We Are On The Edge Of Something Big

I wouldn’t believe it unless I saw it myself.

After seeing it though, I’ve felt more confident than ever that the markets will be able to hang onto recent gains and add more over the next few months. Let me explain.

Every six months, hundreds of CEO’s, investors, and commentators focused on the microcap stocks on the TSX Venture Exchange gather in the lovely city of Vancouver, Canada (your editor’s part-time residence) for a conference.

It’s one of the largest conferences for junior resource stocks in the world. There are a lot of happy handshakes - even more so in a market like the TSX Venture Exchange where hope and greed are propelling junior stocks higher every week.

There’s a lot of salesmanship. After all, it takes a lot of work to convince someone why some plot of land with a lot of magnesium in it in Kazakhstan is better than another plot of land with magnesium in it in Peru.

There are a lot of fun and interesting people to meet there too. It’s a very Libertarian, anti-government, pro-liberty event and it’s something worth seeing - at least once.

But the thing is everyone there is always looking for the “next big thing.”

In past years the next big thing has been the more obscure metals/elements like uranium, molybdenum, potash, or tungsten. This time I was expecting a lot of folks looking for lithium projects. Or rare earth metals. Or manganese…maybe. All are plays on hybrid batteries.

There’s always something “new” and there’s always a buzz. Even six months ago, when it looked like the financial world was on the verge of collapse, attendance was actually up. Gold and silver were the hot topics.

So this time around I’d expect there to be something exciting.

But there was nothing. In fact, there was nobody there.  And it’s the poor attendance that has me so excited about what the junior resource stocks will do in the months ahead.

Could it get Any Better?

Think about what has happened in the world in the past few months.

The Federal Reserve has publicly stated it is buying Treasury bonds at auction (a.k.a. monetizing the debt).

The U.S. government is facing its largest deficit in history.

Congress and the Executive branch are reaching deeper into private business dealings than ever before.

That’s just for starters. There is still legislation pending on cap and trade, semi-socialized medicine, and even discussion of a European-style value added tax (the equivalent of a national sales tax). If it goes the way the European V.A.T.’s have gone, we could be looking at an 18% to 22% tax on practically everything.

Also, we are likely only a few weeks away from the launch of the Public-Private Investment Program (PPIP). If you recall, the PPIP is the scheme where the U.S. Treasury (via TARP) and five select private investors (still don’t know who?) put up about $100 billion to buy $500 billion in Toxic Legacy assets with $400 billion (hot off the Fed’s presses) and all guaranteed by the FDIC. No one talks about it much anymore, but according to Financialstability.gov the program is still a go.

Then there’s the stimulus spending. This, if President Obama is going to create the 600,000 jobs he recently promised quickly, is going to have to get doled out fast.

It’s creating the perfect environment for junior resource stocks to soar. It’s tough to imagine a much better scenario.

This level of government spending and money printing has created massive inflation every time in the past 150 years. For instance, in our analysis of why inflation will win out over deflation the inflation rates that followed these levels of deficit spending (Civil War, WWI, and WWII) were annual rates between 15.7% and 50.3%.

This is the type of environment where investments in real assets perform exceptionally well. And when real asset stalwarts like the major gold miners and oil stocks do well, as they have been, the junior mining stocks eventually follow. And when they begin to follow the upward path, they can catch up very quickly.

Still though, there were very few people who seemed to care enough to come to the conference.

Contrarian Investing 101

That’s why I’m becoming more and more bullish on these junior penny stocks.

As we looked at the other day in The Greenest Shoots of All, everything is in place for a big run in these small penny stocks.

Oil prices have recovered quickly. The price of gold, silver, copper, agriculture commodities, and most other real assets has done exceptionally well too. With the exception of natural gas and a few other more obscure metals, real assets have been doing remarkably well.

Inflation is coming and, although everything we’ve found points to inflation coming much farther away than most people expect, there will be some pretty big consequences for the economy. But the important thing is to get in early and be prepared.

This is the time you want to buy these types of stocks.

But hey, that’s part of investing successfully. You have to buy what no one else wants. It’s the first step in buying low and selling high.

All this just shows investors are still very, very timid. Frankly, I don’t blame them. If you’re a few years away from retirement and your retirement account has been cut in half, it’s a natural reaction.

Of course, the “natural” thing to do when it comes to investing is to run with the herd. It feels safe. You have a bunch of people around who agree with you.

The World is Not Coming to an End

Of course, that kind of mentality couldn’t be more dangerous.

Right now, the majority of investors still believe the whole financial world is coming to an end or they’re waiting for a pullback to buy.

To be fair, with the problems facing commercial real estate, interest rates, and the value of the US dollar, it’s tough to imagine how there is any way out of this mess. Over the long term, the only solution is a painful reallocation of resources. That will involve shutdowns of factories making things people don’t want. There will be a sharp (and natural) period of unemployment as workers are forced to learn new skills and find jobs in fields where there is a need. And plenty of other painful steps necessary to right the economy.

Over the short term though (the next year or two), there are so many other factors which can override the long-term factors. That’s why we focus on the strong bearish sentiment that’s still in the markets, the massive amounts of government spending getting pumped into the economy, and the $3.7 trillion of cash still in money market accounts. Everything is in place for the markets to continue on their way higher.

The key is the $3.7 trillion sitting on the sidelines. All of that doesn’t have to go back into the stock market to keep this rally going. Frankly, all of it is not going back into the stock market. Part of it will be spent by consumers.

The effects of it will be two-fold. First, the part that does go into stocks will keep this rally going. The other part will go a long way to keeping the economy going.

This is just another reason to be buying stocks now. Most investors are still waiting on the sidelines waiting for the next leg of the downturn to buy in or avoid the next collapse.

In the end, nothing in the markets rarely happen when everyone is watching for it. If this poorly attended conference is any indication, there is still a lot of life left in this rally. It will end, but that’s a long time away.

 

US Dollar Rallies As Russian Announcement Disrupts Credit Markets

Following a two-day setback, the U.S. Dollar regained strength as an announcement by Russia to cut its holdings of U.S. Treasuries spooked investors into the safe-haven Dollar.

The same announcement helped put in an early top in the equity markets and chased traders into lower risk assets.

The Treasury Bond market also fell hard as yields shot up as traders braced themselves for more supply and less demand for Treasuries in the future.

It may take a few days for the Forex markets to adjust to the Russian threat. In the meantime, volatility could pick up as a rally in the Dollar may catch many traders by surprise. After the huge drop in the Dollar, short positions have to be large. Today’s trading action in the major currencies indicates that Dollar buyers may have already stepped in. A rally by the Dollar through Monday’s high may ignite the start of a massive short-covering rally.

Now that the near-term fundamental picture seems to be developing, the technicals are starting to show where the Euro can go. The sharp sell-off in the EUR USD has this market in a position to challenge a pair of main bottoms at 1.3804 and 1.3791. A break through these two bottoms will change the trend to down and fuel further weakness to the 50% retracement price at 1.3611.

Up trending Gann Angles from previous bottoms at 1.3422 and 1.2884 indicate that June 11th and 12th are the best dates for the market to reach its downside target.

If the Dollar begins to rally, commodity related currencies should suffer the most. This explains why the British Pound did not break as much as other currency pairs.

The GBP USD produced two consecutive days of higher tops and higher bottoms and formed a new Main Bottom at 1.5801. This action caused the trend line indicator to move up from 1.4397. A move through 1.5801 will turn the Main Trend to down.

On Monday the GBP USD confirmed last week’s closing price reversal top. The first leg down was 1.6663 to 1.5801. Currently this pair is retracing this range. The first upside objective at 1.6232 to 1.6334 has been reached. There was not much of a technical bounce to the downside following a test of this level which means the buying is still strong.

A close over the .618 number at 1.6334 indicates that there is room to rally to the multi-month high at 1.6663. A close under the 50% level at 1.6232 will indicate weakness and could trigger a test of the swing bottom at 1.5801.

If this pair gets weak and the trend turns to down then look for an acceleration to the downside with a test of 1.5530 likely.

A stronger Dollar should mean a decline in commodity prices. This translates into lower gold and crude oil prices. If the trend begins to turn down in these two markets then look for downside pressure on the Canadian Dollar.

The USD CAD Main Trend on the daily chart is down, but today’s action indicates that it is setting up for a test and possible breakout through the last Main Top at 1.1290. A move through this price will turn the Main Trend up.

Earlier this week the rally confirmed last week’s closing price reversal bottom. The first leg up from the bottom was 1.0783 to 1.1290. This range created a retracement zone at 1.1040 to 1.098.

Following two days of lower-lows, the USD CAD tested this retracement zone and stopped at 1.0940. The subsequent reversal to the upside regained both 1.0980 and 1.1040 on a closing basis. This action indicates that the market may be setting up for a test of the Main Top at 1.1290.

A breakout through this price will turn the Main Trend to up and indicate a possible longer-term rally to 1.1922.

The swing chart is indicating the possibility of a short-term rally to 1.1448 by June 16th.

This entire bullish set-up will be negated by a close under 1.0980.

Traders should watch to see if Russia follows through on its threat to cut its interest in U.S. Treasuries. If they are serious then the Dollar is in for a heck of a run to the upside. This would put tremendous pressure on commodity based currencies such as the Canadian Dollar, Australian Dollar and New Zealand Dollar.

 

Inventory Drop Supports Oil Rally

A bigger-than-expected drop in crude oil inventories and the seasonal uptick in gasoline demand is helping sustain the spectacular rally in crude oil prices that has pushed the commodity to a new high for the year.

While an improving economic outlook and favorable currency moves account for the bulk of the commodity’s gains, recent moves on the inventory front have also been helpful. Crude oil stockpiles, still at multi-year highs, have been steadily coming down over the last few weeks. Including today’s report from the Energy Information Administration (EIA), crude oil inventories have dropped in four of the last five weeks.

We continue to believe that there are good fundamental underpinnings for the ongoing oil rally. We continue to favor early-cycle leverage through oilfield service names, such as Weatherford (WFT: 22.45 0.00 0.00%) and Ensco (ESV: 40.47 0.00 0.00%). Our long-term favorites remain Exxon (XOM: 73.84 0.00 0.00%), Schlumberger (SLB: 59.27 0.00 0.00%) and Diamond Offshore (DO: 91.63 0.00 0.00%).

The EIA reported a greater-than-expected 4.4 million barrels drop in crude oil inventories. Current crude oil stocks are 19.9% above the year-earlier level and remain above the upper limit of the average for this time of the year. Driving the drawdown was a drop in crude oil imports, partly offset by reduced refining utilization (85.9% vs. 86.3%).

Gasoline inventories dropped 1.6 million barrels from the previous week, bringing stockpiles roughly inline with year-earlier levels, but below the average range for this time of the year. Given the strong seasonal component of gasoline’s consumption, the current tight inventory picture is expected to continue putting upward pressure on prices through the summer.

Notwithstanding the seasonal uptick in gasoline demand, the overall demand picture  remains very weak. Total refined products supplied over the last four-week period, a proxy for overall petroleum demand, was down 6.9% from the year-earlier period, with gasoline up 0.4%, distillates (includes diesel) down 8.4%, and jet fuel down 14.3%. Gasoline’s improving demand picture is mostly due to easy comparisons — demand last summer was hit hard by $4+ dollar gasoline.

 

World Stock Markets Gain $5 Trillion In May

As stock markets around the world gained ground last month, the total world stock market capitalization increased by almost $5 trillion in May, according to preliminary data released today by the World Federation of Exchanges. The May gain follows increases of $3.65 trillion in April and $1 trillion in March, and is the first time in almost two years of three consecutive monthly advances in world stock market value.

The cumulative three-month gain of $9.625 trillion in world stock market capitalization brings the value of world equities up to $38.39 trillion, the highest level since September 2008, and marks a 33.5% increase from the February bottom (see chart above). All 52 world stock markets reporting to the World Federation of Exchanges registered May increases in their domestic stock market capitalization, led by India with a whopping 44% increase.

Wednesday’s US Stock Market Recap: Initial Rally Short-Lived As Market Falls On Bad Economic News

Equities started the day up well over a percent but that was very short-lived as the markets quickly fell on a slew of bad economic news.  By the end of the day, however, the equity markets were able to recover and posted only small losses on the day.  The Dow Jones Industrial Average fell 24.04 to 8,739.02 for a loss of 0.27% while the Nasdaq Composite and the S&P 500 Index fell 7.05 and 3.28 to levels of 1,853.08 and 939.15, dropping 0.38% and 0.35% respectively.  One of the reasons that the markets sold off was due to a weak U.S. Treasury auction on $19B worth of 10-year notes.  The bid-to-cover ratio on the auction was 2.62, but with a coupon rate of 3.125% and a yield awarded of 3.990% the market was caught off guard and began to sell off.

Crude oil was trading up after hours touching $71.87 a barrel after hours after increasing during the trading day.  Gold was trading at $955.20 an ounce after hours and copper had moved down to $2.36 a pound.  Commodities across the board have sustained a nice sized rally, mostly due to the continuing weakness in the U.S. Dollar as opposed to supply and demand type fundamentals.

Internal congressional investigations that had their results released today showed that members of the Federal Reserve told Bank of America (BAC: 11.98 0.00 0.00%) CEO Kenneth Lewis that they would push to oust him from his position if he did not follow through with his planned acquisition of Merrill Lynch & Co.  Many investors and insiders had believed this to be true for a long time and believe that because Lewis complied with the Federal Reserves wishes that Bank of American is in good graces with the Federal Reserve and the Obama administration.

In international financial news, financial deputies from both Russia and Brazil announced that they would each purchase at least $10B worth of bonds from the International Monetary Fund in order to diversify their sovereign reserves.  Russian financial authorities have been extremely vocal when it comes to criticizing the fiscal and monetary policy of the United States recently, and countries around the world are wondering if their U.S. Treasuries are safe or if they will devalued at a rapid pace in order to help monetize the growing debt problem that America faces.  Many foreign authorities are also commenting on the size of the deficit and the growing level of public debt to gross domestic product in the United States which will approach a ratio of .70 by the end of next year.

Please join us tomorrow for another market recap, have a great night.

Citi Converts Preferred Shares - US Government Now Owns 34% Of The Bank

Citigroup Inc. (C: 3.48 0.00 0.00%) finally agreed to bolster its common equity position by swapping $58 billion of preferred stock on Wednesday in a move that will make the federal government its largest shareholder.

Chief Executive Vikram Pandit said “Following completion of the exchange offers, Citi will be among the best capitalized banks in the world.” As per the highly diluted exchange offer, the ailing bank will convert a part of the Treasury’s $25 billion preferred stock into common shares giving the US government a 34% stake in the company.

Citi had issued these preferred shares to the federal government while taking $45 billion under the Troubled Asset Relief Program at the height of the financial crisis. When regulatory stress tests showed last month that Citi needed a $5.5 billion buffer in case of future losses, Citi chose to convert preferred shares to meet the shortfall.

The exchange with a $3.25 per share conversion rate is expected to close around July 30 and will increase the ailing banking giant’s shares outstanding by 75%.

Citi shares were up nearly 4% to $3.54 at noon after touching an intraday high of $3.59 earlier in the session on the New York Stock Exchange.

Exports & Imports Still Falling

The sharp improvement we have seen over the last year in the trade deficit looks like it is coming to an end. As the chart below (from http://www.calculatedriskblog.com/) shows, a year ago we were consistently running trade deficits in excess of $60 billion a month. But since the start of the year, deficits below $30 billion have been the norm. In April, the deficit was $29.2 billion, up from $28.5 billion in March. A year ago the deficit was $62.2 billion.

However, a very large portion of the improvement that we have seen over the last year has been due to the falling price of oil.  In April, the price of imported oil averaged $46.60 — today oil is trading over $70 a barrel (there is not an exact one-for-one correspondence between the price of imported oil and the quoted price of WTI or Brent, but it is close). This means that the oil portion of our import bill should expand significantly in May and June.

This is not a good omen for the second quarter GDP report. Keep in mind that net exports added almost two full percentage points to growth in the first quarter. In other words, had the trade deficit not improved, we would have seen the economy sink at a 7.7% annual rate in the first quarter rather than at a 5.7% rate.

Thus while the deterioration in April was minor, the absence of that positive will be a negative for GDP. With the trade deficit likely to slip back further in May and June due to oil, it may turn into a significant negative.

The improvement in the trade deficit over the last year has come the “wrong way.” It is due to a reduction of imports rather than from an expansion of exports. Both have been plunging, but over the last year, imports have declined by 30.7% while exports have “only” fallen 21.8%. The reduction in imports was largely, but not entirely, due to falling oil prices.

In April, we exported $121.1 billion, a 2.3% decline from March exports of $123.9 billion. We imported $150.3 billion a 1.4% decline from March imports of $152.5 billion. Put another way, in April we exported $0.806 for every $1.00 we imported, in March we exported $0.812 for every $1.00 we imported. However, in April of 2008 we exported just $0.713 for every dollar of imports.

One non-oil area that also deteriorated in April was the trade deficit with China, which expanded to $16.8 billion from $15.6 billion in March.

While the very strong rebound in oil prices (more than doubled from their lows) is good news for E&P companies like EOG Resources (EOG: 75.25 0.00 0.00%) and XTO Energy (XTO: 41.64 0.00 0.00%), it is probably even better news for the deepwater drillers like Transocean (RIG: 83.95 0.00 0.00%) and Diamond Offshore (DO: 91.63 0.00 0.00%). It is not good news for the rest of the economy, and by extension the rest of the market.

The current price level of oil is not yet fatal to hopes that the economy might recover, but it sure does not help matters. It is one more factor that suggests that if we get an end to the recession in the second half of the year that it will be extremely anemic, with unemployment continuing to rise well into 2010, and most likely clearing the 10% level before this year is over.

Obama Administration Wants New “Pay Czar” And Shareholder Vote To Reign In Executive Compensation

The Obama administration yesterday (Wednesday) continued its assault on highly paid Wall Street executives, announcing plans to appoint a “pay czar” to oversee compensation at financial firms receiving Troubled Asset Relief Program (TARP) funds. The government also will create a new program to give shareholders at nonparticipating firms a vote on executive pay packages.

President Barack Obama has targeted executive pay practices as part of a larger effort to overhaul regulations and prevent a repeat of the worst financial crisis since the Great Depression.

Obama will unveil a “series of specific proposals” on June 17 designed to streamline and reorganize regulations, White House spokesman Robert Gibbs told Bloomberg News.

The administration originally proposed regulations in early February to put a $500,000 per year lid on the salaries of executives at firms that tapped into the government’s $700 billion TARP rescue fund. The only exceptions would be in the form of restricted stock or other long-term incentives.

But the plan was compromised when Senate Banking Committee Chairman Christopher Dodd, D-CT, spearheaded a provision that limited bonuses to no more than one-third of executive compensation. The provision was eventually tacked on to the $787 billion stimulus legislation, along with another stipulation that made it easier for banks to repay TARP funds and avoid the new regulations.

The two-pronged approach announced by the Obama administration Wednesday was designed to reconcile the administration’s initial pay policy with the Congressional bill and prevent financial companies that pay back the government funds from circumventing the guidelines.

Leading the administration’s charge has been Treasury Secretary Timothy Geithner who has repeatedly pointed to executive compensation policies based on short-term profits as a key factor in the financial crisis.

Geithner, who has said compensation practices became “divorced from reality,” met with Securities and Exchange Commission (SEC) Chairman Mary Schapiro, Federal Reserve Governor Daniel Tarullo and other compensation experts, to further discuss how to put the clamps on the practice.

“A centerpiece of sensible reforms will be to tie compensation to better measures of long-term investment and return, and to adjust them to reflect the risk” incurred by executives’ decisions, Geithner said recently during a hearing at a Senate Appropriations subcommittee.

Kenneth Feinberg, who oversaw the government’s compensation to the survivors of the September 11, 2001, terror attacks, will take over the pay czar role, Reuters reported, citing a source familiar with the administration’s plan.

The pay czar, or “special master,” will review compensation structures for the top 100 salaried employees of firms receiving exceptional assistance, such as Bank of America Corp. (BAC: 11.98 0.00 0.00%), Citigroup Inc. (C: 3.48 0.00 0.00%) and insurer American International Group Inc. (AIG: 1.60 0.00 0.00%), the source said.

“In the case of a company receiving exceptional assistance, the special master would have the authority to disapprove of a company’s compensation plan if he determined they were paying excessive and unjustified salaries to their top executives,” the official said.

The other initiative would give the SEC authority to force financial firms to allow shareholder votes on executive pay packages. The nonbinding vote would cover everything from bonuses and salaries to severance packages, and would need Congressional authorization.

Geithner has supported the so-called “say-on-pay” rules ever since he took office. In a May 18 speech in Washington, he said that giving shareholders a vote on compensation would bring a “kind of disclosure that can help a lot.”

“It clearly is going to force companies to be more transparent with their disclosure” on compensation, Irv Becker, national practice leader for Philadelphia-based Hay Group’s executive compensation practice told Bloomberg.

Even if the measure is implemented, it likely will take several years before shareholders begin to confront management, Becker predicted.

“It’ll kind of be novel the first year, maybe the first two, and then likely be a little bit more serious in future years,” said Becker, a former head of compensation and benefits at Goldman Sachs Group Inc. (GS: 146.68 0.00 0.00%).

Nevertheless, Geithner vows to press ahead with the new measures, and perhaps others still on the drawing board.

“As you’ll hear from us in the next few days, the SEC has some important responsibilities and obligations in this area, and some tools and authorities they may seek,” Geithner said.

 

Why Treasury Bond ETFs Are Rising

The Federal Reserve is closely watched by investors, and recent speculation about the raising interest rates has many ready to take action, as bond and treasury bond exchange traded funds (ETFs) will react to a higher rate.

The speculation is that the Federal Reserve may have to raise interest rates sooner rather than later. The 10-year U.S. Treasury yield hit a seven-month high on Monday ahead of fresh supply this week, which also supported the U.S. dollar, reports Kevin Plumberg for the Guardian.

The U.S. dollar edged up, after higher U.S. bond yields and doubts about the speed at which central banks will diversify their dollar reserves have improved its outlook. Meanwhile, investors have their eye on Chinese economic data for clues.

Consumer demand from Asia in Western markets is one area that is watched, as well as domestic demand in China regarding economic conditions despite weak exports.

Susanne Walker and Daniel Kruger for Bloomberg report that 30-year debt fell as traders prepared for the sale of an additional $30 billion in notes and bonds in the next two days. Short-term treasuries fell as speculators and traders were wrong about the interest rates inching higher by the end of this week.

iShares Lehman TIPS Bond (TIP: 100.23 0.00 0.00%): up 1% year-to-date

SPDR Barclays TIPS ETF (IPE: 49.13 0.00 0.00%): up 3.8% year-to-date

Stock Pick For Thursday: Evergreen Solar

All investors dream in finding a stock that could rise three-fold or more and to get long the name before it happens. It’s our dream !! but finding these explosive stocks isn’t always an easy task. It takes a great deal of research to find the right stock in the right industry that is growing fast and has the potential to make such a large move. Recently, I analyzed some solar stocks that made a huge move, including Renesolar (SOL: 7.76 0.00 0.00%) , Canadian Solar (CSIQ: 15.85 0.00 0.00%) and LDK Solar (LDK: 13.90 0.00 0.00%). Now is the time to analyse one that can follow the same way based in the technical chart, it’s name is Evergreen Solar (ESLR: 2.51 0.00 0.00%).

Chart courtesy of http://top-hot-stocks.blogspot.com ( click to enlarge )

The technical chart is showing that the stock is on a bounce back rally after it lost more than 50% of its value since the start of the year. RSI is turning up and is now at 60 levels. MACD indicator is rising above 0 also indicating a buy, and KD line shows the stock is on the positive swing. OBV is beginning to turn around which suggests the stock is no longer being sold off. In my opinion, this stock has been undervalued relative to the sector. The growth in the solar sector is now surging like a volcano. Investors who find the gems in this sector have the potential to be awarded with large gains. The stock needs to break Wednesday’s high of $2.54 to expect a strong rally at this point. Evergreen looks very much like an oversold company that has seen its bottom and is awaiting confirmation before breaking out to higher prices.

 

What Do TARP Repayments Show?

Irrespective of the fact that the stress tests were not “stressful” enough, one of their achievements was to separate the winners from the losers. Since uniform methodology was applied to all banks, the tests were probably precise on relative assessment, which is further reinforced by the TARP repayment approvals for the stronger banks, including JPMorgan Chase (JPM: 34.84 0.00 0.00%), Goldman Sachs Group (GS: 146.68 0.00 0.00%) and Morgan Stanley (MS: 29.26 0.00 0.00%).

The approvals also show that some other banks like Citigroup (C: 3.48 0.00 0.00%) and Bank of America (BAC: 11.98 0.00 0.00%) still need Government crutches. When the TARP was initially implemented, it was “forced” upon all the largest players so that the weakest ones did not have to suffer the bailout stigma. Since then, the markets have absorbed a lot of bad news about the weakest banks and as such the TARP repayment approvals did not cause any shock in the markets.

While the stronger ones might not have needed the TARP, there is no doubt that they benefited a lot from it and also several other Government programs, like the FDIC’s TLGP and the Fed’s emergency lending programs. TARP funds came at a time when confidence in the banking system was at its lowest.

Further, the stronger banks will continue to enjoy many of the concessions as also an “implicit” guarantee from the Government that they will not be allowed to fail. But now, they can go back to their old ways of executive compensation and bonuses, without the fear of having to face the congressional scrutiny and public outcry.

The worst of the credit crisis is now over, and these banks are now able to tap the debt markets without the FDIC’s support and also access the equity markets as the investor confidence returns in the stronger banks.

However, repayments should not be seen as any sign of the banking system being out of the woods. We still do not know the amount of toxic assets on the banks’ balance sheets, and many smaller banks continue to fail. Further, with deteriorating commercial real estate, rising credit card losses, and still declining housing prices, we can expect the credit losses to worsen.

TARP repayments by the stronger companies will enable the Treasury to bailout many smaller banks, which are in dire need of capital. And if Elizabeth Warren’s (the head of the Congressional Oversight Panel of the TARP program) recommendation for a new round of stress tests is implemented (please read Dirk Van Dijk’s blog for details), then it is almost certain that some of the current recipients will need some more bailout funds.

Further, the Administration has yet to provide details of any regulatory revamp, which is now long overdue, especially for those “too big to fail.” While we are not in favor of Government micromanagement of the banking system, it is absolutely necessary to ensure that the banks do not revert to the system of executive compensation that rewarded excessive risk taking — the major cause of the current crisis.

How Equal-Weight ETFs Can Enhance Your Portfolio Now

Many investors have entrusted the plain vanilla index fund as a steady and reliable investment strategy, but there are other takes on indexing can add some spice to many portfolios and add a certain appeal to some exchange traded funds (ETFs).

Equal weighting is an indexing strategy that gives every holding or company in the index equal exposure. There are no market caps or influence one way or another. Jonathon Burton for The Wall Street Journal further explains that this means index funds that track the S&P 500 Index — and follow this approach — give Exxon Mobil (XOM: 73.84 0.00 0.00%), No. 1 with a market value of $352 billion, the same exposure as  No. 500 Dynegy (DYN: 2.27 0.00 0.00%), which has a market value of about $2 billion. Equal attention and exposure is given to the performance of all stocks.

This method of indexing may prove to be beneficial with the possibility of a small-cap rally leading the recovery. As of 2009, small-cap stocks have been outperforming their larger leaders, which is generally the trend after a recession. Small caps are smaller, more nimble and quicker to react.

Keep in mind that equally weighted ETFs tend to be more volatile, yet they can give equal weight within a specific sector. This specialized tool can prove to be worth its own weight in the meantime, if you follow the market trends and are ready to invest with a strategy in place.

• Rydex S&P Equal Weight Consumer Discretionary (RCD: 27.55 0.00 0.00%)

• Claymore/BNY Mellon EW Euro-Pacific Leaders (EEN: 14.8001 0.00 0.00%)

• First Trust NASDAQ-100 Equal Weight (QQEW: 15.68 0.00 0.00%)
  

By Dismantling Banking Rules, U.S. Government Has Guaranteed Future Financial Travails

U.S. banking-industry regulators have long understood that there needed to be a carefully delineated separation between such low-risk activities as deposit-based banking, and much higher-risk activities as investment banking.

But the regulatory walls that separated the two have been steadily dismantled through the years, an intentional act that had the unintentional consequence of helping spawn the worst financial crisis since the Great Depression.

Not unlike the Depression era Glass-Steagall Act, which was enacted to keep FDIC-insured commercial banks separate from the riskier businesses of investment banks and securities broker-dealers, regulators determined that bank ownership should be limited to bank holding companies. The Bank Holding Company Act of 1956 further ensured separation of commerce and banking by prohibiting bank holding companies from engaging in non-financial activities. The essence of the regulations was to prevent banks from failing by not allowing owners to deplete bank resources by diverting them to prop up other businesses they owned or controlled.

Setting the Table for Trouble?

In 1998, in what many experts agree was the starting line in the race to worldwide financial collapse, Citibank Inc. merged with Travelers Group, which owned the Solomon Smith Barney and Shearson investment-banking and securities broker-dealer businesses, to create what is now Citigroup Inc. (C: 3.48 0.00 0.00%). It was a move marked by extraordinary bravado that was made in direct contravention of the existing Glass-Steagall and Bank Holding Company acts.

The flaunted marriage was subsequently blessed a year later when an ocean of lobbying money floated the Gramm-Leach-Bliley Financial Modernization Act, which repealed parts of Glass-Steagall and circumscribed regulations in the Bank Holding Company Act.

The merger that created Citigroup was touted as necessary to compete with other universal banks. Now private equity is touting its burgeoning coffers and the distressed state of undercapitalized banks as a marriage whose time has come - as well as one that will benefit the U.S. economy. Not unlike Citibank and Travelers forcing legislative changes after the fact, private equity is pushing hard against every law and regulation standing in the way of its ultimate prize. The push began more than a year ago and under the weight of last summer’s devastating events finally succeeded in getting a first foot in the door last Sept. 22.

That day, according to a series of memos prepared by powerhouse law firm Simpson, Thacher & Bartlett LLP, the U.S. Federal Reserve issued a long-awaited policy statement that details the new terms under which investors can take stakes in bank holding companies without having been deemed to have acquired actual “control” - which would force the investor to become a bank holding company, too. Those three changes consisted of:

• An investor who will have a seat on the bank holding company’s board could now own as much as 24.9% of the outstanding voting shares of the bank holding company, an increase from the prior limit of 10%.
• An investor could not own as much as 33% of the total equity of a bank holding company - versus the prior limit of 24.9% - provided that the investment does not include ownership of 15% or more of any class of voting securities of the target company.
• And the investor would now be permitted to actively attempt to influence certain governance matters of the bank holding company and was no longer be required to be a completely passive investor.

As if that weren’t enough, on Dec. 22 of last year federal banking regulators adopted a shelf-approval process to facilitate bidding by private equity funds on failing and failed depository institutions Simpson, Thacher said.

“In order to increase the pool of bidders … federal banking regulators recently adopted special pre-clearance procedures to enable parties that do not already own an insured depository institution, most notably private equity funds, to qualify as bidders,” the law firm wrote in a memo.

Up Steps Private Equity

And while private equity firms without a doubt appreciate the openings they’ve been given, none of the shops want to become bank holding companies. The reason: A firm that’s labeled as a “bank holding company” is also deemed to be a “source of strength” to the banks it owns or controls. That means the holding company has to make available its resources to support its banks. Private equity companies don’t want to expose their vast pools of capital to any one investment. Just as Cerberus Capital Management LP refused to put any more money into its failed Chrysler LLC investment - leaving taxpayers to bail it out - firms are loathe to be put into a position to support a bank holding with anything more than what was deemed as a suitable capital investment at the outset.

Just last spring, for instance, The Blackstone Group LP (BX: 10.95 0.00 0.00%) was sued by one of its prospective investment targets when it backed out of buying credit-card processor Alliance Data Systems Corp. (ADS: 47.36 0.00 0.00%). Blackstone’s concern was over conditions imposed by the Office of the Comptroller of the Currency, which required Blackstone to provide at least a $400 million backstop to support Alliance Data’s credit-card bank, which is regulated by the OCC.

“No private equity firm wants to [be labeled as a "source of strength" to companies it controls] since it is an unlimited call on capital,” Hal Scott, a Harvard Law School professor who also serves as director of the Committee on Capital Markets Regulation, recently told CNNMoney.com.

The Committee on Capital Markets Regulation recently published a series of regulatory recommendations, including one that would have regulators remove restrictions on private equity firms owning banks.

Chrysler Officially Sold To Fiat After Supreme Court Clears Deal

Chrysler LLC has officially been sold to Italian automaker Fiat SpA (FIATY.PK: 10.90 0.00 0.00%) after a Supreme Court delay was lifted Tuesday and the court rejected opponents’ appeals.

Supreme Court Justice Ruth Bader Ginsburg halted the sale on Monday to study appeals by Indiana pension funds and consumer group opponents. On Tuesday, the court ruled the appeals didn’t meet the legal standard for an emergency stoppage of the deal, Bloomberg News reported.

The deal gives Chrysler access to Fiat’s technology, platforms and power-trains for small- and mid-sized cars. Such access means a likely line of more environmentally friendly cars from Chrysler, which is known for its larger, fuel-hungry vehicles such as the Jeep Cherokee and the Dodge Grand Caravan. The Associated Press reports the value of the technology is worth billions.

Fiat Chief Executive Officer Sergio Marchionne will take on the same role in the new company, now called Chrysler Group LLC.

“Those Chrysler operations assumed by the new company that were idled during this process will soon be back up and running, and work is already underway on developing new environmentally friendly, fuel-efficient, high-quality vehicles that we intend to become Chrysler’s hallmark going forward,” Marchionne said.

Fiat has a tattered history in the United States and will have a lot to prove when its cars appear at U.S. dealerships, which could be as soon as 18 months.

Fiat will own 20% of Chrysler initially, and could expand that stake by an additional 15% if it meets certain operational milestones. It cannot obtain a majority state until Chrysler repays the money it borrowed from the Treasury’s Troubled Asset Relief Program (TARP). The United Auto Workers (UAW) Retiree Medical Benefits Trust will own 55% of Chrysler, while the United States and Canadian governments will own a combined 10%.

Chrysler expects to name C. Robert Kidder, chairman and CEO of private investment firm 3Stone Advisors, LLC, as its chairman. Three board directors will be appointed by Fiat, four by the U.S. government, one by the Canadian government, and one by the UAW.

 

By “Shopping” For Regulators, Private Equity Firms Have Discovered How To Buy Banks – Leaving Taxpayers With All The Risk

The financial Barbarians are at the gates of the U.S. banking sector.

“Regulatory arbitrage” - sometimes called “regulatory shopping” - has emerged as the favorite strategy for these Barbarians, otherwise known as private equity firms, to get around the federal rules that kept them from owning banks.

Why the sudden interest in banks? Like legendary bank robber Willie Sutton is famously (and probably falsely) remembered for saying: “That’s where the money is.”

Like so many of the businesses in the financial sector, the private equity business is right now reeling - and littered with its own bankrupt leveraged buyout deals. So now these LBO firms are shrewdly targeting failed banks, playing regulatory arbitrage, and shopping around as they search for ways around the regulations that were designed to keep companies with their motives out of the U.S. banking industry’s venerable vaults.

The new twist on acquisition leverage is to have taxpayers, through the Federal Deposit Insurance Corp. (FDIC), backstop losses on acquired banks if the economy continues to falter.  And as soon as they can leverage depositors and the FDIC as a source of funds, these private equity firms will go back to buying leveraged-up targeted companies with cheap borrowed money - to which they’ll have easy access, since they’ll actually own the banks.

The Background on Banking Regs

Banks are regulated at the federal level by a number of agencies. The regulators include the Federal Reserve Board (FRB), which oversees national banks chartered by the government, the Office of Thrift Supervision (OTS), a U.S. Treasury Department office that oversees thrift institutions, savings and loans and credit unions, the Office of the Comptroller of the Currency (OCC), and the FDIC, not to mention various state banking regulatory bodies.

Lately, approval actions by the OTS and FDIC are at odds with the U.S. Federal Reserve, which has not authorized the acquisition of controlling interests in any banks by any private equity players. The FDIC has expressed its acquiescence as a way of more-quickly offloading insolvent banks in the hope that doing so might help limit its exposure to depositor claims. And the OTS, after being somewhat hesitant - and with its future as a regulator now in jeopardy - seems to be doing what it can while it still has the power to grease the wheels for private equity interests.

For a case in point, consider billionaire investor Wilbur L. Ross Jr., an expert purchaser of so-called “distressed” assets who is known by some as “The King of Bankruptcy.”

Using his recently acquired American Home Mortgage Servicing Inc. - one of the nation’s largest mortgage servicing companies, with about $100 billion on its books - as his investment vehicle, Ross sought to buy bankrupt American Home Bank - at one time a would-be Countrywide Financial Corp. emulator.

The OTS denied the sale on the grounds that Ross’ firm wasn’t already a bank, and AHB was subsequently sold to The Bancorp Inc. (TBBK: 7.22 0.00 0.00%), a federally chartered online bank based in Wilmington. But in a classic example of “if-at-first-you-don’t-succeed” strategic resolve, the Ross-led WL Ross & Co. LLC-headed a consortium of private equity giants and investors that included including Blackstone Capital Partners (BX: 10.95 0.00 0.00%), Carlyle Investment Management, Centerbridge Capital Partners LP, LeFrak Organization Inc., The Wellcome Trust, Greenaap Investments and East Rock Endowment Fund - and with the full blessing of the OTS and FDIC just acquired BankUnited Financial Corp. (BKUNQ.PK: 0.162 0.00 0.00%), a Coral Gables, Fla.-based savings and loan that had been shuttered by federal banking regulators.

The “Silo” Sidestep

The vehicle that was used to acquire BankUnited is called a “silo.” In a neat little end-around the bank-holding-company laws separating bank owners from controlling other commercial businesses - and control of multiple businesses is one of the keys to success for a private-equity player - the so-called silo arrangement theoretically establishes a walled-off vehicle to acquire and manage the bank separately from the firms’ other investments. Who knew it was that simple? The Fed has said that it has yet to determine the validity of the silo-structure vehicle approach.

The silo structure was first tested and approved back in January, when the OTS approved New York-based MatlinPatterson Global Advisers LLC’s purchase of Flagstar Bancorp Inc. (FBC: 0.91 0.00 0.00%) in Troy, Mich. But as a precaution - and to address the early OTS denial of Ross’ attempt to buy American Home Bank (based on the fact that he didn’t already own a bank), Ross that same month personally bought a controlling stake in tiny Indiantown, Fla.’s First Bank and Trust Co.

At the time, Miami Banking expert Ken Thomas told the Palm Beach Daily News that Ross “[isn't] buying a bank as much as he’s buying a bank charter. Once you have a bank charter, you can go statewide, region-wide, or nationwide. That may be just the beginning of his endeavors. It could be Bank of Indiantown or Bank of America (BAC: 11.98 0.00 0.00%) - it doesn’t matter.”

As for why Ross bought the stake personally, Mark Tenhundfeld, director of regulatory policy at the American Bankers Association, a Washington-based trade association, told Bloomberg News that “an individual cannot be a bank holding company. If the OCC approves a change in bank control proposal by an individual, then that person may avoid bank-holding-company regulations.”

The Flowering Inferno

Being the cautious type, however, Ross wasn’t the first to personally buy a bank. That distinction goes to billionaire investor J. Christopher Flowers, who personally bought tiny First National Bank of Cainesville in Missouri in order to keep his own private-equity shop from becoming a bank holding company. It seems that both Ross and Flowers are determined to “backdoor” their way into owning and controlling banks, while at the same time limiting the larger exposure of their principal investment vehicles. How that turns out for the banks, or for their depositors, remains to be seen.

J.C. Flowers & Co. LLC. is no stranger to banking, at least not outside the United States. J.C. Flowers bought a 24% stake in Hypo Real Estate Holdings AG, Germany’s second-biggest commercial property lender and a company that’s in such deep trouble that it’s 90% owned by Germany’s national stabilization fund - which wants to “squeeze out” Flowers, according to news reports.

Flowers & Co. also owns a third of Shinsei Bank Ltd., a Japanese bank in which it has invested hundreds of millions of dollars. Too bad Shinsei is in dire straits and has had to be supported by the Bank of Japan.

But in another “if-at-first-you-don’t-succeed,” Flowers is looking to merge Shinsei with another failing Japanese bank, Aozora Bank Ltd., which itself happens to be majority controlled by none other than the three-headed dog from Hell, Cerberus Capital Management LP - the same Cerberus that wouldn’t support its Chrysler LLC investment with any additional capital. One of the reasons Aozora isn’t doing so well is that it invested its depositors’ money in its master’s LBO deals, and in the case of lending to Cerberus’ 51%-owned, struggling and technically insolvent GMAC LLC (GMA: 15.75 0.00 0.00%), has lost hundreds of millions of dollars.

The two failures are now telling Japanese regulators they intend to merge the two banks. The deal is actually being orchestrated by Japan’s banking regulator, the Financial Services Agency, and according to a recent Wall Street Journal article, is the second time that the government has aided the two banks.

Back here in the United States, J.C. Flowers - along with hedge fund Paulson & Co. and others - also bought defunct IndyMac Bancorp Inc. (IDMCQ.PK: 0.045 0.00 0.00%) bank out of receivership from the FDIC.

Allowing private equity players to replicate the failures of their recent history and leverage going concerns with layers of debt by now granting them access to FDIC-insured depositor funds to do more of the same is a mistake of massive proportions. In a recent letter to U.S. Treasury Secretary Timothy F. Geithner, U.S. Sen. Jack Reed, D-R.I., expressed “serious concerns” about this potential problem, stating that “private equity firms are not transparent. There are potential conflicts with their other holdings, investors, management and sources of funding, much of which is not disclosed.”

Desperate times don’t always require desperate measures. While it’s true that banks need to be recapitalized and that private-equity firms have plenty of dry powder at the ready, we should welcome banking-sector investments from these private-equity players only if it’s passive in nature. After all, why should we give the quick brown financial fox access to our already-plucked-to-death hen house?

 

Home Depot Investor Providing Insight

Today, Home Depot (HD: 24.39 0.00 0.00%) is holding its 2009 Investor and Analyst Conference. The company is webcasting the event here. The company is going to discuss its Strategic Priorities, outline its Long-Term Operating Targets and update its 2009 EPS Guidance.

Strategic Priorities

Home Depot’s Strategic Priorities include customer service, product authority, productivity and efficiency driven by disciplined capital allocation.

Customer service - Taking care of associates, putting customers first, and simplifying the business.
Product Authority - An emphasis on re-establishing a merchandising driven business, providing product that meets customer project needs, and building tools for effective implementation.
Productivity and Efficiency - Disciplined capital allocation focused on the existing core retail business, transforming the supply chain, and improving information technology.

Our take: These initiatives all make sense and could be made by just about any retailer. There is little doubt that Home Depot, along with Lowe’s (LOW: 20.37 0.00 0.00%), will survive the current housing downturn and continue to take market share from smaller, less capitalized competitors. That said, we agree with Home Depot’s decision to focus on internal improvements because overall industry growth will be nonexistent as the housing bubble is deflating.

Long-Term Operating Targets

The company believes that its strategic priorities, along with a correction in the home improvement market, will allow Home Depot to achieve an operating margin of approximately 10% and a return on invested capital (ROIC) of approximately 15%.

Our take: At first blush, the company’s long-term targets look reasonable. Since 2000, Home Depot’s operating margin averaged 9.8%, and its ROIC averaged 12.8%. But we need to keep in mind that the company’s results were boosted by an inflated housing market.

During the current housing downturn, Home Depot’s operating margin and ROIC have both declined substantially. In fiscal 2008, Home Depot had an operating margin of 6.1% and an ROIC of 2.9%. We think it is reasonable to assume that Home Depot’s recent profitability measures are below what the company could earn on a “normalized” basis.

However, we do not think the company’s profit margins and returns on capital are going to return to levels that it enjoyed thanks to unsustainable growth in the housing. As a result, we think Home Depot may fall short of its long-term operating targets.

Updated FY2009 EPS Guidance

The company reaffirmed its sales, comparable-store sales and gross margin guidance for fiscal year 2009. The company expects sales to decline by approximately 9%, a comp-store sales decrease in the high single digits, and gross margin to be flat to slightly higher. This translates to total sales of $64.9 billion in fiscal 2009. The company now expects EPS from continuing operations to be flat to down 7% from last year, compared to its prior EPS guidance of down 7%.

Home Depot also expects adjusted earnings per share to be down 20% to 26%. Its previous outlook was for a 26%. In fiscal year 2008, the company earned $1.37/share from continuing operations. Home Depot’s updated guidance implies EPS from continuing operations of $1.27 to $1.37. On an adjusted basis, Home Depot earned $1.78/share in fiscal 2008. Its updated guidance implies fiscal 2009 EPS of $1.32-$1.42.

Our take: Nothing too surprising here, as analyst estimates were already above Home Depot’s previous guidance. The Zacks consensus estimate for fiscal 2009 was $1.41 before the company issued updated guidance. We would expect to see consensus estimates move up slightly on the company’s updated outlook.

For those interested, today’s webcast (which will be available for replay) should be worth listening to. Home Depot’s management will provide more detail about sales and margin trends in its stores, but we are also interested in what management has to say about macro trends such as housing, consumer spending, credit availability and higher oil/gas prices. Home Depot has over 2,200 stores all across the US and can provide valuable insight on the state of the consumer.

The Fed’s Balance Sheet And Excess Bank Reserves

People keep talking and writing about the explosion of the money supply and the coming inflationary tsunami. Let me point out once again that the M1 and M2 measures of the money supply spiked but have since come back down. There is no explosion of the money supply.

I

The monetary base (currency outstanding plus bank reserves) has exploded, and it’s graph is indeed startling-startling that is until you realize that excess bank reserves on deposit at the Fed is the reason. We learned to pay attention to the monetary base because it provided the raw material (reserves) from which the banking system can create new money by lending and investing. Because of the money expansion multiplier, the monetary base has been referred to historically as “high powered money.”

In today’s ongoing financial crisis, however, the base is not being used as the basis for monetary expansion. The accumulation of excess reserves behind the explosion of the monetary base is the result of the weak state of many banks and the fear of bankers that they won’t have enough liquidity to meet deposit withdrawals. In other words, the reserves that are excess in a regulatory or legal sense, aren’t excess at all in the minds of the bankers. They represent the prudent hoarding of bank cash in uncertain times. Measures to reduce “excess” reserves could, therefore, have disastrous results as banks liquidate assets to restore their liquidity.

This movie has been shown before. It played a significant role in the 1930s when the Fed acted to “mop up” excess reserves in the banking system by raising reserve requirements in 1936 and again in early 1937. Then, as now, the reserves were excess only in a regulatory or legal sense. Under the circumstances bankers did not regard them as excess, and their reaction to the increase in reserve requirements helped prolong and deepen the Great Depression. We should not make the same mistake now.

I find it amazing that I have not heard a single talking head on financial television or read a single article in the financial press about this instructive experience in the 1930s that has such important lessons for today. I suppose it’s largely a result of the youth of the pundits these days and their reliance on memory.

What follows is my review of the 1930s episode along with a refresher on money and banking.

II

One might think of the Fed influencing the economy by influencing the reserve base of the banking system to generate more or less lending and money creation. If bank reserves become more plentiful, through Fed loans to banks or open market security purchases, the banks will make more loans or purchase more investments and, in doing so, cause the money supply to expand.

Largely because of gold inflows resulting from the devaluation of the dollar in 1934, banks accumulated large amounts of reserve deposits at the Fed. By 1936 banks had accumulated much more reserve deposits at the Fed than were “required.” In other words, they had excess reserves, or substantially more than were required. The Fed came to think of those excess reserves as a buffer or cushion that loosened its rein on the banks. Its policy actions might not elicit the response intended for the banking system. If the Fed added or removed reserves from the banking system, the banks could let losses be absorbed by their excess reserves and might just let additions add to the excess already there.

In an effort to tighten the link between its actions and the banks’ reactions, the Fed in 1936 and again in early 1937 raised reserve requirements to mop up the excess reserves. Its intent was to tighten the reins, not to tighten monetary policy. It wasn’t tightening policy, it thought, because the reserves absorbed were already in excess. It wouldn’t force banks to cut back on lending.

But cut back they did. On Monday morning, it was revealed that those bank reserves were excess only in a legal or regulatory sense. The banks didn’t regard them as excess given the uncertain and turbulent times. In effect, the banks own reserve requirement were higher than the Fed’s reserve requirement. The banks thought of all their reserves as precautionary balances needed for emergencies; so the increase in reserve requirements had the unintended consequence of a substantial tightening of monetary policy which either made the depression worse or helped cause a double dip recession, whichever you prefer.*

We hear many references today to the “excess liquidity” represented by the large amount of excess reserves on the Fed’s balance sheet. Before we recommend doing something about that in the interest of preventing future inflation, we should consider the lesson of the 1930s. Those excess reserves may not be considered excess by their owners, even less so since they do now earn a nominal interest rate. It would be very easy to repeat the Fed’s mistake in 1936 and 1937.

How Low Can Bonds Go?

Bond yields have jumped in recent weeks due to an increasing supply of Treasury debt and strength in US equity prices. The increased supply of US debt instruments suggests that yields will have to climb to attract investors. China is rumored to have shifted its holdings of US treasuries from long dated Notes and Bonds to shorter-term T-Bills, which could have aided the steepening of the yield curve. Today’s 10-Year Note auction has put pressure on Note and Bond prices in the early going, which is common ahead of auctions. Yields on the 10-Year have climbed to 3.88 percent. Equity prices have remained strong, diminishing trader demand for treasuries. The sharp upturn in commodity prices in recent weeks hurts Bond prices on two fronts. First, traders seeking safe haven investments are flocking to physical commodities, such as precious metals, at the expense of treasuries. Secondly, higher commodity prices suggest inflation is increasing at a higher pace than previously expected, making Bonds unappealing as investments.

The prospect of rising inflation also suggests that the Fed may be forced to raise interest rates later this year. The corporate bond market has shown significant improvement in recent months, with new issues of corporate debt increasing at a steady pace. Investors have shown an increased appetite for higher yielding corporate debt over treasuries. Also, issuers of new debt short the treasury market ahead of new issues to hedge yields. All of the previously mentioned factors have significantly pressured the price of the 30-Year Bonds, but traders have to be asking themselves if this pattern can continue. It is difficult to see the trend reversing course in the foreseeable future unless there is a major shift in fundamentals, such as a sharp sell-off in equities or a material regression in economic indicators.

Another outside market force that could affect interest rates would be the mortgage market. Low interest rates have created a refinancing boom, which has aided the recovery in the banking sector. Higher interest rates could adversely affect the mortgage market and stall the fledgling recovery in the housing market. There are signs that higher interest rates have already made an impact on the mortgage market, with the Mortgage Bankers Association showing mortgage applications dropping 7.2 percent for the week.

Trading Ideas

Seeing that the market is reaching a critical support level, some bearish traders may wish to wait for confirmation in the form of a solid close below 111-27 before entering the short side of the market. Traders that are neutral to bearish, however, may possibly choose to explore entering a bear call spread. An example of one such spread would be selling a Sep Bond 121 call (USU9121C) and buying a Sep Bond 123 call (USU9123C) for a credit of 0-32, or $500. The maximum risk on the trade is approximately $1,500.

Technicals

Looking at the continuation chart, Bonds are coming up to several key support levels. Prices have already tested the October low close of 113-015 in early trade and have held the level to this point. The June low close at 111-27 is critical, as solid closes below this level could signal additional selling pressure, as longs would likely get squeezed out of the market. Holding this close, however, may be a sign that the market may correct or enter a period of consolidation. On average, volume on down days has exceeded that of up days, suggesting the downward trend is not letting up. The RSI indicator is now at oversold levels, which is of major technical significance. Typically, this can be seen as a somewhat supportive indication for the market, as it could signal traders may take profits. On major breakouts, however, the RSI indicator behaves inversely. If key support is broken on oversold conditions, it could be seen as a particularly strong bearish signal

Is The U.S. Economy Headed For A “Jobless Recovery?”

Could the U.S. economy be looking at a “jobless recovery?”

After the worst financial crisis since the Great Depression reached its apex late last year, the U.S. economy has shown signs of life in recent months. Stock prices have soared. The housing market - once in veritable freefall - seems to be bottoming out in preparation for an eventual upsurge. And just last week, the government said that businesses cut jobs in May at the lowest rate in six months, a report that offered encouragement both to investors and to the millions of U.S. workers who have lost their jobs.

But U.S. Federal Reserve Bank Chairman Ben S. Bernanke threw cold water on hope for a full-blown economic rebound when he hinted that the U.S. labor market could well be facing a jobless recovery - an upturn in which the economy and corporate profits advance, but virtually no new jobs are created to compensate for years of layoffs.

Just this week, economists at the Federal Reserve Bank of San Francisco said they see signs that the current turnaround could mimic the aftermath of the 1990-1991 recession - a wheezy, drawn-out recovery with little hiring that means years of additional problems for U.S. workers.

“This projection indicates that the level of labor market slack would be higher by the end of 2009 than experienced at any other time in the post-World War II period, implying a longer and slower recovery path for the unemployment rate,” the Fed economists wrote.  “This suggests that, more than in previous recessions, when the economy rebounds, employers will tap into their existing work forces rather than hire new workers. This could substantially slow the recovery of the outflow rate and put upward pressure on future unemployment rates.”

Unemployment Damage Widespread

Alongside other economic indications of a stabilizing housing market and rising consumer confidence, the unemployment figures offered a glimmer of hope that we may be on the cusp of an economic turnaround and the end of job destruction.

But it’s highly unlikely this economy will produce meaningful job creation anytime soon.  The financial fallout from the biggest recession in 60 years is likely to be so costly and so pervasive that new-job creation is likely to be virtually nonexistent for years to come, particularly in the manufacturing and construction industries.

The U.S. Labor Department reported that the economy lost “only” 345,000 jobs last month, significantly lower than the 520,000 that analysts expected and the first time since October that job losses didn’t increase.

But even though the latest report may be an improvement, the fact is that companies slashed jobs during the latest recession at a rate that’s been rivaled only a couple of times since the Great Depression. Indeed, the Labor Department said that:

• The U.S. economy has lost more than 6 million jobs since the recession began in December 2007 - meaning nearly one out of every 20 jobs was eradicated.

• The unemployment rate now stands at 9.4%, the highest since 1983.

• A total of 14.5 million Americans are now unemployed. The number of long-term unemployed (those without jobs for 27 weeks or more) increased by 268,000 to 3.9 million and has tripled since the start of the recession.

But even those statistics - as grim as they seem - don’t tell the whole story.

As reported previously in Money Morning, the “official” employment rate doesn’t account for workers that have been switched from full-time to part-time jobs. And it also doesn’t include “marginally attached” workers - people who have given up job-hunting altogether.

If you added those unfortunates to the government’s jobless tally of 9.4%, the “real” unemployment rate would stand at a staggering 16.4%.

That’s the worst showing since the 1981-1982 recession when the official jobless rate peaked at 10.8%, which was the worst to hit the labor market since the Great Depression.  A total of 2.8 million jobs disappeared in that downturn, but the labor market was much smaller back then.

Unfortunately, the nature of this recession makes it likely things will get worse before they get better.

As two of the so-called “Big Three” U.S. automakers - General Motors Corp. and Chrysler LLC - attempt to navigate their way through the Chapter 11 bankruptcy process, they are set to close more than a dozen manufacturing plants and to cut another 32,000 jobs. Any moves that GM and Chrysler make will likely also have to pass muster with the Obama administration, which made loans to both of those carmakers.

Other major U.S. employers are likely to follow suit as they continue to reduce inventories and cut back on capital investment. That leaves most economists predicting that even the official jobless rate will top 10% by year-end.

An Economic Recovery May Not Bring New Hiring

So what happens to the labor market when the layoffs end and the economy starts to grow again?

All indications are that the road to recovering the millions of job lost during this recession will be a bumpy one.

Employers remain skittish as they slowly recover from the biggest economic upheaval since World War II and are already saying they will be cautious about replenishing payrolls anytime soon.  And just the sheer numbers of people on the street dictates that it will take some time to bring even a portion of them back into the work force.

But to get to the heart the matter - the one factor that will keep the job market moribund for some time - analysts point to the bubble-bursting events that let the air out of the gigantic auto and housing sectors, the economic engines that drive manufacturing.

“It will take a recovery in automobiles and housing for the manufacturing sector to once again prosper,” Norbert J. Ore, chairman of the Institute for Supply Management Manufacturing Business Survey Committee, told The Kiplinger Letter, noting those sectors have shed more than 1.5 million jobs in the past two years.

And despite the government’s monumental stimulus program to create 3 million jobs in the next two years, those critical sectors are likely to face moribund prospects until at least 2010 - and perhaps even longer.

“It’s going to take five or six years for homebuilders and automakers to fully recover from this recession, and it may take longer,” says Martin Hutchinson, a Money Morning contributing editor who has written extensively about the current downturn. “You’re not going to see aggressive hiring in those industries for a good while.”

Hutchinson says the automobile business is in particular difficulty from outsourcing.

“A great deal of the cutting-edge technology associated with the U.S, automobile business is currently being outsourced to other countries, which will further hinder product development and sales for that sector and constrain future hiring,” Hutchinson said.

Federal Chairman Bernanke also says that the labor markets may continue to suffer for some time.

In a speech to Congress on May 9, Bernanke pointed to lack of consumer spending and weakening demand for commercial and industrial loans as constraints on future hiring.

“Even after a recovery gets under way … we expect that the recovery will only gradually gain momentum and that economic slack will diminish slowly,” Bernanke told U.S. lawmakers.  “In particular, businesses are likely to be cautious about hiring, implying that the unemployment rate could remain high for a time, even after economic growth resumes.”

2001 Recession - Déjà vu All Over Again

This won’t be the first jobless recovery the U.S. economy has experienced.

In the 2001 recession, 1.6 million jobs were slashed. Unfortunately, the end of that downturn didn’t bring an end to the job cuts: In the year that followed the recession’s conclusion, another 562,000 workers lost their jobs. And in the 12 months that came after that, 193,000 more workers lost their jobs.

It wasn’t until 2004 that more than 2 million new jobs were finally created.

In fact, the only job growth we’re seeing now is in healthcare and education where a paltry 44,000 jobs were added in May.  Meanwhile, more than 9.5 million jobless workers took temporary employment last month, a category that’s seen its ranks grow by 5.8 million since the recession started, the U.S. government reported.

But it’s the jobless recovery of the early 1990s - which followed the recession of 1990-1991 - that may offer the best insight into what we can expect to happen next, the Federal Reserve Bank of San Francisco economists say. That admittedly pessimistic view is based on two factors:

• First, of all the jobs that have been slashed, a miniscule number are classic “layoffs,” where workers are actually expecting to be called back to their jobs when economic conditions improve. From July 1981 to November 1982, the share of unemployed workers on temporary layoff rose from 16.1% to 20.7%. From December 2007 to April 2009, however, the share of unemployed workers on temporary layoffs decreased from 12.8% to 11.9%.

• And second, the number of people who are involuntarily working in part-time positions (when they want full-time jobs) is at a historical high. In December 2007, about 3% of the work force had taken part-time jobs for economic reasons. By April of this year, that number had nearly doubled, reaching 5.8%. What’s more, more than half of those workers had reported that their weekly hours had been cut by at least five hours.

Uncle Sam to The Rescue?

It’s not all gloom-and-doom on the hiring front, however.

The government’s $787 billion stimulus package is slowly working its way through the federal bureaucracy to local government coffers with promises to create or save more than 3 million jobs over the next two years.

And on Monday, President Barack Obama announced 10 projects aimed at speeding up stimulus spending to create or save more than 600,000 jobs, Bloomberg News reported.

Calling it a “summer of accelerated Recovery Act activity,” President Obama said the effort includes new services at health centers in all 50 states; work in 107 national parks, airport improvements, and highway construction.  They will also provide funding for schools to hire more teachers.

In the first three months of the Obama administration’s stimulus plan, the government doled out about 11% of the stimulus funds, according to a progress report released by Vice President Joe Biden’s office on May 13.

The report said that most programs and projects were running ahead of schedule and under budget and 70% of the funds will be allocated in the next fiscal year - enough to make a major impact, even though it’s less than the 75% allocation promised by the White House.

Of course, there’s a great deal of political debate over how effective the stimulus program will be.

U.S. Rep. John A. Boehner, R-Ohio, and the House Republican leader, said last week the stimulus “isn’t producing jobs immediately, as the administration promised.”

And Money Morning’s Hutchinson says the net long-term effects of the stimulus program may be a wash for taxpayers and businesses anyway.

“U.S. businesses and consumers will be paying for all this anyway with higher taxes and interest rates,” Hutchinson said. “Any job creation from that will be neutral for the economy.”

Investment News Briefs: US Consumer Confidence, Crude Oil, Wachovia

GM Names Post-Bankruptcy Chairman; Eddie Bauer Going Bust?; Consumer Confidence Climbs; U.S. Bankruptcy Filings Soar; Wells Fargo Lags On Applying for TARP Repayment; Crude Oil Tops $70

• Edward E. Whitacre Jr., who built AT&T Inc. (T: 24.21 0.00 0.00%) into the largest U.S. provider of telephone services, will become chairman of General Motors Corp. when the company leaves bankruptcy, the nation’s biggest automaker announced yesterday (Tuesday).  Whitacre will lead a 13-member board that includes interim Chairman Kent Kresa, and Chief Executive Officer Fritz Henderson.  Whitacre was chairman and CEO at Dallas-based AT&T and predecessor SBC Communications Inc. from 1990 until 2007. The appointment moves GM closer to its goal of completing a restructuring in August after filing for bankruptcy on June 1.
• Sporting good retailer Eddie Bauer Holdings Inc. (EBHI: 0.235 0.00 0.00%) may seek bankruptcy protection as soon as this week, Bloomberg News reported, citing people with knowledge of the discussions.  The Bellevue, Wash.-based company, which operates about 370 stores in the United States and Canada, has reported annual losses for three straight years.  However, the company has not made a final decision about a bankruptcy filing, according to people familiar with the matter.
• U.S. consumer confidence rose in June, marking its highest reading since November 2008, according to a survey released yesterday (Tuesday).  Reflecting strong gains the stock market has made since early March, The Investor’s Business Daily and TechnoMetrica Market Intelligence Index climbed to 50.8 in June from 48.6 in May.  A figure above 50 indicates optimism, while below 50 points to pessimism. “Consumer confidence is building on the momentum that it picked up in April, reflecting the strength we are seeing in the stock market,” Raghavan Mayur, president of TIPP, a unit of TechnoMetrica Market U.S. IBD’s polling partner told Reuters. “Across the board, there is an optimistic feeling that the economy is recovering,” he added.
• Bankruptcy filings soared to the highest levels since 2005 in the first quarter, the Administrative Office of the U.S. Courts said yesterday (Tuesday), as rising unemployment, falling home prices and tight credit made it harder for people to hold off their creditors, Reuters reported.  The records showed that there were 330,477 filings in the January-to-March period, up 10% from the previous quarter and 35% higher than last year. Consumer bankruptcy filings rose 33% from a year earlier, while business filings rose 64%.  For the year ended March 31, bankruptcy filings rose 33% to 1,202,503. Experts expect further increases as the unemployment rate heads toward 10% and the economy struggles.
• Wells Fargo & Co. (WFC: 25.66 0.00 0.00%) has yet to apply to pay back funds it has borrowed from the U.S. Treasury’s Troubled Asset Relief Program (TARP) and instead will focus on integrating Wachovia Corp., according to Bloomberg News. “We want to pay back the government’s investment on behalf of the U.S. taxpayer at the earliest practical date,” a Wells Fargo spokesperson said. “We will work closely with our regulators to determine the appropriate time to repay the TARP funds while maintaining strong capital levels.” Ten other lenders won Treasury approval yesterday (Tuesday) to buy back $68 billion in government shares. Wells Fargo opposed TARP when it was introduced last fall.
• Crude oil yesterday (Tuesday) topped $70 a barrel for the first time in seven months, thanks to a falling dollar and the Department of Energy’s forecast of higher fuel prices. July delivery for oil settled at $70.01 on the New York Mercantile Exchange.

Clear Doji Sell Signal For US Dollar Index

Are lower prices ahead for the US Dollar Index?  Let’s look at a possible powerful sell-signal example as price has formed a classic retracement into resistance, formed a doji candle, and plunged lower off this signal.

US Dollar Index Daily:

I’ve mentioned a few times on the blog in the past regarding the Bear Flag setting up and completing on the daily chart.

We’ve gotten an expected bounce off the price projection lows of the flag (price slightly exceeded its downside target actually).

The bounce was a sharp, quick reaction back to the 20 EMA which formed a long-legged reversal gravestone doji candle which triggered an aggressive short-sell signal.

Today, we see the downward inflection off this clear sell signal and odds now favor a test of the lows in June or below.

The larger trend is down, the moving average structure is in the most bearish position possible… but there is a positive momentum divergence so you probably should take that into consideration as well (meaning, don’t expect price to go screaming down off this level).

Let’s follow this pattern out and perhaps use it as an educational example of how trend, candles, and moving averages combine to set-up powerful, low-risk opportunities.

 

Julian Robertson’s Genius In The Yield Steepener Trade

Recently I mentioned Julian Robertson’s yield steepener trade. The yield steepener, which is a bet on rising long Treasury rates, is a really a bet on rising inflationary expectations.

This trade demonstrates Robertson’s genius. For most investors, a bet on inflation means a bet on gold, or other commodities. Here is what Robertson had to say about gold:

While Julian certainly thinks inflation is in our future, he is hesitant to buy gold. In the Value Investor Insight interview, he goes on to say that, “I’ve never been particularly comfortable with gold as an investment. Once it’s discovered none of it is used up, to the point where they take it out of cadavers’ mouths. It’s less a supply/demand situation and more a psychological one - better a psychiatrist to invest in gold than me.”

The bond market is infinitely more liquid
Whether the statement about being a psychiatrist is true or not, I don’t know. For people like Robertson who run large hedge funds, liquidity is a far bigger concern. While mere mortal like us play around with gold (including the likes of John Paulson). Robertson has moved onto the far more liquid U.S. Treasury market.

To give you an idea of the differences in scale, the U.S. debt clock shows the total U.S. debt outstanding to be roughly $11 trillion. By contrast, Federal Reserve holdings of gold bullion (assuming that it’s not encumbered by gold loans) amount to a little over $200b, even at today’s prices. If we were to look at gold stocks, the total market capitalization of components of the Amex Gold Bugs Index (HUI) total about $120b, which is roughly the market capitalization of Cisco Systems (CSCO).

Robertson has enormous investment capacity in this trade, compared to investors who just play gold and gold stocks.

Now that’s genius.

Are Gold Bulls Losing Their “Golden” Touch?

The bullish stampede into Gold has run into a bit of resistance lately, as the U.S. Dollar has staged a recovery from its lows, and a much better than expected U.S. non-farm payrolls figure on Friday has taken a bit of the luster out of the yellow metal.

Just a few days ago, many analysts and traders were looking for Gold to reach the psychologically important $1,000 per ounce level, as inflationary fears were running rampant with investors were fleeing the U.S. Dollar and moving into commodities (especially Gold). The extent of the speculative interest in Gold futures of late can be seen in the most recent Commitment of Traders report released this past Friday.

As of June 2nd, large non-commercial traders were holding net-long postions of 204,883 contracts, up 14,959 contracts for the week. Small speculative accounts are also net long Gold holding 40,556 contracts according to the COT report. This large and growing long position set the stage for a potential price correction, to shake out weak longs and those who entered the bull trend late in the game. This time the catalyst was the resurgent Dollar - especially last week, with the surprising drop of “only” 345,000 jobs in May, which sparked a major sell-off in the short-term interest rate markets, as talk of possible interest rate hikes entered traders conversations for the first time in many months. This helped to dampen some of the rampant inflation concerns that helped to drive Gold prices sharply higher this year.

Though “Gold Bugs” will argue that the current correction is actually healthy for the bull market because weak longs are weeded out, there are some concerns that Gold’s current failure as prices approach $1,000 may signal strong reluctance by traders and investors from paying four-digit prices for Gold. This can be seen in the Gold jewelry demand from India, one of the largest consumers of Gold, as consumers there are awaiting lower prices to ramp-up their purchases.

Although it is still too early to call a top in the Gold market, the large long speculative interest will need fresh bullish news to attract new buyers into Gold, or else much lower prices will be needed to drive “bargain hunters” back into the precious metals sector.

Trading Ideas

Traders who expect a potential rally in Gold prices this summer but believe a correction is overdue could potentially use both futures and futures options to position themselves in the market. An example of a potential trade is selling 1 August Gold futures and buying 3 August Gold 1000 calls. With August Gold trading at $950.80 as of this writing, the August 1000 calls could be purchased for about $1900 each, plus commissions. This trade hopes to take advantage of any temporary correction in Gold prices by having a short futures position, but it also has upside potential should prices become more volatile or move sharply higher by virtue of owning multiple long call options. The risk in this trade occurs if prices become less volatile (option time decay works against this position) or if Gold prices move only moderately higher by the option expiration in late July.

Technicals

Looking at the daily chart for August Gold, we notice a potential double-top formation, as the recent rally that took August Gold as high as 992.10 failed to match the February highs of 1008.90. Notice that prices are now hovering near the widely watched 20-day moving average. A close below this moving average could signal fresh selling by short-term momentum traders. The 1-day RSI has swiftly moved from overbought conditions to a more neutral reading of 52.10. The recent highs of 992.10 are now the next resistance point for August Gold, with support found at the uptrend line currently at 923.60.