Week of 9/25/11

The $8.2 Trillion Writedown

David Rhodes and Daniel Stelter at The Boston Consulting Group think European leaders will resort to inflation as a cure for their debt overhang, but that they’ll first play for time, fail, then “conclude that debt restructuring is inevitable.”

“They would need to restructure all debt, probably at around a maximum combined level of 180 percent per country. … governments, nonfinancial corporations, and households can each sustain a debt load of 60 percent of GDP, at an interest rate of 5 percent and a nominal economic growth rate of 3 percent per year. Lower interest rates and/or higher growth would help reduce the debt burden even further. Given this assumption, the total debt overhang within the euro zone amounts to 6.1T euro ($8.2T).”

Understatement of the year: “Writing off more than 6T euro would have significant implications for lenders.” Possibly so. – 9/29/11

Fed On Unemployment Crisis

Chairman Bernanke called America’s weak labor market “a national crisis” and called on Washington policy makers to develop plans “that could help them find work, train for work, and retain their skills.”

“We’ve had close to 10 percent unemployment now for a number of years, and of the people who are unemployed, about 45 percent have been unemployed for six months or more. This is unheard of,” he said, and acknowledged that the Fed’s maneuvers to lower interest rates are not magical for the economy. – 9/29/11

Lachman On Lehman Moment

Desmond Lachman of the American Enterprise Institute told Ezra Klein at The Washington Post: “I would be surprised if the Greeks don’t default on their debt within six weeks, and at that point, they will probably leave the euro. … What’s really at stake here is the European banking system. … If the European banks take the hit, that could really cause another Lehman moment.”

“US money market funds have loaned out more than a trillion dollars to European banks. If we see real problems in Europe, that will hit the United States much in the way the US financial crisis in 2008 impacted the rest of the global financial system. … So what will the policy response be? Bernanke just showed you he thinks he has very little ammunition left. There’s no way Congress will go in for another big stimulus package.” – 9/29/11

Use Rallies Prudently

About Europe’s latest proposal, Bill King wrote in yesterday’s King Report: “You have busted nations creating a vehicle, in order to circumvent German demands that the EFSF is not leveraged, to borrow money to buy distressed debt, much of which is their own debt! … Why give losers your money to buy distressed debt when you can buy the distressed debt yourself at market prices, especially when the fund might pay above market prices?”

Thus: “Rallies will be transitory and heavily influenced by trading machinations like performance gaming and expirations. The major concern for bulls or traders playing the usual performance gaming rally is that a German official might appear at anytime, even before Thursday’s key vote, to debunk the latest hackneyed scheme. The stock market rallied smartly on the five-central bank dollar swap liquidity scheme, which was announced in time for expiration week upward bias, two weeks ago. Stocks tanked after the initial euphoria for that latest failed bailout scheme. The same pattern is likely to occur, again. Use rallies prudently!” – 9/28/11

EuroTARP Doomed To Fail

The European Investment Bank (EIB), a bank owned by the member states of the European Union, is to take money from the European Financial Stability Facility (EFSF) and capitalize a special purpose vehicle (SPV) that it will create. The SPV will then issue bonds to investors and use the proceeds to purchase sovereign debt of distressed European states, which will hopefully alleviate the pressure on the distressed states (PIIGS) and the European banks that already own their sovereign debt. “If alarm bells aren’t already going off they will be in just moment as you get the gist of the rest of this disastrous plan,” writes Lance Roberts.

“The European banks which are already undercapitalized and on the brink of failure will buy bonds issued by the SPV that is full of bonds issued by broke countries. The banks will then used these bonds as collateral to borrow money from the ECB. The ECB winds up with loans to broke banks and holding bonds backed by debt issued by broke countries as collateral. [Sounds like] the Credit Default Swap (CDS) markets that helped sink Bear Stearns and Lehman Brothers, just with a European flair. … Are you getting as worried as I am?” – 9/28/11

US Worse Than Japan

Nomura’s Richard Koo told Business Insider the US situation is worse than Japan’s, citing that real interest rates are lower in the US than they were in Japan at the end of 1997, but have yet to help the economy. US unemployment is twice as high as Japan’s ever reached.

The “it’s impossible to lose money in real estate” myth was 45 years old in Japan when it died, but was 70 years old in the US when it died. The resulting impact on consumer moods will be that much worse. We’re already seeing it in abysmal confidence numbers and moribund housing data.

From last Sunday’s Kelly Letter: “[Now that the Fed lowered rates on 30-year mortgages yet again], everybody who bought a year ago for the low rates and low prices isn’t feeling too good, are they? The prices are still low and now their ‘unbelievably low interest rates’ are looking in need of yet another refi. Lesson to sideliners: It pays to wait. How long? Ask Japan.” – 9/28/11

Price/Free Cash Flow Cheap

Gotham Capital’s Joel Greenblatt told CNBC stocks are cheap judging by trailing free cash flow yields over the past 20 years, falling into their “95th percentile towards cheap, meaning it’s one of the cheapest periods we’ve seen based on trailing cash flows.”

He thinks the market could rise 15-20 percent in a year, while value portfolios “could be up the mid-30s.” He noted that usually stocks don’t look this good unless the news looks terrible. He said many companies looking cheap are also hated, such as HPQ and WFC. – 9/28/11

No Sign Of Short Covering

Many are dismissing this rally as being caused by short covering, so Bespoke decided to check. “In a true short covering rally, the decile of stocks with the highest short interest will significantly outperform the decile of stocks with the lowest short interest, and the performance will get better and better as you move up the decile chain from lowest to highest.”

Have we seen that in the current rally? No. “the performance of deciles based on short interest during the current rally has been completely scattered, with no deciles standing out. … Notables on the list of heavily shorted stocks include Netflix (NFLX), US Steel (X), Urban Outfitters (URBN), Best Buy (BBY), Whirlpool (WHR) and Chipotle Mexican Grill (CMG).” – 9/28/11

Socks for Japan, Phase II

We’re gearing up for Socks for Japan’s second phase, a six-month campaign that will take us through autumn and winter up to the one-year anniversary of the earthquake and tsunami on March 11.

This phase will proceed quite differently from the first one, which so many people from around the world cheered. The acute, emergency atmosphere has abated and we’re now in the long-term but still very important support part of our effort. We’ll make smaller, less frequent trips to extend our inventory and spend more time with survivors, many of whom are lonely and depressed now that it’s dawned on them that life is never going to return to normal.

Read about Socks for Japan and prepare to follow our journey through Phase II as we continue getting this wonderful nation back on its feet. – 9/19/11 to 9/28/11

A More Dangerous Phase In Europe

UBS believes the Eurozone sovereign crisis has entered a more dangerous phase. They consider a Greek default inevitable and ponder only when and how it will be handled. Their base case assumes a 15-percent chance of default in the short term as another round of good money after bad is arranged for Athens, but a 60-percent by early 2012.

Don’t let the base case bewitch you, though: “Any relief rally would be temporary and shallow. The root issues of sovereign default, bank recapitalization, and the absence of growth would remain unaddressed, suggesting only limited recovery prospects for markets. … It will most probably take an intensification of the crisis and the realization that disorderly default could lead to severe economic dislocations in the creditor countries in order to mobilize political support for government-funded bank recapitalization in Europe. In that sense, the outlook for risk assets, above all for equity markets, remains challenging over anything but the tactical horizon, even in the ‘base case’ of no disorderly default or exit.” The non-base cases are downright hair-raising.
– 9/27/11

Brutal: Europe Will Crash

Here’s a doozie of an interview on the BBC, where trader Alessio Rastani says “markets are ruled right now by fear” and the smart money does not “buy this rescue plan — they know the market is toast, they know the stock market is finished, the euro as far as they’re concerned they don’t really care, they’re moving their money away to safer assets.”

“This economic crisis is like a cancer. … Get prepared. This is not a time right now for wishful thinking … The governments don’t rule the world; Goldman Sachs rules the world. Goldman Sachs does not care about this rescue package. … In less than 12 months, my prediction is the savings of millions of people is going to vanish. And this is just the beginning.” – 9/27/11

Time To Buy Stocks

Jeff Miller at Dash of Insight: “The bearish case is so easy to make. Problems are obvious, solutions are obscure. … As I read the news from Europe, I am basically pleased.”

He thinks that those not noting progress “are not paying attention.” He sees people without “relevant expertise” grasping for simple solutions when that is just not how democratic governments work. The news out of Europe “is positive, interesting, encouraging, and much better than you might think. Meanwhile, many investors were frightened out of the market last week. I am shopping like a kid in a candy store.”
– 9/27/11

Greece Ain’t The Problem

Mark Hulbert at MarketWatch thinks we need to “let Greece rest in peace” because it’s not the reason “US stocks have lost approximately $2.5T in market cap” since their spring highs.

Last week, “the combined market capitalizations of all publicly traded stocks in the US [lost] $865B. How could Greece have been the cause of that, when Greece’s total sovereign debt amounts to $393B, according to the International Monetary Fund? … How many of us have the guts to say that we don’t really know why the market went up or down?” – 9/27/11

Germany Not Onboard

Ambrose Evans-Pritchard reported in The Telegraph that Germans are worried their nation will lose its AAA credit rating if the EU bailout fund is greatly expanded.

“The sovereignty of the German state is inviolate and anchored in perpetuity by basic law. It may not be abandoned by the legislature (even with its powers to amend the constitution),” said the head of the high court. “There is little leeway left for giving up core powers to the EU. If one wants to go beyond this limit — which might be politically legitimate and desirable — then Germany must give itself a new constitution. A referendum would be necessary. This cannot be done without the people.”

The finance spokesman for the Social Democrats: “A new multi-trillion program is being cooked up in Washington and Brussels, while the wool is being pulled over the eyes of Bundestag and German public. This is unacceptable.” – 9/27/11

The Bull/Bear Balance

Tom Sowanick of OmniVest: “Though stocks experienced a very harsh week, there may be signs that the market is actually beginning to bottom. From our lens, we were pleased to see that the September 22nd closing low for the S&P 500 Index was higher than both the August 8th and August 19th closing lows. … Given the FOMC’s weak assessment of the US economy and the ECB’s downward revision of economic indicators in the Euro-area, suggests that we may be entering into a period of coordinated easing. If so, then demand for risk assets may begin to improve and will do so in a very aggressive manner.”

Joe Fahmy of The Next Big Move: “The amount of impatience I’m seeing amazes me. The market is not closing anytime soon. … The key is not to pick the bottom, but to wait for a confirmed bottom and for stocks to set up again. … I do not recommend buying dips as I’m expecting another leg down in the market over the near term. It’s best to remain patient, defensive, and protect your capital. … It might take a drop below 10,000 on the Dow and 1,000 on the S&P 500 before people really get scared.”
– 9/26/11

Time to Buy Europe

London hedge-fund manager Crispin Odey told his investors that it’s time to buy Europe, reports MarketWatch. “The worries have been there for so long, the causes are so obvious and the valuations are so cheap that this is a case of buying early. For me the crisis will bring resolution and with it higher prices.

“Equities yield 5-6 percent and many are on earnings yields of 20-33 percent. They are mouth-wateringly attractive. … Yet again we may be entering a period when markets do not get a Greek default and the US economy strengthens. Cyclicals, which have all been sold off, will rally and banks, which have led the market down, will catch a bid [i.e. rise].” – 9/26/11

Eurozone Rescue Shapes Up

Leaders in France and Germany are close to unveiling a three-tier plan to contain Europe’s exploding sovereign debt crisis. They want to erect a “firebreak” around Greece, Ireland, and Portugal to contain the worst of the situation there — and prevent needing to save Italy and Spain.

The tiers: Mitigate damage in a Greek default with a 50-percent haircut to bondholders, raise the European Financial Stability Facility (EFSF) bailout kitty to 2T euro from its current 440B euro, and recapitalize European banks well beyond the absurd 2.5B euro recommended after July’s stress tests.

Meanwhile, European Central Bank Governing Council member Ewald Nowotny said a rate cut by the ECB can’t be ruled out. – 9/26/11

Returning to The 1930s?

Robert Samuelson in Newsweek: “Europe is caught in an economic pincer: slow-growth assaults from one side; fickle financial markets from the other. One obvious way out — the China option — seems barred by geopolitics. [Americans and Europeans don’t want to cede power to China, whose goals are suspect. China might seek a new world order based on its own interests.]

“There is precedent. Historians blame the Great Depression’s severity in part on poor international cooperation. Economist Charles Kindleberger found a vacuum of power: Great Britain, the old economic leader, could no longer lead alone; and the United States — a replacement — wasn’t ready to help. Is there a parallel today between the United States and China? Are we repeating the mistakes of the 1930s?” – 9/26/11

Help Wanted: Leadership

Thomas Friedman wrote in his NYTimes column that the collective behavior of Barack Obama, John Boehner, Harry Reid, Mitch McConnell, Nancy Pelosi, and Eric Cantor is setting them “up to be known as our generation’s Herbert Hoovers — the leaders who were on duty when we entered our second great economic meltdown.”

The solution is known: “Short-term stimulus to ease us through this deleveraging process, debt restructuring in the housing market and long-term budget-cutting to put our fiscal house in order.” He frets that “we the people are having an economic crisis and you the politicians are having an election — and there is frighteningly little overlap between the two.” He suggest a Grand Bargain retreat at Camp David. “The toxic paralysis in Washington is, in and of itself, slowing growth.” We’ll pay a high price if until November 2012 all we see is “Republicans blaming Mr. Obama for the bad economy and Mr. Obama running on how crazy the G.O.P. has become.” – 9/26/11

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