Rally Off March Lows Gets First Test

Good Evening: After Ben Bernanke’s performance during 60 Minutes last night, last week’s winning streak in Wall Street looked poised to extend to a fifth day this morning, but it wasn’t to be. Though Barclays joined the growing crowd of banks claiming positive “EBITDAW” during the first two months of 2009, stocks came in for some profit taking this afternoon when financial shares turned tail during the middle of the day. By day’s end, stocks, bonds, and the dollar were all on the weak side, leaving some to wonder about the potential long term impact of all the sovereign debt issuance that governments hope can somehow paper over the problems of our late credit boom.

Twenty of the aforementioned governments came together over the weekend to share ideas about what to do to help end the credit crisis still so evident around the globe. Promises of coordinated attempts to buy and dispose of toxic assets will likely remain just promises, since details unfortunately were scarce. It would be nice if the world’s politicians could find a way to collectively harness their own hot air as an energy source, but environmentalists would probably fret about what to do with the excess carbon dioxide.

With not much to show for all the emissions out of the G-20 meeting, investors turned their gazes to Ben Bernanke’s appearance on 60 Minutes last night. Donning his Uncle Ben persona, Chairman Bernanke offered the soothing opinion that our economy was likely to resume growing later this year. Of course, this happy announcement came with the caveat that the U.S. must find a way to stabilize the financial sector first. This embedded “sine qua non” will probably prove a higher hurdle for economic recovery than many currently believe.

Just how difficult it will be for our economy to jump over the obstacles in its path was quite evident in today’s economic releases. Not one of them came in above the already low expectations for them. The Empire state manufacturing index, released an hour prior to the commencement of equity trading, represented the first such “miss”. Printing -38.2 versus a consensus expectation of -32, this regional survey set a new low (see below). On its heels came the TIC report of international capital flows, which, instead of showing the expected $35 billion of inflows to the U.S. in January, witnessed instead an outflow of $43 billion (for BAC-MER’s take, see below). Rounding out the statistical parade prior to the opening bell in New York, both industrial production and capacity utilization, at -1.4% and 70.9% respectively, were each shy of the estimates. Just after lunchtime, the Housing Market Index made it a clean sweep of poor economic news, as this index remained mired a mere tick above its all time low.

Focusing on the seemingly positive words from Mr. Bernanke, equities began Monday on a positive note. Adding to the early smiles was the claim from the management of Barclays that after two months of operation in 2009 it, too, sports a positive EBITDAW (Earnings Before Interest Taxes Depreciation Amortization & Write-offs). The initial 1% pop in both the Dow and S&P was followed by further gains until just after lunchtime in New York. The financial names, which had led the S&P to a gain of 2.5% by then, began to soften. The profit taking in financials grew more urgent when American Express announced this afternoon that charge-offs in its credit card portfolio jumped a full percentage point in the past month alone. The NASDAQ was already heavy for reasons unknown to me, but the rest of the tape joined it by retreating into the closing bell.

The lone gainer among the indexes was the Dow Transportation index (+3.7%), while the NASDAQ remained lead sled dog to the downside (down almost 2%). This first test of the rally off the march lows (e.g. will it now hold above the November lows at 740?) might just give us some clues in the days ahead as to its potential strength and durability. Treasurys, perhaps shaken by the TIC report, never did catch a bid today. Yields rose between 4 and 9 bps across the coupon curve. The dollar declined a modest amount, and commodity prices for once responded as one would expect by rising. Oil rose after an early decline, the grains were firm, and only natural gas and the precious metals sat out the rally. The CRB index finished the day higher by 1.4%.

After I signed off last week, quite a few murmurs of concern were generated in the wake of China’s expressed concern over the “safety” of its investments in U.S. fixed income securities. China’s leadership is not alone in wondering just how the U.S. will be able to finance wars abroad and an economic war at home while trying to restructure both the energy and healthcare industries. Technically, no holder of U.S. government debt should worry about the safety of the principle or the timely payment of the indicated coupons on them. The U.S. can print as many dollars as it needs to discharge its obligations. Whether those greenbacks will retain their current purchasing power is the more relevant question for investors on both sides of the Pacific ocean. Price risk is the true threat to the safety of wealth tied up in government securities.

Many investors assume that since private credit creation has fallen off Mr. Buffett’s proverbial cliff, sovereign governments can simply step in and create public forms of credit to take up the slack. Unfortunately, this process of enlarging the “G” portion of the GDP formula will not be as easy as many economists suggest. Most developed nations came into this crisis with debt-burdened balance sheets; their liabilities will only accelerate from here. Whether developed countries, and especially the United States, has bitten off more than its citizens can digest via increased productivity and taxes is one of the main subjects of the final essay you see below.

Written by Gregor Macdonald, a self-described “oil analyst and energy sector investor”, this piece describes how our current financial crisis could one day become what Bill Fleckenstein calls a “financing crisis”. As the title hints, Mr. Macdonald cleverly attempts to turn the old game of rock, paper, scissors into a metaphor for our current and future problems. In preview, let’s just say that while paper (a fiat currency) covers rock (hard assets like gold) during financially stable periods, the opposite becomes true when the policies of governments and central banks are called into question. None of the issues Mr. Macdonald raises will be a problem this week, and it’s still too early to seek out a “double short Treasury ETF”, but given the recent warnings out of China, his piece is definitely food for long term thought.

— Jack McHugh

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Rock, Scissors, Paper: Recession vs. Collapse

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