; we are not withdrawing our suspicion about foreign markets breaking hard too;
· In the long-run this forced 'weaning away' from international financing will be quite bullish;
· In the short-run (1-3 years or as determined), downside will ameliorate only if implodes;
· To wit; such failures to quickly redress valuations consumes buying power needlessly (risky);
· Ideas that another Fed rate-cut will stave-off housing tsunamis is still utterly wishful thinking;
· If house prices dip into '09-'10 (per Fed's own bell-curve chart); more than just recession risk;
· Keep in mind my own forecast; for prior 'hot' areas, near all preceding bubble gains give-back;
· To wit equity risks being entirely wiped-out for leveraged homeowners in such regional areas;
· There is no way the property-bubble-based spending spree continues in that environment;
· As stated; U.S. situations are not 'in-isolation'; global markets are dependent on us; so get hit;
· Market rebound impressive in-light of all this; however, narrow focus doesn't change reality;
· Source of rallying generally is not based on growth (that's generally not happening); but fear;
· The fear we refer to is the frenzied nature of short-sellers and misleading rationalizations;
· It may actually set-up next failure; but as noted last week, such likely occurs post-FOMC;
· Rallies could be false and abortive; as surges are limited with markets at risk of pop-and-flop.
MarketCast (intraday analysis & embedded Daily Briefing audio-video). . . remarks continue our position-short from 1585, while intraday guidelines remained mostly on the short side, because we anticipated early squaring and then a weak final hour. In that regard, since our pre-final hour audio outlines some of the reflections; it's here:
Gene's Pre-final-hour audio remarks from MarketCast
(there is no video associated with this comment)
Key credit or derivative issues are not ameliorated, as projected Fed actions were, though 'structuring' does move toward improvement, essentially 'pushing on a string'. That's a different issue then just stemming a tide. The Fed is treading maturely, and doing the right thing. We are hardly yet out of the woods with respect to housing; or debt or war issues. Important: a Fed 'staying ahead of a situation', isn't preventing it.
Consider: this isn't Goldilocks; domestic demand's faltering; much more to come; it is also a scenario where if a Fed doesn't cut rates again, markets are disappointed, but if the Fed cuts too much, markets will rally then ponder whether things are far riskier. In this case the Fed did just what we thought would be just right, and after shuffling, the market moved higher. However that may be a transitory move reversed yet again.
Bits & Bytes . . . provide investors ideas in a few stocks, often special-situations, but also covers an assortment of technology issues (needed for assessment of general factors in tech overall, or as compelling developments call for) that are key movers in the NDX, SOX or S&P, plus ideas ingerletter.com thinks might merit further reflection.
Rarely we will comment about stocks in text. Typically remarks are via audio-video.
Mr. Michael Krall, the CEO of PURE, gave a well-received biotech presentation just today in San Diego. We let members know it is our intention, provided they continue to execute on their game plan, to make it our 'pick of the year' small-cap (not quite so small anymore) for 2008. And we emphasized it has nothing to do with chasing of price; though the current pullback (finally) may afford an entry for those so-interested.
Hence the purpose of the reference was to indicate continuing prominence as relates to the smaller companies with outsized growth potential, and remind all we generally are not engaged in stock-picking during semi-retirement. However, that has a mixed message in that so many big stocks were and are overpriced; small ones increasingly the opposite now. For PURE, we think further awareness that they exist, reasonable progress, in terms of signing distribution or partnering relationships, and progress to listing on a National exchange, are signs that could loft it into a 9-12 price range later.
If all that is accomplished through say Q1 (or even into Q2) of 2008, plus at least one major household-name consumer products partner, it could lift PURE, considerably higher in theory; but putting a particular number on it has no relevance until we see a particular series of benchmark achievements. If they execute, as sales grow steadily; then it's hard to say if 15, 25, 35, 50 or even higher is feasible in the fullness of time. Please do not embed such levels (or even higher) in your thinking, because it's not a time to know that as of yet; but if any of their plans really hit 'paydirt', then sure, with a fairly reasonable number of fully diluted shares, results could be impacted solidly.
Once again; PURE's revenues and past resembles a concept stock typical to many in OTC 'bb' categories. The difference has notable potential if they are able to execute, so that's what we're interested in now. The confidence is palpable in previous notes, and as accompanied the fiscal yearend report, so we'll just have to see what's ahead. I suggested those inclined learn by listening to Thursday's conference presentation.
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In summary . . events continue reminding us of risks Allied fighting forces face, given continued attacks on free peoples, by elements including organized terrorist forces in various countries. A world addressing terror threats continues, as domestic issues absorb us less as we focus on the Middle East crisis and World War III avoidance. (In this case World War III is Islamic terrorist and Iranian interference, targeting 'global village' communication or necessity supply-chains.) Are we maintaining high alerts?
Are we about to hear more about redemptions; reduced capital flows or Fed 'waivers' of regulations intended to separate banking, brokerage or investment banking rules? If so it would probably be after the FOMC decision on rates. Stay tuned for updates.
Per forecast; slow growth likely descends into recession; too much faith in the Fed (it would be worse if they hadn't acted flawlessly). Fear prompted what the Fed did, just inline with expectations, albeit with bigger reaction to it. Our 2007 view has been that we're in an ill-defined recession; likely recognized if at all, only later. As to whether it descends into something like post-railroad bond debacles of the 1880's or panic of 1907 (which we forecast as a 'panic of 2007' by reference); well in-part it's what the Fed worries about. Regression to the mean and traditional affordability 'rules' will be hallmarks of lending guidelines for a while. Overall there is nothing surprising here.
McClellan Oscillator finds NYSE 'Mac' rebounding to overbought on-Fed-rush cue, with those intervening bull-bear shuffles soon returning on the NYSE and NASDAQ. If LBO / hedge funds increasingly implode (post-forecast Fed reprieves), of course allowing rebounds until or unless 'events' occurs (as noted) the Fed will respond as needed. Reflex rallies allow lots of 'risk off-loading' implementation tactics. These are ongoing; holdings aren't all investment grade. Multi-month efforts evolve. And in this regard, we suspect that strategy is actually ramping-up with the market, not trying to revive attractiveness of (in-advance) structured-to-fail creative financial paper.
Issues continue including oil, terror; China, Pakistan (possibly the key to survival for a number of aspects of the 'war on Terror'); certainly all the Middle East, Korea, and yes, a hangover of funny money NY economics. Includes international dependency.
The Goldilocks crowd thinks the 'Fed surely will save us' from a slowdown. We would not count on that; because the business cycle hasn't been legislated out of existence. The Fed however, simply cushions functionality of the banking system; systemically it means things don't entirely 'freeze up', even though it has little salvation for markets.
Further, there is no way that housing doesn't regress to the mean as we said (Schiller agrees with us now; he was more optimistic when we first adopted this stance, but in this case we're gratified to see a professor who watches this area validate what we thought made entire sense); and we think most if not all of the 2002-2006 bubble will be redacted before this is over.
That's a reason we emphasized housing, CMO's etc; not the Fed's irrelevant action. Some said another 10-15% come off price levels for housing; so, that could decimate equity for millions of prudent Americans; and that's indeed a serious problem. There is no way the U.S. economy holds up with that kind of condition, because the ripple effects spread too widely irrespective of short-term actions by the Fed. Long-term of course rates will be lower (but not so much now because all that would do is cause rates to rise significantly); but after a descent into recession becomes as visible to the rose-colored-glass crowd as it is to citizens. Today's forecast decline: crash alert for sure continues; as it has since Wednesday most recently, and from it's inception two weeks ago when we moved to a 'position' short-sale guideline at Dec. S&P 1585.
Enjoy the evening,
Gene
Gene Inger,
Publisher
~Gene Inger’s Daily Briefing™ (The Inger Letter daily analysis on www.ingerletter.com)
~Gene Inger’s MarketCast™ (Intraday audio updates emphasizing S&P futures and market action)
