Good Evening: Just when the U.S. stock market seemed ready for a round of profit-taking ahead of Friday’s nonfarm payrolls figures, investors decided to throw caution to the wind. Apparently deciding that the recession and the stress over the banking system would soon be in the rearview mirror, market participants once again stampeded into large cap stocks in general and banks stocks in specific. If these forecasts come true, then perhaps everyone will soon be wondering what all the fuss has been about. Maybe both Jeremy Grantham and “the Warren Buffett of Mars” can give us some food for thought after such a curious day.
When I went to bed last night, U.S. stock index futures were down more than 1%. Whether this downdraft signaled some imminent profit taking or was due to an early release of a negative Wall Street Journal article about the banks, I don’t know. The futures started to come back early this morning when the Challenger Job Cut report showed a downtick in the number of large scale layoffs in April. Worries about Friday’s jobs report then all but evaporated when the ADP employment report was released an hour before trading began in New York. ADP opined that less than 500,000 people lost their jobs last month, a figure well below consensus forecasts. Even though ADP’s track record in predicting the payroll numbers has been spotty, stock futures scrambled back and were soon up on the day. Just like that.
After jumping more than 1% at the open, the major averages settled back toward unchanged. A weak NASDAQ held back the other indexes for a while, but continued levitation in bank shares eventually won out. Stories like the one you see above proclaiming an imminent end to the Great Recession also played a role in the rally. The averages pushed unevenly higher for the rest of the day, and it looked to me like more than a few managers were trying to play catch up. More than a few individuals were active, too, and many of them seemed to be liquidating their rapidly shrinking double-short and triple-short financial ETFs. The KBW Bank index (BKX) rose another 11.5%. It may not have been a total capitulation by the shorts, but it has been the most heavily shorted names that have been rising the most since the March lows. By day’s end, the NASDAQ’s 0.25% gain lagged the others, while the Dow Transports (+ 2%) led the way. Treasurys were mixed after a solid 10 year note auction; the dollar fell 0.5%,; and another leg up in energy prices pushed commodities up even more than equities. The CRB index rose 2%.
Rumors about the Treasury’s “stress test” results swirled all day, and then the story you see above came out just after the bell. Apparently Treasury Secretary, Tim Geithner, will appear on the Charlie Rose show tonight and say that all 19 banks that were tested are “well capitalized”. Huh? If so, then either the stress test was a complete joke, or its been re-jiggered to be flattering enough to the banks to enable them to hit the market with secondary offerings. We have likely not heard the last of the stress test, but many already wish the whole concept had never been introduced.
The Last Hurrah and Seven Lean Years, by Jeremy Grantham, GMO
More valuable than anything coming out of our Treasury Department in 2009 is Jeremy Grantham’s latest Quarterly Letter (see top). Meant to show investors just how hard it is to predict the future when the forces of de-leveraging and money-printing are still colliding, Mr. Grantham’s piece is at once both bullish and bearish. For readers who get confused about just where he stands on the economy and the stock market, Mr. Grantham summarizes his whole piece in the Appendix. He uses a simple decision tree that starts with the probability the U.S. economy recovers in late ’09 or early ’10 (in his opinion, 80%). The rest of his forecasts flow from there, but he does allow for a wide range of outcomes. Such is the life of a prognosticator when the unwinding of the largest credit bubble in history is met with the largest government stimulus in history.
Finally, I promised last night to finish the latest conversation in the ‘True Outsider’s Perspective” series of commentaries. Last night left off with our eager broker-salesperson (BS) promising to structure the ideal trade for the “Warren Buffett of Mars” (MB)
BS: Thanks for taking my call again. I’m eager to learn what your ideal security looks like so we can set about creating for you.
MB: First, I would like the highest quality credit available, one that assures my investors will be paid back. Your Federal Reserve has a printing press, right? It ensures all obligations of the U.S. government are paid in full, right?
BS: Yes; our government won’t ever technically default because the Fed can always print as many dollars as are necessary to pay off U.S. debt in full. So you want Treasurys?
MB: No, the yields are far too skimpy and inflation is a risk down the road
BS: Uh, you want us to buy you some TIPS, then?
MB: No, thanks, at least not at these levels. I would need to see real yields above 3% before I sense a margin of safety in those securities. Your government has always displayed an unfortunate tendency to underestimate the inflation calculation which help determine the total return on TIPS.
BS: Then I’m confused; what kind of U.S. government security do you want? Or are you after some sort of equity hybrid?
MB: No, your equity market has overshot where fundamentals tell me they should be priced. Since I know you prefer pictures, take a look at these charts of some markets that have struggled to delever after a period of over-investment: http://dshort.com/charts/mega-bear-comparisons.html?mega-bear-quartet
BS: Wow; I see what you mean. Let’s get back to creating a bond for you.
MB: Reading some history, I’ve seen that your Treasury has previously issued obligations denominated in foreign currencies, right?
BS: Yes, but I don’t think they’ve issued those so-called “Carter bonds” in more than 30 years
MB: Good — we won’t be breaking new ground, then. But I don’t want to be paid off in Swiss Francs and the German Mark has gone to currency heaven. I have an undervalued currency in mind.
BS: Whatever; what coupon rate are you expecting to be receive?
MB: Are you familiar with some old Freeport McMorRan bonds that had their coupon payments tied to the price of gold?
BS: No, but I’m sure our research department knows about them, and we have a great structuring department that can customize a note for you that’s tied to the price of gold.
MB: Good — then here’s what I want: A 10 year note, issued by the U.S. government, denominated in Chinese Yuan, and with a semi-annual coupon set at 3% that is tied to the price of gold. If gold averages less than $900/oz. during the coupon period, then the bond pays 3%. For every $1 rise in the average gold price above $900 during each coupon period, however, the coupon steps up 1 basis point (i.e. $950/oz. pays 3.5%, $1000/oz. pays 4%, etc.).
BS: Excuse me? A Yuan denominated Treasury note with a coupon tied to gold?
MB: If there’s a problem issuing in Yuan, I’ll settle for Canadian dollars. Ottawa seems like a good steward of its currency.
BS: No…it’s just that…how will you pay for this note?
MB: In gold, up to half a trillion dollars worth at current prices. But your government has to keep the yellow metal in escrow at the World Bank and agree not to sell any until the note is paid off. No tricks.
BS: Let me guess — Mars is on the gold standard?
MB: Don’t be silly; our currency is based on energy consumption units, much like your BTUs. A currency denominated in energy units gave us the incentive to innovate. We are now energy independent. The gold is a relic from an earlier monetary standard and this investment idea gives us a chance to monetize what would otherwise remain inert.
BS: We can’t structure this! We’re not the U.S. government, and I very much doubt the Fed and Treasury will agree to these terms.
MB: Why not? Half a trillion will finance your budget deficit for at least a few months, and the initial coupon is 1/8 below the 10 year note your government auctioned off just this afternoon. Besides, I’m willing to be a good guy about it and agree to a maximum cap on the coupon of 20%.
BS: Uh, we can’t…I mean, why don’t you just let us issue you the same note on the same terms? At least then we’ll get paid for this trade.
MB: I don’t want the credit risk, but if you can’t handle the negotiations with your government, then don’t worry. I’ll just call Goldman Sachs. A nice gentleman there tells me the direct lines installed by Bob Rubin and Hank Paulson still work. In fact, I think I’ll give Goldman a ring. THEY can structure anything!
BS: No, wait!
— Jack McHugh — I will be attending a family event tomorrow night. This comment will resume next week.